Earnings Call
National Rural Utilities Cooperative Finance Corp /Dc/ (NRUC)
Earnings Call Transcript - NRUC Q3 2023
Heesun Choi, Vice President, Capital Markets Relations
Good morning. I'm Heesun Choi, Vice President of Capital Markets Relations at National Rural Utilities Cooperative Finance Corporation. Thanks for joining us in our fiscal year 2023 third quarter investor conference call. On today's call Andrew Don, our Chief Executive Officer; and Ling Wang, our Chief Financial Officer will discuss our financial and operating performance during the three months as well as nine months ended February 28, 2022. Before we begin our discussion, I want to remind you that some information provided and comments made during today's call will contain forward-looking statements within the Securities Act of 1933 as amended and the Exchange Act of 1934 as amended. Forward-looking statements which are based on certain assumptions and describe our future plans, strategies and expectations are generally identified by our use of words such as intend, plan, may, should, will, project, estimate, anticipate, believe, expect, continue, potential, opportunity and similar expressions, whether in the negative or affirmative. All statements about future expectations or projections are forward-looking statements. Although we believe that the expectations reflected in our forward-looking statements are based on reasonable assumptions, actual results and performance may differ materially from our forward-looking statements. Factors that could cause future results to vary from our forward-looking statements about our current expectations are included in our annual and quarterly reports filed with the U.S. Securities and Exchange Commission. All the forward-looking statements are made as of today, April 18, 2023 and we undertake no obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances and changes in our expectations after the statements are made. Today's discussion will also include certain non-GAAP measures. Please refer to our Form 10-Q, filed on April 12, 2023, with the SEC and also posted on our website for discussion of why we believe our adjusting measures provide useful information in analyzing CFC's financial performance and the reconciliations to the most comparable GAAP measures. We will open the call for Q&A at the end of the presentation. You can ask questions via phone or submit your questions online if you're participating in this event via webcast. We invite you to join the Q&A session to ask questions you may have. Today's presentation slides and financial reports filed with the SEC are available in our Investor Relations page on our website at www.nrucfc.coop. A replay and call transcript will be also made available in our Investor Relations page after this event. With that, I will turn this call over to Andrew.
Andrew Don, Chief Executive Officer
Thank you, Heesun. Good morning. I'm Andrew Don, Chief Executive Officer of CFC. Thank you for joining us today. I'm happy to share our business results and operating performance for the third fiscal quarter of 2023, which ended on February 28, 2023. We have continued to achieve solid financial results during this quarter and throughout the first nine months of our fiscal year. We had another strong quarter with significant loan growth to support our members' capital requirements. Notably, our loans to members grew by $2.3 billion, or 8%, during the nine-month period, reaching a total of $32.4 billion as of February 28, 2023. I will provide more details on our loan growth shortly. Our financial position is strong, as evidenced by solid financial metrics during the third quarter and year-to-date. For the nine months ending February 28, 2023, our adjusted TIER was 1.26x, exceeding our target of 1.1x, while our members' equity stood at over $2.1 billion at the end of the third quarter. Our members' equity has risen by 55%, from $1.4 billion on May 31, 2017, as we remain dedicated to increasing our members' equity through retained earnings accumulation. Our liquidity position is healthy, supported by a variety of well-established funding sources to reduce dependence on any single source or market. Our diverse liquidity sources include cash, investments, committed bank lines, the Guaranteed Underwriter Program, the Farmer Mac note purchase agreement, and repo facilities. We are committed to maintaining strong investment credit ratings from Fitch, Moody's, and S&P, with long-term senior secured ratings of A+, A1, A- and long-term unsecured credit ratings of A, A2, A- all carrying a stable outlook. In this fiscal quarter, all three rating agencies reaffirmed CFC's credit ratings and stable outlook. As I mentioned, we noted a $2.3 billion increase in net loan growth during the current fiscal year-to-date. The $2.3 billion increase in loans to members during the nine months ended February 28, 2023, resulted from net increases in long-term and line of credit loans of $1.2 billion and $1.1 billion, respectively. The rise in line of credit loans was primarily due to increased funding for higher operating expenses and material costs incurred by our members; more bridge loans transitioning to long-term financing from the rural utility service for members still using our U.S. financing; and increased construction financing for broadband infrastructure projects. As of February 28, 2023, our loans to distribution members amounted to $25 billion, while loans to power supply members totaled $5.3 billion. Throughout the current fiscal year, we observed growth across all business segments. Specifically, our distribution loan portfolio grew by $1.6 billion and our power supply loan portfolio increased by $417 million. Additionally, we saw increases in CFC statewide and associate loans, NCSC and RTFC loans of $29 million, $278 million, and $14 million, respectively. Loans to our distribution and power supply members accounted for 95% of total loans to members as of February 28, 2023. In the current year-to-date period, we made long-term loan advances totaling $2.5 billion. Approximately $2.3 billion, or 94%, of those advances were designated for capital expenditures, with the remaining amount allocated for refinancing other lenders' debts or various corporate purposes. In comparison, for the same prior year-to-date period, we made long-term loan advances totaling $2.4 billion, with $1.9 billion, or 79%, directed towards capital expenditures, and $481 million, or 20%, for members' operating expenses, chiefly due to heightened power costs and natural gas price fluctuations during the winter Storm Uri weather event. This quarter, $605 million in long-term loans was allocated to financing our electric distribution cooperative's investments in broadband projects. By February 28, 2023, our outstanding loans to CFC distribution members for broadband initiatives increased to about $2.1 billion, reflecting a net increase of $480 million, or 29%, compared to the May 31, 2022 level of $1.6 billion. I will now hand the call over to Ling, who will provide a more detailed review of our financial results. Thank you.
