UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

X

    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended May 31, 2002

OR

    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

(State or other jurisdiction of incorporation or organization)

52-0891669

(I.R.S. Employer Identification Number)

2201 COOPERATIVE WAY, HERNDON, VA 20171

(Address of principal executive offices)

(Registrant's telecommunications number, including area code, is 703-709-6700)

Securities registered pursuant to Section 12(b) of the Act:

exchange on

exchange on

                Title of each class                

  which listed  

                Title of each class                

  which listed  

6.50% Collateral trust bonds due 2002

NYSE

7.30% Collateral trust Bonds, due 2006

NYSE

6.70% Collateral trust bonds, due 2002

NYSE

6.20% Collateral trust bonds, due 2008

NYSE

5.00% Collateral trust bonds, due 2002

NYSE

5.75% Collateral trust bonds, due 2008

NYSE

5.95% Collateral trust bonds, due 2003

NYSE

5.70% Collateral trust bonds, due 2010

NYSE

7.375% Collateral trust bonds, due 2003

NYSE

7.20% Collateral trust bonds, due 2015

NYSE

5.30% Collateral trust bonds, due 2003

NYSE

6.55% Collateral trust bonds, due 2018

NYSE

6.00% Collateral trust bonds, due 2004

NYSE

7.35% Collateral trust bonds, due 2026

NYSE

6.375% Collateral trust bonds, due 2004

NYSE

7.65% Quarterly income capital securities, due 2046

NYSE

5.50% Collateral trust bonds, due 2005

NYSE

7.375% Quarterly income capital securities, due 2047

NYSE

6.125% Collateral trust bonds, due 2005

NYSE

7.625% Quarterly income capital securities, due 2050

NYSE

6.65% Collateral trust bonds, due 2005

NYSE

7.40% Quarterly income capital securities, due 2050

NYSE

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 .

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of the registrant's knowledge in definitive proxy or information statements incorporated by reference in Part IV of this Form 10-K or any amendment to this Form 10-K. [ X ]

The Registrant has no stock.

TABLE OF CONTENTS

Part No.

Item No.

Page

I.

1.

Business

1

General

1

Members

1

Distribution Systems

2

Power Supply Systems

3

Service Organizations and Associate Member Systems

3

Telecommunications Systems

3

Loan Programs

3

Interest Rates on Loans

5

Electric Loan Programs

5

Telecommunications Loan Programs

6

RUS Guaranteed Loans

7

Largest Borrowers

7

Credit Limitation

7

Loan Security

8

Conversion of Loans

8

Prepayment of Loans

8

Pledging of Loans

8

Guarantee Programs

9

Guarantees of Long-Term Tax-Exempt Bonds

9

Guarantees of Lease Transactions

10

Guarantees of Tax Benefit Transfers

10

Letters of Credit

10

Other Guarantees

10

CFC Financing Factors

10

Members' Subordinated Certificates

11

Members' Equity

11

Debt Issuance

11

Interest Rate and Cross Currency Interest Rate Exchange Agreements

12

Revolving Credit Agreements

12

Borrowing Costs

13

Tax Status

13

Investment Policy

13

Employees

13

CFC Lending Competition

13

Member Regulation and Competition

14

The RUS Program

17

Member Financial Data

17

2.

Properties

25

3.

Legal Proceedings

25

4.

Submission of Matters to a Vote of Security Holders

25

II.

5.

Market for the Registrant's Common Equity and Related Stockholder Matters

26

6.

Selected Financial Data

26

7.

Management's Discussion and Analysis of Financial Condition and Results of Operations

27

7A.

Quantitative and Qualitative Disclosures About Market Risk

53

8.

Financial Statements and Supplementary Data

53

9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

53

III.

10.

Directors and Executive Officers of the Registrant

54

11.

Executive Compensation

58

12.

Security Ownership of Certain Beneficial Owners and Management

60

13.

Certain Relationships and Related Transactions

60

IV.

14.

Exhibits, Financial Statement Schedules, and Reports on Form 8-K

61

Part I

Item 1.

Business.

General

National Rural Utilities Cooperative Finance Corporation ("CFC") was incorporated as a private, not-for-profit cooperative association under the laws of the District of Columbia in April 1969. The principal purpose of CFC is to provide its members with a dependable source of low cost capital and financial products and services. CFC provides its members with a source of financing to supplement the loan programs of the Rural Utilities Service ("RUS") of the United States Department of Agriculture. CFC will also lend 100% of the loan requirement for those members electing not to borrow from RUS. CFC is owned by and makes loans primarily to its rural utility system members ("utility members") to enable them to acquire, construct and operate electric distribution, generation, transmission and related facilities. CFC also provides guarantees to its members for tax-exempt financings of pollution control facilities and other properties constructed or acquired by its members, debt in connection with certain leases and various other transactions. CFC is exempt from federal income taxes under the provisions of Internal Revenue Code section 501(c)(4).

Rural Telephone Finance Cooperative ("RTFC") was incorporated as a private cooperative association in the state of South Dakota in September 1987 and was created for the purpose of providing and/or arranging financing for its rural telecommunications members and affiliates. CFC is the sole source of funding for RTFC and manages the affairs of RTFC through a long-term management agreement. RTFC's results of operations and financial condition have been combined with those of CFC in the accompanying financial statements (see Note 1(b) to the combined financial statements). RTFC is a taxable entity under Subchapter T of the Internal Revenue Code and accordingly deducts allocations of net margins paid to its patrons.

Except as indicated, financial information presented herein includes CFC and RTFC on a combined basis.

There are two primary segments of CFC's business, rural electric lending and rural telecommunications lending. Lending to electric cooperatives is done through CFC and lending to telecommunications organizations is done through RTFC. In many cases, the customers of the electric cooperatives are also the customers of the telecommunications organizations, as both sets of members serve the rural areas of the United States.

Members

CFC had 1,042 members as of May 31, 2002, including 897 utility members, virtually all of which are consumer-owned cooperatives, 72 service members and 73 associate members. The utility members included 826 distribution systems and 71 generation and transmission ("power supply") systems operating in 49 states and four U.S. territories.

CFC currently has five classes of members:

*

Class A - cooperative or not-for-profit distribution systems;

*

Class B - cooperative or not-for-profit power supply systems;

*

Class C - statewide and regional associations which are wholly-owned or controlled by Class A or Class B members;

*

Class D - national associations of cooperatives; and

*

Class E - associate members - not-for-profit groups or entities organized on a cooperative basis which are owned, controlled or operated by Class A, B or C members and which provide non-electric services primarily for the benefit of ultimate consumers. Associate members are not entitled to vote at any meeting of the members and are not eligible to be represented on CFC's board of directors.

RTFC had 512 members as of May 31, 2002. Membership in RTFC is limited to commercial (for-profit) or cooperative (not-for-profit) telecommunications systems eligible to receive loans or other assistance from RUS, which are engaged (or plan to be engaged) in providing telecommunication services to ultimate users and affiliates of such corporations.

