December 31, 2005
Selected Balance Sheet Data:		As Previously Reported			As Restated
		(in thousands)
Assets:
Deferred tax asset, net		$	2,397		$	3,223
Total Assets			4,340,619			4,341,445
Liabilities and Stockholders' Equity:
Notes payable: Due after one year			1,403,598			1,406,527
Total notes payable			3,991,302			3,994,231
Total Liabilities			4,092,487			4,095,416
Accumulated other comprehensive income			3,339			15,247
Retained earnings			115,644			101,633
Total Stockholders' Equity			248,132			246,029
Total Liabilities and Stockholders' Equity			4,340,619			4,341,445

 

- 26 -

---

 

		For the three months ended, September 30, 2005						For the nine months ended, September 30, 2005
Selected Statements of Operations Data:		As Previously Reported			As Restated			As Previously Reported			As Restated
		(in thousands, except per share data)
Interest income
Farmer Mac Guaranteed Securities		$	17,203		$	17,680		$	52,057		$	54,679
Total interest income			49,059			49,536			134,856			137,478
Total interest expense			41,186			38,028			111,054			99,147
Net interest income			7,873			11,508			23,802			38,331
Net interest income after recovery/(provision) for loan losses			5,408			9,043			22,124			36,653
Non-interest income/(loss)
(Loss)/gains on financial derivatives and trading assets			(2,379	)		12,009			(392	)		7,254
Non-interest income			3,505			17,893			16,080			23,726
Income before income taxes			11,663			29,686			32,018			54,193
Income tax expense			3,470			9,778			9,582			17,343
Net income			8,193			19,908			22,436			36,850
Net income available to common stockholders			7,633			19,348			20,756			35,170
Earnings per common share:
Basic earnings /(loss) per common share		$	0.68		$	1.73		$	1.82		$	3.08
Diluted earnings /(loss) per common share		$	0.67		$	1.70		$	1.80		$	3.05

 

		For the nine months ended, September 30, 2005
Selected Statements of Cash Flows Data:		As Previously Reported			As Restated
		(in thousands)
Cash flows from operating activities:
Net income		$	22,436		$	36,850
Adjustments to reconcile net income to net cash used in operating activities:
Net change in fair value of trading securities and financial derivatives			999			(20,428	)
Amortization of SFAS 133 transition adjustment on financial derivatives			1,346			545
Deferred income taxes			-			(9,293	)
Decrease in other assets			1,914			19,179
Net cash used in operating activities			(1,449	)		(1,291	)
Cash flows from financing activities:
Settlement of financial derivatives			158			-
Net cash provided by financing activities			382,100			381,942

 

- 27 -

---

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following management’s discussion and analysis of financial condition and results of operations set forth in this Item 2 reflects changes in financial reporting resulting from the Corporation’s corrections in accounting for financial derivative transactions under SFAS 133 that were contained in the Corporation’s restated audited condensed consolidated financial statements and other financial information as of December 31, 2005 and for the three and nine months ended September 30, 2005 as discussed below and in Note 6 of the restated unaudited condensed consolidated financial statements. Financial information is consolidated to include the accounts of Farmer Mac and its wholly-owned subsidiary, Farmer Mac Mortgage Securities Corporation.

This discussion and analysis of financial condition and results of operations should be read together with: (1) the interim unaudited condensed consolidated financial statements and the related notes that appear elsewhere in this report; and (2) Farmer Mac’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2005.

The discussion below is not necessarily indicative of future results.

 

Special Note Regarding Forward-Looking Statements

Some statements made in this report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 pertaining to management’s current expectations as to Farmer Mac’s future financial results, business prospects and business developments. Forward-looking statements include, without limitation, any statement that may predict, forecast, indicate or imply future results, performance or achievements, and typically are accompanied by, and identified with, such terms as “anticipates,” “believes,” “expects,” “intends,” “should” and similar phrases. The following management’s discussion and analysis of financial condition and results of operations includes forward-looking statements addressing Farmer Mac’s:

 

·

prospects for earnings;

·

prospects for growth in loan purchase, guarantee, securitization and LTSPC volume;

·

trends in net interest income;

·

trends in provisions for losses;

·

trends in expenses;

·

changes in capital position; and

·

other business and financial matters.

