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Author: jackcrow Big gold star, 5000 posts Feste Award Nominee! Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 15  
Subject: Re: Why is the bottom falling out of this stock? Date: 7/9/2002 12:04 PM
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-audited by KPMG, switched to Anderson in 1999, with highly creative accounting

So every firm that has done business with Anderson is/was looking to hide something?

"Second, appraisals of farms are notoriously inaccurate. Farms are businesses with
unstable and unpredictable cash flows, which makes valuations difficult to perform. We
believe that most lenders do not rely heavily on appraisals for this reason."

This is bunk, the people who wrote this report might understand the world of finance but they don't know anything about agriculture. Cash flows aren't as unpredictable as they make them out to be. If that was so most of our farmers wouldn't be in business, especially the big corporate ones. Second they don't understand the appraisals of ag property, which isn't caluculated on its future worth but what its worth on the market today. So the property is appraised at what it's worth, and the farm "business" is often figured as a premium above that.

-mistakenly identified by Bloomberg as AAA rating by Moody's, recently corrected to NR=not rated

The press screws this up but the company is to blame? interesting.

-inadequate capital reserving for bad loans, compared with other lenders

They are after market lenders. So in most instances the report compares apples to grapes. The closest group that they are compared to "Farm Credit Banks" is one of the primary customers buy charter. The reserves can be lower because many of the loans are protected by the USDA. Also most of the ag property is further protected by USDA subsidies. Show me a another group of specialty banks that loan money to a group that has a gauranteed floor for their commodities.

"The irony of the comparison is that these FCBs are the primary customers of Farmer
Mac's LTSPC guarantees. The FCBs are much more conservatively capitalized than
Farmer Mac, with an average of 15.8% capital to total assets,9 and more conservatively
reserved. Yet, the FCBs look to Farmer Mac to insure them against risky loans in their
portfolios."

They either don't get the idea of the program or are intentionaly misrepresenting for their purposes. Without AGM the FCB's would have to be even more conservative and would have less money to loan in the ag. market. At this point in the process AGM is at least three tiers from the original lender w/ some of the risk to the orginal loan built into the compensation for its purchase to the next buyer. They don't just eat bad loans for everyone and anyone.

"For another point of comparison, we compare Farmer Mac's reserves to reserves at large
money center banks. These banks arguably have higher quality, more diversified
portfolios than Farmer Mac, but have reserves which average 161% of non-performing
loans compared with Farmer Mac's 19.5%"

Thats a heck of an arguably. I've watched half full malls sit on the market for a decade. AG. land doesn't sit idle even when its up for sale; Some one is working it and generating revenue from it and its not likely to sit for very long when someone can pick it up and put at the minimum the USDA subsidies in their bank account.

"We believe it is likely that borrowers default because of poor business performance. In
other words, the defaulting loan's underlying collateral is generating insufficient cash
flows to cover debt service, meaning there has likely been a reduction in the collateral
value compared with earlier LTV estimates. As a farm's cash flow declines, its value
necessarily declines.

(bold emphasis mine) So if a poor farmer takes over a piece of property the value of the land goes down? That is exactly what they are saying. They don't get the underlying business. The loan originators have a really good idea what that land is capable of producing and adjust their risk accordingly, that risk is than further mitigated by the experiance of the purchaser and their backers, if any. If the bank has to forclose most of the value of the loan is preserved, because they know what that land can and will produce over time. What they are really at risk for was the mitigation they did for the loan.

"One of the other ways Farmer Mac defends the adequacy of reserves is by referring to the
relatively low level of historical charge-offs. Management, however, can control the
level of charge-offs by retaining rather than selling foreclosed assets and postponing
write-downs. We believe that this may be occurring at Farmer Mac.

If this report carries siginificant wieght it should avoid pure speculation or its motives should be considered suspect. No good study emphasises and then try's defend shear speculation.

"There is a clear trend in the data: with the passage of time, default rates grow."

Duh! pick a loan category and you'll find this to be true. If you want to see scary numbers look a the 2nd and 3rd years of auto loans.

"It is not clear to us which delinquent loans are not “in the process of collection.”"

How about the formal processes describe within the contract and contract law the allow for both sides to be treated fairly while the loan is in default status.

"The introduction of performing loans into an earlier origination year necessarily
obfuscates the delinquency data by increasing the principal amount of performing loans
in the denominator of the delinquency calculation. As a result, the company can
effectively go back in time and “average down” the delinquency data for any distribution
year by adding performing loans under LTSPC."

Which is actualy the point of the excercize. All though its not just data manipulation, its business management. Loans that are stable for 5+ years are a better investment than shorter track records and they free up money for the loan orginators to issue new loans, which is the primary purpose of AGM

"Because a borrower's finances or collateral can deteriorate meaningfully in the six to
twelve months from the time of a borrower's last interest payment, Farmer Mac's loans,
have inherently higher risk than conventional monthly-pay business and real estate loans."