1

Number

Loan and

Number

Loan and

of

Loan

Guarantee

 of

Loan

Guarantee

Members

%

%

Members

%

%

Alabama

30

1.3%

1.5%

Missouri

64

3.1%

3.5%

Alaska

30

1.5%

1.4%

Montana

39

1.1%

1.0%

American Samoa

1

0.0%

0.0%

Nebraska

40

0.1%

0.1%

Arizona

23

0.7%

0.8%

Nevada

5

0.5%

0.4%

Arkansas

29

2.6%

2.5%

New Hampshire

7

1.1%

1.2%

California

11

0.1%

0.1%

New Jersey

1

0.0%

0.0%

Colorado

40

4.0%

3.9%

New Mexico

25

0.2%

0.2%

Connecticut

2

1.0%

0.9%

New York

13

0.1%

0.1%

Delaware

2

0.1%

0.1%

North Carolina

45

4.8%

4.8%

District of Columbia

5

1.7%

3.6%

North Dakota

34

0.3%

0.2%

Florida

20

2.4%

3.1%

Ohio

42

1.9%

1.8%

Georgia

68

8.4%

7.6%

Oklahoma

51

2.6%

2.4%

Guam

1

0.0%

0.0%

Oregon

40

1.4%

1.4%

Hawaii

1

0.0%

0.0%

Pennsylvania

26

0.8%

0.8%

Idaho

17

0.8%

0.7%

South Carolina

38

2.7%

2.4%

Illinois

52

3.4%

3.1%

South Dakota

49

0.8%

0.7%

Indiana

52

1.3%

1.8%

Tennessee

29

0.5%

0.5%

Iowa

121

5.8%

5.4%

Texas

112

20.4%

19.2%

Kansas

50

1.4%

1.5%

Utah

11

2.9%

3.0%

Kentucky

33

1.1%

1.8%

Vermont

8

0.2%

0.2%

Louisiana

18

1.3%

1.2%

Virgin Islands

1

3.1%

2.8%

Maine

6

0.2%

0.2%

Virginia

28

1.3%

1.2%

Maryland

2

0.6%

0.6%

Washington

18

0.4%

0.4%

Massachusetts

2

0.0%

0.0%

West Virginia

5

0.0%

0.0%

Michigan

25

1.5%

1.4%

Wisconsin

64

1.5%

1.4%

Minnesota

77

4.3%

4.4%

Wyoming

15

0.8%

0.8%

Mississippi

26

1.9%

1.9%

Total

1,554

100.0%

100.0%

Distribution Systems

Distribution systems are utilities engaged in retail sales of electricity to consumers in their service areas. Most distribution systems have all-requirements power contracts with their power supply systems, which are owned and controlled by the member distribution systems. The wholesale power contracts between the distribution systems and the power supply systems provide for rate adjustments to cover the costs of supplying power, although in certain cases such adjustments must be approved by regulatory agencies. Wholesale power for resale also comes from other sources, including power supply system contracts with government agencies, investor-owned utilities and other entities, and in rare cases, the cooperative's own generating facilities.

Wholesale power supply contracts ordinarily guarantee neither an uninterrupted supply nor a constant cost of power. Contracts with RUS-financed power supply systems (which generally require the distribution system to purchase all its power requirements from the power supply system) provide for rate increases to pass along increases in sellers' costs. The wholesale power contracts permit the power supply system, subject to approval by RUS and, in certain circumstances, regulatory agencies, to establish rates to its members so as to produce revenues sufficient, with revenues from all other sources, to meet the costs of operation and maintenance (including replacements, insurance, taxes and administrative and general overhead expenses) of all generating, transmission and related facilities, to pay the cost of any power and energy purchased for resale, to pay the costs of generation and transmission, to make all payments on account of all indebtedness and lease obligations of the power supply system and to provide for the establishment and maintenance of reasonable reserves. The board of directors of the power supply system reviews the rates under the wholesale power contracts at least annually.

2

Power contracts with investor-owned utilities and power supply systems which do not borrow from RUS generally have rates subject to regulation by the Federal Energy Regulatory Commission ("FERC"). Contracts with federal agencies generally permit rate changes by the selling agency (subject, in some cases, to federal regulatory approval).

Power Supply Systems

Power supply systems are utilities that purchase or generate electric power and provide it on a wholesale basis to distribution systems for delivery to the ultimate retail consumer.  Of the 61 operating power supply systems financed in whole or in part by RUS or CFC at December 31, 2000 (the most recent year for which data is available), 60 were cooperatives owned directly or indirectly by groups of distribution systems and one was government owned. Of this number, 37 had generating capacity of at least 100 megawatts, and ten had no generating capacity. The systems with no generating capacity generally operated transmission lines to supply certain distribution systems. Certain other power supply systems have been formed but do not yet own generating or transmission facilities.

At December 31, 2000, the 56 power supply systems reporting to CFC owned interests in 146 generating plants representing generating capacity of approximately 33,477 megawatts, or approximately 5.3% of the nation's estimated electric generating capacity, and served 609 RUS distribution system borrowers. Certain of the power supply systems which lease generating plants from others operate these facilities to produce their power requirements. Of the power supply systems' total generating capacity in place as of December 31, 2000, steam plants accounted for 87.4% (including nuclear capacity representing approximately 8.6% of such total generating capacity), internal combustion plants accounted for 10.1% and hydroelectric plants accounted for 1.9%. (These statistics include 5 systems that did not have long-term loans from CFC at December 31, 2000, but reported to CFC subsequent to the filing of the 2001 10-K).

Service Organizations and Associate Member Systems

Service organizations include the National Rural Electric Cooperative Association ("NRECA"), statewide cooperative associations, and the National Cooperative Service Corporation ("NCSC"). NRECA represents cooperatives nationally. The statewide cooperative associations represent the cooperatives within a state. NCSC is owned and governed by its electric cooperative members. NCSC's membership is composed of certain CFC distribution members. NCSC is operated by CFC staff under a management agreement. NCSC's board is composed of 11 directors, ten of whom are elected from its member cooperative organizations and one is selected by CFC. NCSC lends to the for-profit subsidiaries and customers of its members and to organizations that provide substantial benefit to a NCSC member. NCSC obtains all of its funding through direct loans from CFC, private placement debt issuance with a guarantee from CFC and by the sale of commercial paper with a CFC guarantee.

Associate members include organizations that are owned, controlled or operated by, or provide significant benefit to, Class A, B or C members and that provide non-electric services primarily for the benefit of ultimate consumers.

Telecommunications Systems

Telecommunications systems include not-for-profit cooperative organizations and for-profit commercial organizations that provide local exchange and access telecommunications services to rural areas.

Independent rural telecommunications companies provide service in the majority of America's rural areas. These companies, which number approximately 1,020, are called independent because they are not affiliated with the regional bell operating companies or other large holding companies. The majority of these independent rural telecommunications companies are small family-owned or privately-held commercial companies. Fourteen of these commercial companies are publicly traded. Included in the total are approximately 275 not-for-profit cooperative telecommunications companies.

Rural telecommunications companies comprise a small sector of a local exchange telecommunications industry that provides service to over 177 million access lines. These rural companies range in size from fewer than 50 customers to more than 100,000. Rural telecommunications companies' annual operating revenues range from less than $100,000 to over $250 million. In addition to basic local exchange and access telecommunications service, most independents offer other communications services including wireless, cable television and internet access. Most rural telecommunications companies' networks incorporate digital switching, fiber optics and other advanced technologies.

Loan Programs

3

all assets and revenues of the borrower. Intermediate-term loans may be secured or unsecured and line of credit loans are generally unsecured. On line of credit loans with a maturity of more than one year, the outstanding balance is generally required to be paid down to zero for five consecutive days during each year. CFC makes loans to borrowers on a concurrent basis with RUS (generally 70% RUS/30% CFC) and will also make 100% loans to borrowers electing not to borrow from RUS.

Members with long-term loans outstanding are required to provide annual audited financial statements to CFC. Borrowers also must make various representations in an officer's certificate and maintain certain levels of financial performance as prescribed under each loan program.

Loans outstanding and weighted average interest rates

thereon at May 31,

Long-term fixed rate secured loans (C):

2002 (A)

2001

2000

May 31, 2002 (B)

Electric systems

$

7,848,861

6.32%

$

6,088,076

6.85%

$

6,674,470

6.74%

$

-

Telecommunication systems

2,694,945

7.90%

2,453,158

8.17%

1,540,928

7.36%

-

Total long-term fixed rate secured loans

10,543,806

6.72%

8,541,234

7.23%

8,215,398

6.86%

-

Long-term variable rate secured loans (D):

Electric systems

4,127,019

4.21%

5,096,467

7.05%

4,019,155

7.45%

6,135,109

Telecommunication systems

2,138,174

5.71%

2,481,257

7.69%

1,816,826

8.02%

315,047

Total long-term variable rate secured loans

6,265,193

4.72%

7,577,724

7.26%

5,835,981

7.62%

6,450,156

Loans guaranteed by RUS:

Electric systems

242,574

4.75%

182,134

6.31%

89,153

6.53%

58,014

Intermediate-term secured loans:

Electric systems

31,133

5.48%

55,325

7.08%

141,771

7.41%

26,277

Intermediate-term unsecured loans:

Electric systems

177,154

5.19%

276,785

7.24%

200,706

7.35%

238,013

Telecommunication systems

7,298

5.75%

13,836

7.50%

12,206

7.80%

5,779

Total intermediate-term unsecured loans

184,452

5.21%

290,621

7.25%

212,912

7.37%

243,792

Line of credit loans (E):

