RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997 - FORM 10-K - March 29, 2010

Attached files

file filename
EX-12 - COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997exhbit12.htm
EX-99 - OTHER SELECT FINANCIAL INFORMATION JPMC - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997exhibit99.htm
EX-31.1 - CERTIFICATION PURSUANT TO SECTION 302 - PETERSEN - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997exhbit31_1.htm
EX-32.1 - CERTIFICATION PURSUANT TO SECTION 906 - PETERSEN - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997exhbit32_1.htm
EX-32.2 - CERTIFICATION PURSUANT TO SECTION 906 - LILLY - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997exhbit32_2.htm
EX-31.2 - CERTIFICATION PURSUANT TO SECTION 302 - LILLY - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997exhbit31_2.htm

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 December 31, 2009
 
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 333-25029
 
RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997
(Exact name of registrant as specified in its charter)
 
NEW YORK
(State or other jurisdiction of incorporation or organization)
 
(36-7233686)
(I.R.S. Employer Identification Number)
 
2201 Cooperative Way, Herndon, VA 20171-3025
(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:  None.
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes __   No  X

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes __  No X 
 
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 III of this Form 10-K or any amendment to this Form 10-K.    [ X ]
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer.  See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer __            Accelerated filer __                Non-accelerated filer X

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes __      No X

The Registrant has no common or voting stock.



 
 
 


Part I
 
 
Item 3.
Legal Proceedings
 
 
None.
  
Item 4.
Submission of Matters to a Vote of Security Holders
 
 
None.

Part II

 
Item 8.
Financial Statements and Supplementary Data
 
   
See attached audited financial statements.
 
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
   
None.
 
Item 9B.
Other Information
 
   
None.

 
 
 


Part III
  
 
Item 13.
Certain Relationships and Related Transactions
 
 
None.
 
Part IV
 
Item 15.
Exhibits and Financial Statement Schedules
 
             (a)
The following documents are filed as part of this report:
 
 
1.
Financial Statements
   
Report of Independent Registered Public Accounting Firm
   
Balance Sheets as of December 31, 2009 and 2008
   
Statements of Income and Expenses for the Years Ended December 31, 2009, 2008 and 2007
   
Statements of Changes in Deficit for the Years Ended December 31, 2009, 2008 and 2007
   
Statements of Cash Flows for the Years Ended December 31, 2009, 2008 and 2007
   
Notes to Financial Statements
 
 
2.
Financial Statement Schedules are omitted because they are inapplicable.
 
 
3.
Exhibits
 
 
Exhibit
  
 
Number
Description of Exhibit
 
 
 4.1
Form of Trust Agreement, including the form of Rural Electric Cooperative Grantor Trust Certificate (incorporated by reference to Exhibit 4.1 to Registration Statement on Form S-1 [No. 333-25029]).
 
 
 4.2
First Amendment to Trust Agreement (incorporated by reference to Exhibit 4.2 to Registration Statement on Form S-1 [No. 333-25029]).
 
 
10.1
Loan Agreement dated as of February 15, 1988 between CFC and the Cooperative (including form of Note and Guarantee) (incorporated by reference to Exhibit 10.1 to Registration Statement on Form S-1 [No. 33-16789 filed on August 27, 1987]).
 
 
10.2
First Amendment to Loan Agreement (incorporated by reference to Exhibit 10.2 to Registration Statement on Form S-1 [No. 333-25029]).
 
 
10.3
Loan Guarantee and Servicing Agreement, dated as of February 15, 1988, among the Administrator of the RUS, the Cooperative, the Servicer, the Lender and the Trustee (incorporated by reference to Exhibit 10.2 to Registration Statement on Form S-1 [No. 33-16789 filed on August 27, 1987]).
 
 
10.4
First Amendment to Loan Guarantee and Servicing Agreement (incorporated by reference to Exhibit 10.4 to Registration Statement on Form S-1 [No. 333-25029]).
 
 
10.5
Remarketing Agreement (incorporated by reference to Exhibit 10.5 to Registration Statement on Form S-1 [No. 333-25029]).
 
 
10.6
Swap Agreement (incorporated by reference to Exhibit 10.6 to Registration Statement on Form S-1 [No. 333-25029]).

 
 
 


 
10.7
Liquidity Protection (incorporated by reference to Exhibit 10.7 to Registration Statement on Form S-1 [No. 333-25029]).
 
