NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP quarterly report, Q3 FY2013

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 quarter and nine months ended February 28, 2013; comparisons are to the periods ended February 29, 2012. Amounts below are in millions of dollars unless noted. The consolidated statements include RTFC, NCSC and certain controlled entities.

Financial performance and position

Adjusted measures are non-GAAP measures defined by CFC and used for management analysis and debt-covenant compliance. GAAP TIER was 1.52 for the quarter and 1.31 for the nine months; prior-year periods had losses and TIER below 1.00. Nine-month adjusted net interest income was $149.0, up from $135.7; adjusted net yield was 0.89% versus 0.76%.

At February 28, 2013, total assets were $21.50 billion, versus $19.95 billion at May 31, 2012. Loans outstanding were $19.48 billion, up $566 million (3%). Cash and cash equivalents were $789 million and investments were $482 million. Short-term debt was $6.95 billion and long-term debt was $11.13 billion; total debt outstanding as presented in MD&A, including members’ subordinated certificates and related instruments, was $20.01 billion. Total equity was $617 million. GAAP debt-to-equity was 33.84:1; adjusted debt-to-equity was 6.31:1, compared with 6.01:1 at fiscal year-end.

The allowance for loan losses was $148.4 million, or 0.76% of loans. Non-performing loans were $41.8 million (0.21% of loans); criticized loans were $48.7 million. Restructured loans declined to $39.5 million from $455.7 million after a $414 million loan payoff in September 2012. Investing cash flow was a use of $1.03 billion, mainly reflecting net loan advances and investment purchases; financing cash flow provided $1.42 billion.

Material changes versus prior periods

• Nine-month GAAP net income improved to $160.4 million from a $148.0 million loss. A major driver was the swing in derivative gains and foreclosed-asset results; the prior-year period included a $45 million foreclosed-asset impairment and $62 million total foreclosed-asset loss.
• Net interest income increased $56.9 million for the nine months, primarily because refinancing higher-cost debt reduced funding costs. Interest expense fell 11%, despite higher average debt, while interest income declined 1% as lower loan yields offset loan growth.
• Adjusted net income increased to $100.6 million from $33.4 million. Management cited improved foreclosed-asset results, a $13 million prepayment fee, higher fee income and higher adjusted net interest income, partly offset by a $17 million year-over-year increase in the loan-loss provision.
• Total debt increased $1.46 billion, supporting loan growth and a $1.02 billion increase in cash and investments. Short-term funding represented 20% of total debt, versus 17% at May 31, 2012.
• Unsecured credit exposure rose to $2.40 billion, or 12% of total exposure, from $2.04 billion, or 10%. Total guarantees declined to $1.12 billion from $1.25 billion.

Outlook, risks and unusual items

• Management expected lending activity to remain elevated through fiscal year-end, with long-term advances exceeding repayments over the next 12 months. It forecast approximately $2.22 billion of long-term loan advances and $1.37 billion of loan repayments, and anticipated a small increase in core earnings.
• Management expected to refinance $3.04 billion of long-term debt maturing within 12 months and roll over $3.91 billion of short-term funding. It believed available liquidity would fund operations for 12–18 months and expected adjusted debt-to-equity to remain within its target range of 6.00:1; the reported ratio was 6.31:1 at period-end.
• Available liquidity at February 28 included $1.27 billion of cash and investments, $2.84 billion under bank revolving facilities, up to $749 million under Federal Financing Bank facilities, and up to $2.60 billion under a Federal Agricultural Mortgage Corporation facility, subject to market conditions. The bank facilities were undrawn, and CFC reported covenant compliance.
• After period-end, CFC amended its revolving credit agreements on March 28, extending facility maturities and increasing certain commitments. On March 1, it redeemed $300 million of collateral trust bonds at a premium; a $5 million loss was expected in the fourth quarter. It also reported loans outstanding of $20.13 billion at March 31, up $649 million from February 28.
• Unusual items included a voluntary $13 million pension-plan contribution, a $13 million loan prepayment fee, a $10 million reversal of previously accrued expenses at Caribbean Asset Holdings after renewal of a tax-credit arrangement, and a $4 million payment related to the Innovative Communication Corporation bankruptcy. The October 2012 debt exchange replaced $340 million of 8% notes with $379 million of 4.023% bonds and $134 million cash.
• Key risks include access to short-term and capital-market funding, refinancing needs, interest-rate and derivative valuation changes, derivative-counterparty exposure, borrower credit quality and collateral values, guarantees and liquidity commitments, and economic or regulatory developments affecting members. Certain swaps had rating triggers; a downgrade of one counterparty gave CFC an option to terminate swaps with $703 million notional, which would have required a $23 million payment at period-end. Management said it had not elected to terminate them.
• CFC disclosed immaterial corrections to prior cash-flow statement classifications; it stated that the corrections did not affect cash balances, liquidity, balance sheets, income statements, key ratios or covenant compliance. The filing reported no material changes to the risk factors in its latest Form 10-K.

Important facts for investors to verify

• Whether strong reported GAAP earnings persist apart from derivative fair-value gains and foreclosed-asset adjustments; compare GAAP results with adjusted net income and adjusted TIER.
• Whether loan growth, lower portfolio yields, credit ratings and borrower risk-rating trends affect future net interest income and the adequacy of the $148.4 million loan-loss allowance.
• Whether CFC can refinance near-term maturities and roll over commercial paper as assumed, including continued availability of its bank, Federal Financing Bank and Federal Agricultural Mortgage Corporation facilities.
• Potential cash needs from $14.68 billion of unadvanced loan commitments, $1.12 billion of guarantees, $599 million of bond liquidity-provider obligations and derivative rating triggers; CFC expects most unadvanced commitments will not be fully drawn.
• Progress and recoveries in the two borrower bankruptcy cases and the systems being marketed for sale; the filing notes that sale proceeds may not fully repay the related loans.