Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) filed this annual report for the fiscal year ended May 31, 2012, consolidating CFC, Rural Telephone Finance Cooperative (RTFC), National Cooperative Services Corporation (NCSC), and controlled entities. The filing is an FY2012 10-K, not a standalone “2011 Q4” report; it also provides quarterly results for the quarter ended May 31, 2012. CFC is a member-owned, tax-exempt cooperative lender serving rural electric systems, with smaller telecommunications and other lending businesses. Its objective is cost-based member financing, not profit maximization.
Financial performance and position
| Metric | FY2012 / May 31, 2012 | Prior comparable period |
|---|---|---|
| Interest income | $961.0 million | $1,008.9 million in FY2011 |
| Interest expense | $761.8 million | $841.1 million in FY2011 |
| Net interest income | $199.2 million; net yield 0.90% | $167.8 million; net yield 0.59% |
| GAAP net income (loss) | $(148.8) million; loss attributable to CFC was $(144.7) million | $151.2 million; $149.4 million attributable to CFC |
| Adjusted net income and adjusted TIER | $75.0 million; 1.10 | $174.6 million and 1.21 in FY2011 |
| Operating cash flow | $119.1 million | $122.6 million in FY2011 |
| Total assets | $20.0 billion | $20.6 billion at May 31, 2011 |
| Loans outstanding | $18.9 billion | $19.3 billion at May 31, 2011 |
| Allowance for loan losses | $143.3 million, or 0.76% of loans | $161.2 million, or 0.84% |
| Total debt outstanding | $18.6 billion; weighted-average rate 3.67% | $19.1 billion; 4.12% |
| Total equity | $490.8 million | $687.3 million |
| Cash and cash equivalents | $191.2 million | $293.6 million |
Adjusted figures are non-GAAP measures that exclude non-cash derivative valuation effects and make other adjustments; they should not be treated as substitutes for GAAP results. FY2012 derivative losses were $236.6 million, including a $223.8 million non-cash forward-value loss. The reported GAAP debt-to-equity ratio was 39.65-to-1, while the adjusted ratio was 6.01-to-1; management’s target was no more than 6.00-to-1. Cash flows from investing activities were $406.3 million and financing activities used $627.8 million.
For the quarter ended May 31, 2012, consolidated net income was $2.4 million and net income attributable to CFC was $3.3 million; net interest income was $63.2 million. The comparable May 2011 quarter reported net income of $19.2 million, including $19.8 million attributable to CFC.
Material changes versus FY2011
- GAAP results swung from $151.2 million net income to a $148.8 million net loss, principally reflecting the substantially larger derivative forward-value loss and losses from foreclosed assets.
- Adjusted net income fell by $99.6 million to $75.0 million. Management cited a $65 million smaller loan-loss recovery and a $45 million impairment charge related to Caribbean Asset Holdings (CAH).
- Net interest income rose $31.4 million as interest expense declined more than interest income. Adjusted net interest income increased 16% to $186.3 million.
- Loans declined $413 million, mainly from repayments of power-supply bridge loans and maturity of a $200 million telecommunications loan; advances exceeded repayments in the second half as borrowers refinanced other lenders’ debt.
- Total debt declined $569 million. CFC redeemed or repaid $1.5 billion of 7.25% medium-term notes and issued $800 million of collateral trust bonds at a weighted-average rate of 2.03%.
- Non-accrual loans fell to $41 million from $465 million, including after a $420 million restructured loan returned to accrual status in October 2011. All restructured loans were making payments under their revised terms.
Outlook, risks and unusual items
Management expected new long-term loan advances over the following 12 months to approximate scheduled repayments, with core lending earnings broadly stable. It forecast approximately $1.75 billion of long-term advances and $1.725 billion of loan repayments over the next 12 months. CFC expected to refinance $1.247 billion of long-term debt maturities and roll over $3.247 billion of commercial paper, daily liquidity fund notes and bank bid notes. It reported $2.844 billion available under bank revolvers, up to $580 million under Federal Financing Bank commitments, and up to $2.735 billion under its Federal Agricultural Mortgage Corporation facility, subject to market conditions. Management expected to maintain adjusted debt-to-equity at or below 6.00-to-1, although the reported year-end ratio was 6.01-to-1.
- Funding and ratings: CFC depends on continued capital-market access, member investments, committed facilities and refinancing. Downgrades could raise funding costs, impair commercial-paper access or activate contractual provisions.
- Derivatives: At year-end, swaps had $9.0 billion notional and a net fair-value liability of $358 million. Specified rating triggers could require payments; the filing estimates a net payment of up to about $248 million under the applicable trigger scenario. A counterparty downgrade after year-end gave CFC an option to terminate swaps with $717 million notional; estimated settlement would be about $26 million.
- Credit and concentration: Approximately 97% of total exposure was to rural electric cooperatives. Non-performing loans were $41 million, but $456 million remained restructured. Two borrowers were in bankruptcy, and two others were seeking buyers; management expected sale proceeds might not fully repay amounts owed.
- Foreclosed assets: CAH recorded $45 million of goodwill and other asset impairments and a $20 million operating loss, amid regional job losses and weaker economic conditions. Total foreclosed assets were $223.5 million.
- Off-balance-sheet exposure: Guarantees totaled $1.249 billion, including $505 million of letters of credit. A further $787 million could be issued under master letter-of-credit facilities. Unadvanced loan commitments were $14.129 billion, although most were subject to material-adverse-change clauses and management expected much of the amount to expire unused.
- Other risks: Management identified interest-rate and liquidity risk, competition, borrower credit deterioration, energy and telecommunications technology changes, environmental and utility regulation, uncertainty over Dodd-Frank implementation, and potential loss of CFC’s tax-exempt status. Legal proceedings include continuing claims associated with ICC bankruptcy; management said no legal reserve was recorded.
- Capital allocation: After year-end, the board authorized allocation of $71 million of FY2012 net earnings to members and retirement of $35 million, expected to be paid in September 2012. Patronage allocations and retirements remain subject to board approval and financial condition.
Investor verification priorities
- Reconcile the $148.8 million GAAP net loss with $75.0 million adjusted net income, especially the $223.8 million derivative forward-value loss and the exclusions used in adjusted measures.
- Review liquidity and refinancing assumptions for the $1.247 billion of long-term maturities and $3.247 billion of short-term funding due within 12 months, including facility availability and market-dependent funding.
- Assess the credit outlook for the $456 million restructured portfolio, the $41 million non-performing balance, bankruptcy and sale recoveries, and the adequacy of the $143.3 million allowance.
- Evaluate derivative counterparty exposure, rating-trigger terms, potential settlement or collateral requirements, and the post-year-end counterparty downgrade.
- Monitor CAH’s operating performance and asset valuations, guarantee and letter-of-credit claims, covenant headroom, and the effect of future patronage distributions on capital.