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

The Rating Outlook is Stable. 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).

Key Rating Drivers

Strong Franchise, Narrow Business Model: 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. 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.

Funding Structure a Strength: 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 Farm Credit System (FCS). Fitch considers this core, stable funding, even during times of market volatility, as a significant strength and supportive of the rating.

FCBT Relationship Mitigates Risks: CFC's position as an association under FCBT benefits the association's risk profile given the Service Level Agreement, in which the system bank acts as a 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.

Consistently Strong Earnings: Fitch views CFC's earnings as a rating strength as the association has historically maintained their earnings performance at the top end of the Agricultural Credit Associations within the FCS. At 3Q22, CFC's operating profit to risk-weighted assets ratio was 2.3%, outperforming both similarly sized FCS ACAs and commercial bank peers. While stronger than commercial banking peers, CFC's superior earnings are offset by the limited revenue diversity, which is generally consistent across the Farm Credit System.

Solid Asset Quality: Fitch views CFC's asset quality as strong and in line with its rating. Although CFC's nonperforming assets ratio of 0.6% is modestly higher than similarly sized ACA's and commercial banks, nonperforming assets as a percentage of total loans remains muted. Despite slightly higher NPAs, CFC's net charge-offs generally trend well compared to the FCS as a whole, as well as commercial peers, with NCOs not exceeding 5 bps over the last eight years.

Capital Levels Below Peers: CFC's capitalization metrics have moderately declined over the last few years, but remain commensurate with the overall rating. CFC had a common equity Tier 1 (CET1) ratio of 11.7% at 3Q22, which is slightly above commercial banking peers but lower than similarly sized ACAs. CFC's CET1 ratio has declined in recent years as the company has experienced heightened loan growth, which Fitch expects to return to historical levels. While Fitch views the company's strong earnings and history of limited credit losses as relative mitigants to lower capital, Fitch is sensitive to CFC's reliance on organic capital generation and unique structure that limits access to equity markets.

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.

Rating Sensitivities

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

CFC's rating remains sensitive to noncompliance with the terms of its General Financing Agreement with FCBT. Additionally, any resulting 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 grown rapidly over the past several years.

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 ratio of operating profit to risk-weighted assets, to levels at or below the peer median, could result in downwards rating pressure.

CFC's ratings could come under pressure should the bank's CET1 ratio dip below 11.5%, which would be below the threshold for a FIRS 1 rating, which is a rating system used by Farm Credit Association examiners for assessing an association's risk.

Factors that could, individually or collectively, lead to 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.

OTHER DEBT AND ISSUER RATINGS: KEY RATING DRIVERS

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 Farm Credit System Insurance Corporation nor guaranteed in any form by FCBT.

OTHER DEBT AND ISSUER RATINGS: RATING SENSITIVITIES

CFC's preferred rating is primarily sensitive to any change in its Long-term 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 notes, 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 an '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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