Electric systems

1,002,459

4.57%

1,193,795

7.35%

1,281,483

7.59%

4,821,764

Telecommunication systems

226,113

6.32%

377,148

8.12%

329,768

8.32%

413,861

Total line of credit loans

1,228,572

4.89%

1,570,943

7.53%

1,611,251

7.74%

5,235,625

Nonperforming loans:

Electric systems

1,002,782

-

812

-

-

-

-

Telecommunication systems

8,546

-

-

-

-

-

-

Total nonperforming loans

1,011,328

-

812

-

-

-

-

Restructured loans:

Electric systems

540,051

6.92%

1,465,157

2.63%

571,579

3.90%

-

     Total loans

20,047,109

5.61%

19,683,950

6.91%

16,678,045

7.12%

12,013,864

Less: Allowance for loan losses

(506,742

)

(331,997

)

(228,292

)

-

     Net loans

$

19,540,367

$

19,351,953

$

16,449,753

$

12,013,864

Total by member class:

Distribution

$

11,866,442

$

11,444,999

$

10,394,985

$

8,647,187

Power supply

2,624,039

2,308,384

2,037,108

2,405,217

Statewide and associate

481,552

605,168

546,224

226,773

Telecommunication systems

5,075,076

5,325,399

3,699,728

734,687

     Total

$

20,047,109

$

19,683,950

$

16,678,045

$

12,013,864

(A)

The interest rates in effect at August 1, 2002 on loans to electric members were 6.70% for long-term loans with a seven-year fixed rate term, 4.20% on variable rate long-term loans and 4.60% on intermediate-term loans and lines of credit. The rates in effect at August 1, 2002 on loans to telecommunication systems were 7.45% for long-term loans with a seven-year fixed rate term, 5.60% on long-term variable rate loans, 5.85% on intermediate-term loans and 6.25% on lines of credit.

(B)

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. 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 advances on commitments are identical to those on initial loan approval.

(C)

Includes $395 million, $56 million and $102 million of unsecured loans at May 31, 2002, 2001 and 2000, respectively. During the year ended May 31, 2002, long-term fixed rate loans totaling $482 million had their interest rates adjusted.

(D)

Includes $266 million, $65 million and $49 million of unsecured loans at May 31, 2002, 2001 and 2000, respectively.

(E)

Includes $387 million, $445 million and $342 million of secured loans at May 31, 2002, 2001 and 2000, respectively.

4

Set forth below are the weighted average interest rates earned on all loans outstanding during the fiscal years ended May 31:

2002

2001

2000

Long-term fixed rate

6.56%

6.78%

6.66%

Long-term variable rate

5.08%

7.60%

6.59%

Telecommunication organizations (1)

7.13%

8.31%

7.45%

Refinancing loans guaranteed by RUS

3.14%

6.61%

6.29%

Intermediate-term

5.97%

7.99%

6.92%

Short-term

5.49%

8.01%

7.01%

Associate members (1)

5.53%

7.86%

6.85%

Nonperforming (2)

0.00%

0.00%

0.00%

Restructured

3.21%

4.33%

3.90%

All loans

5.98%

7.36%

6.74%

(1)

Includes long-term fixed rate, long-term variable rate, intermediate-term and short-term loans.

(2)

Interest rate earned by CFC recognized on a cash basis.

Electric Loan Programs

Long-Term Loans

Long-term loans are generally for terms of up to 35 years. A borrower can select a fixed interest rate for periods of one to 35 years or a variable rate. Upon the expiration of the selected fixed interest rate term, the borrower must select the variable rate or select another fixed rate term for a period that does not exceed the remaining loan maturity. CFC sets long-term fixed rates daily and the long-term variable rate is set on the first business day of each month. The fixed rate on a loan is determined on the day the loan is advanced based on the rate term selected. A borrower may divide its loan into various tranches. The borrower then has the option of selecting a fixed or variable interest rate for each tranche.

To be eligible for long-term loan advances, distribution systems must maintain an average modified debt service coverage ratio ("MDSC"), as defined in the loan agreement, of 1.35 or greater. The distribution systems must also be in good standing with CFC and their states of incorporation, supply evidence of proper corporate authority and deliver to CFC annual audited financial statements. Generally, the minimum eligibility requirements for power supply systems are an average times interest earned ratio ("TIER") and MDSC, as described in the loan agreement, of 1.0 or greater. Loans to power supply systems are considered on a case-by-case basis depending on the amount of the loan, the intended use of funds, the financial condition of the borrower and any guarantees that may be provided by a third party, including RUS and the member distribution systems. CFC has in the past and may in the future make long-term loans to distribution and power supply systems that do not meet the minimum lending criteria. During the five years ended May 31, 2002, 3.8% of the dollar amount of long-term loans approved was to borrowers that did not meet the minimum lending criteria. In addition, during the five years ended May 31, 2002, CFC approved loans totaling $151 million for discounted RUS note buyouts by one power supply system that did not meet minimum lending criteria. In this transaction, CFC obtained guarantees from the member distribution system for the entire loan amount.

Intermediate-Term Loans and Line of Credit Loans

Intermediate-term loans are generally for terms of one year to five years. Intermediate-term loans can be advanced at a fixed interest rate or at a variable interest rate. Line of credit loans may be advanced only at a variable interest rate. The intermediate-term and line of credit variable interest rate is set on the first business day of each month. Line of credit loans with maturities of greater than one year generally must be paid down to a zero outstanding balance for five consecutive days during each year.

To be eligible for an intermediate-term loan or line of credit loan, distribution and power supply borrowers must be in good standing with CFC and demonstrate their ability to repay the loan.

    5

Power Vision Program

A borrower must meet loan eligibility criteria at the time of any advance under the power vision program. In addition, a borrower must assure CFC that there has been no material adverse change since loan approval.

Telecommunications Loan Programs

(Dollar amounts in thousands)

2002

2001

Rural local exchange carriers

$3,811,897

$3,846,625

Wireless providers

357,292

478,664

Long distance carriers

373,809

422,247

Fiber optic network providers

211,245

216,734

Cable television providers

194,806

212,348

Competitive local exchange carriers

105,307

105,310

Other

20,720

43,471

     Total

$5,075,076

$5,325,399

CFC's telecommunications loan portfolio is heavily concentrated in the rural local exchange carrier ("RLEC") segment of the telecommunications market, with such loans comprising about 75% of the total telecommunications portfolio. CFC believes that this segment of the market will continue to generate strong cash flow and will experience little, if any, competition in the near term. The two barriers to entry for potential competitors are the low population density of the RLEC service territories and the high quality of service the customers receive from the incumbent RLECs. These services are generally delivered over networks that include fiber optic cable and digital switching.

The businesses to which the remaining 25% of the telecommunications loans have been made are generally supporting the operations of the RLECs and are owned, operated or controlled by RLECs. Many such loans are supported by payment guarantees from the sponsoring RLECs, particularly loans to personal communications service providers and competitive local exchange carriers.

Long-Term Loans

CFC makes long-term loans to rural telecommunications companies and their affiliates for the acquisition of and the construction or upgrade of wireline telecommunications systems, wireless telecommunications systems, fiber optic networks, cable television systems and other corporate purposes. Long-term loans are generally for periods of up to 15 years. Loans may be advanced at a fixed or variable interest rate. Fixed rates are generally available for periods from one year to 15 years. Upon the expiration of the selected fixed interest rate term, the borrower must select another fixed rate term for a period that does not exceed the remaining loan maturity or select the variable rate. CFC sets long-term fixed rates for telecommunications loans daily and the long-term variable rate is set on the first business day of each month. The fixed rate on a loan is determined on the day the loan is advanced or converted to a fixed rate based on the term selected. A borrower may divide its loan into various tranches. The borrower then has the option of selecting a fixed or variable interest rate for each tranche.

To borrow from CFC, a wireline telecommunications system generally must be able to demonstrate the ability to achieve and maintain an annual debt service coverage ratio ("DSC") and an annual TIER of 1.25 and 1.50, respectively. To borrow from CFC, a cable television system, fiber optic network or wireless telecommunications system generally must be able to demonstrate the ability to achieve and maintain an annual DSC of 1.25. Loans made to start-up ventures using emerging technologies are evaluated based on the quality of the business plan and the level and quality of credit support from established companies. Based on the business plan, specific covenants are developed for each transaction which require performance at levels deemed sufficient to repay the CFC obligations under the approved terms.

