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 February 28, 1999
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 27
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED BALANCE SHEETS
(Dollar Amounts In Thousands)
A S S E T S
(Unaudited)
February 28, 1999 May 31, 1998
CASH AND CASH EQUIVALENTS $ 76,095 $ 65,274
DEBT SERVICE INVESTMENTS 26,383 22,969
LOANS TO MEMBERS, NET 13,061,888 10,329,345
RECEIVABLES 150,771 112,317
FIXED ASSETS, NET 32,908 25,062
DEBT SERVICE RESERVE FUNDS 103,489 103,489
OTHER ASSETS 39,494 24,432
TOTAL ASSETS $ 13,491,028 $ 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)
February 28, 1999 May 31, 1998
NOTES PAYABLE, due within one year $ 4,496,933 $ 3,848,229
ACCOUNTS PAYABLE 59,612 26,750
ACCRUED INTEREST PAYABLE 109,357 68,497
LONG-TERM DEBT 6,896,413 5,024,621
OTHER LIABILITIES 4,963 6,347
QUARTERLY INCOME CAPITAL SECURITIES 400,000 200,000
MEMBERS' SUBORDINATED CERTIFICATES:
Membership subordinated certificates 644,817 644,817
Loan & guarantee subordinated certificates 600,197 584,349
Total Members' Subordinated Certificates 1,245,014 1,229,166
MEMBERS' EQUITY 278,736 279,278
Total Members' Subordinated
Certificates & Members' Equity 1,523,750 1,508,444
TOTAL LIABILITIES AND
MEMBERS' EQUITY $ 13,491,028 $ 10,682,888
The accompanying notes are an integral part of these combined
financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF INCOME, EXPENSES AND NET MARGINS
(Dollar Amounts in Thousands)
For the Quarters And Nine Months Ended February 28, 1999 and 1998
Quarters Ended Nine Months Ended
February 28, February 28,
1999 1998 1999 1998
<S> <C> <C> <C> <C>
OPERATING INCOME-Interest on loans to members $ 200,098 $ 161,656 $ 572,479 $ 466,128
Less: Cost of funds 172,833 138,040 483,200 396,446
Gross operating margin 27,265 23,616 89,279 69,682
EXPENSES:
General and administrative 6,525 5,174 18,118 15,649
Provision for loan losses - 3,289 15,780 15,104
Total expenses 6,525 8,463 33,898 30,753
Operating margin 20,740 15,153 55,381 38,929
NON-OPERATING INCOME 251 750 1,333 1,777
GAIN ON SALE OF LAND - - - 4,925
NET MARGINS $ 20,991 $ 15,903 $ 56,714 $ 45,631
</TABLE>
The accompanying notes are an integral part of these combined
financial statements.
4
<PAGE>
<TABLE>
<CAPTION>
(UNAUDITED)
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF CHANGES IN MEMBERS' EQUITY
(Dollar Amounts in Thousands)
For the Quarters Ended February 28, 1999 and 1998
Patronage Capital
Allocated
General
Education Unallocated Reserve
Total Memberships Fund Margins Fund Other
<S> <C> <C> <C> <C> <C> <C>
Quarter Ended February 28, 1999
Balance at November 30, 1998 $ 257,754 $ 1,516 $ 428 $ 38,012 $ 500 $ 217,298
Net Margins 20,991 - - 20,991 - -
Other (9) 2 (20) - - 9
Balance at February 28, 1999 $ 278,736 $ 1,518 $ 408 $ 59,003 $ 500 $ 217,307
Quarter Ended February 28, 1998
Balance at November 30, 1997 $ 249,920 $ 1,491 $ 651 $ 32,031 $ 381 $ 215,366
Net Margins 15,903 - - 15,903 - -
Other (297) 3 (286) (14) - -
Balance at February 28, 1998 $ 265,526 $ 1,494 $ 365 $ 47,920 $ 381 $ 215,366
</TABLE>
The accompanying notes are an integral part of these combined
financial statements.
5
<PAGE>
<TABLE>
<CAPTION>
(UNAUDITED)
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF CHANGES IN MEMBERS' EQUITY
(Dollar Amounts in Thousands)
For the Nine Months Ended February 28, 1999 and February 28, 1998
Patronage Capital
General
Education Unallocated Reserve
Total Memberships Fund Margins Fund Other
<S> <C> <C> <C> <C> <C> <C>
Nine Months Ended February 28, 1999
Balance at May 31, 1998 $ 279,278 $ 1,491 $ 676 $ 2,289 $ 500 $ 274,322
Retirement of patronage capital (57,601) - - - - (57,601)
Net Margins 56,714 - - 56,714 - -
Other 345 27 (268) - - 586
Balance at February 28, 1999 $ 278,736 $ 1,518 $ 408 $ 59,003 $ 500 $ 217,307
Nine Months Ended February 28, 1998
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 45,631 - - 45,631 - -
Other 1,016 24 (231) - - 1,223
Balance at February 28, 1998 $ 265,526 $ 1,494 $ 365 $ 47,920 $ 381 $ 215,366
</TABLE>
The accompanying notes are an integral part of these combined
financial statements.
6
<PAGE>
<TABLE>
<CAPTION>
(UNAUDITED)
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF CASH FLOWS
(Dollar Amounts In Thousands)
For the Nine Months Ended February 28, 1999 and 1998
1999 1998
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net margins $ 56,714 $ 45,631
Add (deduct):
Provision for loan losses 15,780 15,104
Depreciation 1,098 935
Amortization of deferred income (3,819) (1,186)
Amortization of issuance costs and deferred charges 2,757 1,553
Gain on sale of land - (4,925)
Receivables (24,697) (8,106)
Accounts payable 32,862 1,017
Accrued interest payable 40,860 20,851
Other (23,264) (9,504)
Net cash flows provided by operating activities 98,291 61,370
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances made on loans (8,497,331) (4,364,038)
Principal collected on loans 5,749,008 3,167,145
Proceeds from sale of land - 13,220
Investments in fixed assets (8,944) (564)
Net cash flows used in investing activities (2,757,267) (1,184,237)
CASH FLOWS FROM FINANCING ACTIVITIES:
Notes payable, net (88,462) 257,095
Debt Service Investments, net (3,414) 50,835
Proceeds from issuance of long-term debt 2,961,765 1,270,728
Payments for retirement of long-term debt (351,197) (493,598)
Proceeds from issuance of Quarterly Income Capital Securities 200,000 75,000
Proceeds from issuance of Members' Subordinated Certificates 54,975 22,569
Payments for retirement of Members' Subordinated Certificates (52,885) (3,929)
Payments for retirement of Patronage Capital (50,985) (54,212)
Net cash flows provided by financing activities 2,669,797 1,124,488
NET CASH FLOWS 10,821 1,621
BEGINNING CASH AND CASH EQUIVALENTS 65,274 50,011
ENDING CASH AND CASH EQUIVALENTS $ 76,095 $ 51,632
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during year for interest $ 445,772 $ 381,801
</TABLE>
The accompanying notes are an integral part of these combined
financial statements.
7
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements
(1) General Information and Accounting Policies
(a) 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 1,061 members as of February 28, 1999, included 909 rural electric
utility system members ("Utility Members"), virtually all of which are
consumer-owned cooperatives, 76 service members and 76 associate members.
The Utility Members included 841 distribution systems and 68 generation and
transmission systems operating in 47 states and two 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 February 28, 1999, RTFC had 514 members other than CFC. 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 two members
other than CFC at February 28, 1999. 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 February 28, 1999 and May 31, 1998, and the combined
results of operations, cash flows and changes in members' equity for the
quarters and nine months ended February 28, 1999 and 1998.
CFC has no components of other comprehensive income, as defined by the
Financial Accounting Standards Board, to report for the quarters and nine
months ended February 28, 1999 and 1998. 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 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).
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.
8
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE 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.