10.8
Form of Standby Certificate Purchase Agreement (incorporated by reference to Exhibit 10.8 to Registration Statement on Form S-1 [No. 333-25029]).
 
 
12
Computations of ratio of margin to fixed charges.
 
 
99
JP Morgan Chase & Co. (successor to Morgan Guaranty Trust Co. of NY) and Morgan Guaranty Trust Company of New York (Swap Counterparty) Financial Information.
 
 
31.1
Certification of the Chief Executive Officer required by Section 302 of the Sarbanes-
Oxley Act of 2002.
 
 
31.2
Certification of the Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
32.1
Certification of the Chief Executive Officer required by Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
32.2
Certification of the Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002.

Supplemental information to be furnished with reports filed pursuant to Section 15(d) of the Act by Registrants which have not registered securities pursuant to Section 12 of the Act.

No annual report, proxy statement, form of proxy or other proxy soliciting material has been sent to Certificate holders, and the Registrant does not presently contemplate sending any such material subsequent to the filing of this report.

Pursuant to the requirements of Section 13 or 15(d) of the Securities 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 29th day of March, 2010.

RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997


By: NATIONAL RURAL UTILITIES COOPERATIVE
FINANCE CORPORATION as Servicer


By:           /s/ SHELDON C. PETERSEN
Sheldon C. Petersen, Governor and
     Chief Executive Officer
 

 
 
 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Trustee of
Rural Electric Cooperative Grantor Trust
(KEPCO) Series 1997
Herndon, Virginia, and

To the Board of Directors of
National Rural Utilities Cooperative Finance Corporation
Herndon, Virginia

We have audited the accompanying balance sheets of Rural Electric Cooperative Grantor Trust (KEPCO) Series 1997 (the “Trust”) as of December 31, 2009 and 2008, and the related statements of income and expenses, changes in deficit, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Trust's management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Trust is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Trust’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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, such financial statements present fairly, in all material respects, the financial position of the Trust as of December 31, 2009 and 2008, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.
 

 
/s/ DELOITTE & TOUCHE, LLP

McLean, Virginia
March 29, 2010
 

 




1
 
 
 


RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997
BALANCE SHEETS


   
DECEMBER 31,
  
   
2009
      
2008
  
ASSETS
 
Interest receivable – KEPCO
$
213,649
    
$
231,270
  
 
Interest receivable - swap counterparty
  
  43,967
      
119,402
  
 
Notes receivable
  
 34,940,000
      
38,040,000
  
 
                Total assets
$
  35,197,616
    
$
38,390,672
  
 
 
 
LIABILITIES AND DEFICIT
 Liabilities
Interest payable - Grantor Trust Certificates
$
   43,967
    
$
119,402
  
 
Servicer fees payable
  
            2,616
      
2,832
  
 
Interest payable - swap counterparty
  
      211,033
      
228,438
  
 
Rural Electric Cooperative Grantor Trust Certificates
  
 34,940,000
      
38,040,000
  
 
Derivative liability
  
   6,731,747
      
9,780,530
  
 
Total liabilities
  
   41,929,363
      
48,171,202
  
 
Commitments and contingencies
 
 Deficit
Accumulated deficit
  
(8,011,162
)
    
(11,365,615
)
 
Accumulated other comprehensive income
  
     1,279,415
      
1,585,085
  
 
               Total deficit
  
    (6,731,747
)
    
(9,780,530
)
 
               Total liabilities and deficit
$
  35,197,616
    
$
38,390,672
  
 
See accompanying Notes to Financial Statements



2
 
 
 


RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997
STATEMENTS OF INCOME AND EXPENSES
 
 
   
YEAR ENDED DECEMBER 31,
   
2009
      
2008
      
2007
                     
INCOME
                    
                     
Interest on notes receivable
$
2,878,778
    
$
3,090,987
    
$
3,285,154
                     
          Total income
  
2,878,778
      
3,090,987
      
3,285,154
                     
EXPENSES
                    
                     
Interest to certificate holders
  
692,179
      
1,580,794
      
2,299,941
                     
Servicer fees
  
35,241
      
37,839
      
40,216
                     
          Total expenses
  
727,420
      
1,618,633
      
2,340,157
                     
Derivative unrealized/realized gain (loss), net
  
1,203,095
      
(4,647,172
)
    
(1,527,683)
                     
          Net income (loss)
$
3,354,453
    
$
(3,174,818
)
  
$
(582,686)
                     
                     
                     
 
See accompanying Notes to Financial Statements.