Ling Wang, Chief Financial Officer
Hi, good morning. This is Ling Wang, Chief Financial Officer at CFC and I'm going to move on to Slide 8 to discuss our financial results during the third fiscal quarter of 2023 and for the 9 months ended February 28, 2023. At February 28, 2023, our total assets were approximately $34 billion, representing a 9% increase or $2.8 billion from fiscal year ended May 31, 2022. The increase in our total assets was primarily due to the growth in our loan portfolio which increased by $2.3 billion or 8% to $32.4 billion from the May 31, 2022 level. The majority of our total assets consist of loans that we have extended to our members. As of February 28, 2023, long-term fixed rate loans accounted for 82% of our total assets, while line of credit loans represented 10%. In comparison, long-term fixed rate loans and line of credit loans accounted for 86% and 7% of our total assets as of May 31, 2022, respectively. Andrew spoke about the drivers behind the increase in line of credit loans outstanding. We typically offer long-term amortizing loans to our members for up to 35 years. The average remaining maturity of our long-term loans which accounted for 89% of total loans outstanding as of February 28, 2023 was 19 years. In order to fund the loan growth, our total liabilities increased by $2.3 billion or 8% to $31.4 billion as of February 28, 2023, compared to $29.1 billion as of May 31, 2022. The increase in total liabilities was driven by increases in long-term debt outstanding. Our members' equity which excludes cumulative derivative forward-value losses and accumulated other comprehensive income increased by $127 million, or 6% to $2.1 billion as of February 28, 2023 from the May 31, 2022 level. Because of strong loan growth, our adjusted debt-to-equity ratio which was at 6.59x to 1x at February 28, 2023, an increase from 6.24x to 1x at May 31, 2022. That being said, about half of our current fiscal year loan growth or $1.1 billion came from increases in line of credit outstanding. It is difficult to predict if these balances will continue to remain outstanding. While our goal is to maintain an adjusted debt-to-equity ratio of approximately 6x to 1 we expect that our adjusted debt-to-equity ratio will remain elevated above our target of 6x to 1 due to sustained strong loan growth. We currently anticipate approximately $1.4 billion in net long-term loan growth over the next 12 months. Our adjusted TIER or times interest earned ratio for the current quarter and for the 9 months ended February 28, 2023 was 1.3x and 1.26x, respectively, compared to 1.33x and 1.31x for the same prior year period. The decrease in our adjusted TIER was due to an increase in adjusted interest expense, the denominator that's used to calculate the adjusted TIER. For the current quarter ended February 28, 2023, CFC generated an adjusted net income of $80 million compared to an adjusted net income of $66 million for the same prior year quarter. The $14 million increase in adjusted net income in the current quarter from the same prior year quarter was primarily attributable to a $5 million increase in adjusted net interest income, a $10 million reduction in losses recorded on our investment securities, partially offset by a $2 million increase in operating expenses and a $2 million reduction in benefit for credit losses. During the 9 months ended February 28, 2023, our adjusted net income reached $185 million, nearly identical to the $184 million generated during the same prior year period. The slight increase in adjusted net income was primarily due to $11 million increase in adjusted net interest income and $13 million reduction in losses recorded on our investment securities, partially offset by an unfavorable shift in the provision for credit losses of $16 million and an $8 million increase in operating expenses. Our adjusted net interest income increased $5 million or 6% to $90 million during the current quarter compared to the same prior year quarter. The $5 million increase was attributable to an increase in average earning assets of $2.8 billion or 9%, partially offset by the decrease in adjusted net interest yield of 4 basis points or 3% to 111 basis points. The 4 basis points decrease in adjusted net interest yield was largely due to the combined impact of an increase in our adjusted average cost of borrowing of 58 basis points to 3.46% partially offset by an increase in the average yield on interest-earning assets of 51 basis points to 4.35% and an increase in the benefit from noninterest-bearing funding of 3 basis points to 22 basis points. Our adjusted net interest income increased $11 million or 4% to $260 million during the current 9-month period compared to the same prior year period. The $11 million increase was primarily attributable to an increase in average earning assets of $2.3 billion or 8%, partially offset by the decrease in adjusted net interest yield of 4 basis points or 4% to 1.09%. The 4 basis points decrease in