Business Context and Reporting Period
Company: National Rural Utilities Cooperative Finance Corporation (National Rural)
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Six months ended November 30, 2008
Business Overview: National Rural is a private, not-for-profit cooperative association providing financing to rural electric and telecommunications utility systems. 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 | Six Months Ended Nov 30, 2008 | Six Months Ended Nov 30, 2007 |
|---|---|---|
| Interest Income | $535.6 million | $531.2 million |
| Interest Expense | $454.5 million | $487.3 million |
| Net Interest Income | $81.0 million | $43.9 million |
| Provision for Loan Losses | $137.0 million | Recovery of $14.3 million |
| Net Loss | $(215.1) million | $(41.6) million |
| Cash and Cash Equivalents | $473.3 million | $177.8 million (May 31, 2008) |
| Total Loans Outstanding | $19.56 billion | $19.03 billion (May 31, 2008) |
| Total Debt Outstanding | $19.09 billion | $18.22 billion (May 31, 2008) |
| Total Equity | $364.4 million | $666.0 million (May 31, 2008) |
Material Changes vs. Prior Period
- Significant Net Loss Increase: The net loss increased by $173.5 million compared to the prior-year period. This was primarily driven by a $151 million increase in the provision for loan losses and a $41 million increase in derivative forward value expenses.
- Loan Loss Provision: The company recorded a $137 million provision for loan losses, a sharp reversal from a $14.3 million recovery in the prior year. This increase was largely due to a reduction in the fair value of collateral supporting impaired loans, specifically related to Innovative Communication Corporation (ICC), and higher variable interest rates impacting impairment calculations.
- Derivative Valuation: Non-interest expenses increased by $51 million, primarily due to a $41 million increase in derivative forward value losses resulting from the lower interest rate environment negatively impacting the value of interest rate swaps.
- Equity Decline: Total equity decreased by $302 million from May 31, 2008, due to the net loss and a board-authorized retirement of $85 million in patronage capital.
- Liquidity Position: Cash and cash equivalents increased significantly to $473.3 million, aided by the Commercial Paper Funding Facility (CPFF) and the repayment of a $418.5 million draw on revolving credit facilities.
Guidance, Outlook, Risks, and Unusual Items
- Market Disruptions: The company faced significant disruptions in capital markets following the Lehman Brothers bankruptcy. Investor demand for commercial paper was limited to very short maturities, and long-term debt issuance required historically high spreads.
- Lehman Brothers Exposure: Lehman Brothers Bank, FSB (LBB), a participant in $239 million of the company's revolving credit facilities, did not fund its portion of a drawdown in October 2008. The company does not expect this portion to be available in the future. Additionally, the company terminated swaps with Lehman Brothers Special Financing, recording a $26 million receivable which was subsequently reduced to $7 million based on estimated recovery rates.
- Non-Performing Loans: Non-performing loans totaled $493 million, with $485 million related to ICC, which is in bankruptcy proceedings. Restructured loans totaled $562 million, with $505 million related to CoServ Electric.
- Guarantees: Total guarantees outstanding increased to $1.24 billion. The company recorded a $5 million provision for guarantee liability.
- Subsequent Events: In December 2008, the company entered into a $500 million note purchase agreement with Farmer Mac and issued $230 million in notes. It also terminated certain interest rate swaps resulting in a $68 million payment to the company, to be recorded in the next quarter.
- Adjusted Metrics: Management utilizes an "Adjusted TIER" (Times Interest Earned Ratio) excluding derivative impacts. For the six months ended November 30, 2008, the Adjusted TIER was below 1.00, compared to 1.13 in the prior year.
Investor Verification Checklist
- Loan Loss Adequacy: Verify the sufficiency of the $649 million allowance for loan losses given the $137 million provision and the specific exposure to ICC and CoServ.
- Liquidity Sources: Confirm the availability of the remaining $3.4 billion in revolving credit facilities, excluding the $239 million Lehman Brothers portion, and the sustainability of commercial paper issuance via the CPFF.
- Derivative Exposure: Assess the impact of interest rate movements on the $13.1 billion notional amount of interest rate swaps and the potential for further non-cash losses affecting equity.
- Guarantee Obligations: Review the $1.24 billion in guarantees, particularly the $601 million in tax-exempt bonds where the company acts as a liquidity provider, and the associated $33 million liability.
- Equity Erosion: Monitor the trend of total equity, which dropped significantly due to non-cash derivative losses and patronage retirements, and its impact on leverage ratios.