may312008_10k.htm
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM
10-K
x ANNUAL REPORT PURSUANT
TO SECTION 13 OR 15(d) OF
THE
SECURITIES EXCHANGE ACT OF 1934
For the
fiscal year ended May 31, 2008
OR
¨ TRANSITION REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE
SECURITIES EXCHANGE ACT OF 1934
For the
transition period
from to
Commission
File Number 1-7102
NATIONAL
RURAL UTILITIES COOPERATIVE
FINANCE
CORPORATION
(Exact
name of registrant as specified in its charter)
DISTRICT
OF COLUMBIA
(State or
other jurisdiction of incorporation or organization)
52-0891669
(I.R.S.
Employer Identification Number)
2201
COOPERATIVE WAY, HERNDON, VA 20171
(Address
of principal executive offices)
(Registrant's
telephone number, including area code, is 703-709-6700)
Securities
registered pursuant to Section 12(b) of the Act:
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Name
of each
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Name
of each
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exchange
on
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exchange
on
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Title
of each class
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which
listed
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Title
of each class
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which
listed
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5.75%
Collateral Trust Bonds, due 2008
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NYSE
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7.35%
Collateral Trust Bonds, due 2026
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NYSE
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5.70%
Collateral Trust Bonds, due 2010
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NYSE
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6.75%
Subordinated Notes, due 2043
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NYSE
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7.20%
Collateral Trust Bonds, due 2015
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NYSE
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6.10%
Subordinated Notes, due 2044
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NYSE
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6.55%
Collateral Trust Bonds, due 2018
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NYSE
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5.95%
Subordinated Notes, due 2045
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NYSE
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Indicated
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes x No ¨
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes ¨ No x
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes x No ¨
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (Section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of the registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K. x
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of “large accelerated filer,”
“accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act. (Check one):
Large
accelerated filer ¨ Accelerated
filer ¨
Non-accelerated filer x Smaller
reporting company ¨
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act). Yes ¨ No x.
The
Registrant is a cooperative and consequently, does not issue any equity capital
stock.
TABLE OF CONTENTS
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Part No.
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Item No.
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Page
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I.
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1.
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Business
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1
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General
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1
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Members
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2
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Distribution
Systems
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3
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Power
Supply Systems
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3
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Service
Organizations and Associate Systems
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4
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Telecommunications
Systems
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4
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Loan
Programs
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4
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Interest
Rates on Loans
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5
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National
Rural Loan Programs
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5
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RTFC
Loan Programs
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6
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NCSC
Loan Programs
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6
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RUS
Guaranteed Loans for Rural Electric Systems
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7
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Conversion
of Loans
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7
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Prepayment
of Loans
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7
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Loan
Security
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7
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Guarantee
Programs
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7
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Guarantees
of Long-Term Tax-Exempt Bonds
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8
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Guarantees
of Tax Benefit Transfers
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8
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Letters
of Credit
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8
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Other
Guarantees
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8
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Disaster
Recovery
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9
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Tax
Status
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9
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Investment
Policy
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9
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Employees
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10
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National
Rural Lending Competition
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10
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Member
Regulation and Competition
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10
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The
RUS Program
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12
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1A.
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Risk
Factors
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13
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1B.
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Unresolved
Staff Comments
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15
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2.
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Properties
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15
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3.
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Legal
Proceedings
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15
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4.
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Submission
of Matters to a Vote of Security Holders
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15
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II.
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5.
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Market
for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of
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Equity
Securities
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16
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6.
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Selected
Financial Data
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16
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7.
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Management's
Discussion and Analysis of Financial Condition and Results of
Operations
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17
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Business
Overview
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17
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Critical
Accounting Estimates
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19
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New
Accounting Pronouncements
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23
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Results
of Operations
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24
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Ratio
of Earnings to Fixed Charges
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33
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Financial
Condition
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33
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Off-Balance
Sheet Obligations
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41
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Liquidity
and Capital Resources
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43
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Market
Risk
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46
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Non-GAAP
Financial Measures
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51
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7A.
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Quantitative
and Qualitative Disclosures About Market Risk
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55
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8.
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Financial
Statements and Supplementary Data
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55
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9.
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Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure
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55
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9A(T).
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Controls
and Procedures
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55
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9B.
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Other
Information
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56
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III.
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10.
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Directors,
Executive Officers and Corporate Governance
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57
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11.
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Executive
Compensation
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62
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12.
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Security
Ownership of Certain Beneficial Owners and Management and Related
Stockholder
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Matters
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72
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13.
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Certain
Relationships and Related Transactions, and Director
Independence
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72
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14.
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Principal
Accountant Fees and Services
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74
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IV.
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15.
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Exhibits
and Financial Statement Schedules
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75
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Signatures
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78
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CAUTIONARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS
This
Form 10-K contains forward-looking statements within the meaning of the
Securities Act of 1933, as amended, and the Exchange Act of 1934, as
amended. Forward-looking statements, which are based on certain
assumptions and describe our future plans, strategies and expectations, are
generally identified by our use of words such as "intend," "plan," "may,"
"should," "will," "project," "estimate," "anticipate," "believe," "expect,"
"continue," "potential," "opportunity," and similar expressions, whether in the
negative or affirmative. All statements that address expectations or projections
about the future, including statements about loan growth, the adequacy of the
loan loss allowance, net income growth, leverage and debt to equity ratios, and
borrower financial performance are forward-looking
statements. Although we believe that the expectations reflected in
our forward-looking statements are based on reasonable assumptions, actual
results and performance could differ materially from those set forth in the
forward-looking statements. Factors that could cause future results
to vary from current expectations include, but are not limited to, general
economic conditions, legislative changes, governmental monetary and fiscal
policies, changes in tax policies, changes in interest rates, the interest
expense, demand for our loan products, changes in the quality or composition of
our loan and investment portfolios, changes in accounting principles, policies
or guidelines, and other economic and governmental factors affecting our
operations. Some of these and other factors are discussed in our
annual and quarterly reports previously filed with the Securities and Exchange
Commission ("SEC"). Except as required by law, we undertake no
obligation to update or publicly release any revisions to forward-looking
statements to reflect events, circumstances or changes in expectations after the
date on which the statement is made.
The
information contained in this section should be read in conjunction with our
consolidated financial statements and related notes and the information
contained elsewhere in this Form 10-K, including that set forth under
Item 1A, Risk Factors.
PART
I
Item
1. Business.
General
National
Rural Utilities Cooperative Finance Corporation ("National Rural" or "the
Company") is a private, not-for-profit cooperative association incorporated
under the laws of the District of Columbia in April 1969. The
principal purpose of National Rural is to provide its members with a source of
financing to supplement the loan programs of the Rural Utilities Service ("RUS")
of the United States Department of Agriculture. National Rural makes
loans to its rural utility system members ("utility members") to enable them to
acquire, construct and operate electric distribution, generation, transmission
and related facilities. National Rural also provides its members with
credit enhancements in the form of letters of credit and guarantees of debt
obligations. National Rural is exempt from payment of federal income
taxes under the provisions of Section 501(c)(4) of the Internal Revenue
Code. National Rural is a not-for-profit member-owned finance
cooperative, thus its objective is not to maximize its net income, but to offer
its members low cost financial products and services consistent with sound
financial management. National Rural’s internet address is www.nrucfc.coop,
where under "Investors," copies can be found of this annual report on Form 10-K,
quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments
thereto, all of which National Rural makes available, free of charge, as soon as
reasonably practicable after the report is filed with the
SEC. Information posted on National Rural’s website is not
incorporated by reference into this Form 10-K.
For
financial statement purposes, the results of operations and financial condition
of National Rural are consolidated with and include Rural Telephone Finance
Cooperative ("RTFC") and National Cooperative Services Corporation
("NCSC"). Unless stated otherwise, references to the Company relate
to the consolidation of National Rural, RTFC, NCSC and certain entities
controlled by National Rural and created to hold foreclosed assets and effect
loan securitization transactions. National Rural also reports the
operations for each of National Rural, RTFC and NCSC as separate
segments. See Note 17 to the consolidated financial
statements for further information on the Company’s segment
reporting.
RTFC is a
private not-for-profit cooperative association originally incorporated in the
state of South Dakota in 1987 and reincorporated in the District of Columbia in
2005. The principal purpose of RTFC is to provide and arrange
financing for its rural telecommunications members and their
affiliates. National Rural is the sole lender to and manages the
lending and financial affairs of RTFC through a long-term management
agreement. Under a guarantee agreement, RTFC pays National Rural a
fee in exchange for which National Rural reimburses RTFC for loan
losses. RTFC is headquartered with National Rural in Herndon,
Virginia. RTFC is a taxable cooperative that pays income tax based on
its net income, excluding net income allocated to its members, as allowed by law
under Subchapter T of the Internal Revenue Code.
NCSC was
incorporated in 1981 in the District of Columbia as a private non-profit
cooperative association. The principal purpose of NCSC is to provide
financing to the for-profit and non-profit entities that are owned, operated or
controlled by, or provide substantial benefit to, members of National
Rural. NCSC also markets, through its cooperative members, a consumer
loan program for home improvements and an affinity credit card
program. NCSC's membership consists of National Rural and
distribution systems that are members of National Rural or are eligible for such
membership. National Rural is the primary source of funding to and
manages the lending and financial affairs of NCSC through a management agreement
which
is
automatically renewable on an annual basis unless terminated by either
party. Under a guarantee agreement, NCSC pays National Rural a fee in
exchange for which National Rural reimburses NCSC for loan losses, excluding
losses in the consumer loan program. NCSC is headquartered with
National Rural in Herndon, Virginia. NCSC is a taxable
corporation.
