Business Context and Reporting Period
National Rural Utilities Cooperative Finance Corporation (CFC) is a member-owned, tax-exempt cooperative lender serving primarily rural electric utilities. It also provides member guarantees and letters of credit. The filing covers the three months ended August 31, 2017, CFC’s first fiscal quarter of 2018, and compares results with the three months ended August 31, 2016. Balance-sheet comparisons are with May 31, 2017.
Financial Performance and Position
| Metric | Quarter / period-end value | Comparison |
|---|---|---|
| Interest income; interest expense | $265.9 million; $192.7 million | Up 4%; up 6% year over year |
| Net interest income; net interest yield | $73.2 million; 1.16% | Down 3%; yield down 10 basis points |
| Net income (loss), consolidated | $9.0 million | Compared with a $132.3 million loss |
| Adjusted net income; adjusted TIER | $35.0 million; 1.16 | Adjusted income was $32.6 million; adjusted TIER was 1.16 |
| Operating cash flow | $88.0 million | Compared with $100.6 million |
| Loans to members | $24.64 billion | Up $275 million, or 1%, since May 31 |
| Total assets; total equity | $25.48 billion; $1.06 billion | Assets up 1%; equity down $37 million since May 31 |
| Total debt outstanding | $23.66 billion | Up $204 million, or 1%, since May 31 |
| Cash, investments and time deposits | $487.4 million | Near the May 31 level |
Reported net interest income after the loan-loss benefit was $73.5 million. Net interest yield was pressured by higher funding costs as short-term rates rose. Adjusted net interest income, which includes derivative cash settlements, was $53.0 million, up 1%, and adjusted net interest yield was 0.84%, down 2 basis points. Adjusted measures are non-GAAP and are not substitutes for GAAP results.
Cash and cash equivalents increased to $270.0 million. Cash flows were $88.0 million provided by operations, $179.0 million used in investing and $194.4 million provided by financing; cash and cash equivalents rose $103.4 million during the quarter. The allowance for loan losses was $37.1 million, or 0.15% of loans. CFC reported no past-due or nonperforming loans and no charge-offs in the quarter.
GAAP debt-to-equity was 23.00-to-1 and adjusted debt-to-equity was 6.05-to-1 at quarter-end, versus 21.94-to-1 and 5.95-to-1, respectively, at May 31. CFC’s stated targets are adjusted TIER of at least 1.10 and adjusted debt-to-equity of approximately 6.00-to-1 or below. Total guarantees were $824 million. Unadvanced loan commitments totaled $12.76 billion; $2.79 billion was unconditional, while most commitments were subject to material-adverse-change clauses.
Material Changes Versus the Prior Comparable Quarter
- Net income improved by about $141 million, principally because derivative losses fell to $46.2 million from $188.3 million. The current-period derivative losses included $26.0 million of forward-value losses and $20.2 million of cash-settlement expense; the forward-value component is mark-to-market and can make GAAP earnings volatile.
- Net interest income declined $2.6 million as the net interest yield narrowed, partly offset by growth in average interest-earning assets. Adjusted net income rose $2.3 million, mainly reflecting a more favorable loan-loss provision and lower foreclosed-asset charges, partly offset by higher operating expenses.
- Loans grew $275 million from fiscal year-end, driven mainly by distribution lending and member advances for capital projects and refinancing. Long-term debt increased, while dealer commercial paper outstanding declined.
- Equity fell primarily because the board authorized a $45 million patronage-capital retirement; cash payment to members occurred in September 2017.
Outlook, Commentary, Risks and Unusual Items
Management expects long-term loan advances to exceed repayments over the next 12 months and net interest income and adjusted net interest income to remain relatively flat, assuming modest loan growth and broadly stable yields. It projects approximately $237 million more long-term advances than repayments over that period. Long-term debt maturities over the next 12 months were $1.45 billion.
Management reported $6.48 billion of available liquidity reserves, including cash and time deposits, committed bank lines, Guaranteed Underwriter Program capacity and Farmer Mac facilities. Availability of some Farmer Mac capacity is subject to market conditions. CFC also received an RUS commitment for a further $750 million facility; access was expected to increase after closing. Management expects to maintain dealer commercial paper below $1.25 billion and adjusted debt-to-equity near 6.00-to-1, and said it expects to remain in compliance with financing covenants. CFC reported covenant compliance at quarter-end.
Key risks include access to external funding and debt-market conditions, interest-rate and yield-curve movements, derivative counterparty performance, credit quality and the concentrated rural-electric borrower base. About 99% of loans were to electric utilities; Texas represented approximately 15% of loans. Derivatives are not designated for hedge accounting, so fair-value movements affect reported earnings. A downgrade could trigger derivative termination payments; the filing estimates net payments of $263.9 million under specified rating-trigger scenarios.
After quarter-end, the purchaser of previously sold Caribbean Asset Holdings asserted potential indemnification claims and sought payment from a $16 million escrow. CFC was evaluating whether the claims were covered and what, if anything, would be payable. The filing reports no reserve for ordinary-course legal proceedings and no material changes to previously disclosed risk factors. Management said disclosure controls were effective and reported no material change in internal control over financial reporting.
Accounting developments include the future expected-credit-loss standard, effective for CFC beginning June 1, 2020; management said the adoption impact will depend on the portfolio at that date. CFC also disclosed an $11 million unrealized gain in accumulated other comprehensive income on Farmer Mac equity investments; the eventual effect of the applicable accounting change will depend on balances at adoption.
Important Facts for Investors to Verify
- Reconcile the reported $9.0 million GAAP net income with adjusted net income of $35.0 million, particularly the treatment and potential future realization of derivative fair-value changes.
- Monitor funding costs, net interest yield, loan growth and the ability to maintain investment-grade ratings and access capital markets.
- Assess leverage against management’s adjusted-ratio target, patronage-capital distributions and the substantial reliance on debt funding.
- Review liquidity availability and upcoming maturities, including conditions attached to committed and market-dependent facilities.
- Track credit quality, borrower and geographic concentration, guarantees and potential draws on unconditional loan commitments.
- Follow the CAH escrow indemnification claim and any resulting payment or disclosure.