(b) 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 permanent majority representation
on their Boards of Directors. CFC manages the affairs of RTFC and GFC through
a long-term management agreement. CFC services the loans for GFC for which it
collects a servicing fee. As of February 28, 1999, 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 $3,424.8
million and $2,233.0 million as of February 28, 1999 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 February 28, At May 31,
(Dollar Amounts In Thousands) 1999 1998
Outstanding loans to members and their affiliates $2,564,982 $1,574,900
Total assets 2,749,299 1,695,231
Notes payable to CFC 2,551,919 1,563,094
Total liabilities 2,583,285 1,581,268
Members' Equity and Subordinated Certificates 166,014 113,963
(Unaudited)
For the Nine Months Ended February 28,
(Dollar Amounts In Thousands) 1999 1998
Operating income $ 105,305 $ 63,810
Net margin 2,761 2,333
Summary financial information relating to GFC is presented below:
(Unaudited)
At February 28, At May 31,
(Dollar Amounts In Thousands) 1999 1998
Outstanding loans to members $ 130,940 $ 133,195
Total assets 134,760 135,761
Notes payable to CFC 130,940 133,195
Total liabilities 134,143 135,430
Members' Equity 617 331
(Unaudited)
For the Nine Months Ended February 28,
(Dollar Amounts In Thousands) 1999 1998
Operating income $ 5,898 $ 6,358
Net margin 546 600
Unless stated otherwise, references to CFC relate to CFC, RTFC and GFC on a
combined basis.
9
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE 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 Collateral Trust Bonds issued since that date and all future Collateral
Trust Bonds will be issued under this new Indenture.
(3) Loans Pledged as Collateral to Secure Collateral Trust Bonds
As of February 28, 1999 and May 31, 1998, mortgage notes representing
approximately $3,031.5 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 February 28, 1999 and May 31, 1998
were $2,996.2 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 nine
months ended February 28, 1999 and the year ended May 31, 1998.
February 28, May 31,
(Dollar Amounts in Thousands) 1999 1998
Beginning Balance $ 250,131 $ 233,208
Provision for loan losses 15,780 19,027
Charge-offs, net of recoveries (1,884) (2,104)
Ending Balance $ 264,027 $ 250,131
Total Loan Loss Allowance As a Percentage of:
Total Loans 1.98% 2.36%
Total Loans and Guarantees 1.75% 1.98%
Total Nonperforming and Restructured Loans 45.06% 74.98%
10
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE 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 member's 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 February 28, 1999, CFC had three revolving credit agreements totaling
$4,792.5 million which are used principally to provide liquidity support for
CFC's outstanding commercial paper, commercial paper issued by the National
Cooperative Services Corporation ("NCSC") and guaranteed by CFC 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 53 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 $2,402.5 million
until November 26, 2001. On November 24, 1998, the 364-day agreement was
renewed with J.P. Morgan Securities Inc. and The Bank of Nova Scotia as
Co-Lead Arrangers and Co-Syndication Agents, Morgan Guaranty Trust Company
of New York as Administrative Agent, and Nationsbank, N.A. and the First
National Bank of Chicago as Co-Documentation Agents. Under this 364-day
agreement, CFC can borrow up to $1,940.0 million until November 23, 1999.
Any amounts outstanding under these facilities will be due on the respective
maturity dates.
A third revolving credit agreement for $450.0 million was executed on November
25, 1998 with nine banks, including the Bank of Nova Scotia as Lead Arranger
and Administrative Agent (the "BNS facility") and the Chase Manhattan Bank,
N.A. as Documentation Agent. This agreement has a 364-day revolving credit
period which terminates November 24, 1999 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 .085 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 at May 31, 1998 (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, Members' Subordinated Certificates and Quarterly
Income Capital Securities 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
11
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NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
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 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 February 28,
1999 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 February 28,
1999 and May 31, 1998, CFC classified $2,402.5 million and $2,345.0 million,
respectively, of its notes payable outstanding as long-term debt. CFC
expects to maintain more than $2,402.5 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 therein.
(7) Unadvanced Loan Commitments
As of February 28, 1999 and May 31, 1998, CFC had unadvanced loan commitments,
summarized by type of loan, as follows:
(Dollar Amounts In Thousands) February 28, 1999 May 31, 1998
Long-term $ 6,094,333 $ 3,747,542
Intermediate-term 328,901 412,035
Short-term 4,316,274 4,022,649
Telecommunications 869,595 663,018
Total unadvanced loan commitments $ 11,609,103 $ 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. GFC retired patronage capital
in September 1998 in the amount of $0.2 million representing 100% of the
allocation for fiscal year 1998. RTFC retired $7.9 million in January 1999,
representing 70% of their fiscal year 1998 allocation. Future retirements of
patronage capital allocated to patrons may be made annually as determined by
CFC's, RTFC's and GFC's Boards of Directors with due regard for CFC's, RTFC's
and GFC's financial condition.
12
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NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
(9) Guarantees
As of February 28, 1999 and May 31, 1998, CFC had guaranteed the following
contractual obligations of its members:
(Dollar Amounts In Thousands) February 28, 1999 May 31, 1998
Long-term tax-exempt bonds (A) $ 1,111,215 $ 1,148,500
Debt portions of leveraged lease
transactions (B) 173,728 437,175
Indemnifications of tax benefit
transfers (C) 290,019 312,771
Other guarantees (D) 153,092 136,048
Total guarantees $1,728,054 $2,034,494
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, $992.2 million and $1,017.8 million as of
February 28, 1999 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 February 28, 1999 and May 31, 1998, CFC had unconditionally guaranteed
commercial paper, along with the related interest rate exchange agreement,
issued by NCSC of $53.4 million and $39.0 million, respectively.
(10) Derivative Financial Instruments
At February 28, 1999 and May 31, 1998, CFC was a party to interest rate
exchange agreements with notional amounts totaling $2,777.8 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 February
28, 1999 and May 31, 1998, CFC was using interest rate exchange agreements
to fix the interest rate on $1,977.8 million and $603.7 million, respectively,
of its variable rate commercial paper. At February 28, 1999 and May 31, 1998,
CFC was also using interest rate exchange agreements at both dates to minimize
the variance between the three month LIBOR rate at which $800.0 million and
$150.0 million of Collateral Trust Bonds and Medium-Term Notes 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.
13
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
The following table lists the notional principal amounts of CFC's interest
rate exchange agreements at February 28, 1999 and May 31, 1998:
<TABLE>
<CAPTION>
Notional Principal Amount Notional Principal Amount
Maturity Date February 28, 1999 May 31, 1998 Maturity Date February 28, 1999 May 31, 1998
(Dollar Amounts in Thousands) (Dollar Amounts in Thousands)
<S> <C> <C> <C> <C> <C>
June 1999 (1) $ 50,000 $ - September 2003 (3) $ 28,000 $ -
September 1999 (2) 75,000 - September 2003 (3) 28,785 -
September 1999 (2) 75,000 - October 2003 (3) 32,532 -
September 1999 (2) 75,000 - October 2003 (3) 32,533 -
September 1999 (2) 75,000 - October 2003 (3) 25,480 -
November 1999 (2) 50,000 50,000 September 2004 (3) 17,650 -
November 1999 (2) 50,000 50,000 October 2004 (3) 38,000 40,700
November 1999 (2) 50,000 50,000 November 2004 (3) 61,000 -
November 1999 (2) 75,000 - November 2004 (3) 61,000 -
November 1999 (2) 75,000 - January 2005 (3) 8,000 8,000
November 1999 (2) 75,000 - April 2006 (3) 25,000 25,000
November 1999 (2) 75,000 - April 2006 (3) 25,000 25,000
January 2000 (3) 52,851 52,851 April 2006 (3) 25,000 25,000
August 2000 (3) 110,000 - April 2006 (3) 25,000 25,000
August 2000 (3) 110,000 - January 2008 (3) 14,000 14,000
September 2000 (3) 7,450 - July 2008 (3) 40,400 -
September 2000 (3) 13,355 - September 2008 (3) 26,235 -
October 2000 (3) 20,000 - September 2008 (3) 10,425 -
January 2001 (3) 42,749 42,749 September 2008 (3) 10,300 -
January 2001 (3) 23,000 - September 2008 (3) 20,600 -
February 2001 (3) 75,000 75,000 October 2008 (3) 33,512 -
February 2001 (3) 75,000 75,000 April 2009 (3) 33,000 -
February 2001 (3) 75,000 75,000 January 2012 (3) 13,000 13,000
February 2001 (3) 75,000 75,000 February 2012 (3) 10,000 10,000
September 2001 (3) 34,810 - December 2013 (3) 65,000 -
January 2003 (3) 10,000 10,000 December 2013 (3) 65,000 -
January 2003 (3) 12,375 12,375 December 2013 (3) 45,100 -
June 2003 (3) 48,000 - June 2018 (3) 5,000 -
August 2003 (3) 25,000 - December 2026 (3) 48,185 -
August 2003 (3) 50,000 - September 2028 (3) 60,000 -
August 2003 (3) 25,000 - September 2028 (3) 60,000 -
September 2003 (3) 16,600 - April 2029 (3) 66,000 -
September 2003 (3) 17,845 - Total (3) $ 2,777,772 $ 753,675
</TABLE>
(1) Under these agreements, CFC pays a variable rate of interest and
receives 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.
