2005 Financial Report

2005 Financial Report contents

Management's Discussion and Analysis 19

Consolidated Financial Statements 47

Notes to Consolidated Financial Statements 51

Board of Directors 78

Leadership 92

A d v a n c i n g o u r c o m m i t m e n t t o r u r a l a m e r i c a

18

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CoBank 2005 Annual Report Financial Information 19

COBANK, ACB

2005 2004 2003 2002 2001

Consolidated Statement of Income Data Net Interest Income $ 483,391 $ 525,288 $ 542,337 $ 552,505 $ 485,705 Provision for Credit Losses 25,000 49,000 68,572 128,379 95,459 Noninterest Income 52,894 21,462 29,240 38,312 52,929 Noninterest Expenses 143,458 154,959 165,511 158,533 163,663 Provision for Income Taxes 70,110 67,840 75,346 68,706 57,825 Minority Interest in Net Income of

Consolidated Subsidiary - - 1,256 1,463 919 297

Net Income $ 297,717 $ 274,951 $ 260,892 $ 233,736 $ 220,768

Net Income Distributed Patronage Distribution:

Capital Stock and Participation Certificates $ 51,250 $ 67,144 $ 68,970 $ 65,496 $ 71,325 Cash 116,347 92,546 66,078 49,715 41,180 Cash - Special - - - - 15,000 Total Patronage Distribution 167,597 159,690 135,048 115,211 127,505

Preferred Stock Dividends 37,442 37,442 25,348 23,442 12,437 Total Net Income Distributed $ 205,039 $ 197,132 $ 160,396 $ 138,653 $ 139,942

Consolidated Balance Sheet Data Total Loans and Leases $ 26,297,284 $ 23,956,352 $ 24,773,446 $ 21,225,279 $ 20,288,840 Less: Allowance for Credit Losses 437,140 435,981 415,427 407,984 344,624

Net Loans and Leases 25,860,144 23,520,371 24,358,019 20,817,295 19,944,216 Investment Securities 6,533,242 5,901,143 5,243,461 4,886,835 4,260,495 Federal Funds Sold, Securities Purchased

Under Resale Agreements and Other 915,200 1,007,000 825,400 662,800 398,500 Other Assets 526,331 427,368 453,906 593,610 556,881 Total Assets $ 33,834,917 $ 30,855,882 $ 30,880,786 $ 26,960,540 $ 25,160,092

Debt Obligations with Maturities ≤ 1 Year $ 10,281,745 $ 11,055,492 $ 11,070,739 $ 11,801,050 $ 11,061,453 Debt Obligations with Maturities > 1 Year 19,757,053 16,296,987 16,584,942 12,449,796 11,461,975 Other Liabilities 894,045 641,590 443,909 416,463 439,385 Total Liabilities 30,932,843 27,994,069 28,099,590 24,667,309 22,962,813 Preferred Stock 500,000 500,000 500,000 300,000 300,000 Capital Stock and Participation Certificates 1,217,710 1,228,109 1,220,629 1,034,286 1,044,395 Unallocated Retained Earnings 1,232,877 1,140,199 1,062,380 917,726 822,643 Accumulated Other Comprehensive (Loss) Income (48,513) (6,495) (1,813) 41,219 30,241 Total Shareholders’ Equity 2,902,074 2,861,813 2,781,196 2,293,231 2,197,279 Total Liabilities and Shareholders’ Equity $ 33,834,917 $ 30,855,882 $ 30,880,786 $ 26,960,540 $ 25,160,092

Key Financial Ratios For the Year:

Return on Average Common Shareholders’ Equity 11.30% 10.58% 10.85% 10.75% 11.22%Return on Average Total Shareholders’ Equity 10.62 10.01 10.44 10.39 10.99 Return on Average Assets 0.94 0.88 0.85 0.91 0.90 Net Interest Margin 1.52 1.68 1.79 2.17 1.99 Net Charge-offs/Average Loans and Leases 0.09 0.12 0.27 0.31 0.28 Patronage Distributions/Total Average Capital

Stock and Participation Certificates Owned by Active Borrowers 15.79 15.27 12.97 12.20 13.67

At Year End: Debt/Total Shareholders’ Equity (: 1) 10.66 9.78 10.10 10.76 10.45 Total Shareholders’ Equity/Total Assets 8.58% 9.27% 9.01% 8.51% 8.73%Allowance for Credit Losses/Total Loans and Leases 1.66 1.82 1.68 1.92 1.70Permanent Capital Ratio 13.71 15.08 13.67 12.06 12.00Total Surplus Ratio 13.71 15.08 13.67 12.06 11.91Core Surplus Ratio 5.89 6.27 5.71 4.99 4.66Net Collateral Ratio 108.27 108.69 108.46 107.18 107.43

Five - Year Summary of Selected Consolidated Financial Data ($ in Thousands)


COBANK, ACB

COBANK, ACB (COBANK or the Bank) is an Agricultural Credit Bank and is one of the five banks of the Farm Credit System (System), a federally chartered network of borrower-owned lending institutions comprised of cooperatives and related service organizations.

Cooperatives are organizations that are owned and controlled by their members who use the cooperative’s products, supplies or services. The System was established in 1916 by the United States Congress, and is a Government Sponsored Enterprise (GSE).

The following chart depicts the overall structure and ownership of the System.

System annual and quarterly information statements and press releases for the current fiscal year and the two preceding fiscal years, as well as offering circulars relating to System debt securities, are available for inspection at, or will be furnished without charge upon request to, the Federal Farm Credit Banks Funding Corporation, 10 Exchange Place, Suite 1401, Jersey City, New Jersey 07302; telephone (201) 200-8000. These documents are also available online at www.farmcredit-ffcb.com.

We are federally chartered under the Farm Credit Act of 1971, as amended (the Farm Credit Act), and are subject to

supervision, examination and regulation by an independent federal agency, the Farm Credit Administration (FCA). Unlike commercial banks and other financial institutions, we are restricted to making loans and leases and providing related financial solutions to eligible borrowers in the agribusiness and rural utility industries, and to certain related entities. Additionally, we are not authorized to accept deposits. We raise debt funds for our operations primarily through participating in the issuance of debt securities by the System’s Federal Farm Credit Banks Funding Corporation (Funding Corporation).

Management’s Discussion and Analysis

Company Introduction

The Farm Credit CouncilFarm Credit Administration

(Regulator)Farm Credit System Insurance

Corporation (FCSIC)

Congressional Agriculture Committees

Federal Farm Credit Banks Funding Corporation

Congressional Oversight

Regulation/ Supervision/Other

Agent for Banks

System Banks

Farmers, Ranchers, Rural Infrastructure Businesses, Rural Homeowners and Other Eligible Borrowers

U.S. AgBank, FCB

FCB of Texas

AgriBank, FCB

AgFirst,FCB

CoBank,ACB

AssociationsCooperatives and Other

Eligible Borrowers


We are cooperatively owned by our U.S. customers, who consist of agricultural cooperatives, rural energy, communications and water companies, farmer-owned financial institutions called Agricultural Credit Associations (ACAs or Associations) and other businesses that serve rural America. We are the primary funding source for five Associations, which we refer to as our affiliated Associations (each of which are regulated financial institutions and members of the System). These Associations serve specified geographic regions in the Northwestern and Northeastern U.S. ACAs make both long-term real estate loans and short- and intermediate-term loans to their farmer-owners for equipment, working capital and agricultural production purposes and provide other financial services. Our loans to agricultural cooperatives and rural utility systems finance short-, intermediate- and long-term capital requirements. We also provide credit and related services in connection with agricultural export transactions.

We completed another successful year in 2005 during which we achieved record earnings, increased our capital, maintained strong credit quality, continued to improve the effectiveness of core business processes and expanded our relationships with other System institutions.

Our earnings increased to a record $297.7 million for 2005 from $275.0 million for 2004. The eight percent increase was largely driven by improved credit quality and a lower level of losses on early extinguishments of debt, which more than offset the decline in net interest income. Loans and leases outstanding at December 31, 2005 increased to $26.3 billion from $24.0 billion at December 31, 2004. Despite the increase in loan and lease volumes, our net interest income declined to $483.4 million in 2005 compared to $525.3 million in 2004. The decrease in our net interest income reflects reduced margins resulting from the systematic increases in short-term market interest rates and the resulting flatter yield curve, the change in mix and risk profile of our loan portfolio, and a competitive credit pricing environment due to high levels of liquidity in debt funding markets. Our net interest margin decreased to 1.52 percent for 2005 from 1.68 percent in 2004. The overall credit quality of our loan and lease portfolio remains very strong at December 31, 2005. Loans and leases outstanding classified in the two highest credit quality classifications were 97.8 percent of the loan and lease portfolio at both December 31, 2005 and 2004. Our nonaccrual loans and leases decreased to $120 million at December 31, 2005 from $184 million at December 31, 2004. Over the past three years, we have significantly reduced our exposure to certain higher-risk, higher-yield sectors in our Communications and Energy Banking Group portfolio. In particular, we have reduced our exposure to merchant independent power production (merchant IPP) customers due to credit challenges resulting from overcapacity in certain regions of the U.S. Our provision for credit losses has decreased from $68.6 million and $49.0 million in 2003 and 2004, respectively, to $25.0 million in 2005.

Our capital increased approximately $40 million at year end 2005 compared to year end 2004. The increase resulted from the retention of a portion of our earnings. As a result of our strong capital position, we are able to return a substantial portion of our earnings to our customer-owners in the form of patronage distributions. During 2005, we increased the amount of patronage to be paid in cash to our customer-owners in March 2006. We will pay $167.6 million in patronage for 2005, of which approximately $116.3 million will be paid in cash. In addition to the cash patronage, we will make stock retirement payments of $54.6 million. As a result, our customer-owners will receive a total of $170.9 million in cash payments in March 2006. In 2005, we continued to deepen our strategic relationships throughout the System. We continued to expand the breadth of products and services offered to System entities and increased the number of customers utilizing these products and services. In addition, we also expanded our lease partner services provided by our wholly-owned leasing subsidiary, Farm Credit Leasing Services Corporation (FCL). In addition, we participated in other System banks’ direct loans to certain of their affiliated Associations. To enhance our governance and internal controls, COBANK has implemented policies and procedures that mirror the provisions of Section 404 of the Sarbanes-Oxley Act of 2002, Management Assessment of Internal Controls. We continue to monitor corporate governance and reporting best practices and implement enhancements where appropriate. We continued to reengineer and improve the effectiveness of core business processes and expanded our non-credit service offerings in 2005 by using information systems designed to improve and integrate bankwide customer service, lease origination and information management. As a result of the actions taken over the past three years, we believe we are strongly positioned to advance our commitment to rural America and continue to serve the increasingly complex needs of our customer-owners.

Earnings Summary

Key Performance Results ($ in Millions)

Year Ended December 31, 2005 2004 2003

Net Income $ 297.7 $ 275.0 $ 260.9 Net Interest Income 483.4 525.3 542.3 Net Fee Income 44.1 42.1 46.4 Provision for Credit Losses 25.0 49.0 68.6 Net Interest Margin 1.52% 1.68% 1.79%Return on Average Assets 0.94 0.88 0.85 Return on Average Common

Shareholders’ Equity 11.30 10.58 10.85 Return on Average Total

Shareholders’ Equity 10.62 10.01 10.44 Patronage Distributions/Total

Average Capital Stock and Participation Certificates Owned by Active Borrowers 15.79 15.27 12.97

Consolidated Results of Operations

Year In Review


As noted above, our earnings increased in 2005 despite a challenging interest rate environment, which contributed to lower net interest margin and net interest income. Our return on average assets and return on average common and total shareholders’ equity increased in 2005 as a result of the eight percent increase in earnings. Patronage distributions as a percent of total average capital stock and participation certificates owned by active borrowers increased in both 2005 and 2004 due to capital plan enhancements made in 2004 and increased loan volumes. Our net income of $275.0 million in 2004 increased compared to net income of $260.9 million in 2003. The five percent increase was largely due to a lower provision for credit losses reflecting improved credit quality and lower noninterest expenses, partially offset by lower net interest income. Our return on average total shareholders’ equity decreased in 2004 from 2003 mostly due to a higher level of average total shareholders’ equity that reflected a full year’s impact of our $200 million issuance of Series B preferred stock in November 2003 and the retention of a portion of our earnings. Changes in the significant components impacting our consolidated results of operations over the past three years are summarized below.

Changes in Significant Components of Net Income

($ in Thousands) 2005 2004 2003

Net Income, Prior Year $ 274,951 $ 260,892 $ 233,736

Increase (Decrease) in Net Income Due to: Net Interest Income (41,897) (17,049) (10,168)Provision for Credit Losses 24,000 19,572 59,807 Net Fee Income 2,014 (4,289) 2,593

Losses on Early Extinguishments of Debt 25,833 13,601 (37,025) Prepayment Income (3,082) (25,406) 37,406 Other Noninterest Income 6,667 8,316 (12,046)

Operating Expenses 5,386 (3,145) (7,014)Systemwide and Other Noninterest Expenses 6,115 13,697 36 Provision for Income Taxes (2,270) 7,506 (6,640)Minority Interest - 1,256 207

Total Increase In Net Income 22,766 14,059 27,156

Net Income $ 297,717 $ 274,951 $ 260,892

Net Interest Income

Net interest income was $483.4 million for 2005 compared to $525.3 million for 2004. The decline in net interest income in 2005 reflected modest growth in average earning assets, more than offset by lower net interest margin. Lower margins resulted from the systematic increases in short-term market interest rates and the resulting flatter yield curve, the change in the mix and risk profile of our interest-earning assets, and a competitive credit pricing environment due to high levels of liquidity in the debt funding markets. Average earning assets increased slightly to $31.7 billion for 2005, compared to $31.3 billion for 2004. The 1.3 percent increase in average earning assets was primarily driven by increases in loans to Associations, loans to customers within certain energy sectors, and investment securities, partially offset by a decline in international loans and overnight investment funds. Also contributing to the year-over-year decline in net interest income was the resolution of certain significant troubled credits in 2004 resulting in an additional $15.1 million of interest income when compared to 2005. The impact of changes in interest rates and volumes on the change in net interest income is as follows:

Changes in the Components of Net Interest Income

($ in Thousands)

2005 vs. 2004

2004 vs. 2003

Decrease in Net Interest Income Due to:

Interest Earned and Paid, Net $ (57,595) $ (46,868) Change in Average Interest-sensitive

Assets/Liabilities 15,176 26,549 Change in Average Total Shareholders’ Equity 522 3,270

Net Decrease $ (41,897) $ (17,049)


The change in mix of our interest-earning assets includes an increase in loans to our affiliated Associations and participations in the direct loans to non-affiliated Associations, an increase in loans to core rural utility customers, including those in the electric distribution sector, and decreases in loans in the wireless and higher-risk merchant IPP sectors. We have expanded our customer base in our core rural electric, communications and water markets. Loans to these core rural sectors, while producing lower margins, carry a lower risk profile. Our loans to both our affiliated and non-affiliated Association customers have a lower average yield and, therefore, generate a lower net interest margin than loans and leases to non-Association customers. These lower margins are commensurate with the lower overall credit risk of the Associations. The increase in loans to Associations reflects strong loan demand due to generally robust U.S. agricultural markets and the expansion of our participation in other System banks’ loans to certain of their affiliated Associations. Our liability-sensitive position, as more fully discussed under “Corporate Risk Profile - Interest Rate Risk Management” on page 35, provides us with a hedge against prepayments in our fixed-rate investment portfolio and an earnings benefit, assuming an upward-sloping yield curve.

However, the flattening of the yield curve over the past eighteen months has reduced that benefit. Total average loans and leases of $25.3 billion in 2005 were $0.6 billion (two percent) higher compared to 2004, primarily reflecting increases in average loans to Associations and to customers within certain energy sectors. The increases were partially offset by lower average volumes in our international and communications sectors. Average volumes related to our agribusiness segment increased modestly from 2004 to 2005. However, seasonal grain lending volumes in this segment differed significantly in 2005 compared to 2004. In early 2004, loan volumes to certain agribusinesses experienced a larger than normal seasonal increase due to high commodity prices and transportation delays, followed by a considerably greater than normal paydown in late 2004 due to strong farmer cash positions. In contrast, the early 2005 seasonal increase was smaller than normal, as strong farmer cash positions and lower commodity prices incented farmers to hold their grain inventories longer. However, in 2005 we did not experience the seasonal reductions that normally occur during the late summer and early fall. As a result, the year end outstanding balances in our agribusiness segment were approximately $1.0 billion higher at December 31, 2005 than at December 31, 2004.

Average Balances and Rates


Interest IInterest Interest Average Average Income/ Average Average Income/ Average Average Income/

($ in Millions) Balance Rate Expense Balance Rate Expense Balance Rate Expense

Interest-earning Assets Total Loans and Leases $ 25,319 5.06% $ 1,280 $ 24,735 3.91% $ 966 $ 24,431 3.92% $ 957Investment Securities 5,960 3.93 234 5,659 2.97 168 5,283 3.14 166Federal Funds Sold, Securities

Purchased Under Resale Agreements and Other 420 3.10 13 903 1.22 11 563 1.07 6

Total Interest-earning Assets $ 31,699 4.82 $ 1,527 $ 31,297 3.66 $ 1,145 $ 30,277 3.73 $ 1,129

Interest-bearing Liabilities Bonds and Notes $ 26,168 3.78% $ 988 $ 25,226 2.33% $ 587 $ 23,649 2.28% $ 539Discount Notes 1,648 3.09 51 2,467 1.30 32 3,427 1.34 46Other Notes Payable 353 1.42 5 362 0.28 1 493 0.41 2

Total Interest-bearing Liabilities $ 28,169 3.71 $ 1,044 $ 28,055 2.21 $ 620 $ 27,569 2.13 $ 587

Total Shareholders’ Equity $ 2,894 $ 2,847 $ 2,621 Interest Income/Average Interest-

earning Assets 4.82% 3.66% 3.73% Interest Expense/Average Interest-

earning Assets 3.30 1.98 1.94

Net Interest Margin and Net Interest Income 1.52% $ 483 1.68% $ 525 1.79% $ 542


Net interest income declined in 2004 compared to 2003 primarily due to lower net interest margins more than offsetting a $1.0 billion increase in average earning assets. The decline in margins reflects a change in the mix of our interest-earning assets and tighter spreads for our loans and investments in 2004 due to low market interest rates, an overall lower portfolio risk profile and increased market liquidity. The change in mix of our interest-earning assets includes increases in average investments and overnight funds. Investment securities and overnight funds increased due to the opportunistic issuance of designated bonds, the impact of loan paydowns due to declining interest rates and the full year’s effect of adopting a higher minimum liquidity standard. Increases in the level of average investments and overnight funds reduce the Bank’s overall net interest margin as these assets have a lower margin than our loan and lease portfolio. Provision and Allowance for Credit Losses

Our allowance for credit losses reflects our assessment of the risk of probable loss in the loan and finance lease portfolio. Our allowance is maintained at a level consistent with the loss potential identified, considering such factors as loss experience, portfolio quality, portfolio concentrations, current production conditions, and economic and environmental factors specific to our business segments. The provision for credit losses is recorded to bring the allowance for credit losses to a level deemed appropriate based on the factors described above and more fully discussed in the “Critical Accounting Estimates - Allowance for Credit Losses” section on page 44. We believe the allowance for credit losses is adequate as of December 31, 2005. Our provision for credit losses decreased to $25.0 million for 2005 compared to $49.0 million and $68.6 million for 2004 and 2003, respectively. The decrease in 2005 reflects overall improved credit quality and lower provisions in our communications and agribusiness portfolios. The improvement was partially offset by additional reserves for a limited number of loans to customers in our Corporate Finance Division portfolio of large food and agribusiness credits. Net loan and lease charge-offs for 2005 were $23.8 million compared to $28.4 million for 2004 and $65.2 million for 2003. The allowance for credit losses was 1.66 percent of total loans and leases at December 31, 2005, compared to 1.82 percent at December 31, 2004. The decrease resulted from improvements in credit quality resulting from, among other things, the shift in mix of our loan portfolio to lower risk credits as noted previously. As a result of a significant decrease in nonaccrual loans, the allowance represents 365 percent of nonaccrual loans at December 31, 2005 compared to 237 percent at December 31, 2004. See “Corporate Risk

Profile - Credit Quality” on page 33 for further discussion of the improvement in overall credit quality. As further explained in the “Critical Accounting Estimates - Allowance for Credit Losses” section on page 44, in 2004 we refined our methodology for calculating the allowance for credit losses taking into account guidance from the FCA, as well as the Securities and Exchange Commission (SEC) and Federal Financial Institutions Examination Council (FFIEC) guidelines. The refinement in methodology did not have a material impact on our consolidated results of operations. However, a portion of our allowance for credit losses in 2004 was reallocated between two of our operating segments. Noninterest Income

Noninterest income increased to $52.9 million for 2005, compared to $21.5 million for 2004. Noninterest income is comprised primarily of net fee income, loan prepayment fee income and other income, reduced by losses on early extinguishments of debt. The increase in noninterest income principally resulted from a significant decrease in losses on early extinguishments of debt, as more fully discussed below. The increase in noninterest income in 2005 also included a $6.0 million gain on the sale of an acquired property and increased net fee income. Net fee income increased to $44.1 million for 2005, compared to $42.1 million for 2004, due to an increase in syndication fees in our energy and communications portfolios. It is our general practice to extinguish higher cost,

similarly tenored debt to offset the current and prospective impact of prepayments in both the loan and investment portfolios and to maintain the appropriate mix of interest-earning assets and interest-bearing liabilities. During 2005, we repurchased $158 million of our Systemwide debt on the open market, which compares to debt prepayments of $1.8 billion in 2004. Losses on these early extinguishments of debt exceeded prepayment fee income by $1.6 million in 2005 compared to $24.4 million in 2004. The difference was primarily due to losses on early extinguishments of debt related to 2004 prepayments of fixed-rate investment securities, which do not generate offsetting prepayment fee income. During 2003, we recorded losses of $55.3 million on early extinguishments of Systemwide debt and recognized prepayment fee income of $42.7 million. Total noninterest income decreased in 2004 from 2003

primarily due to higher losses on debt extinguishments in excess of prepayment income, partially offset by a $6.0 million asset impairment charge recorded in 2003 related to an acquired property. We subsequently disposed of that property in 2004 and recognized a gain of $1.0 million.


Noninterest Expenses

We focus on balancing expense discipline and investing in our core business processes and their underlying information systems. We make these investments to improve our ability to effectively serve our customers. We are currently focusing our efforts on initiatives designed to enhance our processes and technology to serve our customers as well as System partners. The table below details our operating and noninterest expenses for each of the last three years.

Analysis of Noninterest Expenses ($ in Thousands)


Employee Compensation $ 75,278 $ 69,789 $ 71,714 Insurance Fund Premium 8,494 8,446 19,232 Information Services 16,919 26,435 18,135 General and Administrative 12,108 11,614 7,344 Purchased Services 7,303 6,245 7,294 Occupancy and Equipment 7,567 10,675 6,221 Travel and Entertainment 6,393 6,094 5,947 Farm Credit System Related 5,240 5,390 5,656

Total Operating Expenses 139,302 144,688 141,543 Reaffiliation-related Expenses - - (165)Intra-System Financial

Assistance Expenses 4,156 10,271 24,133 Total Noninterest Expenses $ 143,458 $ 154,959 $ 165,511

Total Operating Expenses/ Net Interest Income + Net

Fee Income 26.4 % 25.5% 24.0%Operating Expenses, Net of

Insurance Fund Premium/ Net Interest Income + Net Fee Income 24.8 24.0 20.8

Total noninterest expenses decreased $11.5 million for 2005 compared to 2004, primarily due to decreased information services, occupancy and intra-System financial assistance expenses. These reductions were somewhat offset by increased employee compensation expense. Intra-System financial assistance expenses represented our share of costs related to financial assistance provided to certain System institutions, which experienced financial difficulties in the 1980s. Our portion of these expenses declined from $10.3 million in 2004 to $4.2 million in 2005 as the final financial assistance obligations matured in June 2005. See Note 9 to the accompanying consolidated financial statements for more discussion on intra-System financial assistance expenses. Total operating expenses decreased to $139.3 million for 2005, compared to $144.7 million for 2004. The decrease is due in part to a significant change in the cost structure of our information services over the past eighteen months. During

that period, we insourced all information technology functions which had previously been performed by an external provider. Our insourcing initiative has resulted in enhanced quality and service levels as well as cost efficiencies, which have served to lessen the impact of increasing expenses related to information security, disaster recovery and other related costs. As part of this initiative, we incurred one-time costs of $5.0 million in 2004. The one-time charge included costs related to terminating the information services outsourcing contract, staffing our information services division and enhancing our technology infrastructure. The decrease in operating expenses was also partially attributable to two other non-recurring expense items recorded in 2004. We incurred $3.6 million of severance, consulting, information services and other expenses during 2004 related to strategic initiatives at FCL. We undertook these initiatives to enhance performance, lower future costs and improve customer service to our core customers, including System Associations. We also incurred $3.4 million in accelerated costs associated with office space vacated by a sublessee at our national office in Denver, Colorado during 2004. Our employee compensation, which primarily includes salaries, incentive compensation and employee benefits, increased in 2005 to $75.3 million from $69.8 million in 2004. The increase was primarily driven by an increase in the number of employees resulting from our initiative to complete insourcing our information technology services, as discussed above. A significant portion of the cost of these services had previously been reflected as a component of information services expenses in the accompanying consolidated statements of income. An increase in incentive compensation due to strong financial performance also contributed to the increase in employee compensation. Insurance fund premium expenses increased slightly to $8.5 million for 2005 from $8.4 million for 2004 due to the increase in average accruing loan volume. Effective January 1, 2006, insurance premium rates on applicable accruing loans were increased from 6 basis points to 15 basis points for the first six months of 2006. The Farm Credit System Insurance Corporation (Insurance Corporation) will review premium rates again in June of 2006; however, if the current assessment continues through 2006, COBANK’s insurance fund premium expenses will increase by approximately $17.0 million in 2006 as compared to 2005. See Note 6 to the accompanying consolidated financial statements for more discussion on the Insurance Corporation and the System insurance fund. General and administrative services expenses increased $0.5 million in 2005 to $12.1 million. The increase primarily relates to increased contributions to trade groups and other organizations, which strengthen our ties to rural communities and the System.


Purchased services expenses increased to $7.3 million for 2005 compared to $6.2 million for 2004, primarily due to increased credit-related legal expenses. Occupancy expenses decreased in 2005 primarily due to accelerated costs recorded in 2004 associated with office space vacated by a sublessee, as previously discussed. In 2005, we recorded an additional $0.7 million in expenses related to this vacated office space. Total operating expenses as a percent of net interest income plus net fee income was 26.4 percent in 2005 compared to 25.5 percent in 2004 and 24.0 percent in 2003. Excluding the impact of insurance fund premium expenses, operating expenses as a percent of net interest income plus net fee income was 24.8 percent in 2005 compared to 24.0 percent and 20.8 percent in 2003. The increase reflects the impact of declining net interest income, notwithstanding a decrease in total operating expenses during 2005. Total operating expenses increased to $144.7 million in 2004 from $141.5 million in 2003. The increase was primarily attributable to non-recurring charges in 2004, which include the insourcing of our information technology services, the expenses related to vacated sublessee office space, our strategic initiatives at FCL and our expenditure to assist a System strategic partner. A decrease in insurance fund premium expenses partially offset these increases. Provision for Income Taxes

Effective tax rates for 2005, 2004 and 2003 were 19 percent, 20 percent and 22 percent, respectively. Such rates were significantly less than the applicable federal and state statutory income tax rates substantially due to tax-deductible patronage distributions. In the third quarter of 2005, we reduced the rate at which we provide for federal and state taxes from a combined 37.5 percent to 36.5 percent. The reduction in the marginal tax rate resulted from a decline in state tax expense due to the resolution of treating certain income as exempt from taxes in certain states. Additionally, the effective tax rate decreased in 2005 due to $4.9 million of state tax refunds related to this matter and $1.3 million of unrelated federal tax refunds. The change in our marginal tax rate also resulted in a net $3.2 million increase to our provision for income taxes in 2005, which included a write-down of our net deferred tax assets of $4.9 million. The effective tax rates for 2005 and 2004 are lower than 2003 due to increased patronage distributions resulting from enhancements made to our capital plan in 2004. We will distribute 46 percent of income before income taxes and minority interest to shareholders as qualified patronage distributions related to 2005, compared to 47 percent distributed for 2004 and 40 percent distributed for 2003.Patronage Distributions

Patronage distributions are determined annually by the Board of Directors and are made in the form of cash, capital stock and participation certificates, as shown in the following table. Eligible shareholders will receive patronage distributions from COBANK for 2005 in the first quarter of 2006. In the fourth quarter of both 2005 and 2004, the Board

of Directors approved enhancements to our capital plan. As a result of these enhancements, patronage distributions as a percent of total average capital stock and participation certificates owned by active borrowers have increased over the past two years, as shown in the following table. These enhancements increased the value of our patronage program to our shareholders, but did not have a significant impact on our capital levels or capital ratios.

