Fitch Ratings has affirmed Capital Farm Credit, ACA's (CFC) Long-Term (LT) Issuer Default Rating (IDR) at 'BBB'.

The Rating Outlook is Stable. Note that CFC does not have a viability rating (VR), as Fitch does not believe that the association would have a meaningful standalone franchise or business model that could exist outside of the Farm Credit System (FCS).

Fitch has withdrawn CFC's SR and SR Floors as they are no longer relevant to the agency's coverage following the publication of Fitch's updated 'Bank Rating Criteria' on Nov. 12, 2021.

At the same time, in line with the publication of Fitch's updated 'Bank Rating Criteria', Fitch has assigned a Government Support Rating (GSR) to CFC of 'ns' (no support).

Key Rating Drivers

IDR

CFC's rating continues to reflect its funding advantage as an agricultural credit association (ACA) within the FCS, which has resulted in strong operating performance over time. It also reflects the association's strong asset quality through many business cycles and healthy capital levels. Offsetting these strengths are Fitch's view of CFC's narrower business profile compared to similarly-sized commercial banks in the U.S. and the association's significant exposure in agricultural related lending in the state of Texas.

As an ACA, CFC is able to obtain low cost and stable funding via its relationship with the Farm Credit Bank of Texas (FCBT; IDR AA-), which in turn issues debt via the Federal Farm Credit Banks Funding Corp on behalf of the FCS. Fitch considers this core, stable funding, even during times of market volatility, as a notable strength and supportive of the rating.

Fitch considers CFC to have a good franchise, given its position as the largest association in the FCBT district and the eighth largest association in the FCS overall. Further, CFC's role within the FCS provides it with a competitive advantage in agricultural lending within its footprint. Nevertheless, Fitch views CFC's business profile as a rating constraint, as the association's business model is narrowly focused compared to similarly sized commercial banks. While this mainly relates to a spread-income focused revenue mix, Fitch also considers the firm's ties to agricultural and economic activity within Texas as a rating constraint over the long-term.

CFC's ratings also benefit from its Service Level Agreement with FCBT, in which FCBT acts as the service provider for CFC's core systems and risk management infrastructure. FCBT also manages the association's interest rate and liquidity risk, which Fitch views favorably due to FCBT's greater scale and expertise.

Fitch considers CFC's asset quality to be good, and in line with the association's rating. While CFC's nonperforming asset ratio of approximately 0.7% is modestly higher than both similarly sized ACAs, but remains low on an absolute basis. CFC's realized credit losses outperformed commercial banks through the global financial crisis, and have since remained close to zero, averaging just 2bps over the past four years. Furthermore, CFC's credit losses have been in-line with or lower than the FCS as a whole, over the past several years.

CFC's ratings benefit from its historically strong earnings performance, which Fitch views as among the strongest of all ACAs within the FCS. At 3Q21, CFC's operating profit to risk-weighted assets (RWAs) ratio was 2.5%, outperforming both similarly sized FCS ACAs and commercial bank peers. CFC's superior risk-adjusted earnings are somewhat offset compared to commercial bank peers due to the ACA's relatively limited earnings diversity.

Fitch views the association's capital as solid and commensurate with CFC's current rating level. CFC had a common equity Tier 1 (CET1) ratio of 13.1% at 3Q21, which compares favorably to commercial banks, but lower than similarly sized ACAs. Despite lower capital metrics compared to similarly sized associations within the System, Fitch recognizes CFC's superior capital generation capabilities, and views the association's capital targets to be solid over time.

Government Support Rating

CFC's GSR of 'ns' reflects Fitch's view that the probability of sovereign support is unlikely, and thus IDRs do not incorporate any sovereign support. While the 'AAA' and 'AA-' ratings for the FCS and System Banks, respectively, incorporate a high probability of support from the U.S. Government, Fitch does not believe this would be extended to individual associations.

