National Rural Utilities Cooperative Finance Corporation — Form 10-Q
Reporting period: Quarter and nine months ended February 28, 2018; comparative periods ended February 28, 2017. The filing date is April 11, 2018. The supplied request labels the period “2017 Q3,” but the filing covers fiscal 2018 third quarter.
Business context
CFC is a member-owned cooperative lender serving rural electric utilities, with financing also provided through consolidated subsidiaries NCSC and RTFC. It funds lending primarily with debt, member investments and retained equity; its stated aim is cost-based member financing and sound creditworthiness rather than profit maximization.
Financial performance and condition
| Metric | Three months ended Feb. 28, 2018 | Nine months ended Feb. 28, 2018 | Comparison |
|---|---|---|---|
| Interest income | $271.5 million | $803.2 million | Up 4% in each period |
| Net interest income | $73.4 million | $217.2 million | Nearly unchanged for the quarter; down 2% for nine months |
| Total net revenue | $77.3 million | $230.7 million | Down 2% and 3%, respectively |
| Net income | $221.0 million | $408.8 million | Up 126% and 13%, respectively |
| Adjusted net income (non-GAAP) | $34.1 million | $102.5 million | Down 6% and up 1%, respectively |
| Net interest yield | 1.16% | 1.15% | Down 3 and 7 basis points, respectively |
| Adjusted net interest yield (non-GAAP) | 0.86% | 0.84% | Down 1 and 2 basis points, respectively |
| TIER / adjusted TIER | 2.12 / 1.16 | 1.70 / 1.16 | Prior-year adjusted TIER: 1.18 / 1.17 |
The GAAP earnings increase was primarily driven by derivative fair-value gains: $168.0 million for the quarter and $247.4 million for nine months. These largely reflected rising interest rates and are noncash mark-to-market gains; management’s adjusted results exclude derivative forward-value gains and include derivative cash settlements.
- Balance sheet at February 28, 2018: Assets $26.48 billion; loans to members $25.34 billion gross ($25.31 billion net); total debt $24.43 billion; total equity $1.46 billion.
- Leverage: GAAP debt-to-equity was 17.15-to-1, down from 21.94-to-1 at May 31, 2017. Adjusted debt-to-equity was 6.21-to-1, up from 5.95-to-1 and above management’s approximate 6.00 target.
- Cash flow, nine months: Operating cash flow $172.0 million; investing cash outflow $994.6 million; financing cash inflow $906.8 million. Cash and cash equivalents ended at $250.7 million, versus $166.6 million at fiscal year-end.
- Liquidity: Reported available liquidity reserves were $7.25 billion, including cash, bank revolvers, USDA Guaranteed Underwriter Program capacity and Farmer Mac facilities. Long-term debt maturities over the next 12 months were $2.86 billion.
- Credit quality: No loans were past due or classified as nonperforming, and no charge-offs occurred in the nine-month period. Allowance for loan losses was $37.9 million, or 0.15% of loans.
Material changes and management outlook
- Loans increased $976 million, or 4%, from May 31, 2017; total debt increased $969 million, or 4%, largely to fund loan growth. Long-term advances were $1.86 billion for the nine months.
- Higher short-term rates raised funding costs and compressed yields. Nine-month adjusted net interest income remained broadly flat as asset growth offset lower adjusted yield.
- Management expects net interest income and yield, including adjusted measures, to rise over the next 12 months, citing anticipated loan growth and refinancing of higher-cost debt. It expects long-term advances to exceed repayments and adjusted debt-to-equity to remain above 6.00-to-1 during that period.
- Management expects to refinance or repay $1.83 billion of collateral trust bonds maturing over the next 12 months (weighted-average coupon 6.98%) with lower-cost funding. It projected approximately $713 million more long-term loan advances than repayments over the next 12 months.
- Management intends to keep dealer commercial paper below $1.25 billion and believes member short-term debt can continue to be rolled over. It reported compliance with debt covenants and investment-grade ratings with stable outlooks.
Risks, contingencies and unusual items
- Interest-rate changes affect funding costs and derivative fair values. Derivatives are generally not designated for hedge accounting, causing potentially material volatility in reported GAAP earnings that management says may not reflect underlying operating economics.
- Credit exposure is concentrated in rural electric utilities: approximately 99% of loans were to electric utility organizations; the 20 largest borrowers represented 23% of loans and guarantees. Management also identifies single-industry and single-obligor concentration risk.
- Off-balance-sheet commitments included $12.15 billion of unadvanced loan commitments, of which $2.78 billion was unconditional; CFC notes that historical line-of-credit utilization has been low. Guarantees totaled $680 million, with a recorded liability of $8 million. CFC also provided liquidity support for $251 million of variable-rate tax-exempt bonds.
- A sale agreement was signed in March 2018 for a 28-acre property carried at $14 million; completion remained subject to conditions and was not assured. A separate $1.5 million tax-lien escrow from a prior asset sale remained outstanding; the $14.5 million general indemnity escrow had been released to CFC.
- The filing states that ordinary-course legal proceedings are not expected to materially harm results or financial condition and that no legal reserve was recorded. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Confirm the period: this is fiscal 2018 third quarter, ended February 28, 2018, notwithstanding the request’s “2017 Q3” label.
- Assess earnings using both GAAP and adjusted measures; determine how much reported profit reflects unrealized derivative gains and how sensitive results are to rates.
- Review liquidity availability, debt maturities, funding-market access, covenant compliance and the assumptions underlying the $7.25 billion liquidity reserve.
- Monitor the adjusted debt-to-equity ratio, loan growth, interest-rate margins, borrower concentrations, guarantees and potential draws on unconditional commitments.
- Check the status and accounting outcome of the property sale, remaining escrow and any subsequent developments after the filing date.