This and the paragraphs preceding it demonstrate more ignorance of the undrlying business the loans support. Farms don't have monthly income, its seasonal. Their cost are higher during spring and fall planting and their gains come from the sales of the commondities. Those commodities are harvested at their peak and sometimes not sold until the price changes to benefit the farmer. A good farmer manages their budget over several years not quarterly, monthly, or even annually. The nature of the business doesn't allow it. I would like to see the writers of this report show hard statistics that demonstrate that farmers fail at a higher rate than other businesses, to back up their claim that the risks on the loans are higer. The payments on the loans are arranged around the revenue cycle of the farmer as are the loans to other businesses.

"Farmer Mac has been criticized for its growth in new “products” out of concern as to
whether these products are within the mission chartered for the company by Congress.
Representative Richard H. Baker, Chairman of the Congressional Subcommittee on
Capital Markets, Securities and Government Sponsored Enterprises stated:"

Its not just AGM but fannie mae and freddi mac that are under scrutiny. This is the banking industry's lobbiest at work. Its proof that these types of corporation can make money and now that the experment is succesful the banking industry wants a bigger part of the pie. I can't fault the banking industry for wanting to contain these three quasi-corporations but its not an indicator of thier potential failure its the opposite.

I partially agree with their assesment of LTSPC's in that they pose a potential risk to AGM's fiscal solidity. To hedge against this the loans these loans are prequalified before they are purchased. But the writers pile up a bunch of ifs to make it look darker than it really is. This is a great tool for primary Ag lenders but not necessarily a good thing for AGM.

Which brings me to the most accurate statement you brought forth
-conflicts of interest in board of directors

All though this is typical of businesses. The board is controlled by people with a vested interest in the earlier stages of Ag. loans. Which from their standpoint makes a great deal of sense. Most of AGM's biggest customers sit on the board, the largest is the chair and CEO. Which makes me question the inteligence of LTSPC's as a business decision for AGM. The flip side of this is that these people have hitched their primary business wagons, their banks, to the solvency of AGM. If AGM disapears they stand to lose alot of money, not just from their stake in AGM. Its a strange quid-pro-quo. And IMHO the greatest risk attatched to investing in AGM

"We believe that underwriting is a core competency of any lender or purchaser of loans
and that contracting it out is antithetical to good business practice. Contracting
underwriting to primary sellers of loans seems risky and fraught with potential for
conflicts."

Here they hit the nail on the head.

"In the recent first quarter earnings press release, Farmer Mac states that it believes that
the new risk-based capital requirements would have been $32.3 million as of March 31,
2002 compared with the existing minimum capital requirements of $112.2 million. We
find it astonishing that, according to Farmer Mac, the risk-based capital standards are
below the current minimum capital requirements and below even the critical capital
requirements of $56.1 million."

Another legitimate point of concern.

"We beg to differ with the company that preferred stock in its Farm Credit Bank
customers is a mission-related asset. Farmer's Mac's mission was to create liquidity in
agricultural mortgages by guaranteeing and securitizing portfolios of qualified loans. Its
mission, as we understand it, is not to make investments in preferred stock of members of
the Farm Credit System. The riskiness of preferred stock in an institution as leveraged as
Gotham Partners Management Co., LLC Page 35
a bank is self-evident. The illiquidity of private preferred could also pose a significant
problem. Finally, we believe the potential conflict in making investments in its
customers is similarly evident."

Board in bed with the banks; this is IMHO abusive use of AGM's chartered purpose. Whether its a good investment or not it is outside the bounds of what AGM ought to be doing, its not a typical free market business, its a chartered entity of the government.

"Farmer Mac has been a significant beneficiary of the recent decline in short-term rates
and the currently steep yield curve because of the mismatch between its short-term
liabilities and long-term assets.30 This has led to a widening of the company's
historically narrow interest margins, greater prepayment penalty gains, and short-term
profits for the company. These earnings, however, have not come without risk. Were
short-term rates to rise substantially, the company would quickly become unprofitable
because of its narrow net interest margin."

This is the core risk of the business model. Its cyclical and the true test IMHO of managements ability to run the company.

I don't understand credit default swaps enough to know if that is truly a fair analogy but the writers have consitently mis-understood the nature of ag business up to this point in the report so I remain in the grey.

-misleading statements in press releases and earnings statements

This is only true if you buy into the rest of the report.

The greatest risk attatched to investing in AGM has just occured. Its a small co. w/ a small # of shares on the market which make it more vulneralbe to manipulation. That combinded with lack of understanding of the core business it supports and of AGM's business model has made for a truly brutal pull back in the price. It isn't possible to educate enough people in a short time to fend off these types of mistatements/misunderstandings. This vulnerability will not go away easily.

Its unfortunate that a well written report such as this can be off target on so many points, while being dead-on on others. In the end I take it with a grain of salt, the report was created by bears/short-sellers to drum up shorting. As such they made some serious leaps and added up a bunch of ifs to overstate the risk vulnerability of AGM. Much, maybe 1/2 of this report is smoke and mirrors.

I was comfortable w/ the risks they assesed correctly and appriciated their throughness in explaining them but truly dissapointed to find out how much they didn't understand but continued to througouhly explain their conjecture as if it carried the same wieght of expertize.

I'm still long on AGM, and I mean long, it will take years for the price to recover from this beating. I believed AGM was overpriced and needed a correction but this wasn't a correction it was game playing for profit at the expense of many. A sad but true aspect of trying to make money in stocks.

jack
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