Members
The
Company's consolidated membership was 1,538 as of May 31, 2008 including 898
utility members, the majority of which are consumer-owned electric cooperatives,
511 telecommunications members, 66 service members and 63 associates in 49
states, the District of Columbia and two U.S. territories. The
utility members included 829 distribution systems and 69 generation and
transmission ("power supply") systems. Memberships between National
Rural, RTFC and NCSC have been eliminated in consolidation.
National
Rural currently has four classes of electric members:
·
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Class
A - cooperative or not-for-profit distribution
systems;
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·
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Class
B - cooperative or not-for-profit power supply
systems;
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·
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Class
C - statewide and regional associations wholly-owned or controlled by
Class A or Class B members; and
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·
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Class
D - national associations of
cooperatives.
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Class A
membership in National Rural is limited to cooperative or not-for-profit
distribution systems that receive or are eligible to receive loans or other
assistance from RUS. The associates are not-for-profit entities
organized on a cooperative basis which are owned, controlled or operated by
Class A, B or C members and which provide non-electric services primarily for
the benefit of ultimate consumers. Associates are not entitled to
vote at any meeting of the members and are not eligible to be represented on
National Rural’s board of directors. All references to members within
this document include members and associates.
Membership
in RTFC is limited to commercial (for-profit) or cooperative (not-for-profit)
telecommunications systems that receive or are eligible to receive loans or
other assistance from RUS, and that are engaged (or plan to be engaged) in
providing telecommunications services to ultimate users.
Membership
in NCSC is limited to National Rural and organizations that are Class A members
of National Rural or are eligible to be Class A members of National
Rural.
In many
cases, the residential and commercial customers of National Rural’s electric
members are also the customers of RTFC's telecommunications members, as the
service territories of the electric and telecommunications members overlap in
many of the rural areas of the United States.
Set forth
below is a table showing by state or U.S. territory the total number of National
Rural, RTFC and NCSC members, the percentage of total loans and the percentage
of total loans and guarantees outstanding at May 31, 2008.
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Number
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Loan
and
|
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Number
|
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Loan
and
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of
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|
Loan
|
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Guarantee
|
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|
of
|
|
Loan
|
|
Guarantee
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State/Territory
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Members
|
|
%
|
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%
|
|
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State/Territory
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Members
|
|
%
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|
%
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Alabama
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|
|
30
|
|
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2.18
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%
|
|
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2.43
|
%
|
|
|
Missouri
|
|
|
65
|
|
|
|
3.59
|
%
|
|
|
3.78
|
%
|
Alaska
|
|
|
30
|
|
|
|
1.96
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%
|
|
|
1.86
|
%
|
|
|
Montana
|
|
|
40
|
|
|
|
0.70
|
%
|
|
|
0.71
|
%
|
American
Samoa
|
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
|
|
Nebraska
|
|
|
40
|
|
|
|
0.10
|
%
|
|
|
0.09
|
%
|
Arizona
|
|
|
27
|
|
|
|
1.09
|
%
|
|
|
1.20
|
%
|
|
|
Nevada
|
|
|
7
|
|
|
|
0.82
|
%
|
|
|
0.80
|
%
|
Arkansas
|
|
|
30
|
|
|
|
2.74
|
%
|
|
|
2.64
|
%
|
|
|
New
Hampshire
|
|
|
4
|
|
|
|
0.75
|
%
|
|
|
0.88
|
%
|
California
|
|
|
11
|
|
|
|
0.14
|
%
|
|
|
0.16
|
%
|
|
|
New
Jersey
|
|
|
1
|
|
|
|
0.09
|
%
|
|
|
0.09
|
%
|
Colorado
|
|
|
39
|
|
|
|
4.95
|
%
|
|
|
4.96
|
%
|
|
|
New
Mexico
|
|
|
25
|
|
|
|
0.19
|
%
|
|
|
0.19
|
%
|
Connecticut
|
|
|
1
|
|
|
|
1.05
|
%
|
|
|
1.00
|
%
|
|
|
New
York
|
|
|
21
|
|
|
|
0.10
|
%
|
|
|
0.10
|
%
|
Delaware
|
|
|
1
|
|
|
|
0.20
|
%
|
|
|
0.19
|
%
|
|
|
North
Carolina
|
|
|
42
|
|
|
|
2.56
|
%
|
|
|
2.93
|
%
|
District
of Columbia
|
|
|
4
|
|
|
|
0.05
|
%
|
|
|
0.13
|
%
|
|
|
North
Dakota
|
|
|
33
|
|
|
|
0.36
|
%
|
|
|
0.38
|
%
|
Florida
|
|
|
19
|
|
|
|
3.56
|
%
|
|
|
3.39
|
%
|
|
|
Ohio
|
|
|
42
|
|
|
|
2.39
|
%
|
|
|
2.31
|
%
|
Georgia
|
|
|
68
|
|
|
|
8.24
|
%
|
|
|
7.94
|
%
|
|
|
Oklahoma
|
|
|
49
|
|
|
|
2.54
|
%
|
|
|
2.41
|
%
|
Guam
|
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
|
|
Oregon
|
|
|
39
|
|
|
|
1.59
|
%
|
|
|
1.66
|
%
|
Hawaii
|
|
|
1
|
|
|
|
0.04
|
%
|
|
|
0.04
|
%
|
|
|
Pennsylvania
|
|
|
26
|
|
|
|
1.88
|
%
|
|
|
1.87
|
%
|
Idaho
|
|
|
17
|
|
|
|
0.83
|
%
|
|
|
0.80
|
%
|
|
|
South
Carolina
|
|
|
38
|
|
|
|
2.55
|
%
|
|
|
2.45
|
%
|
Illinois
|
|
|
52
|
|
|
|
3.16
|
%
|
|
|
2.99
|
%
|
|
|
South
Dakota
|
|
|
46
|
|
|
|
0.78
|
%
|
|
|
0.74
|
%
|
Indiana
|
|
|
52
|
|
|
|
2.79
|
%
|
|
|
2.64
|
%
|
|
|
Tennessee
|
|
|
29
|
|
|
|
0.57
|
%
|
|
|
0.54
|
%
|
Iowa
|
|
|
118
|
|
|
|
2.44
|
%
|
|
|
2.36
|
%
|
|
|
Texas
|
|
|
108
|
|
|
|
16.00
|
%
|
|
|
16.14
|
%
|
Kansas
|
|
|
49
|
|
|
|
4.62
|
%
|
|
|
4.68
|
%
|
|
|
Utah
|
|
|
11
|
|
|
|
3.00
|
%
|
|
|
2.91
|
%
|
Kentucky
|
|
|
33
|
|
|
|
1.91
|
%
|
|
|
2.33
|
%
|
|
|
Vermont
|
|
|
7
|
|
|
|
0.39
|
%
|
|
|
0.38
|
%
|
Louisiana
|
|
|
17
|
|
|
|
1.76
|
%
|
|
|
1.67
|
%
|
|
|
Virgin
Islands
|
|
|
-
|
|
|
|
2.58
|
%
|
|
|
2.45
|
%
|
Maine
|
|
|
6
|
|
|
|
0.02
|
%
|
|
|
0.02
|
%
|
|
|
Virginia
|
|
|
27
|
|
|
|
1.24
|
%
|
|
|
1.19
|
%
|
Maryland
|
|
|
2
|
|
|
|
1.18
|
%
|
|
|
1.18
|
%
|
|
|
Washington
|
|
|
19
|
|
|
|
0.65
|
%
|
|
|
0.71
|
%
|
Massachusetts
|
|
|
1
|
|
|
|
-
|
|
|
|
-
|
|
|
|
West
Virginia
|
|
|
4
|
|
|
|
0.03
|
%
|
|
|
0.03
|
%
|
Michigan
|
|
|
27
|
|
|
|
1.39
|
%
|
|
|
1.33
|
%
|
|
|
Wisconsin
|
|
|
62
|
|
|
|
2.02
|
%
|
|
|
1.92
|
%
|
Minnesota
|
|
|
74
|
|
|
|
3.45
|
%
|
|
|
3.28
|
%
|
|
|
Wyoming
|
|
|
15
|
|
|
|
0.70
|
%
|
|
|
0.73
|
%
|
Mississippi
|
|
|
27
|
|
|
|
2.08
|
%
|
|
|
2.39
|
%
|
|
|
Total
|
|
|
1,538
|
|
|
|
100.00
|
%
|
|
|
100.00
|
%
|
Distribution
Systems
Distribution
systems are utilities engaged in retail sales of electricity to consumers in
their service areas. Most distribution systems have all-requirements
power purchase contracts with their power supply systems, which are owned and
controlled by the member distribution systems. Wholesale power for
resale also comes from other sources, including power supply contracts with
government agencies, investor-owned utilities and other entities, and in rare
cases, the distribution system's own generating facilities.
Wholesale
power supply contracts ordinarily guarantee neither an uninterrupted supply nor
a constant cost of power. Contracts with RUS-financed power supply
systems (which generally require the distribution system to purchase all its
power requirements from the power supply system) provide for rate increases to
pass along increases in sellers' costs. The wholesale power contracts
permit the power supply system, subject to approval by RUS and, in certain
circumstances, regulatory agencies, to establish rates to its members so as to
produce revenues sufficient, with revenues from all other sources, to meet the
costs of operation and maintenance (including replacements, insurance, taxes and
administrative and general overhead expenses) of all generating, transmission
and related facilities, to pay the cost of any power and energy purchased for
resale, to pay the costs of generation and transmission, to make all payments on
account of all indebtedness and lease obligations of the power supply system and
to provide for the establishment and maintenance of reasonable
reserves. The board of directors of the power supply system may
review the rates under the wholesale power contracts at least
annually.