6

Intermediate-Term Loans and Line of Credit Loans

CFC provides intermediate-term equipment financing to telecommunications borrowers for periods up to five years. These loans are provided on an unsecured basis and are used to finance the purchase and installation of central office equipment, support assets and other communications equipment. Intermediate-term equipment financing loans are generally made to operating telecommunications companies with an equity level of at least 25% of total assets and which have achieved a DSC ratio for each of the previous two calendar years of at least 1.75.

CFC also provides line of credit loans to telecommunications systems for periods of up to five years. These line of credit loans are typically in the form of a revolving line of credit, which generally requires the borrower to pay off the balance for five consecutive business days at least once during each 12-month period. These line of credit loans may be provided on a secured or unsecured basis and are designed primarily for cash management. Line of credit loans are available to telecommunications systems generally in amounts not to exceed the greater of 5% of total assets or 25% of equity in excess of 35% of total assets.

Interim financing line of credit loans are also made available to CFC telecommunications members that have an RUS and/or Rural Telephone Bank ("RTB") loan application pending and have received approval from RUS to obtain interim financing. These loans are for terms up to 24 months and must be retired with advances from the RUS/RTB long-term loans.

RUS Guaranteed Loans

Congress enacted legislation that allows certain systems to prepay existing borrowings from the Federal Financing Bank ("FFB") without prepayment penalties or fees. CFC established a program under which it made long-term loans to members for the purpose of prepaying these loans. Each note evidencing such a loan was issued to a trust, which in turn issued certificates evidencing its ownership to CFC. The principal and interest payments on these notes are guaranteed by RUS. Under RUS loan repayment regulations, the note rate may not exceed the rate borne by the system's prepaid borrowings from the FFB adjusted to reflect savings accrued since prepayment of the note compared with the rate on the prepaid borrowing. The systems are required to pay servicing fees to CFC in connection with these transactions. At May 31, 2002, CFC was holding certificates totaling $44 million. In addition, at May 31, 2002, CFC serviced $138 million of these loans for trusts, the certificates of which have been sold in public offerings.

Largest Borrowers

At May 31, 2002, the ten largest borrowers had outstanding loans from CFC totaling $5,193 million, which represented 26% of CFC's total loans outstanding. At May 31, 2002, outstanding guarantees for these same ten borrowers totaled $493 million, which represented 25% of CFC's total guarantees outstanding. CFC's ten largest credit exposures represented 26% of total exposure at May 31, 2002 and 2001. On those dates, no member had outstanding loans and guarantees in excess of 4.6% of the aggregate amount of CFC's outstanding loans and guarantees.

Credit Limitation

Under CFC's policy, (1) CFC's total exposure to any borrower is limited to 25% of CFC's defined net worth, (2) CFC's unsecured loans to any borrower are limited to 10% of CFC's defined net worth, and (3) CFC's guarantees outstanding for the benefit of any member are limited to 10% of CFC's defined net worth. CFC's defined net worth is the total of subordinated certificates issued and outstanding, members' equity (see Note 8 to the combined financial statements) and the loan loss allowance. If a borrower submitting a new loan application has a CFC exposure in excess of any one of the three tests, only the CFC board of directors may approve the new loan application. CFC's board of directors may approve a loan to a borrower with an exposure in excess of one or more of these tests after consideration of other factors, including the amount of the loan, the maturity of the loan, and the value of collateral held by CFC. At May 31, 2002, there were two borrowers with total exposure greater than 25% of CFC's defined net worth and one borrower which had total guarantees outstanding in excess of 10% of CFC's defined net worth. Only CFC's board of directors may approve new loans to these borrowers.

 7

Loan Security

CFC typically makes long-term loans to its members on a secured basis. Intermediate-term loans may be secured or unsecured, as determined on a case-by-case basis. Line of credit loans are generally unsecured. At May 31, 2002, a total of $1,687 million of loans were unsecured, representing 8% of total loans. CFC's long-term loans are typically secured pro-rata with other secured lenders (primarily RUS) by all assets and future revenues of the borrower. In addition to the collateral received, CFC also requires that its borrowers set rates designed to achieve certain financial ratios.

Events of default under the long-term mortgages include default in the payment of the mortgage notes, default (continuing after grace periods in some cases) in the performance of the covenants in the loan agreements or the mortgages and events of bankruptcy and insolvency. Under common mortgages securing long-term CFC loans to distribution system members, RUS has the sole right to exercise remedies on behalf of all holders of mortgage notes for 30 days after default. If RUS does not act within 30 days or if RUS is not legally entitled to act on behalf of all noteholders, CFC may exercise remedies. Under common mortgages securing long-term CFC loans to, or guarantee reimbursement obligations of, power supply members, RUS retains substantial control over the exercise of mortgage remedies. RUS holds the loan security on loans for which it has provided a guarantee.

Security for long-term loans made to RUS telecommunications borrowers generally consists of a first mortgage lien on the assets and revenues of the system on a pari passu basis with RUS. Security for long-term loans made to non-RUS telecommunications borrowers is typically a first mortgage lien on all assets and revenues of the borrower and generally a loan will not exceed 80% of the estimated value of the collateral. At May 31, 2002, a total of $305 million or 6% of CFC's telecommunications loans outstanding were unsecured. These unsecured loans are primarily lines of credit made to RUS borrowers and a long-term loan made to a non-RUS borrower which has no secured debt.

At May 31, 2002, CFC had a total of $282 million of unsecured guarantees, representing 14% of total guarantees. When considered together, CFC's unsecured credit at May 31, 2002, totaled $1,969 million, representing 9% of total loans and guarantees outstanding.

Conversion of Loans

A borrower may convert a long-term loan from a variable interest rate to a fixed interest rate at any time without a fee. A borrower may convert a fixed rate to another fixed rate or a variable rate at any time, subject to a fee in most instances. Intermediate-term loans and line of credit loans do not offer conversion options. The fee on the conversion of a fixed interest rate to a variable interest rate ranges from 25 to 50 basis points of the outstanding loan amount plus an amount to cover the funding loss on the remainder of the current fixed rate pricing term.

Prepayment of Loans

Borrowers may prepay long-term loans at any time, subject to the payment of a prepayment premium of 33 to 50 basis points and a make-whole premium, if applicable. Line of credit loans may be prepaid at any time without a premium.

Pledging of Loans

CFC pledges long-term secured distribution member loans as collateral to secure its collateral trust bonds. CFC must maintain collateral on deposit with the trustee in a principal amount at least equal to the principal balance of collateral trust bonds outstanding. At May 31, 2002 and 2001, CFC had $6,144 million and $5,612 million, respectively, of collateral on deposit securing $5,819 million and $4,739 million, respectively, of collateral trust bonds outstanding. In addition, $2 million of cash is pledged at May 31, 2002. CFC may withdraw collateral at any time, provided that the principal balance of notes, cash and eligible securities on deposit after withdrawal is greater than the principal amount of bonds outstanding.

8

Guarantee Programs

Set forth below is a table showing CFC's guarantees:

May 31,

(Dollar amounts in thousands)

2002

2001

2000

Long-term tax-exempt bonds*

$

940,990

$

979,725

$

1,024,340

Debt portions of leveraged lease transactions

41,064

103,794

111,319

Indemnifications of tax benefit transfers

208,637

232,930

259,223

Letters of credit

310,926

370,592

275,995

Other guarantees

469,750

444,640

274,325

     Total

$

1,971,367

$

2,131,681

$

1,945,202

*

Includes $859 million, $886 million and $920 million at May 31, 2002, 2001 and 2000, respectively, of adjustable rate pollution control bonds which can be tendered for purchase at specified times at the option of the holders (in the case of $198 million, $208 million and $239 million of such bonds outstanding at May 31, 2002, 2001 and 2000, respectively, at any time on seven days' notice, in the case of $186 million, $193 million and $219 million outstanding at May 31, 2002, 2001 and 2000, respectively, at any time on a minimum of one day's notice; and in the case of the remainder on a five-week or semiannual basis). CFC has agreed to purchase any bonds that cannot be remarketed. Since the inception of the program, CFC has not been required to purchase any bonds.