Patronage Distributions ($ in Thousands)


Capital Stock and Participation Certificates $ 51,250 $ 67,144 $ 68,970

Cash 116,347 92,546 66,078

Total Patronage Distributions $ 167,597 $ 159,690 $ 135,048

Patronage Distributions/ Total Average Capital Stock and Participation Certificates Owned by Active Borrowers 15.79% 15.27% 12.97%

As an Agricultural Credit Bank, we provide domestic and international financial solutions to farmer-owned cooperatives; farmer-owned financial associations; energy, communications and water customers; and other related businesses. We conduct lending and leasing operations through four operating segments: Agribusiness Banking Group, including FCL (ABG), Strategic Relationships Division (SRD), Global Financial Services Group (GFSG) and Communications and Energy Banking Group (CEBG). Effective January 1, 2005, we made several changes to our organization and related reporting segments to better align our segments with the markets they serve and their related portfolio credit risks. We combined our FCL and former ABG segments into one consolidated ABG segment. We also transferred into this ABG segment our portfolio of purchased participations in loans made by other System Associations that was previously included in SRD. In addition, we combined our Communications and Energy and Water segments into one consolidated CEBG segment. Segment data for prior years has been reclassified to conform to the current year’s presentation. Net interest income on investment securities, federal funds sold, securities purchased under resale agreements and other highly-liquid investments is allocated to all segments, whereas the underlying investment assets are not allocated. Net income by operating segment is summarized in the accompanying table and is more fully disclosed in Note 15 to the accompanying consolidated financial statements. The following tables also provide period-end and average loan and lease amounts, and allowance for credit loss activity by operating segment.

Operating Segment Financial Review


As more fully discussed in “Critical Accounting Estimates - Allowance for Credit Losses” on page 44, in 2004 we refined our methodology for calculating our allowance for credit losses. While this refinement did not materially impact the Bank’s total allowance, it resulted in a reallocation of a portion of the allowance between ABG and GFSG. Excluding the effect of the refinement in methodology, ABG’s and GFSG’s net income in 2004 would have been $103.0 million and $59.5 million, respectively.

Period-end Loan and Lease Portfolio by Operating Segment ($ in Millions)

December 31, 2005 2004 2003 2002 2001

Agribusiness $ 6,884 $ 5,850 $ 6,411 $ 6,193 $ 5,301Strategic Relationships Division 7,848 6,856 6,609 2,170 1,991Global Financial Services 4,770 4,938 5,302 5,962 6,276Communications and Energy 6,795 6,312 6,451 6,900 6,721

Total Loans and Leases $ 26,297 $ 23,956 $ 24,773 $ 21,225 $ 20,289

Average Loan and Lease Portfolio by Operating Segment ($ in Millions)

Year Ended December 31, 2005 2004 2003 2002 2001

Agribusiness $ 6,232 $ 6,123 $ 5,824 $ 5,532 $ 5,372Strategic Relationships Division 7,197 6,701 6,086 2,048 1,908Global Financial Services 5,339 5,530 5,825 6,268 6,326Communications and Energy 6,551 6,381 6,696 6,877 6,201

Total Average Loans and Leases $ 25,319 $ 24,735 $ 24,431 $ 20,725 $ 19,807

Net Income by Operating Segment ($ in Thousands)


Operating Segment:Agribusiness $ 122,672 $ 86,754 $ 106,502 Strategic Relationships

Division 38,106 36,162 31,819 Global Financial Services 39,200 74,903 65,611 Communications and Energy 101,136 92,496 67,155 Total Operating Segments 301,114 290,315 271,087 Corporate/Other (3,397) (15,364) (10,195)

Total $ 297,717 $ 274,951 $ 260,892


Analysis of the Allowance for Credit Losses ($ in Thousands)

2005 2004 2003 2002 2001 Beginning of Year $ 435,981 $ 415,427 $ 407,984 $ 344,624 $ 304,645

Charge-offs: Agribusiness (9,235) (6,670) (17,569) (25,492 ) (44,940) Strategic Relationships Division - - - - -Global Financial Services (4,078) (5,604) (12) (3,890 ) (59) Communications and Energy (28,236) (54,267) (58,195) (48,489 ) (16,126)

Total Charge-offs (41,549) (66,541) (75,776) (77,871 ) (61,125)

Recoveries: Agribusiness 7,196 14,646 9,350 12,580 5,610 Strategic Relationships Division - - - - -Global Financial Services 1,076 990 419 63 35 Communications and Energy 9,436 22,459 829 209 -

Total Recoveries 17,708 38,095 10,598 12,852 5,645 Net Charge-offs (23,841) (28,446) (65,178) (65,019 ) (55,480) Provision Charged to Operations 25,000 49,000 68,572 128,379 95,459Allowance Related to Assumed

Loans and Other - - 4,049 - -End of Year $ 437,140 $ 435,981 $ 415,427 $ 407,984 $ 344,624Allowance/Total Loans and Leases 1.66% 1.82% 1.68% 1.92 % 1.70%Allowance/Nonguaranteed Loans and Leases (Excluding Loans to Associations) 2.63 2.93 2.65 2.53 2.21 Allowance/Impaired Loans and Leases 360 229 121 119 186 Allowance/Nonaccrual Loans and Leases 365 237 130 143 248 Net Charge-offs/Average Loans and Leases 0.09 0.12 0.27 0.31 0.28

Allocation of the Allowance for Credit Losses ($ in Thousands)

December 31, 2005 2004 2003 2002 2001Agribusiness $ 214,707 $ 210,246 $ 155,457 $ 153,907 $ 138,187Strategic Relationships Division - - - - - Global Financial Services 72,420 59,922 86,037 95,429 95,107 Communications and Energy 150,013 165,813 173,933 158,648 111,330

Total Allowance for Credit Losses $ 437,140 $ 435,981 $ 415,427 $ 407,984 $ 344,624


Agribusiness Banking Group (ABG)

Overview

ABG provides financial solutions to cooperatives and noncooperative agribusinesses engaged in agricultural activities, including grain handling, farm supply, food processing, dairy, livestock, fruits, nuts, vegetables, cotton, biofuels and finance. Products and services offered include traditional commercial and industrial loan programs, tax-exempt bond guarantees, leasing, private placements, capital markets solutions and cash management and investment products. To enhance portfolio diversification, ABG participates in agribusiness loans to businesses not structured as cooperatives that are purchased from other System entities and financial institutions. ABG also includes FCL, which provides lease-related financial services to Association partners, agribusinesses, agricultural producers and rural utilities. FCL leases a broad range of equipment, machinery, vehicles and facilities through a variety of tax and non-tax oriented lease products. We have long-standing relationships with most of our agribusiness customers and continue to offer a wide array of financial solutions to meet their changing needs. A significant level of ABG loan volume relates to the financing of seasonal grain inventories. Financing requirements for this seasonal lending are driven by a number of factors, including commodity prices, farmer selling patterns and transportation availability. ABG loan volume generally reaches a seasonal low in August and September before harvest financing demands result in loan volume increases in the late fall of each year, then peaking in the spring. Agribusinesses face increasing regulation, changing consumer demands and evolving globalization of markets. These trends are leading a number of our cooperative customers to consolidate and consider mergers, acquisitions, joint ventures and new alliances while developing different markets and innovative, value-added products. Other cooperatives have elected to change their corporate structure and move away from the traditional cooperative structure. We have responded to these trends by adapting our business to these changing conditions, including expanding relationships throughout the System and with commercial banks. ABG continues to have a significant market share in providing financing to U.S. agribusiness cooperatives. Growth opportunities in this segment include expanding relationships with well-positioned cooperative customers, working together with System Associations to meet the needs of their customers and providing non-credit products and services that add value and further strengthen our long-standing relationships with customers.

Loan and Lease Volume

ABG loans and leases outstanding increased to $6.9 billion at December 31, 2005 from $5.9 billion at December 31, 2004. Average volume increased modestly in 2005 to $6.2 billion from $6.1 billion in 2004. ABG experienced an above normal level of seasonal financing in late 2003 through mid-2004 due to high commodity prices and transportation delays, followed by a considerably greater than normal seasonal decrease in late 2004 as farmer cash positions were strong. The carryover of these strong cash positions into early 2005, coupled with lower commodity prices, led to lower grain inventory levels at agribusinesses and lower than normal seasonal loan demand in early 2005. However, in the second half of 2005, we did not experience the typical seasonal reductions and accordingly, the end of period loan volume was significantly higher at December 31, 2005 than at December 31, 2004.

Credit Quality

We focus considerable attention on asset quality. We manage single borrower hold positions and industry concentrations based on underlying risk. The geographic and business diversity in our portfolio, coupled with disciplined underwriting, reduces the potential for significant credit losses. See “Corporate Risk Profile - Credit Risk Management” on page 32 for a complete discussion of our approach to managing asset quality and credit risk. Credit quality remained high within the ABG portfolio during 2005, however, nonaccrual loans increased to $102.1 million at December 31, 2005 from $87.4 million at December 31, 2004. The increase primarily relates to credit challenges impacting a limited number of agribusiness customers which resulted in their loans being transferred to nonaccrual status in the first quarter of 2005.Earnings

ABG net income increased from $86.8 million in 2004 to $122.7 million in 2005. The increase reflects a $20.0 million adjustment ($16.2 million after tax), recorded in 2004, which resulted from a refinement in our methodology for calculating our allowance for credit losses, as more fully discussed in “Critical Accounting Estimates - Allowance for Credit Losses” on page 44. Excluding the impact of this refinement, ABG net income increased $19.7 million or 19.1 percent. The improvement in earnings primarily resulted from a lower 2005 provision for credit losses due to the overall improvement in credit quality, notwithstanding the increased level of nonaccrual loans noted above. The increase in ABG’s earnings also resulted from an increase in noninterest income. Noninterest income increased in 2005 due to a $6.0 million ($4.7 million after tax) gain on the sale of an acquired property and fewer losses on the early extinguishments of debt as previously discussed in “Consolidated Results of Operations – Noninterest Income” on page 24. An increase in income taxes due to higher pre-tax income partially offset these items.


Strategic Relationships Division (SRD)

Overview

SRD manages the direct funding relationships with our affiliated Association customer-owners (Northwest Farm Credit Services, First Pioneer Farm Credit, Farm Credit of Western New York, Yankee Farm Credit and Farm Credit of Maine), as well as funding relationships with other System institutions. The SRD portfolio primarily consists of loans to our five affiliated Association customers. Associations make primarily long-term real estate loans and short- and intermediate-term loans to their farmer-owners for equipment, working capital and agricultural production purposes. Our five affiliated Associations serve approximately 27,000 customers. We have senior secured interests in the Associations’ assets, which extend to the underlying collateral of the Associations’ loans to their customers. We regularly perform collateral and asset reviews of our five affiliated Association customers in order to monitor compliance with our general financing agreement, appropriate lending guidelines and underwriting standards. Note 18 of the accompanying consolidated financial statements contains selected unaudited financial information of our affiliated Associations and further discussion of our monitoring activities. At December 31, 2005, our SRD portfolio also consisted of $600 million of purchased participations in loans made by two other System banks to certain of their affiliated Associations. SRD focuses its efforts on maintaining strong relationships with the affiliated Associations as a model for further developing other relationships within the System. Lending partnerships with the Associations provide access to a broader set of customers, products, services and capital. The Associations’ strong market presence and local relationship management, combined with our product suite and lending capacity, provide a competitive advantage in attracting and retaining customers in the rural and agricultural sectors.Loan Volume

SRD loans outstanding increased to $7.8 billion at December 31, 2005, compared to $6.9 billion at December 31, 2004. Average loan volume also increased, from $6.7 billion in 2004 to $7.2 billion in 2005. SRD loan volume has increased principally as a result of the overall strength of U.S. agricultural markets. Specifically, increased volume is attributable to growth in various industries and commodities, including dairy, cattle, apples, fisheries, timber and related agricultural services, and growth in real estate mortgage loans. SRD loan volume also increased in 2005 due to the impact of a new loan participation relationship with another System bank.

Credit Quality

The credit quality of the SRD loan portfolio is exceptionally high due to the financial and operating strength of the Associations and the quality and diversification of their loan portfolios. Accordingly, SRD does not have any criticized assets, nonaccrual loans or an allowance for credit losses.

Earnings

SRD net income increased five percent to $38.1 million for 2005 compared to $36.2 million for 2004 due to increased net interest income related to higher loan volume.

Global Financial Services Group (GFSG)

Overview

GFSG includes our Corporate Finance Division portfolio, consisting of large food and agribusiness loans, and our International Division’s lending portfolio. GFSG also provides capital markets products, cash management and business advisory services to our customers. The Corporate Finance Division provides financial solutions that meet the diverse needs of our largest cooperative customer shareholders as well as lending to eligible large food and agribusiness companies who operate businesses similar to our cooperative customers. This latter activity complements our core portfolio by improving risk diversification and opening up new opportunities for capital markets, cash management, business advisory and international services. Our Capital Markets Division supports COBANK’s business segments through its network of participants involved with the syndicated loan market. In 2005, we syndicated or sold approximately $7.4 billion of loan commitments to System entities and other financial institutions to help meet customers’ credit needs and to effectively manage our capital and risk diversification. The Capital Markets Division manages syndications and loan sales with participation from over 140 financial institutions. This includes loans where we are the agent or co-agent as well as our own participations in transactions agented by others where we participate part of our share to other System banks and Associations. The Capital Markets Division works closely with SRD, the Corporate Finance Division and ABG to increase participations purchased from and sold to affiliated and non-affiliated Associations. Our Non-Credit Services Division provides cash management, commercial credit card and merchant card processing solutions through alliances with other financial providers. Our Business Advisory Services Division provides consulting services such as business feasibility studies and market assessments.


The International Division provides tailored short-term and medium-term trade finance to support the export of U.S. agricultural products. The International Division’s borrowers consist primarily of foreign commercial banks in 30 countries (generally emerging markets), exporters who sell and ship U.S. agricultural products to international markets and, in a few cases, the foreign importers themselves. Priority is given to supporting the exports of U.S. farmer-owned cooperatives. Our presence in global markets will remain important as U.S. agriculture increasingly depends on world markets for future growth. To help our customers grow in these markets, the International Division maintains representative offices in Singapore and Mexico City. The U.S. government-sponsored export loan guarantee General Sales Manager (GSM) program provides guarantees for a significant portion of the International Division’s portfolio. The overall loan volume of our International Division is largely driven by the amount of financing available through the GSM program. Any significant change in the U.S. government support and use of the GSM program, while not material to the overall financial results of the Bank, would have a material impact on loan volumes and related fees in the International Division. The use of the GSM program, along with prudent lending practices, results in a high quality international loan portfolio, minimum capital usage and a lower overall net interest margin reflective of the low risk portfolio.

Loan Volume

GFSG’s loans outstanding decreased to $4.8 billion at December 31, 2005 from $4.9 billion at year end 2004, while average loans decreased to $5.3 billion in 2005 from $5.5 billion in 2004. Our Corporate Finance Division portfolio balances increased to $2.5 billion at December 31, 2005 from $2.3 billion at December 31, 2004 due to a combination of loans to new customers and expanding existing relationships. While Corporate Finance balances have increased in total, the portfolio has experienced significant paydowns resulting from a small number of customers sourcing capital in the public equity markets. International loans outstanding decreased to $2.3 billion at December 31, 2005 from $2.6 billion at December 31, 2004 due generally to a lower level of U.S. agricultural exports and reduced or delayed availability of the GSM program. As of December 31, 2005, 74 percent of international loans outstanding were granted under U.S. government guaranteed export lending programs, compared to 78 percent at year end 2004. COBANK works with U.S. government agencies to ensure that the GSM program remains viable and is utilized so that our agricultural exporting customers will continue to benefit from this important financing option.

Credit Quality

Credit quality within the GFSG portfolio is strong, largely due to the high level of government guarantees in the International Division portfolio. We also manage credit exposures and concentrations in the Corporate Finance Division portfolio by selling participations and syndicating transactions. There were no GFSG nonaccruals at December 31, 2005 compared to $8.3 million at December 31, 2004. The decrease resulted from the charge-off of an unguaranteed international loan balance and the repayment of another international loan.

Earnings

GFSG’s net income decreased to $39.2 million for 2005 from $74.9 million for 2004. Excluding the impact of the refinement in allowance for credit losses methodology discussed on page 44, GFSG’s 2004 net income was $59.5 million. The decrease in adjusted net income is largely attributable to an increased 2005 provision for credit losses and to reduced net interest income. The provision for credit losses in 2005 was necessary due to increased risk exposures in the Corporate Finance portfolio. The decline in net interest income was due to lower overall volumes, reduced loan spreads resulting from highly-liquid, competitive debt capital markets and a significant interest recapture in 2004. Lower taxes and fewer losses on early extinguishments of debt partially offset the impact of these items.

Communications and Energy Banking Group (CEBG)

Overview

CEBG provides financial solutions to companies in the energy, communications and water industries. Customers include electric generation and transmission cooperatives, electric distribution cooperatives, independent power producers, rural local exchange carriers, wireless providers, cable TV systems, and water and waste water companies. We provide traditional loan programs, lines of credit, project financing and additional products and services. These products and services include leasing, capital markets solutions and cash management and investment products. The focus for our energy portfolio is to finance plant expansion and acquisition, and to increase market penetration in the electric distribution and generation and transmission sectors. Generation and transmission cooperatives continue to add base load capacity to meet core customer needs. As a result, certain cooperative customers have increased borrowings to acquire and construct additional facilities. We have also significantly expanded our relationships with rural electric distribution cooperatives, resulting in additional loan volume in this sector. We expect continued growth opportunities in the electric distribution and generation and transmission sectors as well as growth in selected energy markets, including project finance and renewables, and infrastructure upgrades in the water industry.


The communications industry continues to experience several challenges including rapidly changing technology, regulatory uncertainty and competition. These factors are resulting in further industry consolidation, particularly in the wireless sector. Rural communications companies are diversifying beyond their traditional services and territories, expanding their fiber optic networks and acquiring other rural exchange and cable TV systems. We are focused on providing financial solutions to rural communications companies who are positioned to provide the correct mix of services, including voice (both wireline and wireless), broadband and video. We expect the financing of capital investment together with the financing of merger and acquisition activity to continue to provide lending opportunities in this sector. We believe that our industry experience and customer knowledge give us a competitive advantage and position us for growth in the rural communications industry. Loan Volume

CEBG loans outstanding increased to $6.8 billion as of December 31, 2005 compared to $6.3 billion as of December 31, 2004. Average loan volume increased by $0.2 billion, to $6.6 billion in 2005 from $6.4 billion in 2004. The increases are primarily the result of increased penetration in the rural electric distribution and rural local exchange sectors.

Credit Quality

Overall portfolio credit quality continued to improve in 2005. Improved credit quality has resulted from our increased focus on lending to core rural utilities and a shift away from higher-risk loans to merchant IPP customers. We also manage credit exposures and concentrations in the CEBG portfolio by selling participations and syndicating transactions. CEBG nonaccrual loans decreased to $17.8 million at December 31, 2005 from $88.2 million at December 31, 2004. This decrease was due to paydowns from two wireless customers and an energy customer, as well as the charge-off of another energy customer’s loan. Earnings

CEBG net income increased to $101.1 million in 2005 from $92.5 million in 2004. The improvement in earnings is due to improved credit quality on slightly higher loan volumes and increased fee income in 2005, partially offset by reduced net interest income. CEBG’s provision for credit losses of $3.0 million in 2005 was $20.7 million lower than the 2004 provision. Similar to ABG and GFSG, CEBG net income also increased due to fewer losses on early extinguishments of debt. Net interest income decreased by $21.4 million in 2005 reflecting interest recapture of a significant nonaccrual loan repaid in 2004, and the shift in mix of our loan portfolio to refocus on our core rural markets, as discussed above. Loans to these core markets produce lower margins, yet carry a lower risk profile.

Managing risk is an essential part of successfully operating our Bank. Our most prominent risk exposures are credit, interest rate, liquidity and operational. Credit risk is the risk of not collecting the amounts due on loans, leases, investments or derivatives. Interest rate risk is the potential reduction of net interest income and the market value of equity as a result of changes in interest rates. Liquidity risk is the possible inability to repay obligations or fund borrowers. Operational risk includes risks related to fraud, legal and compliance matters, processing errors, technology and breaches of internal controls. The following is a discussion of these risks, and our approach to managing them.

Credit Risk Management

Credit risk represents the potential for financial loss resulting from the failure of a borrower or counterparty to honor its financial or contractual obligation. Credit risk occurs in our business activities, including lending, leasing, investing and derivatives activities, and when we act as an intermediary on behalf of our customers. Credit risk arises from changes in a borrower’s ability to repay funds borrowed, changes in a derivative counterparty’s ability to perform under the terms of the contract, changes in collateral values and changes in prevailing economic environments. However, to date, no investment or derivative counterparty has failed in their ability to perform under the terms of the contract. We actively manage credit risk through a structured and centralized credit approval process, a well-disciplined risk management process, a sound credit administration program, and comprehensive credit guidelines and procedures to ensure consistency and integrity. Our most critical element in managing and controlling risk in the extension of credit is the initial decision to make a loan or lease and the structure and terms of the relationship with the borrower. As a result, we place significant emphasis on the evaluation and understanding of a borrower’s management and business, the initial credit analysis and approval process and the resultant need for skills and expertise of lending and credit staffs. The Board of Directors establishes our overall lending policies, and the Credit Group manages our credit approval process pursuant to the board policies. The Credit Group is independent of the lending segments and is led by the Chief Credit Officer. The credit approval process begins with the COBANK Loan Committee (CLC), which has ultimate credit authority as authorized by board policy. The CLC is appointed by the Chief Executive Officer, and includes the Chief Operating Officer, Chief Credit Officer, senior members of the Credit Group and senior executives of each lending segment. CLC meets frequently to act on individual credit actions or administrative matters. The CLC also delegates lending authorities to specific committees at other levels based on size of exposure and risk rating.

Corporate Risk Profile


No single individual is granted credit approval authority within COBANK, except for certain smaller-dollar lease transactions, where one individual may approve a credit action if the transaction first passes a credit scorecard that evaluates credit worthiness. Several minor and specifically described administrative actions as well as small credit requests from existing customers may be approved by as few as two officers, if so designated. All approvals or credit actions taken at the CLC, or any further delegated level, require formal documentation. Additionally, we regularly report loan volume, credit quality trends, strategies and details on significant high-concern or troubled assets to our board. We discuss individual loan issues in more detail with the board’s Loan Review Committee. The Risk Management Division also reports to the board any material issues raised by the Asset Review and Internal Audit Departments. Each borrower is assigned a risk rating using a 14-point scale of 1 (highest quality) to 14 (lowest quality). The rating is primarily determined by the financial characteristics of the borrower and reflects the probability of default driven by factors related to the borrower, including industry risk, management capability and financial condition. The risk rating system, which is intended to provide a relative indication of probability of default, has been validated by third parties. The lending divisions and appropriate loan committee are responsible for the initial assignment of a risk rating and for monitoring and, when necessary, changing the risk rating prospectively. The basis for assignment is described in the Bank’s lending guidelines, which are maintained by the Credit Group. The Asset Review Department of our Risk Management Division reviews assigned ratings for accuracy and conformity with our established guidelines. In the event of a difference in ratings between the lending division and the Risk Management Division, the assigned rating will be derived by the Risk Management Division. We make extensive use of exposure limits to manage risk and volatility in the loan and lease portfolio. Exposure to individual borrowers and related entities is managed through a matrix that considers the dollar exposure, type of exposure and risk rating of the borrower. Individual borrower exposures are examined at the time of each borrower’s formal review, which occurs at least annually. The dollar exposure, risk rating, type and complexity of credit extended further determine the delegated level of authority required to approve the credit. These individual borrower exposures are then further subject to total portfolio limits on exposure to different commodities, industries and countries. Exposures to different commodities, industries or countries are reviewed on a quarterly basis, but we allow for more frequent evaluation when conditions warrant. We also manage credit exposures and concentrations by selling and purchasing loans. Our capabilities in purchasing,

underwriting and selling loans will continue to be critical to managing the portfolio and maintaining market discipline. We take a prudent approach to purchased loans by limiting the size of purchased loans, exiting certain loans, obtaining a better understanding of purchased loan risks and ensuring that loan purchases enhance our risk/return and market discipline profiles. We emphasize cash flow and repayment capacity as primary sources for collection of loans, while collateral is normally considered a secondary source of repayment. In circumstances where the credit decision supplements cash flow with analysis of collateral to repay the loans, independent appraisals may be used to assist in the collateral valuation. Such appraisals are conducted in accordance with FCA regulations and professional appraisal standards. While we believe these standards, processes and tools are appropriate to manage our credit risk, there is no assurance that significant deterioration in credit quality will not occur, which could reduce our earnings. Credit Quality

We are limited to making loans and leases and providing related financial solutions to eligible borrowers in certain specified sectors, as mandated by the Farm Credit Act. As a result, we have a concentration of lending and leasing to the agricultural, energy, communications and water industries. Earnings, loan growth and the credit quality of our loan and lease portfolio can be impacted significantly by the general state of the economy affecting these industries. Although our business is national in scope, regional agricultural economies can be impacted by weather. Extreme seasonal conditions can negatively affect grain harvests, commodity prices and, ultimately, lessen the credit quality of agricultural borrowers. Significant increases in foreign production of agricultural commodities can lead to surpluses and lower commodity prices, which could also ultimately reduce the profitability and credit quality of some of our agricultural customers. Other factors, including U.S. consumer perceptions of the U.S. food supply, can also impact credit quality. Fluctuating weather conditions, such as violent storms or simply a lack of expected cold or hot weather, can reduce electricity usage, which can adversely affect our customers in the energy industry. Further, the pace and degree of the restructuring of the electric energy industry in the U.S., including the lack of open access transmission, may also continue to impact the credit quality of our energy sector loans. The communications industry is impacted by significant competition. Regulatory or legislative change may impact the future competitive position and markets for the communications industry. These factors may place downward pressure on the credit quality of certain sectors of our communications loans.


The U.S. agricultural sector receives significant financial support from the U.S. government through payments authorized under federal legislation. While U.S. government support for agriculture has historically remained consistent, there is no assurance that such financial support will remain at current levels. Although most of our customers do not generally receive direct support from the federal support programs, the significant reduction or elimination of such support would have a negative impact on the credit quality of certain borrowers who derive a significant share of their earnings from farmers who could be affected by such a reduction. Other factors that influence credit risk exposure include, but are not limited to:

• Changes in technology, regulations or shifts in demographics;

• An outbreak of a widespread disease in human or livestock populations;

• The relationship of demand for, and supply of, U.S. agricultural commodities in a global marketplace or electricity and communications services in localized domestic marketplaces; and

• Major international events, such as a downturn in the world economy, military conflicts, political disruptions or trade agreements, which can affect, among other things, the price of commodities or products used or sold by our borrowers or their access to markets.

Approximately $7.8 billion of our total loan and lease portfolio at December 31, 2005 represented direct loans to our affiliated Associations and participations in the direct

loans of non-affiliated Associations. As previously mentioned, the credit quality of these loans is exceptionally high due to the financial and operating strength of these Associations and the quality and diversification of their loan portfolios. Credit Quality Measurements

In general, credit quality measurements as of December 31, 2005 were consistent with those at the end of 2004 and remain strong. Loans and leases classified in the two highest credit quality classifications were 97.8 percent of the loan and lease portfolio at December 31, 2005 and 2004. Total nonaccrual loans and leases decreased to $120 million at December 31, 2005 from $184 million at December 31, 2004 primarily as a result of paydowns and, to a lesser extent, charge-offs in our CEBG segment. Our allowance for credit losses as a percent of total nonguaranteed loans and leases outstanding (excluding loans to Associations) was 2.63 percent as of December 31, 2005 compared to 2.93 percent at December 31, 2004. The decrease resulted from improvements in credit quality resulting from, among other things, the shift in mix of our loan portfolio to lower risk credits as noted previously. See “Critical Accounting Estimates - Allowance for Credit Losses” on page 44 for a more complete description of our process to determine the adequacy of our allowance. Net loan and lease charge-offs for 2005 were $23.8 million compared to $28.4 million for 2004 and $65.2 million for 2003. Net charge-offs for 2005 were primarily related to loans to a limited number of energy customers. The reduction in net charge-offs since 2003 reflects improved credit quality, particularly in our CEBG segment. Gross charge-offs for 2005 were $41.5 million compared to $66.5 million for 2004.


