Farm Credit System Insurance Corporation

Statements of Income and Expenses and Changes in Insurance Fund for

the Years Ended December 31, 1994 and 1993

($ in thousands)

Income
Premiums (Note 4)
Interest Income

Total Income

Expenses
Administrative Operating Expenses
(Note 7)
Provision for Estimated Insurance Obligations

(Note 5)
Net Income
Farm Credit Insurance Fund, Beginning of Year

Farm Credit Insurance Fund, End of Year

1994 1993
$ 76,526 $ 74,101
46,389 41,277

$ 122,915 $115,378
$ 1,482 $ 1,279
8,890 (39,444)
112,543 153,543
642,003 488,460
$754,546 $642,003

The accompanying notes are an integral part of these financial statements.

15


authorizes a System bank to join with any or all banks organized and operating under
the same title of the Act to issue consolidated notes, bonds, debentures, or other
obligations. Section 4.2(d) authorizes a System bank to join with the other banks of
the System to issue Systemwide notes, bonds, debentures, or other obligations.
Insured obligations are issued through the Federal Farm Credit Banks Funding
Corporation on behalf of the System banks. The outstanding principal and interest
balances of insured obligations at December 31 for the past 5 years are shown in the
following graph.

INSURED OBLIGATIONS
(Principal and Interest)

$ Billions

$56

55

54

53

52

51

1990 1991 1992 1993 1994

The Corporation is also required by statute to use the Insurance Fund to: (a) satisfy
System institution defaults on obligations related to FAC-issued bonds under section
6.26(d)(3) of the Act; and (b) ensure the retirement of eligible borrower stock. The
outstanding balances of these obligations at December 31 for the past 5 years are
illustrated in the following graph.



payments to be made in the future based
on the Corporation’s analysis of eco-
nomic conditions of insured System
banks. (Also see Note 5).

The insured System banks’ primary
lending markets are borrowers engaged
in farming, ranching, and producing or
harvesting of aquatic products, and their
cooperatives. Financial weaknesses in
these market segments and the effect of
general market conditions on the insured
System banks’ borrowers could adversely
affect the banks’ financial condition and
profitability. Insured System banks also
face risks from changing interest rate
environments and the need to maintain
ongoing access to financial markets.
Adverse changes in the financial
condition and profitability of insured
System banks resulting from increased
levels of credit, financial, or other risks
could occur in the future which would
have a material effect on the liability for
estimated insurance obligations.

Premiums — Annual premiums are
recorded as revenue during the period on

which the premiums are based. All
premiums are due on or before January
31 of the year subsequent to the year in
which they are earned.

Retirement Plan — All permanent
Corporation employees are covered by
the Civil Service Retirement System
(CSRS) or the Federal Employees
Retirement System (FERS).

The Corporation’s contribution to the
CSRS plan equals the 7 percent of base
pay contributed by employees covered by
that system. For those employees covered
by FERS, the Corporation’s contribution
is 11.4 percent of base pay. In addition,
for FERS-covered employees, the
Corporation automatically contributes 1
percent of base pay to the employee’s
Thrift Savings Plan account, matches the
first 3 percent contributed by the
employee, and matches one-half of the
next 2 percent contributed by the
employee.

Retirement plan expenses amounted to
$79,500 in 1994 and $72,537 in 1993.

19




Farm Credit System Insurance Corporation

Statements of Cash Flows for the Years Ended December 31, 1994 and 1993

($ in thousands)
1994
Cash Flows from Operating Activities
Net Income $112,543
Adjustments to Reconcile Net Income
to Net Cash Provided by Operating Activities:
(Increase) Decrease in Accrued Interest

Receivable (3,451)
(Increase) Decrease in Premiums Receivable (2,475)
(Increase) Decrease in Other Assets (6)
Net Amortization and Accretion of Investments 12,902
Increase (Decrease) in Accounts Payable

and Accrued Expenses 64

Increase (Decrease) in Liability for Eligible
Borrower Stock, Richmond PCA -
Increase (Decrease) in Liability for Estimated

Insurance Obligations 8,890

Net Cash Provided by Operating Activities 128,467

Cash Flows from Investing Activities
Payments for Purchase of U.S. Treasury

Obligations (245,388)
Proceeds from Redemption of
U.S. Treasury Obligations 116,923
Net Cash Used in Investing Activities (128,465)
Net Change in Cash and Cash Equivalents 2
Cash and Cash Equivalents, Beginning of Year 528
Cash and Cash Equivalents, End of Year $ 530

1993

$153,543

(3,809)

9,662
38

(1,171)

(39,444)

118,827

(251,182)

132,051

(119,131)

(304)
832

$ 528

The accompanying notes are an integral part of these financial statements.

