The Long and Short
NRUC Cooperative Member Files for Chapter 11 but Exposure Limited
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
National Rural Utilities Finance Corporation (NRUC) filed an 8-K on March 1, 2021 stating that they were informed that one of their cooperative members, Brazos Electric Power Cooperative, filed for Chapter 11. This sparked concerns that other cooperative members in Texas may also be looking to file for Chapter 11 or experiencing credit stress, after a week of extreme winter weather increased demand for both power and natural gas, leading to soaring wholesale prices for utilities that were short on supply or not hedged properly. Despite the alarm, exposure appears limited and all three agencies have maintained a stable outlook on NRUC’s current A2/A/A senior unsecured ratings.
NRUC quickly disclosed its exposure to Brazos in the 8-K, with $81.6 million in unsecured loans and $3.4 million in letters of credit extended to Brazos at the time of the bankruptcy filing. Additionally, NRUC has a $29.6 million secured loan to one of Brazos’ wholly owned subsidiaries (Brazos Sandy Creek Electric Cooperative), however, the Sandy Creek subsidiary is not a debtor in the bankruptcy filing. Exposure appears to be limited given that NRUC’s total loan exposure to Brazos on a secured and unsecured basis represents approximately 0.42% of its total member loan portfolio (Exhibit 1).
Exhibit 1. NRUC Loans Outstanding by Member Class (as of 11/30/20)
Source: Company Reports (8k, 10k); APS
But What About Other Texas Exposure?
As of the company’s last 10-K for the fiscal year ended 5/31/20, NRUC had the most geographic exposure to Texas with 15.82% of its total loan portfolio outstanding to the state. That 15.82% exposure in Texas was spread across 67 borrowers, with each borrower representing an average of 0.24% of loans outstanding. NRUC does not break out its loan exposure per member as the company currently has 909 distribution system and power supplier members.
Prior to Brazos filing for bankruptcy on 3/1/21, S&P had placed six Texas utility companies on review for a downgrade, including Brazos, given their exposure to the extreme wholesale prices for power and natural gas as a result of the weather. At the time of writing, Brazos was the only utility of the six to have filed for bankruptcy. S&P ended up downgrading one other utility from the initial release, Georgetown Utility System, to A+ from AA-, with the rating remaining on credit watch negative.
Historical Electric Portfolio Defaults Limited
NRUC has only witnessed sixteen defaults over the past 51 years in its electric portfolio. While six of the defaults resulted in historical net charge-offs of $86 million, ten of the defaults actually resulted in no losses for NRUC. The company has witnessed more losses related to its telecommunications portfolio, an area that NRUC has been actively limiting its exposure to given the riskier nature. That portfolio now stands at $431 million outstanding, down from over $4.0 billion in fiscal 2003. The telecommunications portfolio saw 15 defaults which produced nearly $427 million of net charge-offs, with its most significant charge off happening in fiscal 2011 ($354 million). Despite the size of the charge off that year, NRUC was able to maintain its existing senior unsecured credit ratings at both Moody’s (A2) and S&P (A). NRUC was not rated by Fitch at that time.
NRUC owes its limited defaults and losses in their electric portfolio to the fact that the majority of its electric cooperative borrowers operate in states where they are not subject to rate regulation. Therefore, the cooperative is able to make rate adjustments and pass along increased costs to the end customer without regulatory approval. Furthermore, the cooperatives face limited competition given that they tend to operate in largely rural territories not serviced by publicly owned utilities. Since cooperatives are consumer owned and not-for-profit entities, they are deemed to be essential providers of service to its end-user, the majority of which are residential customers. That said, when a cooperative utility company files for Chapter 11, they tend to continue to operate and make payments to its lenders and ultimately re-emerge from bankruptcy.
Agencies Continue to Maintain a Stable Outlook
Despite the 8-K filing all three agencies have maintained a stable outlook on NRUC’s current A2/A/A senior unsecured ratings. Moody’s stable outlook is rooted in the company’s long history of maintaining strong asset quality in the loan portfolio. This has led to the company outperforming its adjusted times interest earned ratio (TIER) of 1.1x. For fiscal 2020 and 2019, NRUC’s TIER was 1.17x and 1.19x, respectively. S&P sees NRUC as serving an important role in providing financing for the rural electric utility industry. Furthermore, its access to low cost funding from the Federal Financing Bank and Farmer Mac help lend to business stability. Fitch currently estimates that NRUC maintains over a 20% market share of the electric cooperative lending market with a high retention rate. Currently 100% of NRUC’s borrowers use NRUC exclusively for long-term financing.
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