Business context and reporting period
National Rural Utilities Cooperative Finance Corporation (CFC) is a member-owned, tax-exempt cooperative lender serving rural electric utilities; its consolidated results include RTFC and NCSC. This Form 10-Q covers the quarter ended August 31, 2016, CFC’s first quarter of fiscal 2017. Results are compared with the three months ended August 31, 2015; balance-sheet changes are compared with May 31, 2016.
Key financial metrics
| Metric | Quarter or period-end result | Comparable / change |
|---|---|---|
| Interest income | $256.8 million | Up 4% from $246.1 million |
| Interest expense | $181.1 million | Up 9% from $165.7 million |
| Net interest income | $75.8 million; yield 1.26% | Down $4.7 million; yield down 18 basis points |
| Provision for loan losses | $1.9 million | Down from $4.6 million |
| Derivative losses | $188.3 million | Compared with $12.0 million losses |
| Net income (loss) | $(132.3) million consolidated; $(131.6) million attributable to CFC | $43.1 million consolidated income; $43.3 million attributable to CFC |
| Adjusted net income and adjusted TIER | $32.6 million; 1.16 | $35.0 million; 1.19 |
| Operating cash flow | $100.6 million | $110.7 million |
| Total assets / loans to members, net | $24.68 billion / $23.53 billion | Assets up 2% from May 31; loans up 2% |
| Total debt outstanding | $22.91 billion | Up $306.6 million, or 1%, from May 31 |
| Total equity | $652.9 million | Down $164.5 million from May 31 |
| Liquidity reserve | $6.95 billion available | Includes $631 million cash, cash equivalents and time deposits |
Cash and cash equivalents increased by $86.1 million to $290.7 million. Cash flows were $100.6 million from operations, $(316.6) million from investing and $302.0 million from financing. The filing reports no gross margin measure. Total debt includes short-term borrowings of $3.15 billion, long-term debt of $17.57 billion, subordinated deferrable debt of $742.2 million and members’ subordinated certificates of $1.44 billion.
Material changes versus prior comparable period
- The reported quarterly loss was primarily driven by $164.9 million of derivative forward-value losses, alongside $23.4 million of derivative cash-settlement expense. Management attributes the forward-value loss mainly to falling longer-term rates and a flattening yield curve; it is a fair-value mark that can create GAAP earnings volatility.
- Adjusted net interest income fell 13% to $52.4 million, and adjusted net interest yield declined 21 basis points to 0.86%. Management cited lower loan yields and higher funding costs. Average interest-earning assets grew 7%, while average cost of funds rose 8 basis points to 3.16%.
- Loans outstanding grew $403.2 million from May 31, primarily in CFC distribution and power-supply loans. Debt increased $306.6 million, largely from higher commercial paper and a $100 million Federal Financing Bank advance.
- Equity fell $164.5 million from May 31, mainly due to the reported loss and a $42.1 million patronage capital retirement payable. GAAP debt-to-equity rose to 36.80 from 28.69; adjusted debt-to-equity was 5.94 versus 5.82.
- Loan-loss allowance was $33.1 million, or 0.14% of loans, versus $38.3 million a year earlier. The filing reports no nonperforming loans at August 31 and criticized loans equal to 0.2% of the portfolio.
Outlook, risks and unusual items
- Management expects new long-term loan advances to exceed scheduled repayments by about $462 million over the next 12 months, while anticipating lower net interest income and adjusted net interest income as loan yields decline and interest expense increases.
- Long-term debt maturities over the next 12 months were $2.46 billion. CFC stated it expects sufficient liquidity from cash, repayments, committed facilities and debt-market access. Its $6.95 billion reserve includes $3.31 billion available under bank revolvers, $500 million under then-available USDA Guaranteed Underwriter Program facilities, and up to $2.51 billion under Farmer Mac agreements, subject to market conditions where applicable. A further $375 million USDA guarantee commitment was received September 28, 2016; closing would raise available program facilities to $875 million.
- CFC expected to roll over $2.44 billion of member short-term debt and $710 million of dealer commercial paper, and intended to keep dealer commercial paper below $1.25 billion. Management expected compliance with debt covenants; CFC reported compliance as of August 31. Its adjusted debt-to-equity goal is at or below 6.00, compared with 5.94 at quarter-end.
- The July 1 sale of foreclosed-asset holding company CAH generated $109 million net proceeds from a $144 million purchase price after closing adjustments. $16 million was placed in escrow for potential indemnification claims for 15 months. RTFC provided the buyer a $60 million loan, guaranteed unsecured by the buyer’s parent. CFC recorded a $1.1 million quarterly loss related to foreclosed assets and reported none on its balance sheet at August 31.
- Derivative agreements include rating-trigger termination provisions. A qualifying downgrade scenario could require net payments of up to $489.9 million under the disclosed triggers. CFC’s senior unsecured ratings were A2 from Moody’s and A from S&P, both with stable outlooks; all three disclosed agency outlooks were stable.
- RTFC is contesting a Virgin Islands tax deficiency notice covering specified tax years from 1996–2005. Management said it believes the claims are without merit; the matter remained pending, with no legal reserve recorded. Management reported no known material changes to the risk factors in the 2016 Form 10-K.
Important facts for investors to verify
- How much of future reported earnings volatility may arise from derivative fair-value movements, and how adjusted results reconcile to GAAP results and actual cash settlement costs.
- Whether falling loan yields and rising funding costs cause adjusted net interest income or adjusted TIER to deteriorate further.
- Debt maturity, commercial-paper rollover and committed-facility availability, including conditions, collateral requirements and market dependence.
- Whether CFC maintains its adjusted debt-to-equity goal and covenant compliance as loans and funding grow.
- Credit quality, allowance assumptions, borrower concentration and the performance of Farmer Mac-covered loans; the filing states no covered loans had been put to Farmer Mac for purchase.
- Potential CAH indemnification claims against escrowed proceeds and the repayment and guarantee terms of RTFC’s buyer financing.
- Outcome of RTFC’s pending Virgin Islands tax dispute and any resulting financial exposure.