Guarantees by Member Class

(Dollar amounts in thousands)

2002

2001

2000

Electric systems:

Distribution

$

69,580

4%

$

157,202

7%

$

103,767

5%

Power supply

1,423,981

72%

1,556,229

73%

1,575,891

81%

Associate & service members

472,468

24%

418,250

20%

265,544

14%

     Subtotal electric systems

1,966,029

100%

2,131,681

100%

1,945,202

100%

Telecommunication systems

5,338

-

-

-

-

-

     Total

$

1,971,367

100%

$

2,131,681

100%

$

1,945,202

100%

Guarantees of Long-Term Tax-Exempt Bonds

CFC has guaranteed debt issued in connection with the construction or acquisition by CFC members of pollution control, solid waste disposal, industrial development and electric distribution facilities. Governmental authorities issue such debt and the interest thereon is exempt from federal taxation. The proceeds of the offering are made available to the member system, which in turn is obligated to pay the governmental authority amounts sufficient to service the debt. The debt, which is guaranteed by CFC, may include short- and long-term obligations.

In the event of a default by a system for nonpayment of debt service, CFC is obligated to pay, after available debt service reserve funds have been exhausted, scheduled debt service under its guarantee. The bond issue may not be accelerated so long as CFC performs under its guarantee. The system is required to repay, on demand, any amount advanced by CFC pursuant to its guarantee. This repayment obligation is secured by a common mortgage with RUS on all the system's assets, but CFC may not exercise remedies thereunder for up to two years following default. However, if the debt is accelerated because of a determination that the interest thereon is not tax-exempt, the system's obligation to reimburse CFC for any guarantee payments will be treated as a long-term loan. The system is required to pay to CFC initial and/or on-going guarantee fees in connection with these transactions.

Certain guaranteed long-term debt bears interest at variable rates which are adjusted at intervals of one to 270 days, weekly, each five weeks or semi-annually to a level expected to permit their resale or auction at par. At the option of the member on whose behalf it is issued, and provided funding sources are available, rates on such debt may be fixed until maturity. Holders have the right to tender the debt for purchase at par at the time rates are reset when it bears interest at a variable rate and CFC has committed to purchase debt so tendered if it cannot otherwise be remarketed. If CFC held the securities, the cooperative would pay interest to CFC at its intermediate-term loan rate.

  9

Guarantees of Lease Transactions

CFC has a program of lending to or guaranteeing debt issued by NCSC in connection with leveraged lease transactions. In such transactions, NCSC lends money to an industrial or financial company (a "lessor") for the purchase of a power plant (or an undivided interest therein) or utility equipment which is then leased to a CFC member (the "lessee") under a lease requiring the lessee to pay amounts sufficient to permit the lessor to service the loan. The loans are made on a non-recourse basis to the lessor but are secured by the property leased and the owner's rights as lessor. NCSC borrows the funds it lends either directly from CFC or from another creditor with a CFC guarantee. NCSC is obligated to pay administrative and/or guarantee fees to CFC in connection with these transactions. The lessee in each transaction reimburses such fees to NCSC. CFC may also guarantee the rent obligation of its members to a third party.

Guarantees of Tax Benefit Transfers

CFC has also guaranteed members' obligations to indemnify against loss of tax benefits in certain tax benefit transfers that occurred in 1981 and 1982. A member's obligation to reimburse CFC for any guarantee payments would be treated as a long-term loan, secured on a pari passu basis with RUS by a first lien on substantially all the member's property to the extent of any cash received by the member at the outset of the transaction. The remainder would be treated as an intermediate-term loan secured by a subordinated mortgage on substantially all of the member's property. Due to changes in federal tax law, no guarantees of this nature have occurred since 1982.

Letters of Credit

CFC issues irrevocable letters of credit to support members' obligations to energy marketers, other third parties and to the Rural Business and Cooperative Development Service. Letters of credit are generally issued on an unsecured basis and with such issuance fees as may be determined from time to time. Each letter of credit issued by CFC is supported by a reimbursement agreement with the member on whose behalf the letter of credit was issued. In the event a beneficiary draws on a letter of credit, the agreement generally requires the member to reimburse CFC within one year from the date of the draw, with interest accruing from such date at CFC's line of credit variable rate of interest. The agreement also requires the member to pay, as applicable, any late payment charges and all costs of collection, including reasonable attorneys' fees.

Other Guarantees

CFC may provide other guarantees as requested by its members. Such guarantees may be made on a secured or unsecured basis with guarantee fees set to cover CFC's general and administrative expenses, a provision for losses and a reasonable margin.

Members' interest expense for the year ended May 31, 2002 on debt obligations guaranteed by CFC was approximately $39 million.

CFC Financing Factors

2002

2001

2000

Weighted

Weighted

Weighted

Average

Average

Average

Amounts

% of

Interest

Amounts

% of

Interest

Amounts

% of

Interest

(Dollar amounts in thousands)

Outstanding

Total

Rate

Outstanding

Total

Rate

Outstanding

Total

Rate

Commercial paper (1)

$

3,237,001

16%

1.89%

$

6,193,990

31%

4.44%

$

6,705,035

40%

6.17%

Collateral trust bonds

5,819,138

29%

6.03%

4,739,079

24%

6.28%

3,351,366

20%

6.34%

Medium-term notes

8,213,395

41%

4.82%

6,388,338

32%

4.80%

4,791,361

28%

6.33%

Quarterly income

    capital securities

600,000

3%

7.48%

550,000

3%

7.62%

400,000

2%

7.62%

Members' subordinated

    certificates

1,691,970

9%

2.73%

1,581,860

8%

2.74%

1,340,417

8%

3.02%

Members' equity (2)

392,056

2%

0.00%

393,899

2%

0.00%

341,217

2%

0.00%

     Total

$

19,953,560

100%

4.50%

$

19,847,166

100%

4.86%

$

16,929,396

100%

5.91%

(1)  Includes $100 million, $100 million and $155 million of bank bid notes and $45 million, $23 million and $0 for the daily liquidity fund for 2002, 2001 and 2000, respectively.

(2)  See Note 8 to the combined financial statements.

  10

Members' Subordinated Certificates

As a Condition of Membership

Generally, members are required to purchase membership subordinated certificates as a condition of membership. The amount of certificates required to be purchased is determined by applying a formula to the member's operations for a period of time, generally 15 years. The membership subordinated certificates generally mature in 100 years from issuance and bear interest at a rate of 5% per annum. At May 31, 2002, CFC had a total of $641 million in membership subordinated certificates outstanding.  Issuance of these certificates has not been significant in recent years. At May 31, 2002, the weighted average maturity of these certificates is approximately 74 years.

As a Condition of Borrowing

Distribution system members may be required to purchase, on long-term loans, a loan subordinated certificate for 2% of the loan amount. Power supply system members may be required to purchase a loan subordinated certificate for 7% of the loan amount. These certificates do not pay interest, do not amortize and have the same maturity as the related long-term loan. The requirement to purchase such a certificate is determined by the member's leverage ratio with CFC and the type of loan selected. In large transactions or for other reasons, CFC may increase the loan subordinated certificate purchase requirement to 12.5% of the loan amount. Certificates issued in these transactions may pay interest and/or may amortize. Telecommunications systems and associate members are required to purchase, on long-term loans, loan subordinated certificates for up to 10% of each loan advance. These certificates do not pay interest, but amortize annually based on the outstanding loan balance. At May 31, 2002, CFC had a total of $860 million of loan subordinated certificates outstanding.

As a Condition of Receiving a Guarantee

Members may be required to purchase a guarantee subordinated certificate of up to 12.5% of the principal amount of the guarantee. The guarantee subordinated certificate matures at the same time as the guarantee. The certificates pay interest at a rate determined in each transaction and may amortize. At May 31, 2002, CFC had a total of $191 million of guarantee subordinated certificates outstanding.