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.
14
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
During the nine months ended February 28, 1999, CFC has issued Commercial
Paper and Medium-Term Notes to European investors in foreign currencies.
The following chart provides details of the foreign currency swaps that CFC
has outstanding at February 28, 1999:
Type of Foreign Rate
Debt (1) Date US Dollars Currency (2)
CP Issue December 3, 1998 $ 2,894,142 2,477,862 EU 1.168
Maturity March 3, 1999 2,931,188 2,500,000 EU 1.172
CP Issue December 7, 1998 3,705,239 5,930,755 AUD 0.625
Maturity March 9, 1999 3,753,720 6,000,000 AUD 0.626
MTN Issue February 24, 1999 390,250,000 350,000,000 EU 1.115
Maturity February 24, 2006 390,250,000 350,000,000 EU 1.115
(1) CP - CFC Commercial Paper, MTN - CFC Medium Term Notes
(2) EU - Euros, AUD - Australian Dollars
CFC enters into a swap to sell the amount of foreign currency received from
the investor for US Dollars on the issuance date, and to buy the amount of
foreign currency required to repay the investor principal and interest due
through or on the maturity date. By locking in the exchange rates at the
time of issuance, CFC has eliminated the possibility of any currency gain or
loss which might otherwise have been produced by the foreign currency
borrowing. CFC includes the difference between the amount of US Dollars
received at issuance and the amount of US Dollars required to purchase the
foreign currency at the interest payment dates and at maturity as interest
expense.
Principal and interest is paid at maturity, which will range from 1 day to
270 days on CFC Commercial Paper investments. Interest is paid annually on
foreign currency denominated Medium-Term Notes with maturities longer than
one year. CFC will consider the cost of all related foreign currency swaps
as part of the total cost of debt issuance when deciding on whether to issue
debt in the US or foreign capital markets and whether to issue the debt
denominated in US or foreign currencies.
(11) Contingencies
(a) At February 28, 1999 and May 31, 1998, CFC had nonperforming loans in the
amount of $1.7 million and $4.1 million and restructured loans in the amount
of $584.2 million and $329.5 million, respectively. At both dates, all loans
classified as nonperforming were on a nonaccrual status with respect to the
recognition of interest income. CFC elected to apply all payments received
against principal outstanding on all nonperforming loans at both dates. All
loans classified as restructured were on a nonaccrual status with respect to
the recognition of interest income through January 31, 1999. All payments
received through January 31, 1999 were applied against principal outstanding.
On February 1, 1999, all restructured loans were placed on accrual status
with respect to the recognition of interest income. All payments received
after February 1, 1999 will be first applied against accrued interest with
all remaining amounts applied against principal outstanding. A total of $1.9
million of interest was accrued on restructured loans for the quarter and
nine months ended February 28, 1999.
(b) CFC classified $585.9 million and $333.6 million of the amount described
in footnote 11(a) as impaired with respect to the provisions of FASB Statements
No. 114 and 118 at February 28, 1999 and May 31, 1998, respectively. CFC had
allocated $135.0 million of the loan loss allowance for such impaired loans
at both dates. 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
accrued interest income totaling $1.9 million on loans classified as impaired
during the nine months ended February 28, 1999. All payments received prior
to February 1, 1999, were applied as a reduction of principal. The average
recorded investment in impaired loans for the nine months ended February 28,
1999 was $420.7 million compared to $345.3 million for the year ended May
31, 1998.
15
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
(c) On December 31, 1996 the Wabash Valley Power Association ("Wabash") plan
of reorganization became effective. Under the plan, CFC received a $4.9
million cash payment and offset $9.9 million of Wabash'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 at February 28, 1998. Wabash is current with respect to amounts due on
the notes. In April 1998, CFC received a payment of $0.7 million from Wabash
as its share of the proceeds from the sale of assets. In September 1998, CFC
wrote off the remaining $2.2 million of the loan outstanding to Wabash against
the loan loss reserve.
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 Wabash 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.
Subsequent to the end of the third quarter, CFC and RUS agreed upon the
amount required to true-up the post-petition, pre-confirmation payments made
by Wabash to both parties. On March 29, 1999, CFC wrote off $37.4 million
related to the true-up payment. At February 28, 1999, CFC had an $8.2 million
deferred gain related to the amounts received in the Wabash bankruptcy
settlement. This gain will be recognized as the amounts are paid to CFC. At
February 28, 1999, CFC had a specific reserve for Wabash that was sufficient to
cover the net write-off.
(d) Deseret Generation & Transmission Co-operative ("Deseret") is a power
supply member of CFC located in Utah. Deseret owns and operates the Bonanza
generating plant ("Bonanza") and 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. 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). 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. As a consequence, Deseret
and its creditors entered into several restructuring agreements.
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. Certain creditors did not
participate in the ORA which resulted in litigation.
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
16
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
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.
On December 4, 1998, CFC, Deseret, the Deseret member systems, and all other
parties involved in the ongoing litigation entered into a settlement
arrangement. The arrangement includes the following terms and conditions:
* a payment of $94 million was made to the owner of the Bonanza generating
plant ($80.0 million from the guarantor of the equity portion of the lease
payments, $10.4 million from CFC and $3.6 million from Deseret)
* the transfer of ownership of the plant to Deseret,
* dismissal of the foreclosure action as well as all cross and counter claims,
* the previous plant owner dropped all claims related to the tax
indemnification agreement,
* the ORA between CFC and Deseret remains substantially intact,
* a portion of the ORA payments from 2020 to 2025 will be shared with the
party that had guaranteed the equity portion of the lease payments,
* Deseret will be required to make additional payments based on excess
cashflow to the same party for the years 2026 to 2031, up to a maximum of
$439 million,
* as a result of the transfer of plant ownership, the 9.375% Bonanza Secured
Lease Obligation Bonds were redeemed on December 14, 1998.
On December 14, 1998, CFC effected the redemption of the Bonanza Secured
Lease Obligation Bonds. The amount advanced to redeem the bonds, $265.9
million ($255.1 million principal and $10.8 million of accrued interest),
becomes part of the outstanding loan balance to Deseret and is secured by
CFC's mortgage claim on all of Deseret's assets and future revenues. This
amount will be repaid through the annual ORA minimum and excess cashflow
payments Deseret is required to make to CFC through December 31, 2025.
On March 20, 1998, the City of Riverside, California ("Riverside") commenced
an action against Deseret in the United States District Court for the Central
District of California. Riverside is seeking (i) 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 California actions have been
dismissed. Currently, litigation is pending in the United States District
Court for the District of Utah.
Riverside has also filed a complaint with the Federal Energy Regulatory
Commission ("FERC"). A FERC mandated period for settlement discussions
ended on January 4, 1999, with no agreement between the parties. All
parties will now enter into a discovery period with a hearing before an
administrative law judge scheduled for May 25, 1999. The administrative law
judge 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 Power Sales Agreement requires Deseret to supply up to 52 MW to Riverside
through December 31, 2009. This contract represents approximately 10% 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.
Deseret is current on its minimum payment obligations to CFC. During calendar
1998, Deseret made quarterly payments of $35.5 million to CFC. In December
1998, Deseret made an excess payment of $2.0 million related to an equipment
lease and in February 1999 Deseret made a payment of $18.5 million
17
<PAGE>
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
Notes to Combined Financial Statements - (Continued)
representing excess cashflow for calendar year 1998. The entire amount of the
excess payment received in February 1999 was applied to principal, since that
amount was related to calendar year 1998. CFC placed the loans to Deseret on
accrual status, at a rate of 3.90% as of February 1, 1999. For the month of
February 1999, CFC accrued a total of $1.9 million of interest income related
to the Deseret loans. The rate at which interest accrues will be adjusted
from time to time as events require to reflect the current estimate of the
amount CFC expects to receive through December 31, 2025.