16


Note 5 — Financial Assistance to
System Banks and Estimated
Insurance Obligations

Financial Assistance to Certain
System Banks

The 1987 Act required that the FCA
charter the Farm Credit System
Assistance Board (Assistance Board) and
the FAC (see Note 1) for the purpose of
carrying out a program to provide assis-
tance to System institutions experiencing
financial difficulty. In order to raise
funds to provide this assistance, the FAC
had the authority to issue debt obliga-
tions with a maturity of 15 years. Subject
to Assistance Board approval, these
funds were used by the FAC to purchase
preferred stock issued by an institution
experiencing financial difficulty.

During the period from 1988 to 1992,
assistance was provided to four open
banks through the purchase by the FAC
of $419 million in preferred stock issued

22

by these institutions. Similar assistance
was provided to the Federal Land Bank
of Jackson in Receivership.

Prior to the maturity of the related 15-
year debt obligations, each institution
can redeem its preferred stock, pursuant
to Section 6.26 of the Act, so as to allow
the FAC to pay the principal of the
maturing obligation. While an institution
that issues preferred stock to the FAC is
primarily responsible for providing
funds for payment of the FAC bonds
(through redemption of the preferred
stock purchased with the proceeds of the
FAC bonds), the institution may be
prohibited from redeeming, or may elect
not to redeem, the preferred stock
pursuant to section 6.26 of the Act. If
this occurs, then the FAC must use funds
from its Trust Fund, to the extent
available, to retire the debt. The FAC
Trust Fund (Trust Fund) represents the
funds received from System institutions’
purchase of stock in the FAC. The Trust
Fund totaled approximately $78 million


The Corporation, in its sole discretion, is
authorized to expend amounts to provide
financial assistance to certain insured
institutions.

Under section 5.63 of the Act the
Corporation is exempt from all Federal,
state, and local taxes with the exception
of real property taxes.

Note 2 — Summary of Significant
Accounting Policies

Accounting Principles and Reporting
Practices—The accounting and reporting
policies of the Corporation conform to
generally accepted accounting principles
and, as such, the financial statements
have been prepared using the accrual
basis of accounting.

Cash and Cash Equivalents — Cash and
cash equivalents include investments in
U.S. Treasury obligations with original
maturities of 90 days or less.

Investments in U.S. Treasury

Obligations — An investment portfolio is
maintained as required by section 5.62 of
the Act. The Act requires that funds of
the Corporation, not otherwise employed,

18

shall be invested in obligations of the
United States or in obligations
guaranteed as to principal and interest
by the United States. In 1994 the
Corporation adopted Statement of
Financial Accounting Standard (SFAS)
Number 115, Accounting for Certain
Investments in Debt and Equity Securities.
The Corporation classified its invest-
ments as held to maturity and carried
them at cost, adjusted for amortization of
premiums and accretion of discounts in
1994 and 1993. This is consistent with
the Corporation’s investment policy and
its positive intent and ability to hold its
investments to maturity. Premiums and
discounts are amortized or accreted
using the straight-line method, which
approximates the interest method, over
the terms of the respective issues.
Management reviews the portfolio classi-
fications at least quarterly in accordance
with the Corporation’s Investment Policy
to ensure the classifications are consis-
tent with Corporation liquidity require-
ments and SFAS 115.

Liability for Estimated Insurance
Obligations — The liability for estimated
insurance obligations is the present value
of estimated probable insurance


REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

Coopers & Lybrand L.LP.

Coopers
&Lybrand

2 professional serwces fhm

Report of Independent Accountants

To the Board of Directors of the
Farm Credit System Insurance Corporation

We have audited the accompanying statements of financial condition of the Farm Credit System
Insurance Corporation as of December 31, 1994 and 1993, and the related statements of income
and expenses and changes in insurance fund, and cash flows for the years then ended. These
financial statements are the responsibility of the Corporation's management. Our responsibility is
to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with generally accepted auditing standards and
Government Auditing Standards issued by the Comptroller General of the United States. Those
standards require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects,

the financial position of Farm Credit System Insurance Corporation as of December 31, 1994 and
1993, and the results of its operations and its cash flows for the years then ended in conformity

with generally accepted accounting principles.
Lays tXalrmud LLP

Washington, D.C.
February 2, 1995

Coopers & Lybrand LLP. a registered limited labity partnership, is a member firm of Cogpers & Lybrand (International)

13


GROWTH IN THE INSURANCE FUND
(Total Assets vs. Insurance Fund Equity)

$ Millions

$1000
800
600
400
200

i)

5/89 1/90 1/91 1/92 1/93 1/94 1/95

@ Total Assets

The Corporation’s principal liability for
insurance obligations at December 31,
1994, was $136 million, which represents
the liability to repay the Farm Credit
System Financial Assistance Corporation
(FAC) for financial assistance to the
Federal Land Bank of Jackson in
Receivership. This liability was revised
significantly downward at yearend 1993
to reflect management’s expectation that
the FAC Trust Fund will be available to
assist in the repayment of FAC assistance
(see Note 5).

