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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, 1998
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 telephone number, including area code, is 703-709-6700)
Securities registered pursuant to Section 12(b) of the Act:
Name of each exchange
Title of each class on which registered
9.00% Collateral Trust Bonds, Series V, Due 2021 New York Stock Exchange
8.00% Quarterly Income Capital Securities Due 2045 New York Stock Exchange
7.65% Quarterly Income Capital Securities Due 2046 New York Stock Exchange
7.375% Quarterly Income Capital Securities Due 2047 New York Stock Exchange
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.
Yes X No .
The Registrant has no common or voting stock.
DOCUMENTS INCORPORATED BY REFERENCE:
None
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
Telephone Systems 3
Loan Programs 3
Interest Rates on Loans 5
Electric Loan Programs 5
Telecommunications Loan Programs 6
Associate Member Loans 7
RUS Guaranteed Loans 7
Largest Borrowers 8
Credit Limitation 8
Loan Security 8
Conversion of Loans 9
Prepayment of Loans 9
Pledging of Loans 9
Guarantee Programs 9
Guarantees of Pollution Control Facility and
Utility Property Financings 9
Guarantees of Lease Transactions 10
Guarantees of Tax Benefit Transfers 10
Other 10
CFC Financing Factors 10
Members' Subordinated Certificates 11
Members' Equity 11
Debt Issuance 11
Interest Rate Exchange Agreements 12
Revolving Credit Agreements 12
Tax Status 13
Investment Policy 13
CFC Lending Competition 13
Member Regulation and Competition 14
Electric Systems 14
Telephone Systems 15
Employees 16
The RUS Program 16
Member Financial Data 17
2. Properties 23
3. Legal Proceedings 23
4. Submission of Matters to a Vote of Security Holders 23
II. 5. Market for the Registrant's Common Equity and
Related Stockholder Matters 24
6. Selected Financial Data 24
7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 25
8. Financial Statements and Supplementary Data 40
9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 40
III. 10. Directors and Executive Officers of the Registrant 41
405 Compliance with Section 16(a) of the Exchange Act 45
11. Executive Compensation 45
12. Security Ownership of Certain Beneficial Owners and
Management 47
13. Certain Relationships and Related Transactions 47
IV. 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K 48
Part I
Item 1. Business.
General
National Rural Utilities Cooperative Finance Corporation (the
"Company" or "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 state-of-the-art financial
products and services. CFC provides its members with a source of
financing to supplement the loan programs of the Rural Utility 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,
properties constructed or acquired by its members, taxable debt in
connection with certain lease and various other transactions. CFC is
exempt from federal income taxes under the provisions of IRS code
section 501(c)(4). CFC has formed two affiliated corporations that are
controlled by CFC through majority representation on the companies'
boards of directors.
Rural Telephone Finance Cooperative ("RTFC") was incorporated as a
taxable 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 financing to its rural telecommunication
members and affiliates. RTFC's bylaws and voting members' agreement
require that the majority of RTFC's Board of Directors be elected from
individuals designated by CFC. CFC is the sole source of external
funding for RTFC.
Guaranty Funding Cooperative ("GFC") was organized in December
1991 as a taxable cooperative association owned by its member rural
electric systems and CFC to provide a source of funds for members to
refinance the Rural Utilities Service ("RUS"), guaranteed debt previously
held by the Federal Financing Bank of the United States Treasury
("FFB"). GFC is a controlled affiliate of CFC (the majority of its
directors are appointed by CFC). All loans from GFC are guaranteed by
RUS. CFC is the sole source of external funding for GFC.
Except as indicated, financial information presented herein includes CFC,
RTFC and GFC on a combined basis.
Members
CFC had 1,052 members as of May 31, 1998, including 903 Utility
Members, virtually all of which are consumer-owned cooperatives, 75
service members and 74 associate members. The Utility Members
included 835 distribution systems and 68 generation and transmission
("power supply") systems operating in 46 states and U.S. territories.
CFC currently has five classes of members: Class A-cooperative or
nonprofit distribution systems; Class B-cooperative or nonprofit power
supply systems which are federations of Class A or other Class B
members; 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-nonprofit
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 491 members as of May 31, 1998. Membership in RTFC is
limited to CFC and commercial or cooperative (non-profit) telephone
systems eligible to receive loans or other assistance from RUS and which
are engaged (or plan to be engaged) in providing telecommunication
services to ultimate users and affiliates of such corporations.
GFC had four members as of May 31, 1998. Membership in GFC is
limited to CFC and cooperative or nonprofit Utility Member systems who
have refinanced all or a portion of their FFB debt through CFC.
Set forth below is a table showing by State or U.S. territory the total
number of CFC, RTFC and GFC members (memberships in each other have been
eliminated and corporations which belong to more than one of CFC, RTFC and
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GFC have been counted only once), the percentage of
total loans and the percentage of total loans and guarantees outstanding
at May 31, 1998.
Number Loan and Number Loan and
of Loan Guarantee of Loan Guarantee
members % % members % %
Alabama 32 1.4% 1.7% Montana 38 1.6% 1.3%
Alaska 28 1.3% 1.1% Nebraska 39 0.1% 0.1%
American Samoa 1 0.0% 0.0% Nevada 5 0.6% 0.5%
Arizona 20 0.8% 1.1% New Hampshire 7 2.5% 2.1%
Arkansas 29 2.8% 3.3% New Jersey 1 0.1% 0.1%
California 10 0.3% 0.3% New Mexico 18 0.8% 0.7%
Colorado 39 3.3% 2.9% New York 14 0.1% 0.1%
Delaware 1 0.2% 0.1% North Carolina 46 3.7% 4.0%
District of Columbia 5 1.2% 1.0% North Dakota 35 0.5% 0.4%
Florida 21 4.0% 5.8% Ohio 40 1.4% 1.2%
Georgia 73 7.7% 6.5% Oklahoma 52 2.8% 2.7%
Guam 1 0.0% 0.0% Oregon 38 2.1% 1.8%
Idaho 16 0.9% 0.8% Pennsylvania 23 1.0% 0.9%
Illinois 55 4.3% 3.6% South Carolina 39 3.0% 2.9%
Indiana 55 1.4% 2.1% South Dakota 52 1.5% 1.3%
Iowa 105 2.5% 2.2% Tennessee 25 0.9% 0.7%
Kansas 52 2.8% 2.7% Texas 117 12.6% 11.6%
Kentucky 35 2.0% 3.1% Utah 11 3.7% 5.6%
Louisiana 18 1.7% 1.4% Vermont 9 0.5% 0.4%
Maine 9 0.5% 0.4% Virgin Islands 1 2.0% 1.7%
Maryland 2 0.8% 0.7% Virginia 29 2.2% 2.2%
Massachusetts 1 0.0% 0.0% Washington 22 0.8% 0.7%
Michigan 26 2.5% 2.1% West Virginia 4 0.0% 0.0%
Minnesota 72 4.3% 4.7% Wisconsin 66 2.4% 1.9%
Mississippi 26 2.3% 2.5% Wyoming 15 1.1% 1.0%
Missouri 65 3.0% 4.0% Total Members 1,543 100.0% 100.0%
Distribution Systems
Distribution systems are utilities engaged in retail sales of electricity to
consumers in their service area. Most distribution systems have all-
requirements power contracts with their power supply systems, which are
owned and controlled by the member 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, without limitation, 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
leases of the power supply system and to provide for the establishment
and maintenance of reasonable reserves. The rates under the wholesale
power contracts are required to be reviewed by the Board of Directors of
the power supply system at least annually.
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).
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Power Supply Systems
Power supply systems are utilities which purchase or generate electric
power and provide it wholesale to distribution systems for delivery to the
ultimate retail consumer. Of the 63 operating power supply systems
financed in whole or in part by RUS or CFC at December 31, 1997, 62
were cooperatives owned directly or indirectly by groups of distribution
systems and one was government owned. Of this number, 39 had
generating capacity of at least 100 megawatts, and nine had no
generating capacity. Eight of the nine systems with no generating
capacity operated transmission lines to supply certain distribution
systems. Certain other power supply systems had been formed but did
not yet own generating or transmission facilities.
At December 31, 1997, the 57 power supply systems reporting to CFC
owned interests in 155 generating plants representing generating capacity
of approximately 32,066 megawatts, or approximately 5.7% of the
nation's estimated electric generating capacity, and served 709 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, 1997, steam plants
accounted for 90.9% (including nuclear capacity representing
approximately 10.5% of such total generating capacity), internal
combustion plants accounted for 6.8% and hydroelectric plants
accounted for 2.3%.
Service Organizations and Associate Member Systems
Service organizations include the National Rural Electric Cooperative
Association ("NRECA"), which represents cooperatives nationally, as
well as the statewide cooperative associations, which represent the
cooperatives within the state. Associate members include organizations
that are nonprofit 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.
Telephone Systems
Telephone systems include not-for-profit cooperative organizations and
for-profit commercial organizations that provide telecommunications
services to rural areas.
Independent rural telephone companies provide service in the majority
of America's rural areas. These companies, which number
approximately 1,000, are called independent because they are not
affiliated with the Bell operating companies or other large holding
companies. The majority of these independent rural telephone
companies are small, family-owned or privately-held commercial
companies. A handful of these commercial companies are publicly
traded. In addition, there are approximately 280 not-for-profit
cooperative telephone companies.
Rural telephone companies serve approximately 5 million customers
in 48 states, and range in size from fewer than 50 customers to more
than 50,000. Rural telephone companies' annual operating revenues
range from less than $100,000 to $50 million. In addition to basic
telephone service, most independents offer other communications
services ranging from wireless to cable TV to Internet access. Most
rural telephone companies' networks are state-of-the-art,
incorporating digital switching, fiber optics and other advanced
technologies.
Loan Programs
CFC offers long-term loans with maturities of up to 35 years,
intermediate-term loans with maturities of up to five years, and line of
credit loans. Long-term and intermediate-term loans are available at fixed
or variable interest rates and line of credit loans are available only at a
variable interest rate. Long-term loans are generally secured by a first
mortgage lien on 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.
All borrowers must forward annual audited and interim financial
statements to CFC. Borrowers also must supply various other
representations in an officer's certificate, and maintain certain levels
of financial performance as prescribed under each loan program.
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Set forth below is a table showing loans outstanding to borrowers as of
May 31, 1998, 1997 and 1996 and the weighted average interest rates
thereon and loans committed but unadvanced to borrowers at May 31,
1998.
Loans outstanding and weighted average interest Loans committed
rates thereon at May 31, but unadvanced at
(Dollar Amounts In Thousands) 1998 1997 1996 May 31,1998(A)(B)
Long-term fixed rate secured loans(C):
Distribution Systems (D) $3,857,645 6.95% $2,503,890 7.20% $2,380,587 7.29% $ 101,083
Power Supply Systems (D) 349,038 7.43% 239,381 7.54% 247,556 7.71% 10,787
Telecommunication Organizations 222,733 8.05% 148,566 8.53% 134,497 8.66% -
Service Organizations (D) 76,102 8.63% 82,634 8.62% 77,205 8.03% 5,407
Associate Members 6,844 7.29% 1,512 10.25% 1,542 10.25% 4,907
Total long-term fixed rate secured loans 4,512,362 7.07% 2,975,983 7.33% 2,841,387 7.41% 122,184
Long-term variable rate secured loans (E):
Distribution Systems 2,693,266 6.55% 3,209,472 6.55% 2,717,494 6.45% 2,622,181
Power Supply Systems 409,039 6.55% 281,368 6.55% 202,249 6.45% 878,282
Telecommunication Organizations 1,131,561 6.65% 875,135 6.65% 764,911 6.55% 276,104
Service Organizations 64,538 6.55% 54,802 6.55% 46,376 6.45% 113,190
Associate Members 42,972 6.31% 48,186 6.29% 47,541 6.19% 11,705
Total long-term variable rate
secured loans 4,341,376 6.57% 4,468,963 6.57% 3,778,571 6.47% 3,901,462
Refinancing variable rate loans guaranteed
by RUS:
Power Supply Systems 133,195 6.36% 137,984 6.49% 416,637 6.47% -
Intermediate-term secured loans:
Distribution Systems 4,479 6.70% 12,530 6.70% 4,831 6.60% 20,239
Power Supply Systems 134,574 7.48% 198,985 6.70% 53,614 6.60% 193,894
Telecommunication Organizations 86 7.25% - - - - -
Service Organizations 12,149 6.70% 14,592 6.70% 27,652 6.60% 9,379
Total intermediate-term secured loans 151,288 7.39% 226,107 6.70% 86,097 6.60% 223,512
Intermediate-term unsecured loans:
Distribution Systems 114,747 6.70% 72,860 6.70% 16,019 6.45% 63,942
Power Supply Systems 83,374 6.70% 43,129 6.70% 28,957 6.45% 124,581
Telecommunication Organizations 15,495 7.25% 13,683 7.25% 12,048 6.80% 15,457
Total intermediate-term unsecured loans 213,616 6.74% 129,672 6.76% 57,024 6.52% 203,980
Line of credit loans (F):
Distribution Systems 587,193 6.70% 473,639 6.70% 409,664 6.60% 2,915,512
Power Supply Systems 48,991 6.70% 25,051 6.70% 25,763 6.60% 955,958
Telecommunication Organizations 205,026 7.25% 61,779 7.25% 63,813 7.15% 371,457
Service Organizations 38,979 6.70% 27,420 6.70% 23,467 6.60% 130,687
Associate Members 13,832 6.70% 13,417 6.70% 9,240 6.60% 20,492
Total line of credit loans 894,021 6.83% 601,306 6.76% 531,947 6.67% 4,394,106
Nonperforming loans (G):
Distribution Systems - - 1,705 7.21% 1,739 7.20% -
Power Supply Systems 2,159 6.55% 7,723 6.64% 23,555 6.48% -
Associate Members 1,921 6.25% - - - - -
Total nonperforming loans 4,080 6.41% 9,428 6.75% 25,294 6.53% -
Restructured loans (G):
Distribution Systems - - - - 2,576 18.37% -
Power Supply Systems 329,538 7.17% 361,961 8.32% 205,074 9.13% -
Service Organizations - - - - 1,711 6.45% -
Total restructured loans 329,538 7.17% 361,961 8.32% 209,361 9.22% -
Total loans 10,579,476 6.70% 8,911,404 6.81% 7,946,318 6.85% 8,845,244
Less: Allowance for loan losses 250,131 233,208 218,047 -
Net loans $10,329,345 $8,678,196 $7,728,271 $8,845,244
(A) The interest rates in effect at August 3, 1998, for loans to electric
members were 6.85% for long-term loans with a seven-year fixed rate
term, 6.55% on variable rate long-term loans and 6.70% on
intermediate-term loans and lines of credit. The rates in effect at
August 3, 1998, on loans to telecommunication organizations were
7.25% for long-term loans with a seven-year fixed rate term, 6.65% on
long-term variable rate loans, 6.90% on intermediate-term loans and
7.25% on lines of credit. The rates in effect at August 3, 1998, on
loans to associate members were 7.15% for long-term loans with a
seven-year fixed rate term, 6.55% on long-term variable rate loans and
6.70% on lines of credit.
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(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. Long-
term unadvanced commitments that do not have an interest rate
associated with the commitment have been listed with the variable rate
loans. Rates, fixed or variable, are set at the time of each advance on
the amount of the advance.
(C) Includes $121.6 million, $38.4 million and $198.3 million of unsecured
loans at May 31, 1998, 1997 and 1996.
(D) During fiscal year 1999, $330.0 million of such outstanding fixed rate
loans, which currently have a weighted average interest rate of 7.32%
per annum, will become subject to rate adjustment. During the first
quarter of calendar year 1998, long-term fixed rate loans totaling
$47.6 million had their interest rates adjusted. These loans will be
eligible to readjust their interest rate again during the first quarter of
calendar year 1999 to the lowest long-term fixed rate offered during
1998 for the term selected. At January 1 and May 31, 1998, the
seven-year long-term fixed rate was 6.95% and 6.85%, respectively.
(E) Includes $53.3 million, $112.4 million and $84.6 million of unsecured
loans at May 31, 1998, 1997 and 1996.
(F) Includes $81.4 million, $99.1 million and $92.7 million of secured
loans at May 31, 1998, 1997 and 1996.
(G) The rates on nonperforming and restructured loans are the weighted
average of the stated rates on such loans as of the dates shown and do
not necessarily represent the interest recognized by CFC from such
loans.
Interest Rates on Loans
CFC's goal as a non-profit cooperatively owned finance company is to
set its rates at levels that will provide its members with the lowest cost
financing as well as to maintain sound financial results required to obtain
the highest credit ratings possible on its debt instruments. CFC sets its
interest rates based on the cost of funding plus provisions for general and
administrative expenses, the loan and guarantee loss allowance and a
reasonable net margin. Various discounts from the stated interest rates
are available to borrowers meeting certain criteria related to performance,
number of creditors and loan volume.
Set forth below are the weighted average interest rates earned by CFC
(recognized on a cash basis in the case of nonperforming and restructured
loans) on all loans outstanding during the fiscal years ended May 31:
INTEREST RATES EARNED ON LOANS
1998 1997 1996
Long-term fixed rate 7.12% 7.65% 7.92%
Long-term variable rate 6.53% 6.25% 6.30%
Telecommunication organizations 7.05% 6.73% 6.86%
Refinancing loans guaranteed by RUS 6.32% 6.36% 6.75%
Intermediate-term 7.08% 7.08% 6.57%
Short-term 6.74% 6.40% 6.49%
Associate members 6.65% 6.42% 6.46%
Nonperforming 0.00% 0.00% 0.25%
Restructured 0.00% 0.56% 1.49%
All loans 6.60% 6.58% 6.77%
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 the
variable rate. 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. A
borrower may elect to switch their fixed rate loan to a variable rate loan
at any time and may be subject to a conversion fee. A borrower
5
may convert their variable rate loan to a fixed rate loan at any time, without
a fee. Long-term fixed rates are set daily by CFC and the long-term
variable rate is set on the first 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 their loan into various mini-notes. The
borrower then has the option of selecting a fixed or variable interest rate
for each mini-note. Long-term loans are generally secured by a mortgage
on all assets and revenues of the borrower on a pari passu basis with
RUS. Long-term loans may be prepaid by the borrower at any time,
subject to the payment of a prepayment premium.
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. 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. 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, 1998,
5.1% of the dollar amount of long-term loans approved were to
borrowers that did not meet the minimum lending criteria.
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 only be
advanced at a variable interest rate. The intermediate-term loan and
line of credit loan variable interest rate is set on the first day of each
month. Intermediate-term loans may be secured or unsecured and line
of credit loans are generally unsecured. 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.
The rates on intermediate-term loans may not be converted from
variable to fixed or from fixed to variable. Intermediate-term loans
may be prepaid at any time, subject to the payment of a prepayment
premium. Line of credit loans may be prepaid at any time, without a
premium.
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.
Power Vision
Power Vision is a program that CFC launched during fiscal year 1998.
Under the Power Vision program, CFC distribution system
borrowers were pre-approved for loans up to a maximum
amount based on an evaluation of their financial condition
and operating results. To establish a commitment for the
pre-approved loan amount, the borrower has only to complete the
required loan documents and obtain the approval of its board of
directors. The committed amounts are available to the borrower for a
period of five years. The borrower may request advance of funds under
any of the loan programs available to electric systems, subject to the
conditions previously described for each loan program.
Telecommunications Loan Programs
Long-Term Loans
CFC makes long-term loans to rural telephone companies and their
affiliates for the acquisition of and the construction or upgrade of wireline
telephone systems, wireless telephone systems, fiber optic networks and
cable television systems as well as other legitimate 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 1 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. A borrower may elect to switch their fixed rate
loan to a variable rate loan at any time and may be subject to a conversion
fee. A borrower may convert their variable rate loan to a fixed rate loan
at any time, without a fee. Long-term fixed rates for telephone loans are
set daily by CFC and the long-term variable rate is set on the first 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 their
loan into various mini-notes. The borrower then has the option of
selecting a fixed or variable interest rate for each note. Long-term loans
are generally secured by a mortgage on all assets and revenues of the
borrower and may be further supported by guarantees from affiliated
companies. Long-term loans may be prepaid by the borrower at any
time, subject to the payment of a prepayment premium.
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A wireline telephone system generally must be able to demonstrate the
ability to achieve and maintain an annual DSC and an annual TIER of
1.25 and 1.50, respectively, to borrow from CFC. A cable television
system, fiber optic network or cellular telephone system generally must be
able to demonstrate the ability to achieve and maintain an annual DSC of
1.25 to borrow from CFC. 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 sufficient to
repay the CFC obligations under the approved terms.
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 from
non-RUS telecommunications borrowers is considered on a case-by-case
basis, but generally a loan will not exceed 80% of the estimated value of
the collateral. At May 31, 1998, a total of $178.0 million or 11.3% of
CFC telecommunications loans outstanding were unsecured.
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 telephone 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 telecommunication 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 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 are provided on an unsecured
basis and are used primarily for normal cash management. Line of credit
loans are available to telecommunication systems generally in amounts
not to exceed the greater of five percent 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 which have an RUS and/or Rural
Telephone Bank ("RTB") loan 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.
Associate Member Loans
Long-term Loans
CFC makes long-term loans to associate members for periods of up to 35
years. Loans may be advanced at a fixed or variable interest rate. Fixed
rates are available for periods from 1 year to 35 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. A borrower may elect
to switch their fixed rate loan to a variable rate loan at any time and may
be subject to a conversion fee. A borrower may convert their variable
rate loan to a fixed rate loan at any time, without a fee. Long-term fixed
rates for associate member loans are set daily by CFC and the long-term
variable rate is set on the first 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 their loan into various mini-notes. The
borrower then has the option of selecting a fixed or variable interest rate
for each mini-note. Long-term loans are generally secured by a mortgage
on all assets and revenues of the borrower and/or a guarantee from a
Utility Member. Long-term loans may be prepaid by the borrower at any
time, subject to the payment of a prepayment premium.
Intermediate-Term Loans and Line of Credit Loans
CFC also provides intermediate-term loans and line of credit loans to
associate members for periods of up to five years. The line of credit loans
are generally revolving lines of credit which may require the borrower to
pay off the balance for five consecutive business days during each 12-
month period. Line of credit loan interest rates are set monthly (and may
be adjusted semi-monthly). Generally, these loans are secured by a
guarantee from a Utility Member of CFC.
RUS Guaranteed Loans
Congress enacted legislation which allowed certain systems to prepay
existing borrowings from the 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 which are guaranteed
by RUS. 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
7
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 service
fees to CFC in connection with these transactions. All of these
certificates that have not been sold in public offerings have been
transferred to GFC ($133.2 million outstanding at May 31, 1998). In
addition, CFC services $323.2 million of these loans for trusts, the
certificates of which have been sold in public offerings. The proposed
level of authority for RUS loan guarantees for the fiscal year beginning
October 1, 1998, has increased to $700 million, from $300 million for the
current year. CFC may participate as an eligible lender under the RUS
loan guarantee program.
Largest Borrowers
At May 31, 1998, the ten largest borrowers had outstanding loans from
CFC totaling $1,397.1 million, which represented approximately 13.3%
of CFC's total loans outstanding. At May 31, 1998, outstanding
guarantees for these same ten borrowers totaled $976.2 million which
represented 46.9% of CFC's total guarantees outstanding. CFC's ten
largest credit exposures represented 19% of total exposure at May 31,
1998 and 22% at May 31, 1997. On those dates, no member had
outstanding loans and guarantees in excess of 10% of the aggregate
amount of CFC's outstanding loans and guarantees; however, one of the
ten largest borrowers, Deseret Generation & Transmission Co-operative
("Deseret"), was in financial difficulty (see Note 10 to Combined
Financial Statements). At May 31, 1998, loans outstanding to Deseret
accounted for 3.1% of total loans outstanding. Guarantees outstanding to
Deseret accounted for 15.2% of total guarantees outstanding. Total
loans and guarantees outstanding to Deseret equaled 36.7% of total
Members' Equity, Members' Subordinated Certificates and the allowance
for loan losses. At May 31, 1998, CFC had $3,187 million in loans
outstanding, excluding loans guaranteed by RUS, and $1,757 million in
guarantees outstanding, to its largest 40 borrowers, representing 31% of
total loans outstanding and 85% of total guarantees outstanding. Credit
exposure to the largest 40 borrowers represented 39% of total credit
exposure at May 31, 1998, compared to 42% at May 31, 1997. At May
31, 1998, no borrower had more than 6% of total loans (excluding loans
guaranteed by RUS) and guarantees outstanding.
Credit Limitation
CFC maintains credit underwriting standards and other on-going credit
procedures so that, under "worst case" scenarios, any potential loss to a
single borrower will not exceed 10% of defined net worth. CFC
calculates a weighted total exposure for each borrower by applying a risk
factor to each category of exposure and giving the borrower credit for
their equity investments. The weighted exposure is then compared
against the credit limitation, 10% of defined net worth. Defined net
worth is the sum of Members' Equity, Members' Subordinated
Certificates and the allowance for loan and guarantee losses. As of May
31, 1998, all borrowers were within CFC's policy limit.
Loan Security
CFC typically makes long-term loans to its members on a secured basis.
Intermediate-term loans may be secured, as determined on a case by case
basis. Line of credit loans are generally unsecured. At May 31, 1998, a
total of $1,201.1 million of loans were unsecured representing 11.4% of
total loans and 9.5% of total loans and guarantees. 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. 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.
In the case of members whose property is already subject to a mortgage
to RUS, RUS approval of the loan is required, even in the case of a 100%
CFC loan, in order to accommodate RUS's mortgage lien so that CFC
may share ratably in the security provided by the mortgaged property.
CFC and RUS are then mortgagees in common, entitled to the security in
proportion to the unpaid principal amounts of their respective loans.
Mortgages do not require that the value of the mortgaged property be
equal to the obligations secured thereby.
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.
8
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 for a longer pricing term at
any time, without a fee. A borrower is allowed to convert a fixed
interest rate to a variable interest rate at any time, subject to a fee.
Intermediate-term loans and line of credit loans do not offer
conversion options. There is no fee on the conversion of a fixed
interest rate to a variable interest rate at the end of a fixed rate term.
The fee on the conversion of a fixed interest rate to a variable interest
rate at all other times 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 term.