Management’s expectations for Farmer Mac’s future involve a number of assumptions and estimates and the evaluation of risks and uncertainties. Various factors or events could cause Farmer Mac’s actual results to differ materially from the expectations as expressed or implied by the forward-looking statements, including the factors discussed under “Risk Factors” in Part II, Item 1A in this report and in Part I, Item 1A of Farmer Mac’s Annual Report on Form 10-K/A for the year ended December 31, 2005, as filed with the SEC on November 9, 2006 and uncertainties regarding:

- 28 -

---

·

the possible establishment of additional statutory or regulatory restrictions or constraints on Farmer Mac that could hamper its growth or diminish its profitability;

·

the general rate of growth in agricultural mortgage indebtedness;

·

the rate and direction of development of the secondary market for agricultural mortgage loans, particularly lender interest in the Farmer Mac secondary market and Farmer Mac credit products;

·

borrower preferences for fixed-rate agricultural mortgage indebtedness;

·

the willingness of investors to invest in Farmer Mac Guaranteed Securities; and

·

possible reaction in the financial markets to events involving government-sponsored enterprises other than Farmer Mac.

In light of these potential risks and uncertainties, no undue reliance should be placed on any forward-looking statements expressed in this report. Furthermore, Farmer Mac undertakes no obligation to release publicly the results of revisions to any forward-looking statements that may be made to reflect new information or any future events or circumstances, except as otherwise mandated by law.

Restatement of Condensed Consolidated Financial Statements

On November 9, 2006, the Corporation filed amendments to: (1)  its Form 10-K for the year ended December 31, 2005 to restate the Corporation’s consolidated financial statements as of December 31, 2005 and 2004, and for the years ended December 31, 2005, 2004 and 2003, and other financial information as of and for the years ended December 31, 2002 and 2001 and the quarterly unaudited data for 2005 and 2004; (2) its Form 10-Q for the quarter ended March 31, 2006 to restate the quarterly unaudited interim consolidated financial statements and other financial information contained in that report; and (3) its Form 10-Q for the quarter ended June 30, 2006 to restate the quarterly unaudited interim consolidated financial statements and other financial information contained in that report. These restatements and resulting revisions related to the accounting treatment for financial derivatives transactions under SFAS 133. In this regard, and as the Corporation previously reported on Form 8-K on October 6, 2006, investors should not rely on the Corporation’s previously issued consolidated financial statements and other financial information for the years and each of the quarters in the years 2005, 2004, 2003, 2002 and 2001 and the first and second quarters of 2006.

The Corporation, in light of SEC staff comments, has recently concluded a reassessment of its documentation and accounting treatment of financial derivative transactions in accordance with SFAS 133, interpretations of which have evolved. Based on the reassessment, while the transactions engaged in by the Corporation were highly effective economic hedges of interest rate risk, the Corporation has determined that it was not appropriately applying hedge accounting in accordance with SFAS 133.

As a result, the condensed consolidated financial statements included in Item 1 have been restated from the amounts previously reported to correct the accounting for financial derivatives. The corrections related to the Corporation’s accounting for fair value hedges and cash flow hedges as described in more detail below.

- 29 -

---

The Corporation reduced its stockholders’ equity by $0.9 million as of January 1, 2003 as the cumulative effect of the correction of its accounting for financial derivatives for all periods preceding January 1, 2003, and restated its consolidated statements of operations and cash flows for the years ended December 31, 2005, 2004 and 2003 and its consolidated balance sheet as of December 31, 2005 and 2004. The restatement resulted in an increase to previously reported net income available to common stockholders of $5.8 million ($0.51 per diluted common share) and $15.8 million ($1.39 per diluted common share) for the three and six months ended June 30, 2006, and an increase of $11.7 million ($1.03 per diluted common share) and $14.4 million ($1.25 per diluted common share) for the three and nine months ended September 30, 2005, respectively. There was no effect on net cash flows, core earnings, or the amount of dividends declared for any periods presented.

