NRUC

Business Context and Reporting Period

Company: National Rural Utilities Cooperative Finance Corporation (CFC), a private, not-for-profit cooperative association incorporated in the District of Columbia.

Reporting Period: Fiscal year ended May 31, 1998.

Operations: CFC provides low-cost capital and financial services to rural electric and telecommunications utility cooperatives. It supplements the loan programs of the Rural Utilities Service (RUS) and lends 100% of requirements for members electing not to borrow from RUS. The filing includes combined results for CFC and its controlled affiliates: Rural Telephone Finance Cooperative (RTFC) and Guaranty Funding Cooperative (GFC).

Membership: As of May 31, 1998, CFC had 1,052 members (903 Utility Members, 75 service members, 74 associate members). RTFC had 491 members, and GFC had 4 members.

Key Financial Metrics

Material Changes vs. Prior Period

• Loan Portfolio Growth: Net loans increased by $1.65 billion (19%) to $10.33 billion. This was driven by a $1.41 billion increase in long-term loans and a $293 million increase in line of credit loans.
• Interest Rate Mix: There was a significant shift toward fixed-rate loans. Long-term fixed-rate loans represented 53% of total long-term loans in 1998, up from 38% in 1997. Approximately $1.07 billion of loans converted from variable to fixed rates.
• Profitability: Net margins increased by $7.5 million (14%) to $62.2 million. Operating income rose 13% due to higher average loan volume and a slight increase in the average interest rate earned (6.60% vs. 6.58%).
• Cost of Funds: The average cost of funding increased to 5.60% from 5.54%, resulting in a gross operating margin of 1.00% (down from 1.04%).
• Nonperforming Assets: Nonperforming loans decreased to $4.1 million from $9.4 million. Restructured loans decreased to $330 million from $362 million.

Guidance, Outlook, and Risks

• Outlook: Management expects demand for loans to maintain its current pace, driven by RUS debt buyouts, economic strength, and member diversification. CFC anticipates modest increases in its leverage ratio as it obtains external capital to fund loan growth.
• Regulatory Environment: The company monitors the impact of the Telecommunications Act of 1996 and electric utility restructuring (customer choice laws). While rural markets are expected to be the last to see wide-scale competition, revenue reductions from access charge changes are anticipated but not expected to cause material loan losses.
• Key Risks & Contingencies:
  • Deseret Generation & Transmission Co-operative: A significant concentration of risk exists with Deseret (Utah). Total exposure was $645.7 million (36.7% of Members' Equity and allowance). Deseret is in financial difficulty, and CFC is engaged in foreclosure litigation and settlement negotiations. CFC believes it has adequately reserved for potential losses.
  • Wabash Valley Power Association: CFC has a remaining exposure of $2.2 million following a bankruptcy settlement. A deferred gain of $10.5 million exists, which may offset future true-up payments to RUS.
  • Interest Rate Risk: CFC manages this through gap analysis and interest rate swaps ($753.7 million notional amount). Approximately 2.7% of fixed-rate loans were funded with variable-rate debt at year-end.
  • Liquidity: CFC maintains $5.22 billion in revolving credit agreements to support commercial paper rollovers and guarantee obligations.

Investor Verification Checklist

• Deseret Exposure: Verify the status of the foreclosure litigation and settlement negotiations regarding Deseret Generation & Transmission Co-operative, which represents a material portion of the company's equity.
• Loan Conversion Trends: Confirm the sustainability of the shift from variable to fixed-rate loans and its impact on future interest rate risk management.
• RUS Funding Levels: Monitor congressional appropriations for RUS insured loans and guarantees, as CFC's supplemental lending volume is tied to RUS funding constraints.
• Credit Ratings: Verify that CFC maintains its investment-grade ratings (Moody's Aa3/A1, S&P AA/AA-, Fitch AA/AA-) which are critical for its cost of funding.
• Year 2000 Compliance: Confirm the completion of testing and implementation of Year 2000 compliant systems, scheduled for completion by January 1, 1999.