Members' Equity

CFC is required by the District of Columbia cooperative law to have a methodology to allocate its net margin to its members. Annually, CFC allocates its entire net margin before the effects of Statement of Financial Accounting Standards ("SFAS") 133, Accounting for Derivative Instruments and Hedging Activities (see Note 1 to the combined financial statements) to an education fund, to a members' capital reserve and to members based on the members' patronage of CFC during the year. Under that law, CFC is required to maintain an education fund to further the teaching of cooperative principals. CFC allocates a small portion of its annual net margin to the education fund. In fiscal year 2000, CFC established a members' capital reserve in which a portion of the annual net margin may be allocated and held by CFC as equity. CFC established the members' capital reserve to increase equity retention. The net margin allocated to members is retained by CFC and used to fund operations until retired. Currently, CFC retires 70% of the prior year's margin allocated to members during the current fiscal year and holds the remaining 30% for a period of 15 years. The board of directors must authorize all retirements with consideration being given to CFC's financial condition. CFC allocates and retires margins to its affiliated organization, RTFC, which in turn allocates its net margin, including the CFC allocation, to its members under similar policies. At May 31, 2002, CFC had a total of $352 million of allocated but unretired margins, $21 million of unallocated margins and $16 million of margins in the members' capital reserve, which along with $1 million of education fund reserve and $2 million of membership fees comprise the total of members' equity before the effects of SFAS 133 (see Note 8 to the combined financial statements).

Debt Issuance

Debt Issued in the Capital Markets

CFC issues long- and short-term debt in the domestic and foreign capital markets. CFC issues long-term secured collateral trust bonds for periods of two years to 30 years, unsecured medium-term notes for periods of nine months to 30 years, unsecured quarterly income capital securities ("QUICS") for periods of up to 49 years, unsecured commercial paper for periods of one to 270 days and extendable commercial notes with maturities up to 390 days. CFC also enters into bank bid note arrangements with banks. CFC's collateral trust bonds, medium-term notes, QUICS and commercial paper all carry investment grade ratings from three rating agencies (see table in the Management Discussion and Analysis section, page 48).

   11

Debt Issued to Members

CFC sells unsecured commercial paper and medium-term notes to its members. Commercial paper is sold for periods of up to 270 days and medium-term notes are sold for periods of nine months to 30 years. CFC sets rates for both securities daily. In addition, members may invest in the daily liquidity program, under which funds can be withdrawn by the members on demand.

Interest Rate and Cross Currency Interest Rate Exchange Agreements

CFC enters interest rate and cross currency interest rate exchange agreements to minimize interest rate and currency exchange risk. At May 31, 2002, CFC was a party to $12,667 million of interest rate exchange agreements and $1,408 million of cross currency interest rate exchange agreements (see Note 5 to the combined financial statements).

Revolving Credit Agreements

At May 31, 2002, CFC had three revolving credit agreements totaling $4,562 million which were used principally to provide liquidity support for CFC's outstanding commercial paper, commercial paper issued by NCSC and guaranteed by CFC and the adjustable or floating/fixed rate bonds which CFC has guaranteed and of which CFC is standby purchaser.

Under a three-year agreement, CFC may borrow $1,028 million. This agreement terminates on August 8, 2004. In connection with this facility, CFC pays a per annum facility fee of 0.125 of 1% based on CFC's senior unsecured credit ratings per a pricing schedule in the credit agreement.

At May 31, 2002 there were two 364-day agreements totaling $3,534 million. These agreements were scheduled to expire onAugust 7, 2002 and were replaced on July 1, 2002 with two 364-day agreements totaling $2,678 million that expire on June 30, 2003. Under one of the 364-day agreements, CFC may borrow $2,378 million. This credit agreement was entered into with a syndicate of 17 banks with JPMorgan Securities, Inc. and Banc of America Securities LLC as Joint Lead Arrangers, JPMorgan Chase Bank as Administrative Agent, Banc of America Securities LLC as Syndication Agent, and The Bank of Nova Scotia, ABN AMRO Bank, N.V. and Bank One, N.A. as Documentation Agents. In addition, CFC entered into a second 364-day agreement for $300 million with a syndicate of six banks with The Bank of Nova Scotia serving as Lead Arranger and Administrative Agent, ABN AMRO Bank, N.V. as Syndication Agent and The Bank of Tokyo-Mitsubishi, Ltd., JPMorgan Chase Bank and Banc of America Securities LLC as Documentation Agents. Both agreements have a revolving credit period that terminates on June 30, 2003 during which CFC can borrow, and such borrowings may be converted to a one-year term loan at the end of the revolving credit period with a .250 of 1% per annum fee on the outstanding principal amount of the term loan.

The facility fee for both of the 364-day facilities is .085 of 1% per annum. Upfront fees between .075 to .090 of 1% were paid to the banks in each of the agreements based on their commitment level, totaling in aggregate $2 million. Each agreement contains a provision under which if borrowings exceed 50% of total commitment, a utilization fee of .150 of 1% must be paid on the outstanding balance.

The revolving credit agreements require CFC to achieve an average fixed charge coverage ratio over the six most recent fiscal quarters of at least 1.025 and prohibit the retirement of patronage capital unless CFC has achieved a fixed charge coverage ratio of at least 1.05 for the preceding fiscal year. For the purpose of the revolving credit agreements, the fixed charge coverage ratio is calculated by dividing net margin prior to the SFAS 133 forward value and the cumulative effect of change in accounting principle by the cost of funds including the SFAS 133 cash settlements. The revolving credit agreements prohibit CFC from incurring senior debt in an amount in excess of ten times the sum of members' equity (see Note 8 to the combined financial statements), members' subordinated certificates and QUICS. Senior debt includes guarantees; however, it excludes:

*

guarantees for members where the long-term unsecured debt of the member is rated at least BBB+ by Standard & Poor's Corporation or Baa1 by Moody's Investors Service;

*

indebtedness incurred to fund RUS guaranteed loans; and

*

the payment of principal and interest by the member on the guaranteed indebtedness if covered by insurance or reinsurance provided by an insurer having an insurance financial strength rating of AAA by Standard & Poor's Corporation or a financial strength rating of Aaa by Moody's Investors Service.

12

Based on the ability to borrow under the bank line facilities, CFC classified $3,706 million and $4,637 million, respectively, of its notes payable outstanding as long-term debt at May 31, 2002 and May 31, 2001. CFC expects to maintain more than $3,706 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 three-year credit agreement for $1,028 million and the new agreements totaling $2,678 million discussed above, subject to the conditions therein.

Borrowing Costs

Years Ended May 31,

2002

2001

2000

Short-term borrowings

2.81%

6.24%

5.83%

Long-term borrowings

4.68%

6.26%

6.11%

     Total short- and long-term borrowings

4.39%

6.25%

6.00%

Tax Status

In 1969, CFC obtained a ruling from the Internal Revenue Service recognizing CFC's exemption from the payment of federal income taxes under Section 501(c)(4) of the Internal Revenue Code. Such exempt status could be removed as a result of changes in legislation or in administrative policy or as a result of changes in CFC's business. CFC believes that its operations have not changed materially from those described to the Internal Revenue Service in its exemption filing. RTFC is taxable under Subchapter T of the Internal Revenue Code. As long as RTFC continues to qualify under Subchapter T of the Internal Revenue Code, it is allowed a deduction from taxable income for the amount of net margin allocated to its members.

Investment Policy

Debt service reserve funds are invested with maturities scheduled to coincide with interest and sinking fund payment dates.

Employees

At May 31, 2002, CFC had 215 employees, including engineering, financial and legal personnel, management specialists, credit analysts, accountants and support staff. CFC believes that its relations with its employees are good.

CFC Lending Competition

CFC competes with other lenders on price and the variety of options and additional services offered as well as its overall approach to and relationship with its member/owners. 

According to annual financial statements filed with CFC, the 811 reporting electric cooperative distribution and 53 reporting power supply systems had a total of $41.9 billion in long-term debt outstanding at December 31, 2001. RUS is the dominant lender to the electric cooperative industry with $26.3 billion or 63% of the total outstanding debt for the 864 systems reporting 2001 results to CFC. At December 31, 2001, CFC had a total of $13.4 billion of long-term exposure to its reporting distribution and power supply member systems, including $11.9 billion of long-term loans and $1.5 billion of guarantees. CFC's $13.4 billion long-term exposure represented 32% of the total long-term debt to these electric systems. The remaining $2.2 billion or 5% was borrowed from other sources. (Competition data is based on December 31, 2001 financial data filed with CFC by its members).