An analysis of high-risk assets is shown in the accompanying table.

Interest Rate Risk Management

In the normal course of our lending, leasing and investment activities, we are subject to interest rate risk defined as the risk of changes to future earnings or long-term market value of equity due to changes in interest rates. This risk arises from differences in the timing between the contractual maturity, repricing characteristics and prepayments of our assets and the financing obtained to fund these assets. While we actively manage our interest rate risk position within policy limits approved by the Board of Directors and strategies established by our Asset/Liability Committee (ALCO), there can be no assurance that changes in interest rates will not adversely impact our earnings and capital. Our asset/liability management objective is to manage the mix of interest-earning assets and interest-bearing liabilities to moderate interest rate risk and stabilize our net interest margin while enhancing profitability and insulating net interest

income and shareholders’ equity from significant adverse fluctuations in market interest rates. The existence of shareholders’ equity that serves as a source of funding for the balance sheet requires us to make decisions about the maturity mix of the assets funded by this equity. Using equity to fund short-term assets results in increased volatility of net interest income, whereas using equity to fund long-term assets results in increased volatility in the market value of our equity. We currently choose to use this equity to fund intermediate-term assets to balance the risks to net interest income and market value of equity. Occasionally, mismatches in interest rate repricing of assets and liabilities arise from the interaction of customer business needs and our investment portfolio and liability management activities. Exposure to changes in the level and direction of interest rates is managed by adjusting the asset/liability mix through the use of various interest rate risk management tools, including derivatives.

Analysis of High-Risk Assets ($ in Millions)

December 31, 2005 2004 2003 2002 2001Nonaccrual Loans and Leases $ 120 $ 184 $ 320 $ 285 $ 139Other Accruing Loans and Leases - - - - 1Accruing Loans and Leases 90 Days or More Past Due - 5 21 49 20Restructured Loans and Leases 1 2 3 10 26Total Impaired Loans and Leases 121 191 344 344 186Other Property Owned - - 10 18 14Total High-Risk Assets $ 121 $ 191 $ 354 $ 362 $ 200


The interest rate gap analysis shown in the following table presents a comparison of interest-earning assets and interest-bearing liabilities in defined time segments as of December 31, 2005. The interest rate gap analysis is a static indicator that

does not reflect future changes in repricing characteristics and may not necessarily indicate the sensitivity of net interest income in a changing interest rate environment.

Interest Rate Sensitivity Analysis at December 31, 2005 ($ in Millions)

One Month or Less

Over One Through

Six Months

Over Six Months

Through One Year

Over One Year but less than

Five Years

Over Five Years and Not Rate Sensitive Total

Interest-earning Assets:Floating-rate Loans: Adjustable-rate/Indexed-rate Loans $ 5,430 $ 1,688 $ 186 $ 263 $ 2 $ 7,569 Administered-rate Loans 5,822 - - - - 5,822Fixed-rate Loans: Fixed-rate Loans (1) 1,801 2,815 820 3,950 3,274 12,660 Fixed-rate Loans, Prepayable (2) 3 9 9 58 47 126Nonaccrual Loans - - - 120 - 120 Total Loans 13,056 4,512 1,015 4,391 3,323 26,297

Investment Securities 2,144 418 499 3,212 260 6,533Federal Funds Sold, Securities Purchased Under Resale Agreements and Other 915 - - - - 915

Total Interest-earning Assets $ 16,115 $ 4,930 $ 1,514 $ 7,603 $ 3,583 $ 33,745

Interest-bearing Liabilities:Callable Bonds and Notes $ 215 $ - $ - $ - $ - $ 215Noncallable Bonds and Notes 4,435 2,752 3,303 14,449 4,205 29,144

Bonds, Master Notes, Medium Term Notes and Discount Notes 4,650 2,752 3,303 14,449 4,205 29,359

Effect of Interest Rate Swaps, Forwards, Futures, etc. 11,818 1,825 (2,352) (10,524) (767) -Cash Investment Services Payable and Other

Interest-bearing Liabilities 666 2 8 - 4 680

Total Interest-bearing Liabilities $ 17,134 $ 4,579 $ 959 $ 3,925 $ 3,442 $ 30,039

Interest Rate Sensitivity Gap (Total Interest-earning Assets less Total Interest-bearing Liabilities) $ (1,019) $ 351 $ 555 $ 3,678 $ 141 $ 3,706

Cumulative Gap $ (1,019) $ (668) $ (113) $ 3,565 $ 3,706Cumulative Gap/Total Interest-earning Assets (3.02)% (1.98)% (0.33)% 10.56% 10.98% (1) Prepayment penalties apply that compensate COBANK for economic losses (2) Freely prepayable or only minimal prepayment penalties apply


Consistent with the negative gap between our interest-earning assets and interest-bearing liabilities as reflected in the interest rate sensitivity analysis on the previous page, our interest rate sensitivity position at December 31, 2005 through the six-month repricing interval may be characterized as “liability sensitive” (i.e., interest rates on the interest-bearing liabilities used to fund assets may change more quickly than interest rates earned on interest-earning assets). Typically, our net interest income, when our position is liability sensitive, will be favorably impacted in a declining interest rate environment and unfavorably impacted in a rising interest rate environment. We currently maintain this position because we believe that over the long-term, the yield curve will remain positively sloped with a positive spread between the rates on short-term interest-bearing liabilities and the rates on intermediate-term interest-earning assets funded with these liabilities. As importantly, this liability sensitive position provides a partial hedge against prepayment risk in our fixed-rate investment portfolio under certain interest rate scenarios. In a falling rate environment, these investment portfolio assets prepay faster than assumed at acquisition and the yield we earn on this portfolio declines as a result. A liability sensitive position allows our short-term interest-bearing liabilities to reprice lower in this falling interest rate environment, thereby providing an offset to the lower yield on our investment portfolio assets. Gap analysis does not incorporate the risk that loan and investment prepayments pose to our business. Asset/liability simulation models are used to evaluate the dynamics of the balance sheet and to estimate earnings volatility under different interest rate environments. These simulations include calculating the impact of significant increases or decreases in interest rates on net interest income and the estimated market value of equity. Another risk measurement is duration gap, which we calculate using a simulation model. The duration gap is the difference between the estimated durations of assets and liabilities. Duration gap summarizes the extent to which estimated cash flows for assets and liabilities are matched, on average, over time. A positive duration gap means there is increased exposure to rising interest rates over the long-term because it indicates that the duration of our assets exceeds the duration of our liabilities. A negative duration gap means that there is increased exposure to declining interest rates over the long-term because the duration of our assets is less than the

duration of our liabilities. We apply the same interest rate process, prepayment models, and volatility assumptions used in our sensitivity analysis to generate portfolio duration gap. The duration gap provides a relatively concise and simple measure of the interest rate risk inherent in our balance sheet, but it is not directly linked to expected future earnings performance. At December 31, 2005, our aggregate positive duration gap was 2.1 months compared to 3.2 months as of December 31, 2004. As previously noted, we maintain a simulation model, which is updated monthly with information on loans, securities, borrowings and derivatives. This “current position” is the starting point for all analysis. The current position data is then combined with base case business plan assumptions and independent, third party economic forecasts for future periods to derive our estimates of future net interest income. We update our net interest income forecast monthly for changing assumptions and differing outlooks based on economic trends and market conditions. Implicit are assumptions about the level of loans, investment securities, borrowings and derivatives for our base case business plan. Generally, we set assumptions on pricing, maturity characteristics and funding mix using trend analysis of actual asset and liability origination data. Net interest income forecasts are derived utilizing different interest rate scenarios. As noted above, we obtain independent market interest rate forecasts when preparing our forecasts. These forecasts are designed around economic forecasts that are meant to estimate the most likely path of interest rates for the planning horizon and alternate views of a rapidly expanding economy, and a dramatically slowing economy. In addition, we review scenarios based on the market’s implied forward rates and unchanged rates. We also review the impact on net interest income of parallel and nonparallel shifts in the yield curve over different time horizons. In addition to calculating the net interest income forecast and duration gap, we estimate our market value of equity utilizing our simulation model. Market value of equity is the net present value of all future cash flows discounted to a valuation date, using discounting factors derived from observed market rates on the same valuation date. The cash flows are based on a “continuity” of business operations perspective rather than a “terminal” value view.


The table below summarizes interest rate risk on net interest income and the market value of equity. In all cases, the underlying assumptions and hedging strategies are held constant so that results are comparable from scenario to scenario. However, actual results would differ to the extent changes in strategy were undertaken to mitigate the impact of interest rate changes.

Our interest rate risk position was less liability sensitive at December 31, 2005 than at December 31, 2004. The change in the rate-risk position is primarily due to lower levels of fixed-rate term assets we chose to fund with short-term liabilities and the issuance of capped floating-rate debt used to fund capped floating-rate investments. Our simulation analysis estimates the effect of immediate and sustained parallel shifts in the yield curve of 100, 200 and 300 basis point changes, except that in 2004 and 2003 downward shocks in a low rate environment were limited to one-half of

the three-month Treasury bill rate. We provide up to a 300 basis point shock in the table above to simulate the effects of extreme scenarios. Our board-established limit dictates that a 200 basis point rate shock cannot cause a change to net interest income or market value of equity of more than 15 percent. At December 31, 2005, 2004 and 2003, we were well within our policy limits as detailed above. When analyzing net interest income at risk, in 2004 we also began estimating the effect of gradual upward or downward changes in market rates (called “ramps”) over a one year period of 100, 200 and 300 basis point changes, where possible. Prepayment risk is minimal on our loans since approximately 99 percent of our fixed-rate loans contain, at a minimum, make-whole prepayment penalties. These provisions require a borrower to compensate us for the cost we absorb in retiring debt funding associated with the prepayment of loans. This allows us to generally match-fund all of our loan assets and eliminates the need to use callable debt to manage the risk of prepayments in the loan portfolio. Prepayment risk in the investment portfolio is moderate based on the type and average life of securities we purchase for the portfolio. Purchases of mortgage-backed securities are currently subject to a price risk eligibility test where the value of the security may not change by more than 13 percent when subject to a 300 basis point immediate rate shock. In addition, fixed-rate mortgage-backed securities other than hybrid-ARMS (adjustable-rate mortgage securities) generally contain some embedded prepayment protection in the form of PAC (planned amortization class) bands at purchase. These bands ensure the securities’ principal payment schedule is within some band of prepayments. Over time, these bands may erode resulting in incremental increase in prepayment risk within the investment portfolio. As the vast majority of our loans reprice in the short-term, our investment portfolio assets are used to produce the desired maturity for the investment of our equity. To the extent the amount of investments we are required to hold for liquidity purposes creates prepayment risk in the investment portfolio, which results in risks to net interest income and market value of equity outside our targeted levels, we offset this risk by funding these fixed-rate investments with short-term debt. Since the risk of early payment occurs in a falling rate environment, short-funding these securities mitigates prepayment risk and avoids high-cost, longer-term debt remaining on the balance sheet without offsetting assets. The amount of investments funded with short-term debt is limited by our overall interest rate risk limits related to variability in our net interest income and market value of equity.

Net Interest Income at Risk

December 31, 2005 2004 2003 Scenario:

- 200 bp shock 0.5 %Not Applicable Not Applicable

- 111 bp shock Not Applicable 2.3% Not Applicable- 100 bp shock 2.1 2.2 Not Applicable -46 bp shock Not Applicable Not Applicable 1.1%

+ 100 bp shock (2.0) (4.3) (3.4) + 200 bp shock (3.7) (8.9) (7.1) + 300 bp shock (6.7) (13.6) (10.7) - 200 bp ramp 1.0 1.5 Not Calculated - 100 bp ramp 0.7 1.4 Not Calculated

+ 100 bp ramp (0.7) (1.6) Not Calculated + 200 bp ramp (1.1) (3.2) Not Calculated + 300 bp ramp (1.6) (4.9) Not Calculated

Market Value of Equity at Risk

December 31, 2005 2004 2003 Scenario:

- 200 bp shock 4.4% Not Applicable Not Applicable- 111 bp shock Not Applicable 4.0% Not Applicable- 100 bp shock 3.1 3.7 Not Applicable -46 bp shock Not Applicable Not Applicable 1.9%

+ 100 bp shock (3.7) (5.0) (4.6) + 200 bp shock (8.0) (10.7) (9.5) + 300 bp shock (12.8) (16.5) (14.5)


Use of Derivatives

We use derivatives as an integral part of our interest rate risk management activities. To achieve risk management objectives and satisfy the financing needs of our borrowers, we execute various derivative transactions with other financial institutions. Derivatives, primarily interest rate swaps, are used to manage liquidity, lower funding costs and manage the interest rate risk arising from maturity and repricing mismatches between assets and liabilities. The notional amounts of derivatives, weighted average interest rates to be received and paid, and their estimated fair value at December 31, 2005 are shown in the following table. Activity in the notional amounts of derivatives is shown separately below. We more fully discuss derivatives in Note 13 to the accompanying consolidated financial statements.

Derivative Financial Instruments at December 31, 2005($ in Millions)

Derivative ProductNotional Amount

Weighted Average Receive

Rate

WeightedAveragePay Rate

EstimatedFair

Value

Receive Fixed Swaps $ 16,630 3.40% 4.31 % $ (304.5) Receive Fixed

Amortizing Swaps 428 4.86 4.15 5.2 Pay Fixed Swaps 676 4.36 3.55 7.3 Pay Fixed Amortizing

Swaps 547 4.23 4.88 (4.6) Other 749 - - 0.2

Total $ 19,030 3.50% 4.29 % $ (296.4)

Activity in the Notional Amounts of Derivative Financial Instruments ($ in Millions)

Swaps Other Total

December 31, 2004 $ 18,139 $ 546 $ 18,685 Additions 6,328 279 6,607 Maturities/Amortizations 6,116 66 6,182 Terminations 70 10 80December 31, 2005 $ 18,281 $ 749 $ 19,030

We have included an analysis of our derivatives portfolio by strategy with further explanation of each strategy in the following section.

Notional Amounts of Derivative Financial Instruments by Strategy ($ in Millions)

December 31, 2005 2004 2003Liquidity Management $ 13,330 $ 12,955 $ 11,255Equity Positioning 2,230 2,358 2,587Lower Funding Cost 730 1,315 1,123Options Risk Management 200 200 215Customer Transactions 2,540 1,857 1,495Total $ 19,030 $ 18,685 $ 16,675

Liquidity Management

A substantial majority of our interest rate swaps are executed to improve liquidity, primarily by converting specific fixed-rate bonds and notes into floating-rate debt indexed to LIBOR, Prime or similar short-term rates. The fixed rate received on the swap largely offsets the fixed rate paid on the associated debt leaving a net floating payment on the swap. This allows us to issue longer-term debt and still match fund the predominantly short-term repricing nature of our interest-sensitive asset portfolio. Liquidity risk management is discussed further on page 40.

Equity Positioning

We also use interest rate swaps to manage interest rate risk on the balance sheet. If the cash flows of loans and investments on the balance sheet are not available to create the targeted maturity for the investment of our equity, we enter into receive-fixed interest rate swaps to produce the desired maturity profile for the investment of our equity.

Lower Funding Cost

In the ordinary course of funding our operations, we have opportunities to issue callable and other fixed-rate term debt and enter into identically offsetting derivative transactions that transform this debt into short-term floating-rate liabilities subject to various call options. These opportunities result in funding costs that have historically been slightly below comparable funding alternatives.

Options Risk Management

In the course of managing risk in the investment portfolio, we may periodically choose to hedge cap riskembedded within our floating-rate investment securities that do not meet our risk management objectives. We enter into offsetting derivative transactions to hedge these types of cap risk. We currently do not hedge prepayment risk due to the composition of the balance sheet and the existence of make-whole prepayment penalties on the majority of our assets.

Customer Transactions

Derivatives are offered to customers as a service to enable them to transfer, modify or reduce their interest rate risk by transferring such risk to us. We substantially offset this risk transference by concurrently entering into offsetting agreements with approved counterparties.

Counterparty Exposure

By using derivative instruments, we are exposed to counterparty credit risk. Credit risk associated with derivatives is measured based on the replacement cost that would be incurred should the counterparties with contracts in a net gain position to us fail to perform under the terms of the contract. We manage this risk through diversification of our derivative positions among various counterparties, use of master netting agreements, requiring collateral to support certain credit exposures, evaluating the creditworthiness of each counterparty and establishing reasonable individual credit exposure limits. We estimate the fair value of all derivative positions monthly and evaluate counterparty credit risk based on the current fair values of our positions.


We also perform stress tests on derivatives using simulation models to better understand the potential effects of market rate changes on fair value, including extreme rate changes. The forward interest rate curves used to project the future expected cash flows for the derivative positions are modeled in potential scenarios of both increases and decreases in interest rates of a magnitude which generate a 99 percent confidence interval that future rate movements will fall somewhere within the range of shocked curves. These extreme rate scenarios are then used to further evaluate potential counterparty credit risk and to establish placement limits. Notwithstanding our credit evaluation process and the maintenance of collateral support annexes with our derivative counterparties, the failure of a counterparty to perform on its obligations could negatively impact our earnings. Furthermore, although our credit evaluations consider the possibility of default by a counterparty, our ultimate exposure to a default by a counterparty could be greater than our credit evaluation predicts. However, we do not expect nonperformance by any of these counterparties. As of December 31, 2005, exclusive of customer transactions, we had no exposure to counterparties as there were no counterparties in a net gain position. The following table details the notional amount of our derivatives and related number of non-customer counterparties classified by their Standard & Poor’s credit rating.

Derivative Counterparties at December 31, 2005 ($ in Millions)

AAA AA A

Total Notional Amount $ 490 $ 13,960 $ 3,405Total Number of

Counterparties 2 14 4

We must continually raise funds to provide credit and related services to customers, repay maturing debt obligations and meet other obligations. Our primary source of liquidity is the ability to issue Federal Farm Credit Banks Consolidated Systemwide bonds, medium-term notes, master notes and discount notes (collectively referred to as bonds and notes) as well as the ability to use cash and convert investments to cash. As a result of the System’s credit quality and standing in the capital markets as a GSE, we have ready access to funding. However, the U.S. government does not guarantee the System’s debt obligations. See Notes 6 and 16 to the accompanying consolidated financial statements for information regarding interest rates and maturities of bonds and notes, and contingencies. Our liquidity management objectives are to meet maturing debt obligations, provide a reliable source of funding to borrowers and fund operations on a cost-effective basis. Approximately 67 percent of our assets mature or reprice in one year or less with 48 percent maturing or repricing in one month or less. Match funding these assets from an interest rate risk perspective would create an unacceptable concentration of short-term liabilities. Instead, we manage this risk by issuing longer-term debt and swapping this debt from a fixed to floating rate using derivative transactions, as previously described. By so doing, we reduce the need to fund maturing liabilities on any given business day to a more manageable level. We believe that sufficient resources are available to meet liquidity management objectives through our debt maturity structure, holdings of liquid assets and access to the agency market via the Funding Corporation.

Liquidity Risk Management

The following table provides a summary of our debt obligations, operating lease payments and other material purchase obligations.

In February 2006, we entered into a new ten-year lease agreement for our national office in Denver, Colorado. As a result of the new agreement, our operating lease commitments increased by approximately $13 million. At December 31, 2005, outstanding commitments to extend credit and commercial letters of credit were $11.4 billion and $158 million, respectively. In addition, we provide standby letters of credit, which guarantee payment or performance of an

obligation. As of December 31, 2005, the maximum potential amount of future payments that we may be required to make under standby letters of credit was $979 million. Since most of these commitments are expected to expire without being drawn upon, the total commitments do not necessarily represent future cash requirements. See Note 11 to the accompanying consolidated financial statements for a full discussion of financial instruments with off-balance sheet risk.

Contractual Obligations as of December 31, 2005 ($ in Millions)

Payments Due by Period

One Year Over One Through

Over Three Through Over

Or Less Three Years Five Years Five Years Total

Bonds and Notes $ 10,282 $ 10,451 $ 4,816 $ 4,490 $ 30,039 Operating Lease Payments 8 10 1 1 20 Other Purchase Obligations 9 - - - 9

Total $ 10,299 $ 10,461 $ 4,817 $ 4,491 $ 30,068


We monitor our liquidity position by calculating the number of days into the future we could fund operations and meet obligations without the ability to issue debt. Our liquidity policy requires us to maintain a minimum of 90 days of liquidity (cash and readily marketable investments generally discounted by 5 to 10 percent of market value) on a continuous basis with an operating target of 180 days. The accompanying table details debt maturities over various time periods and provides data for comparison to the size of our investment portfolio, which, assuming no ability to issue debt, would serve as our primary source of liquidity. At December 31, 2005, our liquidity was 195 days, compared to 199 days at December 31, 2004. Our average liquidity was 177 days in 2005 compared to 183 days in 2004.

Debt Maturities ($ in Millions)

Book Par 1 Day $ 674 $ 674

2-7 Days 407 4078-30 Days 1,287 1,290

31-90 Days 2,381 2,38891-180 Days 1,046 1,047

181-365 Days 4,487 4,5321-5 Years 15,267 15,555

Over 5 Years 4,490 4,479 Total $ 30,039 $ 30,372

We also maintain a liquidity plan covering certain contingencies in the event our access to normal funding mechanisms is not available. We purchase only high credit quality investments to ensure our investment portfolio is readily marketable and available to serve as a source of funding in the event of disruption of our normal funding mechanisms. Our liquid investment portfolio can also be used as collateral to borrow funds to cover maturing liabilities. We have also identified certain portions of our loan portfolio that could be sold, participated or securitized within the period of time our investment portfolio would serve as our primary source of funding. These loan portfolios serve as an additional source of liquidity and would allow us to extend the period of time over which we would not need to access the agency funding market.

Operational Risk Management

Operational risk is inherent in all business activities and the management of this risk is important to the achievement of our objectives. Operational risk represents the risk of loss resulting from conducting our operations including the execution of unauthorized transactions by employees, errors relating to transaction processing and technology, breaches of internal control systems and compliance requirements and the risk of fraud by employees or persons outside our Bank. This risk of loss also includes the potential legal actions that could arise as a result of operational deficiency, noncompliance with regulatory standards, adverse business decisions or the risk of customer attrition due to negative publicity. In the event of a breakdown in the internal control system, improper operation of systems or improper employee actions, the Bank could suffer damage to its reputation, incur financial loss or face regulatory action. We rely on sound, well-controlled business policies and processes, and well-trained and experienced employees to manage operational risk. We utilize a risk management framework and internal control processes. Under this framework, business segments have direct and primary responsibility and accountability for identifying, controlling and monitoring operational risk. Business managers maintain controls with the objective of providing proper transaction authorization and execution, proper system operations, safeguarding of assets from misuse or theft and ensuring the reliability of financial and other data. Business continuation and disaster recovery planning is also important to effectively manage our operational risks. Each critical business unit is required to develop, maintain and test such plans at least annually to ensure that recovery activities, if needed, could sustain critical functions including technology, networks and information supporting customers and business operations. Our corporate Risk Management Division is responsible for, among other matters, coordinating the completion of ongoing risk assessments, ensuring that operational risk management is integrated into business decision-making activities and determining the scope and level of review performed by the internal audit function. Our internal audit function validates the system of internal controls through risk-based, regular and ongoing audit procedures, and reports on the effectiveness of internal controls to executive management and the Audit Committee of the Board of Directors. While we believe that we have designed effective policies and procedures to minimize operational risks, there is no absolute assurance that business disruption or operational losses would not occur in the event of a disaster.


Joint and Several Liability for the Debt of the Farm Credit System

We, along with the other banks in the System, obtain funds for our lending operations primarily from the sale by the Funding Corporation of debt securities. Systemwide debt securities are not obligations of, and are not guaranteed by, the U.S. government or any agency or instrumentality thereof. Under the Farm Credit Act, each System bank is primarily liable for the portion of the Systemwide debt securities issued on its behalf. At December 31, 2005, we were primarily liable for $29.4 billion of the Systemwide debt securities. Additionally, each System bank is contingently liable for Systemwide debt securities of the other System banks. Although the System banks have established mutual covenants and measures which are monitored on a quarterly basis, there is no assurance that these would be sufficient to protect a System bank from liability should another System bank default and the insurance fund be insufficient to cure the default. At December 31, 2005, the total aggregate principal amount of the outstanding Systemwide debt securities was $112.7 billion. The insurance fund (which totaled $2.1 billion as of December 31, 2005) is available from the Insurance Corporation to ensure the timely payment by each System bank of its primary obligations on the Systemwide debt securities. Under the Farm Credit Act, before joint and several liability can be invoked, available amounts in the insurance fund would be exhausted. There is no assurance, however, that the insurance fund would have sufficient resources to fund a System bank’s defaulted obligations. If the insurance fund is insufficient, then the remaining System banks must pay the default amount in proportion to their respective available collateral positions. Available collateral approximates the amount of total shareholders’ equity of the System banks. The Insurance Corporation does not insure any payments on any class of our stock, participation certificates or preferred stock. To the extent we must fund our allocated portion of another System bank’s portion of the Systemwide debt securities due to a default, our earnings and total shareholders’ equity would be negatively impacted. See Note 6 to the accompanying consolidated financial statements for more information on the Insurance Corporation and insurance fund. Our Funding Costs Would Increase if the Farm Credit System Lost its Status as a Government Sponsored Enterprise

As a member of the System, we benefit from the highly liquid, low cost debt funding available to us through the Funding Corporation. We (as well as the other System banks)

are not authorized to accept deposits and therefore do not use deposits as a funding source. Instead, we raise debt funds for our lending and leasing activities and operations primarily through the Systemwide debt securities issued by the Funding Corporation. The System is a GSE and its debt, which is publicly issued through the Funding Corporation, is rated Aaa by Moody’s Investors Service, Inc. and AAA by Standard & Poor’s Ratings Services, Inc. We are a direct beneficiary of this high investment grade rating as it relates to the cost of the Systemwide debt securities. The U.S. Congress continues to examine the funding advantage afforded to certain GSEs. In recent years, the Federal National Mortgage Association (Fannie Mae), the Federal Home Loan Mortgage Corporation (Freddie Mac) and the Federal Home Loan Bank system have come under public and Congressional scrutiny as to the appropriateness of the implicit funding perquisites afforded to GSEs. Although it has not been the subject of specific Congressional scrutiny, and is not subject to the jurisdiction of the same congressional committees as the housing GSEs, the System could become subject to similar scrutiny. In the unlikely event the System lost its status as a GSE, we believe such an event would occur over time and would result in increased funding costs and reduced earnings.

We use our capital and both short-term and long-term borrowings to fund our assets. Other than $680 million of cash investment services obligations and other notes payable, our debt represents COBANK’s portion of Systemwide bonds and notes. Our bonds and notes were $30.0 billion at December 31, 2005, an increase of $2.6 billion from $27.4 billion at December 31, 2004. Refer to Note 6 of the accompanying consolidated financial statements and the “Corporate Risk Profile - Liquidity Risk Management” section on page 40 for additional information regarding bonds and notes. Investment securities, federal funds sold, securities purchased under resale agreements and other highly-liquid holdings are primarily held for the purposes of maintaining a liquidity reserve, managing short-term surplus funds and managing interest rate risk. As detailed in Note 5 to the accompanying consolidated financial statements, in accordance with board approved policies, we purchase only high credit quality investments to ensure the portfolio is readily marketable and available to serve as a source of funding in the event of disruption to our normal funding mechanisms.

Other Risk Factors

Liquidity and Capital Resources


Investment securities are reported at estimated fair value on the consolidated balance sheets and include unrealized losses, net of deferred taxes, of $50.0 million and $7.3 million at December 31, 2005 and 2004, respectively. Changes in the fair values of these investments are accounted for as a component of accumulated other comprehensive loss. We recorded an unrealized loss of $42.7 million, net of deferred taxes, for 2005 compared to $4.0 million for 2004. These unrealized losses result from changes in interest rates and are not due to credit risk. See Note 5 to the accompanying consolidated financial statements for a complete discussion of how we determined that these unrealized losses are temporary in nature. Investment securities increased to $6.5 billion at December 31, 2005, compared to $5.9 billion at December 31, 2004. Federal funds sold, securities purchased under resale agreements and other highly-liquid holdings were $0.9 billion at December 31, 2005 and $1.0 billion at December 31, 2004. See the “Corporate Risk Profile - Liquidity Risk Management” section for further discussion of our investment and liquidity policies.

Derivatives are recorded at fair value as assets or liabilities on the consolidated balance sheets. Changes in the fair value of these derivatives are accounted for as gains or losses through current period earnings or as a component of accumulated other comprehensive income (loss), depending on the use of the derivatives and whether they qualify for hedge accounting treatment. Changes in the fair value of derivatives recorded in the consolidated statements of income totaled gains of $6.3 million for 2005 compared to $3.7 million for 2004. Changes in the fair value of derivatives recorded as other comprehensive income (loss) totaled gains, net of deferred taxes, of $2.5 million for 2005 compared to $0.1 million for 2004.