Power
contracts with investor-owned utilities and power supply systems which do not
borrow from RUS generally have rates subject to regulation by the Federal Energy
Regulatory Commission ("FERC"). Contracts with federal agencies
generally permit rate changes by the selling agency (subject, in some cases, to
federal regulatory approval).
Power
Supply Systems
Power
supply systems are utilities that purchase or generate electric power and
provide it on a wholesale basis to distribution systems for delivery to the
ultimate retail consumer. Of the 61 operating power supply systems
that have financing commitments from National Rural at December 31, 2007 (the
most recent year for which data is available as of the date of filing this Form
10-K), 37 had generating capacity of at least 100 megawatts, 7 had less than 100
megawatts of generating capacity and 17 had no generating
capacity. The systems with no generating capacity generally operated
transmission lines to
supply
certain distribution systems. Certain other power supply systems have
been formed but do not yet own generating or transmission facilities or have
financing commitments from National Rural.
Service
Organizations and Associate Systems
Service
organizations include National Rural Electric Cooperative Association ("NRECA"),
statewide and regional cooperative associations. NRECA represents
cooperatives nationally.
Associates
include organizations that are owned, controlled or operated by Class A, B or C
members and that provide non-electric services primarily for the benefit of
ultimate consumers.
Telecommunications
Systems
Telecommunications
systems include not-for-profit cooperative organizations and for-profit
commercial organizations that primarily provide local exchange and access
telecommunications services to rural areas.
Independent
rural telecommunications companies provide service throughout many of the rural
areas of the United States. These companies, which number
approximately 1,300, are called independent because they are not affiliated with
Verizon, AT&T or Qwest. Included in the 1,300 total are
approximately 250 not-for-profit cooperative telecommunications
companies. The remainder of these independent rural
telecommunications companies are family-owned or privately-held commercial
companies. Approximately 20 of these commercial companies are
publicly traded or issue bonds publicly.
Rural
telecommunications companies, including all local exchange carriers ("LECs")
other than Verizon, AT&T, Qwest, Cincinnati Bell and Embarq (formerly
Sprint's local exchange properties) comprise less than 15% of a local exchange
telecommunications industry that provides service to over 172 million access
lines. These rural companies range in size from fewer than 100
customers to more than one million. Rural telecommunications
companies' annual operating revenues range from less than $100,000 to over $2
billion. In addition to basic local exchange and access
telecommunications service, most independents offer other communications
services including wireless telephone, cable television and internet
access. Most rural telecommunications companies' networks incorporate
digital switching, fiber optics, internet protocol telephony and other advanced
technologies.
Loan
Programs
Set forth
below is a table showing the weighted average loans outstanding to borrowers and
the weighted average interest rates thereon by loan program and by segment
during fiscal years ended May 31:
|
|
2008
|
|
2007
|
|
|
Weighted
average
|
|
Weighted
average
|
|
Weighted
average
|
|
Weighted
average
|
|
|
loans
outstanding
|
|
interest
rate
|
|
loans
outstanding
|
|
interest
rate
|
(Dollar
amounts in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by loan type: (1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
|
$
|
14,573,227
|
|
|
6.05
|
%
|
|
$
|
14,323,272
|
|
|
5.87
|
%
|
Long-term
variable rate loans
|
|
|
1,170,017
|
|
|
6.94
|
%
|
|
|
1,433,484
|
|
|
7.58
|
%
|
Loans
guaranteed by RUS
|
|
|
252,788
|
|
|
5.49
|
%
|
|
|
258,407
|
|
|
5.59
|
%
|
Short-term
loans
|
|
|
1,310,313
|
|
|
5.89
|
%
|
|
|
1,028,585
|
|
|
7.06
|
%
|
Non-performing
loans
|
|
|
504,310
|
|
|
0.01
|
%
|
|
|
534,733
|
|
|
0.02
|
%
|
Restructured
loans
|
|
|
589,662
|
|
|
0.64
|
%
|
|
|
614,580
|
|
|
0.61
|
%
|
Total
loans
|
|
$
|
18,400,317
|
|
|
5.81
|
%
|
|
$
|
18,193,061
|
|
|
5.79
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
|
$
|
16,167,441
|
|
|
5.85
|
%
|
|
$
|
15,803,285
|
|
|
5.80
|
%
|
RTFC
|
|
|
1,791,100
|
|
|
4.97
|
%
|
|
|
1,993,672
|
|
|
5.30
|
%
|
NCSC
|
|
|
441,776
|
|
|
7.68
|
%
|
|
|
396,104
|
|
|
8.00
|
%
|
Total
|
|
|
$
|
18,400,317
|
|
|
5.81
|
%
|
|
$
|
18,193,061
|
|
|
5.79
|
%
|
(1) Loans
are classified as long-term or short-term based on their original
maturity.
Total
loans outstanding by state or U.S. territory based on the location of the
system's headquarters are summarized below at
May
31:
(in
thousands)
|
|
|
|
|
|
|
State/Territory
|
|
2008
|
|
2007
|
|
2006
|
|
State/Territory
|
|
2008
|
|
2007
|
|
2006
|
|
Alabama
|
$
|
414,961
|
|
|
$
|
347,723
|
|
|
$
|
355,420
|
|
|
|
Montana
|
$
|
133,655
|
|
|
$
|
132,603
|
|
|
$
|
147,731
|
|
|
Alaska
|
|
371,768
|
|
|
|
335,352
|
|
|
|
333,716
|
|
|
|
Nebraska
|
|
18,756
|
|
|
|
16,447
|
|
|
|
14,149
|
|
|
American
Samoa
|
|
769
|
|
|
|
769
|
|
|
|
1,604
|
|
|
|
Nevada
|
|
155,625
|
|
|
|
147,401
|
|
|
|
137,701
|
|
|
Arizona
|
|
206,558
|
|
|
|
178,659
|
|
|
|
169,754
|
|
|
|
New
Hampshire
|
|
143,417
|
|
|
|
149,496
|
|
|
|
164,651
|
|
|
Arkansas
|
|
522,018
|
|
|
|
518,273
|
|
|
|
549,552
|
|
|
|
New
Jersey
|
|
17,747
|
|
|
|
18,217
|
|
|
|
18,211
|
|
|
California
|
|
25,968
|
|
|
|
27,283
|
|
|
|
24,362
|
|
|
|
New
Mexico
|
|
36,636
|
|
|
|
32,344
|
|
|
|
36,528
|
|
|
Colorado
|
|
942,179
|
|
|
|
922,558
|
|
|
|
876,100
|
|
|
|
New
York
|
|
19,735
|
|
|
|
19,844
|
|
|
|
21,782
|
|
|
Connecticut
|
|
200,000
|
|
|
|
200,000
|
|
|
|
200,000
|
|
|
|
North
Carolina
|
|
487,249
|
|
|
|
519,214
|
|
|
|
522,194
|
|
|
Delaware
|
|
37,950
|
|
|
|
39,582
|
|
|
|
23,842
|
|
|
|
North
Dakota
|
|
69,120
|
|
|
|
77,072
|
|
|
|
77,002
|
|
|
District
of Columbia
|
|
9,514
|
|
|
|
9,717
|
|
|
|
9,908
|
|
|
|
Ohio
|
|
455,491
|
|
|
|
390,350
|
|
|
|
410,346
|
|
|
Florida
|
|
677,365
|
|
|
|
617,010
|
|
|
|
659,416
|
|
|
|
Oklahoma
|
|
483,623
|
|
|
|
480,536
|
|
|
|
490,351
|
|
|
Georgia
|
|
1,567,108
|
|
|
|
1,566,308
|
|
|
|
1,557,675
|
|
|
|
Oregon
|
|
303,166
|
|
|
|
305,506
|
|
|
|
305,961
|
|
|
Hawaii
|
|
6,804
|
|
|
|
7,157
|
|
|
|
7,500
|
|
|
|
Pennsylvania
|
|
357,337
|
|
|
|
376,193
|
|
|
|
438,914
|
|
|
Idaho
|
|
157,703
|
|
|
|
168,253
|
|
|
|
165,035
|
|
|
|
South
Carolina
|
|
484,733
|
|
|
|
476,139
|
|
|
|
501,990
|
|
|
Illinois
|
|
600,571
|
|
|
|
543,389
|
|
|
|
509,391
|
|
|
|
South
Dakota
|
|
147,916
|
|
|
|
161,247
|
|
|
|
169,335
|
|
|
Indiana
|
|
530,008
|
|
|
|
481,243
|
|
|
|
432,953
|
|
|
|
Tennessee
|
|
107,575
|
|
|
|
96,073
|
|
|
|
111,043
|
|
|
Iowa
|
|
465,056
|
|
|
|
482,513
|
|
|
|
468,236
|
|
|
|
Texas
|
|
3,044,117
|
|
|
|
2,618,010
|
|
|
|
2,877,586
|
|
|
Kansas
|
|
878,630
|
|
|
|
849,864
|
|
|
|
593,670
|
|
|
|
Utah
|
|
570,971
|
|
|
|
565,768
|
|
|
|
580,472
|
|
|
Kentucky
|
|
363,720
|
|
|
|
355,503
|
|
|
|
335,551
|
|
|
|
Vermont
|
|
74,957
|
|
|
|
75,905
|
|
|
|
81,761
|
|
|
Louisiana
|
|
333,984
|
|
|
|
320,765
|
|
|
|
382,505
|
|
|
|
Virgin
Islands
|
|
491,706
|
|
|
|
492,795
|
|
|
|
488,392
|
|
|
Maine
|
|
4,566
|
|
|
|
9,884
|
|
|
|
11,737
|
|
|
|
Virginia
|
|
235,916
|
|
|
|
184,986
|
|
|
|
209,153
|
|
|
Maryland
|
|
224,754
|
|
|
|
206,491
|
|
|
|
176,797
|
|
|
|
Washington
|
|
122,674
|
|
|
|
110,907
|
|
|
|
102,128
|
|
|
Michigan
|
|
265,116
|
|
|
|
271,541
|
|
|
|
294,162
|
|
|
|
West
Virginia
|
|
6,109
|
|
|
|
5,355
|
|
|
|
7,700
|
|
|
Minnesota
|
|
655,576
|
|
|
|
731,883
|
|
|
|
744,941
|
|
|
|
Wisconsin
|
|
384,748
|
|
|
|
369,427
|
|
|
|
348,351
|
|
|
Mississippi
|
|
395,423
|
|
|
|
366,989
|
|
|
|
426,634
|
|
|
|
Wyoming
|
|
133,087
|
|
|
|
117,374
|
|
|
|
117,098
|
|
|
Missouri
|
|
682,860
|
|
|
|
630,289
|
|
|
|
669,914
|
|
|
|
Total
|
$
|
19,026,995
|
|
|
$
|
18,128,207
|
|
|
$
|
18,360,905
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The
Company's loan portfolio is widely dispersed throughout the United States and
its territories, including 48 states, the District of Columbia, American Samoa
and the U.S. Virgin Islands. At May 31, 2008, 2007 and 2006, loans
outstanding to borrowers located in any one state or territory did not exceed
16%, 15% and 16%, respectively, of total loans outstanding.