13

During fiscal year 2002, CFC was selected as the lender for 96% of the total supplemental lending requirement (not including amounts lent by FFB). RUS currently prices the majority of its insured loans to distribution systems based on a municipal government obligation index, prices hardship loans at a rate of 5% and provides guarantees of loans to its electrical cooperatives by others, principally the FFB. Under the insured loan program, RUS typically does not lend the full amount of debt requested by the cooperative, requiring the cooperative to seek supplemental lending from private capital sources. The amount of funding proposed for RUS direct lending for fiscal year 2003 is $1.3 billion. The amount approved for the prior year was $1.4 billion. The amount proposed for RUS guaranteed loans for fiscal year 2003 is $2.7 billion. CFC and other lenders are not in competition with RUS, but rather compete for the supplemental lending requirement, as well as for the full lending requirement for those cooperatives that have decided not to borrow from RUS. Under the hardship program, RUS lends 100% of the amount. Under the guarantee program, RUS will guarantee the repayment of all principal and interest by the cooperative.

Legislation enacted in 1992 allows RUS electric borrowers to prepay their loans to RUS at a discount based on the government's cost of funds at the time of prepayment. If a borrower chooses to prepay its notes, it becomes ineligible for future RUS insured loans for a period of ten years, but remains eligible for RUS loan guarantees. During the year ended May 31, 2002, CFC was selected as lender for 100% of the total lent to distribution systems for the repayment of their RUS debt. As of May 31, 2002, 229 borrowers had either fully prepaid or partially prepaid their RUS notes under these provisions. In total, CFC has lent $3.2 billion to distribution systems for the purpose of prepaying their RUS debt, representing 93% of the total note buyouts.

The competitive market for providing credit to the rural telecommunications industry is difficult to quantify, since many rural telecommunications companies are not RUS borrowers and do not report financial results to RUS. At December 31, 2001, RUS had a total of $3.2 billion outstanding to telecommunications borrowers. The RTB, an instrumentality of the United States that provides supplemental financing to RUS borrowers and is managed by RUS, had a total of $1.1 billion outstanding to telecommunications borrowers. CFC is not in direct competition with RUS or RTB, but rather competes with other lenders for additional supplemental lending and for the full lending requirement of the rural telecommunications companies that have decided not to borrow from RUS or RTB or for projects not eligible for RUS or RTB financing. CFC's competition includes regional banks, a government sponsored enterprise and insurance companies. At December 31, 2001, CFC had a total of $4.9 billion in long-term loans outstanding to telecommunications borrowers. At December 31, 2001, CFC is aware of only CoBank (which at December 31, 2001 had a telecom portfolio of approximately $3.1 billion) as a lender with a telecommunications loan portfolio of similar size to CFC's and RUS/RTB's.

Member Regulation and Competition

Electric Systems

In 1992 Congress passed the Energy Policy Act effectively requiring competition in the generation sector of the wholesale electric power industry. In 1996, FERC issued orders 888 and 889. Order 888 provides for competitive wholesale power sales by requiring jurisdictional public utilities that own, control or operate transmission facilities to file non-discriminatory open access transmission tariffs that provide others with transmission service comparable to the service they provide themselves. The reciprocity provision associated with order 888 also provides comparable access to transmission facilities of non-jurisdictional utilities (including RUS borrowers and municipal and other publicly owned electric utilities) that use jurisdictional utilities' transmission systems. The order further provides for the recovery of stranded costs from departing wholesale customers with agreements dated prior to July 11, 1994. After that date, stranded costs must be agreed upon in the service agreement. Order 889 provides for a real-time electronic information system referred to as the Open Access Same-Time Information System. It also establishes standards of conduct to ensure that transmission owners and their affiliates do not have an unfair competitive advantage by using transmission to sell power.

Section 211 of the Federal Power Act as amended by the Energy Policy Act of 1992 classifies any cooperative with significant transmission assets as a "transmitting utility" for purposes of this section. Under the provisions of this act, FERC has the authority to order such cooperatives to provide open access for unaffiliated entities. This provision also authorizes FERC to require investor-owned and other utilities to provide the same open access transmission for the benefit of cooperatives. Electric cooperatives have strongly supported section 211 for this reason. Under sections 205 and 206 of the Federal Power Act, a cooperative that pays off its RUS debt may be treated as a jurisdictional public utility subject to FERC regulation if it is a "transmitting utility." FERC is proceeding under the legal theory that, under these sections, it can order jurisdictional public utilities to provide open access.

14

The trend toward retail electric competition has been reversed or slowed. At May 31, 2002, 17 states were active in the restructuring process. In these states, customer choice was either currently available to all or some customers or will soon be available. Those states are Arizona, Connecticut, Delaware, Illinois, Maine, Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Oregon, Pennsylvania, Rhode Island, Texas, and Virginia. Of the remaining states, 26 states were not actively pursuing restructuring, six states have delayed the restructuring process or the implementation of customer choice, and one state has suspended customer choice.

In the 17 states that were active in customer choice, CFC had a total of 244 electric members (183 distribution, 21 power supply and 40 associate) and $5,412 million of loans to electric systems in these states. In New York, where CFC has five electric members and $9 million of loans, cooperatives are not required to file competition plans with the state utility commission. CFC continues to believe that the distribution systems, which comprise the majority of CFC's membership and loan exposure, will not be materially impacted by a move to customer choice. The experience to date has been that, even in those states where customers have a choice of alternative energy suppliers, very few customers have switched from the traditional supplier.

In addition, in 5 of the 17 states actively operating under customer choice laws, co-ops have a choice whether to "opt in" to competition or retain a monopoly position with respect to energy sales. Those states are Illinois, New Jersey, Ohio, Oregon, and Texas. As of May 31, 2002, CFC had loans outstanding in the amount of $4,310 million in those states. Furthermore, even if customers choose to purchase energy from an alternative supplier, the distribution systems own the lines to the customer and it would not be feasible for a competitor to build a second line to serve the same customers in almost all situations. Therefore the distribution systems will still be charging a fee or access tariff for the service of delivering power regardless of who supplies the power.

The impact on power supply systems cannot be determined until final rules have been approved in each state with regard to stranded cost recovery.

While customer choice laws have been passed in the above states, there are many factors that may delay or influence the choices that customers have available and the timing of true competition. One of the biggest factors will be the issue of stranded cost recovery. Stranded costs are the portion of the investment in generation and/or other facilities which in a competitive environment would be above market price and therefore not otherwise recoverable by the utility. The amount of stranded costs a system is allowed to recover, the timing of the recovery and the method of recovery will all affect the level of competition in a state. The level of fees that systems will be allowed to charge other utilities for use of their transmission and distribution system may also impact the level of residential competition. Other issues that may delay competition include the following:

*

cooperatives are allowed to "opt out" of the provisions of the customer choice laws in some states;

*

utilities in many states will still be regulated regarding rates on non-competitive services, such as distribution;

*

many states will still regulate the borrowing by utilities;

*

FERC regulation of transmission;

*

reconciling the differences in various state laws, so that out-of-state utilities can compete with in-state utilities; and

*

the fact that few competitors have targeted residential or rural customers.

In addition to customer choice laws, some state agencies regulate electric cooperatives with regard to rates and borrowing. There are 17 states that regulate the rates electric systems charge; of these states, three states have partial oversight authority over the cooperatives' rates, but not the specific authority to set rates, and seven states allow cooperatives the right to opt in or out of state regulation. There are five states that regulate electric systems regarding the issuance of long-term debt and there are two states that regulate the issuance of short-term debt. FERC also has jurisdiction to regulate rates of and refinancing by electric systems within its jurisdiction that are not borrowers of RUS, but which are otherwise jurisdictional.

Telecommunications Systems

CFC member telecommunications systems are regulated at the state and federal levels. Most state regulatory bodies regulate local service rates, intrastate access rates and telecommunications company borrowing. The Federal Communications Commission ("FCC") regulates interstate access rates and the issuance of licenses required to operate certain types of telecom operations.

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The Telecommunications Act of 1996 (the "Telecom Act") created a framework for competition and deregulation in the local telecommunications market. The Telecom Act had four basic goals: competition, universal service, deregulation and fostering advanced telecommunications and information technologies. The Telecom Act seeks to achieve competition by requiring all carriers to interconnect with all others and by requiring local exchange carriers to provide competitors with total service resale, number portability, dialing parity, access to rights-of-way, reciprocal compensation, co-location, and unbundled access. Congress included provisions in the Telecom Act granting RLECs an exemption from the above requirements.

