NRUC

Business Context and Reporting Period

Company: National Rural Utilities Cooperative Finance Corporation (CFC), including affiliates Rural Telephone Finance Cooperative (RTFC) and Guaranty Funding Cooperative (GFC).

Reporting Period: Fiscal year ended May 31, 1999.

Business Overview: CFC is a private, not-for-profit cooperative association providing low-cost capital to rural electric and telecommunications utility systems. It supplements the loan programs of the Rural Utilities Service (RUS) and provides guarantees for tax-exempt financings. The company is exempt from federal income taxes under Section 501(c)(4).

Key Financial Metrics

Material Changes vs. Prior Period

• Loan Portfolio Growth: Net loans increased by $3.2 billion (31%) to $13.5 billion, driven by strong economic conditions, RUS waiting periods, and increased demand for refinancing RUS debt.
• Profitability: Net margins increased 23% to $76.4 million. Operating income rose 24% due to higher average loan volume, despite a slight decrease in the average interest rate earned on loans (6.51% vs. 6.60%).
• Cost of Funds: Total cost of funding increased 23% to $664 million, reflecting the larger loan volume. The average cost of funds decreased to 5.47% from 5.60%.
• Restructured Loans: Restructured loans increased significantly to $577 million (from $330 million), primarily due to advances made to redeem secured lease obligation bonds for Deseret Generation & Transmission Co-operative. These loans were placed on accrual status in February 1999.
• Guarantees: Total guarantees decreased by $350 million to $1.7 billion, largely due to the redemption of Bonanza secured lease obligation bonds.

Outlook, Risks, and Management Commentary

• Outlook: Management expects demand for electric loans to maintain its current pace, driven by RUS debt buyouts, mergers, and diversification. Telecommunications loan growth is expected to continue via acquisitions and wireless expansion.
• Capital Structure: The leverage ratio increased to 7.00 and the debt-to-equity ratio to 5.52. Management is reviewing options to slow the growth of these ratios as the portfolio expands.
• Key Risks:
  • Interest Rate Risk: CFC manages this via gap analysis and interest rate swaps. At year-end, 2.1% of fixed-rate loans were funded by variable-rate debt.
  • Liquidity Risk: Mitigated by $4.8 billion in revolving credit agreements and active shelf registrations.
  • Member Performance: CFC's performance is tied to rural utility members. Regulatory changes (e.g., customer choice laws) and stranded cost recovery issues pose potential risks to member revenue.
• Unusual Items:
  • Wabash Valley Power Association: CFC wrote off $37.4 million related to a "true-up" payment and recognized $13.4 million in deferred gain during the year.
  • Saluda River Electric Cooperative: CFC wrote off $20.9 million related to the defeasance of tax-exempt bonds.

Investor Verification Checklist

• Deseret Restructuring: Verify the status of the $577 million in restructured loans to Deseret Generation & Transmission Co-operative and the terms of the Obligations Restructuring Agreement (ORA).
• Loan Loss Allowance Adequacy: Review the $212 million allowance in the context of $62 million in charge-offs (including Wabash and Saluda) and the concentration of restructured assets.
• Regulatory Impact: Assess the potential impact of state-level customer choice laws and stranded cost recovery on the revenue stability of electric cooperative members.
• Capital Ratios: Monitor the trend of the leverage ratio (currently 7.00) and management's plan to stabilize it against the 10x debt-to-equity covenant limit.
• RUS Program Changes: Track the shift from direct RUS loans to RUS guarantees, which drives CFC's supplemental lending volume.