Prepayment of Loans
Borrowers may prepay long-term loans at any time, subject to the
payment of a prepayment premium. Long-term loans prepaid before
the maturity of the fixed rate term will be assessed a prepayment
premium ranging from 33 to 50 basis points of the outstanding loan
balance at the time of prepayment. In addition, long-term loans with
a fixed interest rate which have a rate greater than the current rate for
the same remaining term will be assessed a premium to cover funding
losses. 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 balance of Collateral Trust Bonds outstanding. At May
31, 1998 and 1997, CFC had $1,930.9 million and $1,294.5 million,
respectively, of collateral on deposit and $1,902.1 million and
$1,002.1 million of Collateral Trust Bonds outstanding. CFC may
withdraw specific collateral at any time, provided that the principal
balance of notes or cash or eligible securities on deposit after
withdrawal is greater than the amount of bonds outstanding. At least
annually, CFC provides the trustee with a report of the principal
amount of all collateral pledged.
Guarantee Programs
Substantially all guarantees have been provided on behalf of power supply
members. Set forth below is a table showing CFC's guarantees:
(Dollar Amounts In Thousands) 1998 1997 1996
Long-term tax-exempt bonds $1,148,500* $1,190,925* $1,317,655*
Debt portions of leveraged lease transactions 437,175 418,916 432,516
Indemnifications of tax benefit transfers 312,771 338,264 363,702
Other guarantees 136,048 132,566 135,567
Total $2,034,494 $2,080,671 $2,249,440
* Includes $1,017.8 million, $1,043.2 million and $1,168.9 million at May
31, 1998, 1997 and 1996, 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 $252.8 million, $260.7 million
and $370.1 million of such bonds outstanding at May 31, 1998, 1997 and
1996, respectively, at any time on seven days' notice, in the case of
$235.6 million, $242.3 million and $248.8 million outstanding at May 31,
1998, 1997 and 1996, 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 such bonds that
cannot be remarketed. Since the inception of the program, CFC has not
been required to purchase any such bonds.
Guarantees of Pollution Control Facility and Utility Property
Financings
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. Such debt is
issued by governmental authorities 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 and the bond issue
will not be accelerated so long as CFC performs under its guarantee. The
system is required to repay, on demand, any amount advanced by CFC
9
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.
Guarantees of Lease Transactions
CFC has a program of lending to or guaranteeing debt issued by National
Cooperative Services Corporation ("NCSC") in connection with
leveraged lease transactions. In such transactions, NCSC has lent 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
was 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 were made on a non-recourse basis to the Lessor but
were secured by the property leased and the owner's rights as Lessor.
NCSC borrowed the funds it lent 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. Such fees are reimbursed to NCSC by the Lessee in each
transaction. 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 in 1982, no guarantees of
this nature have occurred since 1982.
Other
CFC may provide other loans and guarantees as requested by its
members. Such loans and guarantees will generally be made on a secured
basis with interest rates and guarantee fees set to cover CFC's cost of
capital, general and administrative expenses, a provision for loan and
guarantee losses and maintenance of a reasonable margin.
CFC Financing Factors
CFC funds its loan programs through retained margins for the current
year, allocated but unretired patronage capital (Members' Equity
investments), Members' Subordinated Certificate investments,
issuance of debt to members and in the capital markets. The
following table details the funds outstanding and percentage of total
capitalization at May 31, 1998, 1997 and 1996.
(Dollar Amounts In Thousands) 1998 1997 1996
Commercial Paper (1) $ 5,865,904 55% $ 5,607,373 62% $4,901,570 61%
Collateral Trust Bonds 1,897,688 18% 1,149,192 13% 999,611 13%
Medium-Term Notes 1,109,258 10% 615,396 7% 604,252 8%
Quarterly Income Capital Securities 200,000 2% 125,000 1% - -
Members' Subordinated Certificates 1,229,166 12% 1,212,486 14% 1,207,684 15%
Members' Equity 279,278 3% 271,594 3% 269,641 3%
Total $10,581,294 100% $ 8,981,041 100% $ 7,982,758 100%
(1) Includes $185.0 million, $115.0 million and $183.5 million of
Bank Bid Notes for 1998, 1997 and 1996, respectively.
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 purchased mature
in 100 years and pay interest at a rate of 5%. At May 31, 1998, CFC
had a total of $644.8 million in Membership Subordinated Certificates
outstanding. A small portion of these certificates mature 50 years
from issuance and pay interest at a rate of 3%.
As a Condition of Borrowing
Distribution system members may be required to purchase, on long-
term loans, a Loan Subordinated Certificate for up to 3% of the loan
amount. The amount of the required certificate purchase is
determined by the member's leverage ratio with CFC and the type of
loan selected. Power supply system members may be required to
purchase a Loan Subordinated Certificate of up to 12% of the loan
amount. Telecommunications systems and Associate members are
required to purchase, on long-term loans, Loan Subordinated
Certificates equal to 5% of each loan advance. These certificates do
not pay interest, but amortize annually based on the outstanding loan
balance. This amortization amount is paid back to the member
annually. At May 31, 1998, CFC had a total of $355.7 million of
Loan Subordinated Certificates outstanding. A small portion of these
certificates, issued prior to policy changes, mature at the same time as
the loan and pay interest at a rate of 3%.
As a Condition of Receiving a Guarantee
Members may be required to purchase a Guarantee Subordinated
Certificate of up to 12% of the principal amount of the guarantee.
The Guarantee Subordinated Certificates mature at the same time as
the guarantee. The certificates pay interest at a rate to be determined
in each transaction. At May 31, 1998, CFC had a total of $228.6
million of Guarantee Subordinated Certificates outstanding.
Members' Equity
Patronage Capital
CFC is required by law to have a methodology to allocate its net
margins to its members. CFC allocates substantially all of its net
margins annually based on the members' patronage of CFC during the
year. The patronage capital allocations are maintained by CFC and
used to fund operations until retired. Currently CFC retires 70% of
the prior year's net margins during the first quarter of the current year
and holds the remaining 30% for a period of 15 years. All retirements
must be authorized by the Board of Directors with regard to CFC's
financial condition. CFC allocates and retires net margins to its
affiliated organization, RTFC, which in turn allocates its net margins,
including the CFC retirement, to its members under similar policies.
At May 31, 1998, CFC had a total of $274.8 million of allocated, but
unretired net margins, which along with the education fund reserve
and membership fees comprise the total of Members' Equity.
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 2 years to 30 years, unsecured Medium-Term
Notes for periods of nine months to 30 years, unsecured Quarterly
Income Capital Securities for periods of up to 49 years and unsecured
Commercial Paper for periods of 1 to 270 days. CFC also enters into
Bank Bid Note arrangements with banks. CFC's Collateral Trust
Bonds, Medium-Term Notes, Quarterly Income Capital Securities and
Commercial Paper all carry investment grade ratings from three rating
agencies (see table in the Management Discussion and Analysis
section, page 36).
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. Rates for both securities are set daily by CFC.
11
Interest Rate Exchange Agreements
CFC will enter interest rate exchange agreements when required by
certain transactions. CFC also uses interest rate exchange agreements
as part of its funding strategy to match the interest rate paid on its
liabilities with the interest rate received on its assets. At May 31,
1998, CFC was a party to $753.7 million of interest rate exchange
agreements (see Note 5 to the Combined Financial Statements for
further information on the interest rate exchange agreements to which
CFC is a party).
Revolving Credit Agreements
As of May 31, 1998, CFC had three revolving credit agreements totaling
$5,217.5 million which are used principally to provide liquidity support
for CFC's outstanding Commercial Paper, obligations guaranteed for its
members and its standby purchase obligations.
Two of these agreements are with 51 banks, with J.P. Morgan Securities,
Inc. and The Bank of Nova Scotia as Co-Syndication Agents, and
Morgan Guaranty Trust Company of New York as Administrative Agent.
Under the five-year agreement, executed in November 1996, CFC can
borrow up to $2,345.0 million until November 26, 2001. Under the 364-
day agreement, renewed on November 25, 1997, CFC can borrow up to
$2,322.5 million until November 24, 1998. Any amounts outstanding
under these facilities will be due on the respective maturity dates.
A third revolving credit agreement for $550.0 million was executed on
November 26, 1997 with 11 banks, including the Bank of Nova Scotia as
Administrative and Syndication Agent ("the BNS facility"). This
agreement has a 364-day revolving credit period which terminates
November 25, 1998 during which CFC can borrow and such borrowing
may be converted to a 1-year term loan at the end of the revolving credit
period.
In connection with the five-year facility, CFC pays a per annum facility
fee of .090 of 1%. The per annum facility fee for both agreements with a
364-day maturity is .065 of 1%. There is no commitment fee for any of
the revolving credit facilities. If CFC's long-term ratings decline, the
facility fees may be increased by no more than .035 of 1%. Generally,
pricing options are the same under all three agreements and will be at one
or more rates as defined in the agreements, as selected by CFC.
The revolving credit agreements require CFC among other things to
maintain Members' Equity and Members' Subordinated Certificates of at
least $1,356.7 million at May 31, 1998, an increase of $6.8 million
compared to the $1,349.9 million required at May 31, 1997. Each year,
the required amount of Members' Equity and Members' Subordinated
Certificates is increased by 90% of net margins not distributed to
members. CFC is also required to maintain an average fixed charge
coverage ratio over the six most recent fiscal quarters of at least 1.025
and may not retire patronage capital unless CFC has achieved a fixed
charge coverage ratio of 1.05 for the preceding fiscal year. The credit
agreements prohibit CFC from incurring senior debt (including guarantees
but excluding indebtedness incurred to fund RUS guaranteed loans) in an
amount in excess of ten times the sum of Members' Equity and
subordinated debt and restrict, with certain exceptions, the creation by
CFC of liens on its assets and contain certain other conditions to
borrowing. The agreements also prohibit CFC from pledging collateral in
excess of 150% of the principal amount of Collateral Trust Bonds
outstanding. Provided that CFC is in compliance with these financial
covenants (including that CFC has no material contingent or other liability
or material litigation that was not disclosed 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 date. As of May 31,
1998, CFC was in compliance with all covenants and conditions.
As of May 31, 1998, there were no borrowings outstanding under the
revolving credit agreements. On the basis of the five-year facility, at May
31, 1998, CFC classified $2,345.0 million of its notes payable outstanding
as long-term debt. CFC expects to maintain more than $2,345.0 million
of notes payable outstanding during the next 12 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.
12
Set forth below are the weighted average costs incurred by CFC on its
short-term borrowings (Commercial Paper and Bank Bid Notes) and on
its long-term borrowings (Collateral Trust Bonds, Medium-Term Notes,
Quarterly Income Capital Securities and debt supported by interest rate
swaps) for the period shown.
Years Ended May 31,
1998 1997 1996
Short-term borrowings 5.73% 5.54% 5.83%
Long-term borrowings 6.74% 7.36% 7.99%
Total short- and long-term borrowings 6.03% 5.99% 6.33%
Tax Status
In 1969, CFC obtained a ruling from the Internal Revenue Service (the
"IRS") 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 IRS. CFC's affiliates, RTFC and GFC, are taxable under
Subchapter T of the Internal Revenue Code.
Investment Policy
Surplus funds are invested pursuant to policies adopted by CFC's Board
of Directors. Under present policy, surplus funds may be invested in
direct obligations of or guaranteed by the United States or agencies
thereof, the World Bank, certain high quality commercial paper,
obligations of foreign governments, Eurodollar deposits, bankers'
acceptances, bank letters of credit, certificates of deposit or working
capital acceptances. The policy also permits investments in certain types
of repurchase agreements with highly rated financial institutions, whereby
the assets consist of eligible securities of a type listed above set aside in a
segregated account. CFC typically has two types of funds available for
investment: (1) the debt service reserve funds held by the trustee under
the indenture under which CFC formerly issued Collateral Trust Bonds
(the "1972 Indenture"), used to make bond interest and sinking fund
payments; and (2) member loan payments and Commercial Paper
investments in excess of daily cash funding requirements. Debt service
reserve funds are invested with maturities scheduled to coincide with
interest and sinking fund payment dates.
CFC Lending Competition
According to annual financial statements filed with CFC, its electric
cooperative distribution and power supply member systems had a
total of $41.3 billion in long-term debt outstanding at December 31,
1997. RUS is the dominant lender to the electric cooperative industry
with $29.4 billion or 71% of the total outstanding debt. 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 the insured loan program for fiscal year 1999,
$366.5 million, represents a decrease from the level approved for the
prior year, $625 million. The amount proposed for RUS guaranteed
loans for fiscal year 1999, $700 million, is a large increase over the
amount approved for the prior year, $300 million. 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. At
December 31, 1997, CFC had a total of $9.4 billion of total exposure
to distribution and power supply member systems, $7.3 billion of
long-term loans and $2.1 billion of guarantees outstanding. The
guarantees represent CFC's assurances of payment on long-term debt
to third party lenders on behalf of its electric cooperative members.
The remaining $2.5 billion was outstanding from other sources.
During fiscal year 1998, CFC was selected as the lender for 94% of
the total supplemental lending requirement. During this same period,
CFC was selected as lender for 98% of the amount lent to distribution
systems for the repayment of their RUS debt. CFC competes with
other lenders primarily on price, and secondarily on the variety of
options and additional services offered.
The competitive market for providing credit to the rural telephone
industry is difficult to quantify, since many rural telephone
companies are not RUS borrowers. At December 31, 1997, RUS had a
total of $3.8 billion outstanding to
13
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
$1.4 billion outstanding. 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
telephone 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, government sponsored
enterprises and insurance companies. At December 31, 1997, CFC
had a total of $1.3 billion in loans outstanding to telecommunications
borrowers. At December 31, 1997, to the best of CFC's knowledge,
there was one other lender with a portfolio of similar size to CFC's,
but no other lenders to rural telecommunications borrowers with
portfolios of similar size to the RUS.
Member Regulation and Competition
Electric Systems
In 1992 Congress passed the Energy Policy Act effectively providing
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 ("OASIS"). 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.
Recently several states have passed laws requiring utilities to
unbundle their vertically structured retail rates and to subsequently
begin providing customer choice for retail generation services. Many
other states are considering such legislation. The structure of
subsequent legislation and rules defining the competitive retail
market and the provision for stranded cost recovery are not yet
known. The ultimate impact on CFC's members cannot be determined
until these items have been resolved.
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, cooperatives that
pay off their RUS debt are treated as "jurisdictional public utilities".
FERC is proceeding under the legal theory that, under these sections, it
can order "jurisdictional public utilities" to provide open access.
Currently three states are operating under customer choice laws. Two of
these states (Massachussetts and Rhode Island) do not have electric
cooperatives. CFC has three distribution systems in the third state
(California). In 16 states laws have been passed and open access is
scheduled to be in effect by 1999 to 2003. In these states, power supply
systems with rates that are above market may be at risk of losing
customer loads. The distribution systems in these states will continue to
deliver power to the ultimate customer, regardless of who is supplying
the power, the CFC member power supply system or some other power
generator. Thus, CFC's distribution system members are not believed to
be at significant risk due to the move to open customer access to power
supply. A small number of distribution systems have recently bought out
their all-requirements power contracts, through the payment of a
negotiated fee to the power supply system. The distribution system is
then free to purchase power from other sources at market rates.
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. For instance, it is unlikely that residential customers will change
to another utility if they have to pay a fee to cover the stranded investment
the current utility incurred to provide them with power. So during the
14
stranded cost recovery period, there may be very little residential
competition in some states. The level of fee that systems
will be allowed to charge other utilities for use of their transmission /
distribution system may also impact the level of residential
competition. Other issues that may delay competition include the
following: (1) cooperatives are allowed to "opt out" of the provisions
of the laws in some states; (2) utilities in many states will still be
regulated regarding rates on non-competitive services, such as
distribution; (3) many states will still regulate the borrowing by
utilities; (4) FERC regulation of transmission; and (5) reconciling the
differences in various state laws, so that out of state utilities can
complete with in state utilities.
The pace of states passing customer choice laws has slowed recently.
As of December 31, 1997, there were 31 states that had not passed
customer choice laws. The time required to pass such laws, as well as
the issues described above could significantly delay nationwide retail
competition.
In addition to customer choice laws, state agencies regulate electric
cooperatives with regard to rates and borrowing. There are 16 states
that regulate the rates electric systems charge. There are 19 states
that regulate electric systems regarding the issuance of long-term debt
and there are 5 states that regulate the issuance of short-term debt.
FERC also has jurisdiction to regulate electric systems that are not
borrowers of RUS, with regard to rates and financing.
The 1990 amendments to the Clean Air Act of 1970 (the
"Amendments"), required utilities and others to reduce emissions. The
Amendments contain a range of compliance options and a phase-in period
which will help mitigate the immediate costs of implementation. Many of
CFC's member systems already comply with the provisions of the
Amendments. CFC is currently monitoring the overall impact of the
Amendments on individual member systems, which must implement
compliance plans and operating or equipment modifications for Phase II
of the Act (2000). Compliance plans for member systems with units
affected in Phase I primarily involved fuel switching to low-sulfur coal.
The trading of emission allowances may also be an economical alternative
in Phase II. Some member systems originally believed to be adversely
affected by the Amendments have developed strategies designed to
minimize the Amendments' impact. At this time, it is not anticipated that
the Amendments will have a material adverse impact on the quality of
CFC's loan portfolio.
Telephone Systems
CFC member telephone systems are regulated at the state and federal
levels. Most state regulatory bodies regulate local service rates and
telephone company borrowing, although some states have exempted
small rural telephone companies and/or cooperatives from regulation.
Interstate access rates are regulated by the Federal Communications
Commission ("FCC").
The Telecommunications Act of 1996 (the "Telco Act") created a
framework for competition in the local telephone market. Recognizing
that building duplicate telephone systems would require significant
levels of capital investment and take years to complete, Congress
included provisions in the Telco Act that require Bell operating
companies and other local telephone companies to open their systems
to competitors. Telephone companies must open their systems to
competition through either: total service resale (to a reseller who has
no facilities at all) at wholesale prices; or interconnection (with a
competitor that may have some telecommunications facilities of its
own) through sale of elements of the telephone company's network at
discounted prices. Congress included provisions in the Telco Act
which allow rural telephone companies to receive waivers from the
resale and interconnection requirements. The FCC rulemaking placed
the burden of proof for justifying the waivers on the rural telephone
companies.
In its rulemaking implementing the Telco Act's interconnection
provisions, the FCC mandated very steep discounts for the sale of
network elements. Telephone companies and state regulators sued
the FCC over its authority to set the discounted rates for these
network elements and won. The FCC has appealed to the Supreme
Court, which has not yet heard the case. Because these issues have
not been settled, relatively little local service competition through
resale or interconnection has occurred. In America's largest cities,
competitors are going after and winning large business users. But no
large competitor to date, to CFC's knowledge, has targeted
residential customers. Rural markets, with their preponderance of
residential subscribers, will almost certainly be the last to see wide-
scale local telephone service competition. Rural telephone companies
that border metropolitan areas will be the first to experience
competition.
In addition to resale and interconnection, the Telco Act also mandated
a new universal telephone service support mechanism and required
that it be sufficient to ensure that rural customers received reasonably
comparable rates and services when compared to urban customers.
Congress stated its intent that implicit subsidies presently contained in
the access charges local telephone companies levy on long distance
carriers be eliminated and be made explicit in the new universal
service support mechanism. The FCC has found this difficult to
implement. While undertaking a complex
15
proceeding to move to a new costing basis for universal service funding,
the FCC has left the existing universal service fund in place.
It is unlikely, however, that a new universal service fund will ever be
large enough to make rural telephone companies whole for their
reduced access revenues. New flat rate charges will result in higher
local telephone bills to end user customers. Those customers that are
not large users of long distance services (and therefore will not save
from lower long distance charges) will pay more. Ultimately,
however, it is probable that access charges will come down from
present levels and that rural telephone companies will experience
some revenue reductions. CFC does not anticipate that this loss in
revenue will result in material losses on loans outstanding to rural
telephone companies.
Many of CFC's member rural telephone companies are positioning
themselves to meet or take advantage of future local service competition.
With the future of adequate support mechanisms in question, such as the
universal service fund, many rural telephone companies are diversifying
into new lines of business. The most proactive are pursuing, individually
or through joint ventures, competitive local exchange projects in
neighboring towns; becoming personal communications services
(wireless) operators; and internet service providers. Rural telephone
companies will attempt to leverage their financial resources, infrastructure
and industry experience in entering new businesses.
Employees
At May 31, 1998, CFC had 164 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.
The RUS Program
Since the enactment of the Rural Electrification Act in 1936 (the "Electric
Act"), RUS has financed the construction of electric generating plants,
transmission facilities and distribution systems in order to provide
electricity to persons in rural areas who were without central station
service. Principally through the organization of systems under the RUS
loan program in 46 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 99% currently.
Rural electric systems serve 11% of all consumers of electricity in the
United States and its territories and account for approximately 8% of
total sales of electricity and about 7% of energy generation and
generating capacity.
In 1949, the Electric Act was amended to allow RUS to lend for the
purpose of furnishing and improving rural telephone service. The RUS
telecommunications lending program had 859 reporting borrowers at
December 31, 1997. The 859 borrowers operated 4,792 exchanges,
providing service to approximately 1.2 million business customers and 4.4
million residential customers.
The Electric Act provides for RUS to make insured loans and to provide
other forms of financial assistance to borrowers. 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 which 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
telephone 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. 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 fiscal year 1999, both the House and Senate Agriculture
Appropriation Committees have approved RUS electric insured loan
levels of $366.5 million, of which $71.5 million would be at the 5% rate
and $295 million would be at a municipal government obligation index.
RUS is also authorized to provide 100% guarantees on an additional
$700 million of loans available from the FFB or other lenders. Electric
funding levels for fiscal year 1998 were $125 million at the 5% rate, $500
million for loans at a municipal government obligation index and $300
million for guarantees.
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 loans for a period of ten years, but
remains eligible for RUS loan guarantees. As of May 31, 1998, 113
borrowers had either fully prepaid or partially prepaid their RUS notes,
under these provisions, in the total amount of $2,169.5 million.
16
Member Financial Data
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, 1997, and
their respective composite balance sheets at the end of each such year.
The data in the tables for 1993 to 1995 is comprised of information
collected by RUS for all CFC members that were RUS borrowers and
information collected by CFC on the members that do not borrow from
RUS. The data for 1996 and 1997 is data collected by CFC only. CFC
began making its own data collection in 1996 due to the larger number of
borrowers that no longer borrow from RUS. Distribution members
submit annual data as of December 31, on form 7 and power supply
members submit annual data as of December 31 on form 12 or FERC
form 1. As of July 31, 1998, CFC had received a form 7 from 822
distribution systems and a form 12 or FERC form 1 from 57 power
supply systems.
While CFC is reporting 835 distribution system members at May 31,
1998, only 823 were required to file form 7's with CFC at December 31,
1997. CFC collected form 7's from 821 distribution systems, one system
files annual data based on a June 30 fiscal year end and one system
became a CFC member on December 30, 1997. The other 12 systems
were not required to file form 7 because they became members after
December 31, they were in the process of merging and filed a
consolidated form 7 with the surviving distribution system, or they did
not have an outstanding balance of long-term loans at December 31,
1997.
Only 57 of the 68 total power supply systems report financial results to
CFC/RUS. Nine are power supply systems in which all revenues and
costs are passed through to their member distribution systems. The two
remaining power supply systems are subsidiaries of other member power
supply systems and thus their financial results were consolidated with and
filed by the parent power supply system.
NOTE: Statistical information contained in this section has not been
examined by CFC's independent public accountants, and the number and
geographical dispersion of the systems have made impractical an
independent investigation by CFC of the statistical information. The
information presented is based upon financial statements submitted to
CFC, subject to year-end audit adjustments, by reporting borrowers and
do not, with minor exceptions, take into account current data for certain
systems, primarily those which are not active CFC borrowers.
17
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMPOSITE STATEMENTS OF REVENUES, EXPENSES AND PATRONAGE CAPITAL
AS REPORTED BY CFC MEMBER DISTRIBUTION SYSTEMS
The following are unaudited figures which are based
upon financial statements submitted to RUS and
CFC by Member Distribution Systems
Years Ended December 31,
(Dollar Amounts In Thousands) 1997 1996 1995 1994 1993
Operating revenues and patronage capital $17,232,257 $17,028,087 $16,253,957 $15,603,853 $15,072,400
Operating deductions:
Cost of power (1) 10,907,145 10,924,695 10,486,773 10,174,716 9,882,450
Distribution expense (operations) 472,629 445,990 412,058 386,235 366,148
Distribution expense (maintenance) 829,991 804,663 752,659 699,253 643,390
Administrative and general expense (2) 1,720,805 1,627,925 1,584,099 1,506,729 1,398,749
Depreciation and amortization expense 1,134,149 1,069,101 1,000,017 942,435 879,957
Taxes 458,620 458,623 436,563 417,471 396,024
Total 15,523,339 15,330,997 14,672,169 14,126,839 13,566,718
Utility operating margins 1,708,918 1,697,090 1,581,788 1,477,014 1,505,682
Non-operating margins 235,334 180,311 172,118 134,831 110,612
Power supply capital credits (3) 268,015 282,800 254,839 260,335 274,250
Total 2,212,267 2,160,201 2,008,745 1,872,180 1,890,544
Interest on long-term debt (4) 919,892 869,076 833,110 752,749 730,078
Other deductions 45,439 43,711 46,859 52,574 36,644
Total 965,331 912,787 879,969 805,323 766,722
Net margins and patronage capital $ 1,246,936 $ 1,247,414 $ 1,128,776 $ 1,066,857 $1 ,123,822
TIER (5) 2.34 2.44 2.42 2.42 2.54
DSC (6) 2.26 2.42 2.40 2.26 2.44
MDSC (7) 2.17 2.30 2.28 2.09 2.21
Number of systems included 821 832 824 828 825
(1) Includes cost of purchased power, power production and transmission
expense.
(2) Includes sales expenses, consumer accounts and customer service and
informational expense as well as other administrative and general expenses.
(3) Represents net margins of power supply systems and other associated
organizations allocated to their member distribution systems and added in
determining net margins and patronage capital of distribution systems under
RUS accounting practices. Cash distributions of this credit have rarely
been made by the power supply systems and such other organizations to
their members.
(4) Interest on long-term debt is net of interest charged to construction,
which is stated separately as a credit on form 7. CFC believes that
amounts incurred by distribution systems for interest charged to
construction and allowance for funds used during construction are
immaterial relative to their total interest on long-term debt and net
margins and patronage capital.