In cities, telecommunications competition is occurring. Despite the shakeout in the competitive local exchange carrier segment, facility and non-facility based competitors are focused primarily on the large business user market. Few of these competitors have targeted residential customers. The regional bell operating companies are motivated to cooperate with competitors in order to win approval to enter the long distance market in their service territories. For example, Verizon has won FCC approval to provide long distance service in New York, Connecticut, Pennsylvania and Massachusetts. SBC Communications, Inc. has received approval in Arkansas, Missouri, Texas, Oklahoma and Kansas. Bellsouth has recently won approval to offer long distance in Georgia and Louisiana.

Rural markets, with their preponderance of residential subscribers, are the last to see wide-scale local telecommunications service competition. Rural telecommunications companies that border metropolitan areas are experiencing competition for their largest business customers. These rural telecommunications providers generally are using the period before they come under competitive pressure to enter small towns and smaller cities as competitive local exchange carriers. They are able to leverage their infrastructure, organization skills, financial strength and local presence to compete with larger, incumbent providers that are not focused on these small markets.

In addition to competition, the Telecom Act also mandated a new universal telecommunications service support mechanism and required that it be sufficient to ensure that rural customers receive reasonably comparable rates and services when compared to urban customers. Congress stated its intent that implicit subsidies presently contained in the access charges local telecommunications companies levy on long distance carriers be eliminated and be made explicit in the new universal service support mechanism. In late 2000, the FCC issued new rules for determining rural high-cost universal service support for the next five years. The rules, among other things, base support on actual 2000 cost levels, allow for growth of the universal service fund and freeze the national average cost of a telco subscriber loop (the benchmark for determining eligibility for support) at $240. CFC believes that adoption of these rules will benefit RLECs.

In 1999, the FCC approved a plan (the "CALLS" plan) put forward by large local exchange carriers ("LECs") and interexchange carriers ("IXCs") that reduced access charges the large LECs charge the IXCs, and authorized alternative mechanisms by which the large LECs can recover a significant portion of lost access revenues. The national telephone trade associations have developed a similar plan (the "MAG" plan) for small RLECs that includes a solution for the uncertainty that has surrounded universal service funding. The FCC issued its MAG order in October 2001. The ruling, among other things, reduces access charges, allows RLECs to recover the lost revenues through increased subscriber flat-rate charges and retains an 11.25% interstate rate of return. Recent rulings by the FCC have enabled rural local exchange carriers to recover costs allocated to the interstate jurisdiction through flat cost of service charges to the end users rather than through per minute access charges on long distance carriers.  CFC does not anticipate that any revenue losses resulting from these orders will result in material losses on loans outstanding to rural telecommunications companies.

Deregulation thus far has not had much effect on LECs. The FCC has promulgated a series of rules to implement the Telecom Act, and eliminated very few existing regulatory requirements.

The final aspect of the Telecom Act dealt with advanced telecommunications and information technologies. The concern that there is a growing "digital divide" between various groups and areas within the country and the desire on the part of legislators to provide broadband connectivity to all Americans has led to programs which provide funding to connect schools and libraries to the internet. RUS has issued rules liberalizing its lending criteria to facilitate provision of advanced telecommunications and information services in rural areas. It is anticipated that RUS will play a significant role in financing infrastructure to help provide rural Americans with access to these services. Given the increased availability of government financing for rural broadband, it is unlikely that CFC or any other supplemental lender will be participating in this financing to any significant degree.

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The RUS Program

Since the enactment of the Rural Electrification Act in 1936 (the "RE Act"), RUS has financed the construction of electric generating plants, transmission facilities and distribution systems in order to provide electricity to rural areas. Principally through the organization of systems under the RUS loan program in 48 states and U.S. territories, the percentage of farms and residences in rural areas of the United States receiving central station electric service increased from 11% in 1934 to almost 100% currently. Rural electric systems serve 12% of all consumers of electricity in the United States and its territories and account for approximately 8% of total sales of electricity and own about 5% of energy generation and generating capacity.

In 1949, the RE Act was amended to allow RUS to lend for the purpose of furnishing and improving rural telecommunications service. For fiscal year 2002, RUS has $670 million in lending authority for rural telephone systems and an additional $690 million for other telecommunications programs, including distance learning, broadband and local-to-local television.

The RE Act provides for RUS to make insured loans and to provide other forms of financial assistance to borrowers. RUS also provides financing at the Treasury rate. RUS is authorized to make direct loans, at below market rates, to systems which are eligible to borrow from it. RUS is also authorized to guarantee loans that have been used mainly to provide financing for construction of bulk power supply projects. Guaranteed loans bear interest at a rate agreed upon by the borrower and the lender (which generally has been the FFB). For telecommunications borrowers, RUS also provides financing through the RTB. The RTB is an instrumentality of the United States providing financing at rates reflecting its cost of capital and is managed by RUS. The RUS exercises financial and technical supervision over borrowers' operations. Its loans and guarantees are generally secured by a mortgage on substantially all of the system's property and revenues.

For the fiscal year ending September 30, 2003, both the House  and Senate Appropriations Committees have approved RUS electric loan levels as follows: municipal rate loans of $100 million, hardship loans of $121 million, treasury rate loans of $1.1 billion, and loan guarantees of $2.7 billion. Electric funding levels for fiscal year 2002 were as follows: municipal rate loans of $500 million, hardship loans of $121 million, treasury rate loans of $750 million, and loan guarantees of $2.7 billion. Thus, the total amount of fiscal year 2003 RUS electric loan levels approved by both the House and Senate Appropriations Committees represent substantially the same amounts as current year levels.

Member Financial Data

Electric Systems

On the following pages are tables providing composite statements of revenues, expenses and patronage capital from the distribution systems and power supply systems which were members of CFC during the five years ended December 31, 2001, and their respective composite balance sheets at the end of each such year. As of July 31, 2002, CFC had received financial information from 811 distribution systems and 53 power supply systems.

While CFC had 826 distribution system members at May 31, 2002, 13 systems were not required to report financial results because they did not have outstanding balances of long-term loans at December 31, 2001, one system is in bankruptcy and did not file financial results with CFC, and one system is not required to file as it is a flow-through cooperative that buys power and sells only to other power distributors.

Only 53 of the 71 total power supply systems reported December 31, 2001 financial results to CFC. A total of 15 power supply systems did not report financial results because they did not have an outstanding balance of long-term loans at December 31, 2001. One power supply system merged with another and filed combined financial results. In addition, 2 power supply systems did not file financial results with CFC.

Telecommunications Systems

On the following pages are tables providing composite statements of revenues and expenses from the telecommunications systems that were members of CFC during the four years ended December 31, 2001. The first year for which CFC has collected such data and their respective composite balance sheet was 1998. Members with long-term loans outstanding are generally required to submit annual data as of December 31 in the form of audited financial statements. As of July 15, 2002, CFC had received audited financial statements from 208 telecommunications systems.

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NOTE: The information presented is based upon financial statements submitted to CFC, subject to year-end audit adjustments, by reporting borrowers and does not, with minor exceptions, take into account current data for certain systems, primarily those which are not active CFC borrowers. CFC takes no responsibility for the accuracy or completeness of the member data. CFC's independent public accountants have not examined statistical information contained in this section, and the number and geographical dispersion of the systems have made impractical an independent investigation by CFC of the statistical information. 

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NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

COMPOSITE STATEMENTS OF REVENUES, EXPENSES AND PATRONAGE CAPITAL

AS REPORTED TO CFC BY MEMBER DISTRIBUTION SYSTEMS

The following are unaudited figures that are based

upon financial statements submitted to

CFC by Member Distribution Systems

Years ended December 31,

(Dollar amounts in thousands)

2001

2000

1999

1998

1997

Operating revenues and patronage capital

$

21,627,713

$

20,419,019

$

18,805,359

$

18,284,021

$

17,232,257

Operating deductions:

Cost of power (1)

13,550,239

12,925,630

11,828,572

11,580,829

10,907,145

    Distribution expense (operations)

899,310

856,378

792,249

728,565

472,629

    Distribution expense (maintenance)

1,183,558

1,106,780

1,024,734

985,571

829,991

    Administrative and general expense (2)

2,144,824

1,972,220

1,864,344

1,735,074

1,720,805

    Depreciation and amortization expense