At February 28, 1999 and May 31, 1998, CFC had the following exposure to
Deseret:
(Dollar Amounts In Millions) February 28, 1999 May 31, 1998
Loans outstanding (1) $ 584.2 $ 329.5
Guarantees outstanding:
Tax-exempt bonds 3.2 4.1
Mine equipment leases 50.3 54.1
Bonanza plant lease - 258.0
Total Guarantees 53.5 316.2
Total Exposure $ 637.7 $ 645.7
(1) From January 1, 1989 through February 28, 1999, CFC has funded a total
of $449.4 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.
Subsequent to the end of the third quarter, on March 31, 1999, Deseret made
a payment of $8.6 million, the first quarterly payment for calendar year
1999. A total of $34.6 million is due from Deseret for minimum payments
during calendar year 1999.
Based on its analysis, CFC believes that it has adequately reserved for any
potential loss on its loans and guarantees to Deseret.
(e) Saluda River Electric Cooperative ("Saluda") is a generation
cooperative located in Laurens, SC. Saluda is experiencing cashflow
difficulties related to its minority interest in the Catawba nuclear
generating station. Saluda and RUS have agreed upon the basic terms of a
debt restructuring. As part of this agreement, on April 15, CFC will place
$36.6 million on deposit with the bond trustee to defease the tax-exempt
bonds guaranteed for Saluda. The bonds will be redeemed on August 15, 1999.
On April 15, 1999, CFC will receive a cash payment from Saluda and will
offset certain amounts Saluda has invested with CFC as part of the
transaction. CFC estimates that it will have a write-off of approximately
$21 million related to the Saluda transaction. CFC will have no exposure to
Saluda after April 15, 1999. At February 28, 1999, CFC had a total exposure
of $36.2 million to Saluda. All of CFC's exposure is related to the
guarantee of Saluda's debt service obligation on the tax-exempt pollution
control bonds.
(12) Loans Guaranteed by RUS
At February 28, 1999 and May 31, 1998, CFC held $130.9 million and $133.2
million, respectively, 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.
18
<PAGE>
Part I. Item 2.
Management's Discussion and Analysis of Financial Condition and Results of
Operations.
(all dollar amounts in millions)
The management discussion and analysis contains statements that may be
considered forward looking. In making these statements, CFC has made an
evaluation of estimates and assumptions discussed in this presentation,
which could cause the actual results to differ materially.
Financial Condition
At February 28, 1999, CFC had $13,491 in total assets an increase of $2,808
or 26% over May 31, 1998. Net loans outstanding to members totaled $13,062
at February 28, 1999 an increase of $2,733 compared to a total of $10,329 at
May 31, 1998. Net loans represented 97% of total assets at February 28, 1999
and May 31, 1998. The remaining assets $429 and $354 at February 28, 1999
and May 31, 1998, respectively, consisted of other assets to support CFC's
operations. Except as required for the debt service account and unless
excess cash is invested overnight, generally CFC does not use funds to invest
in debt or equity securities.
Loans Outstanding at:
February 28, May 31,
1999 1998 Inc/(Dec)
Long-term Loans:
Electric $ 8,932.8 $ 7,499.5 $ 1,433.3
Telephone 2,210.3 1,354.3 856.0
Total Long-term Loans 11,143.1 8,853.8 2,289.3
Intermediate-term Loans:
Electric 273.6 349.3 (75.7)
Telephone 13.6 15.6 (2.0)
Total Intermediate-term Loans 287.2 364.9 (77.7)
Short-term Loans:
Electric 837.7 689.0 148.7
Telephone 341.0 205.0 136.0
Total Short-term Loans 1,178.7 894.0 284.7
RUS Guaranteed Loans 130.9 133.2 (2.3)
Non-performing Loans 1.7 4.1 (2.4)
Restructured Loans 584.3 329.5 254.8
Total Loans $ 13,325.9 $ 10,579.5 $ 2,746.4
Percentage of loans with
a fixed interest rate 64% 46% 18 %
Percentage of loans with
a variable interest rate 36% 54% (18)%
There were a number of reasons underlying the increased demand for CFC loan
advances, including (1) the strong economy, which has spurred construction
and business development; (2) RUS waiting periods are at an all time high,
which caused more borrowers to buyout their RUS debt and/or make greater use
of CFC 100% loan funds; (3) a large number of systems have bought out their
RUS debt over the last few years, requiring them to seek non-RUS financing;
(4) some borrowers have begun to expand and diversify their operations
through acquisitions and mergers; and (5) growth in demand for both existing
and new telecommunications technologies.
Long-term loans (excluding loans guaranteed by RUS) represented 84% of loans
outstanding at February 28, 1999 and May 31, 1998. Long-term fixed rate loans
represented 64% and 46% of the total loans at February 28, 1999 and May 31,
1998, respectively. Loans converting from a variable rate to a fixed rate
for the nine months ended February 28, 1999 totaled $1,610, an increase
from the $1,069 that converted for the year ended May 31, 1998. Offsetting
the conversions to the fixed rate were $53 and $19 of loans that converted
from the fixed rate to the variable for the nine months ended February 28,
1999, and the year ended May 31, 1998, respectively. This resulted in a net
conversion of $1,557 from the variable rate to a fixed rate for the nine
months ended February 28, 1999 compared to a net conversion of $1,050 for
the year ended May 31, 1998.
19
<PAGE>
Guarantees Outstanding at:
February 28, May 31,
1999 1998 Inc/(Dec)
Tax Exempt Bonds $ 1,111.2 $ 1,148.5 $ (37.3)
Lease Transactions 173.8 437.2 (263.4)
Indemnifications of
"Safe Harbor" Leases 290.0 312.8 (22.8)
Other Guarantees 153.1 136.0 17.1
Total $ 1,728.1 $ 2,034.5 $ (306.4)
The decrease in guarantees outstanding for the nine months ended February 28,
1999, was primarily due to the redemption of the bonds used to finance the
Deseret Bonanza generating plant. CFC guaranteed Deseret's lease obligations
to a third party in a leveraged lease transaction. A total of $255 of bonds
were redeemed as part of the settlement agreement reached between Deseret and
its creditors in December 1998. The remaining reduction to the guarantee
balances was a result of regularly scheduled payments on tax-exempt pollution
control bonds, leverage leases and reduction to the amounts guaranteed under
safe harbor leases.
At February 28, 1999, CFC had also committed to lend $11,609 to its members,
an increase of $2,764 over the balance of $8,845 committed at May 31, 1998.
Unadvanced commitments include loans approved by CFC for which loan contracts
have not yet been executed or for which contracts have been executed, but
funds have not been advanced. The majority of the short-term unadvanced
commitments provide backup liquidity to CFC borrowers, and therefore CFC
does not anticipate funding most of such commitments. Approximately 41% of
the outstanding commitments at February 28, 1999 were for short-term or line
of credit loans. To qualify for the advance of funds under all commitments,
a borrower must assure CFC that there has been no material change since the
loan was approved. The increase to commitments during the nine months ended
February 28, 1999, was due to the Power Vision program. Power Vision is a
program under which CFC performed a review of its borrowers and pre-approved
additional loan funds for a number of borrowers.
Total Credit Committed at:
February 28, May 31,
1999 1998 Inc/(Dec)
Loans $ 13,325.9 $ 10,579.5 $ 2,746.4
Unadvanced Commitments 11,609.1 8,845.2 2,763.9
Guarantees 1,728.1 2,034.5 (306.4)
Total $ 26,663.1 $ 21,459.2 $ 5,203.9
At February 28, 1999, total credit commitments outstanding represented an
increase of 24% over the total at May 31, 1998.
Liabilities and Members' Equity totaled $13,491 at February 28, 1999 an
increase of $2,808 or 26% over the balance of $10,683 at May 31, 1998.
The increase to total liabilities and Members' Equity for the nine months
ended February 28, 1999 was primarily due to increases in short- and
long-term debt required to fund the increase in loans outstanding. Total
debt outstanding at February 28, 1999 was $11,793 an increase of $2,720 over
the May 31, 1998 balance of $9,073.