(5) The ratio of (x) interest on long-term debt (in each year including all
interest charged to construction) and net margins and patronage capital to
(y) interest on long-term debt (in each year including all interest charged
to construction).
(6) The ratio of (x) net margins and patronage capital plus interest on long-
term debt (including all interest charged to construction) plus
depreciation and amortization to (y) long-term debt service obligations.
(7) The ratio of (x) operating margins and patronage capital plus interest on
long-term debt (including all interest charged to construction) plus
depreciation and amortization expense plus Non-operating Margins
Interest plus cash received in respect of generation and transmission and
other capital credits to (y) long-term debt service obligations.
18
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMPOSITE BALANCE SHEETS
AS REPORTED BY CFC MEMBER DISTRIBUTION SYSTEMS
The following are unaudited figures which are based
upon financial statements submitted to RUS and
CFC by Member Distribution Systems
At December 31,
(Dollar Amounts In Thousands) 1997 1996 1995 1994 1993
Assets and other debits:
Utility plant:
Utility plant in service $37,763,550 $35,406,826 $33,118,001 $31,162,069 $29,172,898
Construction work in progress 1,062,356 975,357 881,171 799,327 697,329
Total utility plant 38,825,906 36,382,183 33,999,172 31,961,396 29,870,227
Less: accumulated provision for
depreciation and amortization 10,608,302 9,911,677 9,221,378 8,631,903 7,992,325
Net utility plant 28,217,604 26,470,506 24,777,794 23,329,493 21,877,902
Investments in associated organizations (1) 3,483,154 3,348,326 3,207,671 3,051,840 2,847,260
Current and accrued assets 4,185,884 4,126,415 3,980,052 3,789,699 3,733,893
Other property and investments 552,033 503,871 496,105 456,923 366,452
Deferred debits 514,670 488,009 511,977 472,536 463,194
Total assets and other debits $36,953,345 $34,937,127 $32,973,599 $31,100,491 $29,288,701
Liabilities and other credits:
Net worth:
Memberships $ 105,505 $ 105,497 $ 127,749 $ 114,080 $ 100,689
Patronage capital and other equities (2) 15,674,556 14,731,432 13,633,993 12,804,404 11,859,273
Total net worth 15,780,061 14,836,929 13,761,742 12,918,484 11,959,962
Long-term debt (3) 16,924,955 16,214,420 15,718,979 15,020,664 14,569,363
Current and accrued liabilities 3,046,528 2,697,605 2,418,230 2,260,514 2,066,601
Deferred credits 864,384 872,013 786,455 714,083 598,997
Miscellaneous operating reserves 337,417 316,160 288,193 186,746 93,778
Total liabilities and other credits $36,953,345 $34,937,127 $32,973,599 $31,100,491 $29,288,701
Equity Percentage (4) 42.7% 42.5% 41.7% 41.5% 40.8%
Number of systems included 821 832 824 828 825
(1) Includes investments in service organizations, power supply capital
credits and investments in CFC.
(2) Includes non-refundable donations or contributions in cash, services or
property from states, municipalities, other government agencies,
individuals and others for construction purposes separately listed on
form 7.
(3) Principally debt to RUS and includes $6,121,902, $5,467,636,
$4,824,491, $3,989,914, and $3,607,159 for the years 1997, 1996,
1995, 1994 and 1993, respectively, due to CFC.
(4) Determined by dividing total net worth by total assets and other debits.
19
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMPOSITE STATEMENTS OF REVENUES, EXPENSES AND PATRONAGE CAPITAL
AS REPORTED BY CFC MEMBER POWER SUPPLY SYSTEMS
The following are unaudited figures which are based
upon financial statements submitted to RUS and
CFC by Member Power Supply Systems
Years Ended December 31,
(Dollar Amounts In Thousands) 1997 1996 1995 1994 1993
Operating revenues and patronage capital $10,702,813 $10,585,875 $10,182,928 $9,972,873 $9,976,560
Operating deductions:
Cost of power (1) 7,604,521 7,322,039 6,984,648 6,760,543 6,606,419
Distribution expense (operations) 12,555 15,431 16,019 14,668 14,391
Distribution expense (maintenance) 12,937 16,607 15,950 14,703 11,081
Administrative and general expense (2) 474,681 473,869 483,030 431,645 433,278
Depreciation and amortization expense 915,879 1,056,113 956,889 930,483 902,810
Taxes 231,843 237,700 246,700 241,775 223,122
Total 9,252,416 9,121,759 8,703,236 8,393,817 8,191,101
Utility operating margins 1,450,397 1,464,116 1,479,692 1,579,056 1,785,459
Non-operating margins 232,778 493,874 253,883 221,003 328,958
Power supply capital credits (3) 46,520 55,590 48,981 32,531 47,838
Total 1,729,695 2,013,580 1,782,556 1,832,590 2,162,255
Interest on long-term debt (4) 1,295,082 1,436,200 1,476,062 1,857,644 2,014,794
Other deductions (5) 409,396 1,601,919 89,784 129,794 184,902
Total 1,704,478 3,038,119 1,565,846 1,987,438 2,199,696
Net margins and patronage $ 25,217 $(1,024,539) $ 216,710 $ (154,848) $ (37,441)
TIER (6) 1.02 .29 1.15 .93 .98
DSC (7) 1.11 .69 1.02 1.01 1.03
Number of systems included 57 54 53 53 50
(1) Includes cost of purchased power, power production and
transmission expense, separately listed on the form 12.
(2) Includes sales expenses and consumer accounts expense and
consumer service and informational expense as well as other
administrative and general expenses, separately listed on the form 12
or FERC form 1.
(3) Certain power supply systems purchase wholesale power from other
power supply systems of which they are members. Power supply
capital credits represent net margins of power supply systems
allocated to member power supply systems on the books of the
selling power supply systems. This item has been added in
determining net margins and patronage capital of the purchasing
power supply systems under RUS accounting practices. Cash
distributions of this credit have rarely been made by the selling power
supply systems to their members. This item also includes net margins
of associated organizations allocated to CFC power supply members
and added in determining net margins and patronage capital of the
CFC member systems under RUS accounting practices.
(4) Interest on long-term debt is net of interest charged to construction.
Allowance for funds used during construction has been included in
non-operating margins. According to unpublished information,
interest charged to construction and allowance for
funds used during construction for CFC power supply members in
the years 1993-1997 were as follows:
20
Allowance for
Interest Charged Funds used
(Dollar Amounts In Thousands) to Construction During Construction Total
1997 $ 7,798 $12,684 $20,482
1996 13,434 11,620 25,054
1995 68,400 11,018 79,418
1994 46,773 8,913 55,686
1993 49,237 8,621 57,858
(5) Includes $1,119,635 in 1996 related to the reorganization of Cajun
Electric Power Coop., Inc., with whom CFC has no credit exposure.
(6) The ratio of (x) interest on long-term debt (in each year including all
interest charged to construction) and net margins and patronage
capital to (y) interest on long-term debt (in each year including all
interest charged to construction). The TIER calculation includes the
operating results of six systems which failed to make debt service
payments or are operating under a debt restructure agreement,
without which the composite TIER would have been 1.04, 1.21,
1.23, 1.31 and 1.20 for the years ended December 31, 1997, 1996,
1995, 1994 and 1993, respectively.
(7) The ratio of (x) net margins and patronage capital plus interest on
long-term debt (including all interest charged to construction) plus
depreciation and amortization to (y) long-term debt service
obligations (including all interest charged to construction). The DSC
calculation includes the operating results of six systems which failed
to make debt service payments or are operating under a debt
restructure agreement. Without these systems, the composite DSC
would have been 1.13, 1.20, 1.22, 1.24 and 1.21 for the years ended
December 31, 1997, 1996, 1995, 1994, and 1993, respectively.
21
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMPOSITE BALANCE SHEETS
AS REPORTED BY CFC MEMBER POWER SUPPLY SYSTEMS
The following are unaudited figures which are based
upon financial statements submitted to RUS and
CFC by Member Power Supply Systems
At December 31,
(Dollar Amounts In Thousands) 1997 1996 1995 1994 1993
Assets and other debits:
Utility plant:
Utility plant in service $31,656,202 $32,191,089 $34,182,352 $32,934,304 $32,240,926
Construction work in progress 825,421 640,005 931,397 1,624,978 1,469,882
Total utility plant 32,481,623 32,831,094 35,113,749 34,559,282 33,710,808
Less: accumulated provision for
depreciation and amortization 12,558,247 11,783,058 11,586,462 10,777,786 9,936,528
Net utility plant 19,923,376 21,048,036 23,527,287 23,781,496 23,774,280
Investments in associated organizations(1) 1,179,185 1,178,785 1,049,409 248,677 992,921
Current and accrued assets 3,697,391 3,984,238 4,211,004 3,997,466 4,284,613
Other property and investments 1,553,774 2,000,584 1,656,563 2,483,232 1,899,809
Deferred debits 3,228,708 3,636,749 4,391,800 4,366,377 4,078,879
Total assets and other debits $29,582,434 $31,848,392 $34,836,063 $34,877,248 $35,030,502
Liabilities and other credits:
Net worth:
Memberships $ 258 $ 258 $ 250 $ 322 $ 252
Patronage capital and other equities (2) (778,357) (646,115) 497,756 246,262 432,095
Total net worth (778,099) (645,857) 498,006 246,584 432,347
Long-term debt (3) 24,426,867 25,900,628 28,372,321 28,779,577 28,528,640
Current and accrued liabilities 1,791,628 2,040,563 1,848,755 2,747,022 1,185,182
Deferred credits 1,343,053 1,826,945 1,309,860 1,206,488 1,849,906
Miscellaneous operating reserves 2,798,985 2,726,113 2,807,121 1,897,577 3,034,427
Total liabilities and other credits $29,582,434 $31,848,392 $34,836,063 $34,877,248 $35,030,502
Number of systems included 57 54 53 53 50
(1) Includes investments in service organizations, power supply capital
credits and investments in CFC.
(2) Includes a $1.2 billion decrease in 1996 related to the reorganization
of Cajun Electric Power Coop., Inc., with whom CFC has no credit exposure.
(3) Principally debt to RUS or debt guaranteed by RUS and loaned by
FFB and includes $1,411,157, $1,264,475, $1,085,594, $1,065,556, and
$1,041,731 for the years 1997, 1996, 1995, 1994, and 1993, respectively,
due to CFC.
22
Item 2. Properties.
CFC owns and operates a headquarters facility in Fairfax County, Virginia.
This facility consists of a six-story office building with separate parking
garage situated on four acres of land. The Company also owns an
additional 8 acres of unimproved land. In June 1998, the Company began
construction of a second building on the adjacent unimproved land. The
new building will be about the same size as the CFC headquarters building
and is scheduled to be completed in June 1999.
Item 3. Legal Proceedings.
None.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
23
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
Inapplicable.
Item 6. Selected Financial Data.
The following is a summary of selected financial data for each of
the five years ended May 31, 1998.
(Dollar Amounts In Thousands) 1998 1997 1996 1995 1994
For the year ended May 31:
Operating income $ 637,573 $ 564,439 $ 505,073 $ 440,109 $ 324,682
Operating margin $ 54,411 $ 51,530 $ 46,857 $ 41,803 $ 29,159
Nonoperating income 2,611 3,206 3,764 3,409 4,029
Gain on sale of land 5,194 - - - -
Extraordinary loss (A) - - (1,580) - -
Net margins $ 62,216 $ 54,736 $ 49,041 $ 45,212 $ 33,188
Fixed charge coverage ratio (A) 1.12 1.12 1.12 1.13 1.13
As of May 31:
Assets $10,682,888 $9,057,495 $8,054,089 $7,080,789 $6,224,296
Long-term debt (B) $ 5,024,621 $3,596,231 $3,682,421 $3,423,031 $2,841,220
Members' subordinated certificates $ 1,229,166 $1,212,486 $1,207,684 $1,234,715 $1,222,858
Members' equity $ 279,278 $ 271,594 $ 269,641 $ 270,221 $ 260,968
Leverage ratio (C) 6.37 5.84 5.69 5.13 4.63
Debt to equity ratio (D) 4.51 3.97 3.63 3.01 2.52
(A) During the year ended May 31, 1996, CFC paid a premium of $1.6
million in connection with the prepayment of Collateral Trust
Bonds. Margins used to compute the fixed charge coverage ratio
represent net margins before extraordinary loss plus fixed charges.
The fixed charges used in the computation of the fixed charge
coverage ratio consist of interest and amortization of bond discount
and bond issuance expenses.
(B) Includes commercial paper reclassified as long-term debt and
excludes $327.3 million, 268.7 million, $351.5 million, $262.7
million and $200.8 million in long-term debt that comes due,
matures and/or will be redeemed early during fiscal years 1999,
1998, 1997, 1996 and 1995 respectively (see Note 5 to Combined
Financial Statements).
(C) In accordance with CFC's revolving credit agreements, the leverage
ratio is calculated by dividing debt and guarantees outstanding,
excluding Quarterly Income Capital Securities and debt used to
fund loans guaranteed by the RUS, by the total of Quarterly Income
Capital Securities, Members' Subordinated Certificates and
Members' Equity.
(D) The debt to equity 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 Quarterly Income
Capital Securities, Members' Subordinated Certificates, Members'
Equity and the loan loss allowance.
CFC has had outstanding guarantees for its members' indebtedness in
each of the fiscal years shown above. Members' interest expense on such
indebtedness was approximately $90.8 million for the year ended May 31,
1998.
The Company does not have any outstanding common stock and does
not pay dividends. Under current policies, CFC retires Patronage Capital
Certificates, which represent annual allocations of CFC's net margins,
70% during the next fiscal year and expects to retire the remaining 30%
after 15 years, if permitted by CFC's contractual obligations and to the
extent that the Board of Directors in its discretion may determine from
time to time that the financial condition of CFC will not be impaired as a
result.
24
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
The management discussion and analysis contains statements that may be
considered forward looking. In making these statements, CFC has made
an evaluation of estimates, risks and uncertainties related to each
circumstance. The actual results may differ from the estimates and
assumptions discussed in this presentation, which could cause the actual
results to differ materially.
Overview
The following discussion and analysis is designed to provide a better
understanding of the Company's combined financial condition and results
of operations and as such should be read in conjunction with the
Combined Financial Statements, including the notes thereto.
CFC was formed in 1969 by the rural electric cooperatives to provide
them with a source of funds to supplement the financing provided by
RUS. The Company was organized as a cooperative in which each
member (other than associate members) receives one vote. Under CFC's
bylaws, the Board of Directors is comprised of 22 individuals who must
be either general managers or directors of members. CFC was granted
tax-exempt status under Section 501(c)(4) of the Internal Revenue Code.
In 1987, RTFC was formed by CFC to provide a source of funds for the
rural telephone industry. Like CFC, RTFC is a cooperative. However,
RTFC's bylaws and voting members' agreement require that the majority
of RTFC's Board of Directors be elected from individuals designated by
CFC. The remaining board positions are filled by individuals nominated
by the other RTFC members. CFC is the sole source of external funding
for RTFC. Because CFC has control of the RTFC Board, RTFC's
financial condition and results of operations are combined with those of
CFC.
Guaranty Funding Cooperative ("GFC") was organized in December
1991 as a taxable cooperative association owned by its member rural
electric systems and CFC to provide a source of funds for members to
refinance the Rural Utilities Service ("RUS"), guaranteed debt previously
held by the Federal Financing Bank of the United States Treasury
("FFB"). GFC is a controlled affiliate of CFC (the majority of its
directors are appointed by CFC). All loans from GFC are guaranteed by
RUS. CFC is the sole source of external funding for GFC. Because CFC
has control of the GFC Board, GFC's financial condition and results of
operations are combined with those of CFC. (Unless stated otherwise, all
references to CFC refer to the combined results of CFC, RTFC and
GFC.)
CFC's primary objective as a cooperative is to provide its members with
the lowest possible loan and guarantee rates. Therefore, CFC marks up
its funding costs only to the extent necessary to cover its operating
expenses, a provision for loan and guarantee losses and to provide for
margins sufficient to preserve interest coverage in light of CFC's financing
objectives. To the extent members contribute to CFC's base capital with
Subordinated Certificates carrying below-market interest rates, CFC can
offer proportionally lower interest rates on its loans to members.
CFC obtains its funding from the capital markets and its membership.
CFC enters the capital markets, based on the combined strength of its
members to borrow the funds required to fulfill the financing
requirements of its members. On a regular basis, CFC obtains debt
financing in the capital markets by issuing long-term fixed rate or variable
rate Collateral Trust Bonds and Quarterly Income Capital Securities,
intermediate-term fixed or variable rate Medium-Term Notes,
Commercial Paper and enters into Bank Bid Note agreements. CFC also
offers its AA/A credit rating to enhance its members' credit on other
public or private placement transactions through guarantees. In
addition, CFC obtains debt financing from its membership and other
qualified investors through the direct sale of its Commercial Paper and
Medium-Term Notes.
Rural electric cooperatives that join CFC are required to purchase
Membership Subordinated Certificates from CFC as a condition of
membership. In connection with any long-term loan or guarantee made
by CFC to or on behalf of one of its members, CFC may require that the
member make an additional investment in CFC by purchasing Loan or
Guarantee Subordinated Certificates. Like the Membership Subordinated
Certificates, the Loan and Guarantee Subordinated Certificates are
unsecured and subordinate to other debt.
CFC is required by the cooperative laws under which it is incorporated to
have a mechanism to allocate its earnings to its members. CFC allocates
its net margins (patronage capital) annually based on each member's
participation in loan
25
programs during the year. The Membership, Loan and Guarantee
Subordinated Certificates along with unretired patronage
capital provide CFC's base capitalization.
CFC's performance is closely tied to the performance of its member rural
electric and telephone utility systems due to the near 100% concentration
of its loan and guarantee portfolio in those industries. The following
provides an analysis of both CFC's performance and a discussion of the
quality of CFC's loan and guarantee portfolio.
Financial Condition
At May 31, 1998, CFC had $10.7 billion in total assets. Net loans
outstanding to members represented approximately $10.3 billion or 97%
of total assets. The remaining $0.4 billion 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.
At May 31, 1998, 87% of CFC's loan portfolio consisted of long-term
amortizing loans, including long-term loans classified as nonperforming
and restructured, the majority of which are secured. The remaining 13%
consisted of secured and unsecured intermediate-term and line of credit
loans as well as long-term loans guaranteed by RUS. Approximately
46% or $4.8 billion in loans carried a fixed rate of interest. All other
loans, including $4.3 billion in long-term loans, are subject to interest rate
adjustment monthly or semimonthly.
In addition to its loans, CFC provided approximately $2.0 billion in
guarantees for its members at May 31, 1998. These guarantees relate
primarily to tax-exempt financed pollution control equipment and to
leveraged lease transactions for equipment and plant.
At May 31, 1998, CFC had also committed to lend an additional amount
of approximately $8.8 billion to its members. Most unadvanced loan
commitments contain a material adverse change condition. About one-
half of these commitments are provided for operational back-up liquidity.
CFC does not anticipate funding the majority of the commitments
outstanding for this purpose.
As discussed previously, Subordinated Certificates include both original
Membership Subordinated Certificates and Loan and Guarantee
Subordinated Certificates, all of which are subordinate to other CFC debt.
At May 31, 1998, Membership Subordinated Certificates totaled $645
million. These certificates generally mature in 100 years and pay interest
at 5.0%. At May 31, 1998, Loan Subordinated Certificates totaled $356
million and carried a weighted average interest rate of 1.0%. At May 31,
1998, Guarantee Subordinated Certificates totaled $229 million and
carried a weighted average interest rate of 4.7%. Both the Loan and
Guarantee certificates are long-term instruments which generally amortize
at a rate equivalent to that of the loan or guarantee to which they relate.
On a combined basis, Subordinated Certificates carried a weighted
average interest rate of 4.2%. Loan and Guarantee Subordinated
Certificates are required to be purchased in conjunction with the receipt
of a loan or credit enhancement based on the member's leverage ratio
(total debt and credit enhancements divided by total equity investments in
CFC). Members that have a leverage ratio with CFC in excess of a level
in the approved policy are required to purchase additional Subordinated
Certificates to receive a loan or credit enhancement. At the present time,
the majority of CFC's members maintain a CFC leverage ratio within the
policy limit. The issuance of zero percent loan Subordinated Certificates
is expected to exceed the issuance of 5.0% Membership Subordinated
Certificates. Therefore, management expects the average interest rate
paid on all certificates to decline over time. CFC paid a total of $43.2
million in interest to holders of Subordinated Certificates during fiscal
year 1998.
CFC returns 70% of the allocated net margins in the next fiscal year, with
the remaining 30% to be held and then retired at a future date, as
permitted by CFC's contractual obligations and to the extent that the
Board of Directors in its discretion may determine from time to time that
the financial condition of CFC will not be impaired as a result. During the
next 11 years, CFC will retire the unretired allocations representing net
margins for fiscal years 1988 to 1993, all of which had been allocated
under a previous retirement policy. The unretired allocations (Members'
Equity) do not earn interest and are junior to all debt instruments,
including Subordinated Certificates. At May 31, 1998, CFC had $279
million in retained equity.
CFC enters the capital markets through the issuance of Collateral Trust
Bonds, Medium-Term Notes, Commercial Paper and Quarterly Income
Capital Securities. At May 31, 1998, CFC had $1,748 million in fixed
rate Collateral Trust Bonds and $150 million in variable rate Collateral
Trust Bonds outstanding. Under its Collateral Trust Bond Indentures,
CFC must pledge as collateral eligible mortgage notes from its
distribution system borrowers, evidencing loans equal in principal
26
amount to at least 100% of the outstanding principal amount of Collateral
Trust Bonds. At May 31, 1998, CFC had pledged $1,931 million in mortgage
notes. During fiscal year 1998, CFC issued a total of $900 million in
Collateral Trust Bonds in five separate debt offerings. All Collateral
Trust Bonds issued after February 1994 have been issued under an
Indenture with First Bank National Association as trustee ("1994
Indenture"). Virtually all Collateral Trust Bonds were offered to outside
investors in underwritten public offerings.
At May 31, 1998, CFC had $1,109 million outstanding in Medium-Term
Notes. Medium-Term Notes are issued for terms of 270 days to 30 years
and are unsecured obligations of CFC. Medium-Term Notes outstanding
to CFC's members totaled $240 million at May 31, 1998. The remaining
$869 million were sold through dealers to outside investors including
$249 million in the European markets.
At May 31, 1998, CFC had $5,681 million outstanding in Commercial
Paper with a weighted average maturity of 34 days. Commercial Paper
notes are issued with maturities up to 270 days and are unsecured
obligations of CFC. Commercial Paper sold directly by CFC and
outstanding to CFC's members and others totaled $1,318 million at May
31, 1998. The remaining $4,363 million was sold through dealers to
outside investors in the United States and Europe. European Commercial
Paper may be issued in currencies other than U.S. dollars. For notes
issued in a foreign currency, CFC will enter into a currency swap with a
highly rated counterparty at the time of the issuance. As of May 31,
1998, no Commercial Paper notes had been issued in a foreign currency.
In addition, CFC obtains funds from various banking institutions under
Bank Bid Note arrangements, similar to bank lines of credit. The notes
are issued for terms up to three months and are unsecured obligations of
CFC. At May 31, 1998, CFC had $185 million outstanding in Bank Bid
Notes.
At May 31, 1998, CFC had $200 million outstanding in Quarterly Income
Capital Securities. During fiscal year 1998, CFC issued $75 million in
Quarterly Income Capital Securities. The securities are unsecured
obligations of CFC, subordinate and junior in right of payment to senior
debt and the debt obligations guaranteed by CFC, but senior to
Subordinated Certificates. CFC has the right at any time and from time
to time during the term of the Quarterly Income Capital Securities to
suspend interest payments for a period not exceeding 20 consecutive
quarters.
During the year, total assets increased by $1,625 million. Net loan
balances increased by $1,651 million or 19%. Gross loans increased by a
total of $1,668 million, partially offset by a net increase in the allowance
for loan losses of $17 million, over the prior year. As a percentage of the
portfolio, long-term loans (excluding loans guaranteed by RUS)
represented 87% at May 31, 1998, compared to 88% at May 31, 1997.
Long-term fixed rate loans represented 53% and 38% of the total long-
term loans at May 31, 1998 and 1997, respectively. Loans converting
from a variable rate to a fixed rate for the year ended May 31, 1998
totaled $1,069 million, an increase from the $136 million that converted
for the year ended May 31, 1997. Offsetting the conversions to the fixed
rate were $19 million and $109 million of loans that converted from the
fixed rate to the variable for the years ended May 31, 1998 and 1997,
respectively. This resulted in a net conversion of $1,050 million from the
variable rate to a fixed rate for the year ended May 31, 1998 compared to
a net conversion of $27 million for the year ended May 31, 1997.
The increase in total loans outstanding at May 31, 1998, was primarily
due to an increase of $1,409 million in long-term loans, an increase of
$293 million in line of credit loans and an increase of $9 million in
intermediate-term loans offset by a decrease of $5 million in RUS
guaranteed loans. The increase to loans outstanding for fiscal year 1998
included the advance of $448 million for the purpose of repaying RUS
loans, $1,211 million under the 100% loan program, $216 million under
the RUS concurrent loan program and $69 million under the Power
Vision loan program. The loans advanced under the 100%, RUS
concurrent and Power Vision loan programs were used for a variety of
general corporate purposes, including, construction of headquarters
facilities and transmission facilities, system upgrades, refinancing of non-
RUS debt, and electric plant upgrades. 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 (6) the Power
Vision program has made it very easy to borrow from CFC.
Notes Payable, which consists of Commercial Paper, Bank Bid Notes and
long-term debt due within one year, totaled $3,848 million, an increase of
$341 million over the prior year. At May 31, 1998, CFC's short-term
debt consisted of $4,363 million in dealer Commercial Paper, $1,196
million in Commercial Paper issued to CFC's members, $122 million in
27
Commercial Paper issued to certain nonmembers, $327 million in
Medium-Term Notes that mature within one year and $185 million in
Bank Bid Notes. The Commercial Paper sold to CFC's members and
certain nonmembers increased by $39 million, the amount of Bank Bid
Notes outstanding increased by $70 million and Commercial Paper sold
through CFC's dealers increased by $149 million from the prior year.