@ Insurance Fund
Corporation Revenues

The Corporation’s revenues are derived
from two sources, premiums collected
from insured System banks and interest
income earned on the Corporation’s
investment portfolio. Total revenues
increased by 6.5 percent from $115
million in 1993 to $123 million in 1994.
Revenues for the past five years are
depicted in the following graph.



REFERENCES

Annual Reports for the Farm Credit System Insurance Corporation for 1990-1993 are
available without charge. Copies may be requested by contacting:

Farm Credit System Insurance Corporation
1501 Farm Credit Drive

McLean, VA 22102

(703) 883-4380 Fax (703) 790-9088

For additional information about the Farm Credit System, its financial condition and
performance, and activities of the Farm Credit Administration, the following
publications are recommended:

Farm Credit System Annual Reports to Investors and Quarterly and Annual
Information Statements for the current fiscal year and the two preceding fiscal years.
These are available without charge from:

Federal Farm Credit Banks Funding Corporation
10 Exchange Place, Suite 1401

Jersey City, NJ 07302

(201) 200-8000

Annual Reports of the Farm Credit Administration for the past five fiscal years. These
are available without charge from:

Office of Congressional and Public Affairs
Farm Credit Administration

1501 Farm Credit Drive

McLean, VA 22102

(703) 883-4056

Production of the 1994 Annual Report of the Farm Credit System Insurance
Corporation coordinated by Anna Lacey with assistance from Christine Quinn,
Barbara Shaffer and Linda Naderi.

28


of a similar trust in early 1994. With the
completion of the Spokane merger and
early redemption of financial assistance-
related preferred stock, all four of the
open FCBs to which the FAC provided
assistance through the purchase of
preferred stock have provided the funds
necessary to redeem their $419 million
in preferred stock.

Other significant developments during
1993 and 1994, supporting management’s
consideration of the Trust Fund’s
availability included: (1) the continuing
annual annuity payments by System
banks required by the Farm Credit Banks
and Associations Safety and Soundness
Act of 1992 (1992 Act) to provide for the
repayment of Capital Preservation
Agreement-related FAC bonds and
Treasury-paid interest; and (2) the
improved financial condition of System
banks. The Corporation cannot predict
the effects of future events upon System
operations and upon the amount of the
Trust Fund that will ultimately reduce

the Corporation’s liability for FLBJR-
related FAC bonds. The Corporation will
annually reassess the likelihood of earlier
use of the Trust Fund, changes in Trust
Fund earnings, and other assumptions
underlying the Corporation’s estimate of
its liability for FLBJR-related FAC bonds.

Other Financial Assistance
Provided to System Institutions
by the FAC

The 1992 Act expanded the Corporation’s
responsibility to insure defaults by
System institutions on payments related
to other assistance funded by FAC bonds.
These FAC bonds, aggregating $454
million, were issued to pay System Capital
Preservation Agreement accruals, to retire
eligible borrower stock of certain liquidating
System institutions, and to pay operating
expenses of the Assistance Board.

Previously, the Corporation had only been

required: (1) to satisfy defaults on the
repayment of Treasury-paid interest; and

25


She brings to her position 33 years of
experience in agriculture and agricultural
finance. The Texas native, who holds a
B.A. from Texas Woman’s University and
an M.S. from Texas A&M University,
joined the Federal Intermediate Credit
Bank of Texas in 1970 and in 1979
earned the distinction of being the first
woman appointed to a senior officer
position. During her career with the Farm
Credit Bank of Texas, she gained broad
management experience, providing
leadership and direction for the bank’s
corporate relations, legal, operations and
supervision, management information,
human resources, marketing, and public
and legislative affairs departments. She
has held leadership positions with
various agricultural councils and
advisory committees in the state of Texas,
including the Texas Agricultural Loan
Mediation Program Advisory Board, the
Texas Department of Commerce’s Credit
Advisory Committee, the Board of
Directors of Texas Agricultural Lifetime
Leadership, and the Texas Agricultural

Cooperative Council. In 1990, she
received the Cooperative Communicators
Association’s H.E. Klinefelter Award, the
association’s highest honor, in recognition
of her distinguished contributions to
cooperative communications.

Gary C. Byrne served as Chairman of the
Corporation from June 1992 until March
1995. He is a former Administrator of the
Rural Electrification Administration
(REA) and Governor of the Rural
Telephone Bank. As Administrator of the
REA, he managed an agency that
approved more than $62 billion in loans
to 2,116 rural electric and telephone
utilities in 47 states and several U.S.
territories and possessions. A native of
California, Mr. Byrne served as
Chairman of the Bank of Alex Brown in
Sacramento and also as President and
Chief Executive Officer of the Alex
Brown Financial Group, a multibank
holding company. He holds a B.A. from
the University of Redlands and a Ph.D.
from the University of North Carolina.