A sound capital position is critical to our long-term financial success and future growth. We are capitalized by our common stockholders (including Associations), preferred stockholders and unallocated retained earnings. Shareholders’ equity increased $40 million during 2005. This increase was primarily due to earnings of $298 million, reduced by $116 million in accrued cash patronage, $67 million in 2005 equity retirements, $37 million in preferred stock dividends and a $42 million increase in accumulated other comprehensive loss. We, along with other System banks, are subject to regulatory oversight by the FCA. Under the Farm Credit Act, a number of rules and regulations are imposed on the operations of the System banks, including requirements to maintain a minimum permanent capital ratio, total surplus ratio, core surplus ratio, and net collateral ratio. If these standards are not met, the FCA could impose restrictions, including restricting shareholder access to capital and limiting a System bank’s ability to pay patronage distributions and preferred stock dividends. As displayed in the following table, at December 31, 2005, 2004 and 2003, we significantly exceeded the minimum regulatory requirements, which are noted parenthetically. The permanent capital and core surplus ratios decreased during 2005 due to increases in loans and commitments outstanding. We more fully discuss capital resources and compliance with regulatory

capital adequacy standards in Note 7 to the accompanying consolidated financial statements.

Selected Capital Information ($ in Millions)

As of December 31, 2005 2004 2003

Total Shareholders’ Equity $ 2,902 $ 2,862 $ 2,781

Total Shareholders’ Equity/ Total Assets 8.58 % 9.27% 9.01%

Permanent Capital Ratio (7.00%) 13.71 15.08 13.67Total Surplus Ratio (7.00%) 13.71 15.08 13.67Core Surplus Ratio (3.50%) 5.89 6.27 5.71Net Collateral Ratio (103.00%) 108.27 108.69 108.46

The Board of Directors and management are committed to preserving a strong capital base. We pay particular attention to balancing patronage distribution levels with the retention of earnings to build unallocated retained earnings. Maintaining a strong capital base enables us to more conservatively leverage capital while accommodating quality asset growth related to increasing customer needs. In conjunction with the annual financial planning process, the Board of Directors reviews and approves a capital adequacy plan. The board determines a targeted equity level based on projected asset levels, earnings, economic conditions, possible credit losses and other contingencies. The board also balances the amount required to properly capitalize the Bank with the desire to distribute a level of patronage that provides appropriate returns to our customer-owners. When setting capital adequacy targets, the board considers the following: risk diversification of the loan portfolio, anticipated future capital needs, equity levels required of the Bank’s proprietary economic capital model, the Bank’s capital levels in comparison to commercial banks and the regulatory minimum capital standards. As part of this process, the Board also evaluates the Bank’s projected financial performance under various scenarios, including unanticipated loan growth and prolonged periods of financial stress. As of December 31, 2005, internal capital ratio targets were 11 percent for the permanent capital and total surplus ratios, and 5 percent for the core surplus ratio. During 2005, the Board of Directors approved certain changes to our primary loan-based capital plan. The target equity level remains at ten percent of the historical five-year average loan volume. However, effective for 2005 patronage to be paid in 2006, the level of cash patronage to be distributed was increased to 80 percent for stockholders whose equity level is greater than seven percent and to 50 percent for the remaining stockholders. In addition, beginning in 2006, patronage and stock retirement payments will be combined and made annually in March. Previously, stock retirement payments were made quarterly. No changes were made to the capital plans governing loans to affiliated Associations or for loans to certain other System institutions.


During 2004, the Board of Directors approved substantial enhancements to our loan-based capital plan for our customer-owners. While there was no change to the capital plan governing loans to Associations who borrow directly from us, a new capital plan was established in 2003 for participation loans purchased from other System banks, which represent direct loans to certain of their Associations. Our capital plan changes continue to demonstrate our commitment to our customer-owners. While we have a history of paying cash patronage and retiring excess equity, all such payments require the approval of our Board of Directors. In order to solidify our capital position in conjunction with our capital management strategy, in 2001 the Board of Directors authorized the issuance of up to $500 million of preferred stock. We issued $300 million and $200 million of preferred stock in 2001 and 2003, respectively. Our Series A and Series B cumulative perpetual preferred stock pays cumulative dividends quarterly at fixed rates of 7.814 percent and 7.000 percent, respectively, per annum of the $50 per share par value. Our Series A and Series B preferred stock is not mandatorily redeemable at any time, but may be redeemable, at our option, at par value, beginning July 1, 2011 and January 2, 2009, respectively. Our preferred stock is more fully discussed in Note 7 to the accompanying consolidated financial statements.

Management’s discussion and analysis of the financial condition and results of operations are based on the Bank’s consolidated financial statements, which we prepare in accordance with accounting principles generally accepted in the United States of America. In preparing these financial statements, we make estimates and assumptions. Our financial position and results of operations are affected by these estimates and assumptions, which are integral to understanding reported results. Note 2 of the accompanying consolidated financial statements contains a summary of our significant accounting policies. We consider certain of these policies to be critical to the presentation of our financial condition, since they require us to make complex or subjective judgments that affect the value of certain assets and liabilities. Some of these estimates relate to matters that are inherently uncertain. Most accounting policies are not, however, considered critical. Our critical accounting policies relate to determining the level of the allowance for credit losses, the valuation of financial instruments with no ready markets and assumptions affecting pension expense and obligations. Management has reviewed each of the critical accounting policies with the Audit Committee of the Board of Directors.

Certain of the statements below contain forward-looking statements, which are more fully discussed on page 46.

Allowance for Credit Losses

We maintain an allowance for credit losses at a level we consider adequate to provide for probable and estimable credit losses within the loan and finance lease portfolio. Senior-level committees approve specific credit and allowance-related activities. The Audit Committee of the Board of Directors reviews and approves the year end allowance for credit losses prior to final approval by the Board of Directors. The allowance is based on our regular evaluation of our loan and finance lease portfolio. We establish the allowance for credit losses attributed to loans and finance leases via a process that begins with estimates of probable loss within the portfolio. Our methodology generally consists of analysis of specific individual credits and evaluation of the remaining portfolio. We evaluate significant individual credit exposures, including adversely classified loans and leases, based upon the borrower’s overall financial condition, resources, payment record and projected viability. We also evaluate the prospects for support from any financially viable guarantors and the estimated net realizable value of any collateral. Reasonably possible near-term changes in certain assumptions underlying this critical accounting estimate could increase or decrease our provision for credit losses. Such a change would increase or decrease net income and the related allowance for credit losses. If we had made different assumptions about probable credit losses or recovery rates, the Bank’s financial position and results of operations could have differed materially. To analyze the impact of assumptions on the level of our allowance for credit losses and the related provision expense, we changed certain critical assumptions to reflect the impact of deterioration or improvement in credit quality. For each one percentage point increase or decrease in our estimated loss given default rates, our expected losses would increase or decrease by $11.5 million. In April 2004, the FCA, the System’s regulator, issued an “Informational Memorandum” to System institutions regarding the criteria and methodologies that would be used in evaluating the adequacy of a System institution’s allowance for credit losses. The FCA endorsed the direction provided by the FFIEC and the SEC and indicated the conceptual framework addressed in their guidance would be included as part of their examination process. In 2004, we completed studies and refined our methodology for calculating our allowance for credit losses, taking into account FCA, SEC and FFIEC guidelines. While this refinement in methodology did not materially impact our allowance, it did result in a reallocation of a portion of the allowance between two of our operating segments in 2004.

Critical Accounting Estimates


Valuation of Financial Instruments with No Ready Markets

We apply various valuation methodologies to assets and liabilities that often involve a significant degree of judgment, especially when no ready markets exist for the specific assets and liabilities being valued.

All of our investment securities are classified as “available-for-sale” and are reported at their estimated fair value on the consolidated balance sheets. Interest rate swaps and other derivative instruments are also carried at fair value on the consolidated balance sheets. We recognize changes in the fair value of investment securities in accumulated other comprehensive income (loss), a component of shareholders’ equity. We record changes in the fair value of derivatives in accumulated other comprehensive income (loss) or current period earnings, depending on the use of the derivative and whether it qualifies for hedge accounting. When available, quoted market prices provide the best indication of fair value. If quoted market prices are not available, we determine an estimated fair value by discounting future cash flows using market interest rates commensurate with the credit quality and maturity of our financial instruments. Estimates using these methods are subjective. The determination of fair value considers various factors, including time value and volatility factors underlying derivatives, price activity for equivalent synthetic instruments, counterparty credit quality and the potential impact on fair value of liquidating our positions in an orderly manner over a reasonable period of time under current market conditions. Changes in assumptions could affect the fair values. For our investment securities, fair values are determined based upon readily quotable market prices. For our derivative positions, we calculate an estimated fair value using a quantitative pricing system with externally verifiable model inputs. All financial models, which we use for updating the financial statements or for independent risk monitoring, are periodically reviewed and validated in accordance with our policies. The reported amounts of investment securities and accumulated other comprehensive income (loss) could increase or decrease with no effect on net income, based on possible near-term changes in certain assumptions underlying critical accounting estimates related to investment securities. The reported amounts of derivatives, accumulated other comprehensive income (loss) and net income could increase or decrease based on possible near-term changes in certain assumptions underlying critical accounting estimates related to derivatives.

Pensions

We have funded qualified defined benefit pension plans, which are noncontributory and together cover substantially all our employees. We also have a noncontributory, unfunded non-qualified defined benefit Supplemental Executive Retirement Plan (SERP) covering a limited number of our executives and senior managers. We record pension expense for all plans as part of employee compensation expense. Pension expense is determined by actuarial valuations based on assumptions that are evaluated annually as of the measurement date for our pension obligations. The most significant assumptions are the long-term expected rate of return on the plans’ assets and the discount rate used to determine the present value of pension obligations. We have established the current year assumptions related to the accounting for the plans based on our review of current market conditions and our view of anticipated long-term market conditions.

The expected rate of return on the plans’ assets was 8.0 percent at September 30, 2005 and 2004. Assumptions for the expected rate of return on our plans’ assets focus on a weighted range of anticipated rates of return by asset class based on target asset allocations. We consider the expected rate of return to be a longer-term assessment of return expectations and do not anticipate changing these assumptions annually unless there are significant changes in economic conditions. In calculating pension expense for the plans and in determining the expected rate of return, we use the calculated value of assets, which phases in investment gains and losses over a five-year period. For 2005, if the expected rate of return on the plans’ assets had been increased or decreased by one percent, net pension expense for the plans would have decreased or increased by $0.8 million.

At September 30, 2005, the discount rate used to determine our pension plan obligations was 5.25 percent, compared to 6.00 percent at September 30, 2004. We selected the discount rate for the pension plans by reference to Moody’s Aa Long-term Corporate Bond Yield, actuarial analyses and industry norms. For 2005, if the discount rate had been increased by one percent, net pension expense would have decreased by $0.3 million. If the discount rate had been decreased by one percent, net pension expense would have increased $1.0 million. Pension expense for 2005 and the assumptions used in that calculation are presented in Note 8 to the accompanying consolidated financial statements.


Our Board of Directors and management are committed to continuing our strong financial and operating performance and to fulfilling our mission, as Rural America’s Cooperative Bank, to be the preferred provider of financial solutions for our customers to enhance their business success. To a large degree, our ability and the System’s ability to access the capital markets is linked to the confidence investors have in our system of controls and governance processes. We are committed to proactively evaluating and enhancing our own governance and disclosure practices. While the Sarbanes-Oxley Act of 2002 does not apply directly to us, COBANK has voluntarily adopted policies and procedures that mirror its material provisions, to the extent they are not inconsistent with our cooperative structure. We continually evaluate our internal controls and governance to ensure the use of “best practices.” Our future growth and diversification will be achieved by delivering on our value proposition, creating opportunities to work constructively with other System institutions, increasing market share, improving competitiveness, optimizing current lending authorities and pursuing various strategic alliances with other financial services organizations. We will enhance our strong financial condition through the continuation of strong earnings, effective risk management and increased shareholders’ equity through the retention of a portion of our earnings. We will continue to closely monitor asset quality and emphasize effective management of credit risk, interest rate risk, liquidity risk and operational risk. Rising short-term market interest rates, a flatter yield curve, the changing mix of our interest-earning assets toward lower risk and lower spread business and strong competition due to the continued high levels of debt capital available in the market are likely to continue to pressure our net interest margin and earnings. Increased insurance fund premiums will also negatively impact earnings in 2006. However, as our portfolio mix continues to evolve to a higher level of lending to those customers in our core rural markets, we believe our overall portfolio credit quality will continue to be strong.

Certain of the statements contained in the 2005 Annual Report that are not historical facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act. Our actual results may differ materially from those included in the forward-looking statements that relate to our plans, projections, expectations and intentions. Forward-looking statements are typically identified by words such as “believe,” “expect,” “anticipate,” “intend,” “estimate,” “plan,” “project,” “may,” “will,” “should,” “would,” “could” or similar expressions. Although we believe that the information expressed or implied in such forward-looking statements is reasonable, we can give no assurance that such projections and expectations will be realized or the extent to which a particular plan, projection or expectation may be realized. These forward-looking statements are based on current knowledge and are subject to various risks and uncertainties, including, but not limited to: fluctuations in the agricultural, communications, energy and water, international and leasing industry sectors; weak U.S. and global economic conditions; sovereign or regulatory actions; macro-economic factors and political policies and developments in the countries in which we make loans; the level of interest rates; changes in assumptions underlying the valuations of financial instruments; changes in our estimates underlying the allowance for credit losses; economic conditions and credit performance of the loan and lease portfolios, portfolio growth and seasonal factors; the effect of banking and financial services reforms; possible amendments to, and interpretations of, risk-based capital guidelines and reporting instructions; the ability of states to adopt more extensive consumer privacy protections through legislation or regulation; the resolution of legal proceedings and related matters; and nonperformance by counterparties to our derivative positions.

Business Outlook Forward Looking Statements


COBANK, ACB


Interest Income

Loans and Leases $ 1,279,856 $ 965,962 $ 957,387Investment Securities 234,456 167,428 165,995Federal Funds Sold, Securities Purchased

Under Resale Agreements and Other 13,490 11,356 6,216

Total Interest Income 1,527,802 1,144,746 1,129,598

Interest Expense 1,044,411 619,458 587,261

Net Interest Income 483,391 525,288 542,337Provision for Credit Losses 25,000 49,000 68,572

Net Interest Income After Provision for Credit Losses 458,391 476,288 473,765

Noninterest Income / Expense Net Fee Income 44,137 42,123 46,412Prepayment Income 14,209 17,291 42,697Losses on Early Extinguishments of Debt (15,844) (41,677 ) (55,278)Other, Net 10,392 3,725 (4,591)

Total Noninterest Income 52,894 21,462 29,240

Noninterest Expenses Operating Expenses:

Employee Compensation 75,278 69,789 71,714Insurance Fund Premium 8,494 8,446 19,232Information Services 16,919 26,435 18,135General and Administrative 12,108 11,614 7,344Purchased Services 7,303 6,245 7,294Occupancy and Equipment 7,567 10,675 6,221Travel and Entertainment 6,393 6,094 5,947Farm Credit System Related 5,240 5,390 5,656

Total Operating Expenses 139,302 144,688 141,543Reaffiliation-related Expenses - - (165)Intra-System Financial Assistance Expenses 4,156 10,271 24,133

Total Noninterest Expenses 143,458 154,959 165,511

Income Before Income Taxes and Minority Interest 367,827 342,791 337,494Provision for Income Taxes 70,110 67,840 75,346

Income Before Minority Interest 297,717 274,951 262,148Minority Interest in Net Income of

Consolidated Subsidiary - - 1,256

Net Income $ 297,717 $ 274,951 $ 260,892

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

Consolidated Income Statements ($ in Thousands)


COBANK, ACB

As of December 31, 2005 2004 2003

Assets Total Loans and Leases $ 26,297,284 $ 23,956,352 $ 24,773,446Less: Allowance for Credit Losses 437,140 435,981 415,427

Net Loans and Leases 25,860,144 23,520,371 24,358,019

Cash 14,518 16,017 9,032Investment Securities 6,533,242 5,901,143 5,243,461Federal Funds Sold, Securities Purchased

Under Resale Agreements and Other 915,200 1,007,000 825,400Accrued Interest Receivable 183,857 159,425 111,345Interest Rate Swaps and

Other Financial Instruments 43,647 39,294 198,953Other Assets 284,309 212,632 134,576

Total Assets $ 33,834,917 $ 30,855,882 $ 30,880,786

LiabilitiesBonds and Notes $ 30,038,798 $ 27,352,479 $ 27,655,681Accrued Interest Payable 290,143 188,484 115,904Interest Rate Swaps and

Other Financial Instruments 340,027 191,988 100,426Other Liabilities 263,875 261,118 208,385Minority Interest - - 19,194

Total Liabilities 30,932,843 27,994,069 28,099,590

Commitments and Contingent Liabilities (Note 16)

Shareholders’ Equity Preferred Stock 500,000 500,000 500,000Capital Stock and Participation Certificates 1,217,710 1,228,109 1,220,629Unallocated Retained Earnings 1,232,877 1,140,199 1,062,380Accumulated Other Comprehensive Loss (48,513) (6,495) (1,813)

Total Shareholders’ Equity 2,902,074 2,861,813 2,781,196

Total Liabilities and Shareholders’ Equity $ 33,834,917 $ 30,855,882 $ 30,880,786


Consolidated Balance Sheets ($ in Thousands)


COBANK, ACB


Cash Flows Provided by Operating Activities Net Income $ 297,717 $ 274,951 $ 260,892Adjustments to Reconcile Net Income to Net Cash

Provided by Operating Activities: Provision for Credit Losses 25,000 49,000 68,572 Deferred Income Taxes (16,529) 23,303 19,025 Depreciation and Amortization/Accretion, Net 18,698 19,394 18,997 Net Gains on Sales of Investment Securities - (368) (15) Decrease (Increase) in Accrued Interest Receivable (24,432) (12,566) 55,101 Decrease (Increase) in Other Assets (21,281) (34,422) 8,988 (Decrease) Increase in Accrued Interest Payable 101,659 37,066 (27,060) (Decrease) Increase in Other Liabilities 37,570 (33,637) (22,538) Fair Value Adjustment of Interest Rate Swaps, Other

Financial Instruments and Bonds and Notes, Net (5,596) (7,714) (3,927)Net Cash Provided by Operating Activities 412,806 315,007 378,035

Cash Flows Used in Investing Activities Net Decrease (Increase) in Loans and Leases (2,364,773) 711,538 41,980Net Decrease (Increase) in Federal Funds Sold,

Securities Purchased Under Resale Agreements and Other 91,800 (181,600) (162,600)Investment Securities:

Purchases (2,195,971) (2,269,505) (4,057,957)Proceeds from Maturities and Prepayments 1,438,417 1,628,475 3,903,736Proceeds from Sales - 35,938 115,879

Acquisition of Minority Interest of Consolidated Subsidiary - (12,834) -

Net Cash Used in Investing Activities (3,030,527) (87,988) (158,962)

Cash Flows Provided by (Used in) Financing Activities Bonds and Notes Proceeds 43,209,866 18,391,989 22,944,066Bonds and Notes Retired (40,439,290) (18,619,067) (23,103,935)Net (Decrease) Increase in Notes Payable and

Other Interest-bearing Liabilities 39,098 169,295 (71,813)Proceeds from Issuance of Preferred Stock, Net - - 196,516Preferred Stock Dividends Paid (37,442) (35,848) (23,442)Capital Stock and Participation Certificates Issued 5,383 6,207 57Capital Stock and Participation Certificates Retired (67,032) (65,871) (111,693)Cash Patronage Distribution Paid (94,361) (66,739) (49,361)

Minority Interest of Consolidated Subsidiary - - 92Net Cash Provided by (Used in) Financing Activities 2,616,222 (220,034) (219,513)Net (Decrease) Increase in Cash (1,499) 6,985 (440)Cash at Beginning of Year 16,017 9,032 9,472Cash at End of Year $ 14,518 $ 16,017 $ 9,032

Supplemental Noncash Investing and Financing Activities

Net Change in Accrued Purchases of Securities $ (59,577) $ 59,577 $ (49,914)Increase in Net Unrealized Losses on Investment Securities, Before Taxes (65,878) (7,355) (73,817)Change in Interest Rate Swaps and Other Financial Instrument Assets (4,353) 159,659 133,307Decrease in Bonds and Notes Related to Hedging Activities (149,282) (258,935) (197,795)Increase in Interest Rate Swaps and Other Financial Instrument Liabilities 148,039 91,562 60,561Patronage in Capital Stock/Participation Certificates 51,250 67,144 68,970

Supplemental Disclosure of Cash Flow Information Interest Paid $ 941,760 $ 550,824 $ 598,793Income Taxes Paid 62,129 57,987 65,379

Reaffiliation of Northwest ACA Loans and Other Assets $ - $ - $ 4,148,399Bonds, Notes and Other Liabilities - - 3,872,337Stock and Surplus - - 276,651


Consolidated Statements of Cash Flows ($ in Thousands)


COBANK, ACB

PreferredStock

Capital Stock and

Participation Certificates

Unallocated Retained Earnings

Accumulated Other

Comprehensive Income (Loss)

Total Shareholders’

Equity

Comprehensive Income:

Net Income 297,717 297,717

Other Comprehensive Income, Net of Taxes: Net Change in Unrealized Losses on Investment

Securities, Net of Reclassification Adjustment (42,710) (42,710)

Net Change in Unrealized Gains on Interest

Rate Swaps and Other Financial Instruments 2,473 2,473

Net Minimum Pension Liability Adjustment (1,781) (1,781)

Comprehensive Income 255,699

Preferred Stock Dividends (37,442) (37,442)

Capital Stock / Participation Certificates Issued 5,383 5,383

Capital Stock / Participation Certificates Retired (67,032) (67,032)

Patronage Distribution:

Cash (116,347) (116,347)

Capital Stock / Participation Certificates 51,250 (51,250) -

Balance at December 31, 2005 $ 500,000 $ 1,217,710 $ 1,232,877 $ (48,513) $ 2,902,074


Balance at December 31, 2002 $ 300,000 $ 1,034,286 $ 917,726 $ 41,219 $ 2,293,231Comprehensive Income:

Net Income 260,892 260,892Other Comprehensive Income, Net of Taxes: Net Change in Unrealized Losses On Investment Securities, Net of Reclassification Adjustment (45,107) (45,107)

Net Change in Unrealized Gains on Interest Rate Swaps and Other Financial Instruments 2,075 2,075

Comprehensive Income 217,860Preferred Stock Issued 200,000 200,000Preferred Stock Issuance Costs (3,484) (3,484)

Preferred Stock Dividends (25,348) (25,348)

Reaffiliation of Northwest ACA 229,009 47,642 276,651Capital Stock / Participation Certificates Issued 57 57Capital Stock / Participation Certificates Retired (111,693) (111,693)

Patronage Distribution: Cash (66,078) (66,078)

Capital Stock / Participation Certificates 68,970 (68,970) -

Balance at December 31, 2003 500,000 1,220,629 1,062,380 (1,813) 2,781,196Comprehensive Income:

Net Income 274,951 274,951Other Comprehensive Income, Net of Taxes: Net Change in Unrealized Losses on Investment

Securities, Net of Reclassification Adjustment (4,045) (4,045)Net Change in Unrealized Gains on Interest Rate Swaps and Other Financial Instruments 54 54

Net Minimum Pension Liability Adjustment (691) (691)

Comprehensive Income 270,269Preferred Stock Dividends (37,442) (37,442)Capital Stock / Participation Certificates Issued 6,207 6,207Capital Stock / Participation Certificates Retired (65,871) (65,871)Patronage Distribution:

Cash (92,546) (92,546)Capital Stock / Participation Certificates 67,144 (67,144) -

Balance at December 31, 2004 500,000 1,228,109 1,140,199 (6,495) 2,861,813

Consolidated Statements of Changes in Shareholders’ Equity ($ in Thousands)


COBANK, ACB (COBANK or the Bank), an Agricultural Credit Bank, is one of the five banks of the Farm Credit System (System), a federally chartered network of borrower-owned lending institutions comprised of cooperatives and related service organizations. The System was established in 1916 by the United States Congress (Congress) and is a Government Sponsored Enterprise (GSE). We are federally chartered under the Farm Credit Act of 1971, as amended (the Farm Credit Act). We are cooperatively owned by our U.S. customers, who consist of agricultural cooperatives, rural communications companies, rural energy and water systems, farmer-owned financial associations called Agricultural Credit Associations (ACAs or Associations) and other businesses that serve rural America. Our wholly-owned leasing subsidiary, Farm Credit Leasing Services Corporation (FCL), specializes in lease financing and related services for a broad range of equipment, machinery, vehicles and facilities. In conjunction with other System entities, the Bank jointly owns the following service organizations, which were created to provide a variety of services for the System: (1) Federal Farm Credit Banks Funding Corporation

(Funding Corporation), which issues, markets and processes Systemwide debt securities, using a network of investment dealers and dealer banks, and also provides financial management and reporting services;

(2) FCS Building Association, which leases premises and equipment to the Farm Credit Administration (FCA), the System’s regulator, as required by the Farm Credit Act; and

(3) Farm Credit System Association Captive Insurance Company, a reciprocal insurer that provides insurance services such as directors and officers liability, fiduciary liability and a bankers bond to System organizations.

We also have a minority ownership interest in Farm Credit Financial Partners, Inc., chartered under the Farm Credit Act as a service organization providing a range of support and technology services to certain System Associations. Additionally, we have a small equity interest in two other System banks as required in connection with the purchase and sale of participation loans. Copies of COBANK’s financial reports are available on request by calling or visiting one of our banking center locations and through our website at www.cobank.com. Copies of financial reports of our affiliated Associations and the System are available on their respective websites, which can also be accessed through links on our COBANK website under “Financial Highlights.”

Basis of Presentation and Principles of Consolidation

The accompanying consolidated financial statements include the accounts of COBANK and FCL after elimination of all significant intercompany accounts and transactions. Effective January 1, 2004, we acquired the remaining 18 percent minority interest in FCL, resulting in FCL becoming a wholly-owned subsidiary. The purchase price represented a $6.4 million discount to the book value of the minority interest. This discount is being amortized into income ratably over the weighted average remaining life of operating leases. The accompanying consolidated financial statements exclude financial information of Northwest Farm Credit Services, ACA (Northwest) as well as the System ACAs in the Northeastern region of the United States (Northeast Associations), which are collectively referred to as our affiliated Associations. Selected unaudited financial information of our affiliated Associations is presented in Note 18, along with a discussion of our relationship with these Associations. We prepare our financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) and prevailing practices within the financial services industry. These principles require us to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results may differ from those estimates. Significant estimates are discussed in these notes to consolidated financial statements, as applicable. We have reclassified certain amounts in prior years’ financial statements to conform to current year presentation.

Segment Reporting

We measure our financial performance by business groups based on industry served, the size of the customers served and the types of services provided to customers. Our four reportable operating segments are more fully discussed in Note 15.Loans and Leases

We report loans at their principal amount outstanding less unearned income. We amortize unearned income on loans made on a discount basis using the straight-line method, which approximates the interest method. For loans not made on a discount basis, we accrue interest income based upon the daily principal amount outstanding. We defer loan and lease origination fees and costs, and amortize them over the life of the related loan or lease as an adjustment to yield. Impaired loans and leases are loans and leases for which it is probable that not all principal and interest will be collected according to the contractual terms of the loans and leases. Impaired loans and leases include loans and leases that are in nonaccrual status, restructured or past due 90 days or more and still accruing interest.

