Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) filed this unaudited Form 10-Q for the quarter and six months ended November 30, 2012, its fiscal 2013 second quarter. Consolidated results include Rural Telephone Finance Cooperative (RTFC), National Cooperative Services Corporation (NCSC), and certain subsidiaries. CFC is a tax-exempt, member-owned cooperative lender; it does not issue capital stock. Amounts below are in U.S. dollars.
Key financial results and position
| Metric | Three months ended Nov. 30, 2012 | Six months ended Nov. 30, 2012 | Prior-year comparison |
|---|---|---|---|
| Interest income | $241.6 million | $481.7 million | $237.8 million and $485.0 million, respectively |
| Net interest income | $67.3 million | $130.8 million | $43.1 million and $88.3 million |
| Net income (loss) attributable to CFC | $59.4 million | $72.0 million | Losses of $26.8 million and $110.8 million |
| Adjusted net income (non-GAAP) | $48.4 million | $71.8 million | $19.5 million and $44.6 million |
| Adjusted TIER (non-GAAP) | 1.26 | 1.19 | 1.10 and 1.11 |
Six-month adjusted net interest income was $101.5 million versus $87.5 million. The filing’s adjusted measures exclude derivative fair-value changes from adjusted net income and include derivative cash settlements in adjusted interest expense; they are not GAAP measures.
At November 30, 2012, total assets were $20.61 billion, including $19.11 billion of loans outstanding before the allowance. Net loans were $18.96 billion. The allowance for loan losses was $148.7 million, or 0.78% of loans. Non-performing loans were $42.7 million (0.22% of loans); restructured loans were $39.7 million, down from $455.7 million at May 31, 2012 following a large borrower payoff.
Six-month operating cash flow was $96.4 million, compared with $56.3 million a year earlier. Investing cash flow was a use of $468.0 million, versus a source of $986.0 million; financing provided $619.6 million, versus a use of $776.3 million. Cash and cash equivalents increased $248.0 million to $439.2 million. Balance-sheet investments were $309.9 million.
Total debt outstanding was $19.21 billion, up $656 million from May 31, 2012. Balance-sheet short-term debt was $6.05 billion and long-term debt $11.20 billion. Total equity was $528.2 million. The GAAP debt-to-equity ratio was 38.02-to-1; adjusted debt-to-equity was 6.04-to-1, compared with 6.01-to-1 at May 31.
Material changes versus the prior comparable period
- Six-month GAAP net income improved from a $113.9 million loss to $72.7 million of consolidated net income. A key factor was derivative losses falling to $28.4 million from $159.3 million; derivative fair-value movements can materially affect GAAP results.
- Net interest income rose 48% for the six-month period as interest expense fell 12%, primarily reflecting lower-cost refinancing and funding mix. Interest income declined 1%, as lower loan yields more than offset loan growth.
- Adjusted net income increased to $71.8 million from $44.6 million. Contributing items included lower adjusted interest expense, a $13 million prepayment fee, and no comparable early-debt-redemption loss; a higher loan-loss provision partly offset these benefits.
- Loans outstanding grew $185 million, or about 1%, to $19.10 billion. Growth in power-supply and NCSC loans was partly offset by lower CFC distribution loans, including repayment of a $414 million restructured loan.
- Cash and investments increased, including two $250 million deposits made during the period. Total debt rose to fund loan growth and increased cash and investments.
Outlook, risks, contingencies and unusual items
Management expected long-term loan repayments to slightly exceed advances over the next 12 months and anticipated a slight increase in core earnings, citing debt-exchange savings and short-term funding. It expected to keep adjusted debt-to-equity within a 6.00-to-1 range, although the reported period-end ratio was 6.04-to-1. Management stated that available liquidity should support operations and debt maturities over the next 12–18 months.
Liquidity resources included $439 million of cash and cash equivalents, approximately $2.84 billion available under bank revolving credit agreements, up to $325 million under Federal Financing Bank facilities, and up to $2.60 billion under a Federal Agricultural Mortgage Corporation facility, subject to market conditions. Long-term debt of $2.59 billion was scheduled to mature within one year; $3.46 billion of commercial paper and other short-term instruments was scheduled to mature through May 31, 2013. Management expected to refinance or roll over these obligations. A further $424 million Federal Financing Bank facility closed in December 2012, after quarter-end.
Unadvanced loan commitments totaled $14.92 billion. The filing says most are generally subject to material-adverse-change clauses and are not expected to be fully drawn; $1.44 billion of committed line-of-credit availability was not subject to such a clause at each advance, provided borrowers complied with facility terms.
Credit risks include two non-performing borrowers in bankruptcy and two borrowers seeking buyers for their systems; management anticipated that sale proceeds might not repay the loans in full. The allowance was considered adequate by management. Derivative exposure is also material: swap notional was $9.29 billion, and a ratings-trigger termination could result in a net payment of up to $252.6 million under the disclosed trigger scenarios. A counterparty downgrade gave CFC an option to terminate swaps with $715 million notional; the disclosed settlement payment would have been $23 million, and CFC had not given notice to terminate.
Other obligations include $1.13 billion of guarantees, a separate $606 million liquidity-provider commitment for member tax-exempt bonds, and potential issuance of up to $837 million in additional letters of credit under master facilities. CFC reported compliance with revolving-credit and senior-debt covenants. Its ratings were A2 from Moody’s and A from S&P, both with stable outlook. The filing reported no material changes to the risk factors in the prior Form 10-K.
Unusual items included an October 2012 exchange of $340 million principal amount of 8% notes due 2032 for $379 million principal amount of 4.023% collateral trust bonds due 2032 plus $134 million cash; $3 million of transaction costs; a $13 million borrower prepayment fee; and a $4 million payment related to the Innovative Communication Corporation bankruptcy plan, confirmed in November 2012.
Important facts for investors to verify
- Review the drivers and repeatability of earnings improvement, separating derivative fair-value movements and the $13 million prepayment fee from core operating performance.
- Assess liquidity and refinancing assumptions against the $2.59 billion of near-term long-term debt maturities, short-term funding maturities, and dependence on continued market access.
- Monitor borrower credit developments, bankruptcy outcomes, potential recovery shortfalls from system sales, and changes in the loan-loss allowance.
- Evaluate the size and draw risk of unadvanced commitments, guarantees, letters of credit, and member-bond liquidity obligations.
- Track adjusted debt-to-equity against management’s 6.00-to-1 objective and covenant limits, and verify the effect of subsequent-period financing, including the December 2012 facility.