BOARD OF DIRECTORS

The Farm Credit System Insurance Corporation (Corporation) is managed by a three-
member board of directors comprised of the Members of the Farm Credit
Administration (FCA) Board. The Chairman of the Corporation’s Board of Directors,
however, must be a Board Member other than the Chairman of the FCA Board. One
position on the Board of Directors is vacant following the March 31, 1995 resignation

of Gary C. Byrne.

Doyle L. Cook joined the Corporation’s
Board in October 1994 and was elected
Chairman in March 1995. He brings to
this position 32 years of experience in
agricultural lending, 19 of which were
with various Farm Credit System institu-
tions. Preceding his appointment to the
Board, Mr. Cook served as President and
Chief Executive Officer of the Farm Credit
Bank of Spokane and as an active partici-
pant on various committees of the banks of
the Farm Credit System, a director of the
Federal Agricultural Mortgage Corporation,
and a member of the Chicago Mercantile
Exchange Lender Advisory Committee.
Previously, he served as President and
Chief Executive Officer of Farm Credit
Services of Mid-America, Senior Vice

President for Credit for the Federal
Intermediate Credit Bank of Texas, and
Senior Vice President of the Federal
Intermediate Credit Bank of Louisville.
He began his career with Ralston Purina
where he worked in credit, marketing,
finance, and general management for 13
years before joining the Farm Credit
System. Mr. Cook, a native of Star City,
Arkansas, holds a B.S. in agricultural
business and an M.S. in agricultural
economics from the University of
Arkansas.

Marsha Pyle Martin, a Member of the
Corporation’s Board since October 1994,
is also Chairman and Chief Executive
Officer of the Farm Credit Administration.


FINANCIAL STATEMENTS

Farm Credit System Insurance Corporation
Statements of Financial Condition as of December 31, 1994 and 1993
($ in thousands)

1994 1993
Assets
Cash and Cash Equivalents $ 530 $ 528
Investments in U.S. Treasury Obligations
(Note 3) 786,132 670,569
Accrued Interest Receivable 27,463 24,012
Premiums Receivable (Note 4) 76,556 74,081
Other Assets 6 -
Total Assets $ 890,687 $ 769,190
Liabilities and Insurance Fund
Accounts Payable and Accrued Expenses
(Note 7) $ 249 $ 185
Liability for Eligible Borrower Stock,
Richmond PCA 2 2
Liability for Estimated Insurance Obligations
(Note 5) 135,890 127,000
Farm Credit Insurance Fund 754,546 642,003
Total Liabilities and Insurance Fund $ 890,687 $ 769,190

The accompanying notes are an integral part of these financial statements.

14


CORPORATE ACTIVITIES

Performance Measures

The Corporation has developed an initial
set of performance measures for its
principal program areas. The
Government Performance and Results
Act of 1993 requires all Federal
Government organizations to begin
reporting on program performance in FY
1999. As performance measures are
implemented, modifications may be
made to respond to changes in the
Corporation’s operating environment and
experience. These performance
measures, which are listed below, are
discussed in more detail in each of the
program areas.

Insurance Fund Management

Investment results will be measured by
comparing the Corporation’s average
yield with peer investment funds which
have similar investment parameters for
quality and maturity.

Risk Analysis/Management

Special examination procedures will be
applied to all institutions identified by
the Corporation’s risk analysis criteria.

Additional performance measures will be
developed in the event of any receiver-
ships or conservatorships in the future.

Insurance Fund Management

Growth in the Insurance Fund

The Corporation had net income for 1994
of $112 million. The Insurance Fund
balance at December 31, 1994, was $754
million, an increase of 17 percent from
1993. The Insurance Fund represents the
Corporation’s equity i.e., the difference
between its total assets ($891 million) and
its total liabilities, including its insurance
obligations ($136 million). The following
graph depicts the growth in the
Corporation’s total assets and the
Insurance Fund.


Note 3 — Investments

At December 31, 1994, and at December 31, 1993, investments in U.S. Treasury
obligations consisted of the following:
($ in thousands)

Gross Gross Estimated
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
December 31, 1994
U.S. Treasury Notes $786,132 $625 ($31,760) $754,997
December 31, 1993
U.S. Treasury Notes $670,569 $20,517 ($563) $690,523

The amortized cost and estimated market value of U.S. Treasury obligations at
December 31, 1994, by contractual maturity, are shown below. Amounts are in
thousands.

Estimated

Amortized Market

Cost Value
Due in one year or less $132,320 $132,331
Due after one year through five years 653,812 622,666
$786,132 $754,997

20


Annual
Report

Farm Credit System Insurance Corporation



with its liquidity needs and a minimum exposure to loss of principal. The average
portfolio yield for 1994 was 6 percent compared with 6.28 percent for 1993.

As a measure of investment management performance, the Corporation’s average
yield was compared with the interest yield of five peer investment funds. These
funds invest in short-term U.S. Treasury securities. This comparison

for the past four years is shown in the following graph.

