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Edited Transcript of **RURAL earnings conference call or presentation 10-Apr-17 6:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 National Rural Utilities Cooperative Finance Corp Earnings Call

Apr 25, 2017 (Thomson StreetEvents) -- Edited Transcript of National Rural Utilities Cooperative Finance Corp earnings conference call or presentation Monday, April 10, 2017 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* J. Andrew Don

National Rural Utilities Cooperative Finance Corporation - CFO and SVP

* Ling Wang

National Rural Utilities Cooperative Finance Corporation - VP of Capital Markets Relations

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Conference Call Participants

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* J. Christopher Haberlin

Agincourt Capital - Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the National Rural Utilities Cooperative Finance Corporation's Fiscal Year 2017 Third Quarter Financial Results Conference. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Ms. Ling Wang. Thank you, Ms. Wang. You may begin.

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Ling Wang, National Rural Utilities Cooperative Finance Corporation - VP of Capital Markets Relations [2]

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Hi, good afternoon. This is Ling Wang, Vice President of Capital Markets Relations at National Rural Utilities Cooperative Finance Corporation. Thank you for joining us today to review our third quarter fiscal year 2017 financial results.

Our Senior Vice President and Chief Financial Officer, Andrew Don, will discuss our third quarter results.

During today's call, we will make forward-looking statements with the Securities Act of 1933 as amended and the Exchange Act of 1934 as amended. The forward-looking statements 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 other similar expressions, whether in the negative or affirmative. All statements about future expectations or projection are forward-looking statements. Although we believe that the expectations reflecting 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 forward-looking statements about our current expectations are included in our annual and quarterly periodic reports as previously filed with the U.S. Securities and Exchange Commission. Except as required by law, we undertake no obligations to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date on which the statement is made.

We will have a Q&A session at the end of this presentation. You can ask questions via phone or submit your question online, if you are participating in this event via webcast. We encourage you to ask -- to take this opportunity to ask any questions you may have.

In addition, all of the materials for this event, including presentation slides and financial reports, are available on our website at nrucfc.coop. A replay and call transcript will be made available on our website after the event.

With that, I'd like to turn the call over to Andrew.

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J. Andrew Don, National Rural Utilities Cooperative Finance Corporation - CFO and SVP [3]

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Thank you, Ling, and again, good afternoon, and thank you for joining us today for National Rural Utilities Cooperative Finance Corporation's call to review our financial performance for our third quarter of fiscal 2017 for the 9-month period ended February 28, 2017.

We provide our results based on generally accepted accounting principles, or GAAP, in our Form 10-Q, which we filed on April 5. In addition to our GAAP results, during parts of this discussion, I will refer to certain financial measures that are calculated based on amounts that include adjustments to amounts determined under GAAP and are, therefore, referred to as adjusted. The primary adjusted metrics include adjusted net income, adjusted net interest income, adjusted times interest earned ratio, or TIER, and adjusted debt-to-equity ratio.

We provide a reconciliation of our adjusted measures to the most comparable GAAP measures in our recently filed Form 10-Q. It's important to note that we use our adjusted measures to manage our business and evaluate our results of operations.

Additionally, the financial covenants in our revolving credit agreements and debt indentures are based on our adjusted measures rather than the comparable GAAP measures. We therefore believe these adjusted measures are useful to investors in evaluating our performance.

As of February 28, 2017, CFC's total assets increased by $1.3 billion from the May 31, 2016, fiscal year end date, driven by a $1.1 billion or 5% increase in loans to our members and a $290 million increase in time deposits, offset partially by a $103 million decrease in foreclosed assets.

The increase in loans to members was driven by a $1 billion increase in CFC distribution loans and a $121 million increase in CFC power supply loans. The increase in loans outstanding was attributable to advances for capital investments and member refinancing other lenders' loans with CFC.

Specifically, excluding regular loan amortization repayments, CFC's long-term loan advances to our borrowers for the first 9 months totaled $1.9 billion. Approximately 56% of those new advances were for capital expenditures and 37% were made to refinance other lenders' loans.