Fair Value Hedges:

The Corporation has determined that it did not meet the specific documentation requirements required by SFAS 133 to assume no ineffectiveness in its fair value hedge relationships or to apply hedge accounting to its fair value hedges. As a result, the Corporation’s designation of its financial derivatives as fair value hedges for the period from January 1, 2001 to June 30, 2006 did not meet the requirements of SFAS 133.

The impact of the restatement on the consolidated statements of operations related to fair value hedges was to reverse previously applied hedge accounting for all hedging relationships. For financial derivatives previously accounted for as fair value hedges, the net accruals for the derivatives were previously recorded to net interest income, and net changes in fair values of the financial derivatives were previously recorded as basis adjustments to the hedged items, such as notes payable, loans held for sale, or investment securities. As a result of the restatement, the previous accounting treatment was reversed (i.e., the net accruals recorded to net interest income were reclassified to gains and losses on financial derivatives and basis adjustments for the hedged items was reversed), and the total changes in the fair values of the derivative instruments, including interest accrual settlements, were recorded directly to gains/(losses) on financial derivatives and trading assets.

Cash Flow Hedges:

The Corporation determined also that it did not meet specific documentation and other requirements of SFAS 133 to apply hedge accounting to its cash flow hedges. In this regard, the Corporation has determined that its forecasted transactions were not documented with sufficient specificity at the inception of the hedge relationship to allow those transactions to be identified as the intended “hedged transactions” when they occurred; some of its forecasted transactions related to the acquisitions of assets, or incurrences of liabilities, involved subsequent remeasurements with changes in fair value attributable to the hedged risk reported currently in earnings; and the benchmark index identified for its basis swaps did not meet the definition of a “benchmark interest rate” as that term is defined in SFAS 133. As a result, the Corporation’s designation of its financial derivatives as cash flow hedges for the period from January 1, 2001 to June 30, 2006 did not meet the requirements of SFAS 133.  

- 30 -

---

The impact of the restatement on the consolidated statements of operations related to cash flow hedges was to reverse previously applied hedge accounting for all hedging relationships. For financial derivatives previously accounted for as cash flow hedges, the Corporation recorded accruals from the financial derivatives to net interest income and recorded net changes in the fair values of the derivatives, net-of-tax, to accumulated other comprehensive income (“OCI”). As a result of the restatement, the previous accounting treatment for cash flow hedges was reversed from accumulated OCI and net interest income, and recorded to gains/(losses) on financial derivatives and trading assets.

Critical Accounting Policy and Estimates

The critical accounting policy that is both important to the portrayal of Farmer Mac’s financial condition and results of operations and requires complex, subjective judgments is the accounting policy for the allowance for losses. For a discussion of Farmer Mac’s critical accounting policy, changes implemented in its methodology for determining its allowance for losses as of September 30, 2005, as well as Farmer Mac’s use of estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and related notes for the periods presented, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policy and Estimates” in the Corporation’s Annual Report on Form 10-K/A for the year ended December 31, 2005, as filed with the SEC on November 9, 2006.

Results of Operations

Overview. Net (loss)/income available to common stockholders for third quarter 2006 was $(6.3) million or $(0.58) per diluted common share, compared to $19.3 million or $1.70 per diluted common share for third quarter 2005. Net income available to common stockholders for the nine months ended September 30, 2006 was $22.2 million or $1.98 per diluted common share, compared to $35.2 million or $3.05 per diluted common share for the nine months ended September 30, 2005. These decreases were due principally to the effects of losses on financial derivatives used to manage interest rate risk. Although Farmer Mac’s financial derivatives provided highly effective economic hedges of that risk, accounting under SFAS 133 caused the losses on the financial derivatives to be reflected in net income for the quarter while the offsetting economic benefits of the hedged items were not. Similarly, the gains on financial derivatives for the previous two quarters were reflected in net income, while the offsetting economic losses on the hedged items were not. As a result of Farmer Mac’s classification of its financial derivatives as undesignated hedges under SFAS 133, factors unrelated to the performance of the Corporation’s business, such as changes in interest rates, may cause the Corporation’s earnings under accounting principles generally accepted in the United States of America (“GAAP”) to be more volatile than - and even counter-directional to - the underlying economics of its business operations.

