Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) is a member-owned, tax-exempt cooperative lender serving rural electric utilities, with financing also provided through consolidated NCSC and RTFC. This Form 10-Q covers the quarter and six months ended November 30, 2019; balance-sheet comparisons are to May 31, 2019.
Financial performance and condition
- Quarter: Revenue was $83.0 million, net income was $241.6 million, and TIER was 2.16, versus $80.7 million, $119.7 million, and 1.59, respectively, a year earlier. The quarter’s earnings included $183.5 million of derivative gains.
- Six months: Revenue was $170.7 million, up 12%; net loss was $82.5 million versus net income of $167.7 million a year earlier. Net interest income rose 7% to $155.9 million. The reported loss principally reflected $212.3 million of derivative losses.
- Adjusted results (non-GAAP): Six-month adjusted net income was $104.6 million versus $72.5 million; adjusted TIER was 1.23 versus 1.17. Quarterly adjusted net income was $44.0 million versus $44.6 million, and adjusted TIER was 1.20 versus 1.21. Management uses these measures to exclude derivative fair-value volatility while including periodic derivative cash settlements.
- Interest performance: Six-month net interest yield was 1.16%, up 4 basis points; adjusted net interest yield was 0.97%, also up 4 basis points. Quarterly adjusted net interest yield was 0.96%, down 5 basis points year over year.
- Loans and assets: Loans to members were $26.44 billion, up $521 million (2%) since May 31. Total assets were $27.57 billion. Long-term fixed-rate loans represented 90% of outstanding loans.
- Debt, equity and leverage: Total debt was $25.56 billion, up 2%; short-term borrowings increased 33% to $4.79 billion. Total equity fell 11% to $1.16 billion, reflecting the six-month loss and $63 million patronage capital retirement. GAAP debt-to-equity was 22.81, compared with 19.80 at May 31; adjusted debt-to-equity was 5.78 versus 5.73.
- Cash flow and liquidity: Six-month operating cash flow was $97.6 million; investing cash use was $489.3 million and financing cash provided was $330.2 million. Cash, cash equivalents and restricted cash fell $61.5 million to $124.7 million. Available liquidity was $6.59 billion, including $114 million cash and committed facilities.
- Credit quality: No loans were delinquent or nonperforming, and there were no defaults or charge-offs in the six-month period. The allowance was $16.5 million, or 0.06% of loans. Criticized loans were $199 million (0.75% of loans); $173 million were substandard.
Material changes, outlook and risks
- Derivative fair-value swings drove the sharp difference between reported quarterly profit and six-month loss. CFC generally does not apply hedge accounting to its interest-rate swaps; pay-fixed swaps lose value when rates decline and gain when rates rise. The reported fair-value changes may not reflect near-term cash flows.
- Management expects net interest income, adjusted net interest income, and net and adjusted yields to increase slightly over the next 12 months, mainly from lower average funding costs and growth in earning assets. It targets annual adjusted TIER of at least 1.10 and adjusted debt-to-equity at or below approximately 6.00; both current adjusted measures were within those targets.
- Long-term debt maturities over the next 12 months totaled $1.77 billion. Management stated liquidity was sufficient to fund member advances and repay maturities. Its projection was for $1.41 billion of long-term loan advances over the next 12 months, exceeding anticipated loan repayments by about $101 million.
- Funding risks include reliance on short-term borrowing, member investment rollover and capital-market access. Dealer commercial paper was $1.04 billion; management intends to keep it near or below $1.25 billion. Bank revolver commitments were amended to $2.725 billion; the three-year facility maturity was extended to November 2022, while total commitments were reduced by $250 million.
- Credit exposure is concentrated by industry: approximately 99% of loans were to electric utilities, and the 20 largest borrowers represented 22% of loans. Guarantees outstanding were $794.7 million, in addition to $13.33 billion of unadvanced loan commitments, including $3.07 billion of unconditional credit lines.
- Interest-rate and liquidity risks include the LIBOR transition after 2021; management was assessing affected contracts and systems. Derivative downgrade triggers could require payments; the filing estimates $381.6 million net payable under specified triggers. The company reported investment-grade ratings with stable outlooks and compliance with debt covenants.
- Unusual items included an $8 million gain on a July 2019 land sale and a $0.6 million loss on early debt extinguishment in the six-month period. Management reported no material change in risk factors from its 2019 Form 10-K and no legal-proceeding reserve.
Most important facts for investors to verify
- Review the derivative portfolio, fair-value assumptions and cash-settlement costs, and distinguish GAAP results from adjusted measures.
- Assess available liquidity and funding rollover capacity against short-term borrowings, upcoming maturities and projected loan advances.
- Monitor credit quality, especially the substandard borrower exposure, industry concentration, allowance coverage and contingent guarantees.
- Confirm the effect of the LIBOR transition, rating-trigger provisions and any changes in credit ratings or facility availability.
- Check whether management’s projected modest improvement in interest income and yields, and its leverage targets, are being achieved.