1 Organization 2 Summary of Significant Accounting Policies

Notes to Consolidated Financial Statements ($ in Thousands, Except per Share Data and as Noted)


We do not accrue interest income on impaired loans unless the loan is adequately secured and in the process of collection. When interest accruals are suspended, accrued and unpaid interest income is reversed with current year accruals charged to earnings and prior year amounts charged off against the allowance for credit losses. For nonaccrual loans, we primarily apply cash receipts against the loan balance. If collectibility of the loan or lease balance is fully expected and certain other criteria are met, we recognize interest payments as interest income. We may return loans or leases to accrual status when the borrower is current, has demonstrated payment performance, collection of future payments is fully expected and there are no unrecovered charge-offs. Accruing restructured loans and leases are those for which the contractual terms and conditions have been amended or otherwise revised to incorporate certain monetary concessions made to the borrower that would not otherwise be made if not for economic or legal reasons. We place the loan or lease in nonaccrual status if the borrower’s ability to meet the revised contractual terms is uncertain. We record leases primarily as either direct financing or operating leases. Under direct financing leases, unearned finance income from lease contracts represents the excess of gross lease receivables over the cost of leased equipment, net of estimated residual values. Residual values, which are reviewed at least annually, represent the estimated amount to be received at lease termination from the disposition of leased assets. We amortize net unearned finance income to interest income using the interest method. Under operating leases, property is recorded at cost and depreciated over the lease term to an estimated residual or salvage value, on a straight-line basis. We recognize revenue as earned ratably over the term of the operating lease. We establish an impairment reserve if the fair value of assets held for operating leases decreases to below book value.Allowance for Credit Losses

We maintain an allowance for credit losses at a level we consider adequate to provide for probable and estimable credit losses within the loan and finance lease portfolios. We base the allowance on our regular evaluation of the loan and finance lease portfolios. For purposes of determining our allowance, we divide our loans into two broad categories: loans that are impaired and those that are not. A loan is impaired when, based on current information and events, it is probable that we will not collect all amounts due under the contractual terms. We apply Statement of Financial Accounting Standards (SFAS) No. 114 to determine the amount of this impairment. Impairment of these loans and leases is measured based on the present value of expected future cash flows discounted at the effective interest rate of the loan or lease or, when available, at the loan’s or lease’s observable market price. In limited cases, we base the impairment on fair value of the collateral if the loan or lease is collateral dependent. Changes in the financial condition of our borrowers and changes in the general economy will cause these estimates, appraisals and evaluations to change.

We apply SFAS No. 5 to loans that are not individually assessed for impairment and set up an allowance for probable and estimable credit losses as of the balance sheet date. The evaluation of this portion of our portfolio generally considers default rates from peer data, internal risk ratings, historical recovery rates, industry groupings, specific industry conditions, general economic and political conditions, and changes in the character, composition and performance of the portfolio, among other factors. We also consider overall portfolio indicators, including trends in internally risk-rated exposures, classified exposures, and historical write-offs and recoveries. Additionally, we review industry, geographic and portfolio concentrations, including current developments within operating segments. Changes in these factors, or our assumptions and estimates thereof, could result in a change in the allowance and could have a direct and material impact on the provision for credit losses and our results of operations. The total allowance is available to absorb probable and estimable credit losses within our entire portfolio. We increase the allowance by recording a provision for credit losses in the income statement. We record credit losses against the allowance when management determines that any portion of the loan or lease is uncollectible. We add subsequent recoveries, if any, to the allowance. In April 2004, the FCA issued an “Informational Memorandum” to System institutions regarding the criteria and methodologies that would be used in evaluating the adequacy of a System institution’s allowance for credit losses. The FCA endorsed the direction provided by the Federal Financial Institutions Examination Council (FFIEC) and the Securities and Exchange Commission (SEC) and indicated the conceptual framework addressed in their guidance would be included as part of their examination process. In 2004, we refined our methodology for calculating our allowance for credit losses, taking into account the FCA’s guidance as well as the SEC and FFIEC guidelines. While this refinement in methodology did not materially impact the Bank’s allowance, it resulted in a reallocation of a portion of the allowance between two of our operating segments in 2004. Cash

For purposes of these financial statements, cash represents deposits at banks and cash on hand which are used for operating purposes.

Investment Securities

We hold investment securities for purposes of maintaining a liquidity reserve, managing short-term surplus funds and managing interest rate risk. Our investment securities may not necessarily be held to maturity and, accordingly, we classify these investment securities as available-for-sale and report them at their estimated fair value. We have no trading securities or held-to-maturity securities. We report unrealized gains and losses, net of applicable income taxes, in the accumulated other comprehensive income (loss) component of shareholders’ equity on the consolidated balance sheets. We amortize or accrete purchased premiums and discounts using the constant yield method, which approximates the interest method, over the


terms of the respective issues. We use the specific identification method for determining cost in computing realized gains and losses on sales of investment securities. We evaluate investments in a loss position to determine if such a loss is other-than-temporary. However, we generally have the ability and intent to hold these securities until such time as the value recovers or maturity.

Premises and Equipment

We carry premises and equipment at cost less accumulated depreciation and amortization. We generally provide for depreciation and amortization on the straight-line method over the estimated useful lives of the assets. We record gains and losses on dispositions in current operating results. We record maintenance and repairs to operating expense when incurred and capitalize improvements. We capitalize and depreciate leased property and equipment meeting certain criteria using the straight-line method over the terms of the respective leases. Derivative Financial Instruments and Hedging Activities

In the normal course of business, we enter into derivative financial instruments (derivatives) including interest rate swaps and caps, options and forward contracts that are principally used to manage interest rate risk and our liquidity position. We record derivatives as assets or liabilities at their fair value on the consolidated balance sheets. We record changes in the fair value of a derivative in current period earnings or accumulated other comprehensive income (loss), depending on the use of the derivative and whether it qualifies for hedge accounting. For fair-value hedge transactions that hedge changes in the fair value of assets, liabilities or firm commitments, changes in the fair value of the derivative will generally be offset in the income statement by changes in the hedged item’s fair value. For cash-flow hedge transactions, in which we hedge the variability of future cash flows related to a variable-rate asset, liability or a forecasted transaction, changes in the fair value of the derivative are reported in accumulated other comprehensive income (loss). The gains and losses on the derivatives that we report in accumulated other comprehensive income (loss) will be reclassified as earnings in the periods in which earnings are impacted by the variability of the cash flows of the hedged item. We record the ineffective portion of all hedges in current period earnings. For derivatives not designated as a hedging instrument, we record the related change in fair value in current period earnings. We formally document all relationships between derivatives and hedged items, as well as risk management objectives and strategies for undertaking various hedge transactions. This process includes linking all derivatives that are designated as fair-value or cash-flow hedges to: (i) assets and liabilities on the consolidated balance sheets, (ii) firm commitments, or (iii) forecasted transactions.

We also formally assess (both at the hedge’s inception and at least quarterly on an ongoing basis) whether the derivatives that are used in hedging transactions have been effective in offsetting changes in the fair value or cash flows of hedged items and whether those derivatives are expected to remain effective in future periods. We typically use regression analyses or other statistical analyses to assess the effectiveness of hedges. Hedge accounting is discontinued prospectively when: (i) it is determined that the derivative is no longer effective in offsetting changes in the fair value or cash flows of a hedged item; (ii) the derivative expires or is sold, terminated or exercised; (iii) the hedged firm commitment no longer meets the definition of a firm commitment; (iv) it is probable that the forecasted transactions will not occur by the end of the specified time period; or (v) management determines that the fair-value or cash-flow hedge designation is no longer appropriate. If we were to determine that a derivative no longer qualifies as an effective fair-value or cash-flow hedge, or if management removes the hedge designation, we would continue to carry the derivative on the balance sheet at fair value, with changes in fair value recognized in current period earnings as part of noninterest income. We would amortize the component of other comprehensive income (loss) related to discontinued cash-flow hedges to net interest income over the original term of the hedge contract. Fair Value of Guarantor’s Obligations

As a guarantor, we recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee in accordance with the accounting provisions of Financial Accounting Standards Board (FASB) Interpretation No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others” (FIN 45). We provide standby letters of credit, which are irrevocable undertakings to guarantee payment of a specified financial obligation. We applied the initial accounting provisions of FIN 45 to guarantees issued or modified after December 31, 2003, with no material impact on our financial position, results of operations or cash flows. Our commercial letters of credit and other loan commitments, which are commonly thought of as guarantees of funding, are not included in the scope of FIN 45. As of December 31, 2005, our liability for the fair value of obligations was $2.9 million and was determined by applying a risk-adjusted spread percentage to those obligations.Employee Benefit Plans

The Bank’s employees participate in our qualified defined benefit pension plans, which are noncontributory and cover substantially all employees. We also have a noncontributory, non-qualified defined benefit Supplemental Executive Retirement Plan (SERP) covering a limited number of our executives and senior managers. The net expense for these plans is recorded as employee compensation expense. We use the “Projected Unit Credit” actuarial method for financial reporting and funding purposes.


We provide certain contributory and unfunded health care and life insurance benefits to eligible retired employees. Substantially all employees may become eligible for these benefits if they reach early retirement age while working for the Bank. The anticipated costs of these benefits are accrued during the period of the employees’ active service and are classified as employee compensation expense. However, substantially all retirees pay the full premiums associated with these benefits. Employees are also eligible to participate in an employee savings plan. We match a certain percentage of employee contributions, with costs being expensed as accrued and funded. We also have a supplemental savings plan, which includes benefits not provided under the employee savings plan due to certain limitations.

Loans and Leases Outstanding Loans and leases outstanding by type are shown below.

Income Taxes

We operate as a nonexempt cooperative, which qualifies for tax treatment under Subchapter T of the Internal Revenue Code. Accordingly, amounts distributed as qualified patronage distributions to borrowers in the form of cash, stock or participation certificates may be deducted from taxable income. We base provisions for income taxes for financial reporting purposes only on those earnings that will not be distributed as qualified patronage distributions. We record deferred tax assets and liabilities for temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. We measure these deferred amounts using the current marginal statutory tax rate. Calculating deferred tax assets and liabilities involves various management estimates and assumptions as to future taxable earnings. We expect to fully realize deferred tax assets based on the projected level of future taxable income.

($ in Millions)

December 31, 2005 2004 2003

Amount % Amount % Amount %Agribusiness $ 6,884 26 % $ 5,850 24 % $ 6,411 26 % Strategic Relationships Division 7,848 30 6,856 29 6,609 27 Global Financial Services 4,770 18 4,938 21 5,302 21 Communications and Energy 6,795 26 6,312 26 6,451 26 Total $ 26,297 100 % $ 23,956 100 % $ 24,773 100 % Loans and Leases Purchased $ 2,002 $ 2,961 $ 2,834Loans and Leases Sold $ 3,257 $ 3,011 $ 2,877Guaranteed Loans and Leases $ 1,806 7 % $ 2,257 9 % $ 2,455 10 %

Loans and leases are outstanding in 50 states as well as 30 foreign countries and a limited number of U.S. territories. Our international loan portfolio, included in our Global Financial Services Group segment, reflects significant concentration in U.S. government-sponsored trade financing programs which guarantee payment in the event of default by the borrower of generally 98 percent of loan principal outstanding and varying percentages of interest due. Of the $2.3 billion in international loans outstanding as of December 31, 2005, 74 percent were guaranteed by the U.S. government under one of these trade financing programs, primarily the General Sales Manager (GSM) program of the U.S. Department of Agriculture’s Commodity Credit Corporation. We make loans and leases to customers in various industries. Industries that represent more than 10 percent of total loans and leases outstanding are as follows:

December 31, 2005 2004 2003

Farm Supply, Grain and Marketing 17 % 15 % 17 %Communications 9 9 11 Energy 17 17 15

Commodities (Other than Fruits, Nuts and Vegetables) 10 12 11

Loans to our affiliated Associations represented 28 percent, 27 percent and 25 percent of total loans and leases outstanding at December 31, 2005, 2004 and 2003, respectively. Together, our affiliated Associations provide financing to approximately 27,000 farmer-owners for real estate, equipment, working capital and agricultural production purposes in geographic regions in the Northwestern and Northeastern U.S.

3 Loans and Leases


A summary of the components of FCL’s net investment in direct financing leases and property on operating leases is as follows:

($ in Millions)

December 31, 2005 2004 2003 Net Investment in Direct

Financing Leases:

Minimum Lease Payments to be Received, net of Participation Interests $ 750 $ 672 $ 560Estimated Residual Values of Leased Property (Unguaranteed) 205 182 133 Initial Direct Costs 7 7 7 Less: Unearned Finance Income (184) (160) (114)Net Investment in Direct Financing Leases $ 778 $ 701 $ 586

Property on Operating Leases: Vehicles and Other Equipment $ 595 $ 604 $ 553

Initial Direct Costs 2 2 2 Total 597 606 555 Less: Accumulated Depreciation (243 ) (234) (216) Net Property on Operating Leases $ 354 $ 372 $ 339Year Ended December 31, 2005 2004 2003 Depreciation Expense $ 88 $ 86 $ 83

At December 31, 2005, gross minimum lease payments to be received for direct financing leases and minimum future rental revenue for noncancelable operating leases are as follows:

($ in Millions)

Year

Minimum Lease

Payments

MinimumFuture Rental

Revenue 2006 $ 254 $ 862007 199 672008 149 502009 110 332010 70 17Subsequent Years 125 11

Impaired Loans and Leases

Impaired loan and lease information is shown in the following table. Loans and leases past due 90 days or more and still accruing interest are adequately secured and in the process of collection.

December 31, 2005 2004 2003

Nonaccrual Loans and Leases $ 119,846 $ 183,899 $ 319,569 Accruing Loans and Leases 90

Days or More Past Due 240 4,969 21,461 Restructured Loans 1,284 1,760 3,475 Total Impaired Loans

and Leases $ 121,370 $ 190,628 $ 344,505

Impaired Loans and Leases with Specific Allowance $ 71,706 $ 151,497 $ 102,360

Impaired Loans and Leases without Specific Allowance 49,664 39,131 242,145

Total Impaired Loans and

Leases $ 121,370 $ 190,628 $ 344,505

Specific Allowance on Impaired Loans and Leases $ 30,490 $ 47,328 $ 27,541

Allowance for Credit Losses as a Percentage of: Total Loans and Leases 1.66% 1.82% 1.68%

Impaired Loans and Leases 360 229 121 Nonaccrual Loans and Leases 365 237 130

Interest income is recognized and cash payments are applied on nonaccrual impaired loans as described in Note 2. The following table presents interest income recognized on impaired loans and leases as well as the average balances of impaired loans and leases.

Interest income forgone on nonaccrual and accruing restructured loans is as follows:

Year Ended December 31, 2005 Interest Income Which Would Have

Been Recognized Per Original Terms $ 20,270

Less: Interest Income Recognized (2,312)

Forgone Interest Income $ 17,958

Commitments on Impaired Loans and Leases

There were no material commitments to extend additional credit to borrowers whose loans and leases were classified as impaired at December 31, 2005.


Interest Income Recognized on Impaired Loans and Leases $ 2,560 $ 6,959 $ 1,296

Average Impaired Loans and Leases $ 201,023 $ 266,791 $ 326,589


A summary of changes in the allowance for credit losses follows:


Balance at Beginning of Year $ 435,981 $ 415,427 $ 407,984 Provision for Credit Losses 25,000 49,000 68,572

Charge-offs (41,549 ) (66,541 ) (75,776)Recoveries 17,708 38,095 10,598 Allowance Related to Assumed

Loans and Other - - 4,049

Balance at End of Year $ 437,140 $ 435,981 $ 415,427

A summary of investment securities available-for-sale follows. All investment securities are rated AAA by Standard & Poor’s Ratings Services, Inc. or Aaa by Moody’s Investors Service, Inc. Fair values are determined based upon currently quoted market prices. See Note 12 for disclosures about estimated fair values of financial instruments.

($ in Millions)

December 31, 2005 Amortized

Cost

Gross Unrealized

Gains

Gross Unrealized

Losses Fair

Value

Mortgage-backed $ 6,190 $ 7 $ (83) $ 6,114

Other Asset-backed 421 - (2) 419

Total $ 6,611 $ 7 $ (85) $ 6,533


Cost

Gross Unrealized

Gains

Gross Unrealized

Losses Fair

Value

Mortgage-backed $ 5,486 $ 10 $ (22) $ 5,474Other Asset-backed 427 2 (2) 427Total $ 5,913 $ 12 $ (24) $ 5,901


Cost

Gross Unrealized

Gains

Gross Unrealized

Losses Fair

Value

Mortgage-backed $ 4,764 $ 16 $ (26) $ 4,754Other Asset-backed 485 5 (1) 489Total $ 5,249 $ 21 $ (27) $ 5,243

A summary of the contractual maturity, amortized cost, fair value and weighted average yield of investment securities by type at December 31, 2005 is as follows:

Mortgage-backed Securities

($ in Millions) Amortized

Cost Fair

Value

Weighted Average

Yield

In One Year or Less $ - $ - 0.00% One to Five Years 1 1 4.85 Five to Ten Years 137 135 3.95 After Ten Years 6,052 5,978 4.23Total $ 6,190 $ 6,114 4.22

Other Asset-backed Securities

($ in Millions) Amortized

Cost Fair

Value

Weighted Average

Yield

In One Year or Less $ - $ - 0.00%One to Five Years 18 18 3.54 Five to Ten Years 75 75 4.57After Ten Years 328 326 4.14Total $ 421 $ 419 4.19

Substantially all mortgage-backed and other asset-backed securities have contractual maturities in excess of ten years. However, expected maturities for these securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without penalties. The expected average maturity for mortgage-backed securities and other asset-backed securities was 2.85 years and 1.13 years, respectively, at December 31, 2005. Proceeds from sales of investment securities and the related realized gross gains and gross losses are shown in the following table.

Sales of Investment Securities


Proceeds from Sales $ - $ 35,938 $ 115,879 Realized Gross Gains - 368 185 Realized Gross Losses - - (170)

4 Allowance for Credit Losses

5 Investment Securities


The following table shows the fair value and gross unrealized losses for investments in a loss position aggregated by investment category, and the length of time the securities have been in a continuous unrealized loss position at December 31, 2005. The continuous loss position is based on the date the impairment first occurred. All of the investments in unrealized loss positions, including those impaired for longer than 12 months, are impaired due to market interest rate changes, and not due to credit quality. We expect to collect all principal and interest payments on our investment securities given the high credit quality of these securities and our ability and intent to hold the securities until such time as the value recovers or maturity. There are currently no plans to sell these investments and it is unlikely that our liquidity position will require us to do so. As a result, there were no other-than-temporary impairments recognized for any securities as of December 31, 2005.

($ in Millions)

Less Than12 Months

Greater Than 12 Months

FairValue

UnrealizedLosses

FairValue

UnrealizedLosses

Mortgage-backed $ 2,391 $ (36) $ 2,024 $ (47) Other Asset-backed 144 (1) 109 (1)

Total $ 2,535 $ (37) $ 2,133 $ (48)

We are primarily liable for the following bonds and notes:

($ in Millions) December 31, 2005 2004 2003

Bonds and Master Notes $ 25,318 $ 22,835 $ 21,241 Medium-term Notes 1,438 1,941 2,507 Discount Notes 2,603 1,936 3,437 Cash Investment

Services Payable 674 634 453 Other 6 6 18

Total $ 30,039 $ 27,352 $ 27,656

Systemwide Debt Securities

We obtain funds for our lending activities and operations primarily from the sale of debt securities issued by System banks through the Funding Corporation. These debt securities are comprised of bonds, medium-term notes, master notes and discount notes and are hereinafter referred to as Systemwide Debt Securities. Pursuant to the Farm Credit Act, Systemwide Debt Securities are the general unsecured joint and several obligations of the System banks. Systemwide Debt Securities are not obligations of, and are not guaranteed by, the United

States government or any agency or instrumentality thereof, other than the System banks. Bonds, master notes and medium-term notes are issued at fixed or floating interest rates with original maturities of up to 30 years. Bonds and master notes have original maturities of 3 months to 30 years. Medium-term notes have original maturities ranging from 1 to 30 years. Discount notes are issued with maturities ranging from 1 to 365 days. The weighted average remaining maturity of discount notes at December 31, 2005 was 35 days and their weighted average interest rate was 4.14 percent. Cash investment services payable mature within one year. The aggregate maturities of bonds (including master notes) and medium-term notes and the weighted average interest rates at December 31, 2005 are shown below. Weighted average interest rates include the effect of related derivative financial instruments.

Maturities of Long-Term Debt ($ in Millions)

Bonds and Master Notes Medium-term Notes

Year of Maturity Amount

Weighted Average

Interest Rate Amount

WeightedAverage

Interest Rate

2006 $ 6,734 4.1% $ 265 6.6%2007 5,478 4.2 176 7.62008 4,450 4.2 348 6.92009 3,311 4.2 126 7.32010 1,261 4.3 118 6.4Subsequent

Years 4,084 4.8 405 6.0Total $ 25,318 4.3 $ 1,438 6.8

At December 31, 2005, the aggregate weighted average interest rate for all bonds and medium-term notes is 4.43 percent. Certain Systemwide Debt Securities include debt which may be called on the first call date and, generally, on each interest payment date thereafter. At December 31, 2005, callable debt was $215 million, with the range of first call dates being from January 2006 through June 2006.

Conditions for Issuing Systemwide Debt

Certain conditions must be met before we can participate in the issuance of Systemwide Debt Securities. As one condition of participation, we are required by the Farm Credit Act and FCA regulations to maintain specified, eligible, unencumbered assets at least equal in value to the total amount of debt obligations outstanding for which we are primarily liable. Such assets exceeded applicable debt by $2.9 billion at December 31, 2005. This requirement does not provide holders of Systemwide Debt Securities with a security interest in any of our assets.

6 Bonds and Notes


The System banks and the Funding Corporation operate under a Market Access Agreement (MAA) designed to address certain Funding Corporation statutory responsibilities. The MAA agreed-upon financial conditions establish mechanisms for monitoring, limiting and ultimately denying a troubled System bank’s access to and participation in Systemwide debt issuances, thereby limiting other System banks’ exposure to statutory joint and several liabilities. The MAA promotes the identification and resolution of financial problems of individual System banks in a timely manner. The System banks and the Funding Corporation have also entered into an Amended and Restated Contractual Interbank Performance Agreement (CIPA). The CIPA establishes an agreed-upon standard of financial condition and performance for each System bank and their affiliated associations (the District). The CIPA measures various ratios taking into account the capital, asset quality, earnings, interest rate risk and liquidity of the Districts and System banks. In the event the Districts do not meet the agreed-upon standards, the CIPA provides for certain intra-System bank economic incentives to be applied. At December 31, 2005, 2004 and 2003, all System banks, including COBANK, were in compliance with all of the conditions of participation for the issuances of Systemwide Debt Securities.

Insurance Fund

The Farm Credit Act established the Farm Credit System Insurance Corporation (Insurance Corporation) to administer the Farm Credit Insurance Fund (Insurance Fund). The Insurance Corporation insures the timely payment of principal and interest on Systemwide Debt Securities and carries out various other responsibilities. The primary sources of funds for the Insurance Fund are premiums paid by the System banks and earnings on the Insurance Corporation assets.

Each System bank is required to pay premiums into the Insurance Fund based on its annual average loan and lease principal outstanding until the assets in the Insurance Fund reach the “secure base amount,” which is defined in the Farm Credit Act as two percent of the aggregate insured Systemwide Debt Securities or such other percentage of the aggregate obligations as the Insurance Corporation in its sole discretion determines to be actuarially sound. When the amount in the Insurance Fund exceeds the secure base amount, the Insurance Corporation is required to reduce premiums, but still must ensure that premiums are sufficient to maintain the level of the Insurance Fund at the secure base amount. The premiums are determined and assessed to System banks semiannually by the Insurance Corporation. The amount of the premium is capped by FCA regulations and is generally up to 15 basis points of accruing loans outstanding. The Insurance Fund is available to assist with the timely payment of principal and interest on Systemwide Debt Securities in the event of a default by a System bank to the extent that net assets are available in the Insurance Fund. No other liabilities reflected in our financial statements are insured by the Insurance Corporation. In addition, the Insurance Fund could be used to ensure the retirement of System entities’ protected borrower equity at par or stated value and for other specified purposes. The Insurance Fund is also available for the discretionary uses, by the Insurance Corporation, of providing assistance to certain troubled System institutions and to cover the operating expenses of the Insurance Corporation. At December 31, 2005, the assets of the Insurance Fund aggregated $2.1 billion. However, due to the other authorized uses of the Insurance Fund, there is no assurance that any available amount in the Insurance Fund will be sufficient to fund the timely payment of principal or interest on Systemwide Debt Securities in the event of a default by any System bank having primary liability thereon.


Early Extinguishments of Debt

During 2005, 2004 and 2003, we recorded losses of $15.8 million, $41.7 million and $55.3 million, respectively, on the early extinguishments of $0.2 billion, $1.8 billion and $1.2 billion, respectively, of Systemwide debt. These early extinguishments of debt resulted from our general practice of repurchasing higher cost, similarly tenored debt to offset the impact of prepayments in both the loan and investment portfolios and to maintain the appropriate mix of interest-earning assets and interest-bearing liabilities. All gains and losses on early extinguishments of debt are reported as a component of noninterest income.

Patronage

As a customer-owned bank, we return a portion of our earnings to stockholders in the form of patronage distributions. Eligible shareholders will receive patronage for 2005 amounting to $167.6 million, of which $116.3 million will be paid in cash in 2006 and the balance will be paid in capital stock and participation certificates. For 2004 and 2003, total patronage was $159.7 million and $135.0 million, respectively, of which $92.5 million and $66.1 million, respectively, were paid in cash in the subsequent year. All patronage payments require the approval of our Board of Directors. Capitalization Requirements

In accordance with the Farm Credit Act, eligible borrowers are required to purchase equity as a condition of borrowing. The minimum initial borrower investment is equal to the lower of one thousand dollars or two percent of the amount of the loan. The minimum initial investment is generally received in cash at the time the borrower receives the loan proceeds. Association customers are required to invest in our capital stock, as more fully discussed in Note 18. International borrowers, certain other borrowers and customers of FCL are not required to purchase, nor do they own, capital stock or participation certificates. Likewise, they do not participate in patronage distributions. Retirements, if any, are calculated annually after a determination by the Board of Directors of a target equity level. Net cash retirements are made at the sole discretion of the Board of Directors and are at book value not to exceed par or face value. Through 2005, net cash retirements occurred quarterly. However, beginning in 2006, annual net cash retirements approved by the board will be paid in a single installment each March.

Regulatory Capitalization Requirements and Restrictions

The FCA’s capital adequacy regulations require us to maintain certain minimum capital ratios and collateral standards.

We are prohibited from reducing permanent capital by retiring stock or making certain other distributions to shareholders unless prescribed capital standards are met. All such minimum regulatory capital requirements and collateral standards were met as of December 31, 2005. At December 31, 2005, our permanent capital, total surplus, core surplus and net collateral ratios exceeded the regulatory minimums as noted in the following table.

Capital Ratios as of December 31,

RegulatoryMinimums 2005 2004 2003

PermanentCapital Ratio 7.00% 13.71% 15.08% 13.67%

Total Surplus Ratio 7.00 13.71 15.08 13.67

Core Surplus Ratio 3.50 5.89 6.27 5.71

Net Collateral Ratio 103.00 108.27 108.69 108.46

The ratios are calculated in accordance with FCA regulations and are discussed below. • The permanent capital ratio is quarterly permanent capital

(generally shareholders’ equity) as a percentage of quarterly average risk-adjusted assets.

• The total surplus ratio is quarterly total surplus (generally shareholders’ equity) as a percentage of quarterly average risk-adjusted assets.

• The core surplus ratio is quarterly core surplus (generally unallocated retained earnings) as a percentage of quarterly average risk-adjusted assets.

• The net collateral ratio is net collateral divided by total liabilities, as adjusted to exclude the fair value of certain derivatives.

Preferred Stock

At December 31, 2005, we had authorized and outstanding $500 million of cumulative perpetual preferred stock, which is the total represented by our Series A and Series B preferred stock. We issued $200 million of Series B cumulative perpetual preferred stock in November 2003, representing 4,000,000 shares at $50 per share par value. The Series B preferred stock pays cumulative dividends quarterly at a fixed rate of 7.0 percent per annum of the $50 per share par value. The Series B preferred stock is not mandatorily redeemable at any time. However, on or after January 2, 2009, the Series B preferred stock will be redeemable in whole at our option on any dividend payment date at its par value plus accrued and unpaid dividends.

7 Shareholders’ Equity


We issued $300 million of Series A cumulative perpetual preferred stock in June 2001, representing 6,000,000 shares at $50 per share. The Series A preferred stock pays cumulative dividends quarterly at a fixed rate of 7.814 percent per annum of the $50 per share par value. Beginning July 1, 2011, the rate will change to a variable rate equal to three-month LIBOR plus 2.72 percent. On July 1, 2016, the rate will increase to three-month LIBOR plus 4.72 percent. The dividend rate, however, will never fall below the original issue coupon rate of 7.814 percent. The Series A preferred stock is not mandatorily redeemable at any time, but on or after July 1, 2011, will be redeemable in whole or in part at our option on any dividend payment date at its par value plus accrued and unpaid dividends. All preferred stock retirements require the approval of our Board of Directors. If preferred stock dividends have not been paid for six quarters, the preferred stockholders will have the right to appoint two individuals to observe our Board of Directors meetings until all dividends are paid. In addition, we may not enter into agreements restricting our ability to declare or pay preferred stock dividends.

Description of Equities

Information regarding preferred stock, capital stock and participation certificates (PCs) at December 31, 2005, is shown below.