20
<PAGE>
Debt Outstandi
February 28, May 31,
1999 1998 Inc/(Dec)
Notes Payable
Commercial Paper $ 5,647.4 $ 5,680.9 $ (33.5)
Bank Bid Notes 130.0 185.0 (55.0)
Medium-Term Notes 972.0 327.3 644.7
Long-Term debt maturing
within one year 150.0 - 150.0
Commercial Paper
reclassified as L/T (2,402.5) (2,345.0) (57.5)
Total Notes Payable 4,496.9 3,848.2 648.7
Long-Term Debt
Collateral Trust Bonds 2,846.1 1,897.7 948.4
Medium-Term Notes 1,647.8 781.9 865.9
Commercial Paper
reclassified as L/T 2,402.5 2,345.0 57.5
Total Long-Term Debt 6,896.4 5,024.6 1,871.8
QUICS 400.0 200.0 200.0
Total Debt Outstanding $ 11,793.3 $ 9,072.8 $ 2,720.5
Percentage of Short-Term Debt 38% 42% (4)%
Percentage of Long-Term Debt 62% 58% 4 %
Percentage of Fixed Rate Debt (1) 58% 39% 19 %
Percentage of Variable Rate Debt (2) 42% 61% (19)%
1) Includes fixed rate Collateral Trust Bonds, Dealer Medium-Term Notes and
QUICS plus Commercial Paper with rates fixed through interest rate
exchange agreements.
2) The rate on Commercial Paper notes does not change once the note has been
issued. However, the rates on new Commercial paper notes change daily
and Commercial Paper notes generally have maturities of less than 90 days.
Therefore, Commercial Paper notes are considered to be variable rate debt
by CFC.
As a result of the conversion of loans from the long-term variable interest
rate to the long-term fixed interest rate, the portion of the total loan
portfolio carrying a variable interest rate has decreased significantly
during the first nine months of fiscal year 1999, from 54% at May 31, 1998
to 36% at February 28, 1999. During the nine months ended February 28, 1999,
CFC's debt funding has changed in line with the loan portfolio. The balance
of fixed rate debt has increased due to increased issuance of Collateral
Trust Bonds and Medium-Term Notes and the balance of Commercial Paper
outstanding has decreased.
CFC has issued Medium-Term Notes and Commercial Paper in the European capital
markets during the nine months ended February 28, 1999. At February 28, 1999,
CFC had a total of $249 in European Commercial Paper outstanding, an increase
of $167 over the May 31, 1998 balance of $82. At February 28, 1999, CFC had
a total of $735 of European Medium-Term Notes, an increase of $485 over the
May 31, 1998 balance of $250.
21
<PAGE>
Members' Subordinated Certificates and Members' Equity Outstanding at:
February 28, May 31,
1999 1998 Inc/(Dec)
Subordinated Certificates
Membership Certificates $ 644.8 $ 644.8 $ -
Loan Certificates 417.4 355.7 61.7
Guarantee Certificates 182.8 228.7 (45.9)
Total Certificates 1,245.0 1,229.2 15.8
Equity
Memberships 1.5 1.5 -
Allocated Margins 217.8 274.8 (57.0)
Education Fund 0.4 0.6 (0.2)
Year-to-date Unallocated Margins 59.0 2.3 56.7
Total Equity 278.7 279.2 (0.5)
Total Equity and Certificates $ 1,523.7 $ 1,508.4 $ 15.3
Membership certificates are required to be purchased as a condition of
becoming a CFC member. The majority of membership certificates outstanding
and all new membership certificates have a maturity of 100 years and pay
interest at 5%. A small portion of membership certificates have a maturity
of 50 years and pay interest at a rate of 3%. Members are required to
purchase certificates with each new loan and guarantee, depending on the
borrower's internal leverage ratio with CFC. Subordinated Certificates are
junior to all debt instruments used by CFC.
Cooperatives are required to pay a one-time fee to become a member. The fee
varies from two hundred dollars to a thousand dollars depending on the
membership class. CFC maintains current year net margins as unallocated
through the end of its fiscal year. All net margins earned for the year are
allocated back to the members. A small portion of annual net margins is
placed in the education fund, which is distributed to the statewide
cooperatives to assist with the teaching of cooperative principles. CFC
immediately retires 70% of the allocated net margins for the prior year and
holds the remaining 30% as allocated margins, which are currently retired
after 15 years. All retirements of allocated margins are subject to approval
by the board of directors. CFC does not pay interest on the allocated but
unretired margins.
The increase to Members' Subordinated Certificates and Equity for the nine
months ended February 28, 1999 is due to the issuance of new loan
certificates related to loan advances and current year net margins offset by
the redemption of certificates related to guarantees and the retirement of
patronage capital.
CFC's leverage ratio increased during the nine months ended February 28, 1999
from 6.37 at May 31, 1998, to 6.84 at February 28, 1999. The ratio is
calculated after excluding from debt the Quarterly Income Capital Securities
and all debt associated with the funding of the RUS 100% guaranteed loans.
Members' Subordinated Certificates and Quarterly Income Capital Securities
are treated as equity in the calculation of the leverage ratio. The increase
in the leverage ratio was primarily due to an increase in loans outstanding
to members financed by the issuance of debt issued to members and in the
capital markets partially offset by the issuance of the $200 million in
Quarterly Income Capital Securities. CFC contemplates that its leverage
ratio will continue to increase modestly as it obtains external capital to
accommodate its loan growth. CFC will retain the flexibility to further
amend its capital retention policies to retain members' investments in CFC
consistent with maintaining acceptable financial ratios.
CFC's debt/equity ratio increased from 4.51 at May 31, 1998, to 5.23 at
February 28, 1999. The ratio is calculated by dividing debt outstanding,
excluding Quarterly Income Capital Securities and debt used to fund loans
guaranteed by RUS, by the total of Members' Subordinated Certificates,
Members' Equity, the loan loss allowance and Quarterly Income Capital
Securities.
22
<PAGE>
Margin Analysis
CFC uses an interest coverage ratio instead of the dollar amount of gross or
net margins as its primary performance indicator, since CFC's net margins
are subject to fluctuation as interest rates change. Management has
established a 1.10 Times Interest Earned Ratio ("TIER") as its minimum
operating objective. CFC has earned a TIER of 1.12 for the nine months
ended February 28, 1999 and for the year ended May 31, 1998. TIER is a
measure of CFC's ability to cover the interest expense on funding.
Results for nine months ended February 28, 1999 versus February 28, 1998
Net margins for the nine months ended February 28, 1999, were $57, an
increase of $11 over the $46 earned the prior year.
Net margins for the nine months ended:
February 28, February 28,
1999 1998 Inc/(Dec)
Interest Income $ 572.5 $ 466.1 $ 106.4
Cost of Funds 483.2 396.4 86.8
Gross Margin 89.3 69.7 19.6
General & Admin Expenses 18.1 15.7 2.4
Loan Loss Provision 15.8 15.1 0.7
Total Expenses 33.9 30.8 3.1
Operating Margin 55.4 38.9 16.5
Non-operating Income 1.3 6.7 (5.4)
Net Margin $ 56.7 $ 45.6 $ 11.1
TIER 1.12 1.12 -
Net margins expressed as a percentage of average loans outstanding for
the nine months ended:
February 28, February 28,
1999 1998 Inc/(Dec)
Interest Income 6.53% 6.60% (0.07)%
Cost of Funds 5.51% 5.61% (0.10)%
Gross Margin 1.02% 0.99% 0.03 %
General & Admin Expenses 0.21% 0.22% (0.01)%
Loan Loss Provision 0.18% 0.21% (0.03)%
Total Expenses 0.39% 0.43% (0.04)%
Operating Margin 0.63% 0.56% 0.07 %
Non-operating Income 0.01% 0.09% (0.08)%
Net Margin 0.64% 0.65% (0.01)%
Average loan volume for the nine months ended February 28, 1999 totaled
$11,719, an increase of $2,275 or 24% over the average loan balance of
$9,444 for the prior year period. The increase to net margins for the nine
month period ended February 28, 1999 was due to the increase in loan volume
offset by a reduction in non-operating income as compared to the prior year
period. The average yield earned on the loan portfolio has decreased
slightly as has the average cost of funds due to reduction in interest rates
in the capital markets during the nine months ended February 28, 1999. While
the total dollar amount of operating expenses and provision to the loan loss
have increased, the percentage of average loan volume represented by these
amounts has decreased slightly compared to the prior year. The total amount
of net margins has increased by $11 over the prior year, but the current net
margin represents a slightly lower percentage of average loan volume
compared to the prior year.