the adjusted net interest yield was largely due to the combined impact of an increase in our adjusted average cost of borrowing of 34 basis points to 3.24%, partially offset by an increase in the average yield on interest-earning assets of 28 basis points to 4.12% and an increase in the benefit from noninterest-bearing funding of 2 basis points to 21 basis points. We expect our adjusted net income will increase slightly over the next 12 months based on our projected modest increase in adjusted net interest income. However, we believe that our adjusted TIER will decrease slightly over the next 12 months, primarily due to our projected increase in adjusted interest expense. We also believe that our adjusted net interest yield will decline based on our current yield curve assumption and our balance sheet position. The overall composition of our loan portfolio at February 28, 2023, remained similar as compared to May 31, 2022, with $32 billion or 98% of our portfolio consisting of loans to rural electric systems and $482 million or 2% to the telecommunications sector. As of February 28, 2023, 79% of our loans were made to electric distribution borrowers and 16% of our loans were made to power supply borrowers. The percentage of CFC's long-term fixed rate loans was at 86% of total loans outstanding as of February 28, 2023, compared to 90% as of May 31, 2022, primarily due to the increase in line of credit loans outstanding. The line of credit loans accounted for 11% of total loans outstanding as of February 28, 2023, compared to 8% as of May 31, 2022. We typically lend to our members on a senior secured basis, with 91% of our loans being senior secured as of February 28, 2023, compared to 93% as of May 31, 2022. As of February 28, 2023, we had 2 nonperforming loans, both to CFC power supply borrowers totaling $108 million or 33 basis points of total loans outstanding, compared to 3 nonperforming loans totaling $228 million or 76 basis points as of May 31, 2022. The $120 million reduction in nonperforming loans during the current fiscal year-to-date period was due to a combination of the 3 factors: number one, the loan principal payment received on the nonperforming loans; number two, the partial $15 million charge-off related to Brazos Electric Power Cooperative and Brazos Sandy Creek nonperforming loans; and now three, the classification of the remaining Brazos nonperforming loans to troubled debt restructuring loans during the current quarter. As of February 28, 2023, loans outstanding to Brazos and Brazos Sandy Creek totaled $23 and $4 million, respectively. Our allowance for credit losses decreased to $56 million as of February 28, 2023, compared to $68 million as of May 31, 2022. The allowance coverage ratio decreased to 17 basis points as of February 28, 2023, from 22 basis points as of May 31, 2022. The allowance for credit losses reflected a decrease in the asset-specific allowance of $13 million, partially offset by a $1 million increase in the collective allowance. The decrease in the asset-specific allowance was attributable to primarily the charge-offs totaling $15 million related to Brazos and Brazos Sandy Creek loans, partially offset by an increase in the asset-specific allowance for another nonperforming CFC power supply loan due to a reduction in the timing change in the expected payment on this loan. The increase in the collective allowance was primarily due to the loan portfolio growth. We had no loan charge-offs during the current quarter and we recorded $15 million in charge-offs during the current fiscal year-to-date period which represented 6 basis points of our average loans outstanding. Prior to these charge-offs, we had not experienced any defaults or charge-offs in our electric utility portfolio and the telecommunication loan portfolio since fiscal year 2013 and 2017, respectively. We continue to believe that the overall quality of our loan portfolio remains strong as of February 28, 2023, evidenced by limited defaults and losses in our electric utility loan portfolio since the inception of CFC. Our total debt outstanding was $30.9 billion at February 28, 2023, an increase of $2.2 billion or 8% from May 31, 2022, primarily to fund our loan growth. We maintained diverse funding sources, including funding from our members as well as capital markets and non-capital markets funding to minimize the risk of being dependent on any single source of market. As of February 28, 2023, 52% of our funding came from capital markets, 22% from the Guaranteed Underwriter Program, 15% from our members, and 11% from the Farmer Mac note purchase program. Compared to our fiscal year ended May 31, 2022, our capital markets funding increased by $1.8 billion and our funding from the Guaranteed Underwriter Program and Farmer Mac increased by $1.1 billion, offset by a decrease in our member investment of $720 million. As of February 28, 2023, 58% of our total debt was secured and 42% was unsecured, compared to 56% secured and 44% unsecured