<PAGE>
FORM 10-Q
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended August 31, 1998
OR
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period From To
Commission File Number 1-7102
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
DISTRICT OF COLUMBIA 52-0891669
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Woodland Park, 2201 Cooperative Way, Herndon, VA 20171-3025
(Address of principal executive offices)
Registrant's telephone number, including the area code (703)709-6700
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. YES X NO
Page 1 of 25
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED BALANCE SHEETS
(Dollar Amounts In Thousands)
A S S E T S
(Unaudited)
August 31, 1998 May 31, 1998
Cash and Cash Equivalents $ 128,759 $ 65,274
Debt Service Investments 26,384 22,969
Loans To Members, net 10,813,196 10,329,345
Receivables 112,338 112,317
Fixed Assets, net 26,090 25,062
Debt Service Reserve Funds 103,489 103,489
Other Assets 29,529 24,432
Total Assets $ 11,239,785 $ 10,682,888
The accompanying notes are an integral part of these combined financial
statements.
2
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED BALANCE SHEETS
(Dollar Amounts In Thousands)
L I A B I L I T I E S A N D M E M B E R S' E Q U I T Y
(Unaudited)
August 31, 1998 May 31, 1998
Notes Payable, due within one year $ 3,779,955 $ 3,848,229
Accounts Payable 28,607 26,750
Accrued Interest Payable 78,564 68,497
Long-Term Debt 5,460,652 5,024,621
Other Liabilities 11,005 6,347
Quarterly Income Capital Securities 400,000 200,000
Commitments, Guarantees and Contingencies
Members' Subordinated Certificates:
Membership subscription certificates 644,817 644,817
Loan & guarantee certificates 596,229 584,349
Total Members' Subordinated Certificates 1,241,046 1,229,166
Members' Equity 239,956 279,278
Total Members' Subordinated Certificates &
Members' Equity 1,481,002 1,508,444
Total Liabilities and Members' Equity $11,239,785 $10,682,888
The accompanying notes are an integral part of these combined financial
statements.
3
<PAGE>
(UNAUDITED)
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF INCOME, EXPENSES AND NET MARGINS
(Dollar Amounts in Thousands)
For the Quarters Ended August 31, 1998 and 1997
Quarters Ended
August 31,
1998 1997
Operating Income-Interest on loans to members $180,143 $150,477
Less-cost of funds allocated 151,969 127,779
Gross operating margin 28,174 22,698
Expenses:
General, administrative and loan processing 5,540 5,329
Provision for loan losses 5,886 8,250
Total expenses 11,426 13,579
Operating margin 16,748 9,119
Nonoperating Income 745 592
Gain on Sale of Land - 4,939
Net Margins $ 17,493 $ 14,650
The accompanying notes are an integral part of these combined financial
statements.
4
<PAGE>
(UNAUDITED)
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF CHANGES IN MEMBERS' EQUITY
(Dollar Amounts in Thousands)
For the Quarters Ended August 31, 1998 and 1997
<TABLE>
<CAPTION>
Patronage Capital
Allocated
Educa- Unal- General
Member- tional located Reserve
Total ships Fund Margins Fund Other
<S> <C> <C> <C> <C> <C> <C>
Quarter Ended August 31, 1998
Balance at May 31, 1998 $ 279,278 $ 1,491 $ 676 $ 2,289 $ 500 $ 274,322
Retirement of Patronage Capital (57,364) - - - - (57,364)
Net Margins 17,493 - - 17,493 - -
Other 549 13 (41) - - 577
Balance at August 31, 1998 $ 239,956 $ 1,504 $ 635 $ 19,782 $ 500 $ 217,535
Quarter Ended August 31, 1997
Balance at May 31, 1997 $ 271,594 $ 1,470 $ 596 $ 2,289 $ 504 $ 266,735
Retirement of Patronage Capital (52,715) - - - (123) (52,592)
Net Margins 14,650 - - 14,650 - -
Other 1,297 9 65 - - 1,223
Balance at August 31, 1997 $ 234,826 $ 1,479 $ 661 $ 16,939 $ 381 $ 215,366
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
5
<PAGE>
(UNAUDITED)
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF CASH FLOWS
(Dollar Amounts In Thousands)
For the Three Months Ended August 31, 1998 and 1997
<TABLE>
<CAPTION>
1998 1997
<S> <C> <C>
Cash Flows From Operating Activities:
Net margins $ 17,493 $ 14,650
Add (deduct):
Provision for loan losses 5,886 8,250
Depreciation 372 347
Amortization of deferred income (178) (382)
Amortization of issuance costs and deferred charges 734 456
Gain on sale of land - (4,939)
Add (deduct) changes in:
Receivables (1,115) (3,016)
Accounts payable 1,857 1,479
Accrued interest payable 10,067 12,841
Other (6,685) (1,531)
Net cash flows provided by operating activities 28,431 28,155
Cash Flows From Investing Activities:
Advances made on loans (1,728,970) (1,195,441)
Principal collected on loans 1,239,233 874,386
Proceeds from sale of land - 13,235
Investments in fixed assets (1,399) 58
Net cash flows used in investing activities (491,136) (307,762)
Cash Flows From Financing Activities:
Notes payable, net (106,060) 165,651
Debt service Investments, net (3,415) (37,728)
Proceeds from issuance of long-term debt 569,212 323,993
Payments for retirement of long-term debt (95,533) (146,473)
Proceeds from issuance of Quarterly Income Capital Securities 200,000 -
Proceeds from issuance of Members' Subordinated Certificates 12,974 4,401
Payments for retirement of Members' Subordinated Certificates (3) (897)
Payments for retirement of Patronage Capital (50,985) (47,771)
Net cash flows provided by financing activities 526,190 261,176
Net Cash Flows 63,485 (18,431)
Beginning Cash and Cash Equivalents 65,274 50,011
Ending Cash and Cash Equivalents $ 128,759 $ 31,580
Supplemental Disclosure of Cash Flow Information:
Cash paid for Interest Expense $ 142,681 $ 116,550
</TABLE>
The accompanying notes are an integral part of these combined financial
statements.
6
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements
1. General Information
National Rural Utilities Cooperative Finance Corporation ("CFC") is a
private, not-for-profit cooperative association which provides
supplemental financing and related financial service programs for the
benefit of its members. Membership is limited to certain cooperatives,
not-for-profit corporations, public bodies and related service organizations,
as defined in CFC's Bylaws. CFC is exempt from the payment of Federal income
taxes under Section 501(c)(4) of the Internal Revenue Code.
CFC's 1,053 members as of August 31, 1998, included 903 rural electric
utility system members ("Utility Members"), virtually all of which are
consumer-owned cooperatives, 75 service members and 75 associate
members. The Utility Members included 835 distribution systems and 68
generation and transmission systems operating in 46 states and U.S.
territories.
Rural Telephone Finance Cooperative ("RTFC") was incorporated as a
private cooperative association in the state of South Dakota in September,
1987. RTFC is a controlled affiliate of CFC and was created for the
purpose of providing, securing and arranging financing for its rural
telecommunication members and affiliates. RTFC's results of operations
and financial condition have been combined with those of CFC in the
accompanying financial statements. As of August 31, 1998, RTFC had
503 members. RTFC is a taxable entity under Subchapter T of the Internal
Revenue Code and accordingly takes tax deductions for allocations of net
margins to its patrons.