As reported previously, during the second quarter, CFC invested $300 million in 6-month time deposits with several commercial banks. We put these time deposits in place to manage and reduce the refinancing risk associated with collateral trust bond and medium-term note maturities in April and May 2017.

Also as previously reported, on July 1, 2016, CFC closed the sale of Caribbean Asset Holdings, or CAH, which resulted in no longer having foreclosed assets reported on our consolidated balance sheet.

At February 28, 2017, total debt outstanding increased by $1.2 billion or 5% from May 31, 2016, primarily to fund the new loan growth.

Total equity increased by $330 million mainly due to the GAAP net income of $361 million for the 9 months ended February 28, 2017, partially offset by patronage capital retirements of $43 million. Our members' equity, which excludes the derivative forward value gains and losses, accumulated other comprehensive income and noncontrolling interest, increased by $61 million at February 28, 2017 from May 31, 2016. The increase was due to the adjusted net income of $102 million, partially offset by distribution of the $43 million patronage capital mentioned.

Our adjusted debt-to-equity ratio increased to 6.11:1 at February 28, 2017, from 5.82:1 at May 31, 2016, due to a greater increase in adjusted liabilities to fund the loan growth and time deposits during the period than an increase in adjusted equity. Over the remaining 3 months of the fiscal year, we expect a slight increase in loan growth. However, because of anticipated earnings during the balance of the fiscal year and projected lower time deposit amounts, we believe we will be able to maintain our adjusted debt-to-equity ratio around our target of 6:1. Over the next 12 months, we expect to maintain our adjusted debt-to-equity at approximately 6:1.

For the 9 months ended February 28, 2017, that is from June 1, 2016, to February 28, 2017, CFC generated adjusted TIER of 1.17x compared with an adjusted TIER of 1.24x for the same prior year period. Adjusted net income totaled $102 million for the 9-month period as compared to $135 million for the same prior year period. The $33 million decrease in adjusted net income was largely driven by a $29 million decrease in adjusted net interest income and a $5 million negative variance in other noninterest income.

For the 9 months ended February 28, 2017, adjusted net interest income totaled $158 million as compared to $187 million for the same prior year period. The $29 million decrease in adjusted net interest income was driven by a 23 basis point decrease in the adjusted net interest yield to 86 basis points for the current period from 109 basis points for the same prior year period. Specifically, for the 9 months ended February 28, 2017, the average yield on our interest earning assets decreased by 17 basis points to 4.23%, from 4.4% for the same prior year period, while our adjusted cost of funds increased by 7 basis points to 3.55% from 3.48%. The impact of lower adjusted net interest income resulting from a lower asset yield and higher cost of funds was partially offset by a 7% increase in average interest earning assets, mainly loans to our members.

For the next 12 months, we expect a slight increase in loans outstanding. We also expect a relatively flat net interest income and adjusted net interest income compared to the current level.

Other noninterest income, excluding derivative forward value gains or losses, decreased by $5 million for the 9 months ended February 28, 2017, compared to the same prior year period. The decrease was driven by a $2 million decrease in fee and other income and a $3 million negative variance from the results of operations of foreclosed assets. Specifically, for the 9 months ended February 28, 2017, CFC incurred $1.7 million in expenses related to the sale of CAH as compared to a $1.6 million gain due to CAH valuation adjustments during the same prior year period.

CFC recorded $259 million derivative forward value gains during the current 9-month period compared to $291 million of losses in the prior year period. The derivative forward value gains were primarily attributable to a net increase in the fair value of our pay fixed interest rate swaps due to an overall increase in interest rates. Specifically, the derivative forward value gains or losses reflect the changes in estimated fair value of our interest rate swaps at February 28, 2017, based on the projected movement in interest rates due to the maturity of the swap agreements in place at February 28, 2017. As such, these amounts do not represent current period realized cash gains or losses.