Stock and Participation Certificates

Stock PCs

Preferred Class B Class E Class B

Shares Authorized (000) 10,000 Unlimited Unlimited Unlimited Shares Outstanding (000) 10,000 290 10,210 1,677 Voting or Nonvoting Nonvoting Nonvoting Voting Nonvoting Par / Face Value (per share) $50 $100 $100 $100

Holders of equities may not pledge, hypothecate or otherwise grant a security interest in such equities except as consented to by the Bank under FCA regulations. We have a statutory first lien on the stock or PCs owned by borrowers. Only preferred stock pays dividends. In case of liquidation or dissolution, preferred stock, capital stock, PCs and unallocated retained earnings would be distributed to shareholders, after the payment of all liabilities in

accordance with FCA regulations, in the following order: (1) retirement of all preferred stock at par plus all accrued

but unpaid dividends; (2) retirement of all nonvoting stock and participation

certificates at par; (3) retirement of voting stock at par; (4) retirement of all patronage surplus (a component of

unallocated retained earnings) in amounts equal to the face amount of the applicable nonqualified written notices of allocation or such other notice; and

(5) remaining unallocated retained earnings and reserves shall be paid to the holders of voting stock, nonvoting stock and participation certificates in proportion to patronage to the extent possible.

Employee Benefit Plans

We have funded qualified defined benefit pension plans, which are noncontributory and together cover substantially all of our employees. Employees hired prior to September 15, 2003 were given a one-time option to elect either to have their benefits determined by a formula based on years of service and final average pay or to have benefits accumulate as a cash balance with interest credits and contributions based on years of service and eligible compensation. For those employees hired on or after September 15, 2003, benefits accumulate as a cash balance with interest credits and contributions based on years of service and eligible compensation. We also have a noncontributory, unfunded non-qualified Supplemental Executive Retirement Plan (SERP) covering a limited number of our executives and senior managers. The defined benefit pension plans and the SERP are collectively referred to as Retirement Plans. We hold assets in a trust fund that covers all obligations related to our SERP, however, such assets are not included as plan assets in the disclosures below. We have other postretirement benefit plans that cover substantially all of our employees. The plans are unfunded contributory plans with participant contributions adjusted annually. Substantially all retirees pay the full premiums associated with these plans. In addition to the benefit plans described above, we have a contributory employee savings plan covering substantially all employees. The employee savings plan expenses, which are recorded as employee compensation expense, were $2,008, $2,114 and $1,846 for 2005, 2004 and 2003, respectively. In 2004, the measurement date for all employee benefit plans was changed to September 30 from December 31 to align all measurement dates across the System.

8 Employee Benefit Plans and Incentive Compensation Plans


The following table provides a reconciliation of the changes in the plans’ projected benefit obligations and fair values of assets over the three-year period ended December 31, 2005 as well as a statement of funded status as of December 31 of each year:

The fair value of assets and the accumulated benefit obligations for the Retirement Plans as of year end are as follows:

2005 2004 2003 Accumulated Benefit Obligation:

Funded Plans $ 99,818 $ 86,706 $ 75,657 Unfunded SERP 5,030 3,816 2,477

Fair Value of Plan Assets 103,028 92,159 89,660

In accordance with SFAS No. 87, “Employer’s Accounting for Pensions” (SFAS 87), pension obligations and changes in the value of plan assets to meet those obligations are not recognized as actuarial gains or losses of the plan as they occur but are recognized systematically over subsequent periods. These differences are treated as unrecognized actuarial gains/losses.

Retirement Plans Other Postretirement Benefits

2005 2004 2003 2005 2004 2003

Change in Projected Benefit Obligation: Benefit Obligation at Beginning of Year $ 106,316 $ 93,290 $ 92,660 $ 4,472 $ 4,377 $ 4,437 Service Cost 4,401 4,081 3,729 90 85 58 Interest Cost on Benefit Obligation 6,287 5,850 5,978 260 267 266 Plan Participant Contributions - - - 303 294 247 Plan Amendments 214 - (3,173) - - - Actuarial Loss (Gain) 11,284 5,688 3,854 (94) (93) (298)Benefits Paid (5,268) (2,593) (9,758) (535) (458) (333)

Projected Benefit Obligation at End of Year 123,234 106,316 93,290 4,496 4,472 4,377

Change in Plan Assets: Fair Value of Plan Assets at Beginning of Year 92,159 89,660 76,950 - - - Actual Return on Plan Assets 9,137 1,192 17,468 - - - Employer Contributions 7,000 3,900 5,000 232 164 86 Benefits Paid (5,268) (2,593) (9,758) (535) (458) (333)Plan Participant Contributions - - - 303 294 247

Fair Value of Plan Assets at End of Year 103,028 92,159 89,660 - - -

Funded Status – Fair Value of Plan Assets Less Than Projected Benefit Obligation (20,206) (14,157) (3,630) (4,496) (4,472) (4,377)

Unrecognized Actuarial Loss (Gain) 27,925 18,441 6,847 (2,415) (2,477) (2,543)Unrecognized Prior Service Cost (4,857) (5,600) (6,129) (121) (170) (218)Fourth Quarter Payments - - - 142 47 -

Net Amounts Recognized in the Consolidated Balance Sheets $ 2,862 $ (1,316) $ (2,912) $ (6,890) $ (7,072) $ (7,138)

COBANK 2005 Annual Report Financial Information 62

The following table provides the amounts recognized in the accompanying consolidated balance sheets as of December 31 of each year:

Retirement Plans Other Postretirement Benefits

2005 2004 2003 2005 2004 2003

Prepaid Pension Assets $ 6,962 $ 2,445 $ - $ - $ - $ - Accrued Benefit Liabilities (7,992) (4,875) (2,912) (6,890) (7,072) (7,138)Accumulated Other Comprehensive Income 3,892 1,114 - - - -

Net Amounts Recognized $ 2,862 $ (1,316) $ (2,912) $ (6,890) $ (7,072) $ (7,138)

The following table presents the components of net periodic benefit cost for the plans:

Retirement Plans Other Postretirement Benefits 2005 2004 2003 2005 2004 2003

Service Cost $ 4,401 $ 4,081 $ 3,729 $ 90 $ 85 $ 58 Interest Cost on Benefit Obligation 6,287 5,850 5,978 260 267 266 Expected Return on Plan Assets (7,566) (7,154) (7,042) - - - Amortization of Unrecognized Transition Obligation - - (1) - - - Amortization of Prior Service Cost (529) (529) (358) (49) (49) (49)Recognized Actuarial Loss (Gain) 240 56 195 (155) (159) (185)

Net Periodic Benefit Cost $ 2,833 $ 2,304 $ 2,501 $ 146 $ 144 $ 90

Assumptions

SFAS 87 requires us to measure plan obligations and annual expense using assumptions that reflect future economic conditions. As the bulk of pension benefits will not be paid for many years, the computations of pension expenses and benefits are based on assumptions about future interest rates, estimates of annual increases in compensation levels, and expected rates of return on plan assets. The weighted-average rate assumptions used in the measurement of our benefit obligations are as follows:

The weighted-average rate assumptions used in the measurement of our net periodic benefit costs are as follows:

We establish the expected rate of return on plan assets based on a review of past and expected future anticipated returns on plan assets. The expected rate of return on plan assets assumption also matches the pension plans’ long-term interest rate assumption used for funding purposes.

Assumed health care cost trend rates have an effect on the amounts reported for other postretirement benefits. For measurement purposes, an 8.0 percent annual rate of increase in the per capita cost of covered health care benefits was assumed for 2005. The rate was assumed to decrease gradually to 5.50 percent through 2010 and remain at that level thereafter. A one-percentage-point increase in the assumed health care cost trend rate would increase total annual service and interest cost by $38 and total other postretirement benefit obligations by $387, as of January 1, 2005. Conversely, a one-percentage-point decrease in the assumed health care cost trend rate would decrease total annual service and interest cost by $36 and total other postretirement benefit obligations by $345.

Plan Assets

The asset allocation targets for the pension plans follow the investment policy adopted by the Retirement Trust Committee. This policy provides for a certain level of trustee flexibility in selecting target allocation percentages, which may vary from time to time. The actual asset allocations at December 31, 2005, 2004 and 2003 are shown in the following table along with the adopted range for target allocation percentages by asset class and the selected target allocations by asset class established for 2006. The actual allocation percentages are as of December 31 and reflect the quoted market values at that point in time and may vary during the course of the year.

2005 2004 2003Discount Rate 5.25% 6.00% 6.25%Rate of Compensation Increase 5.00 5.00 5.00

2005 2004 2003Discount Rate 6.00% 6.25% 6.75%Expected Rate of Return on

Plan Assets (Retirement Plans Only) 8.00 8.00 8.00

Rate of Compensation Increase 5.00 5.00 5.00


The plan assets are rebalanced back to the target allocation percentages once each year in the second quarter at the direction of the Trustees. No COBANK stock or debt, or that of any other System institution, is included in the assets of the pension plans. Investment strategy and objectives are described in the pension plans’ formal investment policy document. The basic strategy and objectives as adopted in the investment policy are:

• Manage portfolio assets with a long-term time horizon appropriate for the participant demographics and cash flow requirements;

• Optimize long-term funding requirements by generating rates of return sufficient to fund liabilities and exceed the long-term rate of inflation;

• Generate prudent rates of return to minimize unexpected increases in pension expense or annual cash contributions; and

• Provide competitive investment returns and reasonable risk levels when measured against appropriate benchmarks.

Contributions

We expect to contribute $6.5 million to our funded qualified defined benefit pension plans and a net $0.3 million, after reflecting collected retiree premiums, to our other postretirement benefit plans in 2006. Estimated Future Benefit Payments

We expect to pay the following benefit payments, which reflect expected future service, as appropriate.

Estimated Benefit Payments

Year: Retirement

Benefits

Other Postretirement

Benefits 2006 $ 6,071 $ 2682007 6,261 2652008 8,536 2702009 7,557 2722010 8,300 2812011 to 2015 60,006 1,513

Incentive Compensation Plans

We have broad-based annual incentive compensation plans covering substantially all employees pursuant to which cash awards may be granted. Criteria used to determine amounts payable primarily include the achievement of our strategic business objectives, overall Bank financial performance, capital levels and asset quality, as well as individual performance, and are approved annually by the Executive Committee of the Board of Directors. We also have a rolling three-year Long-Term Incentive Plan, pursuant to which cash awards may be granted to key senior officers who have a significant impact on long-term financial performance. Criteria used to determine amounts payable include achievement of certain longer-term Bank financial targets and strategic business objectives. Cash awards are to be paid subsequent to completion of each three-year plan, subject to approval by the Executive Committee of the Board of Directors.

The Farm Credit System Financial Assistance Corporation (FAC) was created in 1988 by Congress to carry out a temporary program to provide financial assistance to System institutions that were then experiencing financial difficulty. Although we did not receive any FAC financial assistance, we were required to pay a share of the interest on the FAC bonds used to fund System financial assistance and to repay portions of financial assistance provided to other System institutions. In June 2005, the last outstanding FAC debt of $325 million matured and was redeemed. As provided in the Farm Credit Act, the FAC will continue in existence no longer than two years following the maturity of the debt in June 2005. Our portion of the intra-System financial assistance expenses totaled $4.2 million, $10.3 million and $24.1 million in 2005, 2004 and 2003, respectively.

Retirement Benefit Plan Assets

TargetAllocation

Percentage of Plan Assets at December 31,

TargetRange 2006 2005 2004 2003

Asset Category Domestic Equity 45-55 % 50 % 51% 51% 56%Domestic Fixed

Income 40-50 45 44 44 39 International

Equity 0-10 5 5 5 5 Total 100 % 100 % 100% 100% 100%

9 Intra-System Financial Assistance Expenses


The components of the provision for income taxes are as follows:


Current:

Federal $ 89,049 $ 40,715 $ 51,181 State (2,410) 3,822 5,140

Total Current 86,639 44,537 56,321 Deferred:

Federal (26,628) 20,176 16,358 State 10,099 3,127 2,667

Total Deferred (16,529) 23,303 19,025 Total $ 70,110 $ 67,840 $ 75,346

Year Ended December 31, 2005 2004 2003 Comprehensive Tax Provision

Allocable to: Pre-Tax Income $ 70,110 $ 67,840 $ 75,346 Shareholders’ Equity- Amounts Allocated to Other Comprehensive Income (23,979 ) 2,818 (26,430)

Total $ 46,131 $ 70,658 $ 48,916

The components of deferred tax assets and liabilities are shown below.

December 31, 2005 2004 2003 Allowance for Credit Losses $ 163,485 $ 169,546 $ 156,301Employee Benefits 16,100 14,500 8,490Loan Origination Fees 12,215 13,248 12,954Unrealized Net Losses on

Investment Securities and Derivatives 26,465 3,629 1,088

Other Deferred Tax Assets 15,445 25,388 22,734Gross Deferred Tax Assets 233,710 226,311 201,567

Leasing 163,834 194,789 158,725Other Deferred Tax Liabilities 9,035 11,189 2,025

Gross Deferred Tax Liabilities 172,869 205,978 160,750Net Deferred Tax Assets $ 60,841 $ 20,333 $ 40,817

Deferred income taxes are provided for the change in temporary differences between the basis of certain assets and liabilities for financial reporting and income tax reporting purposes. The expected future tax rates are based upon enacted tax laws. The effective tax rates for the years ended December 31, 2005, 2004 and 2003, of 19 percent, 20 percent and 22 percent, respectively, were significantly less than the statutory income tax rate primarily due to the distribution or planned distribution of $167.6 million, $159.7 million and $135.0 million, respectively, of taxable income as qualified

patronage distributions, which are tax deductible as permitted by Subchapter T of the Internal Revenue Code.

Year Ended December 31, 2005 2004 2003 Federal Tax at Statutory Rate $ 128,740 $ 119,977 $ 118,123 State Tax, Net 3,280 4,518 5,074 Patronage Distributions (57,750 ) (55,826) (47,267)Other (4,160) (829) (584)Provision for Income Taxes $ 70,110 $ 67,840 $ 75,346

We will distribute 46 percent of income before income taxes and minority interest to our shareholders as qualified patronage distributions related to 2005, compared to 47 percent for 2004 and 40 percent for 2003.

We may participate in various financial instruments with off-balance sheet risk to satisfy the financing needs of our borrowers and to manage our exposure to interest rate risk. These financial instruments with off-balance sheet risk include commitments to extend credit and commercial letters of credit. The instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the financial statements. Commitments to extend credit are agreements to lend to a borrower provided that certain contractual conditions are met. Commercial letters of credit are agreements to pay a beneficiary under conditions specified in the letter of credit. Commitments and letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. At December 31, 2005, outstanding commitments to extend credit and commercial letters of credit were $11.4 billion and $158 million, respectively. Since many of these commitments are expected to expire without being drawn upon, the total commitments do not necessarily represent future cash requirements. However, these credit-related financial instruments have off-balance sheet credit risk because their amounts are not reflected on the consolidated balance sheets until funded or drawn upon. The credit risk associated with issuing commitments and commercial letters of credit may be substantially the same as that involved in extending loans to borrowers. Therefore, management applies the same credit policies to these commitments. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the borrower. When we have fully funded a commitment, the credit risk amount may equal the contract amount, assuming that the borrower fails completely to meet its repayment obligation and the collateral or other security obtained has no value.

10 Income Taxes

11 Financial InstrumentsWith Off-Balance Sheet Risk


For a fee, we provide financial standby letters of credit for borrowers, which are irrevocable commitments to guarantee payment of a specified financial obligation. We also provide performance standby letters of credit which are irrevocable agreements by us, as a guarantor, to make payments to the guaranteed party in the event a specified third party fails to perform under a nonfinancial contractual obligation, such as a third party failing to timely deliver certain commodities at a specified time and place. We also issue indemnification agreements, which function like guarantees, that contingently require us, as the indemnifying party (guarantor), to make payments to an indemnified party under certain specified circumstances. Certain recourse provisions

would enable us, as a guarantor, to recover from third parties any of the amounts paid under guarantees, thereby limiting our maximum potential exposure. As of December 31, 2005, the maximum potential amount of future payments that we may be required to make under our outstanding standby letters of credit was $979 million, with a fair value of $2.9 million which is included in the consolidated balance sheets as part of interest rate swaps and other financial instruments. These outstanding standby letters of credit have expiration dates ranging from January 2006 to December 2015.

The following table presents the estimated fair values of financial instruments at December 31, 2005, 2004 and 2003.

Estimated Fair Value of Financial Instruments

December 31, 2005 2004 2003

($ in Millions) Carrying Amount

Estimated Fair Value

Carrying Amount


Carrying Amount


Financial Assets: Net Loans and Leases $ 25,860 $ 26,009 $ 23,520 $ 23,759 $ 24,358 $ 24,788 Cash 15 15 16 16 9 9 Investment Securities 6,533 6,533 5,901 5,901 5,243 5,243 Federal Funds Sold, Securities Purchased

Under Resale Agreements and Other 915 915 1,007 1,007 825 825 Interest Rate Swaps and Other

Financial Instruments 44 44 39 39 199 199 Financial Liabilities: Bonds and Notes $ 30,039 $ 30,109 $ 27,352 $ 27,671 $ 27,656 $ 28,115 Interest Rate Swaps and Other

Financial Instruments 340 340 192 192 100 100 Off-Balance Sheet Financial

Instruments: Commitments to Extend Credit - (25) - (14) - (18)

The estimated fair value amounts were determined using available market information, current pricing information and various valuation methodologies. Broadly-traded markets do not exist for most of our financial instruments. When market quotes are unavailable, valuation methodologies are used to estimate fair values. These estimated fair values are based on judgments regarding anticipated cash flows, future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates involve uncertainties and matters of judgment, and therefore cannot be determined with precision. Due to the uncertainty of expected cash flows resulting from financial instruments, the use of different assumptions and valuation methodologies could significantly affect the estimated fair value amounts. Accordingly, the estimated fair values may not be indicative of the amounts for which the financial instruments could be exchanged in a current or future market transaction.

Furthermore, the disclosure of certain nonfinancial assets and liabilities is not required. For all of these reasons, the fair value disclosure is not intended to represent the market value of the Bank as a whole. A description of the methods and assumptions used to determine or estimate the fair value of each class of financial instruments, for which it is practicable to estimate that value, follows. Loans and Leases

Since no active market exists for most of our loans and leases, fair value is estimated by discounting the expected future cash flows using current interest rates at which similar loans and leases would be made to borrowers with similar credit risk. As the discount rates are based on current loan and lease rates as well as management estimates, management has no basis to determine whether the estimated fair values presented would be indicative of the value negotiated in an actual sale.

12 Disclosures About Estimated Fair Value of Financial Instruments


Investment Securities

Estimated fair values for investment securities are based upon currently quoted market prices. The estimated fair values of investment securities also appear in Note 5.

Cash, Federal Funds Sold and Securities Purchased Under Resale Agreements and Other

The estimated fair value of these instruments approximates their carrying value due to the short-term nature of these instruments.

Derivative Assets and Liabilities and Other Financial Instruments

The fair value of derivatives is the estimated amount to be received or paid to replace the instruments at the reporting date, considering current interest rates. Estimated fair values are determined primarily through internal market valuation models. Estimates determined using these methods are subjective and require judgments regarding matters such as the amount and timing of future cash flows and the selection of discount rates that reflect market and credit risk.

Bonds and Notes

Bonds and notes are not all regularly traded in the secondary market and those that are traded may not have readily available quoted market prices. To the extent that quoted market prices are not readily available, the fair value of these instruments is estimated by discounting expected future cash flows based on the quoted market price of similar maturity U.S. Treasury notes, assuming a constant estimated yield spread relationship between Systemwide bonds and notes and comparable U.S. Treasury notes. Commitments to Extend Credit

The fair value of commitments is estimated by applying a risk-adjusted spread percentage to these obligations.

We maintain an overall interest rate risk management strategy that incorporates the use of derivative financial instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. Our goal is to manage interest rate sensitivity by modifying the repricing frequency or effective maturity of certain balance sheet assets and liabilities. As a result of interest rate fluctuations, fixed-rate assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation is expected to be substantially offset by gains and losses on the derivative instruments that are linked to these assets and liabilities. Interest rate fluctuations also cause interest income

and interest expense of variable-rate assets and liabilities to increase or decrease. The effect of this variability in earnings is expected to be substantially offset by gains and losses on the derivative instruments that are linked to these assets and liabilities. We enter into derivatives, particularly interest rate swaps, to manage liquidity, lower funding costs or to manage interest rate risk arising from maturity and repricing mismatches between assets and liabilities. Under interest rate swap arrangements, we agree with a third party to exchange, at specified intervals, payment streams calculated on a specified notional amount, with at least one stream based on a specified floating-rate index. We use a variety of interest rate swaps including the exchange of floating-rate for fixed-rate and fixed-rate for floating-rate swaps with payment obligations tied to specific indices. We also enter into derivatives for our customers as a service to enable them to transfer, modify or reduce their interest rate risk by transferring such risk to us. We substantially offset this risk transference by concurrently entering into offsetting agreements with professional counterparties. Fair Value Hedges: The majority of the fair value hedging activity relates to entering into interest rate swaps primarily to convert our non-prepayable fixed-rate debt to floating-rate debt. The amount converted depends on contract interest rates and maturities. For the remaining fair value hedges, we enter into receive-fixed, pay-floating swaps. These swaps align our equity positioning strategy with our risk management strategy. Cash Flow Hedges: We use pay-fixed swaps to protect against an increase in interest rates by exchanging the debt’s variable-rate payment for a fixed-rate payment. The combination of the pay-fixed, receive-floating swap with floating-rate funding results in a net fixed-rate payment. We primarily use this strategy to create synthetic fixed-rate debt for certain variable-rate discount note issuances. Customer Transactions: Customer derivatives are not designated as hedging instruments and do not receive hedge accounting treatment. Accordingly, any changes in the fair value of customer derivatives are recognized immediately in current period earnings in noninterest income. For both fair value and cash flow hedges, the amount of hedge ineffectiveness and the amounts reclassified from accumulated other comprehensive income (loss) into current period earnings are reflected in net interest income. The change in the fair value of derivatives not designated as hedges is included in noninterest income. The table below includes the hedge ineffectiveness amounts recorded in the income statement. All components of each derivative’s gain or loss were included in the assessment of hedge effectiveness.

13 Derivative Financial Instruments and Hedging Activities


Also included below is the amount expected to be reclassified from other comprehensive income (loss) into the income statement in the next 12 months, based on the anticipated cash flows of existing financial instruments. The maximum term over which we are hedging our exposure to the variability of future cash flows (for all forecasted transactions, excluding interest payments on variable-rate instruments) is six months.

Year Ended December 31, 22005

Fair Value Hedges – Hedge Ineffectiveness $ 2,407 Cash Flow Hedges – Hedge Ineffectiveness 2,711Total Increase in Net Income

for Hedge Ineffectiveness $ 5,118Cash Flow Hedges -

Expected Amount to be Reclassified Into Earnings Within the Next 12 Months $ 2,810

The use of derivatives for risk management activities includes the credit risk of dealing with counterparties and market risks related to movements in interest rates. If a counterparty fails to fulfill its performance obligations under a derivative contract, the credit risk will equal the fair value gain in a derivative. Generally, when the fair value of a derivative contract is positive, the counterparty owes us, thus creating a performance risk. When the fair value of the derivative contract is negative, we owe the counterparty, and therefore, assume no performance risk. The maximum amount of losses we could be exposed to in the event of nonperformance by the counterparties to our derivative positions was $17 million, $29 million and $207 million at December 31, 2005, 2004 and 2003, respectively. All derivative transactions are governed by master swap agreements, which include netting agreements. The master swap agreements also include bilateral collateral arrangements except for derivative transactions related to customer transactions. As of December 31, 2005, we had posted $88 million in cash and $23 million in securities as collateral with counterparties. Our master agreements mitigate credit risk by requiring the net settlement of covered contracts with the same counterparty in the event of default by the other party. The “net” mark-to-market exposure represents the netting of the positive and negative exposures with that counterparty. The credit risk is further mitigated by setting limits on the amount of net exposure to each respective counterparty.

In the ordinary course of business, we enter into loan transactions with customers, the officers or directors of which may also serve on our Board of Directors. Such loans are

subject to special review and reporting requirements contained in the FCA regulations, and are reviewed and approved only at the most senior loan committee level within the Bank. All related party loans are made in accordance with established policies on the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated borrowers. Total direct loans outstanding to such customers amounted to $5.6 billion at December 31, 2005, including $5.3 billion to three affiliated Associations, with which we had four common directors. During 2005, $9.6 billion of new loans were made and repayments totaled $9.1 billion. None of these loans outstanding at December 31, 2005 were delinquent or in nonaccrual or accruing restructured status or, in the opinion of management, involved more than a normal risk of collectibility.

The table on the following page presents disaggregated income information for our four operating segments. We conduct our lending and leasing operations through the Agribusiness Banking Group, including FCL (ABG), Strategic Relationships Division (SRD), Global Financial Services Group (GFSG) and Communications and Energy Banking Group (CEBG). Effective January 1, 2005, we made several changes to our organization and related reporting segments to better align our segments with the markets they serve and their related portfolio credit risks. We combined our FCL and former ABG segments into one consolidated ABG segment. We also transferred into this ABG segment our portfolio of purchased participations in loans made by System Associations that was previously included in SRD. In addition, we combined our Communications and Energy and Water segments into one consolidated CEBG segment. Segment data for prior years has been reclassified to conform to the current year’s presentation. Allocations of resources and corporate items, as well as measurement of financial performance, are made at these operating segment levels. We also allocate to our segments net interest income on investment securities, federal funds sold, securities purchased under resale agreements and other highly-liquid investments. Information to reconcile the total reportable segments to the total COBANK financial statements is shown as “other”. Intersegment transactions are insignificant. We do not hold significant assets in any foreign country. Our international loans are U.S. dollar-denominated and the majority of these loans are guaranteed by a U.S. government-sponsored loan guarantee program. Additionally, revenue and net interest income from any single customer does not exceed 10 percent or more of total revenue or total net interest income.

14 Related Party Transactions

15 Segment Financial Information


Segment Financial Information

ABG SRD GFSG CEBG Subtotal Other Total COBANK

2005 Results of Operations ($ in Thousands): Net Interest Income $ 207,702 $ 48,775 $ 76,461 $ 150,373 $ 483,311 $ 80 $ 483,391

Provision for Credit Losses 6,500 - 15,500 3,000 25,000 - 25,000

Noninterest Income (Expense) 20,465 160 21,068 12,587 54,280 (1,386) 52,894

Operating Expenses 63,389 7,119 29,252 35,424 135,184 4,118 139,302

Financial Assistance Expenses 890 1,255 945 1,066 4,156 - 4,156Provision (Benefit) for Income Taxes 34,716 2,455 12,632 22,334 72,137 (2,027) 70,110

Net Income (Loss) $ 122,672 $ 38,106 $ 39,200 $ 101,136 $ 301,114 $ (3,397) $ 297,717

2005 Selected Financial Information ($ in Millions): Loans and Leases,

Net of Allowance for Credit Losses at December 31, 2005 $ 6,669 $ 7,848 $ 4,698 $ 6,645 $ 25,860 $ - $ 25,860

Assets at December 31, 2005 $ 6,759 $ 7,877 $ 4,738 $ 6,703 $ 26,075 $ 7,760* $ 33,835

*Other assets are comprised of: Investment Securities $ 6,533

Federal Funds Sold, Securities Purchased Under Resale Agreements and Other 915

Other Assets 312

2004 Results of Operations ($ in Thousands): Net Interest Income (Expense) $ 214,745 $ 47,374 $ 95,179 $ 171,731 $ 529,029 $ (3,741) $ 525,288Provision for Credit Losses 26,812 - (1,500) 23,688 49,000 - 49,000Reclassification of Allowance Due to

Refinement in Methodology 20,000 - (20,000) - - - -Noninterest Income (Expense) 7,742 151 13,662 2,356 23,911 (2,449) 21,462Operating Expenses 62,569 6,413 30,596 35,210 134,788 9,900 144,688Financial Assistance Expenses 2,332 2,958 2,295 2,686 10,271 - 10,271Provision (Benefit) for Income Taxes 24,020 1,992 22,547 20,007 68,566 (726) 67,840Net Income (Loss) $ 86,754 $ 36,162 $ 74,903 $ 92,496 $ 290,315 $ (15,364) $ 274,951

2004 Selected Financial Information ($ in Millions): Loans and Leases,


Assets at December 31, 2004 $ 5,856 $ 6,874 $ 4,905 $ 6,191 $ 23,826 $ 7,030* $ 30,856

*Other assets are comprised of: Investment Securities $ 5,901Federal Funds Sold and Securities Purchased Under Resale Agreements 1,007Other Assets 122

2003 Results of Operations ($ in Thousands): Net Interest Income (Expense) $ 214,955 $ 44,680 $ 96,137 $ 188,883 $ 544,655 $ (2,318) $ 542,337Provision for Credit Losses 5,722 - (9,800) 72,650 68,572 - 68,572Noninterest Income (Expense) 6,170 - 17,215 12,753 36,138 (6,898) 29,240Operating Expenses 64,052 5,724 32,009 37,757 139,542 2,001 141,543Financial Assistance Expenses / Other 5,491 6,275 5,638 6,730 24,134 1,090 25,224Provision (Benefit) for Income Taxes 39,358 862 19,894 17,344 77,458 (2,112) 75,346Net Income (Loss) $ 106,502 $ 31,819 $ 65,611 $ 67,155 $ 271,087 $ (10,195) $ 260,892

2003 Selected Financial Information ($ in Millions):Loans and Leases,


Assets at December 31, 2003 $ 6,441 $ 6,623 $ 5,217 $ 6,317 $ 24,598 $ 6,283* $ 30,881*Other assets are comprised of:

Investment Securities $ 5,243Federal Funds Sold and Securities Purchased Under Resale Agreements 825Other Assets 215


17 Quarterly Financial Information (Unaudited)

We have various commitments outstanding and contingent liabilities as discussed elsewhere in these notes to consolidated financial statements. Under the Farm Credit Act, we are primarily liable for our portion of Systemwide Debt Securities. Additionally, each System bank is jointly and severally liable for the Systemwide Debt Securities of the other System banks. Total Systemwide Debt Securities of the System were $112.7 billion at December 31, 2005.

