NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP quarterly report, Q3 FY2023

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Business context and reporting period

National Rural Utilities Cooperative Finance Corporation (CFC) is a member-owned, tax-exempt cooperative that finances rural electric utilities; consolidated results include NCSC and RTFC. The 10-Q covers the quarter and nine months ended February 28, 2023 (CFC fiscal 2023 Q3), compared with the same 2022 periods. The filing is unaudited.

Financial performance and condition

  • Quarter: GAAP net income was $163.2 million, down 38% from $262.0 million. Total revenue was $76.9 million, down 34%; net interest income was $71.6 million, down 36%. The quarter included $102.3 million of derivative gains.
  • Nine months: GAAP net income was $514.9 million, up 68% from $307.4 million, while total revenue fell 24% to $261.4 million and net interest income fell 25% to $247.8 million. Derivative gains were $342.7 million, versus $43.2 million in the prior-year period.
  • Adjusted results (non-GAAP): Adjusted net income was $79.5 million for the quarter and $184.8 million year to date, versus $66.5 million and $184.4 million. Adjusted net interest income was $90.2 million and $260.5 million, respectively. Adjusted net interest yield was 1.11% for the quarter and 1.09% year to date; adjusted TIER was 1.30 and 1.26. Management’s annual minimum adjusted TIER target is 1.10.
  • Interest margins: GAAP net interest yield declined to 0.88% for the quarter and 1.04% year to date, from 1.50% and 1.48%. Higher borrowing costs, reflecting rising rates, outpaced increases in asset yields. Adjusted yield declined less, by 4 basis points, in each comparison.
  • Cash flow: For nine months, operating cash flow was $296.6 million, investing cash flow was negative $2.392 billion, and financing cash flow was positive $2.114 billion. Cash, cash equivalents and restricted cash rose $19.1 million to $180.3 million.
  • Balance sheet and debt: Total assets were $34.0 billion, including $32.4 billion of member loans, up 9% and 8% respectively from May 31, 2022. Total debt increased 8% to $30.9 billion; long-term debt was $23.8 billion and short-term borrowings $4.9 billion. Total equity was $2.6 billion. GAAP debt-to-equity was 12.06, down from 13.59; adjusted debt-to-equity was 6.59, up from 6.24 and above management’s approximate 6.00 target.
  • Liquidity: Available liquidity was $6.816 billion against $7.155 billion of debt scheduled to mature within 12 months (coverage 0.95). Excluding $3.186 billion of member short-term investments expected to roll over, coverage was 1.72. Management also expects $1.494 billion of scheduled long-term loan principal repayments in that period.
  • Credit: Allowance for credit losses was $56.3 million, or 0.17% of loans, versus $67.6 million, or 0.22%, at May 31, 2022. Criticized loans fell to $337 million (about 1.04% of loans) from $494 million. The filing reports $108 million of nonperforming loans; a separate table reports $131 million of nonaccrual loans, including TDR classification. Nine-month charge-offs were $15 million, primarily related to Brazos and Brazos Sandy Creek.

Material changes versus prior comparable periods

  • Quarterly GAAP income declined mainly because derivative gains were $67 million lower and net interest income fell $40 million. Year-to-date GAAP income rose mainly because derivative gains increased by $300 million, despite lower net interest income.
  • Rising rates increased both yields on loans and the cost of borrowings; the cost increase weakened GAAP net interest yield. Derivative cash settlements shifted to income of $18.6 million for the quarter and $12.7 million year to date, from expenses of $26.2 million and $79.7 million.
  • Operating expenses rose 7% for the quarter and 10% year to date, primarily on salaries, technology, travel and in-person meetings. Nine-month credit-loss results shifted from a $12.1 million benefit to a $3.8 million provision.
  • Loans grew by $2.319 billion. Short-term borrowings decreased slightly, while long-term debt and subordinated debt increased to fund portfolio growth. The $59 million patronage capital retirement partly offset equity growth from earnings.

Outlook, risks and unusual items

  • Management projects net long-term loan growth of approximately $1.378 billion over the next 12 months. It expects reported net interest income and yield to decline, adjusted net interest income to increase modestly, adjusted yield to decline slightly, and adjusted net income to increase slightly. Adjusted TIER is expected to decline slightly; adjusted debt-to-equity is expected to remain above target.
  • Management cites an inverted yield curve expected to persist until mid-2024 and significant interest-rate volatility in March 2023. It cannot provide a forward reconciliation of adjusted outlook measures to GAAP without unreasonable effort, principally because future derivative fair-value changes are unpredictable.
  • GAAP earnings are volatile because most swaps are pay-fixed, long-dated instruments and are not generally designated for hedge accounting. Nine-month derivative forward-value gains were $330.0 million; these noncash gains are excluded from adjusted net income.
  • Credit risks include concentrated lending to rural electric utilities (98% of loans), exposures involving bankrupt borrowers Brazos and Brazos Sandy Creek, and a special-mention borrower affected by hurricane restoration costs. CFC received an $8 million investment in HoldCo in connection with the sale of Brazos Sandy Creek plant interests; HoldCo has no stated disposition timeline.
  • Liquidity depends in part on continued access to capital markets and the rollover of member investments; the company expects member short-term investments to remain stable. Other risks include interest-rate and refinancing exposure, derivative counterparties, LIBOR-to-SOFR transition and possible borrower funding draws. The filing says all debt covenants were met, credit ratings were affirmed with stable outlooks, and no material risk-factor changes were identified.
  • Three $400 million aggregate treasury locks were terminated in February 2023; a $7 million gain was recorded in AOCI for future reclassification to interest expense. Subsequent to quarter-end, CFC sold $36 million of debt securities and borrowed $150 million under the Farmer Mac facility.

Important facts for investors to verify

  1. Reconcile GAAP earnings and reported TIER to adjusted measures, focusing on how unrealized derivative gains affect reported results.
  2. Assess liquidity under stress: member-investment rollover, access to committed facilities and capital markets, and upcoming maturities.
  3. Review credit developments and recoveries for Brazos, Brazos Sandy Creek, and the hurricane-affected special-mention borrower; clarify the filing’s nonperforming-versus-nonaccrual loan presentations.
  4. Track whether loan growth and funding costs meet management’s outlook and whether adjusted debt-to-equity returns toward its 6.00 target.
  5. Monitor interest-rate sensitivity, LIBOR transition exposure and derivative counterparty concentration.