Guaranty Funding Cooperative ("GFC") was incorporated as a private
cooperative association in the state of South Dakota in December 1991.
GFC is a controlled affiliate of CFC and was created for the purpose of
providing and servicing loans to its members to fund the refinancing of
loans guaranteed by the Rural Utilities Service ("RUS"). GFC's results
of operations and statements of financial condition have been combined
with those of CFC and RTFC in the accompanying financial statements.
Loans held by GFC were transferred to GFC by CFC and are guaranteed by the
RUS. GFC had four members other than CFC at August 31, 1998. GFC is a
taxable entity under Subchapter T of the Internal Revenue Code and
accordingly takes deductions for allocations of net margins to its patrons.
In the opinion of management, the accompanying unaudited combined
financial statements contain all adjustments (which consist only of normal
recurring accruals) necessary to present fairly the combined financial
position of CFC, RTFC and GFC as of August 31, 1998 and May 31,
1998, and the combined results of operations, cash flows and changes in
members' equity for the three months ended August 31, 1998 and 1997.
The Notes to Combined Financial Statements for the years ended May 31,
1998 and 1997 should be read in conjunction with the accompanying
financial statements. (See CFC's Form 10-K for the year ended May 31,
1998, filed on August 31, 1998).
CFC has no comprehensive income to report for the quarters ended
August 31, 1998 and 1997. Therefore, no adjustment was required to
the combined statements of income, expenses and net margins or to the
combined statements of changes in members' equity.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the assets, liabilities, revenues and expenses
reported in the financial statements, as well as amounts included in the
notes thereto, including discussion and disclosure of contingent
liabilities. While the Company uses its best estimates and judgments based
on the known facts at the date of the financial statements, actual results
could differ from these estimates as future events occur.
7
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NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
CFC does not believe it is vulnerable to the risk of a near term severe
impact as a result of any concentrations of its activities.
Principles of Combination
The accompanying financial statements include the combined accounts of
CFC, RTFC and GFC, after elimination of all material intercompany
accounts and transactions. CFC has a $1,000 membership interest in
RTFC and GFC. CFC exercises control over RTFC and GFC through
majority representation on their Boards of Directors. CFC manages the
affairs of RTFC through a long-term management agreement. CFC
services the loans for GFC for which it collects a servicing fee. As of
August 31, 1998, CFC had committed to lend RTFC up to $4.5 billion to
fund loans to its members and their affiliates.
RTFC had outstanding loans and unadvanced loan commitments totaling
$2,502.3 million and $2,233.0 million as of August 31, 1998 and May 31,
1998, respectively. RTFC's net margins are allocated to RTFC's
borrowers. Summary financial information relating to RTFC is presented
below:
(Unaudited)
At August 31, At May 31,
(Dollar Amounts In Thousands) 1998 1998
Outstanding loans to members and their affiliates $1,715,438 $1,574,900
Total assets 1,844,110 1,695,231
Notes payable to CFC 1,696,036 1,563,094
Total liabilities 1,720,359 1,581,268
Members' Equity and Subordinated Certificates 123,751 113,963
(Unaudited)
For the Three Months Ended August 31,
(Dollar Amounts In Thousands) 1998 1997
Operating income $ 30,098 $ 19,839
Net margins 1,075 748
Summary financial information relating to GFC is presented below:
(Unaudited)
At August 31, At May 31,
(Dollar Amounts In Thousands)
1998 1998
Outstanding loans to members $ 133,195 $ 133,195
Total assets 137,884 135,761
Notes payable to CFC 133,195 133,195
Total liabilities 137,353 135,430
Members' Equity 531 331
(Unaudited)
For the Three MonthS Ended August 31,
(Dollar Amounts In Thousands) 1998 1997
Operating income $ 2,115 $ 2,174
Net margins 200 219
Unless stated otherwise, references to CFC relate to CFC, RTFC and GFC
on a combined basis.
8
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NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
2. Debt Service Account
A provision of the 1972 Indenture between CFC and Chase Manhattan
Bank as trustee ("1972 Indenture")
requires monthly deposits into a debt service account held by the trustee,
generally in amounts equal to one-twelfth of the total annual interest
payments, annual sinking fund payments and the principal amount of
bonds maturing within one year. These deposits may be invested in
permitted investments, as defined in the indenture (generally bank
certificates of deposit and prime rated commercial paper).
On February 15, 1994, CFC completed a new Collateral Trust Bond
Indenture ("1994 Indenture") with First Bank National Association as
trustee. This indenture does not require the maintenance of a debt service
account. All future Collateral Trust Bonds will be issued under the 1994
Indenture.
3. Loans Pledged as Collateral to Secure Collateral Trust Bonds
As of August 31, 1998 and May 31, 1998, mortgage notes representing
approximately $1,904.4 million and $1,930.9 million, respectively, related
to outstanding long-term loans to members, were pledged as collateral to
secure Collateral Trust Bonds. Both the 1972 Indenture and the 1994
Indenture require that CFC pledge eligible mortgage notes (or other
permitted assets) as collateral that at least equal the outstanding balance
of Collateral Trust Bonds. Under CFC's revolving credit agreement (See
Note 6), CFC cannot pledge mortgage notes in excess of 150% of
Collateral Trust Bonds outstanding.
Collateral Trust Bonds outstanding at August 31, 1998 and May 31, 1998
were $1,897.8 million and $1,897.7 million, respectively.
4. Allowance for Loan Losses
CFC maintains an allowance for loan losses at a level considered to
be adequate in relation to the quality and size of its loan and guarantee
portfolio. CFC makes regular additions to the allowance for loan losses.
These additions are required to maintain the allowance at an adequate level
based on the current year-to-date increase to loans outstanding and the
estimated loan growth for the next twelve months. On a quarterly basis,
CFC reviews the adequacy of the loan loss allowance and estimates the amount
of future provisions that will be required to maintain the allowance at an
adequate level based on estimated loan growth. The allowance is based on
estimates, and accordingly, actual loan losses may differ from the allowance
amount.
Activity in the allowance account is summarized as follows for the three
months ended August 31, 1998 and the year ended May 31, 1998.
August 31, May 31,
(Dollar Amounts in Thousands) 1998 1998
Beginning Balance $250,131 $233,208
Provision for loan losses 5,886 19,027
Charge-offs - (2,104)
Ending Balance $256,017 $250,131
Total Loan Loss Allowance As a Percentage of:
Total Loans 2.31% 2.36%
Total Loans and Guarantees 1.96% 1.98%
Total Nonperforming and Restructured Loans 74.79% 74.98%
9
<PAGE>
NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
5. Members' Subordinated Certificates
Members' Subordinated Certificates are subordinated obligations purchased by
members as a condition of membership and in connection with CFC's extension
of long-term loans and guarantees. Those issued as a condition of
membership (Subscription Capital Term Certificates) generally mature 100
years from issuance date and bear interest at 5% per annum. Those issued as
a condition of receiving a loan or guarantee generally either mature 46 to
50 years from issuance or amortize proportionately based on the principal
balance of the credit extended, and either are non-interest-bearing or bear
interest at varying rates.
