On
September 7, 2008, the United States Department of the Treasury, the Federal
Reserve and the Federal Housing Finance Agency (“FHFA”) announced that FHFA was
placing the Federal National Mortgage Association (“Fannie Mae”) and the Federal
Home Loan Mortgage Corporation (“Freddie Mac”) into conservatorship. The plan
announced by the U.S. government includes, among other things, the elimination
of dividends on Fannie Mae and Freddie Mac common and preferred stock and an
agreement by the U.S. government to provide equity capital to cover mortgage
defaults in return for $1 billion of senior preferred stock in each of Fannie
Mae and Freddie Mac and warrants for the purchase of 79.9% of the common stock
of each company. The senior preferred stock has a liquidation preference senior
to all Fannie Mae and Freddie Mac common and preferred stock.
As
described in the Registrant’s second quarter Form 10-Q and fiscal year 2007
Annual Report on Form 10-K, Farmer Mac’s financial results are subject to a
number of assumptions and estimates and the evaluation of risks and
uncertainties, including but not limited to developments in the financial
markets and fluctuations in the value and liquidity of assets held by Farmer
Mac. Please see “Special Note Regarding Forward-Looking Statements” in Farmer
Mac’s second quarter Quarterly Report on Form 10-Q as filed with the SEC on
August 12, 2008 and “Risk Factors” disclosed in Farmer Mac’s 2007 Annual Report
on Form 10-K as filed with the SEC on March 17, 2008.
As
disclosed in Farmer Mac’s Quarterly Report on Form 10-Q for the quarter ended
June 30, 2008, Farmer Mac recorded a $5.3 million other-than-temporary
impairment related to its investment in Fannie Mae floating rate preferred
stock, with the $52.5 million amortized cost of the investment being written
down to its fair value of $47.2 million as of June 30, 2008. That report also
stated that, subsequent to June 30, 2008, Farmer Mac’s investment in the Fannie
Mae preferred stock had experienced further price declines and volatility, with
a fair value of $30.6 million as of August 1, 2008, and that additional
impairment losses would be recognized during third quarter 2008 if the security
did not otherwise recover in value.
Subsequent
to the announcement of the U.S. government on September 7, 2008, the market
value of the Fannie Mae preferred stock owned by Farmer Mac declined
significantly to $3.2 million as of the close of business on September 11, 2008.
Farmer Mac continues to hold its 1 million share investment in Fannie Mae Series
O preferred stock, and it is currently unclear if or when Farmer Mac will
recover the value of its investment in these securities. Farmer Mac does not
hold any other common or preferred stock or any other equity securities issued
by Fannie Mae or Freddie Mac. Farmer Mac believes the decline in the fair value
of such securities from August 1, 2008 reflects the subordination of all classes
of pre-existing Fannie Mae preferred stock to the U.S. Treasury Department’s
senior preferred stock and investor expectations that dividend payments on
Fannie Mae preferred stock are unlikely to resume in the near term and that the
Series O preferred stock, though currently callable, will not be called in the
foreseeable future. Furthermore, there can be no assurance that the value of the
Series O preferred stock will not decline further, or that Farmer Mac will not
have to recognize additional other-than-temporary impairment charges related to
such preferred stock.
Based on
these developments, Farmer Mac expects to record a further non-cash
other-than-temporary impairment charge on its investment in Fannie Mae preferred
stock for the quarter ending September 30, 2008. The amount of pre-tax
impairment charge for third quarter 2008 will equal the difference between the
carrying value of the securities at June 30, 2008 ($47.2 million) and the market
value of the securities as of September 30, 2008. On an after-tax basis, the
resulting non-cash impairment charge is expected to be approximately $44.0
million because Farmer Mac does not expect to realize any material tax benefit
in connection with the impairment of its Fannie Mae preferred stock. Although
Farmer Mac would realize a capital loss if it sells the securities, such capital
loss would result in a tax benefit to Farmer Mac only to the extent the capital
loss can be used to reduce capital gains available during the applicable
carryback and carryforward periods. Farmer Mac does not expect those capital
gains to be material in relation to the amount of the other-than-temporary
impairment charge.
As a
result of the expected non-cash other-than-temporary impairment charge on the
Fannie Mae preferred stock, Farmer Mac expects to report a loss for the third
quarter 2008. Farmer Mac is required to hold capital at the higher of the
statutory minimum capital requirement or the amount required by the risk-based
capital stress test, as described in more detail in its periodic filings with
the SEC. Farmer Mac currently is in compliance with all applicable capital
requirements and expects to be in compliance as of September 30,
2008.
Farmer
Mac’s outstanding program volume as of September 12, 2008 was approximately $9.5
billion. The mortgages and loans underlying those guarantees and commitments
continue to perform well, with delinquencies remaining at historically low
levels consistent with the continued strength of the U.S. agricultural economy.
Farmer Mac has strong prospects for growth in program volume during the third
and fourth quarters and believes it has capital sufficient to support that
growth.