at May 31, 2022. Our short-term borrowings remained relatively at the same level at $4.9 billion, accounting for about 16% of our total debt outstanding at February 28, 2023, compared with $5 billion or 17% of total debt outstanding at May 31, 2022. A total of $3.2 billion or 65% of our short-term borrowings came from our member short-term investment at February 28, 2023, compared to $4 billion or 79% at May 31, 2022. Our short-term member investment level was lower at February 28, 2023, as our members had utilized a portion of their investment for operating cash needs. As of March 31, 2023, we had a total of $3.4 billion in our short-term member investments. We believe that our member investments are a stable and reliable funding source for us as we continue to receive strong support from our members. Over the last 12 fiscal quarters, our member short-term investments have averaged $3.7 billion and our total member investments have averaged $5.2 billion. We intend to manage our short-term wholesale funding risk by maintaining dealer commercial paper outstanding balance at each quarter end within a range of $1 billion to $1.5 billion. As of February 28, 2023, our dealer commercial paper outstanding was at $1.2 billion. This slide shows the various sources of liquidity that CFC had in place at February 28, 2023. Our available liquidity from various sources included cash and investments, committed bank lines, the Guaranteed Underwriter Program and the Farmer Mac revolving note purchase agreement, totaling $6.8 billion at February 28, 2023. During the current quarter, we closed a new facility totaling $750 million under the Guaranteed Underwriter Program. Our total liquidity amount does not include the $1.5 billion scheduled repayments and amortization on long-term loans that we expect to receive from our members over the next 12 months. As indicated in the table at February 28, 2023, short-term investments from our members totaled $3.2 billion because our members have traditionally rolled over a large portion of their short-term investments with us at maturity, we consider our member investments to be a very stable and reliable source of funding for CFC. Excluding our member short-term debt maturities, we have a total liquidity equaling to 1.7x or $2.8 billion of liquidity in excess of our debt maturities during the next 12 months subsequent to February 28, 2023. This slide represents CFC's projected long-term debt issuance needs over the next 18 months subsequent to February 28, 2023. Our cash needs are derived from two primary areas, refinancing existing debt maturities and funding loan advances to our members, partially offset by the amortization and repayments of loans from our members. Our funding needs are also driven by our member investment levels. During the current quarter, we accessed the capital markets and issued $300 million 10-year collateral trust bonds, $600 million 5-year medium-term notes, and $600 million 3-year medium-term notes. We borrowed $500 million with a 3-month term under the Farmer Mac note purchase agreement and $500 million with a 30-year amortizing structure under the Guaranteed Underwriter Program. In addition, subsequent to February 28, 2023, we borrowed an additional $150 million under the Farmer Mac note purchase agreement. We expect a total of $3.1 billion of long-term debt maturities and amortization over the next 18 months from March 2023 to August 2024, consisting of $1.8 billion in capital markets debt and $1.3 billion in non-capital markets debt. We expect our net loan growth over the next 18-month period to be approximately $1.9 billion. As indicated in the last column of this table, we expect to issue approximately $3.9 billion in long-term debt over this time period to refinance existing debt maturities and to fund the expected loan growth.
Andrew Don, Chief Executive Officer
Thank you once again for joining us today to review our results for our fiscal quarter ended February 28, 2023. We appreciate your interest in CFC and look forward to discussing our financial performance and funding plans in the future. I would like to ask the operator to open the line for questions and also suggest that you submit the questions via the web services, so we may respond to those as well. Thank you.
Operator, Operator
We have a question from Chris Haberlin at Agincourt Capital Management.
Chris Haberlin, Analyst
So I first wanted to ask about the increase in the debt-to-equity ratio. I think you're kind of at a new high watermark here at 6.6x and you're targeting approximately 6x. And I think you've kind of spoken to the loan growth exceeding the earnings growth which is kind of the primary driver. Just kind of thinking over perhaps the medium-term, what's the end game here? Is the intention to get that back down to the 6x? Or would you eventually consider adjusting your target range? And then kind of what's the feedback that you're getting from the rating agencies as they look at the increase in that ratio?