 
 
 


RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997
STATEMENTS OF CHANGES IN DEFICIT

     
Accumulated
    
     
Other
    
 
Accumulated
  
Comprehensive
  
Total
 
Deficit
  
Income
  
Deficit
                       
Balance – December 31, 2006
$
(7,608,111
)
  
$
2,261,515
    
$
(5,346,596
)
                       
 Amortization of  transition adjustment
  
-
      
(348,259
)
    
(348,259
)
                       
Net loss
  
(582,686
)
    
-
      
(582,686
)
                       
Total comprehensive income
                  
(930,945
)
                       
Balance – December 31, 2007
  
(8,190,797
)
    
1,913,256
      
(6,277,541
)
                       
                       
Amortization of  transition adjustment
  
-
      
(328,171
)
    
(328,171
)
                       
Net loss
  
(3,174,818
)
    
-
      
(3,174,818
)
                       
Total comprehensive income
                  
(3,502,989
)
                       
Balance – December 31, 2008
  
(11,365,615
)
    
1,585,085
      
(9,780,530
)
                       
                       
Amortization of  transition adjustment
  
-
      
(305,670
)
    
(305,670
)
 
                      
Net income
  
3,354,453
      
-
      
3,354,453
  
                       
Total comprehensive income
                  
3,048,783
  
                       
Balance – December 31, 2009
$
(8,011,162
)
  
$
1,279,415
    
$
(6,731,747
)
                       
                       
                       

See accompanying Notes to Financial Statements.
 



 
 
 


RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997
STATEMENTS OF CASH FLOWS
 
   
YEAR ENDED DECEMBER 31,
  
   
2009
    
2008
    
2007
  
CASH FLOWS FROM OPERATING ACTIVITIES
                  
 Net income (loss)
$
3,354,453
  
$
(3,174,818
)
$
(582,686
)
                   
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
                  
     Decrease in interest receivable - KEPCO
  
17,621
    
17,431
    
13,210
  
     Decrease in interest receivable – swap counterparty
  
75,435
    
28,070
    
21,424
  
     Derivative unrealized (gain) loss
  
(3,354,453
)
  
3,174,818
    
582,686
  
     Decrease in interest payable- Grantor Trust Certificates
  
(75,435
)
  
(28,070
)
  
(21,424
)
     Decrease in interest payable - swap counterparty
  
(17,405
)
  
(17,218
)
  
(13,049
)
     Decrease in servicer fees payable
  
(216
)
  
(214
)
  
(161
)
                   
 Net cash provided by operating activities
  
-
    
-
    
-
  
                   
CASH FLOWS FROM INVESTING ACTIVITIES
                  
     Principal received on notes receivable
  
3,100,000
    
2,800,000
    
2,500,000
  
                   
 Net cash provided by investing activities
  
3,100,000
    
2,800,000
    
2,500,000
  
 
                  
CASH FLOWS FROM FINANCING ACTIVITIES
                  
     Principal payment to certificate holders
  
(3,100,000
)
  
(2,800,000
)
  
(2,500,000
)
                   
 Net cash used in financing activities
  
(3,100,000
)
  
(2,800,000
)
  
(2,500,000
)
                   
NET INCREASE IN CASH
  
-
    
-
    
-
  
                   
CASH - Beginning of Year
  
-
    
-
    
-
  
                   
CASH - End of Year
$
-
  
$
-
  
$
-
  
                   
                   
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
                  
                   
Cash paid during the year for interest expense on certificates
$
767,615
  
$
1,608,863
  
$
2,321,365
  
                   
                   
 
See accompanying Notes to Financial Statements.
 
 
 
 
 
RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 2009, 2008 AND 2007


1.      ORGANIZATION AND OPERATIONS

Rural Electric Cooperative Grantor Trust (KEPCO) Series 1997 (the “Trust”) was formed under a Trust Agreement dated December 20, 1996, among National Rural Utilities Cooperative Finance Corporation (“CFC”), Kansas Electric Power Cooperative, Inc. (the “Cooperative”) and Bank One, formerly The First National Bank of Chicago (the “Trustee”). The assets of the Trust consist of lender loan notes (the “1997 Notes”) bearing interest at 7.597% and maturing in 2017.

