Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) filed this unaudited Form 10-Q for the quarter ended November 30, 2018, covering the second quarter and first six months of fiscal 2019. CFC is a member-owned cooperative lender serving rural electric utilities; it also provides guarantees and letters of credit. The consolidated results include NCSC and RTFC. CFC’s stated objective is to provide members cost-based financing while maintaining financial strength, rather than maximizing profit.
Financial performance and position
Unless noted otherwise, amounts below are consolidated. Dollar amounts are in millions; quarterly and six-month comparisons are with the corresponding prior-year periods.
| Metric | Quarter ended Nov. 30, 2018 | Six months ended Nov. 30, 2018 |
|---|---|---|
| Total revenue | $81.4, up 7% | $152.9, essentially flat |
| Net interest income | $77.1, up 9% | $145.3, up 1% |
| Net income | $119.7, down 33% | $167.7, down 11% |
| Adjusted net income (non-GAAP) | $44.6, up 33% | $72.5, up 6% |
| Net interest yield / adjusted yield | 1.19% / 1.01% | 1.12% / 0.93% |
| TIER / adjusted TIER | 1.59 / 1.21 | 1.40 / 1.17 |
Interest income rose, but interest expense also increased: six-month expense was $414.4 million, up 7%. The six-month adjusted net interest income was $120.7 million, up 16%. Adjusted measures are non-GAAP and exclude derivative forward-value gains from adjusted net income while including derivative cash settlements in adjusted interest expense.
At November 30, 2018, loans to members were $25.29 billion, up $116 million from May 31; total assets were $26.83 billion. Total debt was $24.70 billion, comprising $4.10 billion short-term borrowings and $18.48 billion long-term debt, plus subordinated debt and member certificates. Total equity was $1.63 billion. The GAAP debt-to-equity ratio was 15.49, and adjusted debt-to-equity was 6.15, above CFC’s approximate 6.00 target.
Cash, cash equivalents and restricted cash totaled $242.9 million, including $227 million of cash and cash equivalents. Available liquidity was reported at $7.81 billion, including committed bank lines, USDA Guaranteed Underwriter Program facilities and Farmer Mac arrangements; part of Farmer Mac availability is subject to market conditions. Six-month operating cash flow was $68.2 million versus $71.0 million a year earlier. Investing activities used $60.4 million and financing activities used $3.7 million; cash and restricted cash increased $4.1 million.
Material changes versus prior periods
- Reported net income fell $59 million in the quarter, primarily because derivative gains declined to $63.3 million from $125.6 million. For six months, derivative gains were $70.5 million versus $79.4 million.
- Adjusted results improved: six-month adjusted net income increased $4.1 million, mainly on $16.7 million higher adjusted net interest income, partly offset by a $7.1 million debt-extinguishment loss and higher operating expenses.
- Management attributed stronger quarterly adjusted interest performance to a higher yield on earning assets and lower adjusted funding cost. For the six-month period, GAAP net interest yield edged down two basis points, reflecting higher funding costs as short-term rates rose.
- Long-term loan advances declined to $814 million from $1.13 billion year over year. Management cited weaker borrower demand, fewer refinancing opportunities and members’ improved profitability.
- Equity increased $121 million from May 31, primarily reflecting six-month earnings, partly offset by a $48 million patronage capital retirement paid to members.
Outlook, risks, contingencies and unusual items
- Management expects net interest income, adjusted net interest income, net income, adjusted net income, TIER and interest yields to increase over the next 12 months, principally due to lower funding costs following redemption and maturity of $1 billion of 10.375% bonds. This is forward-looking and subject to market conditions.
- Long-term debt maturities over the next 12 months were $2.32 billion. CFC projected $7.81 billion of readily available liquidity and stated it expected to meet loan demand and debt obligations. Management projected long-term advances to exceed repayments by about $587 million over the next 12 months.
- CFC had no delinquent or nonperforming loans, defaults or charge-offs during the six-month period. The allowance for loan losses was $16.9 million, or 0.07% of loans. Criticized loans were $184 million (0.73% of loans), including $178 million classified substandard; one electric cooperative borrower accounted for $172 million of substandard loans but remained current on payments.
- Credit concentration remains inherent: about 99% of loans were to electric utilities; the 20 largest borrowers represented 22% of loans and guarantees. Unadvanced loan commitments totaled $13.14 billion, of which $3.05 billion was unconditional; management cautioned that historical low utilization of credit lines makes total commitments an imperfect indicator of funding needs.
- Interest-rate risk is managed partly through swaps. Changes in swap fair values create GAAP earnings volatility because most swaps are not designated for hedge accounting. The filing identifies broader risks including funding-market access, interest rates, borrower credit quality, counterparty performance, and legislative or economic changes.
- Notable financing activity included redeeming and repaying the high-coupon bonds, issuing $625 million of new bonds, closing a $750 million USDA program facility, and extending bank revolver maturities. The early redemption incurred a $7.1 million loss. Credit ratings were affirmed with stable outlook; CFC reported compliance with debt covenants.
- Management reported no material changes to the prior annual report’s risk factors, no material expected legal-proceeding impact, and no reserve for legal proceedings. The filing reported effective disclosure controls and no material internal-control changes during the quarter.
Important facts for investors to verify
- Whether projected funding-cost savings and improved earnings materialize, especially as interest rates and derivative settlements change.
- Whether liquidity remains accessible as debt maturities, member funding rollover and market-dependent Farmer Mac capacity evolve.
- Whether adjusted debt-to-equity stays near management’s forecast; it was 6.15 versus an approximate 6.00 target.
- Whether loan demand, advances and utilization of the $13.14 billion commitment portfolio track management assumptions, and whether the substandard borrower’s condition changes.
- How derivative fair-value volatility, future credit-loss accounting adoption and portfolio concentration affect reported results, capital and liquidity.