Interest
Rates on Loans
National
Rural’s goal as a not-for-profit cooperatively-owned finance company is to set
rates at levels that will provide its members with low cost financing while
maintaining sound financial results as required to obtain high credit ratings on
its debt instruments. National Rural sets its interest rates
primarily based on its cost of funding, as well as general and administrative
expenses, the loan loss provision and a reasonable level of
earnings. Various discounts, which reduce the stated interest rates,
are available to borrowers meeting certain criteria related to business type,
performance, volume and whether National Rural is their sole mortgage
holder.
National
Rural Loan Programs
Long-Term
Loans
Long-term
loans are generally for terms of up to 35 years and can be either amortizing or
bullet loans with serial payment structures. These loans finance
electric plant and equipment which typically have a useful life equal to or in
excess of the loan maturity. A borrower can select a fixed interest
rate for periods of one to 35 years or a variable rate. Upon the
expiration of the selected fixed interest rate term, the borrower may select
another fixed rate term or the variable rate. National Rural sets
long-term fixed rates daily and the long-term variable rate is set on the first
business day of each month. The fixed rate on a loan is determined on
the day the loan is advanced or repriced based on the rate term
selected. A borrower may divide its loan into various
tranches. The borrower then has the option of selecting a fixed or
variable interest rate for each tranche.
In
addition to National Rural’s customary loan standards, to be eligible for
long-term loan advances, distribution systems generally must maintain an average
modified debt service coverage ratio ("MDSC"), as defined in the loan agreement,
of 1.35 or greater. Similarly, power supply systems generally must
maintain an average times interest earned ratio ("TIER") and MDSC, as defined in
the loan agreement, of 1.0 or greater. These are general guidelines
only and National Rural has in the past and may in the future make long-term
loans to distribution and power supply systems that do not meet these
criteria.
Short-Term
Loans
National
Rural’s short-term loans are line of credit loans and generally are advanced
only at a variable interest rate. The line of credit variable
interest rate is set on the first business day of each month. The
principal amount of line of credit loans with maturities of greater than one
year generally must be paid down to a zero outstanding principal balance for
five consecutive days during each 12-month period.
Interim
financing line of credit loans are also made available to National Rural members
that have a loan application pending with RUS and have received approval from
RUS to obtain interim financing. Advances under these interim
facilities are made with the agreement that they will be repaid with advances
from RUS long-term loans.
RTFC
Loan Programs
The RTFC
loan portfolio is concentrated in the core rural local exchange carrier ("RLEC")
segment of the telecommunications market. Most of these RLECs have
evolved from solely being voice service providers to being providers of voice,
data and, often times, video and wireless services. RLECs are
characterized by the low population density of their service
territories. Services are generally delivered over networks that
include fiber optic cable and digital switching. There is generally a
significant barrier to competitive entry.
The
businesses to which the remaining RTFC loans have been made generally support
the operations of the RLECs and are owned, operated or controlled by
RLECs. Many such loans are supported by payment guarantees from the
sponsoring RLECs.
Long-Term
Loans
RTFC
makes long-term loans to rural telecommunications companies and their affiliates
for the acquisition, construction or upgrade of wireline telecommunications
systems, wireless telecommunications systems, fiber optic networks, cable
television systems and other corporate purposes. Long-term loans are
generally for periods not exceeding 15 years. Loans may be advanced
at a fixed or variable interest rate. Fixed rates are generally
available for periods from one year to the final loan maturity. Upon
the expiration of the selected fixed interest rate term, the borrower may select
another fixed rate term or a variable rate. Long-term fixed rates for
telecommunications loans are set daily and the long-term variable rate is set on
the first business day of each month. The fixed rate on a loan is
determined on the day the loan is advanced or converted to a fixed rate based on
the term selected. A borrower may divide its loan into various
tranches. The borrower then has the option of selecting a fixed or
variable interest rate for each tranche.
To borrow
from RTFC, a wireline telecommunications system generally must be able to
demonstrate the ability to achieve and maintain an annual debt service coverage
ratio ("DSC") and an annual TIER of 1.25 and 1.50, respectively. To
borrow from RTFC, a cable television system, fiber optic network or wireless
telecommunications system generally must be able to demonstrate the ability to
achieve and maintain an annual DSC of 1.25. Loans made to start-up
ventures using emerging technologies are evaluated based on the quality of the
business plan, experience of the management team and the level and quality of
credit support from established companies. Based on the business
plan, specific covenants are developed for each transaction which require
performance at levels deemed sufficient to repay the RTFC obligations under the
approved terms.
Short-Term
Loans
RTFC
provides line of credit loans to telecommunications systems for periods
generally not to exceed five years. These line of credit loans are
typically revolving facilities and generally require the borrower to pay off the
principal balance for five consecutive business days at least once during each
12-month period. These line of credit loans may be provided on a
secured or unsecured basis and are designed primarily to assist borrowers with
liquidity and cash management.
Interim
financing line of credit loans are also made available to RTFC members that have
a loan application pending with RUS and have received approval from RUS to
obtain interim financing. These loans are for terms up to 24 months
and the borrower must repay the RTFC loan with advances from the RUS long-term
loans.
NCSC
Loan Programs
NCSC
makes long-term and short-term loans to rural utility members and organizations
affiliated with its members. Loans may be secured or
unsecured. The loans to the affiliated organizations may have a
guarantee of repayment to NCSC from the National Rural member cooperative with
which it is affiliated.
Lease
and General Loan Program
NCSC
provided financing for the purchase of utility plant and/or related equipment,
in some cases by a third party in a sale/leaseback
transaction. Collateral for these loans consists of a mortgage on the
leased asset, utility plant and/or related equipment. NCSC is not a
party to these lease agreements. NCSC no longer provides new
financing of this type.
Associate
Member Loan Program
NCSC
provides financing to for-profit or not-for-profit affiliated entities of member
cooperatives for economic and community development
purposes. Collateral for these loans generally consists of a first
mortgage lien on the assets of the associate member and/or project. These loans
are also generally guaranteed by the sponsoring cooperative.
RUS
Guaranteed Loans for Rural Electric Systems
National
Rural may participate as an eligible lender in the RUS loan guarantee program
under the terms and conditions of a master loan guarantee and servicing
agreement between RUS and National Rural. Under this agreement,
National Rural may make long-term secured loans to eligible members for periods
of up to 35 years, at fixed or variable rates established by National
Rural. RUS guarantees the principal and interest payments on the
notes evidencing such loans. At May 31, 2008, National Rural had $215
million of loans outstanding under this program. In addition, at May
31, 2008, National Rural was holding certificates totaling $35 million
representing interests in trusts holding RUS guaranteed loans.
Conversion
of Loans
A
borrower may convert a long-term loan from a variable interest rate to a fixed
interest rate at any time without a fee. Such conversion will be
effective on the first day of the following month. Generally, a borrower may
convert from a fixed rate to another fixed rate or to a variable rate at any
time, subject to a fee in most instances. The fee on the conversion
of a fixed interest rate to a variable interest rate is 25 basis points plus a
make-whole premium, if applicable, per current loan policies.
Prepayment
of Loans
Generally,
borrowers may prepay long-term loans at any time, subject to the payment of a
prepayment fee of 33 to 50 basis points and a make-whole premium, if
applicable. Line of credit loans may be repaid at any time without a
premium if in variable interest rate mode.
Loan
Security
Except
when providing short-term loans, the Company typically lends to its members on a
senior secured basis. Long-term loans are typically secured on a
parity with other secured lenders (primarily RUS), if any, by all assets and
revenues of the borrower with exceptions typical in utility
mortgages. Short-term loans are generally unsecured lines of
credit.