The 1997 Notes originated from a transaction whereby CFC refinanced loans from the Federal Financing Bank, guaranteed by the Rural Utilities Service (“RUS” – previously Rural Electrification Administration) and in exchange CFC received from the Cooperative the 1997 Notes which CFC subsequently placed into two trusts, K-1 and K-2 that have since been terminated and replaced by the Series 1997 Trust. The 1997 Notes are guaranteed (the “Guarantee”) as to timely payment of principal and interest by the United States of America, acting through the Administrator of RUS. The General Counsel of the United States Department of Agriculture has issued an opinion that the Guarantee is supported by the full faith and credit of the United States of America. The Trust issued Certificates of beneficial interest (the “Series 1997 Certificates”) which bear interest at a variable rate and mature in 2017. In the course of refinancing, certificates of beneficial interest were sold to third party investors. CFC no longer holds a continuing interest in the Trust.

Effective September 2, 2004, U. S. Bank Trust National Association (“U.S. Bank”) replaced Bank One as Trustee.

The Trust also holds certain rights the Cooperative assigned to the Trust under an interest rate swap agreement. The swap agreement was put into place in order to mitigate the interest rate risk inherent in the Trust, which holds a fixed rate asset (the 1997 Notes) and a variable rate obligation. The counterparty to the swap is JP Morgan Chase & Co. (“JP Morgan”). Pursuant to the swap agreement, the Trust pays to JP Morgan a fixed rate of interest on the outstanding notional amount, and JP Morgan pays the Trust a variable rate of interest on the outstanding notional amount. The structure is designed such that the interest amounts paid by the Cooperative to the Trust are the same amounts paid to JP Morgan, pursuant to the swap agreement, plus the amounts payable to CFC, as servicer. The amounts JP Morgan pays to the Trust under the swap agreement are the same amounts as the interest payable by the Trust to the Series 1997 Certificate holders.

The notional amount of the swap agreement (which is not included on the Trust’s balance sheet) was established at $57,390,000 and declines in amount over time such that the outstanding notional amount is always equal to the outstanding balance of the 1997 Notes and the Series 1997 Certificates. The swap agreement terminates in 2017, but is subject to early termination upon the early redemption of the Series 1997 Certificates.

JP Morgan provides a liquidity facility with respect to the Series 1997 Certificates until such time as all outstanding Series 1997 Certificates have been paid in full. Investors have the right to put the certificates back to the remarketing agent in the event they are unable to resell the certificates. The remarketing agent is Goldman Sachs & Co. as successor to the original remarketing agent, Alex Brown & Sons.

Basis of Presentation

The accompanying financial statements are prepared under the accrual method of accounting in conformity with accounting principles generally accepted in the United States of America.

Use of Estimates 

The preparation of financial statements requires the Trust’s management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reported period. The estimates involve judgments with respect to, among other things, various future factors which are difficult to predict and are beyond the control of the Trust.  Actual amounts could differ from these estimates. Areas in which estimates have been made include, but are not limited to, the fair value of derivative financial instruments.


 
 
 
 
Reclassifications

Reclassifications of prior period amounts have been made to conform to the current reporting format and the presentation in our Form 10-K for the year ended December 31, 2009.  Specifically, the interest from swap counterparty recorded in income totaling $1,580,794 and $2,299,941 for the years ended December 31, 2008 and 2007, respectively and the interest to swap counterparty recorded in expenses totaling $3,053,148 and $3,244,938 for the years ended December 31, 2008 and 2007, respectively, have been reclassified to derivative unrealized/realized gain (loss), net on the statement of income and expenses to conform to the December 31, 2009 presentation.  This reclassification was made to present the unrealized gains and losses on the derivative (derivative forward value) in the same category on the statement of income and expenses with the realized gains and losses on the derivate (net periodic cash settlements) as the derivative instrument is not designated as a hedging instrument.

Notes Receivable, Interest, and Servicer Fee Accounting

The Trust accounts for its notes receivable at cost.  No allowance for loan losses has been recorded due to the guarantee provided by the United States of America.

