Business Context and Reporting Period
Company: National Rural Utilities Cooperative Finance Corporation (CFC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: August 31, 2010
Business Overview: CFC is a tax-exempt cooperative lender providing cost-based financial products to rural electric and telecommunications members. It consolidates results with Rural Telephone Finance Cooperative (RTFC) and National Cooperative Services Corporation (NCSC). The company does not issue equity capital stock.
Key Financial Metrics
| Metric | Three Months Ended Aug 31, 2010 | Three Months Ended Aug 31, 2009 |
|---|---|---|
| Interest Income | $251.1 million | $269.5 million |
| Interest Expense | ($219.5 million) | ($242.6 million) |
| Net Interest Income | $31.5 million | $26.8 million |
| Derivative Losses | ($78.3 million) | ($14.3 million) |
| Net (Loss) Income | ($42.3 million) | $16.4 million |
| Net Loss Attributable to CFC | ($37.2 million) | $16.2 million |
| Cash and Cash Equivalents | $450.7 million | $526.5 million (Aug 31, 2009) |
| Total Assets | $20.15 billion | $20.14 billion (May 31, 2010) |
| Total Debt Outstanding | $18.54 billion | $18.78 billion (May 31, 2010) |
| Loans to Members, Net | $18.72 billion | $18.75 billion (May 31, 2010) |
| Allowance for Loan Losses | $580.5 million | $592.8 million (May 31, 2010) |
Material Changes vs. Prior Period
- Net Loss vs. Net Income: The company reported a net loss of $42.3 million for the quarter ended August 31, 2010, compared to net income of $16.4 million in the same period in 2009. This reversal was primarily driven by a $64 million increase in derivative losses.
- Derivative Valuation: Derivative losses increased significantly to $78.3 million (from $14.3 million) due to a $73.8 million decrease in the fair value of interest rate swaps (derivative forward value) caused by a shift in the interest rate curve.
- Loan Portfolio: Total loans outstanding decreased by $48 million to $19.29 billion, driven by a $204 million prepayment of telecommunications loans and anticipated repayments of power supply bridge loans.
- Interest Expense: Interest expense decreased by 10% ($23.1 million) compared to the prior year, primarily due to a reduction in the average volume of medium-term notes and a lower overall cost of debt.
- Equity: Total equity decreased by $94 million to $492.8 million, reflecting the net loss, a $51 million patronage capital retirement payable, and a decrease in accumulated other comprehensive income.
Guidance, Outlook, and Risks
- Outlook: Management expects increased demand for loan advances to refinance debt from other lenders in the second quarter of fiscal year 2011. They anticipate issuing additional debt to fund these advances and meet maturities.
- Adjusted Metrics: While GAAP net income was negative, Adjusted Net Income (excluding derivative forward value effects) was $31.4 million. The Adjusted TIER (Times Interest Earned Ratio) was 1.14, meeting the company's internal target of 1.10, whereas the GAAP TIER was below 1.00.
- Liquidity: The company maintains $3.35 billion in available revolving credit agreements and expects sufficient liquidity to fund operations for the next 12 to 18 months. Commercial paper utilization increased to take advantage of low interest rates.
- Non-Performing Loans: Non-performing and restructured loans totaled $1.06 billion (5.50% of total loans). Significant exposure remains to Innovative Communication Corporation (ICC) ($538 million) and CoServ Electric ($455 million restructured, on non-accrual). ICC assets in the U.S. Virgin Islands were transferred to CFC in October 2010 as partial loan satisfaction.
- Rating Triggers: The company has derivative instruments with rating triggers. If senior unsecured ratings fall below specified levels (Baa1/BBB+), net payments of up to $135.5 million could be required. As of August 31, 2010, ratings were A2 (Moody's) and A (S&P).
Investor Verification Checklist
- Derivative Exposure: Verify the impact of interest rate curve shifts on future earnings, as non-cash derivative valuation changes significantly distort GAAP net income.
- ICC Resolution: Monitor the final valuation and write-off amounts related to the Innovative Communication Corporation (ICC) asset transfer completed in October 2010.
- CoServ Status: Track the performance of the $455 million restructured loan to CoServ Electric, which remains on non-accrual status.
- Debt Maturities: Review the schedule of $1.87 billion in long-term debt maturing within one year and the company's ability to refinance at favorable rates.
- Adjusted vs. GAAP: Distinguish between GAAP results (impacted by mark-to-market derivatives) and Adjusted results (management's primary performance metric) when assessing operational health.