The
following tables summarize the Company's secured and unsecured loans outstanding
by loan program and by segment at May 31:
(Dollar
amounts in thousands)
|
|
2008
|
|
2007
|
Total
by loan program:
|
|
Secured
|
|
%
|
|
Unsecured
|
|
%
|
|
Secured
|
|
%
|
|
Unsecured
|
|
%
|
|
Long-term
fixed rate loans
|
$
|
14,732,058
|
|
97%
|
$
|
472,556
|
|
3%
|
$
|
14,180,956
|
|
97%
|
$
|
482,384
|
|
3%
|
|
Long-term
variable rate loans
|
|
1,728,803
|
|
92%
|
|
153,292
|
|
8%
|
|
1,865,821
|
|
94%
|
|
127,713
|
|
6%
|
|
Loans
guaranteed by RUS
|
|
250,169
|
|
100%
|
|
-
|
|
-
|
|
255,903
|
|
100%
|
|
-
|
|
-
|
|
Short-term
loans
|
|
165,226
|
|
10%
|
|
1,524,891
|
|
90%
|
|
191,231
|
|
16%
|
|
1,024,199
|
|
84%
|
|
Total
loans
|
$
|
16,876,256
|
|
89%
|
$
|
2,150,739
|
|
11%
|
$
|
16,493,911
|
|
91%
|
$
|
1,634,296
|
|
9%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
15,021,067
|
|
89%
|
$
|
1,865,340
|
|
11%
|
$
|
14,462,448
|
|
92%
|
$
|
1,342,842
|
|
8%
|
|
RTFC
|
|
1,497,487
|
|
87%
|
|
229,027
|
|
13%
|
|
1,630,079
|
|
88%
|
|
230,300
|
|
12%
|
|
NCSC
|
|
357,702
|
|
86%
|
|
56,372
|
|
14%
|
|
401,384
|
|
87%
|
|
61,154
|
|
13%
|
|
Total
loans
|
$
|
16,876,256
|
|
89%
|
$
|
2,150,739
|
|
11%
|
$
|
16,493,911
|
|
91%
|
$
|
1,634,296
|
|
9%
|
Guarantee
Programs
The
Company uses the same credit policies and monitoring procedures in providing
guarantees as it does for loans and commitments. The following chart
provides a breakout of guarantees outstanding by type at May 31:
(in
thousands)
|
2008
|
|
2007
|
|
|
Long-term
tax-exempt bonds
|
$
|
498,495
|
|
|
$
|
526,185
|
|
|
|
|
|
Indemnifications
of tax benefit transfers
|
|
94,821
|
|
|
|
107,741
|
|
|
|
|
|
Letters
of credit
|
|
343,424
|
|
|
|
365,766
|
|
|
|
|
|
Other
guarantees
|
|
100,400
|
|
|
|
74,682
|
|
|
|
|
|
Total
|
$
|
1,037,140
|
|
|
$
|
1,074,374
|
|
|
|
|
|
Members'
interest expense for the years ended May 31, 2008 and 2007 on debt obligations
guaranteed by the Company was approximately $21 million and $20 million,
respectively.
Guarantees
of Long-Term Tax-Exempt Bonds
The
Company has guaranteed debt issued in connection with the construction or
acquisition by its members of pollution control, solid waste disposal,
industrial development and electric distribution
facilities. Governmental authorities issue such debt and the interest
thereon is exempt from federal taxation. The proceeds of the offering
are made available to the member system, which in turn is obligated to pay the
governmental authority amounts sufficient to service the debt. The
debt, which is guaranteed by the Company, may include short- and long-term
obligations.
In the
event of a default by a system for non-payment of debt service, the Company is
obligated to pay, after available debt service reserve funds have been
exhausted, scheduled debt service under its guarantee. The bond issue
may not be accelerated due to such non-payment by the system so long as the
Company performs under its guarantee. The system is required to
repay, on demand, any amount advanced by the Company pursuant to its
guarantee. This repayment obligation is secured on a pari passu basis
with other lenders (including, in most cases, RUS), by a lien on substantially
all of the system’s assets. If the security instrument is a common
mortgage with RUS, then in general, the Company may not exercise remedies
thereunder for up to two years following default. However, if the
debt is accelerated under the common mortgage because of a determination that
the interest thereon is not tax-exempt, the system's obligation to reimburse the
Company for any guarantee payments will be treated as a long-term
loan. The system is required to pay to the Company initial and/or
on-going guarantee fees in connection with these transactions.
Certain
guaranteed long-term debt bears interest at variable rates which are adjusted at
intervals of one to 270 days, weekly, each five weeks or semi-annually to a
level expected to permit their resale or auction at par. At the
option of the member on whose behalf it is issued, and provided funding sources
are available, rates on such debt may be fixed until
maturity. Holders have the right to tender the debt for purchase at
par at the time rates are reset when the debt bears interest at a variable rate
and the Company has committed to purchase debt so tendered if it cannot
otherwise be remarketed. If the Company held the securities, the
cooperative would pay interest to the Company at its short-term
rate. Since the inception of the program in the mid-1980s, all bonds
have been successfully remarketed and thus, the Company has not been required to
purchase any bonds. At May 31, 2008, the Company was the guarantor
and liquidity provider for $330 million of tax-exempt bonds issued for its
member cooperatives. Additionally, National Rural was the guarantor,
but not liquidity provider, for $155 million of tax-exempt bonds that were in
the auction rate mode.
Guarantees
of Tax Benefit Transfers
The
Company also has guaranteed members' obligations to indemnify against loss of
tax benefits in certain tax benefit transfers that occurred in 1981 and
1982. A member's obligation to reimburse the Company for any
guarantee payments would be treated as a long-term loan, secured on a pari passu
basis with RUS by a first lien on substantially all the member's property to the
extent of any cash received by the member at the outset of the
transaction. The remainder would be treated as a short-term loan
secured by a subordinated mortgage on substantially all of the member's
property. Due to changes in federal tax law, no guarantees of this
nature have been put in place since 1982. The maturities for this
type of guarantee run through 2015.
Letters
of Credit
The
Company issues irrevocable letters of credit to support members' obligations to
energy marketers, other third parties and to the Rural Business and Cooperative
Development Service. Letters of credit may be issued on a secured or
unsecured basis and with such issuance fees as may be determined from time to
time. Each letter of credit issued by National Rural is supported by
a reimbursement agreement with the member on whose behalf the letter of credit
was issued. In the event a beneficiary draws on a letter of credit,
the agreement generally requires the member to reimburse the Company within one
year from the date of the draw, with interest accruing from such date at the
Company's short-term variable rate of interest.
Other
Guarantees
The
Company may provide other guarantees as requested by its
members. Such guarantees may be made on a secured or unsecured basis
with guarantee fees set to cover the Company's general and administrative
expenses, a provision for losses and a reasonable margin.