Andrew Don, Chief Executive Officer
We are closely monitoring the situation because the numbers have risen. Our main goal is to meet our members' needs, which have been elevated for the reasons we mentioned. We are aware of the issue and have had discussions with the agencies. We are exploring various options to manage the debt-to-equity ratio and the recent increase, as continued growth in this area is not sustainable. It's important to note that nearly 50% of our loan increase this year came from line of credit loans, which may not necessarily remain on our books since some are bridge financings for our U.S. takeout, and could potentially be eliminated. We need to evaluate whether these line of credit increases will become a permanent part of our loan portfolio or are simply a reflection of events over the past nine months. We expect long-term robust loan growth and are considering multiple approaches, including the sub-debt market, which provides varying equity credits from different agencies, though it comes with increased costs currently. We are also exploring ways to accelerate the growth of our members' equity, potentially looking at options like patronage capital retirement and other strategies to strengthen member equity. Addressing the debt-to-equity ratio is a top priority for us, aiming to adjust it closer to the targeted 6x to 1. This is something we've communicated to investors, while being aware that agencies have different calculation methods. I'm not sure if Ling has any additional comments to share.
Ling Wang, Chief Financial Officer
No, I think just wanted to say, like Andrew said, about half of our loan growth this fiscal year is from that line of credit outstanding. So our line of credit outstanding increased about $1.1 billion. So if you just kind of take a simple calculation, kind of adjust our loans outstanding down by $1.1 billion, that adjusted debt to equity will decrease to about 6.35x around that level.
Andrew Don, Chief Executive Officer
And I think a good portion of that, again, that $1.1 billion increase was debt that line of credit advances for those borrowers that are looking for long-term takeout from the RUS. Just to be clear, there's about 900 electric cooperatives in the country, there's about 350 or so that are independent. So that means there's obviously still a large universe of borrowers that do borrow from the RUS. And again, where we actually probably saw some of the largest increases was actually in line of credit advances to our U.S. borrowers with the expectation that some of that line of credit borrowings would be taken out on a long-term basis with the RUS as opposed to other financing.
Chris Haberlin, Analyst
Second question for you. Just on the Brazos, the loans and the Brazos Sandy Creek loans, I'm just trying to kind of understand exactly kind of where we stand here. In the Q2 10-Q, there was some language in there about the remaining balance being repaid over the next 12 months. I know that I want to say $56 million was paid in December but then you moved what $23 million or $24 million to troubled debt restructuring. Just kind of can you give an update on what's the remaining Brazos balance between the 2 entities, what's in nonperforming, what's in troubled debt restructuring and what the outlook or the expectation is in terms of repayment of those balances?
Ling Wang, Chief Financial Officer
Sure. So the loans outstanding to Brazos at the quarter end is $23 million. And that's classified as total debt restructuring. That's there. And the payoff of the outstanding loan balance will basically come from the generation asset sales from the Brazos, so which we expect that to happen in the next 12 months. So the nonperforming loans, the Brazos Sandy Creek loans outstanding at the quarter end is $4 million. So that's still in the nonperforming loans. And so under the restructuring agreement, Brazos will likely be responsible for the payment of that $4 million as well.
Chris Haberlin, Analyst
There's $23 million in troubled debt restructuring, $4 million in nonperforming loans, $56 million that was paid in December, and $15 million that was charged off.
Ling Wang, Chief Financial Officer
Charged off, yes.
Chris Haberlin, Analyst
Is that the entirety of all of the exposure to the 2 Brazos entities?
Ling Wang, Chief Financial Officer
Regarding Brazos Sandy Creek, the noteholders established an entity named Riesel Holdings to manage the ownership interest in the coal-fired plant through Riesel HoldCo. We have approximately $7 million in equity interest in the Brazos Sandy Creek plant, which is listed as part of our other assets on the balance sheet.
Chris Haberlin, Analyst
And is the intention of the lenders group that's taken the equity interest there to eventually sell that equity interest? Or is it just to hold it in the near term?
Ling Wang, Chief Financial Officer
Eventually will be to sell the equity interest. Thank you. So we do have a question that's submitted through the website. So the question is, is CFC actively engaged with ESG rating services like MSCI? So we are aware we have an ESG rating from MSCI. Our understanding is that they have basically taken our public information and put it in their model to derive that rating. We occasionally look at how they assess our ESG rating but we are not actively involved with anybody at MSCI for the ESG rating.
Operator, Operator
And currently, I do not have any other questions holding from the phone line.
Ling Wang, Chief Financial Officer
Okay. It looks like we don't have any questions here either.
Andrew Don, Chief Executive Officer
All right. Well, thank you for joining us today. Hope you have a good day and we look forward to talking to you in the future. Thank you.
Operator, Operator
Thank you. Ladies and gentlemen, that will conclude today's conference. We thank you for your participation. You may disconnect at this time and have a great day.