Annual Report - CoBank

Rural InfrastructureOverviewThe Rural Infrastructure operating segment includes loanand other financial services to companies in the power,communications and water industries. Primary products andservices include term loan and revolving line of creditfinancing, leasing, project financing, tax-exempt bondissuances, capital markets services and cash management andinvestment products.Power industry customers include rural electric generationand transmission cooperatives, electric distributioncooperatives, renewable energy providers, independent powerproducers, and investor-owned utilities. Loan demand frompower supply customers has declined as a result of continuedweakness in the economy and regulatory uncertainty.Nonetheless, customers undertaking infrastructureenhancements to meet long-term requirements or to complywith environmental regulations continue to demand debtcapital. Growth in renewable energy projects also contributesto loan demand from power supply customers. Loan growthhas also resulted from opportunities to refinance theborrowings of other lenders, particularly in the electricdistribution sector.Communications industry customers include rural localexchange carriers, wireless providers, data transport networks,and cable television systems. We focus on ruralcommunications companies that are positioned to provide arange of services, including voice (both wireline and wireless),broadband and video. Loan volume in our communicationsportfolio declined in 2011 due to weak demand for debtcapital and increased availability of government stimulusfunding in certain sectors. However, we anticipate futureopportunities in merger and acquisition activity, and expectconsolidation to continue as carriers seek to improve operatingefficiencies and gain market share in this highly competitiveindustry. Capital spending will also likely continue as wirelinecarriers enhance their networks with fiber optics and wirelesscarriers upgrade to fourth generation (4G) data technology.Water industry customers include rural water and wastewater companies. Capital expenditure growth in this industrycontinues primarily as a result of the need to replace aginginfrastructure and to meet tighter standards for water quality.While much of this need has been filled by financing fromfederal stimulus programs, some private lending opportunitiesfor construction/interim financing have been created as abridge to government grants or loans. With the continuingneed for plant upgrades and expected limitations on theavailability of stimulus funds, we expect private lending tothis industry to grow.2011 PerformanceRural Infrastructure net income increased 11 percent to$194.4 million for 2011 from $175.6 million for 2010. Theincrease in earnings primarily resulted from a $31.8 milliondecrease in the provision for loan losses and a $14.7 milliondecrease in operating expenses.Net interest income declined to $300.9 million for 2011from $315.6 million in the prior year primarily as a result oflower returns on our invested capital, partially offset by amodest increase in average loan volume. Average loan volumegrew 3 percent to $11.9 billion in 2011 from $11.5 billion in2010. Growth in Rural Infrastructure average loan volumeprimarily resulted from increased lending activity in theelectric distribution sector driven by refinancing of borrowingsfrom other lenders. This growth was partially offset by adecline in loans to our communications customers.Rural Infrastructure recorded a $21.0 million provisionfor loan losses in 2011, compared to a $52.8 million provisionin the prior year. The decrease in the provision for loan lossesprimarily resulted from the resolution of a troubled loan to acommunications customer in 2011, as well as greaterprovisions in the 2010 period for specific customers in ourrural energy portfolio. Nonaccrual loans decreased to$54.5 million at December 31, 2011 from $73.6 million atDecember 31, 2010. Rural Infrastructure recorded net chargeoffsof $12.5 million and $36.0 million for 2011 and 2010,respectively. Net charge-offs in both periods related to a smallnumber of rural energy and communications customers.Noninterest income in the Rural Infrastructure operatingsegment was $42.1 million in 2011 compared to $41.8 millionin 2010. The 2011 results include a higher level of fee income,primarily driven by greater arrangement fees, lowerinvestment impairment losses, greater customer derivativeincome and a gain on the sale of an investment security. Asnoted previously, 2010 results included refunds of a portion ofInsurance Fund premiums paid in prior years.Rural Infrastructure operating expenses decreased by$14.7 million in 2011. Operating expenses in 2010 includedcosts related to the settlement of a business dispute. Excludingsuch prior-year costs, operating expenses in 2011 increasedprimarily due to greater employee compensation and mergerrelatedcosts, and, to a lesser extent, increased Insurance Fundpremium expenses. Rural Infrastructure income tax expenseincreased $13.3 million due to growth in its pre-tax earnings.CoBank 2011 Annual Report42