The
following chart summarizes total guarantees by segment at May 31:
(Dollar
amounts in thousands)
National
Rural:
|
2008
|
|
2007
|
|
|
Distribution
|
$
|
184,459
|
|
|
|
18%
|
|
|
$
|
211,320
|
|
|
|
20%
|
|
|
|
|
|
|
|
|
|
Power
supply
|
|
786,455
|
|
|
|
76%
|
|
|
|
797,009
|
|
|
|
74%
|
|
|
|
|
|
|
|
|
|
Statewide
and associate
|
|
22,785
|
|
|
|
2%
|
|
|
|
25,359
|
|
|
|
2%
|
|
|
|
|
|
|
|
|
|
National
Rural Total
|
|
993,699
|
|
|
|
96%
|
|
|
|
1,033,688
|
|
|
|
96%
|
|
|
|
|
|
|
|
|
|
RTFC
|
|
260
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
NCSC
|
|
43,181
|
|
|
|
4%
|
|
|
|
40,686
|
|
|
|
4%
|
|
|
|
|
|
|
|
|
|
Total
|
$
|
1,037,140
|
|
|
|
100%
|
|
|
$
|
1,074,374
|
|
|
|
100%
|
|
|
|
|
|
|
|
|
|
Total
guarantees outstanding, by state and territory based on the location of the
system's headquarters, are summarized as follows at May 31:
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
State/Territory
|
|
2008
|
|
2007
|
|
2006
|
|
State/Territory
|
|
2008
|
|
2007
|
|
2006
|
|
|
|
Alabama
|
|
$
|
72,070
|
|
|
$
|
72,348
|
|
|
$
|
22,250
|
|
|
|
Montana
|
|
$
|
9,056
|
|
|
$
|
9,029
|
|
$
|
145
|
|
|
|
Alaska
|
|
|
1,900
|
|
|
|
1,900
|
|
|
|
1,800
|
|
|
|
Nebraska
|
|
|
4
|
|
|
|
6
|
|
|
-
|
|
|
|
Arizona
|
|
|
33,745
|
|
|
|
38,301
|
|
|
|
43,699
|
|
|
|
Nevada
|
|
|
5,400
|
|
|
|
5,400
|
|
|
-
|
|
|
|
Arkansas
|
|
|
8,008
|
|
|
|
12,027
|
|
|
|
15,921
|
|
|
|
New
Hampshire
|
|
|
32,767
|
|
|
|
34,550
|
|
|
9,550
|
|
|
|
California
|
|
|
6,110
|
|
|
|
1,010
|
|
|
|
-
|
|
|
|
New
Mexico
|
|
|
1,048
|
|
|
|
1,020
|
|
|
1,016
|
|
|
|
Colorado
|
|
|
53,467
|
|
|
|
54,236
|
|
|
|
55,131
|
|
|
|
North
Carolina
|
|
|
99,729
|
|
|
|
100,630
|
|
|
107,817
|
|
|
|
District
of Columbia
|
|
|
17,448
|
|
|
|
20,998
|
|
|
|
21,428
|
|
|
|
North
Dakota
|
|
|
6,474
|
|
|
|
7,115
|
|
|
-
|
|
|
|
Florida
|
|
|
3,725
|
|
|
|
4,623
|
|
|
|
100,038
|
|
|
|
Ohio
|
|
|
8,000
|
|
|
|
5,500
|
|
|
2,000
|
|
|
|
Georgia
|
|
|
26,775
|
|
|
|
26,027
|
|
|
|
35,283
|
|
|
|
Oklahoma
|
|
|
754
|
|
|
|
3,056
|
|
|
4,358
|
|
|
|
Idaho
|
|
|
3,173
|
|
|
|
3,173
|
|
|
|
-
|
|
|
|
Oregon
|
|
|
29,034
|
|
|
|
29,439
|
|
|
24,922
|
|
|
|
Illinois
|
|
|
229
|
|
|
|
219
|
|
|
|
225
|
|
|
|
Pennsylvania
|
|
|
17,416
|
|
|
|
17,519
|
|
|
18,307
|
|
|
|
Indiana
|
|
|
13
|
|
|
|
7
|
|
|
|
911
|
|
|
|
South
Carolina
|
|
|
6,300
|
|
|
|
7,819
|
|
|
50
|
|
|
|
Iowa
|
|
|
8,271
|
|
|
|
8,240
|
|
|
|
8,517
|
|
|
|
South
Dakota
|
|
|
20
|
|
|
|
6
|
|
|
-
|
|
|
|
Kansas
|
|
|
60,797
|
|
|
|
55,472
|
|
|
|
42,561
|
|
|
|
Tennessee
|
|
|
1,460
|
|
|
|
296
|
|
|
295
|
|
|
|
Kentucky
|
|
|
102,423
|
|
|
|
124,013
|
|
|
|
121,864
|
|
|
|
Texas
|
|
|
194,214
|
|
|
|
152,307
|
|
|
167,881
|
|
|
|
Louisiana
|
|
|
389
|
|
|
|
4,733
|
|
|
|
4,778
|
|
|
|
Utah
|
|
|
13,495
|
|
|
|
17,193
|
|
|
20,594
|
|
|
|
Maine
|
|
|
2
|
|
|
|
1
|
|
|
|
-
|
|
|
|
Vermont
|
|
|
1,250
|
|
|
|
3,500
|
|
|
1,250
|
|
|
|
Maryland
|
|
|
11,725
|
|
|
|
25,266
|
|
|
|
24,800
|
|
|
|
Virginia
|
|
|
3,447
|
|
|
|
3,935
|
|
|
4,133
|
|
|
|
Michigan
|
|
|
2,232
|
|
|
|
2,123
|
|
|
|
1,163
|
|
|
|
Washington
|
|
|
19,050
|
|
|
|
23,171
|
|
|
250
|
|
|
|
Minnesota
|
|
|
3,025
|
|
|
|
10,585
|
|
|
|
76,010
|
|
|
|
Wisconsin
|
|
|
320
|
|
|
|
32
|
|
|
322
|
|
|
|
Mississippi
|
|
|
83,549
|
|
|
|
88,312
|
|
|
|
37,267
|
|
|
|
Wyoming
|
|
|
13,724
|
|
|
|
13,969
|
|
|
9,370
|
|
|
|
Missouri
|
|
|
75,102
|
|
|
|
85,268
|
|
|
|
93,074
|
|
|
|
Total
|
|
$
|
1,037,140
|
|
|
$
|
1,074,374
|
|
$
|
1,078,980
|
|
|
Disaster
Recovery
The
Company has had a comprehensive disaster recovery and business continuity plan
in place since May of 2001. The plan includes a duplication of the
Company’s production information systems at an off-site facility coupled with an
extensive business recovery plan to utilize those remote systems. The Company’s
production data is replicated in real time to the recovery site 24 hours a day,
7 days a week. The plan also includes steps for each of the Company’s
operating groups to conduct business with a view to minimizing disruption for
customers. The Company has conducted Disaster Recovery exercises twice a year
that include both the information technology group and business areas. The
Company contracts with an external vendor for the facilities to house the
National Rural owned backup systems as well as office space and related office
equipment. Backup tapes are also stored at an off-site storage
location managed by an external vendor.
Tax
Status
In 1969,
National Rural obtained a ruling from the Internal Revenue Service recognizing
National Rural’s exemption from the payment of federal income taxes under
Section 501(c)(4) of the Internal Revenue Code. Such exempt status
could be revoked as a result of changes in legislation or in administrative
policy or as a result of changes in National Rural’s
business. National Rural believes that its operations have not
changed materially from those described to the Internal Revenue Service in its
exemption filing. RTFC is a taxable cooperative under Subchapter T of
the Internal Revenue Code. As long as RTFC continues to qualify under
Subchapter T of the Internal Revenue Code, it is allowed to exclude from taxable
income the amount of net income allocated to its members. RTFC pays
income tax based on its net income, excluding net income allocated to its
members. NCSC is a taxable corporation. NCSC pays income tax annually
based on its net income for the period.
Investment
Policy
Surplus
funds are invested pursuant to policies adopted by National Rural’s board of
directors. Under present policy, surplus funds may be invested in
direct obligations of, or guaranteed by, the United States or agencies thereof
or other highly liquid investment grade paper. Current investments
may include highly-rated securities such as commercial paper, obligations of
foreign governments, Eurodollar deposits, bankers' acceptances, bank letters of
credit, certificates of deposit or working capital acceptances. The
policy also permits investments in certain types of repurchase agreements with
highly rated financial institutions, whereby the assets consist of eligible
securities of a type listed above set aside in a segregated
account.
Employees
At May
31, 2008, National Rural had 231 employees, including financial and legal
personnel, management specialists, credit analysts, accountants and support
staff. National Rural believes that its relations with its employees
are good.
National
Rural Lending Competition
National
Rural competes with other lenders on price, the variety of financing options
offered and additional services provided to its
member/owners. National Rural is primarily in competition with other
banks for the business of its members. The primary bank competitor is
CoBank, ACB ("CoBank"), a government sponsored enterprise and member of the Farm
Credit System whose status as such gives it the ability to offer lower interest
rates in many situations. In addition, there are some members that
are large enough to access the capital markets for funding. In these
cases, National Rural is competing with the pricing and funding options the
member is able to obtain in the capital markets. National Rural
attempts to minimize the impact of competition by offering a variety of loan
options and complimentary services and by leveraging the working relationship
that it has developed with the majority of the members for more than 35
years.
RUS is
generally the members' first financing option as it is able to offer members
interest rates that are generally lower than the rates National Rural and the
other banks are able to offer. However, National Rural and other
banks do compete for bridge loans in anticipation of long-term funding from RUS,
the portion of a loan that RUS is not able to provide, loans to members that
cannot borrow from RUS and loans to members that have elected not to borrow from
RUS.
According
to December 31, 2006 financial data (the latest full calendar year for which
this data is available as of the date of filing this Form 10-K) provided to
National Rural by its 811 reporting electric cooperative distribution and 57
reporting power supply systems, those entities had a total of $53 billion in
long-term debt outstanding at December 31, 2006. RUS is the dominant
lender to the electric cooperative industry with $29 billion or 54% of the total
outstanding debt for the 868 systems reporting 2006 results to National
Rural. At December 31, 2006, National Rural had a total of $16
billion of long-term exposure to its distribution and power supply member
systems, including $15 billion of long-term loans and $1 billion of
guarantees. National Rural’s $16 billion long-term exposure
represented 30% of the total long-term debt to these electric
systems. The remaining $9 billion or 16% was borrowed from other
sources.
At
December 31, 2007, CFC had a total of $16 billion of long-term exposure to its
distribution and power supply member systems, including $15 billion of long-term
loans and $1 billion of guarantees.
The
competitive market for providing credit to the rural telecommunications industry
is difficult to quantify, since many rural telecommunications companies are not
RUS borrowers. At December 31, 2007, RUS had a total of approximately
$3.7 billion outstanding to telecommunications borrowers. The Rural
Telephone Bank ("RTB") was fully liquidated in November 2007 which resulted in
the transfer of the RTB loan portfolio to RUS. RTFC is not in direct
competition with RUS, but rather competes with other lenders for supplemental
lending and for the full lending requirement of the rural telecommunications
companies that have decided not to borrow from RUS or for projects not eligible
for RUS financing. RTFC's competition includes commercial banks,
CoBank and insurance companies. At December 31, 2007, RTFC had a
total of $1.7 billion in long-term loans outstanding to telecommunications
borrowers.
Member
Regulation and Competition
Electric
Systems
The
movement toward electric competition at the retail level has faltered, while the
wholesale level has become largely competitive. The electric utility
industry has settled into a "hybrid" model in which there are significant
differences in the retail regulatory approaches followed in different states and
regions. As of May 31, 2008, retail customer choice has been
implemented in 15 states. Those states are Arizona, Connecticut,
Delaware, Illinois, Maine, Maryland, Massachusetts, Michigan, New Hampshire, New
Jersey, New York, Ohio, Pennsylvania, Rhode Island, and Texas. Of the
remaining states, retail customer choice was not under consideration in 26
states, delayed in four states (Nevada, Oklahoma, Oregon, and West Virginia),
repealed in four states (Arkansas, Montana, New Mexico, and Virginia), and
suspended in one state (California).