CFC's Commercial Paper and Bank Bid Notes had a weighted average
maturity of 34 days at May 31, 1998. As described in the footnotes to
the Combined Financial Statements, CFC reclassifies a portion of its
short-term debt as long-term, as it has the ability (subject to certain
conditions) to refinance this short-term debt on a long-term basis under
its revolving credit agreements. CFC renegotiated one of its revolving
credit agreements during the second quarter of fiscal year 1998 and was
able to reclassify $2,345 million and $2,250 million in short-term debt as
long-term at May 31, 1998 and 1997, respectively.
During fiscal year 1998, long-term debt outstanding increased by $1,160
million. The increase in long-term debt outstanding was due to an
increase of $898 million in Collateral Trust Bonds, $494 million in
Medium-Term Notes and $95 million in the amount of short-term debt
supported by revolving credit agreements, offset by $327 million of long-term
debt due within one year reclassified as notes payable. This increase
was required to fund the increase in long-term fixed rate loans outstanding.
Members' Subordinated Certificates and Members' Equity increased by $24 million
to $1,508 million at May 31, 1998, compared to $1,484 million at May
31, 1997. During fiscal year 1995, CFC adopted policy changes that
generally reduced the amount of Loan Subordinated Certificates required
to be purchased as a precondition to receiving a loan advance and
increased the amount of allocated net margins to be retired in the next
fiscal year from 50% to 70%. As a result of these policy changes,
significant increases to the amount of Members' Equity and Members'
Subordinated Certificates outstanding are not anticipated.
Off-balance sheet, CFC experienced an increase of $2,158 million in gross
unadvanced loan commitments to a total of $8,845 million 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 one-half of the outstanding commitments
at May 31, 1998 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 large increase to unadvanced loan commitments is primarily due to
the Power Vision program.
Guarantees outstanding at May 31, 1998, $2,034 million represent a
decrease of $47 million from the May 31, 1997 balance of $2,081 million.
The guarantee balance decreased due to the redemption of one tax-
exempt bond issue and scheduled repayments and lease reductions, offset
by the guarantee of lease payments on mine equipment for a subsidiary of
a member. The guarantee balance is anticipated to continue its decline.
CFC's leverage ratio increased during the year from 5.84 at May 31,
1997, to 6.37 at May 31, 1998. 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 offset by the issuance of the $75 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 3.97 at May 31, 1997, to 4.51 at
May 31, 1998. 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 and loss allowance and Quarterly
Income Capital Securities.
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 TIERs of 1.12 for the
years ended May 31, 1998, 1997 and 1996. TIER is a measure of CFC's
ability to cover the interest expense on funding.
28
Fiscal Year 1998 versus 1997 Results
Net margins for the year ended May 31, 1998, were $62 million, an
increase of $7 million over the $55 million earned the prior year.
Operating income for the year ended May 31, 1998 was $638 million, an
increase of $74 million or 13% over the prior year. Operating income
increased due to an increase in average loan volume and a slight increase
in the average interest rate on the loan portfolio offset by a decrease in the
amount of deferred conversion fees recognized. Average loan volume
increased by $1,074 million to a balance of $9,655 million at May 31,
1998. The average interest rate on the portfolio for the year ended May
31, 1998 was 6.60%, an increase of 0.02% over the 6.58% for the prior
year. This increase was due to the conversion of approximately $1,069
million of long-term loans from a variable interest rate to a fixed interest
rate during 1998. During fiscal year 1998, a total of $1 million of
deferred conversion fees were recognized into income, a decrease of $10
million from the prior year. At May 31, 1998, there was a balance of
$1 million of deferred conversion fees. It is anticipated that this balance
will be recognized into income during fiscal year 1999.
The total cost of funding for the year ended May 31, 1998, was $541
million, an increase of $65 million over the prior year. The cost of
funding increased due to the increase in average loan volume outstanding
and to an increase to the average interest rate on funds outstanding. The
average interest rate on funding for the year ended May 31, 1998 was
5.60%, an increase from 5.54% in 1997. This rate increased as a result of
the increase of $1,392 million to Collateral Trust Bonds and Medium-Term
Notes outstanding and the increase of $75 million in Quarterly Income
Capital Securities outstanding, offset by an increase of $24 million in
Members' Subordinated Certificates and Members' Equity outstanding.
The gross margin earned on loans for fiscal year 1998 was $97 million, an
increase of $8 million over the prior year. The gross margin of $97
million represents 1.00% of average loan volume for the year, a decrease
from the 1.04% represented by the $89 million gross margin of the prior
year. The growth in average loans outstanding allowed CFC to price its
loans closer to its cost of funding during fiscal year 1998.
Operating expenses for fiscal year 1998 totaled $24 million, an increase of
$2 million over the prior year. The operating expenses for fiscal year
1998 represented 0.24% of average loan volume, slightly less than the
0.26% for the prior year. While the dollar amount of operating expenses
increased during the year ended May 31, 1998, the cost as a percentage
of average loan volume decreased. The increase to the dollar amount
of operating expenses was due to an increase in salaries and benefits
from normal base salary increases and an increase in the number of
employees, and an increased marketing effort. Staffing increases were
required to support operations related to a growing loan portfolio, the
increased marketing effort and the development of new products and
services.
A total provision of $19 million was added to the loan loss reserve during
the year ended May 31, 1998. The $19 million provision is an increase of
$4 million over the amount added the prior year. The provision to the
reserve for fiscal year 1998 represented 0.20% of average loan volume, a
slight increase over the 0.18% for the prior year. The increase to the
provision for fiscal year 1998 was due to the overall growth in the
portfolio.
A total of $3 million of nonoperating income was earned during fiscal
year 1998, approximately the same total as the prior year.
During fiscal year 1998, CFC recognized a gain of $5 million on the sale
of 23 acres of land.
Fiscal Year 1997 versus 1996 Results
Operating income for the year ended May 31, 1997 was $564 million,
an increase of $59 million or 11.7% over the prior year. The increase
in interest income was due to an increase in average loans
outstanding. The average loan balance outstanding for fiscal year
1997 was $8,581 million, an increase of $1,125 million or 15.1% over
the prior year. The average yield earned on the loan portfolio
decreased by 19 basis points to 6.58% for fiscal year 1997, from
6.77% earned the prior year. A total of $11 million of deferred
conversion fees were recognized as interest income during the year.
At May 31, 1997, only $1 million of deferred conversion fees
remained to be recognized in future years.
CFC's total cost of funding for fiscal year 1997 was $476 million, an
increase of $50 million or 11.7% over the prior year. The increase to
the cost of funding was due to the growth in average loans
outstanding. During the year CFC
29
issued $300 million of Collateral Trust Bonds, $125 million of Quarterly
Income Capital Securities and incurred a net increase of $11 million of
Medium-Term Notes at fixed interest rates. CFC also
issued $150 million of Collateral Trust Bonds and had a net
increase of $706 million of Commercial Paper and Bid Notes
at variable rates. During the year, $150 million of fixed rate
Collateral Trust Bonds and $150 million of variable rate Collateral
Trust Bonds matured. The cost of funds as a percentage of average
loan volume decreased by 17 basis points, from 5.71% for fiscal year
1996 to 5.54% for fiscal year 1997.
The gross margin earned on loans for fiscal year 1997 was $89
million, an increase of $10 million or 12.7% over the prior year. The
increase to the gross margin earned was due to the increased average
loan volume. CFC was able to reduce its yield earned on the portfolio
by 19 basis points and the cost of funding by 17 basis points, resulting
in a reduction of 2 basis points of gross margin. The reduction in the
percentage of gross margin was offset by the large increase in average
loan volume outstanding.
Operating expenses for fiscal year 1997 totaled $22 million, an
increase of $2 million or 10% over the prior year. The increase to
operating expenses was due to foreclosure litigation, conversion of
the information systems and an increased marketing effort. Further
details regarding the foreclosure litigation are contained in the
Footnote 10 to the Combined Financial Statements. The conversion
of the information systems from the main frame to the client server
should be completed during fiscal year 1998. The increased
marketing effort includes the enhancement of the CFC brand image
along with the development and rollout of new products and services
for CFC members to use in differentiating their service from that of
other energy providers.
During fiscal year 1997, CFC added a total of $15 million to the loan
loss allowance, an increase of $3 million over the prior year. The
increase to the amount provided to the loan loss reserve was required
due to the growth in the loan portfolio.
Nonoperating income earned during fiscal year 1997 was $3 million, a
decrease from the $4 million earned the prior year. The decrease was
primarily due to reduced fees from the servicing of grantor trusts.
The total loans serviced by CFC decreased by $538 million during the
year. The decrease was due to the RUS early redemption of loans it
had guaranteed after the negotiated restructuring of the debt for one
of CFC's members.
Net margins earned by CFC for fiscal year 1997 were $55 million, an
increase of $6 million over the prior year. The increase to the net
margins was primarily due to the increase to the average loan volume
outstanding during fiscal year 1997.
The following is a summary of CFC's operating results as a percentage of
average loans outstanding for the last three fiscal years ending May 31,
1998, 1997 and 1996.
1998 1997 1996
Interest on loans 6.60% 6.58% 6.77%
Less: Cost of funds 5.60% 5.54% 5.71%
Gross operating margin 1.00% 1.04% 1.06%
General and administrative expenses 0.24% 0.26% 0.26%
Provision for loan losses 0.20% 0.18% 0.16%
Total expenses 0.44% 0.44% 0.42%
Operating margin 0.56% 0.60% 0.64%
Nonoperating income (1) 0.08% 0.04% 0.02%
Net margins 0.64% 0.64% 0.66%
TIER 1.12 1.12 1.12
(1) Nonoperating income includes the extraordinary loss in fiscal year
1996 resulting from the prepayment of debt and a gain on the sale
of land in fiscal year 1998.
30
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 May 31, 1998, 1997 and 1996.
Percentage of Total
1998 1997 1996
Electric Systems:
Distribution 57.59% 57.16% 54.37%
Power Supply 27.59% 30.29% 33.38%
Service Organizations 1.53% 1.63% 1.77%
Subtotal Electric Systems 86.71% 89.08% 89.52%
Associate Members 0.80% 0.92% 0.91%
Telecommunication Systems:
Local Exchange Carrier ("LEC") 6.43% 6.87% 6.71%
Cable 0.75% 0.51% 0.42%
Cellular 1.21% 1.22% 1.23%
Personal Communications Systems ("PCS") 0.89% 0.05% 0.00%
Other 3.21% 1.35% 1.21%
Subtotal Telecommunication Systems 12.49% 10.00% 9.57%
Total 100.00% 100.00% 100.00%
CFC's members are widely dispersed throughout the United States and its
territories, including 46 states, the District of Columbia, Guam, Samoa
and the U.S. Virgin Islands. At May 31, 1998, 1997 and 1996, no state
or territory had over 11.7%, 10.6% and 9.9%, respectively, of total loans
and guarantees outstanding.
Credit Concentration
In addition to the geographic diversity of the portfolio, CFC limits its
exposure to any one borrower. The majority of the largest single
exposures are concentrated in the power supply systems due to their large
plant and equipment requirements. At May 31, 1998, the total exposure
outstanding to any one borrower did not exceed 6% of total loans
(excluding loans guaranteed by RUS) and guarantees outstanding. At
May 31, 1998, CFC had $3,187 million in loans outstanding, excluding
loans guaranteed by RUS, and $1,757 million in guarantees outstanding,
to its largest 40 borrowers. The amounts outstanding to the largest 40
borrowers at May 31, 1998 represented 31% of total loans outstanding
and 85% of total guarantees outstanding. Total credit exposure to the
largest 40 borrowers represented 39% of total credit exposure at May 31,
1998, compared to 42% at May 31, 1997. CFC's ten largest credit
exposures represented 19% of total exposure at May 31, 1998 and 22%
at May 31, 1997.
Security Provisions
Except when providing lines of credit, CFC typically lends to its members
on a secured basis. At May 31, 1998, a total of $1,201 million of loans
were unsecured representing 11.4% of total loans and 9.5% of total loans
and guarantees. Approximately $136.1 million or 11.3% 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 10.1% of total loans and
8.4% 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.
31
Portfolio Quality
The following table summarizes the key composite operating results of
CFC's two main borrower types, distribution and power supply systems,
which together comprised 85.2% and 87.5% of CFC's total loan and
guarantee portfolio at May 31, 1998 and 1997. The information
presented below is as of December 31, and taken from the data contained
on pages 21 to 25.
CFC Distribution Member Borrowers
Composite Results
1997 1996 1995 1994 1993
TIER 2.34 2.44 2.42 2.42 2.54
DSC 2.26 2.42 2.40 2.26 2.44
MDSC 2.17 2.30 2.28 2.09 2.21
Equity percentage 42.7% 42.5% 41.7% 41.5% 40.8%
CFC Power Supply Member Borrowers
Composite Results
1997 1996 1995 1994 1993
TIER 1.04 1.21 1.23 1.31 1.20
DSC 1.13 1.20 1.22 1.24 1.21
Equity percentage 12.8% 12.3% 11.7% 9.3% 9.7%
NOTE: The power supply composite results have been presented
without the operating results of six systems experiencing
financial difficulties. CFC had credit exposure to four of the six
borrowers (see footnote 10 to the Combined Financial
Statements for a detailed description of these borrowers).
Most CFC power supply borrowers sell the majority of their power under
all-requirements power contracts with their member distribution systems.
These contracts allow, subject to regulatory requirements and
competitive constraints, for the recovery of all costs at the power supply
level. Due to the contractual connection between the power supply and
distribution systems, total combined system equity (power supply equity
plus the equity at its affiliated distribution systems) has typically been
maintained at the distribution level.
As with CFC, to the extent distribution systems can fund their assets with
retained Members' Equity (i.e., unretired capital credits), overall funding
costs for plant and equipment are reduced. Distribution systems can, in
turn, pass these savings on to their member/consumers in the form of
lower utility rates.
The effectiveness of the all-requirements power contract is dependent on
the individual systems' right and ability (legal as well as economic) to
establish rates to cover all costs. The boards of directors of most of
CFC's power supply and distribution members have the authority to
establish binding rates for their consumer members. Some states regulate
rate-setting and can therefore override the system's internal rate-setting
procedures.
During the past few years, power supply members have been increasing
their equity levels. Under recently changed RUS underwriting standards,
in order to qualify for additional RUS loan funds, power supply systems
may be required to maintain, or demonstrate an ability to reach, an equity
level of 20% of assets, or they must obtain guarantees from their affiliated
distribution systems.
CFC telecommunications borrowers reported composite DSC of 2.39 and Equity
ratio of 31% for the year ended December 31, 1997. As of the date of this
filing, all borrowers had not filed December 31, 1997 year end data.
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.
32
Alternatively, CFC may choose to apply all cash received to the reduction of
principal, thereby foregoing interest income recognition. At May 31, 1998,
all nonperforming loans were on non-accrual status with respect to interest
income. At May 31, 1998, nonperforming loans totaled $4 million, a
decrease of $5 million from the prior year-end. The decrease was due to
the settlement of loans outstanding to two borrowers and principal
repayments received during the year, offset by the addition of one
borrower to the nonperforming category.
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 May 31, 1998, restructured loans
totaled $330 million, a decrease of $32 million from the prior year. The
decrease was due to principal repayments received during the year.
Restructured loans in the amount of $330 million, $362 million and $205
million were on a nonaccrual basis with respect to the recognition of
interest income at May 31, 1998, 1997 and 1996, respectively.
NONPERFORMING AND RESTRUCTURED ASSETS
As of May 31
(Dollar Amounts In Thousands) 1998 1997 1996
Nonperforming loans $4,080 $9,428 $25,294
Percent of loans and guarantees outstanding 0.03% 0.09% 0.25%
Restructured loans $329,538 $361,961 $209,361
Percent of loans and guarantees outstanding 2.61% 3.29% 2.05%
Total nonperforming and restructured loans $333,618 $371,389 $234,655
Percent of loans and guarantees outstanding 2.64% 3.38% 2.30%
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
May 31, 1998, the allowance for loan losses totaled $250
million, a net increase of $17 million from the prior year-end. The
allowance represented 75.0% of nonperforming and restructured loans
and 1.98% of total loans and guarantees outstanding at year-end.
During fiscal year 1998, CFC charged off $2.1 million in loans related to
the bankruptcy settlement for two borrowers. CFC no longer has any
loan or guarantee exposure to either of the companies, which are no
longer CFC members.
Since its inception in 1969, CFC has charged off loan balances in the total
amount of $30.5 million, 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 May 31, 1998, 1997 and 1996.
ALLOWANCE FOR LOAN LOSSES
Years Ended May 31,
(Dollar Amounts In Thousands) 1998 1997 1996
Beginning balance $233,208 $218,047 $205,596
Provision for loan losses 19,027 15,161 12,451
Charge offs (2,104) - -
Ending balance $250,131 $233,208 $218,047
As a percentage of total loans outstanding 2.36% 2.62% 2.74%
As a percentage of total loans and
guarantees outstanding 1.98% 2.12% 2.14%
As a percentage of total nonperforming and
restructured loans outstanding 74.98% 62.79% 92.88%
33
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 May 31,
1998, CFC had $520 million in fixed rate assets amortizing or repricing
and $358 million in fixed rate liabilities maturing during fiscal year 1999.
The difference, $162 million, represents the fixed rate assets in excess of
the fixed rate debt maturing during the next fiscal year. This difference of
$162 million at May 31, 1998 represents 1.5% 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 different
intervals from early redemptions, CFC charges conversion fees designed
to compensate for any additional interest rate risk assumed by the
Company.
CFC makes uses 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 May 31, 1998.
34
INTEREST RATE GAP ANALYSIS
(Fixed Assets/Liabilities)
As of May 31, 1998
(Dollar Amounts In Millions) 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
Assets:
Loan Amortization
and repricing $519.8 $798.1 $855.8 $1,169.6 $1,074.0 $ 419.7 $4,837.0
Total Assets $519.8 $798.1 $855.8 $1,169.6 $1,074.0 $ 419.7 $4,837.0
Liabilities and Equity:
Long-Term Debt $149.5 $799.1 $869.2 $1,142.4 $ 65.1 $ 450.0 $3,475.3
Subordinated Certificates 109.4 7.1 7.7 19.2 752.5 81.1 977.0
Members'Equity 99.1 - - 8.0 145.0 - 252.1
Total Liabilities and Equity $358.0 $806.2 $876.9 $1,169.6 $ 962.6 $ 531.1 $4,704.4
Gap * $161.8 $ (8.1) $(21.1) - $ 111.4 $(111.4) $ 132.6
Cumulative Gap $161.8 $153.7 $132.6 $ 132.6 $ 244.0 $ 132.6
Cumulative Gap as a %
of Total Assets 1.51% 1.44% 1.24% 1.24% 2.28% 1.24%
* Loan amortization/repricing over/(under) debt maturities
Derivative and Financial Instruments
All of the financial instruments to which CFC was a party at May 31,
1998 were purchased for purposes other than trading. All of CFC's
financial instruments at May 31, 1998 were interest rate sensitive. The
following table provides the significant balances and contract terms
related to the market risk related financial instruments at May 31, 1998.
(Dollar Amounts in Thousands ) Principal Amortization
Instrument Outstanding Fair Remaining
Balance Value 1999 2000 2001 2002 2003 Years
Assets:
Investments $ 65,485 $ 65,485 $ 65,485 $ - $ - $ - $ - $ -
Average Rate 5.38% 5.38% - - - - -
Long-term Fixed Rate loans 4,512,362 4,574,632 485,871 326,761 418,390 443,761 412,526 2,425,053
Average Rate (1) 7.07% 7.23% 6.89% 6.83% 6.89% 6.87% 7.17%
Long-term Variable Rate loans 4,341,376 4,341,376 155,719 158,057 163,926 162,528 170,062 3,531,084
Average Rate (2) 6.57% - - - - - -
Intermediate-term loans 364,903 364,903 43,385 52,851 42,749 9,261 11,739 204,918
Average Rate (3) 6.72% - - - - - - -
Line of credit loans (4) 894,021 894,021 - - - - - -
Average Rate (2) 6.83% - - - - - -
RUS guaranteed loans 133,195 133,195 2,255 2,090 2,695 3,145 4,095 118,915
Average Rate (2) 6.36% - - - - - -
Nonperforming loans (5) 4,080 4,080 - - - - - -
Average Rate (6) 6.41% - - - - - -
Restructured loans (7) 329,538 329,538 - - - - - -
Average Rate (6) 7.17% - - - - - -
Liabilities & Equity:
Commercial paper 5,680,904 5,680,898 5,680,904 - - - - -
Average Rate 5.54% 5.54% - - - - -
Bank Bid Notes 185,000 185,000 185,000 - - - - -
Average Rate 5.57% 5.57% - - - - -
Medium-Term Notes 1,109,258 1,113,914 327,325 113,121 172,102 105,300 328,050 63,360
Average Rate 6.18% 5.99% 6.18% 6.25% 6.26% 6.25% 6.47%
Collateral Trust Bonds (8) 1,897,688 1,944,005 - 150,000 100,000 100,000 300,000 1,247,688
Average Rate 6.61% - - 6.45% 6.75% 6.38% 6.75%
QUICS 200,000 204,980 - - - - - 200,000
Average Rate 7.87% - - - - - 7.87%
Subordinated Certificates 1,229,166 1,086,350 4,148 2,740 2,646 2,622 3,170 1,213,840
Average Rate 4.20% 7.96% 8.38% 7.24% 8.30% 8.38% 4.16%
35
(1) The principal amount of fixed rate loans is the total of scheduled
principal amortizations and scheduled repricings.
(2) Variable rates set first day of each month.
(3) Intermediate-term loan amortizations include principal payments on
both variable rate and fixed rate loans.
(4) Line of credit loans are generally required to be paid down for a
period of five consecutive days each year. These loans do not have a
principal amortization schedule.
(5) CFC is uncertain as to the amounts and timing of repayments related
to nonperforming loans.
(6) At May 31, 1998, all nonperforming and restructured loans were on
non accrual status with respect to the recognition of interest income.
(7) All restructured loans were performing on the negotiated terms. See
Footnote 10 to Combined Financial Statements for further
information.
(8) The Collateral Trust Bonds maturing in fiscal year 2000 carry a variable
interest rate.
The following table provides the notional amount, average rate paid,
average rate received and maturity dates for the interest rate exchange
agreements to which CFC was a party at May 31, 1998.
Notional Principal Amortization
Notional Principal Remaining
Instrument Balance Value 1999 2000 2001 2002 2003 Years
Interest Rate Swaps $753,675 $741,921 $ - $202,851 $342,749 $ - $22,375 $185,700
Average Rate Paid (1) 5.92% - - - - - -
Average Rate Received (1) 5.68% - - - - - -
(1) Scheduled interest rate swap maturities include agreements in which
CFC pays both fixed and variable rates and receives variable rates.
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 35). 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. At May 31, 1998 and 1997, 2.7% and 3.3%,
respectively, of the fixed rate loans were funded with variable rate debt.
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 May 31,
1998 and 1997, 54.2% and 62.5%, 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 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 May 31, 1998 and
1997, CFC had a total of $5,218 million and $5,000 million, 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 on page 37). CFC
also maintains shelf registrations with
36
the SEC for its Collateral Trust Bonds, Medium-Term Notes and
Quarterly Income Capital Securities. At May 31, 1998 and 1997,
CFC had active shelf registrations totaling $300 million and
$700 million related to Collateral Trust Bonds, $1,264
million and $313 million related to Medium-Term Notes and $50 million
and $125 million 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 May 31, 1998 and 1997, CFC
had $82 million and $239 million of Commercial Paper, respectively, and
$250 million and $0 million of Medium-Term Notes, respectively,
outstanding to European investors. CFC has issuance authority of $1,000
million related to Commercial Paper and $1,000 million related to
Medium-Term Notes under these programs. Subsequent to the end of
the year, on June 5, 1998, Registration Statements for $250 million in
Quarterly Income Capital Securities and $1,000 in Medium-Term Notes
became effective.
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 May 31, 1998 and 1997,
CFC was a party to $754 million and $439 million, 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 May 31, 1998, CFC's interest rate exchange
agreement counter parties had credit ratings ranging from A to AAA as
assigned by Standard & Poor's Corporation.
Foreign Currency Risk
CFC may issue European Commercial Paper, Collateral Trust Bonds or
Medium-Term Notes denominated in foreign currencies. For any such
note issued, CFC expects to enter into a foreign currency swap with a
highly rated counterparty. The cost of the currency swap would be
factored into the interest rate CFC pays on the obligation and included in
CFC's total cost of funds. To date, CFC has not issued any debt
denominated in a foreign currency.
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 May 31,
1998.
Moody's Standard & Poor's Fitch
Investors Service Corporation Investors 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.
37
Member Investments
At May 31, 1998 and 1997, CFC's members provided 27.8% and 33.0%
of total capitalization as follows:
MEMBERSHIP CONTRIBUTIONS TO TOTAL CAPITALIZATION
% of % of
(Dollar Amounts In Thousands) 1998 Total 1997 Total
Commercial Paper $1,195,600 21.0% $1,203,335 21.9%
Long-term debt (primarily Medium-Term Notes) 240,348 8.0% 276,821 17.1%
Members' Subordinated Certificates 1,229,166 100.0% 1,212,486 100.0%
Members' Equity 279,278 100.0% 271,594 100.0%
Total $2,944,392 $2,964,236
Percentage of total capitalization 27.8% 33.0%
The total amount of member investments decreased by $20 million at
May 31, 1998, compared to May 31, 1997. 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 May 31, 1998 was $10,581 million, an increase of $1,600
million over the total capitalization of $8,981 million at May 31, 1997.
When the loan loss allowance is added to both membership contributions
and total capitalization, the percentages of membership investments to
total capitalization are 29.5% and 34.7% at May 31, 1998 and 1997,
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.
Historical Results
The following chart provides CFC's key operating results over the last
five years.
SELECTED KEY FINANCIAL DATA
(Dollar Amounts In Thousands)
As of May 31: 1998 1997 1996 1995 1994
Net loans $10,329,345 $8,678,196 $7,728,271 $6,747,124 $5,921,022
Total liabilities $ 9,174,444 $7,573,414 $6,576,764 $5,575,853 $4,740,470
Total Members' Subordinated
Certificates and Equity $ 1,508,444 $1,484,080 $1,477,325 $1,504,936 $1,483,826
Guarantees $ 2,034,494 $2,080,671 $2,249,440 $2,574,922 $2,655,827
Leverage ratio (1) 6.37 5.84 5.69 5.13 4.63
Debt/Equity (2) 4.51 3.97 3.63 3.01 2.52
Gross margins $ 97,038 $ 88,710 $ 78,994 $ 78,771 $ 61,452
Net margins $ 62,216 $ 54,736 $ 49,041 $ 45,212 $ 33,188
TIER (3) 1.12 1.12 1.12 1.13 1.13
(1) The leverage ratio is calculated by dividing debt and guarantees
outstanding, excluding Quarterly Income Capital Securities and
debt used to fund loans guaranteed by RUS, by the total of
Members' Subordinated Certificates, Members' Equity and
Quarterly Income Capital Securities.