The proceeds from certain non-interest-bearing Subordinated Certificates
issued in connection with CFC's guarantees of tax-exempt bonds are
pledged by CFC to the debt service reserve fund established in connection
with the bond issue, and any earnings from the investment of the fund
inure solely to the benefit of the member.
6. Credit Arrangements
As of August 31, 1998, CFC had three revolving credit agreements
totaling $5,217.5 million which are used principally to provide liquidity
support for CFC's outstanding commercial paper, CFC's guaranteed
commercial paper issued by the National Cooperative Services
Corporation ("NCSC") and the adjustable or floating/fixed rate bonds
which CFC has guaranteed and is standby purchaser for the benefit of its
members.
Two of these agreements are with 51 banks, with J.P. Morgan Securities,
Inc. and The Bank of Nova Scotia as Co-Syndication Agents, and Morgan
Guaranty Trust Company of New York as Administrative Agent. Under
the five-year agreement, executed in November 1996, CFC can borrow up
to $2,345.0 million until November 26, 2001. Under the 364-day
agreement, renewed on November 25, 1997, CFC can borrow up to
$2,322.5 million until November 24, 1998. Any amounts outstanding
under these facilities will be due on the respective maturity dates.
A third revolving credit agreement for $550.0 million was executed on
November 26, 1997 with 11 banks, including The Bank of Nova Scotia as
Administrative and Syndication Agent (the "BNS facility"). This
agreement has a 364-day revolving credit period which terminates
November 25, 1998 during which CFC can borrow and such borrowings
may be converted to a 1-year term loan at the end of the revolving credit
period.
In connection with the five-year facility, CFC pays a per annum facility
fee of .090 of 1%. The per annum facility fee for both agreements with a
364-day maturity is .065 of 1%. There is no commitment fee for any of
the revolving credit facilities. If CFC's long-term ratings decline, the
facility fees may be increased by no more than .035 of 1%. Generally,
pricing options are the same under all three agreements and will be at one
or more rates as defined in the agreements, as selected by CFC.
The revolving credit agreements require CFC, among other things to
maintain Members' Equity and Members' Subordinated Certificates of at
least $1,356.7 million (increased each fiscal year by 90% of net margins
not distributed to members), an average fixed charge coverage ratio over
the six most recent fiscal quarters of at least 1.025 and prohibits the
retirement of patronage capital unless CFC has achieved a fixed charge
coverage ratio of at least 1.05 for the preceding fiscal year. The credit
agreements prohibit CFC from incurring senior debt (including guarantees
but excluding indebtedness incurred to fund RUS guaranteed loans) in an
amount in excess of ten times the sum of Members' Equity, and
subordinated debt and restricts, with certain exceptions, the creation by
CFC of liens on its assets and certain other conditions to borrowing. The
agreements also prohibit CFC from pledging collateral in excess of 150%
of the principal amount of Collateral Trust Bonds outstanding. Provided
that CFC is in compliance with these financial covenants (including that
CFC has no material contingent or other liability or material litigation
that was not disclosed
10
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NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
by or reserved against in its most recent annual financial statements) and
is not in default, CFC may borrow under the agreements until the termination
dates. As of August 31, 1998 and May 31, 1998, CFC was in compliance with all
covenants and conditions under its revolving credit agreements and there were
no borrowings outstanding under such agreements.
Based on the ability to borrow under the five year facility, at August 31,
1998 and May 31, 1998, CFC classified $2,345.0 million of its notes
payable outstanding as long-term debt. CFC expects to maintain more
than $2,345.0 million of notes payable outstanding during the next twelve
months. If necessary, CFC can refinance such notes payable on a long-
term basis by borrowing under the five-year facility, subject to the
conditions herein.
7. Unadvanced Loan Commitments
As of August 31, 1998 and May 31, 1998, CFC had unadvanced loan
commitments, summarized by type of loan, as follows:
(Dollar Amounts In Thousands) August 31, 1998 May 31, 1998
Long-term $4,695,635 $3,747,542
Intermediate-term 364,383 412,035
Short-term 3,920,250 4,022,649
Telecommunications 794,089 663,018
Total unadvanced loan commitments $9,774,357 $8,845,244
Unadvanced commitments include loans approved by CFC for which loan
contracts have not yet been executed and for which loan contracts have
been executed but funds have not been advanced. CFC may require
additional information to assure itself that all conditions for advance of
funds have been fully met and that there has been no material change in
the member's condition as represented in the documents supplied to CFC.
Since commitments may expire without being fully drawn upon, the total
amounts reported as commitments do not necessarily represent future cash
requirements. Collateral and security requirements for loan commitments
are identical to those for advanced loans.
8. Retirement of Patronage Capital
CFC patronage capital in the amount of $57.4 million was retired in
August 1998, representing 70% of the allocation for fiscal year 1998 and
one-sixth of the total allocations for fiscal years 1988, 1989 and 1990.
The $57.4 million includes $6.4 million retired to RTFC. Subsequent to
the end of the quarter, GFC retired patronage capital in September 1998 in
the amount of $0.8 million representing 100% of the allocation for fiscal
year 1997. RTFC will retire 70% of their fiscal year 1998 allocation later
this fiscal year. Future retirements of patronage capital allocated to
patrons may be made annually as determined by CFC's Board of Directors
with due regard for CFC's financial condition.
9. Guarantees
As of August 31, 1998 and May 31, 1998, CFC had guaranteed the
following contractual obligations of its members:
(Dollar Amounts In Thousands) August 31, 1998 May 31, 1998
Long-term tax-exempt bonds (A) $1,141,985 $1,148,500
Debt portions of leveraged lease transactions (B) 432,494 437,175
Indemnifications of tax benefit transfers (C) 302,768 312,771
Other guarantees (D) 144,984 136,048
Total guarantees $2,022,231 $2,034,494
11
<PAGE>
NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
(A) CFC has unconditionally guaranteed to the holders or to trustees
for the benefit of holders of these bonds the full principal, premium (if any)
and interest payments on each bond when due. In the event of default, the
bonds cannot be accelerated as long as CFC makes the scheduled debt service
payments. In addition, CFC has agreed to make up, at certain times,
deficiencies in the debt service reserve funds for some of these issues of
bonds. Of the amounts shown, $1,012.9 million and $1,017.8 million as of
August 31, 1998 and May 31, 1998, respectively, are adjustable or
floating/fixed rate bonds. The interest rate on such bonds may be converted
to a fixed rate as specified in the indenture for each bond offering. During
the variable rate period (including at the time of conversion to a fixed
rate), CFC has unconditionally agreed to purchase bonds tendered or called
for redemption if such bonds are not sold to other purchasers by the
remarketing agents.
(B) CFC has unconditionally guaranteed the repayment of debt raised
by NCSC for leveraged lease transactions.
(C) CFC has unconditionally guaranteed to lessors certain
indemnity payments which may be required to be made by the lessees in
connection with tax benefit transfers. The amounts of such
guarantees reach a maximum and then decrease over the life of the
lease.
(D) At August 31, 1998 and May 31, 1998, CFC had unconditionally
guaranteed commercial paper, along with the related interest rate
exchange agreement, issued by NCSC of $44.6 million and $39.0
million, respectively.