During third quarter 2006, Farmer Mac recorded losses of $20.3 million on financial derivatives. Farmer Mac recorded gains on financial derivatives in first and second quarters 2006 of $11.7 million and $9.9 million, bringing the total gain on financial derivatives for the nine months ending September 30, 2006 to $1.3 million.  By comparison, Farmer Mac recorded gains of $12.0 million and $7.3 million on financial derivatives for third quarter 2005 and the nine months ended September 30, 2005, respectively. Notwithstanding the increased volatility of its GAAP results, the Corporation intends to continue to use financial derivatives to manage interest rate risk to optimize its economic performance. Consistent with the latter, the Board and management of Farmer Mac focus on the long-term growth of its business and its overall return to stockholders, rather than the short-term volatility of GAAP net income.

- 31 -

---

As part of Farmer Mac’s continuing evaluation of the overall credit quality of its portfolio, the state of the U.S. agricultural economy, the recent upward trends in agricultural land values, and the level of Farmer Mac’s outstanding guarantees and commitments, Farmer Mac determined that the appropriate allowance for losses as of September 30, 2006 was $5.1 million. This resulted in the release of $1.2 million from the allowance for losses in third quarter 2006. As of September 30, 2006, the allowance for losses was $5.1 million and 11 basis points relative to the outstanding post-1996 Act Farmer Mac I portfolio, compared to $8.7 million and 20 basis points as of December 31, 2005.

As of September 30, 2006, Farmer Mac’s 90-day delinquencies (Farmer Mac I loans purchased or placed under Farmer Mac I Guaranteed Securities or long-term standby purchase commitments (“LTSPCs”) after changes to Farmer Mac’s statutory charter in 1996 that were 90 days or more past due, in foreclosure, restructured after delinquency, or in bankruptcy, excluding loans performing under either their original loan terms or a court-approved bankruptcy plan) were $28.4 million, representing 0.62 percent of the principal balance of all loans held and loans underlying post-1996 Act Farmer Mac I Guaranteed Securities and LTSPCs, down from $40.6 million (0.95 percent) as of September 30, 2005.

During third quarter 2006, Farmer Mac:

 

·

added $177.9 million of Farmer Mac I loans under LTSPCs;

·

guaranteed $1.0 billion of AgVantage securities;

·

purchased $18.3 million of newly originated and current seasoned Farmer Mac I loans;

·

purchased $74.2 million of Farmer Mac II USDA-guaranteed portions of loans; and

·

converted $341.2 million of pre-existing LTSPCs into Farmer Mac I Guaranteed Securities.

As of September 30, 2006, Farmer Mac’s outstanding program volume was $7.1 billion, which represented approximately 14.8 percent of management’s estimate of a $48.0 billion market of eligible agricultural mortgage loans.

Farmer Mac’s ongoing guarantee and commitment fee income is earned on the cumulative outstanding principal balance of Farmer Mac Guaranteed Securities and loans underlying LTSPCs. Accordingly, guarantee and commitment fees increase or decrease through changes in periodic business volume in proportion to the change in that cumulative outstanding principal balance, not in proportion to the change in periodic volume.

Set forth below is a more detailed discussion of Farmer Mac’s results of operations.

Net Interest Income. Net interest income was $9.1 million for third quarter 2006, compared to $11.5 million for third quarter 2005. Net interest income was $29.9 million for the nine months ended September 30, 2006, compared to $38.3 million for the nine months ended September 30, 2005. The net interest yield was 89 basis points for the nine months ended September 30, 2006, compared to 135 basis points for the nine months ended September 30, 2005. Net interest income includes guarantee fees for loans purchased after April 1, 2001 (the effective date of Statement of Financial Accounting Standards No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (“SFAS 140”)), but not for loans purchased prior to that date. The effect of SFAS 140 was the classification of approximately $2.6 million (7 basis points) of guarantee fee income as interest income for the nine months ended September 30, 2006, compared to $2.8 million (10 basis points) for the nine months ended September 30, 2005.