(2) The debt/equity 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.
(3) TIER is calculated by dividing net margins before extraordinary
items plus the cost of funds by the cost of funds.
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,
38
4. develop plan to address items that will not be compliant,
5. implement solutions,
6. testing of all applications and equipment,
7. final corrections
Currently CFC has completed steps 1 through 4 for the majority of
the identified applications. CFC is now in the process of
implementing solutions, including preparing for the installation of
compliant versions of software applications, which should be available
shortly. CFC is also in the process of implementing test plans for
each application. All testing is scheduled to be completed by January
1, 1999.
CFC has obtained compliance certifications from third party vendors,
for all of its core applications and operating systems. All internally
developed applications have also been determined to be compliant.
All essential applications will be tested, regardless of whether a
certification of compliance has been obtained.
CFC has performed all work related to the year 2000 compliance plan
internally. CFC plans to perform all testing and implementation of the
required solutions internally. The overall cost of remediating CFC's
year 2000 problem is expected to be insignificant and not anticipated
to adversely impact operations. Due to business reasons, CFC moved
from a mainframe platform to a client server platform and
implemented new operating systems and core applications beginning
in 1995. As a result, many of CFC's year 2000 issues were mitigated.
CFC is in the process of reviewing non Information Technology
equipment and systems for year 2000 compliance. At this time, CFC
is uncertain as to the extent of its non Information Technology related
year 2000 problem. The problems caused by non-compliance of this
equipment are expected to be minor in nature and not expected to
impact operations.
As part of the year 2000 compliance plan, a contingency plan has
been developed for each at risk application and system. In this process,
each application owner laid out the steps required to work around a year
2000 failure. CFC is in the process of developing an overall contingency
plan.
At this time, CFC is uncertain as to the scope of the year 2000
problem its borrowers face. CFC will ask its borrowers for compliance
certification as part of the representations required by the mortgage in
the annual officer's certificate at December 31, 1998.
Financial and Industry Outlook
CFC does not expect a significant increase in the competition for the
supplemental electric loan business. RUS will continue to be the
dominant lender, since others can not match the rates it offers. The
total loans and guarantees available from RUS for fiscal year 1998 are
$1,066.5 million, an increase of $141.5 million over the prior year.
The total amount of funding available for loans decreased from $625
million in 1997 to $366.5 million in 1998. RUS will provide almost
two-thirds of its assistance to borrowers through guarantees in 1998,
with approval to guarantee up to $700 million of loans from other
creditors.
CFC expects there to be significant competition for the
telecommunications lending business. RUS and RTB will continue to
be the primary lenders to the rural telecommunications industry which
comprises CFC's target market.
The amount of loan funds available from RUS to its borrowers is
dependent upon the size of the congressionally allocated subsidy for
RUS's revolving loan fund and the current interest rates. As interest rates
rise, a larger portion of the subsidy is required to buy down the interest
rate, reducing the total amount of funding available for new loans. As the
level of loan funds available decreases, borrowers will be required to seek
out additional sources for loan funds.
During fiscal year 1998, CFC advanced approximately $448 million to
electric borrowers for the purpose of prepaying their RUS loans. From
March 1994, the date final regulations were adopted, through May 1998,
CFC has advanced a total of $2,170 million to borrowers for this
purpose. CFC has been selected as the lender for over 94% of the RUS
debt refinancings. There are applications pending at RUS for an
additional $41 million of buyouts, in which CFC has been selected as the
lender and has approved loan commitments. Future volume of RUS note
prepayments will depend on a number of factors including interest rates,
tax consequences and possible acquisition or other business opportunities
available to the members. CFC does not expect large volumes of
prepayment requests to be made at any one time, but believes that there
will be a steady stream of activity.
39
CFC beleives that demand for loans from its members will continue to
maintain the pace set over the last few years. Factors impacting the level
of increase in demand for CFC loan funds will include (1) the number of
systems that decided to buy out their RUS debt; (2) the strength of the
economy; (3) the utilization of loans from the FFB with a guarantee from
RUS; (4) mergers and acquisitions of non-cooperative electric systems
and non-CFC telephone systems; and (5) the pace of diversification into
new businesses, such as gas and propane and new telecommunications
services.
CFC remains optimistic that the effort to restructure the electric utility
industry will provide a reasonable market for generation and that
provisions adopted for stranded cost recovery will permit an orderly
transition to a competitive retail market. The high cost generation
systems have a greater risk of a negative impact, while the low cost
generation systems may have the opportunity to expand their market
share. CFC currently has limited exposure to systems with a high cost
of producing power and is working with these systems to mitigate any
potential negative impact.
Item 8. Financial Statements and Supplementary Data.
The Combined Financial Statements, Auditors' Report and Combined
Quarterly Financial Results are included on pages 53 through 80 (see
Note 12 to Combined Financial Statements for a summary of the
quarterly results of CFC's operations).
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.
None.
40
PART III
Item 10. Directors and Executive Officers of the Registrant.
(a) Directors
Director Date present
Name Age since term expires
Paul J. Liess (President of CFC) 60 1993 1999
Eldwin Wixson (Vice President of CFC) 66 1995 2001
Benson Ham (Secretary-Treasurer of CFC) 64 1995 2001
James O. Baker 59 1997 1999
Glenn English 57 1994 1999
Alden J. Flakoll 64 1996 1999
Wade R. Hensel 46 1997 2000
George W. Kline 69 1993 1999
Kenneth Krueger 60 1997 2000
Stephen R. Louder 46 1998 2001
Eugene Meier 69 1997 2000
R. Layne Morrill 58 1995 2001
Robert J. Occhi 51 1996 1999
Michael Pigott 54 1997 2000
Timothy Reeves 50 1998 2001
Brian D. Schlagel 48 1998 2001
R.B. Sloan Jr. 46 1996 1999
Thomas W. Stevenson 56 1997 2000
Clifford G. Stewart 52 1997 2001
Robert Stroup 53 1996 1999
Robert C. Wade 64 1997 2000
Robert O. Williams 65 1994 2000
(b) Executive Officers
Held present
Title Name Age office since
President and Director Paul J. Liess 60 1997
Vice President and Director Eldwin Wixson 66 1997
Secretary-Treasurer and Director Benson Ham 64 1997
Governor and Chief Executive Officer Sheldon C. Petersen 45 1995
Senior Vice President of Member Services
and General Counsel John J. List 51 1997
Senior Vice President and Chief Financial Officer Steven L. Lilly 48 1994
Senior Vice President for Strategic Services David J. Hedberg 47 1995
Senior Vice President of Operations John T. Evans 48 1997
The President, Vice President and Secretary-Treasurer are elected
annually by the Board of Directors at its first meeting following CFC's
annual membership meeting, each to serve a term of one year; the
Governor serves at the pleasure of the Board of Directors; and the other
Executive Officers serve at the pleasure of the Governor.
(c) Identification of Certain Significant Employees.
Inapplicable.
(d) Family Relationships.
41
No family relationship exists between any director or executive officer
and any other director or executive officer of the registrant.
(e) (1) and (2) Business Experience and Directorships.
In accordance with Article IV of CFC's Bylaws, each candidate for
election to the Board of Directors must be a trustee, director or manager
of a member of CFC.
Mr. Liess has been General Manager of Twin Valleys Rural Public Power
District, Cambridge, NE, since 1978. He has been an alternate Director
of the Nebraska Rural Electric Association ("NREA") and the Nebraska
Electric Generation and Transmission Cooperative, Inc. since 1979. He
was a chairman and still serves on the Board of the Nebraska ACRE and
is currently Chairman of the NREA Credit Union Board. He is a member
and one of five original founders of Five District Joint Venture,
developers of Rural Power Manager Software. Mr. Liess has been a
member of the Board of Governors of the Central Community College
since 1989. He is a member of the Board of Directors of the Central
Plains Technical and Business Development Center and Chairman of the
Cambridge Economic Development Board.
Mr. Wixson has been a Director of New Hampshire Electric Cooperative,
Inc., Plymouth, NH, since June 1986 and President (now retitled Chair)
of the Board of Directors since June 1992. Mr. Wixson has been a
professor of mathematics at Plymouth State College, of the University
System of New Hampshire, since 1966 and was Interim Dean from July
1994 to June 1995. He also has been Chair of the Board of Directors of
the Community Guaranty Savings Bank since 1988 and served as a
Director of the Speare Memorial Hospital since 1986. He was the
principal-controlling partner of the Plymouth Pharmacy from 1979 to
1983 and was a Maine dairy farmer from 1956 to 1963.
Mr. Ham has been a Director of Central Georgia Electric Membership
Cooperative, Jackson, GA, since 1983. He has also been the managing
partner in the law firm of Ham, Jenkins, Wilson & Wangerin, since 1991.
He is a partner in Sleepy Creek Farms, a commercial cow-calf operation
established in 1983. He also served for ten years in the Georgia
Legislature. He is currently a member of the Monroe County Economic
Development Authority. He has served as President of the Flint Judicial
Circuit Bar Association from 1962 to 1963 and has served on the Board
of Governors of the Georgia Bar Association. He currently serves as a
member of the Board of Directors of Georgia Transmission Corporation
and Georgia Electric Membership Corporation.
Mr. Baker has been the General Manager of Middle Tennessee Electric
Membership Cooperative, Murfreesboro, TN, since 1980. He has been
President of the National Rural Electric Cooperative Association
(NRECA) since 1997, and has served on the NRECA Board since 1985.
He has been Chairman of the Action Committee for Rural Electrification
since 1992, a member of Group Purchase Committee of the Tennessee
Electric Cooperative Association since 1992, the Legislative Committee
since 1992, the Tax Committee since 1992, and a member of the Joint
Use and Power Supply Committee of the Tennessee Valley Public Power
Association since 1992. He is the past President of Middle Tennessee
Industrial Development Association, past President and District Governor
of the Lions Club, and past board member of both Southeastern Electric
Reliability Council and EPRI.
Mr. English has been Chief Executive Officer of NRECA, Washington,
DC, since February 1994. He served in the House of Representatives
from 1975 to 1994. He served on the House Agriculture Committee
from 1975 to 1994, and was Chairman of the House Agricultural
Subcommittee on Environment, Credit and Rural Development in 1989.
Mr. Flakoll has been Vice President of FEM Electric Association, Inc.,
Ipswich, SD since 1977, and is a Director of the East River Electric
Power Cooperative, Madison, SD. He has been the owner and operator
of Flakoll Enterprises, a diversified farming, ranching and feedlot
operation, since 1957. He has also been the Chairman of District 4 South
Dakota Rural Electric Association Legislative and Resolutions
Committee since 1992. He is President of the South Dakota Outstanding
Farmers of America and Secretary-Treasurer of North Central Hereford
Association. Mr. Flakoll is a past President of the North Central
Livestock Association and past business manager of Wachter School
District.
Mr. Hensel has been General Manager of BENCO Electric, Mankato,
MN, since 1981. He is a former Chairman of Minnesota Rural Electric
Manager's Association and a former Chairman of the Cooperative Power
Manager's Association. He has been a member of the management
committee of Cooperative Television Association of Southern Minnesota
since 1993, a partner in North Mankato/Frost-BENCO-Wells Industrial
Park since 1991, a director of Mankato Rehabilitation Center since 1995,
and a director and former Chairman of Valley Industrial Development
Corporation. He is a former
42
chairman and former director of the Chamber of Commerce,
a former president of the Jaycees, a former treasurer and
board member of the Independent School District #77, and
former director of Immanuel-St. Joseph's Hospital.
Mr. Kline has been a Director of Trico Electric Cooperative, Tucson, AZ
since 1988. He has been Vice President of Grand Canyon State Electric
Cooperative Association, since 1992. He was a Magistrate for the town
of Marana, AZ, from 1983 to 1993 and is currently retired. He is the
former President of Grand Canyon State Electric Cooperative. He served
as a state representative for District 7 in the Arizona 35th Legislature. He
is also a past Vice President and Treasurer of the Marana Rotary
International.
Mr. Krueger has been a Director of Flathead Electric Cooperative,
Kalispell, MT, since 1972 and was President from 1977 to 1984. He also
served as Director and member of the Executive and Legislative
Committees. He has owned and operated a grain farm since 1960. He
was President of the Montana Electric Cooperatives' Association from
1979 to 1988, and Secretary-Treasurer from 1976 to 1979. He served on
the Building Committee, the Dues and Policy Committee, and the Budget
Committee. He is also a member of the NRECA Region IX Resolutions
Committee. Mr. Krueger was Flathead County Commissioner from 1983
to 1989. He is a past member of the Montana State Rural Area
Development Committee, past Master of the Stillwater Grange, and
former board member and Chairman of the West Valley School Board.
Mr. Louder has been President and General Manager of Deaf Smith
Electric Cooperative, Hereford, TX, since 1992. He is a director at
Golden Spread Electric Cooperative and a member and former Chairman
of the Texas Electric Cooperative Member Services Committee. He is a
registered Professional Engineer in the state of Texas, a member of the
Community Christian School Board of Trustees and a member of the
Board of Elders at Community Church in Hereford, TX. He is also
active in his local economic development and 4-H Club.
Mr. Meier has been a Director of Cooperative Development Services
since 1998 and the Director of Pierce-Pepin Electric Cooperative,
Ellsworth, WI, since 1991. He has been Vice President of the Wisconsin
Electric Cooperative since 1995 and Chairman of its Legislative
Committee since 1994. Prior to his retirement in 1994, Mr. Meier was
Maintenance Foreman of Continental Nitrogen and Resources, Inc. He
has also owned and operated a farm since 1964. He has been a director
of the Wisconsin Federation of Cooperatives since 1995. He is a former
member of Legislative Standing Committee, NRECA, and a former
executive committee member of the Wisconsin Electric Cooperative
Association. He is an active member and past President of Joy Lutheran
Church of Prescott.
Mr. Morrill has been a Director of White River Valley Electric
Cooperative, Inc., Branson, MO, since 1976 and is currently serving as
Secretary-Treasurer. He is also a Director of KAMO Electric
Cooperative. He has been President of Shepherd of the Hills Realty Co.,
Inc. and President of Shepherd of the Hills Properties Inc., since 1967.
He is also a Director of the Bank of Kimberling City and of Rural
Missouri Cable T.V. Inc. He has been President of the Kimberling City
Water Company since 1982.
Mr. Occhi has been Executive Vice President and General Manager of
Coast Electric Power Association, Bay St. Louis, MS since 1986. He has
been a Director of the South Mississippi Electric Power Association since
1986 and past President of the Electric Power Associations of
Mississippi. He is also Vice President of the Mississippi Council of
Farmer Cooperatives and of the Greater Biloxi Economic Development
Foundation, and a past Director of the Mississippi Economic Council.
Mr. Pigott has been the Executive Vice President and General Manager
of Beauregard Electric Cooperative, DeRidder, LA, since 1988. He has
been President of the Association of Louisiana Electric Cooperatives
since 1994, a director of Cajun Electric Power Cooperative since 1992,
and a member of Louisiana Electric Distribution Cooperative Managers
Association since 1988. He has been a director of the Louisiana
Resource Recovery and Development Authority since 1990. Mr. Pigott
is currently Director of the Rotary Club, and is a member of the Chamber
of Commerce, the Beauregard Parish Cattlemen's Association, the Allen
Parish Rice Growers Association, and the Human Resources
Management Association.
Mr. Reeves has been President and General Manager of Southern Illinois
Power Cooperative, Marion, IL, since 1993. He was Executive Vice
President and General Manager of Southern Illinois Power Cooperative
from 1981 to 1990, and Assistant to the Manager of Egyptian Electric
Cooperative Association from 1974 to 1980. He is the Chairman of
Illinois ACRE and a member of Illinois Managers Association and the
G&T Managers Association. He also served as President of the Union
County Hospital Board and the Southern Most Illinois Tourism Board.
43
Mr. Schlagel has been the President of Morgan County REA, Fort
Morgan, CO, since 1997. He has owned and operated Schlagel Farms,
an irrigated agriculture enterprise, since 1971. Mr. Schlagel is also a
Director of the Colorado Rural Electric Association, serves on the
Facilities Committee at Tri-State Generation and Transmission
Association, Inc., is Vice President of Roggen Famer's Elevator
Association and a Fellow of the Colorado Agriculture Leadership
Program. He also served as President of Strasburg School District 31-J
and Vice President of the Southeast Weld Fire Protection District.
Mr. Sloan has been Executive Vice President and General Manager of
Crescent Electric Membership Corporation, Statesville, North Carolina
since 1989. He has been a member of the boards of North Carolina
Electric Membership Corporation, North Carolina Association of Electric
Cooperatives since, Tarheel Electric Membership Association since 1989.
He was Chairman of the North Carolina Rural Electrification Authority
from 1987 to 1993. He is also the past Chairman of the National
Association of Counties' Rural Development Committee, past Chairman
of the Greater Statesville Chamber of Commerce and the past Chairman
of the Iredell County Board of Commissioners.
Mr. Stevenson has been President and Chief Executive Officer of
Wolverine Power Supply Cooperative, Inc., Cadillac, MI, since 1995. He
was the General Manager and Chief Executive Officer of Ketchikan
Public Utilities, Ketchikan, AK from 1989 to 1995. He has been a
Director of Michigan Association of Rural Electric Cooperatives since
1995. He is a member of NRECA's Power and Generation Committee, G
& T Managers Association, and ACES. Mr. Stevenson served as mayor
pro tem and city council member of Longmont, Colorado from 1978 to
1981. He served as a board member of Denver Regional Council of
Governments, and as a board member and executive committee member
of Ketchikan Chamber of Commerce. He is a member of the American
Institute of Certified Public Accountants, the Colorado Society of CPAs,
Rotary International (Paul Harris Fellow), the American Legion, and the
VFW.
Mr. Stewart has been the Vice President and General Manager of Oregon
Trail Electric Consumers Cooperative, Baker City, OR, since 1993, and
Vice President of Pacific Northwest Generating Cooperative since 1995.
He was general manager of Farmers' Electric Cooperative, Inc. from
1985 to 1993 and served on the Clovis-Curry Economic Development
Board from 1990 to 1993. He is past president of the New Mexico Rural
Electric Self Insurers Fund, a former director of the New Mexico Rural
Electric Association, and Chairman of the Association's Publications
committee.
Mr. Stroup has been Vice President of Shelby County REMC,
Shelbyville, IN since 1994 and has owned a construction and design
company since 1964. He has been a Director of Hoosier Energy REC
since 1992 and of the Indiana Statewide Association of Rural Electric
Cooperatives since 1993. He is also a member of the Marietta Volunteer
Fire Department and the Shelby County Chamber of Commerce.
Mr. Wade serves as Chairman of Nolin Rural Electric Cooperative
Corporation, Elizabethtown, KY, and has been engaged in grain farming
since 1960. He is the Director of Kentucky Association of Electric
Cooperatives, of which he was Chairman from 1980 to 1982. He has
been Vice Chairman of Kentucky Electric Cooperatives' Political Action
Committee, SURE--Speak Up for Rural Electrification since 1974. He is
a member of KAEC Strategic Planning Committee and Management and
Employees Committee, and served on CFC's Committee on Objectives
and Planning. Mr. Wade is Treasurer of Hardin County Extension Feed
Committee, Director of PNC Bank Advisory Board, board member and
past President of North Central Kentucky Education Foundation,
Director of Hardin County Community Foundation, a member of
University of Kentucky Community College Futures Commission, past
Chairman of Hardin County Planning and Development Commission and
Hardin County Extension Council, and a member of Public Advisory
Committee of Kentucky Outlook 2000: A Strategy For Kentucky's Third
Century.
Mr. Williams has been President and Chief Executive Officer of York
Electric Cooperative, York, SC since 1974. He has also been a trustee
for both the Saluda River Electric Cooperative, Laurens, SC, and the
Electric Cooperatives of South Carolina since 1974. He was a trustee for
the South Carolina State Development Board from 1991 to 1993 and a
trustee for the York Technical College Foundation Board from 1983 to
1991.
Mr. Petersen joined CFC in August 1983 as an Area Representative. He
became the Director of Policy Development and Internal Audit in January
1990, then Director of Credit Analysis in November 1990 and Corporate
Secretary on June 1, 1992. He became Assistant to the Governor on
May 1, 1993. He became Assistant to the Governor and Acting
Administrative Officer on June 1, 1994. He became Governor and CEO
on March 1, 1995.
Mr. List joined CFC as a staff attorney in February 1972. He served as
Corporate Counsel from June 1980 until 1991. He became Senior Vice
President and General Counsel on June 1, 1992, and became Senior Vice
President, Member Services and General Counsel on February 1, 1997.
44
Mr. Lilly joined CFC as a Senior Financial Consultant in October 1983.
He became Director of Special Finance in June 1985 and Director of
Corporate Finance in June 1986. He became Treasurer and Principal
Finance Officer on June 1, 1993. He became Senior Vice President and
Chief Financial Officer on January 1, 1994.
Mr. Hedberg joined CFC as Director of Rates and Special Projects in
1981. He became Senior Vice President of Strategic Services on June 1,
1995.
Mr. Evans joined CFC as Senior Vice President of Operations in
November 1997. He was Senior Vice President and Chief Operating
Officer of Suburban Hospital Healthcare System, Bethesda, MD from
1994 to 1997. He was Senior Vice President and Chief Operating Officer
for Geisinger Medical Center, Danville, PA from 1991 to 1994.
(f) Involvement in Certain Legal Proceedings.
None to the knowledge of CFC.
(g) Promoters and control persons.
Inapplicable.
Item 405. Compliance with Section 16 (a) of the Exchange Act.
Inapplicable.
Item 11. Executive Compensation
The Summary Compensation Table below sets forth the aggregate
remuneration for services in all capacities to CFC, on an accrual basis, for
the three years ended May 31, 1998, 1997 and 1996 to the named
executive officers. The named executive officers include the CEO and
the next most highly compensated executive officers serving at May 31,
1998, with salary and bonus for fiscal year 1998 in excess of $100,000.
Summary Compensation Table
Annual Compensation
All
Other
Name and Principal Position Year Salary Bonus Comp(1)
Sheldon C. Petersen 1998 $328,854 $ - $ 25,009
Governor and Chief 1997 289,711 - 18,358
Executive Officer 1996 256,250 4,231 17,717
John J. List 1998 194,652 7,000 4,035
Senior Vice President of Member 1997 173,246 - 11,177
Services and General Counsel 1996 155,581 2,464 15,742
Steven L. Lilly 1998 205,869 3,000 10,352
Senior Vice President and 1997 192,620 3,500 9,232
Chief Financial Officer 1996 176,154 13,284 16,612
David J. Hedberg 1998 150,849 5,000 6,615
Senior Vice President for 1997 147,704 - 8,309
Strategic Services 1996 138,230 2,458 11,261
John T. Evans (2) 1998 106,571 - 24,252
Senior Vice President of
Operations
(1) Amounts for fiscal years 1998, 1997 and 1996 include $21,501,
$13,325 and $13,192 related to leave accruals and $3,508, $5,033
and $4,525 related to CFC contributions to a savings plan for Mr.
Petersen; $854, $7,819 and $12,632 related to leave accruals and
$3,181, $3,358 and $3,110 related to CFC contributions to a savings
plan for Mr. List; $7,159, $5,473 and $13,089 related to leave
accruals and $3,193, $3,759 and $3,523 related to CFC
contributions to a savings plan for Mr. Lilly; $3,525,
$5,415 and $8,491 related to leave accruals and
45
$3,090, $2,894 and $2,770 related to CFC contributions to a savings
plan for Mr. Hedberg. For Mr. Evans, amounts for fiscal year
1998 relate to leave accruals.
(2) Mr. Evans joined CFC in November 1997. The compensation table
includes the actual compensation paid to Mr. Evans through May 31,
1998, and not his annual salary.
Defined Benefit or Actuarial Plan Disclosure
NRECA maintains the Retirement and Security Program entitling CFC
employees to receive annually, under a 50% joint and surviving spouse
annuity, 1.90% of the average of their five highest base salaries during their
last ten years of employment, multiplied by the number of years of
participation in the program. As of May 31, 1998, the number of years of
service credited and the compensation covered under the program,
respectively, for the officers listed above was as follows: Sheldon C.
Petersen-14 years 9 months, $240,852; John Jay List-26 years 3 months,
$169,883; Steven L. Lilly-14 years 7 months, $173,993; David J. Hedberg-
16 years 5 months, $132,300, John T. Evans-6 months, $190,000.
Pension Plan Table
Years of Services
Average base salary 5 10 15 20 25 30
$100,000 $ 9,500 $19,000 $28,500 $ 38,000 $ 47,500 $ 57,000
125,000 11,875 23,750 35,625 47,500 59,375 71,250
150,000 14,250 28,500 42,750 57,000 71,250 85,500
175,000 16,625 33,250 49,875 66,500 83,125 99,750
200,000 19,000 38,000 57,000 76,000 95,000 114,000
225,000 21,375 42,750 64,125 85,500 106,875 130,000*
250,000 23,750 47,500 71,250 95,000 118,750 130,000*
275,000 26,125 52,250 78,375 104,500 130,000* 130,000*
*The Tax Reform Act of 1984 places a cap on maximum salary used to
compute retirement benefits and maximum yearly benefit. For calendar year
1998, the salary cap is $160,000 (the cap represents the amount of salary for
1998 that may be used in the computation of the average base salary) and
the benefits cap is $130,000
The Budget Reconciliation Act of 1993 has set a limit of $160,000 on the
compensation to be used in the calculation of pension benefits. In order to
restore potential lost benefits, CFC has set up a Pension Restoration Plan.
Under the plan, the amount that NRECA invoices CFC will continue to be
based on the full compensation paid to each employee. Upon the retirement
of a covered employee, NRECA will calculate the retirement and security
benefit to be paid with consideration of the compensation limits and will pay
the maximum benefit thereunder. NRECA will also calculate the retirement
and security benefit that would have been available without consideration of
the compensation limits and CFC will pay the difference. NRECA will then
give CFC a credit against future retirement and security contribution
liabilities in the amount paid by CFC to the covered employee.
