Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) is a tax-exempt, member-owned cooperative lender serving rural electric and telecommunications systems. This unaudited Form 10-Q covers the three months ended August 31, 2013 (fiscal first quarter 2014); comparisons are with the three months ended August 31, 2012 unless otherwise noted. Consolidated results include RTFC, NCSC and certain controlled entities.
Financial performance and position
| Metric | Quarter ended August 31, 2013 | Prior-year quarter / comparator |
|---|---|---|
| Interest income | $241.1 million | $240.1 million |
| Interest expense | $167.6 million | $176.6 million |
| Net interest income | $73.5 million | $63.5 million |
| Provision for loan losses | $1.3 million | $9.1 million |
| Net income | $158.3 million | $12.6 million |
| Net income attributable to CFC | $155.5 million | $12.6 million |
| Adjusted net income (non-GAAP) | $35.2 million | $23.4 million |
| Operating cash flow | $137.1 million | $133.8 million |
| Loans outstanding, August 31, 2013 | $20.4 billion | $20.3 billion at May 31, 2013 |
| Total assets, August 31, 2013 | $22.4 billion | $22.1 billion at May 31, 2013 |
| Total liabilities, August 31, 2013 | $21.5 billion | $21.3 billion at May 31, 2013 |
| Total equity, August 31, 2013 | $925.5 million | $811.3 million at May 31, 2013 |
Profitability and margins: Reported TIER was 1.94 versus 1.07. Adjusted TIER, which excludes derivative forward-value effects and includes derivative cash settlements in interest expense, was 1.19 versus 1.12; CFC’s stated annual minimum adjusted TIER goal is 1.10. Adjusted net interest income increased to $56.8 million from $49.6 million, and adjusted net yield was 0.99% versus 0.83%.
Cash flow and liquidity: Cash and cash equivalents rose to $362.5 million from $177.1 million at May 31, 2013. Operating cash flow was $137.1 million; investing activities used $114.0 million and financing activities provided $162.4 million. Management reported $1.09 billion of cash, investments and time deposits, $3.34 billion available under revolving bank lines, up to $424 million available under Federal Financing Bank facilities, and up to $2.36 billion available under a Federal Agricultural Mortgage Corporation facility, subject to market conditions.
Debt and capital: Total debt outstanding was $20.71 billion, up $166 million from May 31, 2013; balance-sheet short- and long-term debt were $6.90 billion and $11.68 billion, respectively. Long-term debt of $2.45 billion was scheduled to mature within 12 months. The GAAP debt-to-equity ratio was 23.21-to-1, down from 26.21-to-1; the adjusted ratio was 5.88-to-1, up from 5.76-to-1. CFC was in compliance with its revolving credit agreement covenants; the adjusted senior-debt-to-equity covenant measure was 5.79 versus a 10.00 maximum.
Material changes versus the prior comparable period
- Net income increased sharply, chiefly because derivative gains were $106.4 million compared with derivative losses of $24.6 million a year earlier. The 2013 result included a $123.1 million non-cash derivative forward-value gain; adjusted net income, excluding that forward-value effect, increased by $11.8 million.
- Net interest income rose $10.0 million as interest expense fell $9.0 million while interest income was nearly flat. Management attributed lower funding costs to refinancing higher-cost debt and greater use of lower-cost funding. The average cost of debt declined to 3.17% from 3.66%.
- The loan-loss provision declined to $1.3 million from $9.1 million. Loans grew $109 million during the quarter, mainly in CFC distribution and power-supply lending, partly offset by lower RTFC and NCSC balances.
- Cash increased by $185.5 million. Total debt rose by $166.3 million, while short-term debt on the balance sheet declined by $816.8 million as classification and maturities shifted between short- and long-term debt.
- Non-performing loans were $15.3 million, or 0.07% of loans, versus $15.5 million at May 31, 2013. Restructured loans fell to $7.6 million from $47.0 million, primarily after a $39 million loan was refinanced without concession and treated as performing.
Outlook, risks, contingencies and unusual items
- Management expects scheduled long-term loan repayments to slightly exceed new long-term advances over the next 12 months and core lending earnings to remain fairly stable. It expects to maintain adjusted debt-to-equity below 6.00-to-1 and believes liquidity will be sufficient for operations and maturities over the next 12–18 months.
- Management estimates approximately $1.07 billion of long-term loan advances and $1.27 billion of long-term loan repayments over the next 12 months. It expects to roll over $4.45 billion of short-term funding maturities, relying in part on continued access to commercial-paper and other debt markets.
- Unadvanced loan commitments totaled $13.72 billion. About $1.75 billion related to committed lines not subject to a material-adverse-change clause at each advance, although advances remain subject to borrower compliance. Management says utilization has historically been low and commitments should not be equated with expected funding needs.
- Credit exposures include non-performing borrowers: one is in bankruptcy proceedings; another is contesting a requirement to repay state universal-service-fund payments; and two are seeking buyers for their systems, with expected sale proceeds potentially insufficient to repay the full amounts owed. Management believes the $55.7 million loan-loss allowance is adequate.
- Foreclosed assets were $261.0 million, primarily associated with telecommunications operations and land development; their quarterly operating results reduced income by $4.0 million. The filing identifies estimates of foreclosed-asset values and derivative fair values, as well as the loan-loss allowance, as significant judgment areas.
- Guarantees totaled $1.08 billion. CFC also provided liquidity support for $595 million of member variable-rate tax-exempt bonds; it was not required to purchase tendered bonds during the quarter. A further $179 million of letters of credit could be issued under master facilities, and hybrid facilities could be used for letters of credit or loan advances.
- Interest-rate swaps had $8.30 billion notional value. Derivative fair-value changes are volatile and, as none qualified for hedge accounting, flowed through earnings. Rating-trigger provisions could require termination payments; the filing estimates a net $61.5 million payment under specified rating-trigger scenarios. A counterparty downgrade gave CFC an option to terminate $495 million notional swaps, estimated to require a $17 million payment; CFC had not elected to terminate them.
- The filing corrected immaterial prior-period cash-flow classification errors for the three months ended August 31, 2012. It states that the corrections did not affect cash, liquidity, the balance sheet, earnings, key ratios or covenant compliance. Disclosure controls were assessed as effective, and management reported no material change in internal control over financial reporting.
Important facts for investors to verify
- How much of reported earnings reflects recurring lending operations versus derivative fair-value movements; review adjusted net income and adjusted TIER reconciliations.
- Whether CFC can refinance or roll over the $2.45 billion of near-term long-term maturities and $4.45 billion of short-term funding maturities under changing market conditions.
- Developments in the bankruptcy, disputed payment and potential system-sale situations involving non-performing borrowers, and any resulting recovery shortfalls or allowance changes.
- Actual utilization of unadvanced commitments and exposure under guarantees, letters of credit and member-bond liquidity facilities.
- Changes in adjusted leverage, covenant headroom, credit ratings and derivative counterparties’ credit quality, including any consequences of rating triggers.
- Whether future patronage allocations and retirements remain consistent with capital and liquidity needs; the board authorized a $41 million cash retirement paid October 1, 2013.