NRUC

Business Context and Reporting Period

Company: National Rural Utilities Cooperative Finance Corporation (CFC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: August 31, 2011
Business Overview: CFC is a tax-exempt cooperative lender providing cost-based financial products to rural electric and telecommunications members. It consolidates results with Rural Telephone Finance Cooperative (RTFC) and National Cooperative Services Corporation (NCSC). The company does not issue equity capital stock.

Key Financial Metrics

Note: All figures in thousands. Adjusted Net Income excludes non-cash derivative forward value losses.

Material Changes vs. Prior Period

• Loan Portfolio: Total loans outstanding decreased by $713 million ($19.3B to $18.6B), primarily driven by a $557 million reduction in power supply loans due to repayments of bridge loans with RUS funding.
• Net Loss: GAAP net loss increased to $87 million from $42 million in the prior year quarter. This was primarily driven by a $112 million non-cash derivative forward value loss and a $9 million loss on early extinguishment of debt.
• Interest Income/Expense: Interest income decreased slightly ($247M vs $251M) due to lower rates on new fixed-rate loans. Interest expense decreased significantly ($202M vs $220M) due to refinancing maturing term debt at lower rates and increased use of low-cost commercial paper.
• Liquidity: Cash and cash equivalents increased by $274 million to $568 million, reflecting loan repayments exceeding new advances and debt paydowns.
• Derivatives: Derivative losses widened to $112 million (vs $78 million prior year) due to changes in the estimated yield curve affecting the fair value of interest rate swaps.

Guidance, Outlook, and Risks

• Outlook: Management expects adjusted net income to be lower in fiscal year 2012 due to anticipated reductions in loan volume, lower variable-rate loan pricing, and a slower pace of decline in interest expense.
• Loan Volume: Projected decrease in outstanding loans due to maturities, loan sales, and slower growth in electricity demand.
• Debt Maturities: $2.465 billion of long-term debt matures in the next 12 months. Management expects to refinance these obligations using capital markets, member investments, and federal facilities.
• Key Risks:
  • Interest Rate Risk: Exposure to funding fixed-rate loans with short-term debt; managed via interest rate swaps and gap analysis.
  • Liquidity Risk: Dependence on rolling over commercial paper and accessing capital markets; mitigated by $3.55 billion in revolving credit facilities.
  • Counterparty Risk: Exposure to derivative counterparties; mitigated by dealing only with investment-grade institutions.
  • Credit Risk: Concentration in specific borrowers (e.g., CoServ restructured loans); management believes loan loss reserves are adequate.
• Unusual Items: Recorded a $9.3 million loss on early extinguishment of debt for the redemption of $250 million in Series C medium-term notes. Also recorded a $10 million reduction in impairment for CoServ loans due to rate reductions, expected to be recognized as a recovery in the next quarter.

Investor Verification Checklist

• Derivative Valuation: Verify the impact of the $112 million non-cash derivative loss on GAAP earnings versus the $25 million Adjusted Net Income used for covenant compliance.
• Debt Refinancing: Confirm the company's ability to refinance $2.465 billion in debt maturing within 12 months, specifically the $1.5 billion in medium-term notes.
• Loan Loss Reserve Adequacy: Review the specific valuation allowance for the $427 million in restructured loans to CoServ and the $31 million in non-performing loans to the geothermal borrower.
• Liquidity Coverage: Assess the reliance on commercial paper markets and the availability of the $3.55 billion in revolving credit lines as backup liquidity.
• Adjusted Metrics: Understand the reconciliation between GAAP and Non-GAAP measures (Adjusted TIER and Adjusted Debt-to-Equity), which are the primary metrics for debt covenants.