23
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Loan and Guarantee Portfolio Assessment
Portfolio Diversity
CFC and its combined affiliates make loans and provide financial guarantees
to their qualified members. The combined memberships include rural electric
distribution systems, rural electric generation and transmission systems,
telecommunication systems, statewide rural electric and telecommunication
associations and associate organizations.
The following chart summarizes loans and guarantees outstanding by member
class at February 28, 1999 and May 31, 1998.
Percentage of Total
February 28, 1999 May 31, 1998
Electric Systems:
Distribution 57.04% 57.59%
Power Supply 23.35% 27.59%
Service Organizations 1.91% 1.53%
Associate Members 0.66% 0.80%
Subtotal Electric Systems 82.96% 87.51%
Telecommunication Systems:
Local Exchange Carrier 7.77% 6.43%
Cable 0.65% 0.75%
Cellular 1.52% 1.21%
Personal Communications Systems 1.73% 0.89%
Other 5.37% 3.21%
Subtotal Telecommunication Systems 17.04% 12.49%
Total 100.00% 100.00%
Credit Concentration
In addition to the geographic diversity of the portfolio, CFC limits its
exposure to any one borrower. The majority of the largest exposures are
concentrated in the power supply systems due to their large plant and
equipment requirements. At February 28, 1999, the total exposure outstanding
to any one borrower did not exceed 4% of total loans (excluding loans
guaranteed by RUS) and guarantees outstanding. At February 28, 1999, CFC
had $1,968 in loans outstanding, excluding loans guaranteed by RUS, and $708
in guarantees outstanding to its largest 10 borrowers. The amounts outstanding
to the largest 10 borrowers at February 28, 1999 represented 15% of total
loans outstanding and 37% of total guarantees outstanding. Total credit
exposure to the largest 10 borrowers represented 17.6% of total credit
exposure at February 28, 1999, compared to 19% at May 31, 1998. The largest
10 borrowers include 4 distribution systems, 5 power supply systems and 1
telephone system of total loans and guarantees.
Security Provisions
Except when providing lines of credit, CFC typically lends to its members on
a secured basis. At February 28, 1999, a total of $1,192 of loans were
unsecured representing 8.9% of total loans and 7.8% of total loans and
guarantees. Approximately $131 or 11.0% of the unsecured loans represent
obligations of distribution borrowers for the initial phase(s) of RUS note
buyouts. Upon completion of a borrower's buyout from RUS, CFC receives
first lien security on all assets and future revenues. The unsecured loans
would represent 8.0% of total loans and 7.0% of total loans and guarantees
if these partial note buyout obligations were excluded. CFC's long-term
loans are typically secured, pro-rata with any other secured lenders
(primarily RUS) by all assets and future revenues of the borrower.
Short-term loans are generally unsecured lines of credit. Guarantees are
secured on a pro-rata basis with other secured creditors by all assets and
future revenues of the borrower or by the underlying financed asset.
In addition to the collateral received, CFC also requires that its borrowers
set rates designed to achieve certain financial ratios.
24
<PAGE>
Nonperforming and Restructured Loans
CFC classifies a borrower as nonperforming when any one of the following
criteria are met: (1) principal or interest payments on any loan to the
borrower are past due 90 days or more, (2) as a result of court proceedings,
repayment with the original terms is not anticipated, or (3) for some other
reason, management does not expect the timely repayment of principal or
interest. Once a borrower is classified as nonperforming, interest on its
loans is recognized on a cash basis. Alternatively, CFC may choose to apply
all cash received to the reduction of principal, thereby foregoing interest
income recognition. At February 28, 1999, all nonperforming loans were on
non-accrual status with respect to interest income. At February 28, 1999,
nonperforming loans totaled $2, a decrease of $2 from May 31, 1998. The
decrease was due to the settlement of loans outstanding to one borrower and
principal repayments received during the year.
Loans classified as restructured are loans for which agreements have been
executed that change the original terms of the loan, generally a change to
the originally scheduled cashflows. At February 28, 1999, restructured
loans totaled $584, an increase of $254 from May 31, 1998. The increase was
due to an increase in the amount of a restructured loan relating to one
borrower (see footnote 11). From June 1, 1998 to January 31, 1999, all
restructured loans were on a nonaccrual basis with respect to the recognition
of interest income. On February 1, 1999, CFC placed all restructured loans
on an accrual basis at a rate of 3.9%.
NONPERFORMING AND RESTRUCTURED ASSETS
February 28, 1999 May 31, 1998
Nonperforming loans $ 1.7 $ 4.1
Percent of loans and guarantees outstanding 0.01% 0.03%
Restructured loans $ 584.2 $ 329.5
Percent of loans and guarantees outstanding 3.88% 2.61%
Total nonperforming and restructured loans $ 585.9 $ 333.6
Percent of loans and guarantees outstanding 3.89% 2.64%
Allowance for Loan Losses
CFC maintains an allowance for potential loan losses which is periodically
reviewed by management for adequacy. 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. At February 28,
1999, the allowance for loan losses totaled $264, a net increase of $14 from
May 31, 1998. The allowance represented 45.1% of nonperforming and
restructured loans and 1.75% of total loans and guarantees outstanding at
year-end.
During the nine months ended February 28, 1999, CFC charged off $2 in loans
related to the settlement for one borrower and recovered $0.3 of amounts
previously written off related to another borrower.
Since its inception in 1969, CFC has charged off loan balances in the total
amount of $32 net of recoveries. Management believes that the allowance for
loan losses is adequate to cover any portfolio losses which may occur. The
following chart presents a summary of the allowance for loan losses at
February 28, 1999 and May 31, 1998.
25
<PAGE>
ALLOWANCE FOR LOAN LOSSES
February 28, 1999 May 31, 1998
Beginning balance $ 250.1 $ 233.2
Provision for loan losses 15.8 19.0
Charge-offs, net of recoveries (1.9) (2.1)
Ending balance $ 264.0 $ 250.1
As a percentage of gross loans outstanding 1.98% 2.36%
As a percentage of gross loans and
guarantees outstanding 1.75% 1.98%
As a percentage of total nonperforming and
restructured loans outstanding 45.06% 74.98%
Subsequent to the end of the third quarter on March 29, 1999, CFC wrote off
$37 related to the Wabash bankruptcy true up payment to RUS. CFC has taken
net write-offs of $35 related to the Wabash bankruptcy. The net write-off
is a combination of three write-offs, the $37 in March 1999, $2 in September
1998 and $9 in 1992 offset by $13 of notes receivable from Wabash. At
February 28, 1999, CFC had received approximately $5 on the notes receivable,
leaving an outstanding balance of $8. All amounts received from Wabash on
the notes will be applied as a recovery of amounts previously written off.
At February 28, 1999, CFC had a specific reserve for Wabash that was
sufficient to cover the net amount written off.
On April 15, 1999, CFC anticipates a write-off related to the restructuring
of Saluda's debt. CFC has guaranteed the debt service on a tax-exempt bond
issue for Saluda. As part of a debt restructuring agreement, CFC will
deposit funds with the bond trustee to defease the bonds. CFC will receive
a cash payment from Saluda and take a portion of Saluda's investment in
Subordinated Certificates as an offset. CFC estimates that a write-off of
approximately $21 will be taken related to this transaction. At February 28,
1999, CFC had an amount reserved for Saluda that was sufficient to cover this
write-off.
Asset/Liability Management
A key element of CFC's funding operations is the monitoring and management
of interest rate and liquidity risk. This process involves controlling asset
and liability volumes, repricing terms and maturity schedules to stabilize
gross operating margins and retain liquidity.
Match Funding Policy
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 next year. It is CFC's policy to manage asset and
liability repricing terms within a range of 5% of total assets. At February
28, 1999, CFC had $505.8 in fixed rate assets amortizing or repricing and
$226.0 in fixed rate liabilities maturing during the next 12 months. The
difference, $279.8, represents the fixed rate assets in excess of the fixed
rate debt maturing during the next 12 months. This difference of $279.8 at
February 28, 1999 represents 2.1% of total assets. CFC funds variable rate
assets which reprice monthly with short-term liabilities, primarily
Commercial Paper and Bank Bid Notes, both of which are issued primarily with
original maturities under 90 days. CFC funds fixed rate loans with fixed
rate Collateral Trust Bonds, Medium-Term Notes, Quarterly Income Capital
Securities, Members' Subordinated Certificates and Members' Equity. With
the exception of Members' Subordinated Certificates, which are generally
issued at rates below CFC's long-term cost of funding and with extended
maturities and Commercial Paper, CFC's liabilities have average maturities
that closely match the repricing terms of CFC's fixed interest rate loans.