As noted previously, in managing our operating performance for the purposes of our debt covenant compliance, we exclude derivative forward value gains and losses from adjusted net income and adjusted equity calculations. There have not been any significant changes at February 28, 2017 from May 31, 2016, in the overall composition of our loan portfolio, with $24 billion or 99% of our portfolio consisting of loans to rural electric systems and $363 million or 1% to the telecommunication sector compared to the same percentages at May 31, 2016.

The percentage of CFC's long-term fixed-rate loans was at 91% as of February 28, 2017, compared to 93% at May 31, 2016. We typically lend to our members on a senior secured basis, with 92% of our loans being senior secured at February 28, 2017, which remained unchanged compared to the May 31, 2016, level.

At February 28, 2017, we had no nonperforming loans in our loan portfolio. Net charge-offs during the 9-month period totaled $2 million or 0.01% of our average loans outstanding. As reported previously, the charge-off was taken during the first quarter, and it was related to a loan we had made to a telecommunications borrower, which was classified as a nonperforming troubled debt restructured loan at May 31, 2016.

CFC continues to maintain diverse funding sources so as never to be dependent on any one source. At February 28, 2017, $4.2 billion or 18% of CFC's funding came from our members in the form of short-term and long-term investments, comparable to the same amount at May 31, 2016. The over $4 billion level is very stable and reliable, offering CFC funding with little reinvestment risk as our members consistently invest a large portion of their excess funds with CFC.

Our federal government-based funding increased by $221 million at February 28, 2017, from the fiscal year end date. During the 9-month period, we advanced $250 million under the guaranteed underwriter program. In addition, during the third quarter, we issued $350 million of secured notes under our revolving note purchase agreements with Federal Agricultural Mortgage Corporation, also known as Farmer Mac.

Our capital market related to funding sources increased by $658 million at February 28, 2017, from the May 31, 2016, year end. This increase was driven by a $380 million increase in dealer commercial paper outstanding, a $126 million increase in dealer and medium-term notes outstanding and a $153 million increase in collateral trust bonds. During the third quarter, we issued $450 million collateral trust bonds and had a $300 million collateral trust bond maturity.

This slide presents CFC's long-term debt maturities over the next 12 months, that is, from April 2017 through March 2018. As indicated, our total collateral trust bonds and dealer medium-term note maturities over the next 12 months are $1.3 billion and $775 million, respectively. It should be noted that of the $1.3 billion of collateral trust bond maturities, there was a $570 million maturity today which was repaid as scheduled. The maturity of the aforementioned bond maturities will occur during the months of April and May 2017. In addition to the capital market debt maturities, we have a total of $432 million of member medium-term notes due over the next 12 months. Historically, our members have chosen to roll over their investments at maturity.

We believe we have ample sources of liquidity to meet each of the maturities as will be highlighted on the next slide. This slide depicts the various noncapital market-dependent sources of liquidity that CFC had in place at February 28, 2017, which, in the aggregate, totaled $8.2 billion. With respect to debt maturities, CFC had member debt maturities of $2.6 billion and nonmember debt maturities of $3.2 billion over the next 12 months. As a result, CFC has access to $2.4 billion or 1.4x of defined liquidity greater than the combined member and nonmember debt maturity needs. That said, our member investments are very stable and reliable funding sources. If we were to exclude debt maturities as related to our member investments, we would have access to $5 billion or 2.6x of defined liquidity greater than our nonmember debt maturities. Our nonmember debt maturities include $1 billion of dealer commercial paper outstanding and $2.2 billion of long-term debt maturities over the next 12 months from February 28, 2017.

This slide presents CFC's projected sources and uses of cash over the next 18 months from the date of February 28, 2017. As indicated, our total projected cash needs over this time period are $5.2 billion, with 42% of this amount expected to satisfy projected new loan advances and 58% to meet maturities long-term debt. We expect to grow our loan portfolio by $377 million over the next 18 months, which is modest as compared with the $2.2 billion in loan growth we have experienced during the past 18-month time period.

