Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) filed this unaudited Form 10-Q for the three months ended August 31, 2014, the first quarter of fiscal 2015. CFC is a tax-exempt, member-owned cooperative lender serving rural electric and telecommunications cooperatives; it also provides guarantees and letters of credit. It has no publicly held equity securities. Results consolidate CFC, RTFC and NCSC.
Financial performance and position
| Metric | Quarter ended August 31, 2014 | Prior-year quarter / comparison |
|---|---|---|
| Interest income | $237.3 million | $241.1 million |
| Interest expense | $156.6 million | $167.6 million |
| Net interest income | $80.7 million | $73.5 million; up 10% |
| Net income | $20.6 million | $158.3 million; down 87% |
| Net income attributable to CFC | $20.4 million | $155.5 million |
| Adjusted net income (non-GAAP) | $50.4 million | $35.2 million; up 43% |
| TIER / adjusted TIER | 1.13 / 1.29 | 1.94 / 1.19 |
| Operating cash flow | $124.1 million | $137.1 million |
The decline in GAAP earnings primarily reflected a $49.9 million net derivative loss, compared with a $106.4 million gain a year earlier. The loss included $29.8 million in fair-value (“forward value”) losses and $20.1 million in cash settlement costs. Adjusted measures are non-GAAP and should be read alongside GAAP results.
Net interest yield was 1.51%, compared with 1.39%; adjusted net interest yield was 1.13%, compared with 1.07%. Average earning-asset yield declined to 4.40% from 4.52%, while average funding cost fell to 3.05% from 3.26%. The allowance for loan losses fell to $49.7 million from $56.4 million, reflecting management’s assessment of modest credit improvement and favorable risk-rating migration.
At August 31, total assets were $22.23 billion, loans to members were $20.48 billion, and equity was $953.5 million. Cash, investments and time deposits totaled $974.5 million. Total debt outstanding was $20.54 billion, including $4.17 billion of short-term debt and $14.38 billion of long-term debt; total liabilities were $21.28 billion. The GAAP debt-to-equity ratio was 22.32, while adjusted debt-to-equity was 5.95, compared with 21.91 and 5.90 at May 31. Cash and cash equivalents declined to $320.6 million from $338.7 million; cash flow from operations was positive, but financing activities used $86.1 million.
Changes versus the prior comparable period
- GAAP net income fell sharply because derivative results swung from gains to losses; adjusted net income and adjusted TIER improved.
- Net interest income rose as lower funding costs more than offset lower yields on loans and other earning assets.
- Loans were nearly flat at $20.47 billion. Growth in CFC distribution and power-supply lending was largely offset by lower NCSC and RTFC balances.
- Total debt declined by $85 million from May 31, primarily due to Farmer Mac note maturities. Guarantees fell by $83 million to $981.5 million, mainly from fewer letters of credit.
- Equity declined by $17 million, mainly reflecting a $39.7 million patronage capital retirement payable, partly offset by earnings.
- CFC began classifying debt by original contractual maturity; $1.3 billion was reclassified between short- and long-term debt at May 31, with no impact on debt ratios or covenants.
Outlook, risks and unusual items
Management expects long-term loan advances to exceed scheduled repayments over the next 12 months and anticipates improved earnings from core lending, increased loan balances and lower funding costs. It expects adjusted debt-to-equity to remain below 6.00 and believes liquidity is sufficient for the next 12–18 months. Management projected $1.875 billion in long-term loan advances and $1.348 billion in long-term loan repayments over the next 12 months, and reported $1.020 billion of long-term debt maturities due in that period.
Available liquidity included $3.224 billion under bank revolvers, $624 million under Federal Financing Bank facilities, and up to $2.445 billion under the Farmer Mac agreement subject to market conditions. A further $250 million RUS commitment was received on September 22, 2014, after quarter-end. CFC said it was in compliance with revolving-credit and indenture covenants at August 31 and expected to continue rolling over short-term debt.
Key risks include access to capital markets and refinancing, interest-rate and derivative fair-value volatility, borrower credit quality, counterparty performance and potential funding needs under guarantees and credit commitments. Derivative agreements had rating triggers: a qualifying downgrade could permit termination and imply a net payment of about $151.6 million under the disclosed trigger scenario. CFC also provided liquidity support for $520 million of variable-rate tax-exempt bonds, without needing to fund any purchases during the quarter. One nonperforming borrower was seeking a buyer, and management expected sale proceeds might not repay the debt in full.
Management identified loan-loss allowance and fair-value estimates as critical accounting judgments and reported no significant methodology changes. The filing disclosed ongoing claims related to the Innovative Communication Corporation bankruptcy; management said it did not expect legal proceedings to materially harm the company and had recorded no legal reserve. CFC’s forward-looking statements are subject to economic, legislative, funding, credit, market and counterparty risks.
Most important facts for investors to verify
- Whether derivative fair-value volatility obscures underlying lending performance; compare GAAP earnings with adjusted results and review the non-GAAP reconciliations.
- Whether the $49.7 million loan-loss allowance remains adequate, particularly given the borrower sale with expected repayment shortfall.
- Whether liquidity facilities, commercial-paper rollover and capital-market access remain available as debt matures and loan commitments are drawn.
- Whether CFC maintains covenant compliance and keeps adjusted debt-to-equity below its 6.00 target.
- Whether guarantee, letter-of-credit and derivative-trigger exposures change materially, including the potential cash demands described in the filing.