- 32 -

---

As discussed in Note 6 to the condensed consolidated financial statements, Farmer Mac accounts for its financial derivatives as undesignated financial derivatives. Accordingly, the Corporation classifies the net interest income and expense realized on financial derivatives as gains and losses on financial derivatives and trading assets. For the nine months ended September 30, 2006 and 2005, this classification resulted in decrease of the net interest yield of 9 basis points and 48 basis points, respectively.

The net interest yields for the nine months ended September 30, 2006 and 2005 included the benefits of yield maintenance payments of 9 basis points and 12 basis points, respectively. Yield maintenance payments represent the present value of expected future interest income streams and accelerate the recognition of interest income from the related loans. Because the timing and size of these payments vary greatly, variations do not necessarily indicate positive or negative trends to gauge future financial results. For the nine months ended September 30, 2006 and 2005, the after-tax effects of yield maintenance payments on net income and diluted earnings per share were $1.9 million or $0.17 per diluted share and $2.2 million or $0.19 per diluted share, respectively.

The following table provides information regarding interest-earning assets and funding for the nine months ended September 30, 2006 and 2005. The balance of non-accruing loans is included in the average balance of interest-earning loans presented, although no related income is included in the income figures presented. Therefore, as the balance of non-accruing loans increases or decreases, the net interest yield will decrease or increase accordingly. Net interest income and the yield will also fluctuate due to the uncertainty of the timing and size of yield maintenance payments. The average rate earned on cash and cash equivalents reflects the increase in short-term market rates during the first nine months of 2006. The increase in the average rate for investments reflects the general increase in short-term rates and the short-term or floating rate nature of most investments acquired or reset during the first nine months of 2006. The higher average rate on loans and Farmer Mac Guaranteed Securities during the first nine months of 2006 reflects the increase in market rates during the first part of 2006, which affected the rates on loans acquired or reset during that period and outstanding during the first nine months of 2006. The higher average rate on Farmer Mac’s notes payable due within one year is consistent with general trends in average short-term rates during the periods presented. The upward trend in the average rate on notes payable due after one year reflects the retirement of older debt and the issuance of new debt at higher market rates during the first nine months of 2006.

- 33 -

---

		Nine Months Ended
		September 30, 2006									September 30, 2005
		Average Balance			Income/ Expense			Average Rate			Average Balance			Income/ Expense			Average Rate
		(dollars in thousands)
Interest-earning assets:
Cash and cash equivalents		$	691,632		$	25,667			4.95	%	$	475,649		$	10,607			2.97	%
Investments			1,709,212			66,481			5.19	%		1,180,011			36,634			4.14	%
Loans and Farmer Mac Guaranteed Securities			2,057,086			91,014			5.90	%		2,121,657			90,237			5.67	%
Total interest-earning assets			4,457,930			183,162			5.48	%		3,777,317			137,478			4.85	%
Funding:
Notes payable due within one year			2,565,391			92,287			4.80	%		1,875,762			41,628			2.96	%
Notes payable due after one year			1,679,403			61,023			4.84	%		1,701,524			57,519			4.51	%
Total interest-bearing liabilities			4,244,794			153,310			4.82	%		3,577,286			99,147			3.70	%
Net non-interest-bearing funding			213,136									200,031
Total funding		$	4,457,930			153,310			4.59	%	$	3,777,317			99,147			3.50	%
Net interest income/yield					$	29,852			0.89	%				$	38,331			1.35	%

 

The following table sets forth information regarding the changes in the components of Farmer Mac’s net interest income for the periods indicated. For each category, information is provided on changes attributable to changes in volume (change in volume multiplied by old rate) and changes in rate (change in rate multiplied by old volume). Combined rate/volume variances, the third element of the calculation, are allocated based on their relative size. The increases in income due to changes in rate reflect the short-term or adjustable-rate nature of the assets or liabilities and the general increases in short-term market rates.

		Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
		Increase/(Decrease) Due to
		Rate			Volume			Total
		(in thousands)
Income from interest-earning assets:
Cash and cash equivalents		$	8,945		$	6,115		$	15,060
Investments			10,761			19,086			29,847
Loans and Farmer Mac Guaranteed Securities			3,571			(2,794	)		777
Total			23,277			22,407			45,684
Expense from interest-bearing liabilities			33,526			20,637			54,163
Change in net interest income		$	(10,249	)	$	1,770		$	(8,479	)

- 34 -

---

Guarantee and Commitment Fees. Guarantee and commitment fees, which compensate Farmer Mac for assuming the credit risk on loans underlying Farmer Mac Guaranteed Securities and LTSPCs, were $5.5 million for third quarter 2006 and $15.9 million for the nine months ended September 30, 2006, compared to $4.8 million and $14.7 million, respectively, for the same periods in 2005. The effect of SFAS 140 was the classification as interest income of guarantee fees of $0.9 million for third quarter 2006 and $2.6 million for the nine months ended September 30, 2006, compared to $0.9 million and $2.8 million, respectively, for the same periods in 2005, although management considers the amounts to have been earned in consideration for the assumption of credit risk. That portion of the difference or “spread” between the cost of Farmer Mac’s debt funding for loans and the yield on post-1996 Act Farmer Mac I Guaranteed Securities held on its books compensates for credit risk. When a post-1996 Act Farmer Mac I Guaranteed Security is sold to a third party, Farmer Mac continues to receive the guarantee fee component of that spread, which continues to compensate Farmer Mac for its assumption of credit risk. The portion of the spread that compensates for interest rate risk would not typically continue to be received by Farmer Mac if the asset were sold, except to the extent attributable to any retained interest-only strip.

Expenses. General and administrative expenses were $2.4 million for third quarter 2006 and $7.7 million for the nine months ended September 30, 2006, compared to $2.6 million and $6.8 million, respectively, for the same periods in 2005. Compensation and employee benefits were $3.2 million for third quarter 2006 and $8.8 million for the nine months ended September 30, 2006, compared to $2.2 million and $5.9 million, respectively, for the same periods in 2005. For third quarter 2006 and the nine months ended September 30, 2006, compensation costs were higher primarily due to expense related to stock options of $0.7 million and $1.7 million, respectively. The comparable periods in the prior year did not include expense related to stock options. For more information on stock option expense and the adoption of SFAS 123(R) on January 1, 2006, see Note 1(e).

Regulatory fee expense for each of the nine-month periods ended September 30, 2006 and 2005 were $1.8 million and $1.7 million, respectively. The Farm Credit Administration (“FCA”) has advised the Corporation that its estimated fees for the federal fiscal year ended September 30, 2006 will be $2.4 million. After the end of a federal government fiscal year, FCA may revise its prior year estimated assessments to reflect actual costs incurred, and has issued both additional assessments and refunds in the past. Farmer Mac expects all of the above-mentioned expenses and regulatory fees to continue at approximately the same levels through 2006.

During third quarter 2006, Farmer Mac released $1.2 million from the allowance for losses, compared to a release of $5.6 million for third quarter 2005. During the nine months ended September 30, 2006, Farmer Mac released $2.9 million from the allowance for losses, compared to a release of $6.6 million for the nine months ended September 30, 2005. Included in the releases from the allowance for losses for third quarter 2005 and the nine months ended September 30, 2005, was a $4.8 million decrease in the allowance for losses as a result of a change in accounting estimate. See “—Quantitative and Qualitative Disclosures About Market Risk Management—Credit Risk” for additional information regarding Farmer Mac’s provision for losses, provision for loan losses and Farmer Mac’s methodology for determining its allowance for losses. As of September 30, 2006, Farmer Mac’s total allowance for losses was $5.1 million, or 11 basis points of outstanding loans held or loans underlying post-1996 Act Farmer Mac I Guaranteed Securities (excluding AgVantage securities) and LTSPCs, compared to $8.7 million and 20 basis points as of December 31, 2005.

- 35 -

---

Gains and Losses on Financial Derivatives and Trading Assets. SFAS 133 requires the change in the fair values of financial derivatives to be reflected in a company’s net income or accumulated other comprehensive income. As discussed in Note 6 of the condensed consolidated financial statements, the Corporation accounts for its financial derivatives as undesignated financial derivatives. The pre-tax net effect of gains and losses on financial derivatives and trading assets recorded in Farmer Mac’s consolidated statements of operations was a net loss of $20.3 million for third quarter 2006 and a net gain of $1.3 million for the nine months ended September 30, 2006, compared to gains of $12.0 million and $7.3 million, respectively, for the same periods in 2005.