Sources of cash are expected to be generated from the ongoing amortization of loans extended to our members, with the balance to be provided by the variety of funding vehicles CFC has established. The timing, size and tenor of issuance will be dependent on the timing of our loan advances and the maturity of the loans we extend to our members as well as the most attractive cost of funds.

This slide highlights the major long-term financing activities during fiscal 2017. I've covered the first and second quarter activities during prior calls. During the third quarter, in February 2017, CFC issued $450 million 7-year collateral trust bonds in the capital markets. With respect to the federal government funding source, in December 2016, CFC closed a new Series L credit facility under the Guaranteed Underwriter Program, or GUP, in the amount of $375 million with a draw period of up to 3 years. In February 2017, CFC advanced $150 million under a different GUP series.

In March 2017, CFC submitted a new loan application with the Rural Utility Service, or the RUS, for additional funding under the Guaranteed Underwriter Program. For the private note purchase programs with Farmer Mac, in February 2017, CFC issued a total of $350 million of secured notes under these note purchase agreements.

Finally, during the 9-month period, CFC continued to issue long dated unsecured InterNotes targeted to retail investors. For potential funding needs during the remainder of fiscal 2017, CFC will continue to look to balance capital market and noncapital market secured and unsecured financings, while always looking to access the most attractive cost of funds for our member borrowers.

To conclude our call, I'd like to leave you with a few key takeaways when you consider CFC's investment opportunity. These items are areas that CFC has consistently focused on and represent key credit strengths when viewing CFC as an investment. As indicated, CFC's ratings remain robust, and as discussed on prior calls, CFC's management and all staff has a certain amount of its annual compensation tied to the levels of CFC's credit ratings.

CFC's Board of Directors strongly believes that this incentive structure will align investor interest and management interest to maintaining strong credit fundamentals.

The mainstay of CFC's financial strength is in the quality of our loan portfolio. The loan portfolio is well diversified, with 99% of our assets to financially sound strong cash-flow generating rural electric systems that have limited rate regulation and are geographically dispersed across the United States. CFC has a long history of low nonperforming loans in this portfolio, reflective of the strong financial condition of our borrowers. In addition, 92% of our loans are secured with utility assets and our members' revenue on a senior secured basis.

At February 28, 2017, we have no nonperforming loans in our loan portfolio. As a member-owned cooperative organization, CFC continues to receive strong support from our members, both in terms of new lending business and a valuable funding source. Our members have made significant investments in CFC in the form of short-term investments as well as long-term capital. We view these investments to have limited reinvestment risk, thus providing a stable funding source for CFC.

Our member investment stood at $4.2 billion at February 28, 2017, representing 18% of our funding. CFC will continue to utilize different funding vehicles, public and private, to maintain our low-cost funding structure for the benefit of our members. For short-term funding, our plan is to maintain our dealer commercial paper balance below the $1.25 billion level. With respect to long-term funding, we will continue to target smaller but index-eligible tranches in a consistent issuance pattern for public debt capital market offerings while looking to maintain flexibility and availability in our private funding sources, namely the Guaranteed Underwriter Program at Farmer Mac.

CFC maintains a more than adequate liquidity reserve from a variety of sources to meet our members' borrowing needs as well as service all of our debt obligations. Specifically, at February 28, 2017, CFC has $3.2 billion of committed revolving credit facilities from our relationship banks, $725 million committed availability in the Guaranteed Underwriter Program and the $2.2 billion revolving credit capacity via the Farmer Mac secured note placement programs.

These sources, together with cash, time deposits and scheduled loan amortization, other repayments from our members, result in CFC having $8.2 billion of liquidity available to meet the next 12 months of all of debt maturities of $5.7 billion or 1.4x liquidity coverage. Excluding debt maturities related to our member investments, which historically have had a high re-investment rate, our liquidity coverage ratio would be 2.6x.