CFC also uses Commercial Paper supported by interest rate exchange agreements
to fund its portfolio of fixed rate loans.
Certain of CFC's Collateral Trust Bonds and Medium-Term Notes were issued
with early redemption provisions. To the extent borrowers are allowed to
convert their fixed rate loans to a variable interest rate and to the extent
it is beneficial, CFC takes advantage of these early redemption privileges.
However, because conversions can take place at
26
<PAGE>
different intervals from early redemptions, CFC charges conversion fees
designed to compensate for any additional interest rate risk assumed by the
Company.
CFC makes use of an interest rate analysis in the funding of its long-term
fixed rate loan portfolio. The analysis compares the scheduled fixed rate
loan amortizations and repricings against the scheduled fixed rate debt and
Members' Subordinated Certificate amortizations to determine the fixed rate
funding gap for each individual year and for the portfolio as a whole.
There are no scheduled maturities for the Members' Equity, primarily unretired
patronage capital allocations. The balance of Members' Equity is assumed to
remain relatively stable since annual retirements are approximately equal to
the annual allocation of net margins. The non-amortizing Members'
Subordinated Certificates either mature at the time of the related loan or
guarantee or 100 years from issuance, (50 years in the case of a small
portion of certificates). Accordingly, it is assumed in the funding analysis
that non-amortizing Members' Subordinated Certificates and Members' Equity
are first used to "fill" any fixed rate funding gaps. The remaining gap
represents the amount of excess fixed rate funding due in that year or the
amount of fixed rate assets that are assumed funded by short-term variable
rate debt, primarily Commercial Paper. The interest rate associated with
the assets and debt maturing or equity and certificates is used to calculate
a TIER for each year and for the portfolio as a whole. The schedule allows
CFC to analyze the impact on the over all TIER of issuing a certain amount
of debt at a fixed rate for various maturities, prior to issuance of the
debt. The following chart shows the scheduled amortization and maturity of
fixed rate asset and liabilities outstanding at February 28, 1999.
<TABLE>
<CAPTION>
INTEREST RATE GAP ANALYSIS
(Fixed Assets/Liabilities)
As of February 28, 1999
Over 1 yr. Over 3 yrs. Over 5 yrs. Over 10 yrs.
Less than but less but less but less but less Over
1 year than 3 yrs. than 5 yrs. than 10 yrs. than 20 yrs. 20 yrs. Total
<S> <C> <C> <C> <C> <C> <C> <C>
Assets:
Loan Amortization
and repricing $ 505.8 $ 982.8 $ 1,459.8 $ 2,564.3 $ 2,305.0 $ 1,031.4 $ 8,849.1
Total Assets $ 505.8 $ 982.8 $ 1,459.8 $ 2,564.3 $ 2,305.0 $ 1,031.4 $ 8,849.1
Liabilities and Equity:
Long-Term Debt $ 219.2 $ 1,025.8 $ 1,341.4 $ 2,410.8 $ 1,034.4 $ 512.8 $ 6,544.4
Subordinated Certificates 6.8 23.2 32.8 38.0 422.1 381.6 904.5
Members' Equity - - - - 397.0 232.7 629.7
Total Liabilities and Equity $ 226.0 $ 1,049.0 $ 1,374.2 $ 2,448.8 $ 1,853.5 $ 1,127.1 $ 8,078.6
Gap * $ (279.8) $ 66.2 $ (85.6) (115.5) $ (451.5) $ 95.7 $ (770.5)
Cumulative Gap $ (279.8) $ (213.6) $ (299.2) $ (414.7) $ (866.2) $ (770.5)
Cumulative Gap as a %
of Total Assets 2.07% 1.58% 2.22% 3.07% 6.42% 5.71%
</TABLE>
* Loan amortization/repricing over/(under) debt maturities
Derivative and Financial Instruments
At February 28, 1999 and May 31, 1998, CFC was a party to interest rate
exchange agreements totaling $2,777.8 and 753.7, 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 both of the above dates, CFC was using interest
rate exchange agreements to fix the interest rate on $1,977.8 as of February
28, 1999 and $603.7 as of May 31, 1998 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 $800.0 and
$150.0 of Collateral Trust Bonds and Medium-Term Notes, respectively, were
issued and CFC's variable commercial paper rate. All of CFC's derivative
financial instruments were held for
27
<PAGE>
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.
At February 28, 1999, CFC was a party to $6.6 in foreign currency exchange
agreements related to CFC's sale of Commercial Paper denominated in foreign
currencies. At February 28, 1999 CFC had two foreign denominated Commercial
Paper notes outstanding, one note for $2.9 denominated in Euros maturing on
March 3, 1999 and one note for $3.7 denominated in Australian Dollars
maturing on March 9, 1999. When CFC sells a Commercial Paper note
denominated in a foreign currency, it will immediately enter into a foreign
currency exchange agreement to sell the foreign currency received from the
investor and will also enter into a foreign currency exchange agreement to
buy the amount of principal and interest due to the investor on maturity.
Thus the cost of the note is locked in on the day that the note is sold,
eliminating any gain or loss from changes in the foreign currency exchange
rates. If at the time of issuance, the all-in cost of issuing the note in
a foreign currency is not comparable to the cost of issuing in US dollars,
CFC will not sell the foreign denominated note. CFC will also not sell the
Commercial Paper in a foreign currency if it is unable to enter into the
foreign currency exchange agreements at the time of issuance.
At February 28, 1999, CFC had one foreign denominated Medium-Term Note
outstanding for $390.0 denominated in Euros maturing on February 24, 2006.
CFC has entered into a currency exchange agreement that will fix the exchange
rate for all payments of principal and interest related to this Medium-Term
Note.
Market Risk
CFC's primary market risk exposure is interest rate risk. A secondary risk
exposure is liquidity risk. CFC is also exposed to counterparty risk related
to the interest rate exchange agreements it has entered.
The interest rate risk exposure is related to the funding of the fixed rate
loan portfolio. CFC does not match fund the majority of its fixed rate loans
with a specific debt issuance at the time the loan is advanced. CFC
aggregates fixed rate loans until the volume reaches a level that will allow
an economically efficient issuance of debt. CFC uses fixed rate Collateral
Trust Bonds, Medium-Term Notes, Quarterly Income Capital Securities, Members'
Subordinated Certificates, Member's' Equity and variable rate debt to fund
fixed rate loans. CFC allows borrowers flexibility in the selection of the
period for which a fixed interest rate will be in effect. Long-term loans
typically have a 15 to 35 year maturity. Borrowers may select fixed interest
rates for periods of one year through the life of the loan. To mitigate
interest rate risk related to the funding of fixed rate loans, CFC performs
a monthly gap analysis, a comparison of fixed rate assets repricing or
maturing by year to fixed rate liabilities and equity maturing by year
(see chart on page 27). The analysis will indicate the total amount of
fixed rate loans maturing by year and in aggregate that are assumed to be
funded by variable rate debt. CFC's funding objective is to limit the total
amount of fixed rate loans that are funded by variable rate debt to 5% or
less of total assets. At February 28, 1999 and May 31, 1998 fixed rate
loans funded by variable rate debt represented 5.7% and 2.7%, respectively,
of total assets. CFC has decided to temporarily allow the percentage of
fixed rate loans funded with variable rate debt to slightly exceed the policy
limit of 5%. The reasons for this action include the following:
(1) the stable short-term interest rate environment,
(2) the decision not to fix the rate on funding for a total of $430 of fixed
rate loans scheduled to amortize and/or reprice over the next twelve
months, and
(3) the decision not to fix the rate on funding for $584 of restructured loans
that are accruing interest at a rate of 3.90%.
The interest rate risk is minimal on variable rate loans, since the loans
are priced monthly based on the cost of the debt used to fund the loans.
CFC uses variable rate debt, non-interest bearing Members' Subordinated
Certificates and Members' Equity to fund variable rate loans. At February
28, 1999 and May 31, 1998, 36% and 54%, respectively, of loans carry a
variable interest rate.
