Annual Report - CoBank

In August 2011, Standard & Poor’s Ratings Services(S&P) downgraded the long-term sovereign credit rating ofthe United States from AAA to AA+ with a negative outlook.The credit ratings of GSEs, including the System, areinfluenced by the sovereign credit rating of the United States.As a result, S&P also lowered its long-term debt rating of theSystem from AAA to AA+. The ratings of individual Systembanks rated by S&P, including CoBank, were not affected.The other two major rating agencies, Moody’s InvestorsService (Moody’s) and Fitch Ratings (Fitch), have affirmedthe AAA sovereign credit rating of the United States and theAAA rating of the System. However, both Moody’s and Fitchhave assigned a negative outlook to the U.S. and Systemratings. Notwithstanding these actions, to date we havecontinued to access the funding necessary to support ourlending and business operations. However, such actions andany future downgrades could negatively impact funding costs,earnings and funding flexibility for CoBank and other Systeminstitutions.Our Funding Costs Would Increase if the Farm CreditSystem Lost its Status as a Government SponsoredEnterpriseThe System is a GSE and, as a member of the System,CoBank benefits from favorable debt-funding costs.Additionally, our individual credit ratings are positivelyimpacted by the GSE status of the System.The two largest housing GSEs, Fannie Mae and FreddieMac, have been under increased public and congressionalscrutiny as a result of their significant operating losses andU.S. government efforts to strengthen their capital and provideliquidity for securities they issue. Congressional deliberationsover structural reform related to these housing GSEs began in2011 and are likely to continue for a number of years. TheFarm Credit System has not been the subject of specificcongressional scrutiny, nor is it subject to the jurisdiction ofthe same congressional committees as the housing GSEs.However, we believe there is at least some risk that furtherefforts to regulate GSEs could impact the System’s status orerode some of the GSE-related benefits that it currentlyenjoys, including favorable funding costs and increasedfunding flexibility.We are Subject to Liquidity Risk with Respect to CertainInvestments and DerivativesWe are subject to liquidity risk in the course of ourinvesting activities, particularly with respect to ourinvestments in non-agency mortgage-backed securities (Non-Agency securities) and asset-backed securities (ABS), whichtogether represent approximately 2 percent of our investmentsecurities. As a result of volatile market conditions, it could bedifficult to sell such investments, if the need arises, and thediscounts from face value would likely be significant. Inaddition, because of the inherent uncertainty of determiningthe fair value of investments that do not have a readilyavailable market value, the fair value of our investments maydiffer significantly from the values that would have been usedhad a ready market existed for the investments.Our derivative contracts require the Bank or itscounterparties to post cash or securities as collateral when thefair values of the derivatives change based on changes ininterest rates. The collateral exchanged between parties occursdaily with zero posting thresholds for all dealer counterparties.As a result of these derivative contracts, we are exposed toliquidity risk when changes in interest rates require us to postcollateral to our counterparties. As of December 31, 2011, ourcounterparties had posted $792.3 million in cash and$58.9 million in securities as collateral with us. AtDecember 31, 2011, a parallel increase of 2.0 percentagepoints in the U.S. dollar LIBOR/swap curve would haverequired us to return substantially all of the collateral currentlyposted with us by our counterparties.Liquidity and Capital ResourcesFundingWe use our capital and both short-term and long-termborrowings to fund our assets. Our debt primarily representsSystemwide Debt Securities issued on CoBank’s behalf. Referto Notes 5 and 6 to the accompanying consolidated financialstatements for additional information regarding our debtobligations.As a member of the System, a GSE with continued strongearnings and capital levels, CoBank has traditionallymaintained ready access to debt-funding. As of December 31,2011, Systemwide Debt Securities were rated triple-A byMoody’s Investors Service and Fitch Ratings, and AA+ byStandard & Poor’s Ratings Services.Liquidity InvestmentsInvestment securities and cash are primarily held for thepurposes of maintaining a liquidity reserve and managingshort-term surplus funds. As detailed in Note 4 to theaccompanying consolidated financial statements, inaccordance with Board-approved policies, we purchase highcredit quality investments to ensure that the portfolio is readilymarketable and available to serve as a source of liquidity inthe event of disruption to our normal funding mechanisms.Investment securities totaled $13.0 billion atDecember 31, 2011, and $12.6 billion at December 31, 2010.Our cash balances were $2.8 billion and $1.9 billion atDecember 31, 2011 and 2010, respectively. The followingtable summarizes our investment securities and relatedunrealized gains/losses by asset class.CoBank 2011 Annual Report55