FCSIC INTEREST YIELD COMPARED WITH
SIMILAR BOND FUNDS’ INTEREST YIELD

Percent

= —_
1991 1992 1993 1994
Treasury Bond Funds 1 FCSIC Interest Yield

The Corporation’s average yield is higher than the peer group, primarily as a result of
the slightly longer weighted average portfolio maturity maintained by the Corporation
during the period. The Corporation pursues an investment strategy of purchasing a
ladder of maturities and holding investments to maturity while several of the funds in
the peer group trade their securities prior to maturity.

Corporation operating costs as a percentage of average assets are significantly lower
than the peer group as shown in the following graph.


CORPORATION REVENUES

$ Millions

0 :
1990 1991
Premiums

Premium Collection and
Secure Base Amount

Premium revenue increased by 3 percent
in 1994 to $76.5 million. Premiums are
collected annually from System banks
based on each bank’s and its related
associations’ retail loan volume (see
Note 4). Premium revenue is accrued at
December 31, 1994, representing the
estimated premiums that were earned but
not yet collected for calendar year 1994;
these premiums were collected on
January 31, 1995. All insured System
banks will continue to pay insurance
premiums until the aggregate amount in
the Insurance Fund reaches the secure
base amount, at which time premiums

1993 1994
&& Interest Income

will be reduced to a level to maintain the
Fund at the secure base amount. The
secure base amount is a percentage of the
insured obligations issued and outstanding
by all System banks (see Note 4).

Investment of Insurance
Fund Assets

The Corporation had cash and investments
of $787 million at December 31, 1994.
Funds are invested in U.S. Treasury
securities in accordance with section
5.62 of the Farm Credit Act of 1971 as
amended (Act), 12 U.S.C, 2277a-11 and
the Corporation’s investment policy. The
policy provides that the Corporation will
seek the maximum return consistent


Note 6 — Operating Lease

On September 2, 1993, the Corporation’s
lease agreement with the Farm Credit
System Building Association for office
space and furniture rental was modified
to extend the term to September 30,
1996. The agreement requires payment of
an annual base rent for office space, with
fixed annual increases of 2 percent. The
Corporation recorded $64,280 and
$78,890 in operating expenses related to
the lease in 1994 and 1993, respectively.
Remaining minimum future payments
under the terms of the lease are $67,834,
and $51,613 for 1995 and 1996,
respectively.

Note 7— Related Parties

The Corporation purchases services from
the FCA under an Inter-Agency
Agreement. Such services include
examination, administrative, and legal
support services. The Corporation had
payables due to the FCA of $70,951 at
December 31, 1994, and $63,357 at
December 31, 1993. The Corporation
purchased services for 1994 which
totaled $300,064 compared with
$326,347 for 1993.

27


(2) to purchase the preferred stock of an
assisted institution when the institution
did not retire the stock at the maturity of
the FAC bonds issued to purchase it. The
1992 Act made the Corporation respon-
sible for defaults by System institutions
on obligations related to the remaining
$454 million of FAC bonds and related
interest if such amounts cannot be
recovered from defaulting institutions by
the FAC or the Treasury, as the case may
be, within 12 months.

The 1992 Act also expanded the potential
uses of the Trust Fund to satisfy System
institution defaults on the principal and
interest of other FAC obligations and
required System banks to make annual
annuity payments to the FAC to provide
funds for the retirement of the Capital
Preservation Agreement-related FAC
bonds aggregating $417 million and

26

Treasury-paid interest at maturity. The
Corporation is also required to satisfy
defaults on the annual payments to the
FAC to permit the repayment of Treasury-
paid interest. During 1992 through 1994,
all System banks made their annual
annuity payments as scheduled. The
Corporation is not aware of any events or
circumstances which will prevent System
banks from meeting their FAC obligations.

The Corporation actively monitors the
creditworthiness and financial position
of the insured System banks. Other than
obligations that have occurred as a result
of resolving the FLBJR, as described
above, management is not aware of any
events or circumstances at this time
which would require a liability for
estimated insurance obligations to be
recorded.


OVERVIEW

The Farm Credit System Insurance
Corporation was established by the
Agricultural Credit Act of 1987 (1987 Act)
as an independent U.S. Government-
controlled corporation. The Corporation’s
purpose is to ensure the timely payment
of principal and interest on insured
notes, bonds, and other obligations
issued on behalf of Farm Credit System
(System) banks. The Farm Credit System
is a nationwide system of privately
owned banks and affiliated associations
that serve borrowers and related entities
in the agricultural sector. By ensuring the
repayment of System debt securities to
investors, the Corporation helps to
maintain a dependable source of funds
for the farmers, ranchers, and other
borrowers of the Farm Credit System.
The 1987 Act provided for all System
banks to be insured, effective January 6,
1989. At yearend 1994, there were

11 insured System banks.

