NRUC

Business Context and Reporting Period

Company: National Rural Utilities Cooperative Finance Corporation (CFC)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: February 28, 2010
Business Overview: CFC is a tax-exempt, member-owned cooperative providing financing to rural electric and telecommunications cooperatives. It consolidates results with Rural Telephone Finance Cooperative (RTFC) and National Cooperative Services Corporation (NCSC). The company's primary objective is to offer financial products at the lowest cost consistent with sound financial management, rather than maximizing net income.

Key Financial Metrics

Material Changes vs. Prior Period

• Profitability Turnaround: The company reported net income of $93.8 million for the nine months ended February 28, 2010, a significant improvement from a net loss of $143.0 million in the same period of the prior year. This reversal was driven by a $126.6 million provision for loan losses in the prior year compared to a $4.6 million recovery in the current period.
• Settlement Income: Non-interest income included a one-time settlement gain of $22.9 million from CoBank, ACB, related to unauthorized access of proprietary information. There was no comparable item in the prior year.
• Loan Portfolio: Total loans outstanding decreased by $730 million to $19.5 billion, primarily due to repayments of power supply bridge loans, reduced construction activity due to the economic downturn, and the sale of $67 million in distribution loans.
• Derivative Gains: Derivative gains decreased to $5.1 million for the nine-month period compared to a loss of $86.5 million in the prior year, reflecting changes in the derivative portfolio composition and forward values.
• Debt Structure: Total debt decreased by $966 million. The company shifted funding mix toward term debt and away from commercial paper to mitigate liquidity risks, resulting in higher interest expense than potentially achievable in the low-rate environment.

Guidance, Outlook, and Risks

• Liquidity Management: Management maintains a focus on liquidity, holding commercial paper capacity in reserve. The company replaced a $1 billion 364-day credit facility with a $1.3 billion three-year facility in March 2010, increasing total committed credit to $3.35 billion.
• Non-GAAP Metrics: Management targets an adjusted TIER ratio of at least 1.10 and an adjusted debt-to-equity ratio of 6.0 or less. For the nine months ended February 28, 2010, the adjusted TIER was 1.10 and the adjusted debt-to-equity ratio was 6.00.
• Key Risks and Contingencies:
  • Non-Performing Loans: Significant exposure remains to Innovative Communication Corporation (ICC) with $524 million in non-performing loans on non-accrual status. The company is in the process of acquiring ICC assets through bankruptcy proceedings.
  • Restructured Loans: $470 million in restructured loans to CoServ Electric remain on non-accrual status, though the borrower is current on payments.
  • Interest Rate Risk: The company funds fixed-rate loans with variable-rate debt (commercial paper), creating a gap risk. Management utilizes interest rate swaps to mitigate this exposure.
  • Guarantees: The company holds $1.2 billion in guarantees for member obligations, including tax-exempt bonds and letters of credit.
• Outlook: Management expects loan balances to remain stable for the remainder of fiscal year 2010. They anticipate sufficient liquidity to meet refinancing needs for the next 12 to 18 months.

Investor Verification Checklist

• Settlement Proceeds: Verify the sustainability of earnings excluding the $22.9 million one-time CoBank settlement.
• ICC Asset Acquisition: Monitor the regulatory approval status and final valuation of the ICC Group 1 Assets acquisition to assess recovery on the $524 million non-performing loan.
• CoServ Restructuring: Track the performance of the $470 million CoServ restructured loan and the utilization of the $138 million available capital expenditure facility.
• Derivative Valuation: Review the impact of derivative forward value adjustments on GAAP net income versus adjusted net income, as this significantly affects reported earnings volatility.
• Liquidity Covenants: Confirm continued compliance with the adjusted TIER (1.10) and adjusted debt-to-equity (6.00) covenants required by revolving credit agreements.