In the 15
states where retail customer choice has been implemented, the Company had 158
distribution members and 19 power supply members with a total of $5,164 million
of loans outstanding at May 31, 2008. In New York, where the Company
has four distribution members and $9 million of loans to electric systems,
cooperatives are not required to file competition plans with the state utility
commission. The Company continues to believe that the distribution
systems, which comprise the majority of its membership and loan exposure, will
not be materially impacted by customer choice. In general, even in
those states where customers have a choice of alternative energy suppliers, very
few customers have switched from the traditional supplier.
In
addition, in four of the 15 states where retail customer choice has been
implemented, cooperatives may decide whether to "opt in" to competition or
retain a monopoly position with respect to energy sales. Those states
are Illinois, New Jersey, Ohio, and Texas. As of May 31, 2008,
National Rural had loans outstanding in the amount of $4,002 million in those
states. Even if customers choose to purchase energy from an
alternative supplier, the distribution systems own the lines to the customer and
it would not be feasible for a competitor to build a second line to serve the
same customers in almost all situations. Therefore, the distribution
systems will still be charging a fee or access tariff for the service of
delivering power, regardless of who supplies the power. Customer
choice has had no impact on power supply cooperatives and the Company does not
expect any impact.
Even in
states where retail customer choice laws have been passed, there are many
factors that may delay or influence the choices that customers have available to
them and the timing of competition for cooperatives. One such factor
will be the level of fees that systems will be allowed to charge other utilities
for use of their transmission and distribution system. Other issues
that may further delay retail competition in areas served by cooperatives
include, but are not limited to, the following:
|
·
|
Ability
of cooperatives to "opt out" of the provisions of the customer choice laws
in some states;
|
|
·
|
Utilities
in many states may still be regulated regarding rates on non-competitive
services, such as distribution;
|
|
·
|
Many
states will still regulate the securities issued by utilities, including
cooperatives;
|
|
·
|
FERC
regulation of rates as well as terms and conditions of transmission
service;
|
|
·
|
Reconciling
the differences between state laws, such that out-of-state utilities can
compete with in-state utilities;
and
|
|
·
|
The
fact that few competitors have demonstrated much interest in providing
electric energy to residential or rural
customers.
|
In
addition to retail customer choice laws, some state agencies regulate electric
cooperatives with regard to rates and borrowing. There are 16 states
that regulate the rates electric systems charge. Those states are
Arizona, Arkansas, Georgia, Hawaii, Kentucky, Louisiana, Maine, Maryland,
Michigan, New Mexico, New York, Utah, Vermont, Virginia, West Virginia, and
Wyoming. Two of these states (Georgia and Utah) have partial
oversight authority over the cooperatives' rates, but not the specific authority
to set rates. Nine states allow cooperatives the right to opt in or
out of state regulation. There are 19 states that regulate electric
systems regarding the issuance of long-term debt. Those states are
Alabama, Arizona, Colorado, Delaware, Georgia, Hawaii, Indiana, Kansas,
Kentucky, Louisiana, Maine, Maryland, Massachusetts, New Hampshire, Rhode
Island, Utah, Vermont, Virginia and Wyoming. One of these states
(Alabama) regulates both the issuance of short-term and long-term
debt. FERC also has jurisdiction to regulate transmission rates,
wholesale rates, terms and conditions of service, and the issuance of securities
by public utilities within its jurisdiction, which includes only a few
cooperatives.
Telecommunications
Systems
RTFC
member telecommunications systems generally are regulated at the state and
federal levels. Most state commissions regulate local service rates,
intrastate access rates and telecommunications company borrowing. The
Federal Communications Commission ("FCC") regulates interstate access rates and
the issuance of licenses required to operate certain types of telecom
operations. Some member telecommunications systems have affiliated
companies that are not regulated.
The
Telecommunications Act of 1996 (the "Telecom Act") created a framework for
competition and deregulation in the local telecommunications
market. The Telecom Act had four basic goals: competition, universal
service, deregulation and fostering advanced telecommunications and information
technologies. To achieve competition, the Telecom Act required all
carriers to interconnect with all others and LECs to provide competitors with
access to elements of their networks. Congress included provisions in
the Telecom Act granting RLECs an exemption from the above requirement to
provide competitors with access to their networks, absent a determination that
it would be in the public interest.
Competition
continues to be a significant factor in the telecommunications
industry. A January 2007 FCC report on competition states that as of
June 2006, competitive local exchange carriers ("CLECs") provided service to 30
million access lines - 17.4 % of the nation's 172 million end-user switched
access lines. Wireless carriers are providing service to 217.4
million mobile telephone service subscriptions - more than LECs and CLECs
combined. For the most part, local exchange competition
has benefited RLECs by enabling them to enter nearby towns and cities as CLECs,
leveraging their existing infrastructure and reputation for providing quality,
modern telecommunications service.
In
addition to competition, the Telecom Act also mandated a universal
telecommunications service support mechanism and required that it be: (1)
sufficient to ensure that rural customers receive reasonably comparable rates
and services when compared to urban customers; and (2) portable, that is,
available to all eligible providers. Congress stated its intent that
implicit subsidies presently contained in the access charges local
telecommunications companies levy on long distance carriers be eliminated and be
made explicit in the new universal service support mechanism. Rules adopted by
the FCC in 2000 to date have provided adequate levels of universal service
support. This has been essential for RLECs, as other FCC rulings have
reduced access charges which are a key revenue source. In addition,
RLECs are experiencing some of the access line and access revenue losses
experienced by the RBOCs. However, growth in digital subscriber line
service (DSL) has generally offset the revenue loss created by the decline of
voice access lines.
Numerous
wireless carriers have entered rural markets as competitors to the
RLECs. By obtaining competitive eligible telecommunications carrier
(“CETC”) status from state regulators (as provided for in the Telecom Act),
these wireless carriers are able to receive universal service funds ("USF")
based on the incumbent LEC's costs (the “identical support”
rule). This has led to growth in claims on the fund and great concern
for its sustainability. USF's current funding base of interstate
telecommunications revenues is shrinking as long distance minutes-of-use go down
due to wireless, email and voice over internet protocol
substitution. Uncontrolled demand for USF funding has resulted in the
rate assessed on all participants in the nationwide network (the “contribution
factor”) becoming unsustainably high. The second quarter 2008
contribution factor is 11.3%. Many in the industry agree that changes
need to be made regarding eligibility and the funding mechanism for
USF. However, there is no agreement on what those changes should
be. In May 2008, the FCC ordered that payments to CETCs be
capped. Total support for a CETC will be capped at what they were
eligible to receive in March 2008. In January 2008 the FCC issued
three notices of proposed rulemaking on universal service
funding. These related proceedings addressed creation of separate
funds for incumbent and competitive ETCs, elimination of the “identical support”
rule, and transitioning to a reverse auction regime for determining amounts of
USF support an eligible carrier would receive. RLECs universally
supported the elimination of the identical support rule and opposed reverse
auctions. Positions on the creation of separate funds varied among
RLECs. Predictably, the wireless carriers supported reverse auctions,
opposed elimination of the identical support rule and, as with the RLECs, took
varying positions on creating separate universal service funds.
The FCC
also has a proceeding open on intercarrier compensation – the most important
components of which are access fees LECs charge to interexchange carriers that
originate or terminate long distance traffic on LEC networks. While
the large LECs (most of which now own long distance companies) would like to see
these fees transition to zero, RLECs depend heavily on access charges and are
active participants in the FCC proceeding. RLECs have come together
with a unified proposal that would preserve some access fees and are promoting
it with the FCC. No action has been taken in this proceeding and it
is unlikely that the FCC will take any in the near future.
While
uncertainty exists regarding USF and access, the Company does not anticipate
that any potential revenue losses resulting from these changes will result in
material losses on loans outstanding to rural telecommunications
companies.
As noted
above, most RLECs are expanding their service offerings to
customers. Without competitors in the most rural parts of their
service areas, RLECs are introducing digital video, high-speed data, and local
and long distance voice service. Where they can leverage their
infrastructure, they are competing with Verizon, Qwest, AT&T, Embarq and
cable companies in neighboring towns. RLECs have generally been very
successful competitors in these situations.
Deregulation
has not had much effect on LECs thus far. The FCC has promulgated a
series of rules to implement the Telecom Act, and eliminated very few existing
regulatory requirements. States continue to regulate RLECs
extensively.
Another
aspect of the Telecom Act dealt with advanced telecommunications and information
technologies. In the late 1990s there was the concern that there was
a growing "digital divide" between rural and urban areas within the
country. Legislators sought to provide broadband connectivity to all
Americans through programs which provide funding to connect schools and
libraries to the internet. RUS has issued rules liberalizing its
lending criteria to facilitate provision of advanced telecommunications and
information services in rural areas. Congress also created an RUS
broadband loan program in 2002. To date, RUS has obligated $1.53 billion in
broadband loans. Congress authorized $300 million in fiscal year 2008
lending authority. The appropriation for fiscal year 2009 has been
approved at $298 million.
Given the
increased availability of government financing for rural broadband, it is
unlikely that the Company will be participating in this financing to any
significant degree outside of incremental lending to existing RLEC borrowers to
provide broadband services to their customers.