During the past year, financial conditions
in the System continued to improve,
increasing the resources available to
cushion any potential loss to the Insurance

Fund. The System, on a combined basis,
achieved $1 billion in net income and
increased its capital-to-assets ratio from
12.5 percent to 13.2 percent at yearend.
System asset quality also improved with
nonperforming assets declining from 4.2
percent of total loans and other property
owned in 1993 to 2.9 percent at yearend.

Other significant highlights for 1994
include:

© Growth in the Insurance Fund to $754
million, an increase of $112 million
from 1993;

e Provision for repayment of the
remaining open bank financial
assistance;

e Implementation of the Market Access
Agreement;

e Implementation of the Corporation’s
program performance measures; and

e@ Development of insurance risk
monitoring models.



NOTES TO FINANCIAL STATEMENTS

Farm Credit System Insurance Corporation—Notes to the Financial
Statements as of December 31, 1994 and December 31, 1993

Note 1 — Insurance Fund:
Statutory Framework

The Agricultural Credit Act of 1987 (1987
Act) established the Farm Credit System
Insurance Corporation (Corporation) for
the purpose of ensuring the timely pay-
ment of principal and interest on notes,
bonds, debentures, and other obligations
issued under subsection (c) or (d) of
section 4.2 of the Farm Credit Act of 1971
(Act) (insured obligations). Effective
January 6, 1989, each bank in the Farm
Credit System (System) participating in
insured obligations became an insured
System bank. The Corporation is managed
by a board of directors consisting of the
same individuals as the Farm Credit
Administration (FCA) Board except that
the Chairman of the FCA Board may not
serve as the Chairman of the Corporation’s
Board of Directors.

The Corporation has the responsibility to
expend amounts to the extent necessary to:

1. Ensure the timely payment of interest
and principal on insured obligations

in the event of default by an insured
System bank;

2. Satisfy, pursuant to section 6.26 (d)(3)
of the Act, defaults by System banks
on obligations related to the issuance
of U.S, Treasury-guaranteed bonds by
the Farm Credit System Financial
Assistance Corporation (FAC) (FAC
bonds) (see Note 5); and

3. Ensure the retirement of eligible
borrower stock at par value.

The balances outstanding at December 31,
1994, for each of the components of the
Corporation’s insurance responsibilities
were $53.6 billion of insured obligations,
$1.3 billion of FAC bonds (of which $0.6
billion in repayments have been provided
for), and $195 million of eligible
borrower stock.

If the Corporation does not have sufficient
funds to ensure payment on insured
obligations, System banks will be
required to make payments under joint
and several liability.

17


and $75 million at December 31, 1994
and 1993, respectively. If the Trust Fund
is not sufficient to retire the debt, then
the Corporation must purchase preferred
stock from the FAC to provide funds to
retire such debt. If the Corporation does
not have sufficient funds, the U.S.
Treasury must retire the debt. If this
should occur, the Corporation is required
to repay the U.S. Treasury as funds
become available from the payment of
premiums. At December 31, 1994, the
only preferred stock held by the FAC was
associated with the assistance provided
to the Federal Land Bank of Jackson.

On May 20, 1988, the FCA placed the
Federal Land Bank of Jackson and the
Federal Land Bank Association of
Jackson in receivership (collectively the
FLBJR) and appointed a receiver to
liquidate their assets. As of April 27,
1990, the FCA, the receiver of the FLBJR,
the FAG, the System banks, the
Assistance Board, and the Corporation
entered into an agreement which called

for the FAC to issue 15-year U.S.
Treasury-guaranteed bonds to purchase
preferred stock in the FLBJR. Upon the
maturity in 2005 of the FAC bonds used
to purchase preferred stock in the FLBJR,
the Corporation will provide funds to
repay the principal of these debt
obligations, to the extent that the Trust
Fund is not sufficient for such purpose.
Assistance given by the FAC to the
FLBJR totaled $388 million.

Estimated Insurance Obligation

The Corporation estimated the present
value of its liability to provide funds for
payment of the $388 million of 15-year
maturing debt to be approximately $136
million and $127 million at December
31, 1994 and 1993, respectively. This
liability is reflected in the accompanying
statements of financial condition. The
present value of this obligation is based
on a discount rate of 7 percent to
maturity, which was established at the
time this liability was originally

23


CONTENTS

Board of Ditectots os c2e0; ome reese suas ows temas ws Page 1

Overview 66... Page 3

Corporate Activities 2.0... 0... eee eee eee Page 4
Performance Measures ..............-.ee cues Page 4
Insurance Fund Management ................. Page 4
Risk Management; iausims semi ewaccase cus ewae Page 11

Report of Independent

Public Accountants : 2: teas sens sms Seat emas cma s Page 13
Financial Statements ..................2000 020 Page 14
Notes to

Financial Statements ...... 0... cece Page 17

RelerenCOS o55 costs aes ome tema emes ams samt ames e Page 28



OTHER OBLIGATIONS

$ Billions

$2.50

1990 1991
Eligible Borrower Stock

Other obligations continued to decline
during 1994 as a result of the further
retirement of outstanding eligible bor-
rower stock. In addition, System banks
have been providing for the repayment
of outstanding FAC assistance bonds. At
December 31, 1994, the System had
provided for the repayment of approxi-
mately $0.6 billion of the $1.3 billion
FAC assistance bonds outstanding.

