National Rural Utilities Cooperative Finance Corporation (CFC) — Form 10-Q
Reporting period: Quarter and six months ended November 30, 2014; balance-sheet comparisons are against May 31, 2014. CFC is a tax-exempt, member-owned cooperative lender serving rural electric and related member organizations. It funds lending primarily with debt and member investments; its objective is cost-based member service and sound financial management, not profit maximization.
Financial performance and condition
| Metric | Three months ended Nov. 30, 2014 | Six months ended Nov. 30, 2014 |
|---|---|---|
| Interest income | $235.2 million | $472.5 million |
| Net interest income | $77.0 million | $157.7 million |
| Net income (loss) | $(35.9) million | $(15.3) million |
| Adjusted net income (non-GAAP) | $16.9 million | $67.3 million |
| Adjusted TIER (non-GAAP) | 1.09 | 1.19 |
| Operating cash flow | $103.3 million for the six months |
- GAAP net interest yield was 1.45% for the quarter and 1.48% for the six months. Adjusted net interest yield, which includes derivative cash settlements in interest expense, was 1.04% and 1.08%, respectively.
- At November 30, total assets were $22.57 billion; loans to members, net, were $20.73 billion; and total equity was $918.8 million.
- Total debt outstanding was $21.01 billion, including $4.22 billion short-term debt and $14.84 billion long-term debt. Cash, investments and time deposits totaled $1.09 billion.
- Available liquidity reserves were reported at $7.67 billion: cash and time deposits, revolving bank facilities, FFB commitments and Farmer Mac capacity subject to market conditions.
- Loan portfolio quality remained strong by reported delinquency measures: nonperforming loans were $1.7 million (0.01% of loans); nonperforming and restructured loans totaled $9.2 million (0.05%). The allowance for loan losses was $50.8 million, down from $56.4 million at May 31.
Material changes versus comparable periods
- Quarterly GAAP results shifted from $25.0 million net income in 2013 to a $35.9 million loss. Six-month results shifted from $183.3 million net income to a $15.3 million loss. Results were significantly affected by derivative fair-value movements and the CAH impairment charge.
- Net derivative losses were $74.6 million for the quarter and $124.4 million for the six months, versus losses of $30.8 million and gains of $75.6 million in the respective prior-year periods. Management attributed current-period losses primarily to a flattening yield curve and lower longer-term rates. These mark-to-market amounts are volatile and are excluded from adjusted net income through the company’s stated adjustment for derivative forward value.
- Core net interest income improved: quarterly GAAP net interest income rose 4% and six-month net interest income rose 7%. Lower average funding costs more than offset reduced yields on interest-earning assets. Adjusted net interest income rose 1% for the quarter and 4% for the six months.
- Member loans grew $306 million, or 1%, from May 31, led by CFC distribution and power-supply lending; total debt rose $385 million, or 2%. Equity fell $52 million, primarily reflecting a $40 million patronage capital retirement and the six-month net loss.
- Adjusted debt-to-equity increased to 6.11-to-1 from 5.90-to-1; the company’s stated goal is at or below 6.00-to-1. GAAP debt-to-equity was 23.57-to-1, compared with 21.91-to-1.
Outlook, risks and unusual items
- CAH impairment and sale: CFC recorded a non-cash $27 million impairment of certain Caribbean Asset Holdings (CAH) intangible assets and goodwill, reducing CAH’s carrying value to $210 million. Network construction remediation, delayed testing, weaker-than-expected subscriber and revenue growth, slower customer migration, and a weaker local recovery contributed. CFC intends to sell CAH but gave no certainty on timing, buyer interest or proceeds.
- Management outlook: CFC expects new long-term loan advances to exceed scheduled repayments over the next 12 months and anticipates higher core lending earnings as loans grow and funding costs benefit from prior liability-management actions. It expects long-term advances of approximately $1.915 billion over the next 12 months; projected advances exceeded projected repayments by $675 million over the next six quarters.
- Funding and ratings: S&P downgraded CFC senior secured debt from A+ to A on December 12, 2014, and changed the issuer outlook from stable to negative; corporate and short-term ratings were unchanged. Moody’s reaffirmed its ratings with a stable outlook. CFC cited significant short-term debt as a ratings concern and planned to reduce non-member short-term wholesale debt from $2.08 billion to approximately $1.0–$1.25 billion during fiscal Q3 2015. Management said adjusted debt-to-equity could remain above its 6.00 goal near term.
- Liquidity and refinancing: CFC said it expected sufficient liquidity to meet member lending needs and obligations, including $1.941 billion of long-term debt maturing in the next 12 months. It relied on cash, member repayments, committed facilities and continued capital-market access; continued rollover of member short-term investments and access to dealer commercial paper are assumptions, not guarantees.
- Facilities and debt actions: CFC issued $300 million of 2.30% collateral trust bonds due 2019, amended revolving credit facilities, and entered a $250 million FFB facility guaranteed by RUS. After quarter-end, it issued $200 million under its Farmer Mac agreement, and on January 8, 2015 increased that facility by $600 million to $4.5 billion and extended its draw period to January 11, 2020. CFC also redeemed $400 million of 1.00% bonds on December 1, 2014.
- Other exposures: Guarantees outstanding were $981 million; CFC also provided liquidity support for $503 million of member variable-rate tax-exempt bonds. Derivative rating-trigger disclosures estimated a net payment of $192.8 million under specified downgrade scenarios. CFC reported compliance with revolving-credit and indenture covenants at November 30. One nonperforming borrower was seeking a buyer, and CFC expected sale proceeds might not repay its loan in full.
- CFC identified legal proceedings related to the former Innovative Communication Corporation bankruptcy; certain claims were on appeal. Management believed the proceedings would not materially harm the company and reported no reserve recorded. No material changes to previously disclosed risk factors were reported.
Important facts for investors to verify
- Whether CAH’s network upgrades, customer migration and operating performance improve, and whether a sale occurs and at what proceeds.
- Whether short-term wholesale debt is reduced as planned and refinancing, commercial-paper rollover and committed liquidity remain available on acceptable terms.
- How derivative fair-value volatility affects GAAP earnings, and whether adjusted TIER and adjusted debt-to-equity remain within management objectives and covenant thresholds.
- Whether loan growth, borrower credit quality, the allowance for loan losses and guarantee exposures develop as management expects.
- The consequences of the S&P outlook change and any further rating actions, including possible effects on funding costs, market access or derivative arrangements.