At December 31, 2005, various lawsuits were pending or threatened against the Bank in which claims for monetary damages, some of which are significant, have been or may be asserted. In the opinion of management, based on information currently available and taking into account the advice of legal counsel, the ultimate liability, if any, of pending or threatened legal actions will not have a material adverse impact on our results of operations or financial position. We have entered into employment contracts with two of our senior officers which will provide certain severance benefits to these officers in the event they are terminated, except in the case of a termination for cause.

Unaudited quarterly results of operations for the years ended December 31, 2005, 2004 and 2003, are shown in the table below.

Quarterly Financial Information (Unaudited) 2005 First Second Third Fourth Total

Net Interest Income $ 120,062 $ 120,030 $ 119,884 $ 123,415 $ 483,391

Provision for Credit Losses 7,500 7,500 10,000 - 25,000Noninterest Income and Expenses, Net 13,388 21,633 21,417 34,126 90,564

Provision for Income Taxes 21,571 17,181 20,322 11,036 70,110

Net Income $ 77,603 $ 73,716 $ 68,145 $ 78,253 $ 297,717

2004 First Second Third Fourth Total

Net Interest Income $ 135,484 $ 130,241 $ 134,904 $ 124,659 $ 525,288 Provision for Credit Losses 15,000 15,000 9,000 10,000 49,000 Noninterest Income and Expenses, Net 26,624 22,858 35,918 48,097 133,497 Provision for Income Taxes 21,878 21,358 20,405 4,199 67,840

Net Income $ 71,982 $ 71,025 $ 69,581 $ 62,363 $ 274,951

2003 First Second Third Fourth Total

Net Interest Income $ 141,456 $ 138,493 $ 133,526 $ 128,862 $ 542,337Provision for Credit Losses 19,809 19,759 15,004 14,000 68,572Noninterest Income and Expenses, Net 21,899 36,565 48,155 30,908 137,527Provision for Income Taxes 25,019 17,447 14,204 18,676 75,346

Net Income $ 74,729 $ 64,722 $ 56,163 $ 65,278 $ 260,892

16 Commitments and Contingent Liabilities


We are chartered by the FCA to serve the Associations that provide credit and financially related services to or for the benefit of eligible borrowers/shareholders for qualified purposes primarily doing business in the New England states, New York, New Jersey, Alaska, Idaho, Montana, Oregon and Washington. The Associations are statutorily precluded by the Farm Credit Act from participating in the issuance of Systemwide Debt Securities. Therefore, we are the primary funding source for our affiliated Associations. The Associations primarily originate and service short- and intermediate-term loans for agricultural purposes and secured long-term real estate mortgage loans. The Associations also serve as an intermediary in offering credit life insurance and multi-peril crop insurance and providing additional financial services to borrowers. The Farm Credit Act and FCA regulations require us to exercise limited supervision over the operating activities of our five affiliated Associations. These Associations and COBANK operate under a debtor-creditor relationship evidenced by a General Financing Agreement (GFA) entered into separately with each Association. The GFA sets forth the business relationship between us and each Association and also references certain requirements contained in the Farm Credit Act and FCA regulations. The Associations’ Boards of Directors are expected to establish and monitor the necessary policies and procedures to comply with all FCA regulations. In all other respects, the lending relationship with the Associations is substantially similar to our other borrowers. The FCA’s capital adequacy regulations require all System institutions, including us and the Associations, to individually maintain permanent capital of 7 percent of average risk-adjusted assets. At December 31, 2005, the permanent capital ratios of the Associations and Bank exceeded these standards. We have only limited access to Association capital. Our bylaws permit our Board of Directors to set the target equity level for Association investment in the Bank within a range of 4 to 6 percent of the one-year historical average of Association borrowings. At December 31, 2005, the required investment level was 4 percent. There is no capital sharing agreement between us and the Associations.

We make loans to the Associations, which, in turn, make loans to their eligible borrowers. We have senior secured interests in the Associations’ assets, which extend to the underlying collateral of the Associations’ loans to their customers. Our loans outstanding to the Associations we serve amounted to $7.2 billion at December 31, 2005. During 2005, $10.3 billion of new loans were made to our affiliated Associations and repayments totaled $9.6 billion.

The Associations operate independently and maintain an arms-length relationship with us, except to the limited extent that the Farm Credit Act requires us, as the funding bank, to monitor and approve certain activities of the Associations. Accordingly, the financial information of the Associations is not included in our accompanying consolidated financial statements. As more fully discussed in Note 2, in 2004 System Associations refined their allowance for credit losses methodologies taking into account recently issued guidance by the FCA, as well as the SEC and FFIEC guidelines. As a result, our affiliated Associations recorded a $95 million reversal of their allowance for credit losses in 2004. Selected unaudited financial information of the Associations as of December 31, 2005, 2004 and 2003, and for the years then ended, is presented below on a condensed, combined basis.

.

Combined Affiliated Associations (Unaudited)

December 31, 2005 2004 2003

Assets

Loans $ 8,407,852 $ 7,667,814 $ 7,328,970Allowance for Credit Losses 69,823 73,585 171,503

Net Loans 8,338,029 7,594,229 7,157,467Other Assets 598,138 562,486 534,915

Total Assets $ 8,936,167 $ 8,156,715 $ 7,692,382

Liabilities and Shareholders’ Equity

Notes Payable $ 7,304,941 $ 6,621,422 $ 6,359,511 Other Liabilities 93,744 86,235 82,335

Total Liabilities 7,398,685 6,707,657 6,441,846 Total Shareholders’ Equity 1,537,482 1,449,058 1,250,536

Total Liabilities and

Shareholders’ Equity $ 8,936,167 $ 8,156,715 $ 7,692,382


Interest Income $ 494,722 $ 384,595 $ 350,070 Interest Expense 262,398 169,511 161,130

Net Interest Income 232,324 215,084 188,940 Provision for Credit Losses (1,664) (91,166) 5,145

Net Interest Income After Provision for Credit Losses 233,988 306,250 183,795

Noninterest Income 74,311 72,296 135,986 Noninterest Expenses 129,724 117,777 116,252

Income Before Income Taxes 178,575 260,769 203,529 Provision for Income Taxes 3,997 939 16,798

Net Income $ 174,578 $ 259,830* $ 186,731

18Selected Financial Information of Affiliated Agricultural Credit Associations (Unaudited)

* Excluding the effect of the reversal of allowance for credit losses relatedto the refinement in methodology, net income would have been $165.1million in 2004

71

COBANK, ACB

March 1, 2006

To the Shareholders:

The consolidated financial statements of COBANK, ACB (COBANK) are prepared by management, which is

responsible for their integrity and objectivity, including amounts that must necessarily be based on judgments and

estimates. The consolidated financial statements have been prepared in conformity with accounting principles generally

accepted in the United States of America as appropriate in the circumstances. The consolidated financial statements, in

the opinion of management, fairly present, in all material respects, the consolidated financial position of COBANK.

Other consolidated financial information included in the Annual Report to Shareholders is consistent with that in the

financial statements.

To meet its responsibility for reliable consolidated financial information, management depends on accounting and

internal control systems which have been designed to provide reasonable, but not absolute, assurance that assets are

safeguarded and transactions are properly authorized and recorded. The systems have been designed to recognize that

the cost must be related to the benefits derived. To monitor compliance, COBANK’s internal audit staff performs audits

of the accounting records, reviews accounting systems and internal controls, and recommends improvements as deemed

appropriate. COBANK’s 2005, 2004 and 2003 consolidated financial statements have been audited by

PricewaterhouseCoopers LLP, independent auditors. In addition, our independent auditors have audited our internal

control over financial reporting as of December 31, 2005 and 2004. COBANK is also examined by the Farm Credit

Administration.

The chief executive officer, as delegated by the Board of Directors, has overall responsibility for COBANK’s system

of internal controls and financial reporting, subject to the review of the audit committee of the Board of Directors. The

chief executive officer reports periodically on those matters to the audit committee. The audit committee consults

regularly with management and meets periodically with the independent auditors and internal auditors to review the

scope and results of their work. The audit committee reports regularly to the Board of Directors. Both the independent

auditors and the internal auditors have direct access to the audit committee, which is comprised solely of directors who

are not officers or employees of COBANK.

The undersigned certify that this COBANK Annual Report to Shareholders has been prepared in accordance with all

applicable statutory or regulatory requirements and that the information contained herein is true, accurate, and complete

to the best of their knowledge.

J. Roy Orton Douglas D. Sims Brian P. Jackson Chairman of the Board Chief Executive Officer Chief Financial Officer

Report of Management

72

COBANK, ACB

To the Board of Directors and Shareholders of COBANK, ACB:

We have completed integrated audits of COBANK, ACB’s 2005 and 2004 consolidated financial statements and

of its internal control over financial reporting as of December 31, 2005 and 2004 and an audit of its 2003 consolidated

financial statements in accordance with generally accepted auditing standards as established by the Auditing Standards

Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board

(United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of

income, of changes in shareholders’ equity and of cash flows present fairly, in all material respects, the financial position

of COBANK, ACB and its subsidiary (COBANK) at December 31, 2005, 2004 and 2003, and the results of their

operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with

accounting principles generally accepted in the United States of America. These financial statements are the

responsibility of COBANK’s management. Our responsibility is to express an opinion on these financial statements based

on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards as

established by the Auditing Standards Board (United States) and in accordance with the auditing standards of the Public

Company Accounting Oversight Board (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 of

financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial

statements, assessing the accounting principles used and significant estimates made by management, and evaluating the

overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

Also, in our opinion, management’s assessment, included in Management’s Report on Internal Controls over

Financial Reporting on page 74 of the COBANK 2005 Annual Report to Shareholders, that CoBANK maintained effective

internal control over financial reporting as of December 31, 2005 and 2004 based on criteria established in Internal Control

– Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is

fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, COBANK maintained, in all

material respects, effective internal control over financial reporting as of December 31, 2005 and 2004, based on criteria

established in Internal Control – Integrated Framework issued by the COSO. COBANK’s management is responsible for

maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal

control over financial reporting.

Report of Independent Auditors

73

COBANK, ACB

Our responsibility is to express opinions on management’s assessment and on the effectiveness of the

Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over

financial reporting in accordance with generally accepted auditing standards as established by the Auditing Standards

Board (United States) and in accordance with the auditing standards of the Public Company Accounting Oversight Board

(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about

whether effective internal control over financial reporting was maintained in all material respects. An audit of internal

control over financial reporting includes obtaining an understanding of internal control over financial reporting,

evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control,

and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides

a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance

regarding the reliability of financial reporting and the preparation of financial statements for external purposes in

accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes

those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly

reflect transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are

recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting

principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of

management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely

detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the

financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect

misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls

may become inadequate because of changes in conditions, or that the degree of compliance with the policies or

procedures may deteriorate.

Denver, Colorado March 1, 2006

Report of Independent Auditors

74

COBANK, ACB

Our management is responsible for establishing and maintaining adequate internal control over financial

reporting. COBANK’s internal control over financial reporting is a process designed under the supervision of our Chief

Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial

reporting and the preparation of the Bank’s financial statements for external reporting purposes in accordance with U.S.

generally accepted accounting principles. As of the end of the Bank’s 2005 and 2004 fiscal years, management conducted

an assessment of the effectiveness of the Bank’s internal control over financial reporting based on the framework

established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the

Treadway Commission. Based on this assessment, our management concluded that the Bank’s internal control over

financial reporting is effective as of December 31, 2005 and 2004.

Our internal control over financial reporting includes policies and procedures that (i) pertain to the maintenance

of records that, in reasonable detail, accurately and fairly reflect transactions and dispositions of assets; (ii) provide

reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in

accordance with U.S. generally accepted accounting principles, and that receipts and expenditures are being made only in

accordance with authorizations of management and the directors of COBANK; and (iii) provide reasonable assurance

regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Bank’s assets that could

have a material effect on our financial statements.

Our management’s assessment of the effectiveness of the Bank’s internal control over financial reporting as of

December 31, 2005 and 2004 has been audited by PricewaterhouseCoopers LLP, independent auditors, as stated in their

report appearing on pages 72 and 73, which expresses unqualified opinions on management’s assessment and on the

effectiveness of the Bank’s internal control over financial reporting as of December 31, 2005 and 2004. There have been

no changes in the Bank’s internal control over financial reporting that occurred during our most recent fiscal quarter (i.e.,

the fourth quarter of 2005) that have materially affected, or are reasonably likely to materially affect, the Bank’s internal

control over financial reporting.

Management’s Report on Internal Control Over Financial Reporting

75

COBANK, ACB

We maintain a system of disclosure controls and procedures. Disclosure controls and procedures include,

without limitation, controls and procedures designed to ensure that information disclosed by us in our quarterly and

annual reports is accumulated and communicated to our management, including our principal executive officer and our

principal financial officer, as appropriate, to allow timely decisions to be made regarding disclosure. The Chief Executive

Officer and Chief Financial Officer have evaluated our disclosure controls and procedures as of the end of the period

covered by this annual report and have concluded that our disclosure controls and procedures are effective as of that

date.

We also maintain a system of internal controls. The term “internal controls,” as defined by the American

Institute of Certified Public Accountants’ Codification of Statement on Auditing Standards, AU Section 319, means a

process - effected by the board of directors, management and other personnel - designed to provide reasonable assurance

regarding the achievement of objectives in reliability of our financial reporting, the effectiveness and efficiency of

operations and of compliance with applicable laws and regulations. We continually assess the adequacy of our internal

controls over financial reporting and enhance our controls in response to internal control assessments and internal and

external audit and regulatory recommendations. There have been no significant changes in our internal controls or in

other factors that could significantly affect such controls subsequent to the date we carried out our evaluations.

Controls and Procedures

76

COBANK, ACB

In accordance with Farm Credit Administration (FCA) regulations, COBANK has prepared this Annual Report to Shareholders for the year ended December 31, 2005, in accordance with all applicable statutory or regulatory requirements.

Section Location

Description of Business Territory served, eligible borrowers, types of lending activities engaged in, financial services offered, and related Farm Credit organizations.

Notes to Financial Statements.......................... Note 1 Note 18

Significant developments within the last 5 years that had or could have a material impact on earnings or interest rates to borrowers, acquisitions or dispositions ofmaterial assets, material changes in the manner of conducting business, seasonal characteristics, concentration of assets, and dependence, if any, upon a single customer or a few customers.

Notes to Financial Statements.......................... Note 1 Note 2 Note 3 Note 4 Note 7 Note 9 Note 14 Note 15 Note 16 Note 17 Note 18

Management’s Discussion and Analysis ......... Pages 20 to 46

Description of Property Location of Property Office Locations ................................................. Back Cover As of December 31, 2005, COBANK owned the land on which its national office is located and leased its national office building which is located in Greenwood Village, Colorado through a sale/leaseback arrangement. COBANK leases various facilities which are described on the back cover of this Annual Report to Shareholders. COBANK leases banking center offices in Atlanta, GA; Fargo, ND; Louisville, KY; Lubbock, TX; Minneapolis, MN; Omaha, NE; Sacramento, CA; Spokane, WA; Springfield, MA; St. Louis, MO; and Wichita, KS. COBANK leases office space in Washington D.C., Mexico City and Singapore. Farm Credit Leasing Services Corporation leases its headquarters office in Minneapolis, MN, as well as outside sales offices in Atlanta, GA; Greenwood Village, CO; Hereford, TX; Hunt Valley, MD; Louisville, KY; New Braunfels, TX; Omaha, NE; Sacramento, CA; Spokane, WA; St. Louis, MO; and Wichita, KS, some of which are located in COBANK banking centers.

Legal Proceedings and Enforcement Actions Notes to Financial Statements.......................... Note 16

Description of Capital Structure Notes to Financial Statements.......................... Note 7

Description of Liabilities Debt Outstanding Notes to Financial Statements.......................... Note 6

Intra-System Financial Assistance and Intra-System Financial Obligations Notes to Financial Statements.......................... Note 9

Contingent Liabilities Notes to Financial Statements.......................... Note 16

Selected Financial Data for the Five Years Ended December 31, 2005

Five-Year Summary of Selected Consolidated Financial Data............. Page 19

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Management’s Discussion and Analysis ......... Pages 20 to 46

Directors and Senior Officers Directors’ Information Board of Directors Disclosure ......................... Pages 78 to 86

Senior Officers’ Information Senior Officers.................................................... Pages 87 to 88

Transactions with Directors and Senior Officers Notes to Financial Statements.......................... Note 14

Annual Report to Shareholders Disclosure Information Required by Farm Credit Administration Regulations

77

COBANK, ACB

Section Location

Involvement in Certain Legal Proceedings There were no matters that came to the attention of the Board of Directors or management regarding the involvement of current directors or senior officers in specified legal proceedings which are required to be disclosed.

Relationship with Independent Public Accountants There has been no change in independent public accountants or no disagreements on any matters of accounting principle or financial statement disclosure during the period.

Financial Statements Financial Statements and Footnotes Financial Information ........................................ Pages 47 to 70

Report of Management Report of Management...................................... Page 71

Report of Independent Auditors Report of Independent Auditors ..................... Pages 72 to 73

Credit and Services to Young, Beginning and Small Farmers and Ranchers

and Producers or Harvesters of Aquatic Products Young, Beginning and Small Farmers............. Page 89

Annual Report to Shareholders Disclosure Information Required by Farm Credit Administration Regulations

78

COBANK, ACB

Directors In 2004, COBANK stockholders approved a board-restructuring proposal. The new board structure was made effective starting in January 2005 and will be fully implemented by January 1, 2008. The new provisions accomplish the following:

• Reduce the size of the board to 15-17 members; • Combine the previous board districts into three regions: east, central and west with a total of 12 elected

directors, four from each of the new regions; • Provide a maximum of three outside (independent of any customer or Farm Credit System affiliation) and two

appointed (customer affiliation permitted) director positions; • Extend director terms from three to four years, with a transition period to accomplish the staggering of terms to

fully implement the new structure by January 2008; and • Conduct further reviews of the board structure in 2010, and at least every six years thereafter.

Employees of Farm Credit System (System) institutions, including COBANK, cannot serve on COBANK’s Board of Directors within one year of employment. As of December 31, 2005, the board consisted of 27 directors, however, as a result of the 2005 director elections conducted under the new board structure, the number of directors decreased to 21 effective January 1, 2006.

Information About Committees of the Board of Directors The Board of Directors has established the following standing committees: an Audit Committee, a Budget and Finance Committee, an Executive Committee, a Governance Committee and a Loan Review Committee. The Executive Committee also functions as the board’s compensation committee. The Board of Directors has adopted a written charter for each of these board committees. The full text of each charter is available on our website under “Governance” at www.cobank.com. All board committees report on their meetings at the regular meeting of the full board. Minutes of each committee meeting are signed by the committee chair and secretary, or any other individual acting in their place at the meeting. In 2005, the Board of Directors held six regular meetings and committees of the Board of Directors held a total of 26 meetings. Twenty-one of the Directors attended 100 percent of all regularly scheduled board and committee meetings. The other directors attended at least 85 percent of all board and committee meetings. The primary responsibilities of each committee are described in the following pages.

Board of Directors Disclosure as of December 31, 2005

79

COBANK, ACB

Committee Responsibilities Audit

The Audit Committee is comprised of nine directors, is governed by a formal charter, is chaired by the board’s outside director and reports to the Bank’s Board of Directors. The Audit Committee members are appointed by the board chair in consultation with the board officers and committee chairs. All members of the Audit Committee are independent of management of the Bank and any other System entity. During 2005, the Audit Committee met during the five regular meetings of the Board of Directors, including regular meetings in executive session with senior management, the Risk Management Division manager and the Director of Internal Audit. Quarterly financial statements are reviewed and approved by either the full Audit Committee or a subcommittee of the Audit Committee, which is designated by the Audit Committee chairman. The full Audit Committee, in joint session with the Budget and Finance Committee, review and approve the annual financial statements. Mr. Robert E. Terkhorn was appointed to the Board of Directors in 1998 and served as Chairman of the Audit Committee since 1999. His term expired at the end of 2005. Effective January 1, 2006, Mr. Barry M. Sabloff began serving as Chairman of the Audit Committee. The Board of Directors has determined that Mr. Terkhorn and Mr. Sabloff have the qualifications and experience necessary to serve as an “audit committee financial expert,” as defined by the rules of the Securities and Exchange Commission, and they were so designated. The primary purpose of the Audit Committee is to assist the board in fulfilling its oversight responsibilities by carrying out the following responsibilities:

1. Overseeing management’s conduct of the Bank’s financial reporting process and systems of internal accounting and financial controls,

2. Monitoring the independence and performance of the Bank’s internal audit function, the risk assessment process, and the independent public accountants,

3. Ensuring the Bank’s compliance with legal and regulatory requirements, and 4. Providing an avenue of communication among the outside auditors, management and the board.

Management has the primary responsibility for the consolidated financial statements and the financial reporting process, including the system of internal controls. The Audit Committee oversees the Bank’s independent public accountants, internal control and financial reporting process on behalf of the Board of Directors. In this regard, the Audit Committee helps to ensure independence of the Bank’s independent public accountants, the integrity of management and the adequacy of disclosure to shareholders. The Audit Committee has unrestricted access to representatives of the internal audit department, independent public accountants and financial management. The Audit Committee preapproves all audit and audit-related services and permitted nonaudit services (including the fees and terms thereof) to be performed for the Bank by its independent public accountants, as negotiated by management. The Audit Committee may form and delegate authority to the chairman of the Audit Committee, or a subcommittee of the Audit Committee (consisting of one or more members), when appropriate, including the authority to grant preapprovals of audit and permitted nonaudit services, provided that decisions of the chairman or any subcommittee to grant preapprovals is presented to the full Audit Committee at its next scheduled meeting. The Audit Committee, in joint session with the Budget and Finance Committee, reviewed the audited consolidated financial statements in the Annual Report for the year ended December 31, 2005 with management and the Bank’s independent public accountants. The independent public accountants are responsible for expressing an opinion on the conformity of the Bank’s audited consolidated financial statements with accounting principles generally accepted in the United States of America, including a discussion of the quality of the Bank’s accounting principles, the reasonableness of significant judgments, the clarity of disclosures in the consolidated financial statements and the adequacy of internal controls. The Audit Committee discussed with the independent public accountants the results of the 2005 audit and all other matters required to be discussed by Statement on Auditing Standards No. 61, “Communications with Audit Committees.” In addition, the Audit Committee received, reviewed and discussed the written disclosures from the independent public accountants required by Independence Standards Board Standard No. 1, “Independence Discussions with Audit Committees.” Based on the review and discussions described above, the Audit Committee recommended to the Board of Directors that the audited consolidated financial statements be included in the Bank’s Annual Report for the year ended December 31, 2005 for filing with the FCA.


80

COBANK, ACB

Aggregate fees incurred by the Bank for services rendered by its independent public accountants, PricewaterhouseCoopers LLP, for the years ended December 31, 2005 and 2004 were as follows:

Year Ended December 31, 2005 2004

($ in Thousands)

Audit $ 450,000 $ 555,600 Audit-related 99,150 93,250 Tax - -All Other 24,009 186,000Total $ 573,159 $ 834,850

Audit fees were for the annual audit of the consolidated financial statements, including the audit of our internal control over financial reporting.

Audit-related fees were for assurance and related services primarily in connection with employee benefit plan audits.

All other fees were primarily for services rendered in connection with assistance with strategic modeling in 2005 and information technology consulting in 2004.

Budget and Finance

The Budget and Finance Committee members are appointed by the board chair in consultation with the board officers and committee chairs. The committee is primarily responsible for reviewing the Bank’s budget and reports of operations and financial condition, including reports on investments, liquidity, interest rate risk, capital, derivatives and liability management. The committee annually reviews the Bank’s business and financial plan and recommends such plan for approval by the Board. The committee participates in a joint meeting with the Audit Committee to review year end financial results with management and the Bank’s independent public accountants. The committee also provides advice and counsel to the board and management on capital and finance matters and recommends policies related to these areas for board approval.

Executive Committee The Executive Committee members are appointed by the board chair in consultation with the board officers and committee chairs. The committee is primarily responsible for providing input and direction to management on the development and implementation of the Bank’s strategic plan, policies and significant matters requiring attention between board meetings. The Executive Committee also functions as the Board’s compensation committee and reviews the Bank’s overall compensation and benefits packages, including the performance and compensation for the chief executive officer, and the funding of these programs. The committee also acts as the liaison with the Bank’s regulator, the FCA.

Loan Review Committee The Loan Review Committee members are appointed by the board chair in consultation with the board officers and committee chairs. The committee is primarily responsible for reviewing the lists of high-risk loans and adversely classified loans above $5 million and other sensitive loans requiring the board’s awareness and oversight, and reporting such information to the board as appropriate. The Loan Review Committee reviews all loans to borrowers with which a director has involvement and reports to the board.

Governance Committee Corporate Governance Committee members are appointed by the board chairman in consultation with board officers and committee chairs. This committee makes recommendations to the board to enhance the Bank’s governance practices. The committee also oversees the Bank’s director nomination and election process. In addition, after carefully considering knowledge, background and other credentials, the committee recommends prospective outside and appointed directors to the full board.


81

COBANK, ACB

Other Committees

Nominating Committee

The Nominating Committee is comprised of seven members who are appointed each year by the board chairman in consultation with the board officers. This committee, which must consist of a majority of customer representatives who are not seated on the Board of Directors, proactively identifies qualified candidates for board membership and reviews director nominations, helping to ensure that the Bank continues to attract a highly qualified and diverse board. The committee seeks candidates who are nationally recognized leaders and who fulfill specific needs for industry and geographic diversity on the board. Customers are encouraged to submit resumes of candidates for elected positions. The Nominating Committee makes a best effort to recommend at least two candidates for each position up for election. Stockholders and interested candidates may gather signatures for petitions to run for the board following the conclusion of the Nominating Committee’s work. A nominee cannot be associated with a party to an adversely classified COBANKor Farm Credit System loan unless he or she resigns or disaffiliates from such loan party by the date the term of office is to begin. A nominee must not have reached age 70 on or prior to the date the term of office is to begin and must meet other eligibility requirements established by Bank bylaws and federal regulations.


82

COBANK, ACB

The following represents certain information regarding the directors as of December 31, 2005, including business experience during the past five years. The terms of directors were scheduled to expire as of December 31 of the years indicated.

1 – Audit Committee2 – Budget and Finance Committee3 – Executive Committee4 – Governance Committee5 – Loan Review Committee

6 – Audit Committee Chair 7 – Budget and Finance Committee Chair 8 – Executive Committee Chair 9 – Governance Committee Chair 10 – Loan Review Committee Chair

Name Term Expires Principal Occupation and Other Affiliations

Mack L. Alford 1,5

Age: 65 Year Service Began: 2001

2006 Principal Occupation: M.L. Alford, CPA, accounting practice, Greenwood, MS; Retired Vice President and Treasurer: Staple Cotton Cooperative Association, a cotton-

marketing cooperative, Greenwood, MS; Retired Vice President and Treasurer: Staple Cotton Discount Corporation, a financing

cooperative, Greenwood, MS.