Farmer Mac records financial derivatives at fair value on its balance sheet with the related changes in fair value recognized in the consolidated statement of operations. Although the Corporation’s use of financial derivatives achieves its economic and risk management objectives, its classification of financial derivatives as undesignated hedges under SFAS 133 allows factors unrelated to the economic performance of the Corporation’s business, such as changes in interest rates, to increase the volatility - even the direction - of the Corporation’s GAAP earnings.

Farmer Mac enters into financial derivative transactions to protect against risk from the effects of market price or interest rate movements on the value of assets, future cash flows and debt issuance, not for trading or speculative purposes. Farmer Mac enters into interest rate swap contracts to adjust the characteristics of its short-term debt to match more closely the cash flow and duration characteristics of its longer-term mortgage and other assets, and also to adjust the characteristics of its long-term debt to match more closely the cash flow and duration characteristics of its short-term assets, thereby reducing interest rate risk and also to derive an overall lower effective fixed-rate cost of borrowing than would otherwise be available to Farmer Mac in the conventional debt market. Specifically, interest rate swaps convert economically the variable cash flows related to the forecasted issuance of short-term debt to effectively fixed-rate medium-term and long-term notes that match the anticipated duration, repricing and interest rate characteristics of the corresponding assets. Since this strategy provides Farmer Mac with approximately the same cash flows as those that are inherent in the issuance of medium-term notes, Farmer Mac uses either the bond market or the swap market based upon their relative pricing efficiencies.

Farmer Mac uses callable interest rate swaps (in conjunction with the issuance of short-term debt) as an alternative to callable medium-term notes with equivalently structured maturities and call options. The call options on the swaps are designed to match the implicit prepayment options on those mortgage assets without prepayment protection. The blended durations of the swaps are also designed to match the duration of the related mortgages over their estimated lives. If the mortgages prepay, the swaps can be called and the short-term debt repaid; if the mortgages do not prepay, the swaps remain outstanding and the short-term debt is rolled over, effectively providing fixed-rate callable funding over the lives of the related mortgages. Thus, the economics of the assets are closely matched to the economics of the interest rate swap and funding combination.

 

Business Volume. New business volume for third quarter 2006 was $1.3 billion, up from $657.9 million in second quarter 2006. In July 2006, Farmer Mac guaranteed $1.0 billion of AgVantage securities supported by a five-year mortgage-backed obligation of Metropolitan Life Insurance Company (“MetLife”) backed by agricultural real estate mortgage loans. This transaction was in addition to the similar first quarter transaction in which Farmer Mac guaranteed $500.0 million of AgVantage securities supported by a MetLife agricultural mortgage-backed obligation. Additionally, during third quarter 2006 Farmer Mac added $177.9 million of Farmer Mac I loans under LTSPCs and purchased $74.2 million of Farmer Mac II USDA-guaranteed portions of loans.

- 36 -

---

All of the above-referenced transactions were products of Farmer Mac’s ongoing efforts to diversify its marketing focus to include large program transactions that emphasize high asset quality, with greater protection against adverse credit performance and commensurately lower compensation for the assumption of credit risk and administrative costs. While Farmer Mac’s new business volume has improved as a result of those efforts, its future business with agricultural mortgage lenders may still be constrained by:

 

·

high levels of available capital and liquidity of agricultural lenders;

·

alternative sources of funding and credit enhancement for agricultural lenders; and

·

increased competition in the secondary market for agricultural mortgage loans.

Management believes that legislative or regulatory developments or interpretations of Farmer Mac’s statutory charter could adversely affect Farmer Mac, its ability to offer new products, the ability or motivation of certain lenders to participate in its programs or the terms of any such participation, or increase the cost of regulation and related corporate activities. See “Risk Factors” in Part I, Item 1A of Farmer Mac’s Annual Report on Form 10-K/A for the year ended December 31, 2005, as filed with the SEC on November 9, 2006.

