The Farm Credit System has reported combined net income of $817 million and $2.370 billion for the three and nine months ended September 30, 2008, as compared with combined net income of $727 million and $2.021 billion for the same periods last year.
"We are particularly pleased with the third quarter and year-to-date results given the weakening U.S. and global economy and the unprecedented instability in the global financial markets," remarked Jamie B. Stewart, Jr., President and CEO of the Federal Farm Credit Banks Funding Corporation. "The System has been able to meet its mission and continues to be a reliable source of debt capital for those businesses we serve. Despite the instability in the world financial markets, the System has, to date, maintained the ability to access the debt capital markets, although our cost of funding has increased, particularly for longer-term debt. System institutions are taking appropriate measures to address these issues, while remaining dependable lenders in their markets."
Results of Operations
Net interest income increased $164 million and $497 million to $1.198 billion and $3.505 billion for the three and nine months ended September 30, 2008, as compared with the same periods of 2007. These increases in net interest income resulted from higher levels of average earning assets, primarily from growth in the loan portfolio. Average earning assets grew $30.595 billion or 18.2% to $198.632 billion for the three months ended September 30, 2008 and $29.082 billion or 17.7% to $192.987 billion for the nine months ended September 30, 2008, as compared with the same periods of the prior year.
The net interest margin declined five and three basis points to 2.41% and 2.42% for the quarter and nine months ended September 30, 2008, as compared with 2.46% and 2.45% for the same periods of the prior year. The decrease in the net interest margin for the three and nine months ended September 30, 2008 was primarily due to declines in income earned on earning assets funded by noninterest-bearing sources (principally capital), as yields on average earning assets declined in this lower interest rate environment, and to a decline in capital as a percentage of average earning assets. These declines were mostly offset by increases in the net interest spread of 27 and 26 basis points to 2.01% and 1.99% for the quarter and nine months ended September 30, 2008, as compared with 1.74% and 1.73% for the same periods of 2007. The increases in the net interest spread were primarily attributable to continued favorable agricultural lending conditions and the lower interest rate environment in the first nine months of 2008, as compared with 2007. The Banks took advantage of the lower interest rate environment during the first nine months of the year and called debt totaling $38.4 billion and were able to lower their cost of funds relative to the interest rate earned on their assets, which did not change as quickly.
The System recognized provisions for loan losses of $61 million for the third quarter of 2008 and $124 million for the nine-month period ended September 30, 2008, as compared with provisions for loan losses of $26 million and $64 million for the three- and nine-month periods ended September 30, 2007. The provision for loan losses for the nine-month period ended September 30, 2008 consisted of $140 million of provisions for loan losses recorded by certain System institutions, which was partially offset by $16 million of loan loss reversals recorded by other System institutions. The provisions for loan losses for 2008 primarily resulted from expected credit deterioration in the System's loan portfolio in a more volatile agricultural environment. Noninterest income increased $36 million and $46 million to $162 million and $372 million for the three- and nine-month periods ended September 30, 2008, as compared with the same periods of the prior year. The increases were primarily due to increases in earnings from fees for financially related services and mineral income, although these increases were offset, in part, by an increase in losses on the extinguishment of callable debt. The increase in fees for financially related services resulted from an increase in multi-peril crop insurance income that was due to additional emphasis on marketing and sales of related services and a higher volume of loans outstanding.
Noninterest expense increased $56 million and $93 million to $442 million and $1.242 billion for the three- and nine-month periods ended September 30, 2008, as compared with the same periods of the prior year. The increases were primarily due to increases in salaries and employee benefit costs and other operating expenses. Salaries and employee benefits for the third quarter of 2008 increased significantly in large part because one Bank and its affiliated Associations refined their methodology for deferral of loan origination costs, which caused the recognition of additional salary expense that had previously been deferred. Salaries and employee benefits increased for the nine-month period overall as a result of annual merit and performance-based incentive compensation increases and, to a lesser extent, higher staffing levels at certain System institutions. Other operating expenses increased due, in part, to an increase in purchased services and other general expenses.
The provisions for income taxes were $40 million and $141 million for the three and nine months ended September 30, 2008, as compared with $21 million and $100 million for the three and nine months ended September 30, 2007. The effective tax rate increased from 4.7% for the nine months ended September 30, 2007 to 5.6% for the nine months ended September 30, 2008 primarily due to increased earnings at taxable System institutions.
Loan Portfolio Activity
Gross loans increased $15.157 billion to $158.063 billion at September 30, 2008, as compared with $142.906 billion at December 31, 2007. However, during the third quarter of 2008, gross loans decreased $3.999 billion from $162.062 billion at June 30, 2008, primarily due to a reduction in agribusiness loan volume. During the third quarter, prices for commodities and certain farm inputs decreased, which resulted in customers reducing their borrowings. Agribusiness loan volume had increased in the first six months of 2008 as a result of higher financing demand from grain, farm supply and marketing customers who experienced significant increases in the prices for their commodities.
