NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP quarterly report, Q2 FY2014

Full document

National Rural Utilities Cooperative Finance Corporation (CFC) — Form 10-Q

Reporting period: Quarter and six months ended November 30, 2013; comparisons are with the corresponding 2012 periods. CFC is a tax-exempt, member-owned cooperative lender serving rural electric and telecommunications systems. The consolidated results include RTFC, NCSC and certain controlled entities. Amounts below are in U.S. dollars.

Financial results and position

  • Quarter: Interest income was $239.3 million, down $2.4 million year over year. Net interest income rose to $73.9 million from $67.3 million. Net income was $25.0 million versus $60.1 million; income attributable to CFC was $24.9 million versus $59.4 million.
  • Six months: Interest income was $480.3 million versus $481.7 million; net interest income increased to $147.4 million from $130.8 million. Net income was $183.3 million versus $72.7 million, and income attributable to CFC was $180.5 million versus $72.0 million.
  • Adjusted results (non-GAAP): Six-month adjusted net income was $71.5 million versus $71.8 million, and adjusted TIER was 1.19 in both periods. Quarter adjusted net income was $36.3 million versus $48.4 million; adjusted TIER was 1.20 versus 1.26. Management’s annual minimum adjusted TIER objective is 1.10.
  • Key drivers and margins: Six-month interest expense fell to $332.9 million from $350.9 million as lower-cost debt refinancing reduced funding costs, lifting net interest income despite lower loan yields. Average loan yield was 4.63% versus 4.95%; average debt cost was 3.16% versus 3.62%. Six-month derivative gains were $75.6 million, including a $111.8 million non-cash forward-value gain; the comparable period had a $28.4 million derivative loss. These fair-value movements materially affect GAAP earnings.
  • Balance sheet at November 30: Total assets were $22.43 billion, including $20.33 billion of net member loans. Total liabilities were $21.48 billion and total equity was $948.7 million. Total debt outstanding was $20.81 billion, up $267 million from May 31; cash and cash equivalents were $301.4 million. Cash, investments and time deposits together were $1.13 billion.
  • Cash flow, six months: Operating activities provided $94.6 million; investing activities used $187.7 million; financing activities provided $217.5 million. Cash increased $124.3 million to $301.4 million.
  • Credit quality: Loans outstanding increased $82 million, or 0.4%, to $20.38 billion. The allowance for loan losses was $55.2 million, or 0.27% of loans. Non-performing loans were $10.8 million (0.05% of loans), down from $15.5 million at May 31; restructured loans were $7.6 million, down from $47.0 million. Management considered the allowance adequate.

Material changes and developments

  • Six-month GAAP earnings rose sharply, primarily reflecting the derivative fair-value swing; adjusted net income was nearly unchanged year over year. For the quarter, GAAP and adjusted earnings both declined.
  • Debt increased as CFC funded loan growth and higher cash and time-deposit balances. Long-term debt rose to $12.31 billion while short-term debt, including debt due within one year, fell to $6.47 billion from $7.72 billion at May 31.
  • CFC issued $400 million of collateral trust bonds due 2020 at 2.35% in June and $400 million due 2023 at 3.40% in November. It also issued $325 million under the Federal Financing Bank/RUS program and obtained a further $500 million RUS-guaranteed commitment. On December 16, 2013, after quarter-end, CFC redeemed $150 million of 4.75% bonds due March 2014.
  • Revolving bank facilities totaled $3.345 billion; three facilities were amended in October to extend maturities to 2016, 2017 and 2018. CFC reported compliance with debt covenants and no borrowings under these facilities.
  • The Board authorized retirement of $41 million of patronage capital, paid to members in October. CFC also began calling $86 million of 7.5% member capital securities, with call dates through February 2014.

Outlook, risks and contingencies

  • Management expects core lending earnings to remain fairly stable over the next 12 months and scheduled long-term loan repayments to slightly exceed new long-term advances. It estimates approximately $1.074 billion of advances and $1.184 billion of long-term repayments over that period.
  • CFC expects to meet funding needs through loan repayments, capital-market and member debt issuance, and committed facilities. At November 30, available sources included $3.343 billion of bank revolvers, up to $924 million under Federal Financing Bank commitments, and up to $2.371 billion under a Federal Agricultural Mortgage Corporation facility, subject to market conditions. Management expects to maintain adjusted debt-to-equity below 6.00-to-1; the reported adjusted ratio was 5.82-to-1.
  • Short-term funding remains significant: $4.258 billion of short-term debt and $2.209 billion of long-term debt were scheduled to mature within 12 months. CFC depends on continued access to commercial-paper and other funding markets and on its ability to refinance maturing obligations.
  • Unadvanced loan commitments totaled $14.02 billion, including $1.95 billion of committed lines not subject to a material-adverse-change clause at each advance. Management says commitments are historically used at low rates and should not be treated as equivalent to expected cash outflows.
  • Guarantees outstanding were $1.09 billion. CFC also provided liquidity support for $578 million of member variable-rate tax-exempt bonds; it was not required to purchase bonds under these arrangements during the six months. Credit risks include a borrower in bankruptcy, a borrower contesting repayment of state Universal Service Fund payments, and another borrower whose expected business sale may not repay its debt in full.
  • Derivative contracts had $8.37 billion of notional value. Rating-trigger provisions could require net termination payments; the filing estimates a $74.3 million net payment under specified downgrade scenarios. CFC also reported that two counterparties were below contractual trigger levels; terminating those swaps would require an estimated $25 million payment. Management reported stable CFC ratings of A2 and A.
  • The filing identifies risks from economic and regulatory changes, member loan demand and credit quality, access to external financing, ratings, collateral valuations, foreclosed assets, derivative counterparties, and legal or governmental proceedings. It reports no material changes to the risk factors in the May 31, 2013 Form 10-K. Management stated that disclosure controls were effective.

Investor verification priorities

  1. Reconcile GAAP earnings to adjusted net income and assess how much reported profit depends on non-cash derivative valuations versus core lending performance.
  2. Review short-term debt refinancing needs, commercial-paper market access, facility availability and covenant headroom, including the effect of the post-quarter bond redemption.
  3. Assess loan portfolio quality, the adequacy and assumptions behind the $55.2 million allowance, and developments in the identified distressed borrowers.
  4. Evaluate potential funding exposure from $14.02 billion of unadvanced commitments, $1.09 billion of guarantees and $578 million of liquidity obligations.
  5. Monitor derivative counterparty credit, rating-trigger exposures and CFC’s ability to maintain its stated adjusted TIER and debt-to-equity objectives.