Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) is a tax-exempt, member-owned cooperative lender serving rural electric and related entities. This unaudited Form 10-Q covers the quarter and six months ended November 30, 2015, the second quarter of CFC’s fiscal 2016. Comparisons are with the corresponding 2014 periods; balance-sheet comparisons are with May 31, 2015.
Financial performance and condition
- Quarter: Interest income was $256.3 million, up 9%; net interest income was $89.2 million, up 16%. CFC reported a consolidated net loss of $24.5 million versus a $35.9 million loss. GAAP TIER was 0.85 versus 0.77. Adjusted net income, a non-GAAP measure, was $54.1 million versus $16.9 million; adjusted TIER was 1.29 versus 1.09.
- Six months: Interest income was $502.4 million, up 6%; net interest income was $169.6 million, up 8%. CFC reported net income of $18.6 million versus a $15.3 million loss. GAAP TIER was 1.06 versus 0.95. Adjusted net income was $89.1 million versus $67.3 million; adjusted TIER was 1.24 versus 1.19.
- Yield and operating costs: Net interest yield was 1.56% for the quarter and 1.50% for six months, compared with 1.45% and 1.48%. Adjusted net interest yield was 1.17% and 1.12%, compared with 1.04% and 1.08%. Six-month non-interest expense increased 18% to $43.4 million, mainly from salaries and benefits, system enhancements and legal fees.
- Loans and credit: Loans outstanding rose 6% from May 31 to $22.66 billion, largely from CFC distribution and power-supply lending. The allowance for loan losses increased to $39.6 million from $33.7 million, equal to 0.17% of loans. Criticized loans were $49.6 million, less than 1% of the portfolio; nonperforming loans were $10.5 million, or 0.05%, and TDR loans totaled $10.2 million.
- Debt, equity and leverage: Total debt increased 5% to $22.28 billion; total assets were $23.85 billion and equity was $893.5 million. GAAP debt-to-equity rose to 25.69:1 from 24.06:1; adjusted debt-to-equity rose to 6.53:1 from 6.26:1. CFC’s stated goal is adjusted debt-to-equity below 6.00:1, but management expects it to remain above that level for an extended period as loan growth is financed.
- Cash flow and liquidity: Six-month operating cash flow was $96.0 million versus $103.3 million. Cash and cash equivalents were $242.6 million; cash, investments and time deposits totaled about $670.0 million. Reported liquidity reserve access was $7.12 billion, including $3.31 billion of bank revolvers, $500 million of FFB facilities and Farmer Mac facilities, some availability subject to market conditions. Long-term debt scheduled to mature over the next 12 months was $1.515 billion.
Material changes and unusual items
- Derivative losses were $101.2 million for the quarter and $113.2 million for six months. These largely reflected fair-value decreases in pay-fixed swaps as the swap yield curve flattened. CFC generally does not apply hedge accounting to these swaps, so derivative fair-value movements flow through reported earnings while the economically hedged assets and liabilities are not marked to market. Management therefore also reports adjusted, non-GAAP results.
- Reported results improved year over year despite the quarter’s larger derivative loss, supported by higher net interest income and reduced foreclosed-asset losses. The prior-year periods included a $27 million CAH impairment charge.
- On September 30, 2015, CFC agreed to sell Caribbean Asset Holdings (CAH) to Atlantic for $145 million, subject to adjustments. The balance-sheet carrying amount was $116.9 million, reflecting estimated net proceeds. Closing was expected in the second half of calendar 2016, subject to regulatory approvals and other conditions.
- CFC paid members $39 million in patronage capital in September. Equity fell by $18 million from May 31, as the retirement exceeded six-month net income.
- CFC early-adopted guidance requiring debt issuance costs to be deducted from debt rather than shown as an asset; the retrospective reclassification did not otherwise affect the financial statements.
Outlook, risks and contingencies
Management expected new long-term loan advances to exceed scheduled repayments over the next 12 months and anticipated continued growth in core lending earnings. It estimated about $1.503 billion of long-term loan advances and $1.309 billion of long-term loan repayments over that period. Management said available liquidity, loan repayments, committed facilities and potential debt issuance should meet member funding needs and debt maturities, and expected to roll over member and dealer commercial paper. These expectations depend on market access, member demand and continued covenant compliance.
- CFC was in compliance with revolving-credit and senior-debt covenants at November 30. Ratings were A1/A2/P-1 with stable outlook from Moody’s, A/A/A-1 with negative outlook from S&P, and A+/A/F1 with stable outlook from Fitch (secured/unsecured/commercial paper, as applicable).
- Unadvanced loan commitments totaled $14.04 billion, although most were conditional or historically not fully drawn. Guarantees outstanding were $961.3 million; CFC also had $489 million of variable-rate tax-exempt bonds for which it acted as liquidity provider. No liquidity-provider purchase was required during the six months.
- Derivative rating triggers could have required a net payment of about $279 million if specified ratings thresholds had been reached; no counterparty had fallen below its trigger threshold at period end. Interest-rate, funding rollover, credit, counterparty and rating risks remain material.
- RTFC disputed a Virgin Islands Bureau of Internal Revenue notice alleging taxes or other amounts, plus interest, for specified tax years. The filing does not provide a clear claimed dollar amount. RTFC considered the allegations without merit and was contesting them; management reported no legal reserve recorded.
- Management identified the allowance for loan losses and fair value as critical estimates. It reported no material change in critical-estimate assumptions during the quarter. CFC stated that it was unaware of material changes to the risk factors in its 2015 Form 10-K.
Important facts for investors to verify
- Track GAAP earnings and derivative fair-value volatility alongside adjusted results; adjusted measures are non-GAAP and should not be treated as substitutes for GAAP.
- Monitor adjusted debt-to-equity against CFC’s 6.00:1 goal, loan growth, credit migration, nonperforming exposures and allowance adequacy.
- Confirm refinancing and rollover capacity for the $1.515 billion of near-term long-term debt maturities and commercial paper, including the availability and conditions of committed facilities.
- Follow the CAH sale’s regulatory approvals, closing timetable and final proceeds relative to the estimated carrying value.
- Assess the outcome and potential financial exposure of the RTFC tax dispute, as well as guarantee, commitment and derivative-trigger exposures.