Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) is a tax-exempt, member-owned cooperative lender serving rural electric utilities, with additional telecommunications and other lending through RTFC and NCSC. It funds lending primarily with debt and member investments; its stated objective is cost-based member financing, not profit maximization.
Period clarification: Although the request identifies “2014 Q3,” this filing reports the quarter ended February 28, 2015, CFC’s fiscal 2015 third quarter, and the nine months then ended. Comparisons are with the quarter and nine months ended February 28, 2014.
Financial performance and position
| Metric | Three months ended Feb. 28 | Nine months ended Feb. 28 |
|---|---|---|
| Interest income | $238.7 million in 2015; essentially unchanged year over year | $711.3 million, down 1% |
| Net interest income | $81.9 million, up 9% | $239.6 million, up 8% |
| GAAP net income (loss) | $(34.2) million, versus $28.5 million income | $(49.5) million, versus $211.8 million income |
| Adjusted net income (non-GAAP) | $43.1 million, versus $41.4 million | $110.3 million, versus $112.9 million |
| Adjusted TIER (non-GAAP) | 1.24, versus 1.23 | 1.21, versus 1.20 |
| Operating cash flow | Not presented as a quarterly figure | $222.8 million, versus $281.1 million |
GAAP losses principally reflect mark-to-market derivative losses: $98.8 million for the quarter and $223.2 million for the nine months, compared with losses of $31.6 million and gains of $44.0 million, respectively, in the prior-year periods. Nine-month results also include a $27 million non-cash impairment of CAH assets. CFC uses adjusted measures that exclude derivative forward-value changes; these are non-GAAP measures and are not substitutes for GAAP results.
Net interest yield was 1.51% for the quarter and 1.49% for the nine months, compared with 1.40% and 1.39%. Adjusted net interest yield was 1.13% and 1.10%, respectively. Lower average funding costs more than offset lower yields on earning assets. Operating expenses were $18.7 million for the quarter and $55.4 million for the nine months.
At February 28, 2015, total assets were $22.65 billion, member loans outstanding were $21.20 billion, and the allowance for loan losses was $53.1 million (0.25% of loans). Total debt was $21.00 billion, equity $884.5 million, and guarantees $987.8 million. Cash, investments and time deposits totaled $769.2 million on the balance sheet; cash and time deposits available for liquidity were $684 million.
Reported debt-to-equity was 24.61-to-1, compared with 21.91-to-1 at May 31, 2014; adjusted debt-to-equity was 6.10-to-1, up from 5.90-to-1. Adjusted leverage was 6.41-to-1. CFC reported compliance with its revolving-credit and senior-debt covenants. The adjusted debt-to-equity ratio exceeded management’s goal of at or below 6.00-to-1.
Changes versus prior comparable periods
- Net interest income improved, principally because average funding costs declined; core adjusted earnings were broadly stable.
- Reported earnings deteriorated sharply because derivative fair-value movements reversed and CAH incurred an impairment charge.
- Loans grew $735 million, or 4%, from May 31, 2014, largely from CFC distribution and power-supply lending. Total debt rose $376 million, or 2%.
- Dealer commercial paper fell $789 million to $1.185 billion as CFC shifted funding toward longer-term debt. Short-term borrowings overall declined 22% from May 31, 2014.
- Total equity fell $86 million, reflecting the nine-month net loss and $40 million patronage-capital retirement. Guarantees declined $77 million.
Outlook, risks and unusual items
Management expects new long-term loan advances to exceed scheduled repayments over the next 12 months and anticipates growth in core lending earnings as loans increase. It estimates approximately $2.061 billion of long-term loan advances over the next 12 months, versus $1.069 billion of expected scheduled amortization and prepayments. Long-term debt maturities over that period were $1.703 billion.
Management cited $7.432 billion of liquidity access: $684 million in cash and time deposits, $3.418 billion in available bank revolvers, up to $750 million in FFB facilities, and up to $2.580 billion under the Farmer Mac agreement, subject to market conditions. It expects to roll over member short-term debt of $2.029 billion and dealer commercial paper of $1.185 billion, and plans to keep dealer commercial paper near $1.0–$1.25 billion. These are management expectations, not assured funding.
CFC expects adjusted debt-to-equity to remain above its 6.00-to-1 goal in the near term as borrowing supports loan growth. Interest-rate and yield-curve changes can cause substantial volatility in GAAP results because most swaps are not designated for hedge accounting. A downgrade-related termination of specified swaps could require payments; the filing estimates net payments of $254 million under listed rating-trigger scenarios. Two counterparties were below contractual trigger levels, with estimated settlement of approximately $10 million if CFC elected to terminate those contracts.
CAH experienced weaker-than-expected subscriber and revenue growth, delayed network upgrades, and slower regional economic recovery. CFC recorded a $27 million impairment and is seeking to sell CAH, but timing, buyer interest, transaction structure and proceeds are uncertain. One nonperforming borrower was seeking a buyer for its system; management expected sale proceeds might not repay the full loan. Nonperforming and restructured loans together were $8.9 million, or 0.05% of loans.
Other notable developments included issuance of $900 million in collateral trust bonds in January 2015, an increase and extension of the Farmer Mac facility, and redemption of all $387 million of 7.5% member capital securities. S&P restored CFC’s outlook to stable in January 2015; Moody’s outlook was also stable. Management identified general economic conditions, access to financing, credit quality, derivative-counterparty performance, interest rates and CAH disposition outcomes as risks. It reported no material changes to the risk factors in the prior Form 10-K and no legal-proceeding reserve.
Important facts for investors to verify
- How derivative fair-value volatility, swap cash settlements and potential rating-trigger payments affect reported earnings, liquidity and adjusted metrics.
- Whether CAH’s operating performance improves and whether a sale closes, at what timing and proceeds, and with what further impairment risk.
- Availability and terms of committed liquidity, refinancing of the $1.703 billion of near-term long-term maturities, and rollover of member and dealer commercial paper.
- Loan growth, borrower credit migration, the adequacy of the $53.1 million allowance and potential shortfall on the identified nonperforming borrower.
- Progress toward the adjusted debt-to-equity goal and continued compliance with financing covenants as borrowing and lending expand.