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 cooperatives.

Reporting Period: Quarterly Report (Form 10-Q) for the period ended November 30, 1998 (Six months ended November 30, 1998).

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

Key Financial Metrics

Liquidity & Capital: CFC maintains $4.79 billion in revolving credit agreements with no outstanding borrowings as of November 30, 1998. The leverage ratio was 6.31, and the debt-to-equity ratio was 4.63.

Material Changes vs. Prior Period

• Asset Growth: Total assets increased 14.1% ($1.5 billion) driven primarily by a 13.8% increase in loans outstanding to members.
• Loan Portfolio: Loans to electric members rose 9.9% due to construction financing and RUS debt buyouts. Loans to telecommunications members surged 36.1% due to infrastructure upgrades and competitive local exchange carrier (CLEC) ventures.
• Profitability: Net margins for the six months ended November 30, 1998, increased 20.1% to $35.7 million compared to $29.7 million in the prior year period. This was driven by a $67.9 million increase in operating income, partially offset by a higher provision for loan losses.
• Loan Loss Reserve: The allowance for loan losses increased to $264.0 million (2.19% of total loans) from $250.1 million, reflecting a $15.8 million provision and the write-off of a $2.2 million loan to Wabash Valley Power Association.
• Debt Structure: Long-term debt increased by $747.5 million, while Notes Payable (due within one year) increased by $515.5 million. CFC issued $700 million in Medium-Term Notes and $699 million in Collateral Trust Bonds.

Outlook, Risks, and Contingencies

Management Commentary & Guidance

Management targets a Times Interest Earned Ratio (TIER) of 1.10; CFC achieved 1.12 for the six months ended November 30, 1998. The company expects members to continue converting variable-rate loans to fixed rates due to the low interest rate environment. Unadvanced loan commitments increased to $10.98 billion, largely due to the "Power Vision" pre-approval program.

Significant Risks and Contingencies

• Deseret Generation & Transmission Co-operative: CFC has significant exposure ($641.6 million as of Nov 30, 1998) to Deseret, a member with restructured debt. Litigation involving Deseret's power sales contracts with the City of Riverside and City of Anaheim is ongoing. A settlement regarding the Bonanza plant was reached on December 4, 1998, involving a $94 million payment and transfer of plant ownership to Deseret. CFC advanced $276.3 million to redeem bonds related to this settlement, increasing the loan balance to Deseret.
• Interest Rate Risk: CFC manages risk through matching asset and liability repricing terms and using interest rate exchange agreements (notional amount of $2.21 billion). A fixed-rate gap analysis shows a cumulative gap of $717.3 million over the long term.
• Year 2000 Compliance: CFC has upgraded core systems and is testing applications. While internal operations are expected to be compliant, the company notes potential disruption risks from the federal wire system, capital markets, or borrower service disruptions.

Investor Verification Checklist

• Deseret Exposure: Verify the impact of the December 1998 settlement on the $606.8 million loan balance and the sufficiency of reserves for future cash flow shortfalls.
• Loan Loss Adequacy: Confirm the $264 million allowance remains sufficient given the 36% growth in telecommunications loans and the concentration of restructured loans ($330.5 million).
• Liquidity Covenants: Ensure continued compliance with the $1.36 billion minimum equity/capital requirement and the 1.025 fixed charge coverage ratio under revolving credit agreements.
• Year 2000 Status: Monitor the completion of testing for the treasury system module and borrower compliance certifications.
• Guarantees: Review the $2.01 billion in outstanding guarantees, particularly the $1.13 billion in tax-exempt bonds and $431.9 million in leveraged lease transactions.