National Rural Utilities Cooperative Finance Corporation — Form 10-Q
Reporting period: Quarter ended February 28, 2017, with nine-month results for the period ended the same date. Although the request metadata says “2016 Q3,” the filing is for fiscal 2017’s third quarter. Amounts below are in U.S. dollars; figures are consolidated unless noted.
Business context
CFC is a tax-exempt, member-owned cooperative lender serving rural electric utilities. It also provides member credit enhancements, including guarantees and letters of credit. Its objective is to provide cost-based financing while maintaining a sound financial position, rather than maximizing profit. The filing consolidates CFC, RTFC and NCSC.
Financial performance and position
| Metric | Quarter ended Feb. 28, 2017 | Nine months ended Feb. 28, 2017 | Comparison |
|---|---|---|---|
| Interest income | $259.9 million | $773.9 million | Up 2% in both periods year over year |
| Net interest income | $73.2 million | $222.4 million | Down 11% and 12%, respectively |
| Net interest yield | 1.19% | 1.22% | Down 21 and 25 basis points, respectively |
| Adjusted net interest income | $53.8 million | $158.1 million | Down 10% and 15%, respectively |
| Adjusted net interest yield | 0.87% | 0.86% | Down 15 and 23 basis points, respectively |
| Net income (loss) | $98.0 million | $361.0 million | Prior-year periods recorded losses of $174.4 million and $155.8 million |
| Adjusted net income | $36.2 million | $101.9 million | Down 22% and 25%, respectively |
| Adjusted TIER | 1.18 | 1.17 | Prior-year comparable periods: 1.24 |
Reported earnings were substantially affected by derivative fair-value movements: gains were $42.5 million for the quarter and $194.8 million for nine months, versus losses of $243.0 million and $356.2 million in the prior-year periods. These noncash fair-value changes are excluded from adjusted net income; adjusted measures include periodic derivative cash settlements. Operating expenses were $21.0 million for the quarter and $63.5 million for nine months, down 9% and 5%, respectively. The nine-month loan-loss provision was $4.7 million.
At February 28, 2017, total assets were $25.61 billion, loans to members net of allowance were $24.22 billion, total debt was $23.81 billion, total liabilities were $24.46 billion, and equity was $1.15 billion. Loans outstanding rose 5% to $24.25 billion from May 31, 2016; debt rose 5% to $23.81 billion. The allowance for loan losses was $36.0 million, or 0.15% of loans. Cash, investments and time deposits were $955.9 million; cash and cash equivalents plus time deposits were $865.8 million.
For the nine months, operating cash flow was $192.6 million, investing cash flow was negative $1.31 billion, and financing cash flow was positive $1.15 billion. Cash and cash equivalents increased $31.2 million to $235.8 million; the filing’s broader liquidity measure also includes restricted cash and time deposits.
Material changes and key developments
- Net interest income and adjusted earnings declined despite loan growth, as asset yields fell and funding costs increased. Management attributed lower loan yields to repayment and repricing of higher-rate loans; higher funding costs partly reflected a shift toward longer-term debt.
- Total equity increased $330 million during the nine months, primarily from reported net income, partly offset by $42.5 million of patronage capital retirements.
- CFC completed the sale of Caribbean Asset Holdings on July 1, 2016. Closing proceeds were $109 million; $16 million was placed in escrow for potential indemnification claims. No foreclosed assets remained on the balance sheet at February 28, 2017.
- Financing included a $450 million collateral trust bond issuance and advances under the USDA Guaranteed Underwriter Program and Farmer Mac agreements. A new $375 million USDA-guaranteed facility increased committed program facilities to $5.80 billion.
- The GAAP debt-to-equity ratio was 21.32:1, down from 28.69:1 at May 31, 2016; the adjusted ratio was 6.11:1, up from 5.82:1 and slightly above management’s approximate 6.00:1 target.
Outlook, liquidity and risks
Management expected long-term loan advances to slightly exceed repayments over the next 12 months, with net and adjusted net interest income expected to remain relatively flat as modest loan growth is offset by a modest decline in yields. Projected advances were about $300 million greater than anticipated repayments. Management expected to maintain adjusted debt-to-equity near 6.00:1.
Available liquidity reserves totaled $6.93 billion: $866 million in cash and time deposits, $3.16 billion under bank revolving lines, $725 million under USDA-guaranteed facilities, and up to $2.18 billion under Farmer Mac facilities, of which the larger portion was subject to market conditions. Long-term debt maturities over the next 12 months totaled $2.59 billion, including $1.44 billion in fiscal 2017’s fourth quarter. Management believed liquidity was adequate and expected to roll over member and dealer commercial paper.
Principal risks include member credit quality, access to capital markets and refinancing, interest-rate and derivative exposure, and counterparty performance. Derivatives had a net fair-value liability of $256.0 million; rating-trigger termination provisions could require a net payment of approximately $190.3 million under specified downgrade scenarios. Guarantees totaled $887.5 million, while the recorded guarantee liability was $15.8 million. Unadvanced loan commitments were $12.47 billion, though management expected most would not be fully drawn; $2.66 billion was unconditional. There were no loans past due or on nonaccrual at February 28, 2017, but criticized loans increased to 0.6% of the portfolio from 0.2% at May 31, 2016.
The filing identifies allowance for loan losses and fair value as critical estimates. A new expected-credit-loss accounting standard was scheduled to take effect for CFC on June 1, 2020; the ultimate impact was not yet determined. The company reported compliance with debt covenants and effective disclosure controls. Management said there were no material changes to previously disclosed risk factors. The RTFC tax deficiency matter in the U.S. Virgin Islands was dismissed with prejudice in January 2017; management reported no other legal reserve.
Most important facts for investors to verify
- Separate recurring performance from derivative mark-to-market effects: reported nine-month net income was $361.0 million, while adjusted net income was $101.9 million.
- Track the continued compression in adjusted net interest yield and adjusted TIER against CFC’s minimum annual adjusted TIER goal of 1.10.
- Monitor adjusted debt-to-equity, which stood at 6.11:1 versus management’s approximate 6.00:1 target, and assess debt maturities and refinancing access.
- Review liquidity availability, especially Farmer Mac capacity subject to market conditions, and the ability to roll over short-term funding.
- Follow credit-quality trends, allowance adequacy, unconditional commitments, guarantees, and potential derivative collateral or termination payments.