The Trust records interest income as it is earned and accrues interest expense and servicer fees as they are incurred. Servicer fees are accrued at 0.093% of the outstanding principal balance of the Note.

Fair Value of Financial Instruments

The carrying amounts reported for interest receivable, interest payable, and servicer fees payable approximate fair values due to the short-term maturity of these instruments. See Note 4, Fair Value of Financial Instruments for additional information.

Derivative Financial Instruments

The Trust uses an interest rate swap to mitigate variability in its interest rate risk. The cash flows associated with the swap are determined by any changes in the underlying interest rates.

The Trust is neither a dealer nor a trader in derivative financial instruments.

Comprehensive Income

Comprehensive income includes other comprehensive income related to the transition adjustment recorded upon adoption of the accounting guidance related to derivative financial instruments. The transition adjustment represents the difference between the derivative’s carrying amount prior to adoption of the accounting guidance related to derivative financial instruments and its fair value after adoption.

Tax Status of the Trust

It is expected that the Trust will not have any liability for federal or state income taxes for the current or future years because the Trust is a pass-through entity that is not subject to income taxes.

 
 
 
 
 
Grantor Trust Certificates

Principal payments on the Trust Certificates began in 1998 and will extend over a period of twenty years. The principal payments over the next five years and thereafter are as follows:

   
 Years Ending December 31,
  
     
 
2010
             $ 3,500,000
 
2011
   3,900,000
 
2012
   4,300,000
 
2013
   4,800,000
 
2014
   5,300,000
 
  Thereafter
              13,140,000
     
 
Total
$34,940,000
     


The Certificates are subject to redemption by the Cooperative, through the Trust, at any time at the remaining principal amount plus accrued interest. In the event of a continuing default, the RUS, as guarantor, may prepay or purchase the 1997 Notes at that time. The principal payments received on the 1997 Notes from the Cooperative coincide with the payments due to the Series 1997 Certificate holders.

Each Series 1997 Certificate represents an undivided fractional interest in the Trust. CFC is the depositor of the Trust and acts as servicer of the 1997 Notes.

Significant New Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (SFAS) No. 168, The FASB Accounting Standards Codification (“Codification” or “ASC”) as the only source of authoritative GAAP in the United States, except that rules and interpretive releases issued by the Securities and Exchange Commission (“SEC”) also are sources of authoritative GAAP for SEC registrants.  Subsequent to the issuance of SFAS No. 168, the FASB will no longer issue Statements, Staff Positions, or Emerging Issues Task Force Abstracts, but will issue Accounting Standards Updates (“ASU”) which will amend the Codification.  As a result, the Codification supersedes authoritative literature effective prior to June 2009.

2.  
DERIVATIVE
 
On January 1, 2001, the Trust recorded a derivative asset of $4,628,105 with a corresponding credit to other comprehensive income representing a transition adjustment upon the adoption of the accounting guidance related to derivative financial instruments. The interest rate swap agreement was recorded at fair value on the balance sheet. The interest rate swap was not designated as a hedge on January 1, 2001, and has not been designated as a hedge since that date. Therefore, all changes in the fair value of the interest rate swap subsequent to January 1, 2001 have been recorded through earnings as a forward value adjustment.

The interest rate swap had a negative fair value of $6,731,747 and $9,780,530 and is reflected on the balance sheet as a derivative liability as of December 31, 2009 and 2008, respectively. For the years ended December 31, 2009, 2008 and 2007, respectively, the Trust recorded mark-to-market adjustments of $3,354,453, $(3,174,818) and $(582,686), respectively, which decreased/(increased) expenses and are reflected in the statements of income and expenses as a component of derivative unrealized/realized gain (loss), net.  For the years ended December 31, 2009, 2008 and 2007, respectively, the Trust recorded  income on interest from swap counterparty of $692,179, $1,580,794 and $2,299,941 for the receive variable leg of the interest rate swap and recorded expenses on interest to swap counterparty of $2,843,537, $3,053,148 and $3,244,938 for the pay fixed leg of the interest rate swap.   In addition, amortization of $305,670, $328,171 and $348,259 related to the transition adjustment from other comprehensive income was recorded for the years ended December 31, 2009, 2008, and 2007, respectively. A total of $280,761 is expected to be amortized over the next twelve months. The transition adjustment will continue to be amortized over the life of the interest rate swap, which matures on December 4, 2017.
 