10. Derivative Financial Instruments
At August 31, 1998 and May 31, 1998, CFC was a party to interest rate
exchange agreements with notional amounts totaling $1,297.1 million
and $753.7 million, respectively. CFC uses interest rate exchange
agreements as part of its overall interest rate matching strategy. Interest
rate exchange agreements are used when they provide CFC a lower cost
of funding option or minimize interest rate risk. CFC will only enter
interest rate exchange agreements with highly-rated financial institutions.
At August 31, 1998 and May 31, 1998, CFC was using interest rate
exchange agreements to fix the interest rate on $797.1 million and $603.7
million, respectively, of its variable rate commercial paper. CFC was
also using interest rate exchange agreements at both dates to minimize the
variance between the three month LIBOR rate at which $150.0 million of
Collateral Trust Bonds were issued and CFC's variable commercial paper
rate. All of CFC's derivative financial instruments were held for
purposes other than trading. CFC has not invested in derivative financial
instruments for trading purposes in the past and does not anticipate doing
so in the future.
12
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NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
The following table lists the notional principal amounts of CFC's interest
rate exchange agreements at August 31, 1998 and May 31, 1998:
(Dollar Amounts in Thousands) Notional Principal Amount
Maturity Date August 31, 1998 May 31, 1998
June 1999 (1) $ 50,000 $ -
September 1999 (2) 75,000 -
September 1999 (2) 75,000 -
September 1999 (2) 75,000 -
September 1999 (2) 75,000 -
November 1999 (2) 50,000 50,000
November 1999 (2) 50,000 50,000
November 1999 (2) 50,000 50,000
January 2000 (3) 52,851 52,851
January 2001 (3) 42,749 42,749
February 2001 (3) 75,000 75,000
February 2001 (3) 75,000 75,000
February 2001 (3) 75,000 75,000
February 2001 (3) 75,000 75,000
January 2003 (3) 12,375 10,000
January 2003 (3) 10,000 12,375
June 2003 (3) 48,000 -
August 2003 (3) 25,000 -
August 2003 (3) 50,000 -
August 2003 (3) 25,000 -
October 2004 (3) 40,700 40,700
January 2005 (3) 8,000 8,000
April 2006 (3) 25,000 25,000
April 2006 (3) 25,000 25,000
April 2006 (3) 25,000 25,000
April 2006 (3) 25,000 25,000
January 2008 (3) 14,000 14,000
July 2008 (3) 40,400 -
January 2012 (3) 13,000 13,000
February 2012 (3) 10,000 10,000
June 2018 (3) 5,000 -
Total $1,297,075 $753,675
(1) Under these agreements, CFC pays a variable rate of interest and
receives a fixed rate of interest.
(2) Under these agreements, CFC pays a variable rate of interest and
receives a variable rate of interest.
(3) Under these agreements, CFC pays a fixed rate of interest and receives
interest based on a variable rate.
CFC does not value the interest rate exchange agreements on its balance
sheet, but rather values the underlying hedged debt instruments at
historical cost. All amounts that CFC pays and receives related to the
interest rate exchange agreements and the underlying hedged debt
instruments are included in CFC's cost of funding for the period. In all
interest rate exchange agreements CFC receives the amount required to
service the debt outstanding to its investors from the counter party to the
agreement. The estimated fair value of CFC's interest rate exchange
agreements is presented in the footnotes to the financial statements of
CFC's Form 10-K for the year ended May 31, 1998.
13
<PAGE>
NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
CFC closely matches the terms of its interest rate exchange agreements
with the terms of the underlying debt instruments. Therefore, it is
unlikely that CFC would prepay debt that is hedged or have hedged debt
mature prior to the maturity of the interest rate exchange agreement.
However, circumstances may arise that cause either CFC or the counter
party to the agreement to exit such agreement. In the event of such
actions, CFC would record any gain or loss from the termination of the
interest rate exchange agreement as an extraordinary item on its income
statement for that period.
11. Contingencies
(A) At August 31, 1998 and May 31, 1998, nonperforming loans in the
amount of $4.0 million and $4.1 million, respectively, were on a nonaccrual
basis with respect to interest income. At August 31, 1998 and May 31, 1998,
the total amount of restructured loans was $338.3 million and $329.5 million,
respectively. CFC elected to apply all payments received against principal
outstanding on all restructured loans at both dates.
(B) CFC has classified $342.3 million and $333.6 million, of the amounts
described in footnote 11(A), as impaired with respect to the provisions of
FASB Statements No. 114 and 118 at August 31, 1998 and May 31, 1998,
respectively. CFC had allocated $135.0 million and $126.0 million of the
loan loss allowance for such impaired loans at August 31, 1998 and May
31, 1998, respectively. The amount of loan loss allowance allocated for
such loans was based on a comparison of the present value of the expected
future cashflow associated with the loan and/or the estimated fair value of
the collateral securing the loan to the recorded investment in the loan.
CFC recognized no interest income on loans classified as impaired during the
three months ended August 31, 1998. All payments received were applied
as a reduction of principal. The average recorded investment in impaired
loans for the three months ended August 31, 1998 was $342.3 million
compared to $345.3 for the year ended May 31, 1998.
(C) On December 31, 1996 the Wabash Valley Power Association ("WVPA")
plan of reorganization became effective. Under the plan, CFC received a
$4.9 million cash payment and offset $9.9 million of WVPA's
investments in CFC commercial paper and Subordinated Certificates, for
a total of $14.8 million. CFC also received a combination of secured and
unsecured promissory notes bearing interest at market rates totaling $13.4
million, bringing the total received by CFC to $28.2 million. CFC
applied the cash and offsets against the $17.7 million nonperforming loan
to Wabash, reducing the balance to $2.9 million. In April 1998, CFC
received a payment of $0.7 million from Wabash, as its share of the
proceeds from the sale of assets. At August 31, 1998, CFC had a total of
$2.2 million of loans outstanding to Wabash, all of which have been
classified as nonperforming and are on a nonaccrual status with respect to
the recognition of interest income. The remaining balance on the loan to
Wabash will be reduced by any additional payments received by Wabash
and written off along with any amount paid to RUS as part of a true-up
payment. The notes receivable have been classified as performing and
are accruing interest at CFC's intermediate-term interest rate. WVPA is
current with respect to amounts due on the notes.
CFC and RUS are negotiating a settlement on the amount of true-up
payments under a separate agreement entered into in May 1988. This
agreement provides for CFC and RUS to allocate between them all post-
petition, pre-confirmation payments made by WVPA to CFC on debt
secured by a mortgage under which CFC and RUS were co-mortgagees in
proportion to the respective amounts of debt secured. CFC anticipates
making a payment to RUS under this agreement. At August 31, 1998,
CFC has a deferred gain of $10.5 million (total received $28.2 million
less outstanding loans of $17.7 million). This gain will be used to offset
a portion of any true-up payment that is made to RUS.
(D) Deseret Generation & Transmission Co-operative ("Deseret") is a power
supply member of CFC located in Utah. Deseret operates the Bonanza
generating plant ("Bonanza"), owns a 25% interest in the Hunter generating
plant along with a system of transmission lines. Deseret also owns and
operates a coal mine, through its Blue Mountain Energy subsidiary. In the
1980's, NCSC issued debt, guaranteed by CFC, related to the Bonanza plant and
the coal mine operation. Due to large anticipated demands for electricity,
the Bonanza site was designed for two plants and Deseret built the
infrastructure to support two plants (only one plant has been built to date).