CFC will pay such additional benefits to the covered employee through a
Severance Pay Plan and a Deferred Pay Restoration Plan. Under the
Severance Pay Plan, the employee is paid an amount equal to the lost
pension benefits but not to exceed twice the employee's annual
compensation for the prior year. The benefit must be paid within 24 months
of termination of employment. To the extent that the Severance Pay Plan
cannot pay all of the lost pension benefits, the remainder will be paid under a
Deferred Compensation Plan, which will be paid out in a lump sum or in
installments of up to 60 months.
Compensation of Directors
No director received any remuneration as an officer or director of CFC.
Directors are reimbursed for travel expenses and receive a daily per diem to
cover meals and lodging for their attendance at all Board of Directors
functions.
Employment Contracts and Termination of Employment and Change-
In-Control Arrangements
Pursuant to an employment agreement effective as of March 1, 1996, CFC
has agreed to employ Mr. Petersen as Chief Executive Officer through
February 28, 2001 (with automatic one-year extensions unless either party
objects) at no less than $245,000 per annum plus such bonus (if any) as may
be awarded him. Certain payments have been agreed to in the event of Mr.
Petersen's
46
termination other than for cause, for example, Mr. Petersen
leaving for good reason, disability or termination of his employment due to
death.
Pursuant to a separate employment agreement effective as of the same date,
RTFC has agreed to employ Mr. Petersen for the same term. As
compensation, RTFC must credit to a deferred compensation account on
January 1 of each year of the term $30,000. Interest will be credited to the
account on December 31 of each such year at a rate equal to CFC's 20-year
Medium- Term Note rate on that date. If Mr. Petersen's employment is
terminated by RTFC other than for cause, or by Mr. Petersen for good
reason, or by his death or disability, the account will be deemed continued
for the remainder of the term of employment (but in no event less than six
months nor more than a year), interest will be credited on a proportional
basis for the calendar year during which the continuation ends and the
balance in the account will be paid to Mr. Petersen or his beneficiaries in a
lump sum.
Compensation Committee Interlocks and Insider Participation
During the year ended May 31, 1998 the following directors and former
directors of CFC served as members on the Executive Committee of the
Board of Directors (which functions as the Board's compensation
committee):
Benson Ham (Secretary-Treasurer of CFC)
George W. Kline
Paul J. Liess (President of CFC)
Robert J. Occhi
R.B. Sloan
Robert Stroup
Ed Wixson (Vice President of CFC)
Other than those mentioned above, there were no compensation committee
interlocks or insider participation related to executive compensation.
Item 12. Security Ownership of Certain Beneficial Owners and
Management.
Inapplicable.
Item 13. Certain Relationships and Related Transactions.
(a), (b) and (c) At May 31, 1998, CFC had commitments for long- and
intermediate-term loans aggregating $1,159 million and $43 million,
respectively, and committed lines of credit aggregating $317 million, to
member systems, excluding NCSC, RTFC and GFC, of which executive
officers or directors of CFC are members, employees, officers or directors.
At May 31, 1998, $771 million and $12 million of advances were
outstanding with respect to such long- and intermediate-term loans,
respectively, and $28 million was outstanding under such lines of credit. At
May 31, 1998, CFC had guaranteed $350 million of contractual obligations
of such members. CFC had outstanding guarantees of certain contractual
obligations in the amount of $547 million at May 31, 1998 on behalf of
NCSC. At May 31, 1998, advances outstanding with respect to such loans
were $73 million for NCSC. Such loans and guarantees were made in the
ordinary course of CFC's business on the same terms, including interest rates
and collateral, as those prevailing at the time for comparable transaction with
other members and did not involve more than normal risk of uncollectibility
or present other unfavorable features. It is anticipated that, consistent with
its loan and guarantee policies in effect from time to time, additional loans
and guarantees will be made by CFC to member systems and trade and
service organizations of which officers or directors of CFC are members,
employees, officers or directors. In light of its cooperative nature, pursuant
to which CFC was established for the very purpose of extending financing to
its members (from whose ranks its directors must be drawn), CFC is of the
view that no purpose would be served by including detailed information with
respect to specific loans and guarantees to members with which any of its
directors are affiliated.
(d) Inapplicable.
47
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form
8-K.
(a) Documents filed as a part of this report.
1. Financial statements
Page
Report of Independent Public Accountants 52
Combined Balance Sheets 53
Combined Statements of Income, Expenses and Net Margins 55
Combined Statements of Changes in Members' Equity 56
Combined Statements of Cash Flows 57
Notes to Combined Financial Statements 58
2. Financial statement schedules
Page
Note 13 to Combined Financial Statements "Combined
Quarterly Financial Results" 80
All other schedules are omitted because they are not required or inapplicable
or the information is included in the financial statements or notes thereto.
3. Exhibits
3.1 - Articles of Incorporation. Incorporated by reference to
Exhibit 3.1 to Registration Statement No. 2-46018, filed
October 12, 1972.
3.4 - Amendments to Bylaws as approved by CFC's Board of
Directors and members on February 28, 1995, and a copy of
the Bylaws as amended. Incorporated by reference to Exhibit
3.4 from CFC's Form 10-K filed August 29, 1995.
4.1 - Form of Capital Term Certificate. Incorporated by reference
to Exhibit 4.3 Registration Statement No. 2-46018 filed
October 12, 1972.
4.2 - Indenture dated as of February 15, 1994, between the
Registrant and First Bank National Association, trustee.
Incorporated by reference to Exhibit 4.3 from the report
on Form 8-K filed by CFC on June 14, 1994.
4.3 - Revolving Credit Agreements dated February 28, 1995.
Incorporated by reference to Exhibit 4.3 from CFC's
quarterly report on Form 10-Q filed April 3, 1995.
4.4 - The first amendment to the February 28, 1995 revolving
credit agreements dated February 27, 1996. Incorporated
by reference to Exhibit 4.4 from CFC's Annual Report on
Form 10-K filed August 27, 1996.
4.5 - Revolving Credit Agreement dated April 30, 1996.
Incorporated by reference to Exhibit 4.5 from CFC's
Annual Report on Form 10-K filed August 27, 1996.
- Registrant agrees to furnish to the Commission a copy of
all other instruments defining the rights of holders of
its long-term debt upon request.
4.6 - Amendment to the Revolving Credit Agreement dated as if
November 30, 1997 amending and restating the agreement
dated as of February 28, 1995 and amended and restated as
of November 26, 1996. Incorporated by reference to Exhibit
4.6 to CFC's Quarterly Report on Form 10-Q filed January 14,
1998.
Management Contracts and Compensatory Plans and
Arrangements.
10.1 - Plan Document for CFC deferred compensation program.
Incorporated by reference to Exhibit 10 to Registration
Statement No. 2-70355, filed December 23, 1980.
10.2 - Employment Contract between CFC and Sheldon C. Petersen,
dated as of March 1, 1996. Incorporated by reference to
Exhibit 10.2 to CFC's Form 10-K filed August 27, 1996.
10.3 - Supplemental Benefit Agreement between RTFC and Sheldon C.
Petersen, dated as of March 1, 1996. Incorporated by
reference to Exhibit 10.3 to CFC's Form 10-K filed August
27, 1996.
12 - Computations of ratio of margins to fixed charges.
23 - Consent of Arthur Andersen LLP.
27 - Financial Data Schedules.
48
(b) Reports on Form 8-K.
Item 7 on April 3, 1998 - Filing of an amendment to the Agency
Agreement relating to the distribution of the company's
Medium-Term Notes, Series C, within the United States.
Item 7 on May 27, 1998 - Filing of Underwriting agreement for 6.125%
Collateral Trust Bonds, Due 2005.
49
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in
the County of Fairfax, Commonwealth of Virginia, on the 31st day of
August, 1998.
NATIONAL RURAL UTILITIES COOPERATIVE
FINANCE CORPORATION
By: /s/ SHELDON C. PETERSEN
Sheldon C. Petersen
Governor and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf
of the registrant and in the capacities and on the date indicated.
Signature Title Date
/s/ SHELDON C. PETERSEN Governor and Chief Executive
Sheldon C. Petersen Officer
/s/ STEVEN L. LILLY Senior Vice President and
Steven L. Lilly Chief Financial Officer
/s/ STEVEN L. SLEPIAN Controller (Principal
Steven L. Slepian Accounting Officer)
/s/ PAUL J. LIESS President and Director
Paul J. Liess
/s/ ELDWIN WIXSON Vice President and Director
Eldwin Wixson
/s/ BENSON HAM Secretary-Treasurer and
Benson Ham Director --August 31, 1998
/s/ JAMES O. BAKER Director
James O. Baker
/s/ GLENN ENGLISH Director
Glenn English
/s/ ALDEN J. FLAKOLL Director
Alden J. Flakoll
/s/ WADE R. HENSEL Director
Wade R. Hensel
50
Signature Title Date
/s/ GEORGE W. KLINE Director
George W. Kline
/s/ KENNETH KRUEGER Director
Kenneth Krueger
/s/ STEPHEN R. LOUDER Director
Stephen R. Louder
/s/ EUGENE MEIER Director
Eugene Meier
/s/ R. LAYNE MORRILL Director
R. Layne Morrill --August 31, 1998
/s/ ROBERT J. OCCHI Director
Robert J. Occhi
/s/ CLIFTON M. PIGOTT Director
Clifton M. Pigott
/s/ TIMOTHY REEVES Director
Timothy Reeves
/s/ BRIAN D. SCHLAGEL Director
Brian D. Schlagel
/s/ R. B. SLOAN, JR. Director
R. B. Sloan, Jr.
/s/ THOMAS W. STEVENSON Director
Thomas W. Stevenson
/s/ CLIFFORD G. STEWART Director
Clifford G. Stewart
/s/ ROBERT STROUP Director
Robert Stroup
/s/ ROBERT C. WADE Director
Robert C. Wade
/s/ ROBERT O. WILLIAMS Director
Robert O. Williams
51
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE BOARD OF DIRECTORS
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION:
We have audited the accompanying combined balance sheets of National
Rural Utilities Cooperative Finance Corporation (a not-for-profit
corporation under the District of Columbia Cooperative Association Act)
and other related entities ("the Companies") as discussed in Note 1 as of
May 31, 1998 and 1997, and the related combined statements of income,
expenses and net margins, changes in members' equity and cash flows for the
three years then ended. These financial statements are the responsibility of
the Companies' management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the combined financial position of National Rural
Utilities Cooperative Finance Corporation and other related entities as of
May 31, 1998 and 1997, and the results of their operations and their cash
flows for the years then ended in conformity with generally accepted
accounting principles.
ARTHUR ANDERSEN LLP
Washington, D. C.
July 14, 1998
52
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED BALANCE SHEETS
(Dollar Amounts In Thousands)
May 31, 1998 and 1997
ASSETS
1998 1997
CASH AND CASH EQUIVALENTS $ 65,274 $ 50,011
DEBT SERVICE INVESTMENTS 22,969 77,219
LOANS TO MEMBERS, net 10,329,345 8,678,196
RECEIVABLES 112,317 101,613
FIXED ASSETS, net 25,062 33,208
DEBT SERVICE RESERVE FUNDS 103,489 103,489
OTHER ASSETS 24,432 13,758
$10,682,888 $9,057,494
The accompanying notes are an integral part of these combined
financial statements.
53
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED BALANCE SHEETS
(Dollar Amounts In Thousands)
May 31, 1998 and 1997
LIABILITIES AND MEMBERS' EQUITY
1998 1997
NOTES PAYABLE, due within one year $ 3,848,229 $ 3,507,074
ACCOUNTS PAYABLE 26,750 23,200
ACCRUED INTEREST PAYABLE 68,497 46,924
LONG-TERM DEBT 5,024,621 3,864,887
OTHER LIABILITIES 6,347 6,329
QUARTERLY INCOME CAPITAL SECURITIES 200,000 125,000
COMMITMENTS, GUARANTEES AND CONTINGENCIES
MEMBERS' SUBORDINATED CERTIFICATES:
Membership Subordinated Certificates 644,817 645,449
Loan and Guarantee Subordinated Certificates 584,349 567,037
Total Members' Subordinated Certificates 1,229,166 1,212,486
MEMBERS' EQUITY 279,278 271,594
Total Members' Subordinated Certificates
and Members' Equity 1,508,444 1,484,080
$10,682,888 $9,057,494
The accompanying notes are an integral part of these combined
financial statements.
54
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF INCOME, EXPENSES AND NET MARGINS
(Dollar Amounts In Thousands)
For the Years Ended May 31, 1998, 1997 and 1996
1998 1997 1996
OPERATING INCOME-Interest on loans to members $637,573 $564,439 $505,073
Less: Cost of funds 540,535 475,729 426,079
Gross operating margin 97,038 88,710 78,994
EXPENSES:
General, administrative and loan processing 23,600 22,019 19,686
Provision for loan losses 19,027 15,161 12,451
Total expenses 42,627 37,180 32,137
Operating margin 54,411 51,530 46,857
NONOPERATING INCOME 2,611 3,206 3,764
GAIN ON SALE OF LAND 5,194 - -
NET MARGINS BEFORE EXTRAORDINARY LOSS 62,216 54,736 50,621
EXTRAORDINARY LOSS - - (1,580)
NET MARGINS $ 62,216 $ 54,736 $ 49,041
The accompanying notes are an integral part of these combined
financial statements.
55
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF CHANGES IN MEMBERS' EQUITY
(Dollar Amounts In Thousands)
For the Years Ended May 31, 1998, 1997 and 1996
Patronage
Capital Allocated
General
Education Unallocated Reserve
Total Memberships Fund Margins Fund Other
Balance as of May 31, 1995 $270,221 $1,383 $375 $2,289 $498 $265,676
Retirement of Patronage Capital (48,313) - - - (152) (48,161)
Net Margins - Allocated 49,041 - 101 - 155 48,785
Other (1,308) 41 - - - (1,349)
Balance as of May 31, 1996 269,641 1,424 476 2,289 501 264,951
Retirement of Patronage Capital (50,962) - - - (135) (50,827)
Net Margins - Allocated 54,736 - 120 - 138 54,478
Other (1,821) 46 - - - (1,867)
Balance as of May 31, 1997 271,594 1,470 596 2,289 504 266,735
Retirement of Patronage Capital (52,661) - - - (123) (52,538)
Net Margins - Allocated 62,216 - 404 - 119 61,693
Other (1,871) 21 (324) - - (1,568)
Balance as of May 31, 1998 $279,278 $1,491 $676 $2,289 $500 $274,322
The accompanying notes are an integral part of these combined
financial statements.
56
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMBINED STATEMENTS OF CASH FLOWS
(Dollar Amounts In Thousands)
For the Years Ended May 31, 1998, 1997 and 1996
1998 1997 1996
CASH FLOWS FROM OPERATING ACTIVITIES:
Net margins $ 62,216 $ 54,736 $ 49,041
Add (deduct):
Provision for loan and guarantee losses 19,027 15,161 12,451
Depreciation 1,274 1,253 1,247
Amortization of issuance costs and deferred charges 2,188 1,912 2,627
Amortization of deferred income (1,467) (10,702) (9,942)
Gain on sale of land (5,194) - -
Add (deduct) changes in accrual accounts:
Receivables (12,397) (10,000) 7,987
Accounts payable 4,122 8,520 (114)
Accrued interest payable 21,573 6,105 1,476
Other (13,930) (13,737) (5,188)
Net cash flows provided by operating activities 77,412 53,248 59,585
CASH FLOWS FROM INVESTING ACTIVITIES:
Advances made on loans (5,594,408) (3,799,004) (3,774,427)
Principal collected on loans 3,924,232 2,833,917 2,780,830
Change in fixed assets (1,423) (885) 1,984
Proceeds from sale of land 13,489 - -
Change in certificates of deposit - 25,000 5,000
Net cash flows used in investing activities (1,658,110) (940,972) (986,613)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of notes payable, net 258,531 705,804 658,999
Debt service investments, net 54,250 (36,312) (8,167)
Proceeds from issuance of long-term debt 1,819,265 890,524 794,836
Payments for retirement of long-term debt (574,455) (730,116) (446,521)
Proceeds from issuance of Quarterly Income Capital Securities 75,000 125,000 -
Proceeds from issuance of Members' Subordinated Certificates 34,040 29,026 18,457
Payments for retirement of Members' Subordinated Certificates (15,718) (32,210) (39,365)
Payments for retirement of Patronage Capital (54,952) (45,349) (46,152)
Net cash flows provided by financing activities 1,595,961 906,367 932,087
NET INCREASE IN CASH 15,263 18,643 5,059
BEGINNING CASH 50,011 31,368 26,309
ENDING CASH $ 65,274 $ 50,011 $ 31,368
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during year for interest $ 525,881 $ 476,914 $ 427,846
The accompanying notes are an integral part of these combined
financial statements.
57
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS
As of May 31, 1998, 1997 and 1996
(1) General Information and Accounting Policies
(a) General Information
National Rural Utilities Cooperative Finance Corporation (the
"Company" or "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 source of financing to supplement the loan programs of the Rural
Utilities Service ("RUS") of the United States Department of Agriculture.
CFC 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. Most CFC
long-term loans to Utility Members are made in conjunction with
concurrent loans from RUS and are secured equally and ratably with
RUS's loans by a single mortgage. CFC also provides guarantees for tax-
exempt financings of pollution control facilities and other properties
constructed or acquired by its members and, in addition, provides
guarantees of taxable debt in connection with certain lease and other
transactions of its members. CFC is exempt from payment of Federal
income taxes under Section 501(c)(4) of the Internal Revenue Code.
CFC's 1,052 members as of May 31, 1998, included 903 Utility
Members, virtually all of which are consumer-owned cooperatives, 75
service members and 74 associate members. The Utility Members
included 835 distribution systems and 68 generation and transmission
("power supply") systems operating in 46 states and U.S. territories.
Rural Telephone Finance Cooperative ("RTFC") was incorporated as a
private cooperative association in the state of South Dakota in September
1987. RTFC is a controlled affiliate of CFC and was created for the
purpose of providing and/or arranging financing for its rural
telecommunication members and affiliates. RTFC's bylaws require that
the majority of RTFC's Board of Directors be elected from individuals
designated by CFC. CFC is the sole source of external funding for
RTFC. As of May 31, 1998, RTFC had 491 members. RTFC is a
taxable entity under Subchapter T of the Internal Revenue Code and
accordingly takes 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 a source of funds for its members to refinance their RUS
guaranteed debt previously held by the Federal Financing Bank. Under
this program, notes are purchased from the FFB and placed in a trust and
beneficial certificates in the trust are then sold to investors. The notes
held by the trust are guaranteed by the RUS. All trust certificates held by
GFC were transferred to GFC by CFC. CFC is the sole source of
external funding for GFC. GFC had four members other than CFC at
May 31, 1998. GFC is a taxable entity under Subchapter T of the
Internal Revenue Code and accordingly takes deductions for allocations
of net margins to its patrons.
(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 both
RTFC and GFC. CFC exercises control over RTFC and GFC through
majority representation on their Boards of Directors. CFC manages the
affairs of RTFC through a long-term management agreement. CFC
services the loans for GFC for which it collects a servicing fee.
As of May 31, 1998, CFC was authorized to lend RTFC up to a total of
$4.5 billion to fund loans to its members and their affiliates. As of the
same date, RTFC had outstanding loans and unadvanced loan
commitments totaling $2,233.0 million. RTFC's net margins are allocated
to RTFC borrowers, its patrons.
58
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
Summary financial information relating to RTFC included in the
combined financial statements is presented below:
As of May 31: 1998 1997
(Dollar Amounts In Thousands)
Outstanding loans to members and their affiliates $1,574,900 $1,099,163
Total assets 1,695,231 1,197,753
Notes payable to CFC 1,563,094 1,089,336
Total liabilities 1,581,268 1,100,497
Members' Equity (1) and Subordinated Certificates 113,963 97,256
For the years ended May 31: 1998 1997 1996
(Dollar Amounts In Thousands)
Operating income $ 90,663 $ 71,891 $ 64,674
Net margins (1) 3,135 9,239 8,543
(1) The transfer of RTFC equity is governed by the South Dakota
Cooperative Association Act which provides that net margins
shall be distributed and paid to patrons. However, reserves may
be created and credited to patrons in proportion to total
patronage. CFC has been the sole funding source for RTFC's
loans to its members. As CFC is not a borrower of RTFC and is
not expected to be in the foreseeable future, RTFC's net margins
would not be available to CFC in the form of patronage capital.
As of May 31, 1998, CFC had loaned GFC $133.2 million to fund the
purchase, from CFC, of certificates evidencing interests in trusts holding
RUS guaranteed notes of members. Summary financial information
relating to GFC included in the combined financial statements is presented
below:
As of May 31: 1998 1997
(Dollar Amounts In Thousands)
Outstanding loans to members $133,195 $135,220
Total assets 135,761 141,353
Notes payable to CFC 133,195 136,960
Total liabilities 135,430 139,934
Members' Equity (1) 331 1,419
For the years ended May 31: 1998 1997 1996
(Dollar Amounts In Thousands)
Operating income $8,467 $20,673 $28,064
Net margins (1) 798 1,762 2,701
(1) The transfer of GFC equity is governed by the South Dakota
Cooperative Association Act which provides that net margins
shall be distributed and paid to patrons. However, reserves may
be created and credited to patrons in proportion to total
patronage. CFC has been the sole funding source for GFC's loans
to its members. As CFC is not a borrower of GFC and is not
expected to be in the foreseeable future, GFC's net margins would
not be available to CFC in the form of patronage capital.
Unless stated otherwise, references to CFC relate to CFC, RTFC and
GFC on a combined basis.
(c) Amortization of Bond Discount and Bond Issuance Costs
Bond discount and bond issuance costs are deferred and amortized as
interest expense using the effective interest method over the life of each
bond issue.
59
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
(d) Nonperforming Loans
It is CFC's policy to classify a loan as nonperforming when it meets any of
the following criteria:
(i) Interest or principal payments are contractually past due 90 days
or more,
(ii) As a result of court proceedings, repayment in accordance with
the original terms is not anticipated, or
(iii) For other reasons, timely repayment of principal or interest is not
expected.
(e) Allowance for Loan Losses
CFC maintains an allowance for loan losses at a level believed to be
adequate in relation to the credit quality and size of its loans and
guarantees outstanding. According to the terms of CFC's guarantees, any
amount advanced by CFC under its guarantee of a members' obligation is
treated as a demand loan. It is CFC's policy to review periodically its
loans and guarantees and to make adjustments to the allowance as
necessary. 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 years
ended May 31:
(Dollar Amounts In Thousands) 1998 1997 1996
Balance at beginning of year $233,208 $218,047 $205,596
Provision for loan losses 19,027 15,161 12,451
Charge-offs (2,104) - -
Balance at end of year $250,131 $233,208 $218,047
(f) Fixed Assets
Buildings, furniture and fixtures and related equipment are stated at cost
less accumulated depreciation and amortization of $9.9 million and $9.1
million as of May 31, 1998 and 1997, respectively. Depreciation and
amortization expenses ($1.3 million, $1.3 million and $1.2 million in fiscal
years 1998, 1997 and 1996, respectively) are computed primarily on the
straight-line method over estimated useful lives ranging from 2 to 40
years.
(g) Financial Instruments with Off-Balance Sheet Risk
In the normal course of business, CFC is a party to financial instruments
with off-balance sheet risk both to meet the financing needs of its member
borrowers and to reduce its own exposure to fluctuations in interest rates.
These financial instruments include commitments to extend credit,
standby letters of credit, guarantees of members' obligations and interest
rate exchange agreements. These instruments may involve, to varying
degrees, elements of credit and interest rate risk in excess of the amounts
recognized in the combined balance sheets.
(h) Accounting by Creditors for Impairment of a Loan
CFC calculates impairment on loans receivable by comparing the present
value of the future cash flows associated with the loan against CFC's
investment in the loan; loss reserves are provided based on the calculated
impairment.
(i) Accounting for Certain Investments in Debt and Equity
Securities
Debt service investments are recorded at amortized cost, since it is the
Company's intent and ability to hold all of these investments to maturity.
60
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
(j) Derivative Financial Instruments
CFC is neither a dealer nor a trader in derivative financial instruments.
CFC uses interest rate exchange agreements to manage its interest rate
risk. CFC accounts for these agreements on an accrual basis. CFC does
not value the interest rate exchange agreements on its balance sheet, but
values the underlying hedged debt at cost. CFC does not recognize a
gain or loss on these agreements, but includes the difference between the
interest rate paid and interest rate received in the overall cost of funding.
No agreement to which CFC was a party has been terminated early. In
the event that an agreement was to be terminated early, CFC would
record the fee paid or received due to the early termination as part of the
overall cost of funding.
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities". The statement
establishes accounting and reporting standards for derivative instruments
and for hedging activities. It requires that all derivatives be recognized as
an asset or liability in the statement of financial position and recorded at
fair value. The statement will be effective for all fiscal years beginning
after June 15, 1999. CFC will be required to implement this statement as
of June 1, 2000. CFC has not yet determined the impact of implementing
this statement on its overall financial position.
(k) Comprehensive Income
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income". Comprehensive income is defined as the
change in equity of a business enterprise during a period from
transactions and other events and circumstances from non-owner
sources. It includes all changes in equity during a period except those
resulting from investment by owners or distribution to owners. This
statement requires that registrants display all components of
comprehensive income on the income statement or in a separate
statement of comprehensive income and to display all components of
other comprehensive income in the statement of changes in equity.
This statement is effective for all fiscal years beginning after
December 15, 1997. CFC is required to implement this statement for
its fiscal year 1999, which begins June 1, 1998. CFC does not
anticipate that the implementation of this statement will have a
material impact on its financial statements.
(l) Segment Information
In June 1997, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 131, "Disclosure
about Segments of an Enterprise and Related Information." This
statement requires the disclosure of information on operating
segments of an enterprise and related information about products and
services, geographic areas and major customers. Segments should be
identified based on the same factors used by management in the
allocation of resources. This statement is effective for fiscal years
beginning after December 15, 1997. CFC is required to implement
this statement for its fiscal year 1999, which begins June 1, 1998.
CFC does not anticipate that the implementation of this statement will
have a material impact on its financial statements.