 
 
 
 
3.  
FAIR VALUE MEASUREMENTS
 
The Trust makes estimates regarding valuation of assets and liabilities measured at fair value in preparing the financial statements.  Fair value accounting guidance requires the Trust to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Fair value measurement accounting guidance established the following fair value hierarchy:

· Level 1 — Quoted prices for identical instruments in active markets.
 
· Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations whose inputs are observable or whose significant value drivers are observable.
 
· Level 3 — Instruments whose significant value drivers are unobservable.
 

The Trust’s only asset or liability that is measured at fair value on a recurring or nonrecurring basis is the derivative instrument. The fair market value is provided by the swap counterparty and is estimated taking into account the current market rate of interest.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

The Trust accounts for its interest rate swap in accordance with the accounting guidance for derivative financial instruments, which establishes accounting and reporting standards requiring that derivative instruments (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at fair value. Because there is not an active secondary market for the type of derivative instrument the Trust uses, it obtains market quotes from the derivative counterparty to adjust the derivative to fair value on an annual basis. The market quote is based on the expected future cash flow and estimated yield curves.

The Trust performs its own analysis to validate the market quotes obtained from the derivative counterparty. The Trust entered into an interest rate swap agreement with a highly rated counterparty that participates in the Servicer’s revolving credit agreements. The interest rate swap agreement contains master netting arrangements as part of the ISDA agreement.

The Trust records the change in the fair value of its derivative for each reporting period in the derivative unrealized/realized gain (loss), net line item on the statement of income and expenses as currently the derivative does not qualify for hedge accounting.

The Trust’s valuation technique for derivatives is based upon observable inputs, which reflect market data. Fair value for the Trust’s derivative instruments falls under Level 2, as described above.

The following table presents the Trust’s asset and liability measured at fair value on a recurring basis at December 31, 2009:
 
   
 
Level 1                
Level 2                
Level 3 
Liabilities
      
Derivative liability
$                 -
$   6,731,747
$                 -
 
The Fair Value Option for Financial Assets and Financial Liabilities established the fair value option, which permits entities to choose to measure eligible financial instruments at fair value. The Trust elected not to measure eligible financial instruments at fair value and, therefore, the adoption of this guidance did not have an impact on the Trust’s financial statements.
 
 
 
 

4. FAIR VALUE OF FINANCIAL INSTRUMENTS
 
The following disclosure of the estimated fair value of financial instruments is made in accordance with accounting guidance related to fair value measurement and disclosures.  Whenever possible, the estimated fair value amounts have been determined using quoted market information as of December 31, 2009 and 2008, along with other valuation methodologies. Below is a summary of significant methodologies used in estimating fair value amounts and a schedule of fair values at December 31, 2009 and 2008.

Notes Receivable

Fair value is 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.

Rural Electric Cooperative Grantor Trust Certificates

The Series 1997 Trust Certificates pay a variable rate of interest that is reset weekly, and as such are considered to be carried at fair value.

Derivative Liability

The fair market value is provided by the swap counterparty and is estimated taking into account the current market rate of interest.

The carrying and estimated fair values of the Trust’s financial instruments as of December 31, 2009 and 2008 are as follows:
 
 
2009
  
2008
 
Carrying
Fair
  
Carrying
Fair
 
Value
Value
  
Value
Value
Assets:
          
  Interest receivable — KEPCO
$
213,649
$
213,649
  
$
231,270
$
231,270
  Interest receivable—swap counterparty
  
43,967
  
43,967
    
119,402
  
119,402
  Notes receivable
  
34,940,000
  
39,899,950
    
38,040,000
  
44,866,976
                   
Liabilities:
                  
  Interest payable — Grantor Trust Certificates
$
43,967
$
43,967
  
$
119,402
$
119,402
  Servicer fees payable
  
2,616
  
2,616
    
2,832
  
2,832
  Interest payable — swap counterparty
  
211,033
  
211,033
    
228,438
  
228,438
  Rural Electric Cooperative
                  
    Grantor Trust Certificates
  
34,940,000
  
34,940,000
    
38,040,000
  
38,040,000
  Derivative liability
  
6,731,747
  
6,731,747
    
9,780,530
  
9,780,530

 

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