Operations
The Corporation operated with a total
staff of 9 employees in 1994. The small

staff leverages its resources by utilizing
the Farm Credit Administration for

10

1992 1993 1994

1® FAC Assistance Bonds

examination, legal, and certain other
services. Other specialized services are
available through contractual
arrangements on an as-needed basis. The
Corporation had $1.5 million in
operating costs for 1994 representing 0.2
percent of average assets. Of this amount,
the Corporation’s fixed costs for its
permanent staff, travel, rent, and
miscellaneous expenses totaled $1.0
million. Contract services represented
the balance of operating expenses of $0.5
million. These expenses include
amounts reimbursed to the FCA for
examination, legal, and other support
and amounts paid to other contractors
for purchased services.


adoption of additional screening factors
to support risk monitoring activities and
determine Corporation loss allowances.

Assistance Agreement
Management

The Insurance Corporation is authorized
to provide assistance to a Farm Credit
System institution to prevent default,
restore it to normal operations, or to
facilitate a merger or consolidation.

In January 1993, the Corporation also
assumed responsibility for managing the
assistance agreements that were
previously administered by the Farm
Credit System Assistance Board. This
assistance program ended in April 1994
when the remaining assisted institution,
the Farm Credit Bank of Spokane,
provided for the repayment of its assis-
tance in conjunction with the bank’s merger
with the Farm Credit Bank of Omaha.

Receivership Capability

The Corporation has developed a program
for managing receiverships and conser-
vatorships. To contain costs while

12

providing the statutorily mandated
capacity to deal effectively with any
potential receiverships and
conservatorships, the Corporation has
qualified a pool of private sector vendors
who can be called upon to provide
specialized support if needed. These
contractual arrangements effectively
leverage permanent staff resources while
maintaining low overhead during
periods of limited or no activity.

Market Access Agreement

In November 1994, the Farm Credit
System banks implemented the Market
Access Agreement (MAA). The MAA
establishes certain financial thresholds at
which conditions are placed on the
activities of a bank or the bank’s access
to participation in Systemwide debt
obligations is either restricted or
curtailed. The Corporation supports the
MAA and believes that it will make a
positive contribution to the System’s
financial condition.


MISSION STATEMENT

As an independent entity, the Farm Credit System Insurance Corporation
shall:

¢ Protect investors in insured Farm Credit System obligations and taxpayers
through sound administration of the Farm Credit Insurance Fund
(Insurance Fund);

° Exercise its authorities to minimize loss to the Insurance Fund; and

° Help ensure the future of a permanent system for delivery of credit to
agricultural borrowers.


Note 4 — Premiums

Each System bank which issues insured
obligations under subsection (c) or (d) of
section 4.2 of the Act is an insured
System bank and is required to pay
premiums to the Corporation.

In accordance with the Act, the annual
premium due from each insured System
bank for the calendar year is equal to the
sum of: (1) the annual average principal
outstanding for the year on loans made
by the bank that are in accrual status,
other than the guaranteed portions of
government-guaranteed loans, multiplied
by 0.0015; (2) the annual average principal
outstanding for the year on loans made
by the bank that are in nonaccrual status
multiplied by 0.0025; (3) the annual
average principal outstanding for the year
on the guaranteed portions of Federal
Government-guaranteed loans of the bank
that are in accrual status, multiplied by
0.00015; and (4) the annual average
principal outstanding for the year on the
guaranteed portions of state government-

guaranteed loans of the bank that are in
accrual status, multiplied by 0.0003.

Each insured System bank will continue
to make these annual premium payments
until the aggregate amount in the
Insurance Fund exceeds the secure base
amount. The secure base amount is
equivalent to 2 percent of the aggregate
outstanding insured obligations of all
insured System banks (adjusted downward
by a percentage of the guaranteed
portions of principal outstanding on
Government-guaranteed loans in accrual
status) or such other percentage or amount
determined by the Corporation, in its sole
discretion, to be actuarially sound. When
the amount of the Insurance Fund exceeds
the secure base amount, the Corporation
is required to reduce the premium to a
percentage necessary to maintain the
level of the Insurance Fund at the secure
base amount. At December 31, 1994, the
Insurance Fund was 1.5 percent of
insured obligations outstanding.

21



Farm Credit System Insurance Corporation

May 8, 1995

Gentlemen:

In accordance with the provisions of section 5.64(a) of the Farm Credit Act of 1971, as amended,
the Farm Credit System Insurance Corporation is pleased to submit its Annual Report for
calendar year 1994.