For a more detailed discussion of the above factors and the related effects on Farmer Mac’s business volume, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Outlook for 2006” in the Corporation’s Annual Report on Form 10-K/A for the year ended December 31, 2005, as filed with the SEC on November 9, 2006.

Looking ahead, Farmer Mac is developing innovative ways to serve the financing needs of rural America, and remains confident of opportunities for increased business volume and income growth as a result of the Corporation’s product development and customer service efforts. Farmer Mac’s marketing initiatives are generating business opportunities for 2006 and, it believes, beyond. Current initiatives include:

 

·

an ongoing alliance with the American Bankers Association (“ABA”), under which Farmer Mac agreed to facilitate access and improve pricing to ABA member institutions and the ABA agreed to promote member participation in the Farmer Mac I program;

·

expanded use of AgVantage transactions, targeting highly-rated financial institutions with large agricultural mortgage portfolios; and

·

agribusiness and rural development loans associated with agriculture, in fulfillment of Farmer Mac’s Congressional mission.

 

Some of the agribusiness and rural development initiatives will require Farmer Mac to consider credit risks that expand upon or differ from those the Corporation has accepted previously. Farmer Mac will use underwriting standards appropriate to those credit risks, and likely will draw upon outside expertise to analyze and evaluate the credit and funding aspects of loans submitted pursuant to those initiatives. While Farmer Mac is seeking to expand its mix of loan types within the scope of its Congressional charter, it is too early to assess the probability of success of these efforts. Farmer Mac believes that prospects for large portfolio transactions similar to those that have accounted for a significant portion of Farmer Mac’s previous growth, including the previously mentioned January and July 2006 AgVantage transactions and the April 2006 LTSPC transaction, continue to exist. No assurance can be given at this time as to the certainty or timing of similar transactions in the future.

- 37 -

---

The following tables set forth the amount of all Farmer Mac I and Farmer Mac II loan purchase and guarantee activities for newly originated and current seasoned loans during the periods indicated:

		Three Months Ended						Nine Months Ended
		September 30, 2006			September 30, 2005			September 30, 2006			September 30, 2005
		(in thousands)
Loan purchase and guarantee and commitment activity:
Farmer Mac I:
Loans		$	18,253		$	39,821		$	74,627		$	78,743
LTSPCs			177,885			91,783			821,635			221,484
AgVantage			1,000,000			-			1,500,000			-
Farmer Mac II Guaranteed Securities			74,217			52,181			180,548			140,938
Total purchases, guarantees and commitments		$	1,270,355		$	183,785		$	2,576,810		$	441,165
Farmer Mac I Guaranteed
Securities issuances:
Sold		$	135		$	2,061		$	3,168		$	24,073
Retained			-			-			-			-
Loans previously under LTSPCs exchanged for Farmer Mac Guaranteed Securities			341,164			-			891,278			-
Total		$	341,299		$	2,061		$	894,446		$	24,073

 

- 38 -

---

To fulfill its guarantee and commitment obligations, Farmer Mac purchases defaulted loans underlying Farmer Mac Guaranteed Securities and LTSPCs, all of which are at least 90 days delinquent at the time of purchase. The following table presents Farmer Mac’s loan purchases of newly originated and current seasoned loans and defaulted loans purchased underlying Farmer Mac I Guaranteed Securities and LTSPCs:

 

		Three Months Ended						Nine Months Ended
		September 30, 2006			September 30, 2005			September 30, 2006			September 30, 2005
		(in thousands)
Farmer Mac I newly originated and current seasoned loan purchases		$	18,253		$	39,821		$	74,627		$	78,743
Defaulted loans purchased underlying off-balance sheet Farmer Mac I Guaranteed Securities			-			913			506			2,508
Defaulted loans underlying on-balance sheet Farmer Mac I Guaranteed Securities transferred to loans			854			6,103			1,667			7,277
Defaulted loans purchased underlying LTSPCs			274			202			3,520			1,237
Total loan purchases		$	19,381		$	47,039		$	80,320		$	89,765