Business Context and Reporting Period
Company: National Rural Utilities Cooperative Finance Corporation (National Rural)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: February 28, 2009
Business Overview: National Rural is a private, not-for-profit cooperative association providing financing to rural electric and telecommunications utility 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 Feb 28, 2009 | Nine Months Ended Feb 28, 2009 | Nine Months Ended Feb 29, 2008 |
|---|---|---|---|
| Interest Income | $271.4 million | $807.0 million | $797.8 million |
| Interest Expense | $(240.1) million | $(694.6) million | $(720.8) million |
| Net Interest Income | $31.3 million | $112.3 million | $77.0 million |
| Provision for (Recovery of) Loan Losses | $10.4 million (Recovery) | $(126.6) million (Provision) | $47.9 million (Recovery) |
| Net Income (Loss) | $75.2 million | $(139.9) million | $(41.9) million |
| Total Assets | $20.9 billion | $20.9 billion | $19.4 billion (May 31, 2008) |
| Total Debt Outstanding | $19.5 billion | $19.5 billion | $18.2 billion (May 31, 2008) |
| Total Equity | $439.3 million | $439.3 million | $666.0 million (May 31, 2008) |
| Cash and Cash Equivalents | $453.1 million | $453.1 million | $177.8 million (May 31, 2008) |
Material Changes vs. Prior Period
- Net Loss Increase: The nine-month net loss increased to $139.9 million from $41.9 million in the prior year. This was primarily driven by a $174.5 million swing in loan loss provisions (from a $47.9 million recovery to a $126.6 million provision) and a $30.2 million increase in derivative forward value expenses.
- Loan Loss Provision: The significant increase in the provision for loan losses was attributed to the deterioration in the market value of collateral supporting impaired loans, specifically related to Innovative Communication Corporation (ICC), due to tight credit markets and reduced consumer spending.
- Derivative Activity: Non-interest income increased significantly due to $116.9 million in derivative cash settlements (vs. $30.3 million prior year), largely from the termination of interest rate swaps. However, this was offset by a $203.5 million charge to derivative forward value.
- Equity Decline: Total equity decreased by $226.7 million from May 31, 2008, due to the net loss and the retirement of $85 million in patronage capital.
- Loan Portfolio Growth: Total loans outstanding increased by $1.14 billion (6%) to $20.17 billion, driven by growth in power supply and distribution loans.
Guidance, Outlook, Risks, and Unusual Items
- Liquidity and Funding: The company navigated significant capital market disruptions following the Lehman Brothers bankruptcy. It successfully issued $3.5 billion in new long-term debt to replace maturing obligations. Commercial paper markets stabilized, and the company utilized the Federal Reserve's Commercial Paper Funding Facility (CPFF) in the prior quarter but did not use it in the current quarter.
- Lehman Brothers Exposure: National Rural terminated interest rate swaps with Lehman Brothers Special Financing (LBSF). While a $26 million claim exists, the receivable was reduced to $7 million based on market recovery estimates. Additionally, $239 million of revolving credit commitments from Lehman Brothers Bank are considered unavailable.
- Major Restructured/Non-Performing Loans:
- Innovative Communication Corporation (ICC): $492 million in non-performing loans. RTFC is pursuing a $250 million credit bid for ICC assets in bankruptcy proceedings.
- CoServ Electric: $498 million in restructured loans on non-accrual status since 2001, with a scheduled repayment plan through 2037.
- Adjusted Metrics: Management utilizes "Adjusted TIER" (Times Interest Earned Ratio) and "Adjusted Net Income" to exclude non-cash derivative effects. For the nine months ended Feb 28, 2009, Adjusted Net Income was $60.4 million with an Adjusted TIER of 1.10.
- Rating Triggers: The company has derivative instruments with rating triggers. If credit ratings fall below specific thresholds (e.g., BBB+), the company could be required to post $25 million in collateral and make termination payments totaling $183 million.
Investor Verification Checklist
- Loan Loss Adequacy: Verify the sufficiency of the $638.6 million allowance for loan losses given the $1.04 billion in non-performing and restructured loans, particularly the exposure to ICC.
- Derivative Valuation: Review the impact of the $203.5 million derivative forward value charge and the offsetting $116.9 million cash settlement on reported earnings versus economic reality.
- Liquidity Position: Confirm the availability of the $3.0 billion in revolving credit facilities, noting the exclusion of the $239 million Lehman Brothers portion.
- Debt Maturity Wall: Assess the refinancing risk for the $2.35 billion of long-term debt maturing within the next 12 months.
- NCSC Equity Absorption: Note that National Rural absorbed an $8.1 million excess loss from its subsidiary NCSC, eliminating NCSC's minority interest equity.