The balance in the Farm Credit Insurance Fund at December 31, 1994 was $754 million. The
Corporation expects to incur $1.8 million in operating costs during calendar year 1995. On
January 31, 1995, the Corporation collected $76.5 million in premiums from the insured Farm
Credit System banks.

Sincerely,

ph 1 Cok

Doyle L. Cook
Chairman

The President of the United States Senate
The Speaker of the United States House of Representatives

McLean, Virginia 22102
703/883-4380


recorded. In accordance with Statement
of Financial Accounting Standards No.
107, the fair value of this liability has
been estimated by management using
discount rates based upon U.S. Treasury
securities of similar durations (7.9
percent for 1994 and 6 percent for 1993).
The fair value was approximately $124
million and $141 million as of December
31, 1994 and 1993, respectively.

Provisions for changes in the Corporation’s
liability are reflected in the statements of
income and expenses in the amount of
$8.9 million and ($39.4) million for the
years ended December 31, 1994 and
1993, respectively. The ($39.4) million
provision for 1993 reflected a change in
management's estimate of the liability.

From 1990 when the Corporation’s
liability was established, until December
31, 1992, the Corporation estimated its
ultimate liability for the FAC obligations
at the present value of the entire amount
of the underlying FLBJR preferred stock

24

assuming no funds would be available in
the Trust Fund. During these years, the
availability of the Trust Fund was
considered uncertain by management,
primarily because of the existence of the
preferred stock obligations of the other
four open System banks discussed
above, the options provided under the
Act regarding redemption of their
preferred stock, and related questions
regarding how amounts accumulated in
the Trust Fund might be used.

During 1993, management reevaluated
its estimated insurance obligation and
revised its estimate to reflect availability
of the full amount of the Trust Fund to
repay a portion of the FLBJR-related
FAC bonds. Significant developments
underlying management’s evaluation
were the establishment of an irrevocable
trust by the Louisville FCB for the early
redemption of financial assistance-
related preferred stock and the merger
agreement entered into by the Spokane
FCB, which provided for the establishment


OPERATING EXPENSES AS A PERCENTAGE OF ASSETS
FCSIC Compared with Similar Treasury Bond Funds

Percent
0.6
0.5
0.4
03
0.2
0.1
0
1991 1992 1993 1994
Treasury Bond Funds @ FCSIC

The Corporation’s investment policy
permits flexibility to make investments
with maturities from 0 to 5 years. There
must be a minimum of 15 percent and a
maximum of 25 percent invested in any
maturity range. At December 31, 1994,
the actual portfolio maturities were:

Maturity $ %

Schedule Millions of Portfolio
1Dayto1 Year $133 a7
1 Year to 2 Years 140 18
2 Years to 3 Years 184 23
3 Years to 4 Years 184 23
4 Years to5 Years 146 19
Total $787 100

At December 31, 1994, the portfolio’s
book value exceeded market value by
$31.7 million. This depreciation resulted
from some of the Corporation’s longer term
investments that were purchased when
market interest rates were significantly
lower than in 1994. The weighted average
portfolio maturity at yearend was 2.6 years.

Insured and Other Obligations

Obligations insured by the Corporation
are statutorily defined as any note, bond,
debenture, or other obligation issued on
behalf of insured System banks under
subsection (c) or (d) of section 4.2 of the
Act, 12 U.S.C. 2153. Section 4.2(c)


Beginning January 1, 1996, current law
requires the Corporation to be governed
by a full-time, three-member Board of
Directors independent of the FCA Board.
The Corporation anticipates that
implementation of the current law’s
requirements will significantly increase
its operating costs. The Clinton
Administration in its fiscal year 1996
budget proposes to seek an amendment
to current law to provide for a Board
structure that will be cost-effective,
ensure appropriate coordination with the
System’s regulator, the FCA, and have
adequate authority and resources to carry
out the Corporation’s mission.

Risk Management

The Corporation’s program to identify
and manage risk to the Insurance Fund
minimizes the Fund’s exposure to poten-
tial losses through early detection.
Corporation staff has developed special
examination procedures to evaluate the
condition of weaker System institutions.
FCA examination staff performs these
special examinations on a reimbursable
basis. In addition, the Corporation

assesses risk exposure to the Insurance
Fund through its ongoing review and
analysis of the financial condition of
System institutions, corporate actions
approved by FCA for System institutions,
Reports of Examination of System insti-
tutions, and by serving as a nonvoting
participant on FCA’s enforcement com-
mittee. Corporation staff also monitors
the development of legislative, judicial
and regulatory issues that could alter the
various risks to the Insurance Fund.

During 1994, work proceeded on the
study to develop a methodology for
evaluating the adequacy of the Insurance
Fund’s secure base amount, and to
identify and quantify various risk factors
that could generate insurance claims.
The study, now nearing completion, will
produce an analytical model to enable
the Corporation to evaluate changes in
insurance risk and to estimate the
probability of insurance claims on an
ongoing basis.

Other risk management initiatives in 1994

included implementation of streamlined
special examination procedures, and the

11