Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) filed this Form 10-Q for the three months ended August 31, 2019, its fiscal first quarter. CFC is a member-owned, tax-exempt cooperative lender serving rural electric utilities; consolidated results include NCSC and RTFC. Amounts below are in U.S. dollars.
Key financial results and position
- Revenue and earnings: Total revenue was $87.7 million, up 21% from $72.2 million a year earlier. Net interest income rose 12% to $76.7 million. CFC reported a net loss of $324.1 million versus net income of $48.0 million.
- Derivative impact and adjusted results: Derivative losses were $395.7 million, including $384.7 million of forward-value losses, primarily reflecting falling interest rates and the fair-value accounting treatment of swaps. Management’s non-GAAP adjusted net income was $60.6 million, versus $28.0 million. Adjusted measures exclude derivative forward-value changes and are not GAAP measures.
- Interest performance: Net interest yield increased to 1.14% from 1.04%; adjusted net interest yield rose to 0.97% from 0.85%. Adjusted TIER was 1.27, compared with 1.13; GAAP TIER was negative 0.52.
- Cash flow: Operating activities provided $99.8 million; investing activities used $343.5 million, including $382.9 million of net loan advances; financing activities provided $297.7 million. Cash, cash equivalents and restricted cash increased $54.0 million to $240.2 million.
- Loans and credit: Loans to members were $26.30 billion at August 31, up $383 million, or 1%, from May 31. No loans were delinquent or nonperforming, and there were no defaults or charge-offs in the quarter. The allowance was $17.6 million, or 0.07% of loans. Criticized loans were $198 million (0.75%); most substandard exposure related to one borrower.
- Debt, equity and liquidity: Total debt was $25.46 billion, up $303 million from May 31; total equity fell to $918 million from $1.30 billion. The reported debt-to-equity ratio rose to 29.03, while the adjusted ratio was 5.84 against management’s target of approximately 6.00 or less. Readily available liquidity was $7.09 billion, including $231 million of cash and committed facilities. Some Farmer Mac availability is subject to market conditions.
Material changes versus the prior comparable quarter
- The $372 million swing from prior-year net income to current-quarter net loss was driven principally by a $403 million change in derivative fair-value results: a $395.7 million loss this quarter versus a $7.2 million gain last year.
- Net interest income improved on higher average earning assets and a higher yield; lower-cost replacement funding after repayment of high-coupon debt also helped reduce funding costs.
- Fee and other income increased $7.0 million, mainly from higher loan prepayment fees. CFC also recorded a $7.7 million gain on a land sale; the prior-year quarter included a $7.1 million debt-extinguishment loss.
Outlook, risks and unusual items
- Management expects net interest income, adjusted net interest income, TIER and related yields to increase over the next 12 months, citing expected growth in earning assets and a lower average cost of funds. It expects adjusted debt-to-equity to remain below 6.00.
- Long-term debt maturities over the next 12 months totaled $2.22 billion. Management believes available liquidity and continued market access will support member lending and debt repayment. It also expected to roll over $3.20 billion of member short-term debt and targeted dealer commercial paper below $1.25 billion.
- On September 25, 2019, after quarter-end, CFC received a commitment letter for a $500 million RUS-guaranteed facility. It also announced redemption of $300 million of 2.30% bonds on October 15, 2019.
- Key risks include interest-rate and swap valuation volatility, reliance on external funding and member reinvestment, concentration in electric utilities (99% of loans), and derivative counterparty or rating-trigger exposure. A rating-trigger downgrade could require up to $517.5 million in net derivative payments under specified scenarios. CFC was assessing the transition from LIBOR, which was expected to be phased out after 2021.
- Off-balance-sheet exposure included $801 million of guarantees and $13.05 billion of unadvanced loan commitments; $3.00 billion of commitments were unconditional. CFC also returned $63 million of patronage capital to members in September 2019. Management reported no material change to previously disclosed risk factors and no legal-proceedings reserve.
Important facts for investors to verify
- How much of the reported GAAP loss reflects non-cash swap fair-value movements, and how adjusted results reconcile to GAAP.
- Whether the projected improvement in funding costs and earnings occurs, particularly if interest rates or the swap curve change.
- Liquidity access and refinancing capacity against near-term maturities, short-term debt rollover needs, and member loan demand.
- Credit developments in the largest substandard borrower exposure, the concentrated utility portfolio, and the adequacy of the 0.07% allowance.
- Potential cash demands from guarantees, unconditional loan commitments, derivative rating triggers, and the LIBOR transition.