NRUC

Business Context and Reporting Period

Company: National Rural Utilities Cooperative Finance Corporation (CFC), a private, not-for-profit cooperative providing financing to rural electric and telecommunications systems.

Reporting Period: Quarterly period ended August 31, 1999 (Unaudited).

Scope: Combined financial statements include CFC and its controlled affiliates, Rural Telephone Finance Cooperative (RTFC) and Guaranty Funding Cooperative (GFC).

Key Financial Metrics

Margins & Ratios:

• Gross Operating Margin: $35.6 million (3 months ended Aug 31, 1999) vs. $28.2 million (prior year).
• Times Interest Earned Ratio (TIER): 1.12x (Target minimum: 1.10x).
• Loan Loss Allowance: $221.0 million (1.54% of total loans).
• Leverage Ratio: 7.49 (increased from 7.00 at May 31, 1999).

Material Changes vs. Prior Period

• Asset Growth: Total assets increased by $691 million (5.0%) from May 31, 1999, driven primarily by a $655 million increase in net loans to members.
• Profitability: Net margins for the quarter increased by $4.5 million (25.6%) compared to the same period in 1998, largely due to a 30% increase in average loan volume.
• Debt Structure: Total debt increased by $680 million. Short-term debt (notes payable) rose by $689.5 million to fund loan growth, while long-term debt remained relatively stable.
• Loan Loss Provision: Provision for loan losses increased by $2.9 million (49%) to $8.8 million, reflecting significant loan portfolio growth over the last 12-18 months.
• Equity: Members' equity decreased by $44.0 million due to the retirement of $66.2 million in patronage capital, partially offset by current net margins.

Outlook, Risks, and Contingencies

Management Commentary & Outlook:

• Management anticipates modest increases in the leverage ratio as external capital is obtained to accommodate loan growth.
• Strong economic conditions and high RUS waiting periods continue to drive demand for CFC financing.
• CFC maintains high credit ratings (Moody's Aa3/A1, S&P AA/AA-, Fitch AA/AA-) to facilitate access to capital markets.

Key Risks & Contingencies:

• Deseret Generation & Transmission Co-operative: CFC has a total exposure of $669.1 million to Deseret, including $578.3 million in restructured loans. Deseret is under an Obligations Restructuring Agreement (ORA) requiring payments through 2025. CFC believes it has adequately reserved for potential losses.
• Interest Rate Risk: CFC manages risk through a "Match Funding Policy" and interest rate exchange agreements (notional amount $3.86 billion). Fixed rate loans funded by variable rate debt represent only 1.2% of total assets.
• Liquidity Risk: Mitigated by $4.79 billion in revolving credit agreements (increased to $5.49 billion in September 1999) and active shelf registrations.
• Year 2000 Compliance: CFC reports full compliance with no anticipated operational impact. Approximately 92% of loans are to members with satisfactory Y2K plans.

Investor Verification Checklist

• Deseret Restructuring: Verify the status of Deseret's cash flow payments under the ORA and the adequacy of the $101 million loan loss allowance allocated to impaired loans.
• Loan Growth vs. Provisions: Confirm that the 49% increase in loan loss provisions remains adequate given the 30% surge in loan volume.
• Debt Maturity Profile: Review the concentration of short-term debt (44% of total) and the reliance on rolling over commercial paper.
• Derivative Exposure: Assess the counterparty risk associated with $3.86 billion in interest rate exchange agreements.
• Capital Retention: Monitor the trend of member capital contributions as a percentage of total capitalization, which management expects to decline due to policy changes.