WASHINGTON (MNI) – The following is the second of three sections of
excerpts from Standard & Poor’s analysis of the U.S. Farm Credit System,
published late Friday:

Extraordinary Government Support: Very Likely

We reflect our views on the importance of the GREs’ role to the
government through implementation of our GRE ratings criteria. We
believe the role of the FCS is very important to the government. We
define the strength of the link between it and the U.S. government as
very strong, leading to a very high likelihood of support. The System’s
function is to support agricultural production in the U.S. so the U.S.
does not have to rely on external entities for food production.

In our rating process, we differentiate between the total System
and the individual System banks. Through our criteria, we classify an
individual bank’s role as very important and its link to the government
as strong, leading to our estimation of a high likelihood of support. We
assign stand-alone credit profiles for each bank based on our normal
review process and incorporate our expectation for ongoing support that
the government extends through its regulatory supervision by the FCA. We
believe a single bank’s weakness could have a systemic impact in terms
of investors’ perception of System strength or weakness in a
confidence-driven environment. In part, that is why we define the link
between any one bank and the government as strong, because financial
distress/default of the GRE could significantly affect the government’s
reputation or create a perception of weakness. High likelihood of
extraordinary support results in a prescriptive rating from our GRE
criteria table that is one-to-three levels above the individual bank
SACP.

System-wide Debt Securities are joint and several obligations of
the System banks and do not carry explicit support (guarantee) of the
U.S. government. Therefore, each bank is responsible for the payment of
principal and interest on all consolidated obligations issued by the
System. Per our criteria, the rating on the FCS’s securities receives
enough prescriptive support to achieve the ‘AA+’ sovereign rating of the
U.S. government given the very high likelihood of extraordinary support.
The securities continue to price at a narrow spread over U.S. Treasuries
(as they generally have throughout the crisis), affording the System
banks and their member institutions low funding costs.

Profile: Part Of The Oldest GSE In The U.S.

The FCS is comprised of four farm credit banks (AgFirst FCB,
Agribank FCB, Farm Credit Bank of Texas, and U.S. AgBank FCB) and one
agricultural credit bank (CoBank ACB). The System’s primary mission is
to provide sound and dependable sources of credit to the American
agricultural and rural sectors.

Each bank provides funding and related services to its affiliated
associations, which, in turn, provide loans and related services to
eligible agricultural and rural borrowers. The banks maintain revolving
lines of credit with their associations, which are secured by a senior
secured interest in all assets of each association. The associations
have their own earnings, allowance, and capital supporting these
wholesale loans in addition to the underlying collateral of the
individual loans. The associations use the credit lines to fund their
lending activities and provide services to their farmer and rancher
customers. In interactions with the associations within their districts,
System banks have access to detailed information about their risk
profiles and lending decisions.

The FCS’s funding structure is centralized among all banks in the
System, whereby all System banks have access to ‘AA+’ funding through
the Federal Farm Credit Funding Corp. (Funding Corp.). The market views
the bonds issued as agency obligations, and they are priced at a narrow
spread over U.S. Treasuries. The issues, however, are not direct
obligations of any one System bank, nor are they guaranteed by the U.S.
government.

Support And Ownership: Owned By Associations

The System is structured as a cooperative. The associations to
which any respective System bank lends funds own the respective bank as
they are required to invest and hold equity in a bank as prerequisite to
participating in the lending agreement. The respective borrowers and
customers, in turn, own the associations through the same type of
arrangement. Each bank is managed by an independent management team
consisting of a chief executive and overseen by a board of directors,
made up of elected directors and nonaffiliated appointed directors.

Strategy: Serving The Agricultural And Rural Sectors

The FCS is a GSE with a public-policy mission. By charter, the
System is limited to serving the agricultural and rural sectors–its
primary customer base. An extension of this role (though a small part of
its business) is to stimulate economic growth and development in rural
areas by investing under the FCA-initiated “mission-related investments”
umbrella.

System banks are not allowed to accept deposits. Instead, their
agent, the Funding Corp., sells securities on the banks’ behalf in the
national and international debt markets to fund loans and operations.

Whereas funding is global, lending is localized. Each bank
determines pricing and underwriting at the wholesale level for its
market and products, and the associations set them at the retail level.
District initiatives aim to expand both membership and services. The
System banks seek opportunities to increase and diversify their products
and customer bases.

The System regulator also permits mergers and strategic alliances.
In fact, CoBank and U.S. AgBank are planning to merge by Jan. 1, 2012.
In the summer of 2010, U.S. AgBank selected CoBank as a merger partner
and its board of directors voted to pursue the merger in December 2010.

Risk Profile And Management: Adequate

FCS is subject to regulatory oversight by the FCA and a variety of
System-wide self-policing safety mechanisms. Our overall assessment of
System enterprise risk management is that it is adequate for its
moderate risk profile.

Credit risk dominates the System’s risk profile, as its lending
portfolio is concentrated in the agricultural sector but is mitigated by
its nature as collateralized wholesale lending. Lending by the banks is
not entirely wholesale as System banks can participate alongside their
associations in loans originated by the associations and other eligible
entities. CoBank’s charter permits it to lend directly to agribusiness
and rural utilities as well as to make loans to support export of U.S.
agricultural commodities.

Interest-rate risk is less of a concern because the flexibility
provided by the centralized funding approach helps match-fund the
associations’ lending profiles. System banks enter into derivative
contracts, in particular interest-rate swaps and interest-rate caps, to
hedge its interest-rate exposure and manage its liquidity position.
Liquidity is strong, reflecting regulatory requirements to maintain
conservative on-balance-sheet liquidity.

Credit riskConservative lending practices account for the System’s
strong asset quality. As of June 30, 2011, total System loans of $174
billion had 2.04% of nonperforming loans (1.93% as of Dec. 31, 2010).

The System had 4.3% of loans classified as other assets especially
mentioned (OAEM) at June 30, 2011. This is still higher than levels
observed at year-end 2009 but is trending down slowly (4.8% as of Dec.
31, 2010). OAEM loans are collectible but exhibit some potential
weakness. This level is still acceptable for the rating but it may
become an issue if the trend in improvements reverses. Some
asset-quality deterioration during the past two years has stabilized as
commodity prices have risen significantly due to world food-supply
disruptions. Even so, asset-quality metrics had remained well within
range for the ratings. Higher commodity prices could continue to hurt
unhedged or inappropriately hedged borrowers, or borrowers who cannot
pass “raw material” costs on to customers. If this dynamic significantly
hurts credit stability, individual System bank ratings could come under
pressure.

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** Market News International Washington Bureau: 202-371-2121 **

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