14
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NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
When the large increases in demand never materialized, Deseret was
unable to make the debt payment obligations on the Bonanza plant and debt
service payments to RUS and NCSC. NCSC transferred to CFC all of its
rights as a creditor on the obligations guaranteed by CFC.
In 1991, Deseret and its creditors entered into an agreement to restructure
Deseret's debt obligations, the Agreement Restructuring Obligations
("ARO"). In 1995, Deseret failed to make the payments required under the
ARO. The interested creditors were unable to agree on the terms of a
negotiated settlement and the ARO was terminated as of February 29, 1996.
CFC filed a foreclosure action against the owner of the Bonanza Plant in
State Court in Utah on March 21, 1996. In this action, CFC has not
terminated the lease or sought removal of Deseret as the plant operator.
One of the defendants in the foreclosure action has filed amended
counterclaims against CFC. These amended counterclaims allege breaches
of contract, fraudulent concealment, tortious interference with contract and
conspiracy. These amended counterclaims also seek rescission or equitable
subordination of CFC's interest in the Bonanza Plant.
On October 16, 1996 Deseret and CFC entered into an Obligations
Restructuring Agreement (the "ORA") for the purpose of restructuring
Deseret's debt with CFC. Pursuant to the terms of the ORA, CFC agreed
to (i) forbear from exercising any remedy to collect the CFC Debt (as
defined in the ORA) and (ii) pay and perform all of the CFC Guarantees
(as defined in the ORA) in consideration for Deseret agreeing to make
quarterly minimum payments to CFC through December 31, 2025. In
addition to the quarterly minimum payments, Deseret is required to pay
to CFC certain percentages of its excess cash flow and proceeds from the
disposition of assets, as detailed in the ORA. If Deseret performs all of
its obligations under the ORA, CFC has agreed to forgive any remaining
CFC Debt on December 31, 2025. To date, Deseret has made all required
payments under the ORA.
In connection with the ORA, on October, 16, 1996, CFC acquired all of
Deseret's indebtedness in the outstanding principal amount of $740.0
million from RUS for the sum of $238.5 million (the "RUS Debt"). As a
result of the purchase, CFC holds a majority of Deseret's outstanding
secured debt. Pursuant to a participation agreement dated October 16,
1996, the member systems of Deseret purchased from CFC, for $55.0
million, a participation interest in the RUS Debt. CFC provided long-
term financing to the members of Deseret as follows: (i) $32.5 million in
the aggregate to finance the buyout by the members of their respective
RUS debt (the "Note Buyout Loans"), and (ii) $55.0 million in the
aggregate to finance the members' purchase of participation interests in
the RUS Debt acquired by CFC (the "Participation Loans"). The Note
Buyout Loans and the Participation Loans are secured by the assets and
revenues of the member systems. Under the participation agreement the
Deseret members will receive a share of the minimum quarterly payments
that Deseret makes to CFC, which the members will use to service their
Participation Loans. Each member of Deseret has the option to put its
Participation Loan back to CFC at any time after twelve years, provided
that no event of default exists under the ORA and under such member's
Participation Loan.
Settlement discussions have been ongoing and are expected to continue
up to the date of trial. The case has been bifurcated, with trial on the
foreclosure action scheduled to commence first and a trial on certain
counterclaims and the crossclaims to be scheduled thereafter.
A Memorandum of Settlement Understanding has been entered into it by and
among CFC, Deseret, NCSC and GECC effective October 8, 1998. The settlement
contemplated by the Memorandum of Understanding is scheduled to close on or
before November 23, 1998. If the settlement is consummated, CFC plans
to call for redemption of the 9 3/8% Term Bonds due 2011 issued in respect
of the Deseret Bonzanza Power Station and guaranteed by CFC. If the
settlement does not close by November 23, a hearing on pending motions is
scheduled for December 1, 1998, with the trial to follow on the next
available court date.
15
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NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
On March 20, 1998, the City of Riverside, CA ("Riverside") commenced
an action against Deseret in the United States District Court for the
Central District of California. Riverside is seeking (i) a declaratory
judgment from the court that the Power Sales Agreement dated October
6, 1992 (the "Power Sales Agreement") between Deseret and Riverside
terminated on March 31, 1998 and (ii) unspecified damages against
Deseret. On March 31, 1998, Deseret sought injunctive relief from a
Utah State Court. The Utah State Court has granted a temporary
restraining order that enjoins Riverside from terminating the Power Sales
Agreement. The Utah proceeding has been removed to the United States
District Court for the District of Utah. Deseret and Riverside have
entered into a situation extending the temporary restraining order pending
resolution of venue motions filed in both the Utah and California
proceedings.
On March 24, 1998, the City of Anaheim, CA ("Anaheim") commenced an
action against Deseret that has been consolidated with the Riverside
proceeding in the United States District Court for the Central District of
California. The Anaheim action seeks declaratory relief from the court to
determine that the 40 MW Power Sales Agreement ("Agreement") dated
June 9, 1993, between Deseret and Anaheim has terminated or will
terminate and to set an effective date of that termination. Anaheim has
agreed to continue to purchase power and energy under the terms of that
Agreement pending resolution of the California proceeding. On April 29,
1998, Deseret added Anaheim to the Utah action filed against Riverside,
seeking, among other things, injunctive relief. Various venue motions are
currently pending in both actions concerning the Anaheim dispute.
In addition to the state and federal court proceedings, the City of
Riverside and the City of Anaheim have filed a complaint with the
Federal Energy Regulatory Commission ("FERC"). The FERC has
ordered the parties to enter into settlement discussions for a period of 90
days. The FERC order also states that if no settlement is reached, the
FERC will set a hearing before an administrative law judge who is
expected to render a decision by October 1, 1999, with a decision by the
FERC anticipated by October, 2000. Pursuant to Section 206(b) of the
Federal Power Act, the refund effective date is November 2, 1997.
The Agreements require Deseret to supply up to 52 MW to Riverside
through December 31, 2009, and Anaheim with up to 40 MW through
December 31, 2004. These contracts represent approximately 17% of
Deseret's revenues. The impact of this action on Deseret's ability to
make the payments required under the ORA has not yet been determined.
A factor mitigating any impact is Deseret's contract with PacifiCorp,
under which PacifiCorp has agreed to purchase all excess capacity.
At August 31, 1998 and May 31, 1998, CFC had the following exposure to
Deseret:
(Dollar Amounts In Millions) August 31, 1998 May 31, 1998
Loans outstanding (3) $338.3 $329.5
Guarantees outstanding:
Tax-exempt bonds 4.1 4.1
Mine equipment leases 52.5 54.1
Bonanza plant lease 255.1 258.0
Total Guarantees 311.7 316.2
Total Exposure $650.0 $645.7
1) From January 1, 1989 through August 31, 1998 CFC has funded a total
of $192.3 million in cashflow shortfalls related to Deseret's debt
service and rental obligations guaranteed by CFC. All cashflow
shortfalls funded by CFC represent an increase to loans outstanding
and also represent a decrease to the principal amount of the obligations
guaranteed by CFC.
Based on its analysis, CFC believes that it has adequately reserved for any
potential loss on its loans and guarantees to Deseret.