CFC faces liquidity risk in the funding of its variable rate loans and in
being able to obtain the funds required to meet the loan requests of its
members or conversely, having funds to repay debt obligations when they are
due. CFC offers variable rate loans with maturities of up to 35 years.
These loans are funded by variable rate Commercial Paper, Bank Bid Notes,
Collateral Trust Bonds and Medium-Term Notes; non-interest bearing Members'
Subordinated Certificates and Members' Equity. The average maturity of
Commercial Paper and Bank Bid Notes is typically about 30 to 35
28
<PAGE>
days. The Collateral Trust Bonds and Medium-Term Notes are issued for longer
periods, but typically much shorter than the maturity of the loans. Loan
Subordinated Certificates are issued for the same period as the related loan.
Thus CFC is at risk if it is unable to continually roll over its Commercial
Paper balances or issue other forms of variable rate debt to support its
variable rate loans. To mitigate liquidity risk, CFC maintains back-up
liquidity through revolving credit agreements with domestic and foreign banks.
At February 28, 1999 and May 31, 1998, CFC had a total of $4,793 and $5,218,
respectively in revolving credit agreements and bank lines of credit. To
facilitate entry into the debt markets, CFC maintains high credit ratings on
all of its debt issuances from three credit rating agencies (see chart
below). CFC also maintains shelf registrations with the SEC for its
Collateral Trust Bonds, Medium-Term Notes and Quarterly Income Capital
Securities. At February 28, 1999 and May 31, 1998, CFC had active shelf
registrations totaling $700 and $300 related to Collateral Trust Bonds,
$185 and $1,264 related to Medium-Term Notes and $100 and $50 related to
Quarterly Income Capital Securities. All of the registrations allow for
issuance of the related debt at both variable and fixed interest rates. CFC
also has Commercial Paper and Medium-Term Note issuance programs in Europe.
At February 28, 1999 and May 31, 1998, CFC had $249 and $82 of Commercial
Paper and $735 and $250 of Medium-Term Notes, respectively, outstanding to
European investors. CFC has issuance authority of $1,000 related to
Commercial Paper and $1,000 related to Medium-Term Notes under these
programs.
CFC is exposed to counterparty risk related to the performance of the
parties with which it has entered into interest rate exchange agreements.
To mitigate this risk, CFC only enters into interest rate exchange
agreements with highly rated counterparties. At February 28, 1999 and May
31, 1998, CFC was a party to $2,778 and $754, respectively, of interest
rate exchange agreements. To date, CFC has not experienced a failure of a
counterparty to perform as required under the interest rate exchange
agreement. At February 28, 1999, CFC's interest rate exchange agreement
counter parties had credit ratings ranging from A to AAA as assigned by
Standard & Poor's Corporation.
Credit Ratings
CFC's long- and short-term debt and guarantees are rated by three of the
major credit rating agencies, Moody's Investors Service ("Moody's"),
Standard & Poor's Corporation ("S&P") and Fitch Investors Service ("Fitch").
The following table presents CFC's credit ratings at February 28, 1999.
Moody's Standard & Fitch
Investors Poors Investors
Service Corporation Service
Direct
Collateral Trust Bonds Aa3 AA AA
Domestic and European Medium-Term Notes A1 AA- AA-
Quarterly Income Capital Securities A2 A+ A+
Domestic and European Commercial Paper P1 A-1+ F-1+
Guarantees
Leveraged Lease Debt A1 AA- AA-
Pooled Bonds Aa3 AA- AA-
Other Bonds A1 AA- AA-
Short-Term P1 A-1+ F-1+
The ratings listed above have the meaning as defined by each of the
respective rating agencies, are not recommendations to buy, sell or hold
securities and are subject to revision or withdrawal at any time by the
rating organizations.
29
<PAGE>
Member Investments
At February 28, 1999 and May 31, 1998, CFC's members provided 21.8% and 27.8%
of total capitalization as follows:
February 28, % of May 31, % of
1999 Total(1) 1998 Total(1)
Commercial Paper $ 1,175 21.0% $ 1,196 21.0%
Medium-Term Notes 206 7.9% 240 21.6%
Members' Subordinated
Certificates 1,245 100.0% 1,229 100.0%
Members' Equity 279 100.0% 279 100.0%
Total $ 2,905 $ 2,944
(1) Represents the percentage of each line item outstanding to CFC members.
The total amount of member investments was approximately the same at February
28, 1999, and May 31, 1998. Total member investment as a percentage of total
capitalization decreased due to the increase in nonmember debt required to
fund the growth in loans. Total capitalization at February 28, 1999 was
$13,317, an increase of $2,736 over the total capitalization of $10,581 at
May 31, 1998. When the loan loss allowance is added to both membership
contributions and total capitalization, the percentages of membership
investments to total capitalization are 23.3% and 29.5% at February 28, 1999
and May 31, 1998, respectively. Due to recent policy changes that have
reduced Members' Subordinated Certificate purchase requirements and
accelerated Patronage Capital retirements, CFC expects the percentage of
capitalization provided by its members to continue to decline.
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
CFC has completed steps 1 through 4 for its business critical systems. CFC
has upgraded its HP servers with new and more powerful HP servers. The
primary reason for the upgrade was that business requirements had exceeded
the capacity of the old servers. The new servers, which are year 2000
compliant, came loaded with the newest version of the UNIX operating system,
which is also year 2000 compliant. CFC has also received a free upgrade of
its data base software, the new version of which is year 2000 compliant.
Due to the above actions, CFC's operating system equipment and software is
year 2000 compliant. All business applications are currently being tested
for functionality on the new server and software. CFC's local area network
and NT operating systems are all year 2000 compliant.
CFC has three core business critical applications, a loan accounting system,
a treasury system and a customer information system. The customer
information system was developed in-house and is believed to be compliant.
We have received compliant versions of the loan accounting and the treasury
systems from the vendors. The functionality testing for all three systems
has been completed. CFC is currently performing parallel testing on these
applications. Upon completion of all parallel testing, CFC will conduct its
own year 2000 testing. Testing is scheduled to be completed by October 1999.
Each business application owner has developed a test plan and contingency
plan. A majority of the other business systems used by CFC have been tested
and deemed compliant by CFC. Any systems that have not been tested will be
tested soon after the completion of the functionality testing on the new
server has been completed. All test plans
30
<PAGE>
and results have been documented. The contingency plans will be maintained
as part of the over remediation
effort documentation.
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 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.
At this time, CFC can not estimate the potential impact of year 2000 related
problems on its electric and telecommunications borrowers. CFC will require
its borrowers to provide details of their compliance effort in the officers'
certificate for the year ended December 31, 1998. The majority of these
letters have been mailed at this time. Once the member responses 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.
31
<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
B. Reports on Form 8-K.
Item 7 on December 7, 1998 - Filing of Purchase Agreement for 5.75%
Medium-Term Notes, due 2008.
Item 7 on January 12, 1999 - Filing of Underwriting Agreement for 5.50%
Collateral Trust Bonds, due 2005 and 5.70% Collateral Trust Bonds,
due 2010.
32
<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
April 14, 1999
/s/ Steven L. Slepian
Controller (Principal Accounting Officer)
April 14, 1999
33
WARNING: THE EDGAR SYSTEM ENCOUNTERED ERROR(S) WHILE PROCESSING THIS SCHEDULE.
<TABLE> <S> <C>
[TEXT]
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from the
February 28, 1999, Form 10-Q and is qualified in its entirety by reference to
such financial statements.
</LEGEND>
<MULTIPLIER> 1000
<S> <C>
<PERIOD-TYPE> 9-mos
<FISCAL-YEAR-END> May-31-1999
<PERIOD-END> Feb-28-1999
<CASH> 76,095
<SECURITIES> 0
<RECEIVABLES> 150,771
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 13,315,137
<PP&E> 41,431
<DEPRECIATION> 8,523
<TOTAL-ASSETS> 13,491,028
<CURRENT-LIABILITIES> 7,068,402
<BONDS> 4,893,913
0
0
<COMMON> 0
<OTHER-SE> 1,523,750
<TOTAL-LIABILITY-AND-EQUITY> 13,491,028
<SALES> 572,479
<TOTAL-REVENUES> 573,812
<CGS> 483,200
<TOTAL-COSTS> 483,200
<OTHER-EXPENSES> 18,118
<LOSS-PROVISION> 15,780
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 56,714
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<EPS-DILUTED> 0
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