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 telecommunication utilities.

Reporting Period: Quarterly period ended August 31, 1997 (Unaudited).

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

Key Financial Metrics

Material Changes vs. Prior Period

• Asset Growth: Total assets increased 3.6% ($324.6 million) from May 31, 1997, driven primarily by a $312.8 million increase in net loans and a $37.7 million increase in debt service investments.
• Profitability: Net margins increased 14.8% to $14.7 million compared to $12.8 million in the prior year quarter. This was aided by a $4.9 million non-operating gain on the sale of land.
• Loan Portfolio: Average loans outstanding increased by $1,056.0 million year-over-year. However, the average yield decreased 6 basis points to 6.54%, while the cost of funds increased 11 basis points to 5.56%.
• Equity Reduction: Members' Equity decreased by $36.8 million from the prior quarter, primarily due to the retirement of $52.6 million in patronage capital, partially offset by net margins.
• Allowance for Losses: The allowance for loan and guarantee losses increased to $239.4 million (2.59% of total loans) due to an $8.3 million provision, offset by $2.1 million in charge-offs.

Outlook, Risks, and Contingencies

• Management Commentary: Management maintains a target TIER of 1.10; the current quarter achieved 1.12. The company believes its allowance for loan losses is adequate to cover potential portfolio losses.
• Liquidity: CFC maintains $5.05 billion in available revolving credit facilities. As of August 31, 1997, no borrowings were outstanding under these facilities. The company recently issued $75 million in Quarterly Income Capital Securities and $100 million in Collateral Trust Bonds subsequent to the quarter end.
• Key Contingency - Deseret Generation & Transmission: CFC has significant exposure ($667.7 million) to Deseret, including $344.3 million in secured loans (non-accrual) and $323.4 million in guarantees. Deseret is current on payments under a restructuring agreement (ORA), but CFC is involved in ongoing foreclosure litigation regarding the Bonanza Power Plant with a trial scheduled for June 1998.
• Key Contingency - Wabash Valley Power Association: CFC holds a deferred gain of $10.5 million related to a reorganization settlement. Negotiations are ongoing with the Rural Utilities Service (RUS) regarding true-up payments.
• Interest Rate Risk: CFC utilizes interest rate exchange agreements totaling $438.8 million to manage the mismatch between variable rate funding and fixed rate assets. The fixed rate gap represents 0.93% of total assets.

Investor Verification Checklist

• Deseret Restructuring: Verify the status of Deseret's compliance with the Obligations Restructuring Agreement (ORA) and the outcome of the pending Bonanza Power Plant litigation.
• Loan Quality: Confirm the stability of the $349.4 million in impaired loans and the adequacy of the $126.0 million reserve allocated specifically to these assets.
• Yield Compression: Monitor the trend of the spread between loan yields (6.54%) and cost of funds (5.56%), noting the recent compression in yield and increase in funding costs.
• Patronage Capital Retirements: Assess the impact of continued patronage capital retirements on the company's capital base and leverage ratio (currently 6.21).
• Unadvanced Commitments: Review the $6.8 billion in unadvanced loan commitments to understand potential future liquidity requirements.