Furthermore, while the ratings of the FCS Banks benefit from mutual support mechanisms, Fitch does not believe there are explicit mutual support mechanisms in place at the association level. CFC's rating does not incorporate any expected level of support from other associations.

HYBRID SECURITIES

As a prudentially regulated institution, notching of hybrid instruments follows Fitch's Bank Rating Criteria. Preferred securities are notched four times from the IDR, two notches for loss severity and two notches for non-performance. The ratings of CFC's preferred instruments are notched off the IDR, which incorporates CFC's intrinsic risk characteristics. Fitch does not presume any institutional or sovereign support for these instruments. The issuance of hybrid securities by CFC is not covered by the FCS Insurance Corporation nor guaranteed in any form by FCBT.

RATING SENSITIVITIES

IDR

Factors that could, individually or collectively, lead to a negative rating action/downgrade:

CFC's rating remains sensitive to the downside if it were to violate the terms of its General Financing Agreement (GFA) with FCBT. Additionally, any non-compliance of the GFA resulting in penalties or restrictive conditions that prevent CFC from cost-effectively funding its operations or lead to the default of the direct note, would likely result in a downgrade of the ratings for CFC. Similarly, CFC's ratings would be sensitive to deterioration in FCBT's financial profile which could change CFC's funding access, including FCBT's capital and liquidity position;

Pressure on CFC's ratings could emerge over time should there be evidence of outsized deterioration in credit quality relative to peer associations within both the Texas district as well as the FCS as a whole particularly as CFC has been growing much quicker than commercial bank peers;

CFC's ratings incorporate Fitch's view that the association's earnings profile is among the strongest in its peer group. A deterioration in CFC's earnings, as measured by its operating profit/RWAs, to levels at or below the peer median, could result in downwards rating pressure;

Furthermore, the association's rating could be at risk if its capital position, as measured by CFC's CET1 ratio were to approach or ultimately dip below 12.0% and remain there for multiple quarters absent a credible plan to build levels back above this threshold.

Factors that could, individually or collectively, lead to a positive rating action/upgrade:

Fitch continues to see limited upside potential for CFC's rating over the Outlook horizon due to the bank's limited business profile. Any long-term positive ratings momentum would be predicated on CFC maintaining its stronger-than-peers earnings profile and low credit losses while sustainably improving its regulatory capital ratios.

Government Support Rating

Since CFC's GSR is 'ns', there is limited likelihood that this will change over the foreseeable future absent a change in Fitch's view of sovereign support for CFC.

HYBRID SECURITIES

CFC's preferred rating is primarily sensitive to any change in its LT IDR.

Best/Worst Case Rating Scenario

International scale credit ratings of Financial Institutions and Covered Bond issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579

Criteria Variation

Although Fitch does not assign a VR to CFC, the association's IDR reflects its intrinsic characteristics. As a result of its funding relationship with FCBT and its role as an FCS association, CFC does not accept deposits. Under Fitch's Bank Ratings Criteria, the core metric for a bank's funding and liquidity profile is its loan to customer deposits ratio for its explanatory power of a bank's matching of its assets and core funding.

For CFC, core funding lies in the form of its direct note, which Fitch views as a stable source of funding with unique characteristics related to the policy role of the FCS. Thus, for the purpose of assessing CFC's funding profile, Fitch has adapted the core metric for CFC from a loan to deposit ratio to a loan to direct note funding ratio. In Fitch's view, the loan to direct note funding ratio provides a similar view into CFC's ability to fund its loans with core funding.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

CFC has 'community relations, social access and affordability' scores of '3' which differs from the financial institution standard score of '2' to reflect the extent to which key social services (i.e., farm lending in the U.S.) is supported by this entity.

CFC has a 'exposure to environmental impact' score of '3' which differs from the financial institution standard score of '2'. This reflects the way in which environmental impacts are actively managed by CFC in a way that results in no impact to its rating.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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