16
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NATIONAL RURAL UTILITIES COPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
12. Loans Guaranteed by RUS
At August 31, 1998 and May 31, 1998, CFC held $133.2 million, in Trust
Certificates related to the refinancing of Federal Financing Bank loans.
These Trust Certificates are supported by payments from certain CFC power
supply members whose payments are guaranteed by RUS.
17
<PAGE>
Part I. Item 2.
Management's Discussion and Analysis of Financial
Condition and Results of Operations
(all dollar amounts in millions)
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the assets, liabilities, revenues and expenses reported in the
financial statements, as well as amounts included in the notes thereto,
including discussion and disclosure of contingent liabilities. While the
Company uses its best estimates and judgments based on the known facts at
the date of the financial statements, actual results could differ from these
estimates as future events occur.
CFC does not believe it is vulnerable to the risk of a near term severe
impact as a result of any concentrations of its activities.
Changes in Financial Condition
During the three months ended August 31, 1998, CFC's total assets increased
by $556.9 or 5.2% to $11,239.8 from $10,682.9 at May 31, 1998, primarily due
to an increase of $483.9 in net loans outstanding. Changes to the loan
portfolio included increases of $439.5 in long-term fixed rate loans, $99.7
in short-term loans and $8.7 in restructured loans, partially offset by
decreases of $43.1 in intermediate-term loans and $15.0 in long-term variable
rate loans and an increase of $5.9 to the loan loss reserve.
Net loans to members represented 96% and 97% of total assets at August 31,
1998 and May 31, 1998, respectively. Long-term loans represented 87% of
gross loans at August 31, 1998 and May 31, 1998. Fixed rate loans represented
48% of gross loans at August 31, 1998 and 46% at May 31, 1998, while the
remaining loans carry a variable rate that may be adjusted monthly or
semi-monthly. At August 31, 1998, $1,145.4 or 10.4% of gross loans were
unsecured, compared to $1,201.1 or 11.4% at May 31, 1998. The $1,145.4 of
unsecured loans at August 31, 1998 included $132.8 of temporarily unsecured
loans for RUS note buyouts. Once CFC has advanced the full amount required to
buyout RUS, the loan will be secured by all assets and future revenues of
the borrower. At August 31, 1998, the unsecured loans, excluding the
temporarily unsecured loans, were 9.1% of gross loans. All other loans were
secured pro-rata with other lenders (primarily RUS), by all assets and
future revenues of the borrower.
During the three months ended August 31, 1998, CFC advanced $66.5 for the
prepayment of RUS loans. To date, CFC has financed approximately 94% of the
total lent for RUS prepayments. There are applications pending at RUS for an
additional $40.8 million of buyouts, in which CFC has been selected as the
lender and has approved loan commitments. Future volume of RUS note
prepayments will depend on a number of factors including interest rates,
tax consequences and possible acquisition or other business opportunities
available to the members. CFC does not expect large volumes of prepayment
requests to be made at any one time, but believes that there will be a
steady stream of activity.
At August 31, 1998, CFC had provided $2,022.2 in guarantees, a decrease of
$12.3 from the $2,034.5 at May 31, 1998. The decrease to guarantees was due
to regularly scheduled principal payments. These guarantees relate primarily
to tax-exempt financed pollution control equipment and to leveraged lease
transactions for plant and equipment. All guarantees are secured on a
pro-rata basis with other creditors on all assets and future revenues of
the borrower or by the underlying financed assets.
Also at August 31, 1998, CFC had unadvanced loan commitments of $9,774.4, an
increase of $929.2 from the $8,845.2 committed at May 31, 1998. Most
unadvanced loan commitments contain a material adverse change clause that
would relieve CFC from its obligation to lend if the borrower's financial
condition had changed materially from the time the loan was approved. About
one-half of these commitments are provided for operational back-up liquidity.
CFC does not anticipate funding the majority of the commitments outstanding
for this purpose.
During the three months ended August 31, 1998, CFC's total liabilities and
Members' Equity increased by $556.9 or 5.2% to $11,239.8 from $10,682.9 at
May 31, 1998. The increase was primarily due to increases of $436.0 in
long-term debt,
18
<PAGE>
$200.0 in Quarterly Income Capital Securities and $10.1 in interest payable
offset by decreases of $68.3 in notes payable and $27.4 in Members' Equity
and Certificates.
The long-term debt increase was due to an increase of $435.9 in Medium-Term
Notes. The decrease to notes payable was due to a decrease of $326.1 to
outstanding Commercial Paper, primarily dealer Commercial Paper, offset by
increases of $220.0 in Bid Notes outstanding and $37.8 in long-term debt due
within one year. During the quarter, CFC issued $400.0 of variable rate
Medium-Term Notes to replace maturing dealer Commercial Paper. The decrease
in Members' Equity was due to the retirement of patronage capital partially
offset by year-to-date net margins and by the issuance of Members'
Subordinated Certificates on new loans.
At August 31, 1998, CFC had loans outstanding in the amount of $4.0 classified
as nonperforming and $338.3 classified as restructured. All nonperforming
loans and restructured loans were on a non-accrual basis with respect to the
recognition of interest income. As of August 31, 1998, CFC has classified
$342.3 of loans outstanding as impaired with respect to the provisions of
FASB Statement No. 114. During the three months ended August 31, 1998, the
amount of loans classified as impaired increased by $8.7. The increase to
loans classified as impaired was due to CFC's required payments under the
obligations guaranteed for Deseret, offset by Deseret's required quarterly
ORA payment. The amount of the loan loss reserve allocated for these loans
was $135.0 at August 31, 1998. CFC has applied all payments received on
impaired loans as a reduction to principal outstanding.
As of August 31, 1998, CFC's total exposure to nonperforming and restructured
borrowers was $654.0 ($342.3 in loans and $311.7 in guarantees) an increase of
$4.2 from the total of $649.8 at May 31, 1998. The total exposure increased
due to an increase in the loans outstanding to Deseret.
The allowance for loan losses increased by $5.9 to $256.0 at August 31, 1998
from $250.1 at May 31, 1998. The increase was due to a provision of $5.9 for
the quarter. At August 31, 1998, the loan loss allowance represented 2.31%
of gross loans, 1.96% of gross loans and guarantees, and 74.79% of
nonperforming and restructured loans, compared to 2.36%, 1.98%, and 74.98%
at May 31, 1998, respectively. CFC makes regular additions to the allowance
for loan losses. These additions are required to maintain the allowance at
an adequate level based on the current year-to-date increase in loans
outstanding and the estimated loan growth for the next twelve months. On a
quarterly basis, CFC reviews the adequacy of the loan loss allowance and
estimates the amount of future provision that will be required to maintain
the allowance at an adequate level based on estimated loan growth. In
performing this assessment, management considers various factors including
an analysis of the financial strength of CFC's borrowers, delinquencies, loan
charge-off history,underlying collateral and economic and industry conditions.
As of August 31, 1998, management believes that the allowance for loan losses
is adequate to cover any portfolio losses which have occurred or may occur.