(m) Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates
and assumptions that affect the assets and liabilities and the revenue and
expenses reported in the financial statements, as well as amounts included
in the notes thereto, including discussion and disclosure of contingent
liabilities. While the Company uses its best estimates and judgments
based on the known facts at the date of the financial statements, actual
results could differ from these estimates as future events occur.
CFC does not believe it is vulnerable to the risk of a near-term severe
impact as a result of any concentrations of its activities.
61
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
(n) Membership Fees
Members are charged a one-time membership fee based on member class.
CFC distribution system members (Class A), power supply system
members (Class B), national associations of cooperatives (Class D) and
associate members (Class E) pay a $1,000 membership fee. CFC service
organization members (Class C) pay a $200 membership fee. RTFC
voting members pay a $1,000 membership fee and non-voting members
pay a $100 membership fee. All GFC members pay a $1,000 membership
fee. Membership fees are accounted for as members' equity.
(o) Reclassifications
Certain reclassifications of prior year amounts have been made to
conform with the fiscal year 1998 presentation.
62
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
(2) Loans and Commitments
Loans to members bear interest at rates determined from time to time by
the Board of Directors after considering CFC's cost of funds, operating
expenses, provision for loan and guarantee losses and the maintenance of
reasonable margin levels. In keeping with its not-for-profit, cooperative
character, CFC's policy is to set interest rates at the lowest levels it
considers to be consistent with sound financial management. Loans
outstanding to members, weighted average interest rates thereon and
unadvanced commitments by loan type are summarized as follows as of
May 31:
(Dollar Amounts In Thousands) 1998 1997
Weighted Weighted
Average Average
Loans Interest Unadvanced Loans Interest Unadvanced
Outstanding Rates Commitments(A) Outstanding Rates Commitments(A)
Long-term fixed rate secured loans (B):
Distribution Systems $3,857,645 6.95% $ 101,083 $2,503,890 7.20% $ 46,657
Power Supply Systems 349,038 7.43% 10,787 239,381 7.54% 1,214
Telecommunication Organizations 222,733 8.05% - 148,566 8.53% -
Service Organizations 76,102 8.63% 5,407 82,634 8.62% 3,170
Associate Members 6,844 7.29% 4,907 1,512 10.25% -
Total long-term fixed rate secured loans 4,512,362 7.07% 122,184 2,975,983 7.33% 51,041
Long-term variable rate secured loans (C):
Distribution Systems 2,693,266 6.55% 2,622,181 3,209,472 6.55% 1,185,303
Power Supply Systems 409,039 6.55% 878,282 281,368 6.55% 798,984
Telecommunication Organizations 1,131,561 6.65% 276,104 875,135 6.65% 237,170
Service Organizations 64,538 6.55% 113,190 54,802 6.55% 86,229
Associate Members 42,972 6.31% 11,705 48,186 6.29% 13,666
Total long-term variable rate
secured loans 4,341,376 6.57% 3,901,462 4,468,963 6.57% 2,321,352
Refinancing variable rate loans
guaranteed by RUS:
Power Supply Systems 133,195 6.36% - 137,984 6.49% -
Intermediate-term secured loans:
Distribution Systems 4,479 6.70% 20,239 12,530 6.70% 2,609
Power Supply Systems 134,574 7.49% 193,894 198,985 6.70% 196,385
Telecommunication Organizations 86 7.25% - - - -
Service Organizations 12,149 6.70% 9,379 14,592 6.70% 2,884
Total intermediate-term secured loans 151,288 7.39% 223,512 226,107 6.70% 201,878
Intermediate-term unsecured loans:
Distribution Systems 114,747 6.70% 63,942 72,860 6.70% 37,687
Power Supply Systems 83,374 6.70% 124,581 43,129 6.70% 124,405
Telecommunication Organizations 15,495 7.25% 15,457 13,683 7.25% 9,387
Total intermediate-term unsecured loans 213,616 6.74% 203,980 129,672 6.76% 171,479
Line of credit loans (D):
Distribution Systems 587,193 6.70% 2,915,512 473,639 6.70% 2,436,785
Power Supply Systems 48,991 6.70% 955,958 25,051 6.70% 913,371
Telecommunication Organizations 205,026 7.25% 371,457 61,779 7.25% 478,807
Service Organizations 38,979 6.70% 130,687 27,420 6.70% 93,346
Associate Members 13,832 6.70% 20,492 13,417 6.70% 19,308
Total line of credit loans 894,021 6.83% 4,394,106 601,306 6.76% 3,941,617
Nonperforming loans (E):
Distribution Systems - - - 1,705 7.21% -
Power Supply Systems 2,159 6.55% - 7,723 6.64% -
Associate Members 1,921 6.25% - - - -
Total nonperforming loans 4,080 6.41% - 9,428 6.75% -
Restructured loans (E):
Power Supply Systems 329,538 7.17% - 361,961 8.32% -
Total restructured loans 329,538 7.17% - 361,961 8.32% -
Total loans 10,579,476 6.70% 8,845,244 8,911,404 6.81% 6,687,367
Less: Allowance for Loan Losses 250,131 - 233,208 -
Net loans $10,329,345 $8,845,244 $8,678,196 $6,687,367
63
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
(A) 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. Long-term unadvanced commitments that do not have an
interest rate associated with the commitment have been listed under
the variable rate. Rates, fixed or variable, are set at the time of each
advance.
(B) Generally, long-term fixed rate loans provide for a fixed interest rate
for terms of one to 35 years. Upon expiration of the interest rate
term, the borrower may select another fixed rate term of one to 35
years (but not beyond maturity of the loan) or a variable rate. The
borrower may select either option or may repay to CFC the principal
then outstanding together with interest due thereon and other sums, if
required. Includes $121.6 million and $38.4 million of unsecured loans
at May 31, 1998 and 1997, respectively.
(C) Includes $53.3 million and $112.4 million of unsecured loans at May
31, 1998 and 1997, respectively.
(D) Includes $81.4 million and $99.1 million of secured loans at May 31,
1998 and 1997, respectively.
(E) The rates on nonperforming and restructured loans are the weighted
average of the stated rates on such loans as of the dates shown and do
not necessarily represent the interest recognized by CFC from such
loans.
Loans outstanding, by State or U.S. territory, are summarized below:
(Dollar Amounts In Thousands)
May 31, May 31,
State 1998 1997 State 1998 1997
Alabama $ 153,062 $ 136,644 Nebraska $ 14,041 $ 13,791
Alaska 137,182 107,292 Nevada 63,285 28,446
Arizona 84,997 88,463 New Hampshire 260,737 255,929
Arkansas 300,797 244,033 New Jersey 6,146 6,122
California 33,902 16,235 New Mexico 88,299 91,745
Colorado 354,241 319,516 New York 13,655 11,277
Connecticut 3,000 - North Carolina 391,106 303,507
Delaware 16,196 16,554 North Dakota 49,479 53,870
District of Columbia 125,007 112,593 Ohio 151,578 112,137
Florida 421,289 340,709 Oklahoma 294,963 260,785
Georgia 815,823 723,935 Oregon 227,391 169,983
Idaho 96,038 79,020 Pennsylvania 103,531 99,150
Illinois 452,783 436,197 South Carolina 317,325 307,033
Indiana 145,587 123,415 South Dakota 158,485 112,559
Iowa 266,063 228,042 Tennessee 93,169 84,430
Kansas 293,524 227,768 Texas 1,331,782 1,024,611
Kentucky 208,142 192,815 Utah 391,660 428,217
Louisiana 181,696 162,067 Vermont 55,543 61,762
Maine 47,986 51,592 Virgin Islands 213,615 51,885
Maryland 84,696 86,396 Virginia 228,300 179,307
Michigan 267,598 99,771 Washington 83,996 82,616
Minnesota 456,134 382,531 West Virginia 1,272 1,108
Mississippi 246,000 225,255 Wisconsin 245,183 196,843
Missouri 318,770 295,275 Wyoming 117,963 119,800
Montana 166,459 158,372 Total $10,579,476 $8,911,404
64
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
CFC's members are widely dispersed throughout the United States and its
territories, including 46 states, the District of Columbia, Guam, Samoa and
the U.S. Virgin Islands. At May 31, 1998, 1997 and 1996, no state or
territory had over 11.7%, 10.6% and 9.9%, respectively, of total loans
and guarantees outstanding.
In addition to the geographic diversity of the portfolio, CFC limits its
exposure to any one borrower. The majority of the largest single
exposures are concentrated in the power supply systems due to their large
plant and equipment requirements. At May 31, 1998, the total exposure
outstanding to any one borrower did not exceed 6% of total loans
(excluding loans guaranteed by RUS) and guarantees outstanding. At May
31, 1998, CFC had $3,186.7 million in loans outstanding, excluding loans
guaranteed by RUS, and $1,757.0 million in guarantees outstanding, to its
largest 40 borrowers, representing 31% of total loans outstanding and
85% of total guarantees outstanding. Credit exposure to the largest 40
borrowers represented 39% of total credit exposure at May 31, 1998,
compared to 42% at May 31, 1997. CFC's ten largest credit exposures
represented 19% and 22% of total exposure at May 31, 1998 and 1997,
respectively.
Weighted average interest rates earned (recognized in the case of
nonperforming and restructured loans) on all loans outstanding are
summarized below:
For the
Years Ended May 31,
1998 1997 1996
Long-term fixed rate 7.12% 7.65% 7.92%
Long-term variable rate 6.53% 6.25% 6.30%
Telecommunication organizations 7.05% 6.73% 6.86%
Refinancing loans guaranteed by RUS 6.32% 6.36% 6.75%
Intermediate-term 7.08% 7.08% 6.57%
Short-term 6.74% 6.40% 6.49%
Associate members 6.65% 6.42% 6.46%
Nonperforming 0.00% 0.00% 0.25%
Restructured 0.00% 0.56% 1.49%
All loans 6.60% 6.58% 6.77%
Long-term fixed rate loans outstanding at May 31, 1998 which will be
subject to adjustment of their interest rates during the next five fiscal
years are summarized as follows (due to principal repayments, amounts
subject to interest rate adjustment may be lower at the actual time of
interest rate adjustment):
Weighted
(Dollar Amounts In Thousands) Average
Interest Amounts
Rate Outstanding
1999 7.32% $ 329,971
2000 6.67% 174,133
2001 6.89% 220,542
2002 6.70% 288,350
2003 6.64% 265,937
$1,278,933
During the first quarter of calendar year 1998, long-term fixed rate loans
totaling $47.6 million had their interest rates adjusted. These loans will
be eligible to readjust their interest rates again during the first quarter of
calendar year 1999 to the lowest long-term fixed rate offered during 1998
for the term selected. At January 1 and May 31, 1998, the standard long-
term fixed rate was 6.95% and 6.85%, respectively.
On most long-term secured loans, level quarterly payments are required
with respect to principal and interest in amounts sufficient to repay the
loan principal, generally over a period ending approximately 35 years
from the date of the secured promissory note. Fiscal year 1999
repayments of principal on long-term loans outstanding are expected to
be a relatively minor amount of such outstanding loans.
65
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
CFC evaluates each borrower's creditworthiness on a case-by-case basis.
It is generally CFC's policy to require collateral for long-term and certain
intermediate-term loans. Such collateral usually consists of a first
mortgage lien on the borrower's total system, including plant and
equipment, and a pledge of future revenues. The loan and security
documents also contain various provisions with respect to the mortgaging
of the borrower's property, the maintenance of certain earnings and debt
service coverage ratios, maintenance of adequate insurance coverage and
certain other restrictive covenants.
Under common mortgages securing long-term CFC loans to distribution
system members, RUS has the sole right to 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.
As of May 31, 1998 and 1997, mortgage notes representing
approximately $1,930.9 million and $1,294.5 million, respectively, of
outstanding long-term loans to members were pledged as collateral to
secure CFC's Collateral Trust Bonds.
CFC has received no guarantee of its loans from RUS; however,
"Refinancing variable rate loans guaranteed by RUS" represents loans
made by CFC and transferred to its affiliate GFC to fund the prepayment
of members' Federal Financing Bank debt, effected through grantor trusts
which each hold a note from the member, the repayment of which has
been guaranteed by RUS. Each trust issues beneficial certificates which
represent an undivided interest in the trust assets. GFC, as holder of the
Trust Certificates, is financing these loans from variable rate funds
provided by CFC until fixed rate funding is obtained through the public
markets.
CFC sets variable interest rates monthly on outstanding short- and
intermediate-term loans. On notification to borrowers, CFC may adjust
the interest rate semi-monthly. Under CFC policy, the maximum interest
rate which may be charged on short-term loans is the prevailing bank
prime rate plus 1% per annum; on intermediate-term loans, the prevailing
bank prime rate plus 1.5% per annum; and on RTFC short-term loans,
the prevailing bank prime rate plus 3% per annum.
At May 31, 1998 and 1997, nonperforming loans in the amount of $4.1
million and $9.4 million, respectively, were on a nonaccrual basis with
respect to recognition of interest income. The effect of not accruing
interest on nonperforming loans was a decrease in interest income of $0.4
million, $1.2 million and $2.5 million for the years ended May 31, 1998,
1997 and 1996, respectively. Income recognized on these loans totaled
$0.0 million, $0.0 million and $0.1 million for the years ended May 31,
1998, 1997 and 1996, respectively.
At May 31, 1998 and 1997, the total amount of restructured debt was
$329.5 million and $362.0 million, respectively. CFC elected to apply all
principal and interest payments received on restructured debt for the last
three fiscal years against principal. The interest income that would have
been recorded under the original terms of the debt, assuming the debt had
been outstanding for the period, was $24.5 million, $21.1 million and
$15.0 million, for the years ended May 31, 1998, 1997 and 1996,
respectively. The interest income actually recorded for restructured debt
for the years ended May 31, 1998, 1997 and 1996 was $0.0 million, $1.8
million and $3.1 million, respectively.
(3) Members' Subordinated Certificates
Membership Subordinated Certificates
To join CFC and to establish eligibility to borrow, CFC members (other
than associate members and service organizations) are required to
execute agreements to subscribe to Membership Subordinated
Certificates. Such certificates are interest-bearing, unsecured,
subordinated debt of CFC. CFC is authorized to issue Membership
Subordinated Certificates without limitation as to the total principal
amount.
Generally, Membership Subordinated Certificates mature in the years
2070 through 2095 and bear interest at 5% per annum.
66
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
New members joining CFC are required to purchase Membership
Subordinated Certificates in an amount equal to 5% of each loan advance
up to a maximum amount based on their operating results. The maturity
dates and interest rates payable on such certificates vary in accordance
with applicable CFC policy.
In certain cases, the Board of Directors has approved alternative deferred
payment arrangements for purchase of Membership Subordinated
Certificates. These deferred payments are evidenced by noninterest-
bearing, unsecured notes from the member and are shown as receivables.
Loan and Guarantee Subordinated Certificates
Members obtaining long-term loans, certain intermediate-term loans or
guarantees from CFC are generally required to purchase additional Loan
or Guarantee Subordinated Certificates with each such loan or guarantee.
These certificates are unsecured, subordinated debt of CFC.
Certificates currently purchased in conjunction with loans are noninterest-
bearing and are generally repaid periodically over the life of the loan in
relation to the loan principal balance outstanding. Such certificate
purchase requirements, if any, range from 1% to 12% of the loan amount
depending on the membership classification of the borrower and the
borrower's leverage ratio, including the new loan, with CFC, for Utility
Systems.
The maturity dates and the interest rates payable on Guarantee
Subordinated Certificates purchased in conjunction with CFC's guarantee
program vary in accordance with applicable CFC policy. Members may
be required to purchase noninterest-bearing Debt Service Reserve
Subordinated Certificates in connection with CFC's guarantee of long-
term tax-exempt bonds (see Note 8). Proceeds from the sale of such
certificates are pledged by CFC to the Debt Service Reserve Fund
established in connection with the bond issue and any earnings from the
investments of the fund inure solely to the benefit of the members for
whom the bonds are issued. These certificates have varying maturities but
none is greater than the longest maturity of the guaranteed obligation.
Information with respect to Members' Subordinated Certificates at May
31, is as follows:
(Dollar Amounts In Thousands) 1998 1997
Number of subscribing members 903 907
Membership Subordinated Certificates
Certificates maturing 2020 through 2095 $ 629,044 $ 629,412
Subscribed and unissued 15,773 16,037
Total Membership Subordinated Certificates 644,817 645,449
Loan and Guarantee Subordinated Certificates
3% certificates maturing through 2040 135,428 135,540
5.74% to 13.70% certificates maturing through 2018 110,850 114,834
Noninterest-bearing certificates maturing through 2029 314,517 292,861
Subscribed and unissued 23,554 23,802
Total Loan and Guarantee Subordinated Certificates 584,349 567,037
Total Members' Subordinated Certificates $1,229,166 $1,212,486
CFC estimates the amount of Members' Subordinated Certificates that
will be repaid during the next five fiscal years will total approximately
1.25% of certificates outstanding. The weighted average interest rate
paid on all Members' Subordinated Certificates was 4.20% and 4.29% as
of May 31, 1998 and 1997, respectively. These rates do not include
$103.5 million and $103.5 million of Debt Service Reserve Subordinated
Certificates and $39.3 million and $39.8 million of subscribed but
unissued Subordinated Certificates at May 31, 1998 and 1997,
respectively.
67
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
(4) Notes Payable and Credit Arrangements
Notes payable due within one year as of May 31, and weighted average
interest rates thereon, are summarized as follows:
1998 1997
Weighted Weighted
Average Average
Amounts Interest Amounts Interest
(Dollar Amounts In Thousands) Outstanding Rates Outstanding Rates
Commercial paper, sold through dealers, net of
discounts of $22,902 and $21,529 respectively $4,363,455 5.53% $4,214,109 5.68%
Commercial paper sold by CFC directly to members, at par 1,195,600 5.57% 1,203,335 5.51%
Commercial paper sold by CFC directly to nonmembers,
at par 121,849 5.56% 74,929 5.48%
5,680,904 5.54% 5,492,373 5.64%
Bank Bid Notes 185,000 5.57% 115,000 5.60%
Long-term debt maturing within one year 327,325 5.99% 149,701 8.76%
6,193,229 5.57% 5,757,074 5.72%
Notes payable supported by revolving credit agreements,
classified as long-term debt (see Note 5) (2,345,000) 5.57% (2,250,000) 5.72%
$3,848,229 5.57% $3,507,074 5.72%
Other information with regard to notes payable due within one year at
May 31, is as follows:
(Dollar Amounts In Thousands) 1998 1997 1996
Original maturity range of notes
outstanding at year-end 1 to 268 days 1 to 255 days 1 to 270 days
Weighted average maturity of notes
outstanding at year-end 34 days 34 days 35 days
Average amount outstanding during the year $5,976,346 $5,558,201 $4,839,483
Maximum amount outstanding at any
month-end during the year $6,281,683 $5,781,905 $5,201,552
Weighted average interest rate paid for
the year, without effect of compensating
balances and commitment fees 5.71% 5.51% 5.77%
Weighted average effective interest rate
paid for the year, including effect of
compensating balances and commitment fees 5.74% 5.55% 5.83%
CFC enters short-term Bank Bid Note Agreements which are unsecured
obligations of CFC and do not require back-up bank lines for liquidity
purposes. Bank Bid Note facilities are uncommitted lines of credit for
which CFC does not pay a fee. The commitments are generally subject to
termination at the discretion of the individual banks.
As of May 31, 1998, CFC had three revolving credit agreements totaling
$5,217.5 million which are used principally to provide liquidity support
for CFC's outstanding Commercial Paper, obligations guaranteed for its
members and its standby purchase obligations.
68
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
Two of these agreements are with 51 banks, with J.P. Morgan Securities,
Inc. and The Bank of Nova Scotia as Co-Syndication Agents, and
Morgan Guaranty Trust Company of New York as Administrative Agent.
Under the five-year agreement, executed in November 1996, CFC can
borrow up to $2,345.0 million until November 26, 2001. Under the 364-
day agreement, renewed on November 25, 1997, CFC can borrow up to
$2,322.5 million until November 24, 1998. Any amounts outstanding
under these facilities will be due on the respective maturity dates.
A third revolving credit agreement for $550.0 million was executed on
November 26, 1997 with 11 banks, including The Bank of Nova Scotia
as Administrative and Syndication Agent (the "BNS facility"). This
agreement has a 364-day revolving credit period which terminates
November 25, 1998 during which CFC can borrow and such borrowings
may be converted to a 1-year term loan at the end of the revolving credit
period.
In connection with the five-year facility, CFC pays a per annum facility
fee of .090 of 1%. The per annum facility fee for both agreements with a
364-day maturity is .065 of 1% and there is no commitment fee at CFC's
current credit rating level. If CFC's long-term ratings decline, these 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 total Members' Equity and Members' Subordinated Certificates
of at least $1,356.7 million at May 31, 1998, an increase of $6.8 million
compared to the $1,349.9 million required at May 31, 1997. Each year,
the required amount of Members' Equity and Members' Subordinated
Certificates is increased by 90% of net margins not distributed to
members. CFC is also required to maintain an average fixed charge
coverage ratio over the six most recent fiscal quarters of at least 1.025
and may not retire patronage capital unless CFC has achieved a fixed
charge coverage ratio of 1.05 for the preceding fiscal year. The credit
agreements prohibit CFC from incurring senior debt (including guarantees
but excluding indebtedness incurred to fund RUS guaranteed loans) in an
amount in excess of ten times the sum of Members' Equity and
subordinated debt and restrict, with certain exceptions, the creation by
CFC of liens on its assets and contain certain other conditions to
borrowing. The agreements also prohibit CFC from pledging collateral in
excess of 150% of the principal amount of Collateral Trust Bonds
outstanding. Provided that CFC is in compliance with these financial
covenants (including that CFC has no material contingent or other liability
or material litigation that was not disclosed 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 date. As of May 31,
1998, CFC was in compliance with all covenants and conditions.
As of May 31, 1998, there were no borrowings outstanding under the
revolving credit agreements. On the basis of the five-year facility, at May
31, 1998, CFC classified $2,345.0 million of its notes payable outstanding
as long-term debt. CFC expects to maintain more than $2,345.0 million
of notes payable outstanding during the next 12 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.
69
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
(5) Long-Term Debt
The following is a summary of long-term debt as of May 31:
(Dollar Amounts In Thousands) 1998 1997
Notes payable supported by revolving
credit agreement (see Note 4) $2,345,000 $2,250,000
Medium-Term Notes:
Medium-Term Notes, sold through dealer 722,875 338,575
Medium-Term Notes, sold directly to members 59,823 276,821
Subtotal 782,698 615,396
Less: Unamortized discount 765 -
Total Medium-Term Notes 781,933 615,396
Collateral Trust Bonds:
Variable Rate Bonds, due 1999 (1) 150,000 150,000
6.45%, Bonds, due 2001 (1) 100,000 100,000
6.75%, Bonds, due 2001 (1) 100,000 100,000
6.50%, Bonds, due 2002 (1) 100,000 100,000
6.70%, Bonds, due 2002 (1) 100,000 -
5.95%, Bonds, due 2003 (1) 100,000 100,000
6.00%, Bonds, due 2004 (1) 200,000 -
6.375%, Bonds, due 2004 (1) 100,000 -
6.125%, Bonds, due 2005 (1) 200,000 -
6.65%, Bonds, due 2005 (1) 50,000 50,000
7.30%, Bonds, due 2006 (1) 100,000 100,000
6.20%, Bonds, due 2008 (1) 300,000 -
Floating Rate, Series E-2, due 2010 (2) 2,125 2,142
7.20%, Bonds, due 2015 (1) 50,000 50,000
9.00%, Series V, due 2021 (2) 150,000 150,000
7.35%, Bonds, due 2026 (1) 100,000 100,000
Subtotal 1,902,125 1,002,142
Less: Unamortized bond discount 4,437 2,651
Total Collateral Trust Bonds 1,897,688 999,491
Total Long-Term Debt $5,024,621 $3,864,887
(1) Issued under the 1994 indenture.
(2) Issued under the 1972 indenture.
The weighted average interest rate on Medium-Term Notes and
Collateral Trust Bonds was 6.45% and 6.82% as of May 31, 1998 and
1997, respectively. These rates do not include notes payable supported
by the revolving credit agreement.
The principal amount of Medium-Term Notes and Collateral Trust Bonds
maturing (including any sinking fund requirements) in each of the five
fiscal years following May 31, 1998, is as follows:
(Dollar Amounts In Thousands)
1999 (1) 327,325
2000 263,121
2001 272,102
2002 205,300
2003 628,050
Thereafter 1,311,048
$3,006,946
70
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
(1) The amount scheduled to mature in fiscal year 1999, has been
presented as long-term debt due in one year under
notes payable.
Under the 1972 Indenture for Collateral Trust Bonds, CFC is required to
maintain funds in a Debt Service Investment account equivalent to
principal and interest payments due on the bonds over the next 12
months. At May 31, 1998 and 1997, CFC had $23.0 million and $77.2
million, respectively, of such funds invested in bank certificates of deposit
and marketable securities.
The outstanding Collateral Trust Bonds are secured by the pledge of
mortgage notes taken by CFC in connection with long-term secured loans
made to those members fulfilling specified criteria as set forth in the
indentures. Medium-Term Notes are unsecured obligations of CFC.
Interest Rate Exchange Agreements
The following table lists the notional principal amounts and the weighted
average interest rates paid by CFC under interest rate exchange
agreements at May 31, 1998 and 1997:
(Dollar Amounts in Thousands)
Maturity Interest Rate Paid Interest Rate Received Notional Principal Amount
Date 1998 1997 1998 1997 1998 1997
February 1998 (1) 5.69% 5.61% 5.88% 5.57% $ - $50,000
November 1999(1) 5.71% 5.63% 5.84% 5.52% 50,000 50,000
November 1999 (1) 5.71% 5.63% 5.84% 5.52% 50,000 50,000
November 1999(1) 5.71% 5.63% 5.84% 5.52% 50,000 50,000
January 2000(2) 6.47% 6.47% 5.71% 5.57% 52,851 52,851
January 2001(2) 6.64% 6.64% 5.71% 5.57% 42,749 42,749
February 2001 (2) 5.63% - 5.59% - 75,000 -
February 2001 (2) 5.63% - 5.59% - 75,000 -
February 2001 (2) 5.63% - 5.59% - 75,000 -
February 2001 (2) 5.62% - 5.59% - 75,000 -
January 2003 (2) 5.64% - 5.59% - 10,000 -
January 2003 (2) 5.49% - 5.59% - 12,375 -
October 2004(2) 6.23% 6.23% 5.71% 5.64% 40,700 43,200
January 2005 (2) 5.70% - 5.59% - 8,000 -
April 2006 (2) 6.88% 6.88% 5.71% 5.65% 25,000 25,000
April 2006 (2) 6.89% 6.89% 5.71% 5.65% 25,000 25,000
April 2006 (2) 6.88% 6.88% 5.71% 5.65% 25,000 25,000
April 2006 (2) 6.89% 6.89% 5.71% 5.65% 25,000 25,000
January 2008 (2) 5.84% - 5.59% - 14,000 -
January 2012 (2) 6.01% - 5.59% - 13,000 -
February 2012 (2) 6.00% - 5.59% - 10,000 -
Total $753,675 $438,800
(1) Under these agreements, CFC pays a variable rate of interest and
receives a variable rate of interest.
