Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) filed this unaudited Form 10-Q for the quarter ended August 31, 2018, its first fiscal quarter of 2019. CFC is a member-owned cooperative lender serving rural electric utilities, with financing also provided through consolidated affiliates NCSC and RTFC. Its objective is to provide cost-based financing while maintaining a sound financial position, rather than maximizing profit.
Financial results and condition
Amounts below are in U.S. dollars; financial results compare the three months ended August 31, 2018 and 2017. Balance-sheet amounts compare August 31, 2018 with May 31, 2018.
| Metric | 2018 Q1 / August 31 | Comparable / prior date |
|---|---|---|
| Interest income | $278.5 million | $265.9 million |
| Interest expense | $210.2 million | $192.7 million |
| Net interest income | $68.3 million | $73.2 million |
| Total revenue | $71.4 million | $77.1 million |
| Net income | $48.0 million | $9.0 million |
| Adjusted net income (non-GAAP) | $28.0 million | $35.0 million |
| Net interest yield / adjusted yield | 1.04% / 0.85% | 1.16% / 0.84% |
| TIER / adjusted TIER | 1.23 / 1.13 | 1.05 / 1.16 |
| Loans to members | $25.18 billion | $25.18 billion |
| Total debt outstanding | $24.59 billion | $24.63 billion |
| Total assets / total equity | $26.68 billion / $1.51 billion | $26.69 billion / $1.51 billion |
| Cash, cash equivalents and restricted cash | $274.5 million | $238.8 million |
Operating cash flow was $81.7 million, compared with $88.0 million a year earlier. Investing activities provided $58.5 million, versus using $178.1 million; financing activities used $104.5 million, versus providing $194.4 million. Cash, cash equivalents and restricted cash increased $35.7 million during the quarter.
Available liquidity was reported at $7.30 billion, including $266 million cash, $3.08 billion available under bank revolvers, $1.23 billion under the Guaranteed Underwriter Program, and Farmer Mac facilities. The $2.42 billion available under one Farmer Mac facility is subject to market conditions. The company reported a GAAP debt-to-equity ratio of 16.71 and an adjusted ratio of 6.21.
Material changes versus the prior comparable period
- Net income increased $39 million, mainly because derivative results swung from a $46.2 million loss to a $7.2 million gain. The $53 million favorable change largely reflects non-cash fair-value movements and should not be read as an equivalent improvement in underlying operating performance.
- Adjusted net income fell $7 million. A $7.1 million loss on early debt extinguishment and higher operating expenses more than offset a $2.5 million increase in adjusted net interest income.
- Net interest income declined $4.9 million as the net interest yield fell 12 basis points, largely due to higher funding costs as short-term rates rose. Average interest-earning assets increased 4% to $26.01 billion.
- Loans and total debt were nearly unchanged from May 31. Member investments increased to $4.63 billion, or 19% of total debt, from $4.41 billion, or 18%.
- Operating expenses were $30.7 million versus $22.2 million, including the $7.1 million debt-redemption loss. CFC redeemed $300 million of 10.375% bonds in July, leaving $700 million outstanding.
- Equity was essentially flat: $48 million reported net income was offset by approximately $48 million of patronage capital returned to members.
Outlook, commentary, risks and unusual items
- Management expects net interest income, adjusted net interest income, net income, adjusted net income, TIER and net interest yields to increase over the next 12 months, primarily due to a projected decrease in average funding costs. This is a forecast, not a guarantee.
- Long-term debt of $2.82 billion was scheduled to mature over the next 12 months. Management expects to refinance higher-cost debt with lower-cost funding. The filing also cites $880 million of higher-cost collateral trust bonds scheduled to mature November 1, 2018; $300 million had already been redeemed, leaving $700 million outstanding at quarter-end.
- Management expects adjusted debt-to-equity to move closer to its approximately 6.00 target over the next 12 months, supported by earnings; the quarter-end ratio was 6.21.
- Credit indicators were strong: no delinquent or nonperforming loans, defaults or charge-offs at quarter-end. The allowance was $18.7 million, or 0.07% of loans. However, $186 million of loans (0.7%) were classified as criticized, including $179 million as substandard. A financially challenged electric cooperative and its subsidiary accounted for $173 million of substandard loans; payments were current and management expected full collection.
- Credit exposure is concentrated by industry: approximately 99% of loans were to electric utility organizations. Guarantees totaled $776.7 million, materially above the $9.9 million recorded guarantee liability; CFC also provided liquidity support for $249 million of member tax-exempt bonds.
- Interest-rate risk is material. CFC uses swaps, generally without hedge accounting, so fair-value changes affect reported earnings and can create volatility. Adjusted measures include derivative cash settlements but exclude unrealized forward-value changes. Short-term and variable-rate funding costs increased during the period.
- Unadvanced loan commitments totaled $12.91 billion, including $2.95 billion of unconditional lines of credit. Management noted historically low utilization of line commitments, but most long-term commitments are expected to be drawn. Liquidity and funding depend in part on continued market access, member reinvestment, credit ratings and compliance with covenants.
- The board authorized a $95 million fiscal 2018 patronage allocation and retirement of 50%, returned to members in August. Future retirements depend on CFC’s financial condition and board decisions. CFC reported compliance with its debt covenants and stable credit-rating outlooks.
- Accounting changes effective June 1, 2018 moved unrealized equity-security gains and losses from other comprehensive income to earnings; adoption increased retained earnings by $9 million. Management reported no material change in critical accounting estimates. It reported no material change in risk factors from its 2018 Form 10-K, and no legal-proceeding reserve was recorded.
Important facts for investors to verify
- Whether projected funding-cost reductions and refinancing of maturing debt occur as expected, including repayment of the remaining $700 million high-coupon bonds.
- How adjusted net interest income and adjusted TIER develop relative to GAAP results; these are non-GAAP measures and depend on management’s adjustments.
- Whether the $173 million substandard borrower exposure and the broader concentrated electric-utility portfolio remain current and recoverable.
- Actual draw rates on the $12.91 billion of loan commitments and ongoing availability of market-dependent Farmer Mac funding and other liquidity sources.
- Effects of interest-rate and swap-curve movements on funding costs, derivative valuations, reported earnings and potential rating-trigger payments.
- Future patronage allocations and retirements, and progress toward the adjusted debt-to-equity target of approximately 6.00.