Changes in the Results of Operations
CFC's net margins are subject to change as interest rates change. Therefore,
CFC uses an interest coverage ratio, instead of the dollar amount of gross or
net margins, as a primary performance indicator. During the three months
ended August 31,1998, CFC achieved a Times Interest Earned Ratio (TIER) of
1.12. This is the same as the 1.12 TIER for the three months ended August 31,
1997. Management has established a 1.10 TIER as its operating target.
Operating income for the three months ended August 31, 1998, was $180.1, an
increase of $29.7 from the prior year period. The increase in operating
income was due to a positive volume variance of $32.3 and a negative rate
variance of $2.6. Average loans outstanding increased by $1,717.9 and the
average yield increased by 5 basis points from the prior year period. For
the three months ended August 31, 1998, average loans outstanding were
$10,843.4 and the average yield was 6.59%, compared to average loans
outstanding of $9,125.5 and an average yield of 6.54% for the three months
ended August 31, 1997. The increase to the yield was due to a large volume
of loans converting from variable rates to fixed rates over the past 12
months. CFC sets the interest rates on its loans to cover the cost of funds,
general and administrative expenses, a provision for loan losses and a
reasonable TIER. As a result, the yield earned on the loan portfolio will
move in conjunction with the rates in the capital markets.
19
<PAGE>
CFC's cost of funds for the three months ended August 31, 1998, totaled
$152.0, an increase of $24.2 from the prior year. The increase was due
to a positive volume variance of $24.9 and a negative rate variance of
$0.7. The average interest rate on funds used by CFC at August 31, 1998 and
1997, was 5.56%. Included in the cost of funds is interest expense on CFC's
Subordinated Certificates and other instruments offset by income from the
overnight investments of excess cash and the interest earnings on debt
service investments.
For the three months ended August 31, 1998 and 1997, general and
administrative expenses totaled $5.5 and $5.3, respectively. General and
administrative expenses for the three months ended August 31, 1998 represented
20 basis points of average loan volume, which is a decrease of 3 basis points
from 23 basis points for the prior year period.
The provision for loan losses for the three months ended August 31, 1998,
totaled $5.9 or 22 basis points, compared to the prior year total of $8.3
and 36 basis points. CFC has maintained the provision for loan losses in line
with management's assessment of the size and quality of the loan portfolio.
On August 12, 1997, CFC sold 23.5 acres of land adjacent to its headquarters
building realizing a gain of $4.9 on the sale. CFC had no such gain for the
quarter ended August 31, 1998.
Overall, CFC's net margins for the three months ended August 31, 1998,
totaled $17.5, an increase of $2.8 from the prior year period total of $14.7
Liquidity and Capital Resources
CFC is subject to liquidity risk to the extent cash repayments on its assets
or other sources of funds are insufficient to cover the cash requirements on
maturing liabilities. For the most part, CFC funds its long-term loans with
much shorter term maturity debt instruments, however, CFC's long-term loans
typically are repriced monthly or on a multiple number of years basis, and
as such, CFC will match the loan repricing periods with similarly repriced
sources of funding, thus minimizing interest rate risk.
With regard to liquidity risk, CFC manages its liquidity risk by ensuring
that other sources of funding are available to make debt maturity payments.
CFC accomplishes this in four ways. First, CFC maintains revolving credit
agreements which (subject to certain conditions) allow CFC to borrow funds
on terms of up to five years. Second, CFC has maintained investment grade
ratings, facilitating access to the capital markets. Third, CFC maintains
SEC shelf registrations for its Collateral Trust Bonds, Medium-Term Notes,
Quarterly Income Capital Securities and Board authorization for securities
not requiring SEC registration, which (absent market disruptions and assuming
CFC maintains investment grade ratings) could be issued at fixed or variable
rates in sufficient amounts to fund the next 18 to 24 months funding
requirements. Fourth, CFC obtains a portion of its funding directly from its
members and believes this funding is more stable than funding obtained from
outside sources.
At August 31, 1998, CFC had $5,217.5 in available bank credit, $2,345.0 of
which is available through November 26, 2001, $2,322.5 is available through
November 24, 1998 and $550.0 is available through November 25, 1998. As of
August 31, 1998, CFC was in compliance with all covenants and conditions to
borrowing and there were no amounts outstanding under such agreements.
As of August 31, 1998, CFC had shelf registrations for Medium-Term Notes of
$1,002.4, for Grantor Trust Certificates of $121.8, $100.0 for Quarterly
Income Capital Securities and $300.0 for Collateral Trust Bonds. CFC also
had a shelf registration of $700 for Medium-Term Notes in Europe. Subsequent
to the end of the quarter, CFC issued $300.0 of Collateral Trust Bonds. CFC
is also planning to register an additional $500.0 of Collateral Trust Bonds
with the SEC in October 1998.
Member invested funds, including the loan loss allowance, at August 31, 1998
and May 31, 1998, were $3,201.6 and $3,194.5 or 28.1% and 29.5% of CFC's total
capitalization, respectively (long- and short-term debt outstanding, Members'
Certificates and Equity and the loan loss allowance).
20
<PAGE>
CFC's leverage ratio was 5.98 and 6.37 at August 31, 1998 and May 31, 1998,
respectively. CFC calculates leverage as the ratio of total assets, less
Members' Equity, less Members' Subordinated Certificates, less Quarterly
Income Capital Securities, less funding for loans guaranteed by RUS, plus
guarantees divided by the sum of Members' Equity, Members' Subordinated
Certificates and Quarterly Income Capital Securities. CFC's current leverage
ratio is well below the limit authorized by its Board of Directors and
revolving credit agreements.
The debt to equity ratio was 4.32 and 4.51 at August 31, 1998 and May 31, 1998,
respectively. CFC calculates the debt to equity ratio as the ratio of total
assets, less Members' Equity, less Members' Subordinated Certificates, less
Quarterly Income Capital Securities, less funding for loans guaranteed by RUS,
divided by the sum of Members' Equity, Members' Subordinated Certificates,
Quarterly Income Capital Securities and the loan loss reserve.
The following chart schedules the maturities of CFC's fixed rate loans and
fixed rate funding, including variable rate funding in which the rate has
been fixed through interest rate exchange agreements. The chart is a useful
tool to identify gaps in the matching of fixed rate loans with fixed rate
funds.
Interest-Rate Gap Analysis
(Fixed Assets/Liabilities)
As of August 31, 1998
<TABLE>
<CAPTION>
Assets: FY 99 FY 00-01 FY 02-03 FY 04-08 FY 09-18 FY 19+ Total
<S> <C> <C> <C> <C> <C> <C> <C>
Loan Amortization
and repricing $ 470.6 $ 866.6 $ 943.8 $1,267.2 $1,150.8 $ 466.4 $5,165.4
Total Assets $ 470.6 $ 866.6 $ 943.8 $1,267.2 $1,150.8 $ 466.4 $5,165.4
Liabilities and Equity:
Long-Term Debt $ 118.0 $ 801.5 $1,002.0 $1,147.3 $ 115.1 $ 595.0 $3,778.9
Subordinated Certificates 12.9 23.7 27.0 84.4 715.9 14.6 878.5
Equity - - - - 176.6 - 176.6
Total Liabilities and Equity $ 130.9 $ 825.2 $1,029.0 $1,231.7 $1,007.6 $ 609.6 $4,834.0
Gap * $ 339.7 $ 41.4 $ (85.2) $ 35.5 $ 143.2 $(143.2) $ 331.4
Cumulative Gap $ 339.7 $ 381.1 $ 295.9 $ 331.4 $ 474.6 $ 331.4
Cumulative Gap as a %
of Total Assets 3.02% 3.39% 2.63% 2.95% 4.22% 2.95%
</TABLE>
* Loan amortization/repricing over/(under) debt maturities
CFC is subject to interest rate risk to the extent CFC's loans are subject to
interest rate adjustment at different times than the liabilities which fund
those assets. Therefore, CFC's interest rate risk management policy involves
the close matching of asset and liability repricing terms within a range of 5%
of total assets. CFC measures the matching of funds to assets by comparing
the amount of fixed rate assets repricing or amortizing to the total fixed
rate debt maturing over the periods listed in the above table. At August 31,
1998, CFC had $470.6 in fixed rate assets amortizing or repricing and $130.9
in fixed rate liabilities maturing during the remainder of fiscal year 1999.