(2) Under these agreements, CFC pays a fixed rate of interest and
receives interest based on a variable rate.
CFC's objective in using interest rate exchange agreements in which it
pays a fixed rate of interest and receives a variable rate of interest is to
fix the interest rate on a portion of its commercial paper. CFC then uses
commercial paper, in an amount equal to the notional principal value of
the interest rate exchange agreements, to fund a portion of its long-term
71
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
fixed rate loan portfolio. The net difference between the rate paid by
CFC and the rate received is included in the cost of funds.
CFC's objective in using interest rate exchange agreements in which it
pays and receives a variable rate of interest is to change the variable rate
on a notional amount of debt from a LIBOR rate index to a commercial
paper rate index. The variable rate Collateral Trust Bonds and Medium-
Term Notes are issued based on a LIBOR rate index, while CFC sets its
variable rate loan interest rates based on a commercial paper rate. The
net difference between the rate paid by CFC and the rate received is
included in the cost of funds.
CFC is exposed to interest rate risk on these interest rate swap
agreements if the counterparty to the interest rate swap agreement does
not perform pursuant to the agreement's terms. CFC only enters swap
agreements with highly rated financial institutions.
Quarterly Income Capital Securities
Quarterly Income Capital Securities are long-term obligations that are
subordinated to CFC's other outstanding debt. Quarterly Income Capital
Securities are issued for terms of up to 49 years, pay interest quarterly,
may be called at par after five years and allow CFC to defer the payment
of interest for up to 20 consecutive quarters. The following table is a
summary of Quarterly Income Capital Securities outstanding at May 31:
(Dollar Amounts in Thousands) 1998 1997
8.00% Quarterly Income Capital Securities, due 2045 $125,000 $125,000
7.65% Quarterly Income Capital Securities, due 2046 75,000 -
Total Quarterly Income Capital Securities $200,000 $125,000
The weighted average interest rate on Quarterly Income Capital
Securities outstanding at May 31, 1998 and 1997, was 7.87% and 8.00%,
respectively. There are no Quarterly Income Capital Securities maturing
in each of the next five fiscal years following May 31, 1998.
(6) Employee Benefits
CFC is a participant in the National Rural Electric Cooperative
Association ("NRECA") Retirement and Security Program. This program
is available to all qualified CFC employees. Under the program,
participating employees are entitled to receive annually, under a 50% joint
and surviving spouse annuity, 1.90% of the average of their five highest
base salaries during their last ten years of employment, multiplied by the
number of years of participation in the program. CFC contributed
$677,000 to the Retirement and Security Program during fiscal year
1998. Funding requirements are charged to general and administrative
expenses as billed on a monthly basis. This is a multi-employer plan,
available to all member cooperatives of NRECA, and therefore the
projected benefit obligation and plan assets are not determined or
allocated separately by individual employer.
The Budget Reconciliation Act of 1993 has set a limit of $160,000 for
calendar year 1998 on the compensation to be used in the calculation of
pension benefits. In order to restore potential lost benefits, CFC has set
up a Pension Restoration Plan. Under the plan, the amount that NRECA
invoices CFC will continue to be based on the full compensation paid to
each employee. Upon the retirement of a covered employee, NRECA
will calculate the retirement and security benefit to be paid with
consideration of the compensation limits and will pay the maximum
benefit thereunder. NRECA will also calculate the retirement and
security benefit that would have been available without consideration of
the compensation limits and CFC will pay the difference. NRECA will
then give CFC a credit against future retirement and security contribution
liabilities in the amount paid by CFC to the covered employee.
CFC will pay such additional benefits to the covered employee through a
Severance Pay Plan and a Deferred Pay Restoration Plan. Under the
Severance Pay Plan, the employee is paid an amount equal to the lost
pension benefits but not to exceed twice the employee's annual compensation
for the prior year. The benefit must be paid within 24 months of
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NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
termination of employment. To the extent that the Severance
Pay Plan cannot pay all of the lost pension benefits, the remainder will be
paid under a Deferred Compensation Plan, which will be paid out in a
lump sum or in installments of up to 60 months.
CFC recognizes in current year margins any expected payouts for post-
retirement benefits (other than pensions) as a result of current service.
Post-retirement benefits include, but are not limited to, health and welfare
benefits provided after retirement. While CFC allows retired employees
to participate in its medical and life insurance plans, the retirees must do
so at their own expense. Any liability which may be incurred by allowing
retired employees to remain on CFC's medical and life insurance plans is
not material to CFC's financial condition, results of operations or cash
flows.
CFC offers a 401(k) defined contribution savings program to all
employees that have completed a minimum of 1,000 hours of service, in
either the first 12 consecutive months or first full calendar year of
employment. Employee contributions for calendar year 1998 are tax
deductible up to $10,000, the limit set by IRS regulations. Employees
may contribute additional amounts to the program on an after-tax basis
subject to the limitations established by section 415 of the Internal
Revenue Code. The Company will contribute an amount equal to 2% of
an employee's salary each year for all employees participating in the
program. During the year ended May 31, 1998, the Company
contributed a total of $165,000 under the program.
(7) Retirement of Patronage Capital
Patronage capital in the amount of $54.9 million was retired during fiscal
year 1998. CFC retired $46.8 million to its members, excluding $5.2
million retired to RTFC and $2.7 million retired to GFC. RTFC retired
$6.4 million to its members and GFC retired $1.7 million to its members.
It is anticipated that CFC will retire patronage capital totaling $57.4
million, representing one-sixth of the fiscal years 1988, 1989 and 1990
allocations and 70% of the fiscal year 1998 allocation, in August 1998.
Management anticipates that 70% of RTFC's margins for fiscal year 1998
will be retired in January 1999, and that 100% of GFC's margins for fiscal
year 1998 will be retired in the second quarter of fiscal year 1999. Future
retirements of patronage capital will be made as determined by the
Companies' respective Boards of Directors with due regard for their
individual financial conditions.
(8) Guarantees
As of May 31, 1998 and 1997, CFC had outstanding guarantees of the
following contractual obligations of its members (see Note 1(e) for a
description of CFC's allowance for loan losses and Note 3 for a
discussion of requirements to purchase Guarantee Subordinated
Certificates in connection with these guarantees):
(Dollar Amounts In Thousands) 1998 1997
Long-term tax exempt bonds (A) $1,148,500 $1,190,925
Debt portions of leveraged lease transactions (B) 437,175 418,916
Indemnifications of tax benefit transfers (C) 312,771 338,264
Other guarantees (D) 136,048 132,566
Total $2,034,494 $2,080,671
(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 on each bond when due.
In addition, CFC has agreed to make up, at certain times,
deficiencies in the debt service reserve funds for certain of these
issues of bonds. In the event of a default by a system for
nonpayment of debt service, CFC is obligated to pay any
required amounts under its guarantee, which will prevent the
acceleration of the bond issue. 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 of the system's assets, but CFC may
not exercise remedies thereunder for up to two years.
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.
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NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
Of the amounts shown, $1,017.8 million and $1,043.2 million as
of May 31, 1998 and 1997, respectively, are adjustable or
floating/fixed rate bonds. The floating 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 have not previously been sold to
other purchasers by the remarketing agents.
(B) CFC has guaranteed debt issued by NCSC in connection with
leveraged lease transactions. The amounts shown represent
loans from NCSC to a trust for the benefit of an industrial or
financial company for the purchase of a power plant or utility
equipment which was subsequently leased to a CFC member.
The loans are secured by the property leased and the owner's
rights as lessor. NCSC borrowed the funds for these loans
either under a CFC guarantee or directly from CFC.
(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 shown
represent CFC's maximum potential liability at May 31, 1998
and 1997. However, the amounts of such guarantees vary over
the lives of the leases. A member's obligation to reimburse CFC
for any guarantee payments would be treated as a long-term
loan, secured Pari Passu with the RUS by a first lien on
substantially all of 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
further guarantees of this nature are anticipated.
(D) At May 31, 1998 and 1997, CFC had unconditionally
guaranteed commercial paper issued by NCSC in the amount of
$39.0 million and $33.7 million, respectively.
Guarantees outstanding by state are summarized as follows:
(Dollar Amounts In Thousands)
May 31, May 31,
State 1998 1997 State 1998 1997
Alabama $ 65,610 $ 68,750 Nebraska $ 3,115 $ 3,375
Arizona 53,915 55,825 North Carolina 114,700 117,500
Arkansas 120,635 131,498 Oklahoma 49,162 56,296
Colorado 11,591 12,196 Oregon 4,805 4,945
Florida 304,144 312,400 Pennsylvania 12,839 13,718
Indiana 123,567 126,568 South Carolina 45,140 46,260
Iowa 9,475 10,275 Texas 125,298 125,418
Kansas 40,050 40,949 Utah 316,203 291,826
Kentucky 188,370 193,120 Virginia 43,208 37,875
Minnesota 141,358 148,904 Wisconsin - 7,895
Mississippi 66,615 69,205 Wyoming 10,875 10,875
Missouri 183,819 194,998 Total $2,034,494 $2,080,671
CFC uses the same credit policies and monitoring procedures in providing
guarantees as it does for loans and commitments.
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NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
The following table details the scheduled reductions in each of the fiscal
years following May 31, 1998 to the amount of obligations guaranteed by
CFC:
(Dollar Amounts In Thousands) Amount
1999 $ 71,836
2000 108,215
2001 95,877
2002 115,132
2003 121,542
Thereafter 1,521,892
$ 2,034,494
(9) Fair Value of Financial Instruments
The following disclosure of the estimated fair value of financial
instruments is made in accordance with FASB Statement No. 107,
"Disclosure about Fair Value of Financial Instruments." Whenever
possible, the estimated fair value amounts have been determined using
quoted market information as of May 31, 1998, along with other
valuation methodologies which are summarized below. The estimated
fair value information presented is not necessarily indicative of amounts
CFC could realize currently in a market sale since CFC may be unable to
sell such instruments due to contractual restrictions or to the lack of an
established market. The estimated market values have not been updated
since May 31, 1998, therefore, current estimates of fair value may differ
significantly from the amounts presented. With the exception of
redeeming Collateral Trust Bonds under early redemption provisions and
allowing borrowers to prepay their loans, CFC has held and intends to
hold all financial instruments to maturity. Below is a summary of
significant methodologies used in estimating fair value amounts and a
schedule of fair values at May 31, 1998.
Cash and Cash Equivalents
Includes cash and certificates of deposit with remaining maturities of less
than 90 days, which are valued at the carrying value.
Debt Service Investments
The fair value of debt service investments is estimated based on published
bid prices or dealer quotes or is estimated using quoted market prices for
similar securities when no market quote is available. Debt service
investments purchased with original maturities of less than or equal to 90
days are valued at the carrying value which is a reasonable estimate of fair
value.
Loans to Members
Fair values are estimated by discounting the future cash flows using the
current rates at which similar loans would be made to borrowers with
similar credit ratings and for the same remaining maturities. Loans with
different risk characteristics, specifically nonperforming and restructured
loans, are valued using a discount rate commensurate with the risk
involved. Loans with interest rate repricing maturities of less than or
equal to 90 days are valued at cost which approximates fair value.
Notes Payable
Notes payable consist of Commercial Paper and Bank Bid Notes. The
fair value of Commercial Paper and Bank Bid Notes with maturities
greater than 90 days is estimated based on quoted market rates with
similar maturities for Commercial Paper and on bid prices from the
various banking institutions for Bid Notes. The fair value of Commercial
Paper and Bank Bid Notes with maturities less than or equal to 90 days
are valued at carrying value which is a reasonable estimate of fair value.
75
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
Long-Term Debt
Long-term debt consists of Collateral Trust Bonds and Medium-Term
Notes. The fair value of long-term debt is estimated based on published
bid prices or dealer quotes or is estimated using quoted market prices for
similar securities when no market quote is available.
Quarterly Income Capital Securities
The fair value of Quarterly Income Capital Securities is estimated based
on published market prices.
Members' Subordinated Certificates
As it is impracticable to develop a discount rate that measures fair value,
Subordinated Certificates have not been valued. Members' Subordinated
Certificates are extended long-term obligations to CFC; many have
maturities of 70 to 100 years. These certificates are issued to CFC's
members as a condition of membership or as a condition of obtaining loan
funds or guarantees and are non-transferable. As these certificates were
not issued primarily for their future payment stream but mainly as a
condition of membership and to receiving future loan funds, there is no
ready market from which to obtain fair value rates.
Interest Rate Exchange Agreements
The fair value is estimated as the amount CFC would receive or pay to
terminate the agreement, taking into account the current market rate of
interest and the current creditworthiness of the exchange counterparties.
Commitments
The fair value is estimated as the carrying value, or zero. Extensions of
credit under these commitments, if exercised, would result in loans priced
at market rates.
Guarantees
CFC charges guarantee fees based on the specifics of each individual
transaction. The demand for CFC guarantees has been small in the last
few years. In addition, there is no other company that provides
guarantees to rural electric utility companies from which to obtain market
fee information. As a result, it is impracticable to supply fair value
information related to guarantees.
76
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
Carrying and fair values as of May 31, 1998 and 1997 are presented as
follows:
(Dollar Amounts In Thousands) 1998 1997
Carrying Fair Carrying Fair
Value Value Value Value
Assets:
Cash and Cash Equivalents $ 65,274 $ 65,274 $ 50,011 $ 50,011
Debt Service Investments 22,969 22,969 77,219 77,219
Loans to Members, net 10,329,345 10,391,615 8,678,196 8,602,301
Liabilities:
Notes Payable (1) 5,865,904 5,865,898 5,757,074 5,759,584
Long-Term Debt (1) 3,006,946 3,057,919 1,614,887 1,610,726
Quarterly Income Capital Securities 200,000 204,980 125,000 126,875
Off-Balance Sheet Instruments:
Interest Rate Exchange Agreements - (11,754) - (4,331)
Commitments - - - -
(1) Prior to reclassification of notes payable supported by the revolving
credit agreements and prior to reclassification of long-term debt due
within one year.
(10) Contingencies
(a) At May 31, 1998 and 1997, CFC had a total of $333.6 million and
$371.4 million of loans classified as impaired. At both dates, CFC
had allocated $126.0 million of the loan loss allowance to such
impaired loans. CFC does not recognize interest income on loans
classified as impaired. Instead, all payments received are applied as a
reduction to principal outstanding. The average recorded investment
in impaired loans, for the year ended May 31, 1998, was $345.3
million.
(b) Wabash Valley Power Association ("WVPA"), is a power supply
member of CFC located in Indiana. In the early 1980's, WVPA
began to experience financial difficulty related to the debt service on
loans supporting its investment in the canceled Marble Hill nuclear
power plant. In May 1985, WVPA filed a voluntary petition for
reorganization under Chapter 11 of the U.S. Bankruptcy Code.
CFC had a $8.6 million loan to WVPA and a guarantee of $26.0
million in tax-exempt bonds issued by WVPA. WVPA has not made
any loan payments to CFC since May 1985 and CFC wrote-off the
$8.6 million in 1992. WVPA continued to make the debt service
payments related to the CFC guaranteed bonds.
On December 31, 1996 the WVPA plan of reorganization became
effective. Under the plan, CFC received a $4.9 million cash
payment and offset $9.9 million of WVPA's investments in CFC
commercial paper and Subordinated Certificates, for a total of
$14.8 million. CFC also received a combination of secured and
unsecured promissory notes bearing interest at market rates
totaling $13.4 million, bringing the total received by CFC to
$28.2 million. CFC applied the cash and offsets against the
$17.7 million nonperforming loan to Wabash, reducing the
balance to $2.9 million. In April 1998, CFC received $0.7 million
as its share of the proceeds from the sale of assets by Wabash.
At May 31, 1998, CFC had a total of $2.2 million outstanding to
Wabash. To date, all payments have been made as scheduled on
the notes CFC received as part of the Wabash settlement. The
notes receivable have been classified as performing and are
accruing interest at CFC's intermediate-term interest rate. The
$2.2 million outstanding at May 31, 1998 has been classified as
nonperforming and is on a nonaccrual status with respect to the
recognition of interest income.
CFC and RUS are negotiating a settlement on the amount of
true-up payments under a separate agreement entered into in
May 1988. This agreement provides for CFC and RUS to
allocate between them all post-petition, pre-confirmation
payments made by WVPA to CFC on debt secured by a
mortgage under which CFC and RUS were
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NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
co-mortgagees in proportion to the respective amounts
of debt secured. CFC anticipates making a payment
to RUS under this agreement. At May 31, 1998, CFC
has a deferred gain of $10.5 million (total received
$28.2 million less outstanding loans of $17.7 million).
This gain will be used to offset a portion of any true-up
payment that is made to RUS.
CFC believes that it has adequately reserved for any potential
losses related to WVPA.
(c) Deseret Generation & Transmission Co-operative ("Deseret") is a
power supply member of CFC located in Utah. Deseret operates the
Bonanza generating plant ("Bonanza"), owns a 25% interest in the
Hunter generating plant along with a system of transmission lines.
Deseret also owns and operates a coal mine, through its Blue
Mountain Energy subsidiary. In the 1980's, NCSC issued debt,
guaranteed by CFC, related to the Bonanza plant and the coal mine
operation. Due to large anticipated demands for electricity, the
Bonanza site was designed for two plants and Deseret built the
infrastructure to support two plants (only one plant has been built
to date). When the large increases in demand never materialized,
Deseret was unable to make the payment obligations on the Bonanza
plant and debt service payments to RUS and NCSC. NCSC transferred to
CFC all of its rights as a creditor on the obligations guaranteed by CFC.
In 1991, Deseret and its creditors entered into an agreement to
restructure Deseret's debt obligations, the Agreement Restructuring
Obligations ("ARO"). In 1995, Deseret failed to make the
payments required under the ARO. The interested creditors were
unable to agree on the terms of a negotiated settlement and the
ARO was terminated as of February 29, 1996. CFC filed a
foreclosure action against the owner of the Bonanza Plant in State
Court in Utah on March 21, 1996. In this action, CFC has not
terminated the lease or sought removal of Deseret as the plant
operator. One of the defendants in the foreclosure action has filed
amended counterclaims against CFC. These amended
counterclaims allege breaches of contract, fraudulent concealment,
tortious interference with contract and conspiracy. These amended
counterclaims also seek rescission or equitable subordination of
CFC's interest in the Bonanza Plant.
On October 16, 1996, Deseret and CFC entered into an Obligations
Restructuring Agreement (the "ORA") for the purpose of
restructuring Deseret's obligations to CFC. Pursuant to the terms
of the ORA, CFC agreed to (i) forbear from exercising remedies 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 claims held on December 31, 2025. To date, Deseret has
made all required payments under the ORA.
In connection with the ORA, on October, 16, 1996 CFC acquired
all of Deseret's indebtedness in the outstanding principal amount of
$740.0 million from RUS for $238.5 million (the "RUS Debt"). As
a result of the purchase, CFC holds a majority of Deseret's
outstanding secured debt. Pursuant to a participation agreement
dated October 16, 1996, the member systems of Deseret purchased
from CFC, for $55.0 million, a participation interest in the RUS
Debt. CFC provided long-term financing to the members of
Deseret as follows: (i) $32.5 million in the aggregate to finance the
buyout by the members of their respective RUS debt (the "Note
Buyout Loans"), and (ii) $55.0 million in the aggregate to finance
the members' purchase of participation interests in the RUS Debt
acquired by CFC (the "Participation Loans"). The Note Buyout
Loans and the Participation Loans are secured by the assets and
revenues of the member systems. Under the participation
agreement the Deseret members will receive a share of the
minimum quarterly payments that Deseret makes to CFC which the
members will use to service their Participation Loans. Each
member of Deseret has the option to put its Participation Loan back
to CFC at any time after twelve years, provided that no event of
default exists under the ORA or under such member's Participation
Loan.
All of the parties to the lawsuit participated in a nonbinding
mediation session, but no settlement was reached. CFC is
proceeding with the litigation. A new judge was assigned to the
case in the spring of 1998. Settlement discussions have taken place
since March 1998 and may continue to take place up to the trial
date. The case has been bifurcated, with trial on the foreclosure
action scheduled for October 1998 in Vernal, Utah. All counter
and cross claims are to be tried after the foreclosure trial.
78
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
On March 20, 1998, the City of Riverside, CA ("Riverside")
commenced an action against Deseret in the United States District
Court for the Central District of California. Riverside is seeking (i)
a declaratory judgment from the court that the Power Sales
Agreement date October 6, 1992 ("The Power Sales Agreement")
between Deseret and Riverside terminated on March 31, 1998 and
(ii) unspecified damages against Deseret. On March 31, 1998,
Deseret sought injunctive relief from a Utah State Court. The Utah
State Court has granted a temporary restraining order that enjoins
Riverside from terminating the Power Sales Agreement. The Utah
proceeding has been removed to the United States District Court
for the District of Utah. Deseret and Riverside have entered into a
stipulation extending the temporary restraining order pending
resolution of venue motions filed in both the Utah and California
proceedings.
On March 24, 1998, the City of Anaheim, CA ("Anaheim")
commenced an action against Deseret that has been consolidated
with the Riverside proceeding in the United States District Court
for the Central District of California. The Anaheim action seeks
declaratory relief from the court to determine that the 40 MW
Power Sales Agreement ("Agreement") dated June 9, 1993,
between Deseret and Anaheim has terminated or will terminate and
to set an effective date of that termination. Anaheim has agreed to
continue to purchase power and energy under the terms of that
Agreement pending resolution of the California proceeding. On
April 29, 1998, Deseret added Anaheim to the Utah action filed
against Riverside, seeking, among other things, injunctive relief.
Various venue motions are currently pending in both actions
concerning the Anaheim dispute.
The agreements require Deseret to supply Riverside with up to 52 MW
through December 31, 2009 and Anaheim with up to 40 MW through December
31, 2004. These contracts represent approximately 17% of Deseret's
revenues. The impact of this action on Deseret's ability to make the
payments required under the ORA has not yet been determined. A factor
mitigating any impact is Deseret's contract with PacifiCorp, under which
PacifiCorp has agreed to purchase all excess capacity.
CFC had the following exposure to Deseret:
(Dollar amounts in Millions) May 31, 1998 May 31, 1997
Loans Outstanding (1) $329.5 $362.0
Guarantees Outstanding:
Tax Exempt bonds 4.1 5.0
Mine equipment leases 54.1 23.1
Bonanza plant lease 258.0 263.7
Total Guarantees 316.2 291.8
Total Exposure $645.7 $653.8
(1) From January 1, 1989 through May 31, 1998, CFC has funded a
total of $180.5 million in cash flow shortfalls related to Deseret's
debt service and rental obligations guaranteed by CFC. All cash flow
shortfalls funded by CFC represent an increase to loans outstanding
and also represent a decrease to the principal amount of the
obligations guaranteed by CFC.
Based on its analysis, CFC believes that it has adequately reserved for
any potential loss on its loans and guarantees to Deseret.
(d) On September 13, 1996, CFC advanced $235.0 million to Soyland
Power Cooperative, Inc. ("Soyland"), for the purpose of repaying
its RUS obligations at a significant discount. This loan will
amortize over a five-year term. As a condition to this advance,
certain distribution members of Soyland agreed to guarantee
repayment to CFC of $117.5 million.
As a result of the repayment, RUS assumed responsibility for the
repayment of $618.0 million of guaranteed loans to Soyland. A
total of $354.8 million of these loans were held in grantor
trusts and serviced by CFC, while the
79
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO COMBINED FINANCIAL STATEMENTS - (Continued)
remaining $263.2 million were held by
CFC. On February 13, 1997, RUS repaid the $263.2 million of
guaranteed loans held by CFC. On March 20, 1997 RUS repaid
$257.0 million of the loans held by the grantor trusts and serviced
by CFC. At May 31, 1998, the balance of loans held by grantor
trusts and payable by RUS was $93.7 million.
As of May 31, 1998, CFC had a total of $188.6 million of loans
outstanding to Soyland. All of these loans have been classified as
performing and are on full accrual status with respect to interest
income. Soyland is current with respect to all payments due on its
loans.
CFC believes that it is adequately reserved for any potential loss on
its loans to Soyland.
(e) At May 31, 1998, one other borrower was in payment default to
CFC on an unsecured loan totaling $1.9 million. At May 31, 1997,
two borrowers were in payment default to CFC on secured and
unsecured loans totaling $6.5 million.
(11) Extraordinary Loss
During the year ended May 31, 1996, CFC paid a prepayment
premium of $1.6 million for the early retirement of Collateral Trust
Bonds.
(12) Gain on Sale of Land
During the year ended May 31, 1998, CFC sold land with a cost
basis of $8.3 million for $13.5 million, resulting in a gain of $5.2
million.
(13) Combined Quarterly Financial Results (Unaudited)
Summarized results of operations for the four quarters of fiscal
years 1998 and 1997 are as follows:
Fiscal Year 1998
(Dollar Amounts In Thousands) Quarters Ended Total
August 31 November 30 February 28 May 31 Year
Operating income $150,477 $153,995 $161,656 $171,445 $637,573
Operating margin 9,119 14,657 15,153 15,482 54,411
Nonoperating income 592 435 750 834 2,611
Gain on Sale of Land 4,939 - - 255 5,194
Net margins 14,650 15,092 15,903 16,571 62,216
Fiscal Year 1997
(Dollar Amounts In Thousands) Quarters Ended Total
August 31 November 30 February 28 May 31 Year
Operating income $134,267 $140,233 $142,562 $147,377 $564,439
Operating margin 12,105 12,985 14,842 11,598 51,530
Nonoperating income 661 672 700 1,173 3,206
Net margins 12,766 13,657 15,542 12,771 54,736
80