Gene J. Batali 3


2005 Principal Occupation: Owner/Operator, specialized farming (mint), Yakima, WA.

Other Affiliations: Director: Northwest Farm Credit Services, ACA, agricultural finance, Spokane, WA.

D. Sheldon Brown 3,5,10

First Vice Chair


2006 Principal Occupation: Dairy farmer, Salem, NY; Secretary and Treasurer: Woody Hills Farms, Inc., a dairy farm, Salem, NY; Partner: Woody Hills Farm, LLC, a dairy farm, Salem, NY.

Other Affiliations: Director: Northeast Regional Council, a nonprofit trade association for cooperative farm

credit organizations, Springfield, MA; Partner: A to Z Repairs LLC, a machinery repair corporation, Salem, NY.

Rita M. Brown 2,4,5


2006 Principal Occupation: Senior Vice President and General Manager of CTSI, Dallas, PA; Officer, Commonwealth Telephone Enterprises, Inc., a telephone company, Dallas, PA.

John S. Dean, Sr. 3


2005 Principal Occupation: Retired President and Chief Executive Officer: Amicalola Electric Membership Corp., an

electric distribution cooperative, Jasper, GA. Other Affiliations:

Board Chairman: Crescent Banking Co., a bank holding company, Jasper, GA; Director: Crescent Bank and Trust Co., a community bank, Jasper, GA.

Everett Dobrinski 3


2007 Principal Occupation: Owner/Operator: Dobrinski Farms, a cereal grain and oilseed farm, Makoti, ND; President/CEO: Dakota Skies Biodiesel, LLC, a biodiesel manufacturer, Minot, ND.

Other Affiliations: Board Chairman: Verendrye Electric Cooperative, an electric distribution cooperative,

Velva, ND; Director: Dakota Pride Cooperative, a grain cooperative, Jamestown, ND; Board Chair: North Dakota Coordinating Council for Cooperatives, a trade association,

Jamestown, ND; Director: Agricultural Cooperative Development International/Volunteers in Overseas

Cooperative Assistance, a nonprofit international development organization, Washington, DC.


83

COBANK, ACB

Randal J. Ethridge 1,5


2006 Principal Occupation: Executive Vice President: People’s Electric Cooperative, a rural electric distribution

cooperative, Ada, OK; Owner and Manager: Ethridge Ranch, a ranching and haying operation, Stroud, OK.

Other Affiliations: President and Director: Science and Natural Resources Foundation, Ada, OK; Director: Oklahoma Association of Electric Cooperatives, a trade association,

Oklahoma City, OK; Alternate Director: Western Farmers Electric Cooperative, a generation and transmission

cooperative, Anadarko, OK.

Mary E. Fritz 2,4


2007 Principal Occupation: Owner/Operator: Quarter Circle JF Ranch, Inc., a dry land grain and cow/calf operation,

Chester, MT. Other Affiliations:

Director: Northwest Farm Credit Services, ACA, agriculture finance, Spokane, WA.

Ron Harkey 2


2007 Principal Occupation: President and Chief Executive Officer: Farmers Cooperative Compress, a cotton-

warehousing cooperative, Lubbock, TX. Other Affiliations:

Officer: Cotton Growers Warehouse Association, Washington, DC; Officer: Texas Agricultural Cooperative Council, Austin, TX; Director: National Council of Farmer Cooperatives, Washington, DC; Director: EWR, Inc., electronic warehouse receipts, Memphis, TN; Advisory Director: Plains Capital Bank, Lubbock, TX.

William H. Harris 1


2007 Principal Occupation: Owner/Operator: Harris Farms, a cash crop farming operation, LeRoy, NY; Owner/Operator: HR&W Harvesting, processing vegetable farm, LeRoy, NY.

Other Affiliations: Director: Farm Credit of Western New York, ACA, a credit cooperative, Batavia, NY; Director: Northeast Regional Council, a nonprofit trade association for cooperative farm

credit organizations, Springfield, MA.

Sherwood J. Johnson 2


2005 Principal Occupation: Citrus farmer and Owner/Operator: Buck Hammock Groves, Inc., Fort Pierce, FL.

Other Affiliations: Director: Delta Farms Water Control District, Vero Beach, FL; Director: Farm Credit of South Florida, ACA, agriculture financing, Lake Worth, FL; Director: Highland Exchange Service Cooperative, supplies procurement, Waverly, FL; President: Treasure Coast Agricultural Research Foundation, Ft. Pierce, FL; President: Hilliard Groves, Inc., citrus packing, Fort Pierce, FL; President: Sherwood Johnson and Son Grove Management, grove caretaking,

Fort Pierce, FL.

Daniel T. Kelley 2,4,7


2006 Principal Occupation: Owner/Operator: Kelley Farms, a diversified corn and soybean operation, Normal, IL.

Other Affiliations: President: Evergreen FS, Inc., a farm supply and grain marketing operation,

Bloomington, IL; Chairman and President: Growmark, Inc., farm supply and grain marketing,

Bloomington, IL; Chairman: FS Financial Services, Corp., subsidiary of Growmark, Inc., Bloomington, IL; Director: Illinois Agricultural Leadership Foundation, agricultural leadership development,

Macomb, IL; Director: Farmland Mutual Insurance Company, an insurance company, Des Moines, IA.



84

COBANK, ACB


James A. Kinsey 3


2008 Principal Occupation: Owner/Operator: Kinsey’s Oak Front Farms, a purebred angus seed-stock producer,

Flemington, WV. Other Affiliations:

Director: Farm Credit of the Virginias, ACA, Staunton, VA; Director: Federal Farm Credit Banks Funding Corporation, Jersey City, NJ.

Rodney Gail Kring 1,5


2006 Principal Occupation: President: PYCO Industries, Inc., a cottonseed crusher operation, Lubbock, TX.

Other Affiliations: Officer: National Cotton Council, trade association, Memphis, TN; Director: Texas Agricultural Cooperative Council, trade association, Austin, TX; Advisory Director: Plains Capital Bank, financial institution, Lubbock, TX.

Louis McIntire 2


2005 Principal Occupation: General Manager: Shelby County FCBA, Inc., farm supply, Shelbyville, IN.

Other Affiliations: Finance Committee: Blue River Foundation, Shelbyville, IN; Vice Chair: RSE Propane, LLC, metered propane company, Shelbyville, IN.

Robert D. Nattier 2,4,5


2008 Principal Occupation: Retired President/General Manager: Mid Kansas Cooperative, a farm supply cooperative,

Moundridge, KS; Co-Operator: 4-N, Inc., grain and beef feed lot, Newton, KS.

Other Affiliations: Director: North Newton Housing Authority, North Newton, KS.

Robert E. Newtson 1,5


2006 Principal Occupation: Owner/Operator: Newtson Farms, a grain farm, Helix, OR; Member: Oregon State University / USDA Liaison Committee, Pendleton, OR.

J. Roy Orton 3,8

Chairman


2007 Principal Occupation: Owner: Orton Farms, Inc., a fruit farm, Ripley, NY.

Other Affiliations: Director: Northeast Regional Council, a nonprofit trade association for cooperative farm credit

organizations, Springfield, MA; Director: The Farm Credit Council, a service and trade organization, Washington, DC; Director: FCC Services, a service organization, Denver, CO; Member: FCS Foundation Board, Denver, CO.

Michael Riley 2


2007 Principal Occupation: Adjunct Professor: Humphreys College, Stockton, CA; Retired CFO: Diamond Walnut Growers, Inc., a marketing cooperative,

Stockton, CA. Other Affiliations:

Treasurer: Greater Modesto Area Flood Relief, a nonprofit serving victims of natural disasters, Modesto, CA.

Barry M. Sabloff 1


2008 Principal Occupation: Vice Chair/Director: Marquette National Corporation, a bank holding company, Chicago, IL; Vice Chair/Director: Marquette Bank, a community bank, Chicago, IL.

Other Affiliations: Vice Chair/Director: Marquette Bank Foundation, a foundation, Chicago, IL; Director: Calypso Technology, Inc., a provider of trading systems to financial institutions,

San Francisco, CA; Vice Chair/Trustee: Sherwood Conservatory of Music, a community music school, Chicago, IL; Director/Chair of Remuneration Committee: The American School in London Foundation, Inc.,

a foundation, Princeton, NJ.


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COBANK, ACB


Ronald A. Schuler 2,5


2005 Principal Occupation: Retired President and CEO: California Canning Peach Association, Sacramento, CA; Owner: Tree crop farm, Yuba City, CA; Manager: Northern California Growers Association, a farm labor information association,

Yuba City, CA. Other Affiliations:

Director: Cal West Seeds, Woodland, CA; Director: The Farm Credit Council, a service and trade organization, Washington, DC; Director: FCC Services, a service organization, Denver, CO; Director: Johl Company, a diversified farming operation, Yuba City, CA.

D. Wayne Seaman 3

Second Vice Chair


2008 Principal Occupation: President: Seaman Enterprises, consulting for boards and employees for cooperatives,

Carroll, IA. Other Affiliations:

Director: CADC, a company involved in development, Carroll, IA; Director: Home State Bank, a community bank, Jefferson, IA; Director: Highway Farms, Ogden, IA; Director: FC Feeds, a feed supply cooperative, Farnhamville, IA.

Richard W. Sitman 2

Age: 52 Year Service Began: 1999 Also Served: 1995-1996

2007 Principal Occupation: Owner/Operator: Jos. M. Sitman, Inc., a retail business, Greensburg, LA.

Other Affiliations: Chairman: Dixie Electric Membership Cooperative, an electric distribution cooperative,

Baton Rouge, LA; Chairman: DEMCO Energy Services, Inc., a subsidiary of DEMCO, Baton Rouge, LA; Chairman: Dixie Business Center, a business incubator, Denham Springs, LA; Director: Bank of Greensburg, a community bank, Greensburg, LA.

Kevin A. Still 1,4,9


2007 Principal Occupation: Chief Executive Officer and Treasurer: Co-Alliance, LLP, a partnership of four cooperatives

supplying energy, agronomy and animal nutrition, producing swine and marketing grain, Danville, IN;

Chief Executive Officer and Treasurer: Midland Co-op, Inc., a farm supply cooperative, Danville, IN.

Robert E. Terkhorn 1,5,6


2005 Principal Occupation: Retired Managing Director: Global Transaction Services-Citibank, New York, NY.

Robert M. Tetrault 3


2007 Principal Occupation: President/Owner: T/R Fish, Inc., a marketing company for commercial fishing, Portland, ME; President/Owner: Tara Lynn, Inc., a commercial fishing group, Portland, ME; President/Owner: Tara Lynn II, Inc., a commercial fishing group, Portland, ME; President/Owner: Robert Michael, Inc., a commercial fishing group, Portland, ME.

Other Affiliations: Chairman: Farm Credit of Maine, ACA, a credit cooperative serving Maine, Auburn, ME; Director: Northeast Regional Council, a nonprofit trade association for cooperative farm credit

organizations, Springfield, MA; Director: The Farm Credit Council, a service and trade organization, Washington DC; Director: FCC Services, a service organization, Denver, CO; Member: Farm Credit System Audit Committee, Jersey City, NJ; Director/Owner: Vessel Services, Inc., a manufacturing and sales firm, Portland, ME; Director: Marine Resource Education Project, curriculum development, UNH, Durham, NH; Member: FCC Trust Committee, Denver, CO.

Douglas W. Triplett 1

Age: 69 Year Service Began: 2002 Also Served: 1999-2000

2007 Principal Occupation: Owner/Operator: Triplett Farms, a corn and soybean farm, Annandale, MN.

Other Affiliations: Vice Chairman: Centra Sota Cooperative, a farm supply cooperative, Buffalo, MN; Treasurer: Albion Township, local government, Annandale, MN.


86

COBANK, ACB

Compensation of Directors

Directors are compensated in cash at the rate of $27,060 per year in quarterly installments, in accordance with FCA regulations.Compensation is for attendance at board meetings, certain other meetings preapproved by the board, and special duties as assigned. Directors’ compensation is reduced by $1,000 for unexcused absence at any regular board meeting. FCA regulations also allow additional compensation to be paid to a director in exceptional circumstances where extraordinary time and effort are involved. Amounts in excess of $27,060 were paid in recognition of greater than normal involvement in customer meetings, special meetings of the board committees, involvement in special projects and other special assignments. Also, the board authorized the payment of additional compensation to the Audit Committee chair to reflect increased responsibilities. Total cash compensation paid to all directors as a group during 2005 was $802,856. Additional information for each director who served during 2005 is provided below. Current COBANK policy regarding reimbursements for travel, subsistence and other related expenses states that for meetings designated by the board and approved special assignments, board members shall be reimbursed for reasonable travel and related expenses that are necessary and that support COBANK’s business interests. As may be appropriate, COBANK may share in the reimbursement of expenses with other organizations. A copy of COBANK’s policy is available to shareholders upon request. The aggregate amount of reimbursement for travel, subsistence and other related expenses for all directors as a group was $422,831, $456,934 and $453,763, for the years ended December 31, 2005, 2004 and 2003, respectively.

Number of Days Number of Days Total Served at Served in Other Compensation

Name of Director Board Meetings Official COBANK Activities Paid During 2005

Mack L. Alford 13 14 $ 27,560 Gene J. Batali 20 17 30,060 D. Sheldon Brown* 20 27 32,060 Rita M. Brown 17 14 28,060 John S. Dean, Sr. 21 29 30,060 Everett Dobrinski 20 45 31,060 Randal J. Ethridge 16 21 28,560 Mary E. Fritz 21 31.5 29,060 Ron Harkey 19 5 29,060 William H. Harris* 19 10 28,060 Sherwood J. Johnson 17 10 28,060 Daniel T. Kelley 20 18 30,060 James A. Kinsey 20 19 30,060 Rodney Gail Kring 19 2 28,060 Louis McIntire 20 14 29,060 Robert D. Nattier 20 23 29,060 Robert E. Newtson 17 30 28,060 J. Roy Orton* 20 50 35,178 Michael P. Riley 20 21 29,060 Barry M. Sabloff 20 14 28,560 Ronald A. Schuler* 20 19 29,060 D. Wayne Seaman 20 29.5 32,060 Richard W. Sitman 20 23 29,060 Kevin A. Still 20 13 29,560 Robert E. Terkhorn 20 6 35,178 Robert M. Tetrault* 22 26 30,060 Douglas W. Triplett 20 30 29,060 Total 521 561 $802,856

* In 2005, these directors represented COBANK’s interests by serving on the boards of various trade groups and other organizations important to the Bank. Days of service related to these activities and compensation received (if any) are not included in this report.


87

COBANK, ACB

Douglas D. Sims,Chief Executive Officer

Mr. Sims has been chief executive officer of COBANKsince 1994 and is responsible for implementing the Bank’s strategic and business direction as set by the Board of Directors. He serves as chairman of the Board of Directors of Farm Credit Leasing Services Corporation (FCL). Mr. Sims is the immediate past chairman of both the National Council of Farmer Cooperatives and the Farm Credit System’s President’s Planning Committee. Prior to assuming the CEO position, Mr. Sims was president and chief operating officer of COBANK for five years. Mr. Sims served as president and chief operating officer of the Farm Credit Bank of St. Louis prior to joining COBANK in 1988. He joined the Farm Credit System in 1969. Mr. Sims has announced his retirement as CEO, effective June 30, 2006.

Robert B. Engel, President and Chief Operating Officer (President and CEO Elect)

Mr. Engel oversees COBANK’s lending units, as well as the Credit Group, the Finance and Operations Group and Human Resources. Mr. Engel also serves on the Boards of Directors of FCL, the Federal Farm Credit Bank’s Funding Corporation and Financial Partners, Inc. Prior to assuming the president and COO position in 2000, he was chief banking officer at HSBC Bank USA. Mr. Engel has 21 years of banking experience, and eight years of accounting experience with KPMG and Deloitte & Touche. During his 14-year tenure at HSBC, Mr. Engel served in a variety of management and credit positions with responsibilities for corporate and investment banking, real estate finance, retail banking, equipment leasing, cash management and payments, mortgage banking, wealth management and insurance. The Board of Directors has appointed Mr. Engel president and CEO elect and he will assume the position of president and CEO effective July 1, 2006.

Brian P. Jackson,Executive Vice President and Chief Financial Officer

Mr. Jackson manages the Finance and Operations Group of COBANK. Prior to assuming this position in 2000, he was the treasurer and senior vice president of finance and administrative services at the predecessor to Xcel Energy, Inc., an integrated utility company. Among his responsibilities, Mr. Jackson served as chief financial officer for Public Service Company of Colorado, as well as for other operating subsidiaries. Prior to that, Mr. Jackson, a CPA, was with Arthur Andersen LLP for 17 years, the last several as partner in the firm’s audit and business advisory division.

Robert O. Triplett, Executive Vice President and Chief Credit Officer

Mr. Triplett manages the Credit Group, which was established in 2001 with responsibility for credit approval, policy and compliance and special assets. Prior to assuming this position, Mr. Triplett managed the Risk Management Division and the International Banking Division. Mr. Triplett managed the Loan Policy and Bank Operations Division and served as chief credit officer from 1989 to 1991. From 1984 to 1988, he served as executive vice president and chief operating officer of the Central Bank for Cooperatives (CBC). Mr. Triplett joined the CBC in 1974. Mr. Triplett has 37 years of experience with the Farm Credit System.

Philip S. DiPofi, Executive Vice President

Mr. DiPofi manages the Agribusiness Banking Group (ABG). ABG includes COBANK’s Agribusiness, Strategic Relationships and Farm Credit Leasing Divisions. Prior to assuming this position, Mr. DiPofi served as senior vice president of the Strategic Relationships Division since 2001. Before joining COBANK in 2001, Mr. DiPofi served as a regional president at Key Bank and HSBC Bank USA.

John C. Holsey, Executive Vice President

Mr. Holsey manages the Global Financial Services Group. Prior to assuming this position in 2000, Mr. Holsey was executive vice president and regional president with HSBC Bank USA and, prior to that, served in a variety of management positions at HSBC (both in New York and Hong Kong). Mr. Holsey has 32 years of domestic and international banking experience.

Mary E. McBride, Executive Vice President

Ms. McBride manages the Communications and Energy Banking Group. Prior to assuming this position, she directed the Bank’s Operations and Corporate Finance Divisions. She has also managed COBANK’s Capital Markets Division. Before joining COBANK in 1993, Ms. McBride worked as senior vice president of Wells Fargo/First Interstate Bank of Denver, N.A.

Senior Officers

88

COBANK, ACB

Compensation of Senior Officers and Reimbursement for Travel, Subsistence and Other Related Expenses

A key objective of COBANK is to attract, develop and retain effective senior officers who are capable of maximizing the Bank’s performance for the benefit of its customer-owners. In furtherance of this objective, the Board of Directors, through its Executive Committee, has adopted a total compensation philosophy for senior officers. The total compensation philosophy seeks to achievethe appropriate balance between market-based base salary and benefits and variable incentive compensation, which is designed toincent and reward both the current and long-term achievement of our strategic business objectives and financial and business plans. The Board of Directors, through its Executive Committee, utilizes an independent executive compensation specialist who annuallycompares the Bank’s compensation levels and practices to a select peer group of financial institutions to ensure that our compensation levels for our senior officers are comparable to those at similar financial institutions. The Board of Directors approves the compensation level, including short- and long-term incentive compensation, of the Bank’s Chief Executive Officer annually. Aggregate compensation earned by our CEO and other senior officers for the years ended December 31, 2005, 2004 and 2003, is disclosed in the accompanying table. A description of cash and noncash employee benefit plans is included in Note 8 to the accompanying consolidated financial statements. Disclosure of the total compensation earned during 2005, 2004 and 2003 by any designated senior officer is available to shareholders upon request. Our current board policy regarding reimbursements for travel, subsistence and other related expenses states that senior officers shall be reimbursed for actual reasonable travel and relatedexpenses that are necessary and that support our business interests. A copy of our policy is available to shareholders upon request.

Summary Compensation Table ($ in Thousands)

Annual

Short-Term Long-Term

Incentive Incentive

Name of Individual or Number in Group Year Salary Compensation 1 Compensation 2 Other 3 Total

CEO: Douglas D. Sims 2005 $ 458 $ 543 $ 558 $ 6 $ 1,565 Douglas D. Sims 2004 425 568 647 10 1,650

Douglas D. Sims 2003 425 477 570 14 1,486

Aggregate Number of Senior Officers (including the CEO):

7 2005 $ 2,127 $ 1,938 $ 1,744 $ 29 $ 5,838

8 2004 2,270 2,182 2,194 23 6,669

7 2003 2,030 1,718 1,765 30 5,543

1 Includes short-term incentive compensation awarded, as more fully discussed in Note 8 to the accompanying consolidated financial statements. 2 Includes long-term incentive compensation awarded, as more fully discussed in Note 8 to the accompanying consolidated financial statements. 3 Represents payment of accrued vacation, tax return preparation and financial planning expenses, and certain travel-related expenses.

Code of Ethics

COBANK sets high standards for honesty, ethics, integrity, impartiality and conduct. Each year, every associate certifies compliance with the letter, intent and spirit of our Associate Responsibilities and Conduct Policy, which establishes the ethicalstandards of our organization. Additionally, our Chief Executive Officer, President and Chief Operating Officer, Chief Credit Officer, Chief Financial Officer and other senior financial professionals certify compliance with the letter, intent and spirit of our Code of Ethics. Our Code of Ethics supplements our Associate Responsibilities and Conduct Policy and establishes additional responsibilities specifically related to the preparation and distribution of our financial statements and related disclosures. For details about our Code of Ethics, visit www.cobank.com and click on Governance. At your request, we will provide you with a copy of our Code of Ethics, free of charge. Please contact:

Corporate Relations Division P. O. Box 5110 Denver, CO 80217 (303) 740-4362

Senior Officers

89

COBANK, ACB

We believe the future of agriculture and System institutions will be better served if loan programs are developed by Associations to aid ambitious and capable young, beginning, and small farmers. Therefore, we have adopted a written policy thatencourages the board of directors at each of our five affiliated Associations to establish a program to provide sound and constructive credit and other services to young, beginning, and small farmers and ranchers and producers or harvesters of aquaticproducts (YBS farmers and ranchers). Each Association provides us annually with a report measuring achievement with respect tothese programs for YBS farmers and ranchers. A summary of the combined reports for our affiliated Associations and certain participations COBANK purchased from Associations follows.

YBS Farmers and Ranchers ($ in Thousands)

Loan Numbers Loan Volume

Number Percent of

Portfolio Dollars Percent of

Portfolio

Loans and Commitments Outstandingat December 31, 2005: Young 7,481 19.89 % $ 1,783,046 13.77 % Beginning 8,414 22.37 1,942,217 15.00 Small 15,552 41.35 1,699,061 13.12

Gross New Loans and Commitments Made During 2005: Young 1,492 21.79 % $ 360,808 11.07 % Beginning 1,891 27.61 405,357 12.44 Small 3,062 44.71 374,466 11.49

Small Farmers and Ranchers

Number / Volume of Loans Outstanding by Loan Size

Number / Volume $0 -- $50,000$50,001 - $100,000

$100,001 – $250,000

$250, 001 and greater

Total Number of Loans to Small Farmers and Ranchers 6,663 3,835 3,711 1,343

Total Loan Volume to Small Farmers and Ranchers ($ in Thousands) $ 159,557 $ 282,686 $ 573,576 $ 683,242

Key definitions are as follows:

Young Farmer and Rancher – A farmer, rancher or producer or harvester of aquatic products who is age 35 or younger as of the date the loan was originally made.

Beginning Farmer and Rancher – A farmer, rancher or producer or harvester of aquatic products who has 10 years or less of experience at farming, ranching or producing or harvesting aquatic products as of the date the loan was originally made.

Small Farmer and Rancher – A farmer, rancher or producer or harvester of aquatic products who normally generates less than $250,000 in annual gross sales of agricultural or aquatic products at the date the loan was originally made.

The Young, Beginning, and Small farmer and rancher categories are not mutually exclusive, therefore, certain farmers and ranchers may be classified in more than one category in the tables above.

Young, Beginning, and Small Farmers

90

CERTIFICATION

I, Douglas D. Sims, Chief Executive Officer of CoBank, ACB (CoBank or the Bank), a federally chartered instrumentality under the Farm Credit Act of 1971, as amended, certify that:

(1) I have reviewed this annual report of CoBank;

(2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

(3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present inall material respects the financial condition, results of operations, and cash flows of CoBank as of, and for, the periods presented in this report;

(4) CoBank’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and proceduresand internal control over financial reporting for CoBank and have:

a. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Bank, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c. evaluated the effectiveness of the Bank’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d. disclosed in this report any change in the Bank’s internal control over financial reporting that occurred during the Bank’s most recent fiscal quarter (the Bank’s fourth fiscal quarter in the case of this annual report) that has materially affected, or is reasonably likely to materially affect, the Bank’s internal control over financial reporting; and

(5) CoBank’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Bank’s auditors and the audit committee of the Bank’s board of directors (or persons performing the equivalent functions):

a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Bank’s ability to record, process, summarize, and report financial information; and

b. any fraud, whether or not material, that involves management or other employees who have a significant role in the Bank’s internal control over financial reporting.

/s/ DOUGLAS D. SIMS

Douglas D. Sims Chief Executive Officer

Dated: March 1, 2006

91

CERTIFICATION

I, Brian P. Jackson, Executive Vice President and Chief Financial Officer of CoBank, ACB (CoBank or the Bank), a federally chartered instrumentality under the Farm Credit Act of 1971, as amended, certify that:

(1) I have reviewed this annual report of CoBank;

(2) Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material factnecessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

(3) Based on my knowledge, the financial statements, and other financial information included in this report, fairly present inall material respects the financial condition, results of operations, and cash flows of CoBank as of, and for, the periods presented in this report;

(4) CoBank’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and proceduresand internal control over financial reporting for CoBank and have:

c. designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Bank, including its consolidated subsidiary, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

d. designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

e. evaluated the effectiveness of the Bank’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

b. disclosed in this report any change in the Bank’s internal control over financial reporting that occurred during the Bank’s most recent fiscal quarter (the Bank’s fourth fiscal quarter in the case of this annual report) that has materially affected, or is reasonably likely to materially affect, the Bank’s internal control over financial reporting; and

(5) CoBank’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Bank’s auditors and the audit committee of the Bank’s board of directors (or persons performing the equivalent functions):

a. all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Bank’s ability to record, process, summarize, and report financial information; and

b. any fraud, whether or not material, that involves management or other employees who have a significant role in the Bank’s internal control over financial reporting.

/s/ BRIAN P. JACKSON

Brian P. Jackson Executive Vice President and Chief Financial Officer

Dated: March 1, 2006

92

COBANK, ACB

Executive Office Douglas D. Sims, Chief Executive Officer

Robert B. Engel, President and Chief Operating Officer (President and CEO Elect) Kathleen M. Butler, Human Resources Division Jack E. Cassidy, Corporate Relations Division Allan S. Kantrowitz, Legal Division Douglas E. Wilhelm, Risk Management Division

Finance and Operations Group Brian P. Jackson, Executive Vice President and Chief Financial Officer

James R. Bernsten, Chief Information Officer David P. Burlage, Controller Division George P. Delaune, Administrative Services Division

Stephen F. Staley, Treasury Division John Svisco, Operations Division

Agribusiness Banking Group * Philip S. DiPofi, Executive Vice President

Steven L. Decatur, Farm Credit Leasing Services Corporation Robert E. Egerton, Agribusiness Division - East

Ginny L. Stichternath, Credit Administration Division Scott S. Trauth, Agribusiness Division - West

Communications and Energy Banking Group

Mary E. McBride, Executive Vice President Daniel L. Key, Credit Administration Division Aivars (Jake) Udris, Energy and Water Division Robert F. West, Communications Division

Global Financial Services Group

John C. Holsey, Executive Vice President Antony M. Bahr, Capital Markets Division Lori L. O’Flaherty, Corporate Finance Division Candace A. Roper, International Division Richard A. Scholz, Non-Credit Services Division

Credit Group Robert O. Triplett, Executive Vice President and Chief Credit Officer

Kenneth D. Allen, Policy and Compliance Division Andrew L. King, Credit Approval Division Vincent J. Harper, Special Assets Division

* The Strategic Relationships Division is included within the Agribusiness Banking Group.

Your financial privacy and the security of your other non-public information are important to us. We, therefore, hold your financial and other non-public information in strictest confidence. Federal regulations allow disclosure of such information by us only in certain situations. Examples of these situations include law enforcement or legal proceedings or when such information is requested by a Farm Credit System institution with which you do business. In addition, as required by Federal laws targeting terrorism funding and money laundering activities, we collect information and take actions necessary to verify your identity.

Leadership

COBANK Customer Privacy

Documents

2005 Financial Report