Thank you, once again, for joining us today to review our results for our fiscal quarter ended February 28, 2017. We appreciate your interest in CFC and look forward to discussing our financial performance and funding plans in the future.

I'd like to ask the operator to open the lines for questions and also suggest that you submit any other questions via the web service so that we may respond to those as well. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of Chris Haberlin of Agincourt Capital.

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J. Christopher Haberlin, Agincourt Capital - Analyst [2]

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You -- Andrew, I think you'd mentioned having some cash on deposit with banks to fund upcoming maturities, and I just missed that. Can you just kind of give me the details behind that?

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J. Andrew Don, National Rural Utilities Cooperative Finance Corporation - CFO and SVP [3]

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Sure. We had -- as we noted, we had issued $300 million of medium -- of dealer and medium-term notes, 3-year issuance back in November. We actually invested all of that in time deposits with certain of our existing relationship banks, and we just did it as a kind of a precaution because we do have significant maturities. As you know, in the month of April, we had a $570 million maturity today, and then we have $500 million maturity later in the month. So we just did it as a precaution. And we'll look to use some of that to potentially pay down some of the maturities. And we had some other maturities that -- we had 12 months -- we've done also some investments 12 months ago. So we had timed these purposefully to mature in the month of April to have as another source in case we felt there weren't -- in case there were some issues in the capital markets.

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J. Christopher Haberlin, Agincourt Capital - Analyst [4]

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Sure. So I guess, in total, the total amount you have available there that's going to be maturing is $300 million, or did you have some additional left over?

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J. Andrew Don, National Rural Utilities Cooperative Finance Corporation - CFO and SVP [5]

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No. We had some incremental amount. We had -- I think, it was closer to $500 million of -- total maturities we had was $500 million. So -- but again, we may look to reinvest some of that, and we're not necessarily looking to use the full $500 million for maturities. We could -- if the capital markets are favorable, we would look to potentially reinvest some of that.

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J. Christopher Haberlin, Agincourt Capital - Analyst [6]

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Okay. And then just improving the debt equity, what steps can you all take? I know the diversification of funding sources has kind of squeezed the net interest margin some, but what other steps can you take to kind of sustainably get that debt to equity below 6x? And I know you're expecting it to be approximately 6 here for the next 12 months, but just kind of longer term.

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J. Andrew Don, National Rural Utilities Cooperative Finance Corporation - CFO and SVP [7]

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Well, I mean, as you know, in the past, we have issued subordinated debt. We did a subordinated debt issue in April of 2013 and then April of 2016. So we have done that in the past. That will always continue to be an alternative. I mean, we have considered also various -- we do have a member capital security program with our members which remains open. It's kind of an open window, if you will, that they can purchase member capital securities which pid a coupon of 5%. So I mean, those are the 2 primary vehicles that are available to us on kind of what I'll call an ongoing basis, and then the rest is obviously just retained earnings.

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J. Christopher Haberlin, Agincourt Capital - Analyst [8]

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And then just last question. You all did a $60 million, I think, it was a $60 million loan as part of the CAH sale, and can you just give me the -- give us the terms behind that loan?

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Unidentified Company Representative [9]

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10-year bullet.

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J. Andrew Don, National Rural Utilities Cooperative Finance Corporation - CFO and SVP [10]

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Yes, it was a 10-year bullet. I mean, right, it was obviously seller financing, and it was a -- the borrower was a subsidiary of ATN, who was the purchaser and is guaranteed by ATN, but it was a 10-year bullet.

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Operator [11]

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(Operator Instructions) There are no further questions over the audio portion of the conference. I would now like to turn the conference back over to management for closing remarks.

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J. Andrew Don, National Rural Utilities Cooperative Finance Corporation - CFO and SVP [12]

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Okay. Well, thank you, once again, for joining us today, and we look forward to talking to you in the future. Goodbye.

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Operator [13]

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This concludes today's conference. Thank you for your participation. You may disconnect your lines at this time. Have a wonderful rest of your day.