For the nine months ended September 30, 2008, approximately one-half of the increase in loan volume was attributable to growth in real estate mortgage loans primarily due to continued marketing efforts by System institutions and competitive rates and products. Production and intermediate-term loans, communications loans and energy loans also increased substantially during the nine months ended September 30, 2008. The increase in production and intermediate-term loans was attributable to seasonal crop plantings and to increased demand as borrower needs grew because of rising input costs, such as fertilizer and fuel. The increase in communications and energy loans was driven by increased capital expenditures by these borrowers and the limited sources of financing for these borrowers as a result of the overall tighter credit market conditions.
Credit Quality
The System's accruing loan volume was $157.128 billion at September 30, 2008, as compared with $142.394 billion at December 31, 2007. Nonaccrual loans increased $423 million from December 31, 2007 to $935 million at September 30, 2008. This increase in nonaccrual loans was due, in part, to deterioration in the credit quality of a limited number of loans to borrowers, some of which were adversely impacted by commodity price volatility and higher farm input costs in the current agricultural environment. At September 30, 2008, 42% of nonaccrual loans were current as to principal and interest, as compared with 52% at December 31, 2007. Nonperforming loans (which consist of nonaccrual loans, accruing restructured loans, and accruing loans 90 days or more past due) were $1.029 billion at September 30, 2008, as compared with $621 million at December 31, 2007. These loans represented 0.65% and 0.43% of the System's outstanding loans at September 30, 2008 and December 31, 2007.
"While the overall agricultural economic conditions remained generally positive during this period, the volatility in crop prices and increased cost of certain farm inputs has resulted in higher risk profiles of our borrowers, including livestock producers, producers and marketers of grains and oilseeds, and borrowers that use corn or other grains in their products," noted Mr. Stewart. "In line with these higher risk profiles and the impact from any slowing of the U.S. farm economy as a result of the uncertainty in the global financial markets and the global economy overall, we anticipate that nonaccrual loans will likely increase to a level more consistent with historical averages."
Other credit quality indicators remained generally favorable. Loans classified under the Farm Credit Administration's Uniform Loan Classification System as "acceptable" or "other assets especially mentioned" as a percentage of loans and accrued interest receivable was 97.9% at September 30, 2008, as compared with 98.5% at December 31, 2007. Loan delinquencies (accruing loans 30 days or more past due) as a percentage of accruing loans remained at a low level of 0.36% at September 30, 2008, as compared with 0.43% at September 30, 2007. Net loan charge-offs of $34 million were recorded during the first nine months of 2008, as compared with net loan charge-offs of $26 million for the first nine months of 2007.
The allowance for loan losses was $871 million at September 30, 2008, as compared with $781 million at December 31, 2007. The allowance for loan losses as a percentage of loans was 0.55% at both September 30, 2008 and December 31, 2007. The allowance for loan losses was 85% of the System's total nonperforming loans and 93% of its nonaccrual loans at September 30, 2008, as compared with 126% and 153% at December 31, 2007. Risk funds (total capital and the allowance for loan losses), which is a measure of risk-bearing capacity, totaled $28.756 billion at September 30, 2008 and $27.200 billion at December 31, 2007, and represented 18.2% of System loans at September 30, 2008, as compared with 19.0% at December 31, 2007.
Liquidity and Capital Resources
Cash and investments increased $5.056 billion to $41.516 billion at September 30, 2008, as compared with $36.460 billion at year-end 2007. The Banks' liquidity management objectives are designed to meet maturing debt obligations, to provide a reliable source of funding to borrowers and to fund our operations on a cost-effective basis. As noted above, the global credit markets have experienced significant, negative events and, as a result, the global level of credit availability and investor willingness to purchase debt securities issued by financial institutions has been substantially reduced. Despite these conditions, the Banks have various resources available to meet liquidity management objectives through the debt maturity structure, holdings of liquid assets and expected continued access to the debt capital market as a result of the System's government-sponsored enterprise status and strong financial performance in recent years. At September 30, 2008, the System's liquidity position increased to 174 days, as compared with 122 days at December 31, 2007.
During the third quarter of 2008, one Bank issued $50 million of 8.406% 10-year subordinated debt. In addition, during the second quarter of 2008, another Bank issued $500 million of 7.875% 10-year subordinated debt. The net proceeds from the issuances of subordinated debt were used primarily to increase each of the Bank's regulatory permanent capital and total surplus pursuant to Farm Credit Administration regulations and for general corporate purposes. The debt is subordinate to all other categories of creditors, including any claims of the holders of Systemwide Debt Securities and general creditors, and is senior to all capital stock and surplus. This debt is not a Systemwide Debt Security, and thus is not the joint and several liability of the other Banks, and is not insured by the Farm Credit System Insurance Corporation.