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

Ratings Detail

Strengths: The Farm Credit System receives implicit support in its
ratings as a government-sponsored enterprise (GSE)Good asset-quality
metricsStrong risk-adjusted capitalization, especially at the district
levelAccessibility to favorably priced fundingWeaknesses:Lending limited
to cyclical agricultural sectorLimited revenue diversificationPotential
for adverse regulatory changes related to broader housing GSE
reformSovereign riskRationaleStandard & Poor’s Ratings Services’ ‘AA+’
rating on the Farm Credit System (FCS or the System) reflects the
System’s status as a GSE, its important role as a liquidity provider to
the U.S. agricultural sector, its diverse global investor base that
enables ample liquidity at low funding costs across maturities, and its
excellent aggregate asset quality in its (primarily) wholesale lending
portfolio.

Stand-alone credit profiles (SACP) of individual banks reflect
their excellent loan quality and funding/liquidity benefits that accrue
to them as members of the System. The individual bank rating strengths
are offset by adequate risk-adjusted profitability by virtue of the
System’s cooperative membership structure and the banks’ lending
authority that limits them to the cyclical agricultural sector.

There is a level of sovereign risk even though the System functions
independently from the U.S. government and Treasury. Nevertheless, we
incorporate implicit support in our rating.

In addition to good asset-quality metrics, strong capital provides
an adequate cushion for any losses related to a cyclical downturn. FCS’s
borrowing associations secure their loans from the System banks with
senior secured interests in substantially all the associations’ assets.
This provides an additional layer of first-dollar loss capital,
shielding the bank from retail losses. For this reason, we monitor
capital at the district and bank levels.

The banks can raise capital organically if they need to by
increasing the spread they charges on loans to associations, decreasing
patronage payments to associations, or increasing required equity.
Buttressing capital further, as of June 30, 2011, the System had a $3.3
billion insurance fund (2% of risk-adjusted insured obligations) that is
directed independently by Farm Credit System Insurance Corp. to ensure
principal and interest payments on its obligations.

The System has low funding costs on its debt (System-wide Debt
Securities) because of joint and several liability based on the combined
strength of the five independent banks, the supporting insurance fund,
and the implicit government support the System receives as a GSE.
Nevertheless, the System-wide Debt Securities are not guaranteed by, nor
are they the obligation of, the U.S. government.

The System’s international investor base consists of many sovereign
funds and asset managers. The recent global economic weakness has
continued to bring investors to U.S.-related obligations as a safe haven
for dollar-denominated and government-related assets though demand for
System securities has weakened. However, the U.S. debt ceiling and
fiscal management disputes could gradually erode some of that capacity.
Also, domestic financial institutions awash with deposits and weak loan
demand have also invested excess liquidity in certain System
obligations, keeping funding costs extremely low at the System given the
demand for its securities. We expect the System’s funding costs to be on
par with those of Fannie Mae, Freddie Mac, and the Federal Home Loan
Bank System, with spreads slightly above U.S. Treasuries, which
explicitly include the full faith and credit of the U.S. government.

The System maintains excellent asset quality in its loan portfolio,
which comprises 76% of combined assets. Borrowing associations secure
all loans from the banks with senior secured interests in all of their
assets.

System banks manage their interest-rate risk and seek appropriate
risk-adjusted yields through loans, hedging, and a securities portfolio.
The total System securities portfolio was $42.5 billion as of June 2011.
Mortgage-backed securities (MBS) comprise about 70% of the combined
portfolio. About 51% of $10 billion MBS in the portfolio that have been
in a continuous unrealized loss position for less than 12 months include
$384 million (about 4%) of unrealized losses against them. More than 90%
of the total portfolio securities is categorized as available-for-sale,
which allows management the option to sell them, increasing financial
flexibility, though we recognize management’s intent to hold them
indefinitely.

Although the bonds were rated ‘AAA’ at purchase, the mortgage and
housing-market crises drove their values down significantly. Few
securities have actually realized credit losses, but ongoing
other-than-temporary impairment (OTTI) testing indicates the FCS could
experience some losses in the later lives of the bonds. Because of
continued uncertainty in the housing markets, increased credit-related
OTTI assumptions indicate higher projected losses because of increases
in foreclosure and liquidation costs.

Though they are part of a cooperative structure, System banks earn
approximate market rates on loan assets. Although the profitability
measures are relatively thin in absolute terms, they are satisfactory in
our view of the low-risk nature of their lending business. In normal
economic conditions, normalized, plain-vanilla total revenue streams are
adequate to cover overhead expenses and pay a patronage dividend to
member Associations.

We continue to monitor political activities in Washington to see
what impact, if any, GSE reform could have on the FCA and, ultimately
the FCS. Although several bills have been introduced to Congress with
respect to housing GSE reform, we have not seen any significant reform
proposals for the FCS. However, we think it could come under
consideration after the higher-priority housing GSE reform. At this
point, we believe it is still premature to change our view on the FCS or
our expectation of ongoing support from the U.S. government. We don’t
expect to see more concrete proposals for the housing GSEs until 2012
and, more likely, after the 2012 election.

OutlookThe negative outlook on the System rating reflects our
belief that there could be a reduction in implicit support that we have
historically factored into issuer credit ratings. We have incorporated
extraordinary support due to the important role the System and its banks
play as primary liquidity providers to the U.S. agricultural industry.
Under our government-related entity (GRE) criteria, the issuer credit
rating for the System is one to three notches above the stand-alone
credit profile on any of the system banks. Thus, a lower U.S. sovereign
rating could affect the issuer credit ratings on the FCS and its system
banks.

The negative outlook reflects the Aug. 4, 2011, downgrade of the
U.S. to ‘AA+’. We expect the FCS as a GSE to continue to benefit from
the implied support of the U.S. government for its System-wide Debt
Securities and to continue normal lending and funding operations.
Because our ratings on a supported entity rarely exceeds those on its
supporting entity, the System rating would not likely be above that of
the government at the current rating level.

The outlook on the individual bank ratings is stable based on their
fundamentals and operations. The individual ratings, including support,
are two notches below the System rating and may not be affected with
less than a two-notch further downgrade of the U.S. However, if losses
on the banks’ private-label MBS deteriorate beyond our expectations,
affecting profitability and capital of any of the institutions, we could
lower the respective rating. Furthermore, if legislation or regulatory
developments hurt the System and result in less implicit government
support, we could lower our ratings.

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

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