The difference, $339.7, represents the amount of CFC's assets that are not
considered match-funded as to interest rate. CFC's difference of $339.7 at
August 31, 1998 represents 3.02% of total assets.
Variable rate loans are repriced monthly and are funded with variable rate
liabilities that are also priced monthly and as such are considered to be
match-funded with respect to interest rate.
At August 31, 1998 and May 31, 1998, CFC was a party to interest rate exchange
agreements totaling $1,297.1 and $753.7, respectively. CFC uses interest rate
exchange agreements as part of its overall interest rate matching
21
<PAGE>
strategy. Interest rate exchange agreements are used when they provide CFC
a lower cost of funding option or minimize interest rate risk. CFC will only
enter interest rate exchange agreements with highly-rated financial
institutions. CFC was using interest rate exchange agreements to fix the
interest rate on $797.1 and $603.7 of its variable rate commercial paper at
August 31, 1998 and May 31, 1998, respectively. CFC was also using interest
rate exchange agreements at both dates to minimize the variance between the
three month LIBOR rate at which $150.0 of Collateral Trust Bonds were issued
and CFC's variable commercial paper rate. All of CFC's derivative financial
instruments were held for purposes other than trading. CFC has not invested
in derivative financial instruments for trading purposes in the past and does
not anticipate doing so in the future.
Year 2000 Compliance
CFC has appointed a year 2000 coordinator and assembled a team of individuals
from all areas of the Company to assist in the development of a year 2000
compliance plan and the testing of all business essential applications.
CFC's year 2000 plan includes the following:
1. identification of at risk applications and equipment,
2. obtain certification from vendors,
3. review the results of step 2,
4. develop plan to address items that will not be compliant,
5. implement solutions,
6. testing of all applications and equipment,
7. final corrections
Currently CFC has completed steps 1 through 4 for the majority of the
identified applications. CFC is now in the process of implementing solutions,
including preparing for the installation of compliant versions of software
applications, which should be available shortly. CFC is also in the process
of implementing test plans for each application. All testing is scheduled
to be completed by January 1, 1999.
CFC has obtained compliance certifications from third party vendors, for all
of its core applications and operating systems. All internally developed
applications have also been determined to be compliant. All essential
applications will be tested, regardless of whether a certification of
compliance has been obtained.
CFC has performed all work related to the year 2000 compliance plan
internally. CFC plans to perform all testing and implementation of the
required solutions internally. The overall cost of remediating CFC's
year 2000 problem is expected to be insignificant and not anticipated to
adversely impact operations. Due to business reasons, CFC moved from a
mainframe platform to a client server platform and implemented new operating
systems and core applications beginning in 1995. As a result, many of CFC's
year 2000 issues were mitigated.
CFC is in the process of reviewing non Information Technology equipment and
systems for year 2000 compliance. At this time, CFC is uncertain as to the
extent of the year 2000 problem related to this equipment. The problems
caused by non-compliance of this equipment are expected to be minor in nature
and not expected to impact operations.
CFC does not anticipate that problems related to the year 2000 will
significantly impact internal operations. However, CFC depends on the federal
wire system to advance loan funds and to collect debt service payments on
loans. CFC also depends on the capital markets for the bulk of its loan
funding. Serious disruptions in these areas could also impact CFC. In
addition, the borrowers' ability to make debt service payments to CFC are
dependent on their ability to generate and deliver electric power and to
deliver telecommunications services to their customers. Disruptions to these
services could impact the borrowers' ability to make debt service payments to
CFC. Factors mitigating the potential impact of service disruptions include:
(i) borrowers have cash balances and the ability to draw down on lines of
credit to temporarily cover debt service payments, (ii) electric power was
generated and transmitted to customers prior to the present level of computer
automation, thus manual operation of plants and distribution systems is
possible and (iii) CFC maintains a revolving credit facility and bank lines
of credit, which could be drawn upon to meet debt obligations in the event
that borrowers experience temporary difficulty in making their debt service
payments.
22
<PAGE>
At this time, CFC can not estimate the potential impact of year 2000 related
problems on its electric and telecommunications borrowers. CFC will be
requiring its borrowers to provide details of their compliance effort in the
officers' certificate due for the year ended December 31, 1998. Once these
certificates have been collected, CFC will be able to make a better assessment
of its borrowers' remediation efforts and potential impacts to operations.
CFC is currently working on contingency plans, automated and manual, for each
of its internal systems.
23
<PAGE>
Part II
Item 1, Legal Proceedings.
None.
Item 2, Changes in Securities.
None.
Item 3, Defaults upon Senior Securities.
None.
Item 4, Submission of Matters to a Vote of Security Holders.
None.
Item 5, Other Information.
None.
Item 6,
A. Exhibits
27 - Financial Data Schedules.
B. Reports on Form 8-K.
Item 7 on June 22, 1998 - An amendment to the Agency Agreement
relating to the distribution of the Company's Medium-Term Notes, Series C,
within the United States.
Item 7 on August 28, 1998 - Form of Global Certificate for the
7.375% Quarterly Income Capital Securities.
24
<PAGE>
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONAL RURAL UTILITIES
COOPERATIVE FINANCE CORPORATION
/s/ Steven L. Lilly
Chief Financial Officer
October 9, 1998
/s/ Steven L Slepian
Controller (Principal Accounting Officer)
October 9, 1998
25
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the August
31, 1998, Form 10-Q and is qualified in its entirety by reference to such
financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> MAY-31-1998
<PERIOD-END> AUG-31-1998
<CASH> 128,759
<SECURITIES> 0
<RECEIVABLES> 112,338
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 11,080,677
<PP&E> 33,907
<DEPRECIATION> 7,817
<TOTAL-ASSETS> 11,239,785
<CURRENT-LIABILITIES> 3,887,126
<BONDS> 5,460,652
0
0
<COMMON> 0
<OTHER-SE> 1,481,002
<TOTAL-LIABILITY-AND-EQUITY> 11,239,785
<SALES> 180,143
<TOTAL-REVENUES> 180,888
<CGS> 151,969
<TOTAL-COSTS> 151,969
<OTHER-EXPENSES> 5,540
<LOSS-PROVISION> 5,886
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 17,493
<INCOME-TAX> 0
<INCOME-CONTINUING> 17,493
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,493
<EPS-PRIMARY> 0
<EPS-DILUTED> 0
</TABLE>