The
RUS Program
Since the
enactment of the Rural Electrification Act in 1936 (the "RE Act"), RUS has
financed the construction of electric generating plants, transmission facilities
and distribution systems in order to provide electricity to rural
areas. Principally through the creation of local electric
cooperatives that were originally financed under the RE Act loan program in 47
states and two U.S. territories, the percentage of farms and residences in rural
areas of the United States receiving central station electric service increased
from 11% in 1934 to almost 100% currently. Rural electric systems
serve 12% of all consumers of electricity in the United States and its
territories and account for approximately 8% of total sales of electricity and
own about 5% of electricity generating capacity.
In 1949,
the RE Act was amended to allow lending for the purpose of furnishing and
improving rural telecommunications service. For fiscal year 2008, RUS
has $690 million in lending authority for rural telephone systems and an
additional $523 million for other telecommunications programs, including
distance learning and broadband.
The RE
Act provides for RUS to make insured loans and to provide other forms of
financial assistance to electric borrowers. However, RUS is currently
not offering loans to finance the construction of new coal or nuclear baseload
electric generation facilities. RUS is authorized to make direct loans to
systems that qualify for the hardship program (5% interest rate) or the
municipal rate program (based on a municipal government obligation
index). RUS is also authorized to guarantee loans that bear interest
at a rate agreed upon by the borrower and the lender (which generally has been
the Federal Financing Bank ("FFB")). RUS also provides financing at
the Treasury rate. The RUS exercises financial and technical
supervision over borrowers' operations. Its loans and guarantees are
generally secured by a mortgage on substantially all of the system's property
and revenues.
For the
fiscal year ending September 30, 2009, the President’s budget requests $100
million for hardship loans and $4 billion for loan guarantees with no requested
budget for either municipal rate loans and treasury rate
loans. Electric funding levels for fiscal year 2008 were as follows:
hardship loans of $100 million, and loan guarantees of $6.5
billion.
Item
1A. Risk
Factors.
The
Company's financial condition and results of operations are subject to various
risks inherent in its business. The material risks and uncertainties that
management believes affect National Rural are described below. The
risks and uncertainties described below are not the only ones facing National
Rural. Additional risks and uncertainties that management is not
aware of, or that it currently deems immaterial, may also impair business
operations. If any of the events or circumstances described in the following
risks actually occur, our business, financial condition or results of operations
could suffer. You should consider all of the following risks together
with all of the other information in this Annual Report on
Form 10-K.
The
Company's ability to maintain and grow our business depends on access to
external financing.
The
Company depends on access to the capital markets to refinance its long-term and
short-term debt, fund new loan advances and if necessary, to fulfill its
obligations under its guarantee and repurchase agreements. At May 31,
2008, the Company had $3,150 million of commercial paper, daily liquidity fund
and bank bid notes and $3,177 million of medium-term notes, collateral trust
bonds and long-term notes payable scheduled to mature during the next twelve
months. At May 31, 2008, the Company was the guarantor and liquidity
provider for $330 million of tax-exempt bonds issued for its member
cooperatives. Additionally, National Rural was the guarantor, but not
liquidity provider, for $155 million of tax-exempt bonds that were in the
auction rate mode. There can be no assurance that the Company will be
able to access the markets in the future at all or on terms that are acceptable
to the Company. Downgrades to the Company's long-term debt ratings
and/or commercial paper ratings or other events that may deny or limit the
Company's access to the capital markets could negatively impact its
operations. The Company has no control over certain items that are
considered by the credit rating agencies as part of their analysis for the
Company, such as the overall outlook for the electric and telecommunications
industries.
Fluctuating
interest rates could adversely affect our income, margin and cash
flow.
The
Company is exposed to interest rate risk in its core lending and borrowing
activities. If the Company does not set interest rates on its loans
at a level to cover its cost of funding, there would be an adverse effect on net
interest income and net income.
The
Company provides its members with many options on its loans with regard to
interest rates, the term for which the selected interest rate is in effect and
the ability to prepay the loan. As a result, there is a possibility
of significant changes in the composition of the loan portfolio. If
the Company is not able to adjust its outstanding debt portfolio to match the
changes in the loan portfolio, there could be an adverse impact on net interest
income and net income.
In
addition, the Company's calculated impairment on non-performing and restructured
loans will increase as the Company's long-term variable and short-term interest
rates increase. Based on the current balance of impaired loans at May
31, 2008, an increase or decrease of 25 basis points to the Company's variable
interest rates results in an increase or decrease of approximately $9 million,
respectively, to the calculated impairment on loans irrespective of a change in
the credit fundamentals of the impaired borrower.
Competition
from other lenders could impair the Company's financial results.
The
majority of the Company's members are eligible to borrow from
RUS. The rates offered by RUS are generally lower than the rates that
the Company and other lenders can offer. Thus, the members' first
financing option generally is to borrow funds under the RUS
program. The RUS funding level is determined by the U.S. Congress
each year. Increases to the amount of RUS funding could limit the
amount of loan growth experienced by the Company.
The
Company competes with other lenders for the portion of the loan commitment that
RUS will not lend, for the loans to members that cannot borrow from RUS or for
loans to members that have elected not to borrow from RUS. If other
lenders are more successful than the Company in the competition for this loan
volume, it could have an adverse impact on the Company's financial
results.
We
may not recover the value of amounts that we lend.
National
Rural’s allowance for loan losses is established through a provision charged to
expense that represents management's best estimate of probable losses that have
been incurred within the existing loan portfolio. The level of the
allowance reflects management's continuing evaluation of: industry
concentrations; specific credit risks; loan loss experience; current loan
portfolio quality; present economic, political and regulatory conditions and
unidentified losses and risks inherent in the current loan
portfolio. The determination of the appropriate level of the
allowance for loan losses involves a high degree of subjectivity and requires
National Rural to make significant estimates of current credit risks and future
trends, all of which may undergo material changes. Changes in
economic conditions affecting borrowers, new information regarding existing
loans, identification of additional problem loans and other factors, both within
and outside of National Rural’s control, may require an increase in the
allowance for loan losses. In addition, if actual losses incurred
exceed current estimates of probable losses currently included in the allowance
for loan losses, National Rural will need additional provisions to increase the
allowance for loan losses. Any increases in the allowance for loan
losses will result in a decrease in net income, and may have a material adverse
effect on National Rural’s financial results and credit ratings.
The
Company has been and may in the future be in litigation with borrowers related
to enforcement or collection actions pursuant to loan documents. In such cases,
the borrower or others may assert counterclaims against the Company or initiate
actions against the Company related to the loan
documents. Unfavorable rulings in these cases which result in loan
losses that exceed the related allowance could have a material adverse effect on
the Company’s financial results and credit ratings.
Our
ability to access the capital markets depends on our ability to maintain
adjusted leverage and debt to equity ratios within a reasonable range of market
acceptable levels.
Maintenance
of adjusted leverage and debt to equity ratios within a reasonable range of
market acceptable levels is important in relation to the Company's ability to
access the capital markets. A significant increase above market
acceptable levels in the adjusted leverage or debt to equity ratios could impair
the Company's ability to access the capital markets, its ability to access the
Company's revolving lines of credit and its ability to maintain preferred credit
ratings. See "Non-GAAP Financial Measures" for further explanation
and a reconciliation of adjusted ratios.
A
decline in our credit rating could trigger payments under our derivative
agreements.
If the
Company's credit rating falls to the level specified in certain of its
derivative agreements, the other counterparty may terminate the
agreement. If the counterparty terminates the agreement, a net
payment may be due from one counterparty to the other based on the fair value of
the underlying derivative instrument. Based on the fair market value
of its interest rate exchange agreements subject to rating triggers at May 31,
2008, the Company may be required to make a payment of up to $1 million if its
senior unsecured ratings declined to Baa1 or BBB+, and up to $31 million if its
senior unsecured ratings declined below Baa1 or BBB+. In calculating
the required payments, the Company only considered agreements which, when netted
for each counterparty as allowed by the underlying master agreement, would
require a payment upon termination. In the event the Company is
required to make a payment as a result of a rating trigger, it could have a
material adverse impact on its financial results.
Our
ability to comply with covenants related to our revolving credit agreements and
debt indentures may affect our ability to obtain financing and maintain
preferred rating levels on our debt.
The
Company must maintain compliance with all covenants and conditions related to
its revolving credit agreements, including the adjusted TIER, adjusted leverage
and amount of loans pledged in order to have access to the funds available under
the revolving lines of credit. See "Non-GAAP Financial Measures" for further
explanation and a reconciliation of adjusted ratios. A restriction on
access to the revolving lines of credit would impair the Company's ability to
issue short-term debt, as it is required to maintain backup-liquidity to
maintain preferred rating levels on its short-term debt.
If the
Company does not maintain compliance with covenants and conditions on its
collateral trust bond, medium-term note and subordinated deferrable debt
indentures, the holders of such debt could declare an event of default and
accelerate the repayment of the full amount of the outstanding debt principal
prior to the stated maturity of such debt. Additionally, the Company
could not issue new debt under such indentures. Such an event would
require the Company to obtain new funding to repay the accelerated debt as a
result of the covenant default and could have a material adverse impact on its
financial results and credit ratings.
Our
concentration of loans to borrowers within rural electric and telephone
industries could impair our revenues if either or both of those industries were
to experience economic difficulties.
Credit
concentration is one of the risk factors considered by the rating agencies in
the evaluation of the Company's credit rating. Substantially all of
the Company's credit exposure is to the rural electric and telephone industries
and is subject to risks associated with those industries.
The
Company's credit concentration to its ten largest borrowers could increase from
the current 18% of total loans and guarantees outstanding, if:
·
|
it
were to extend additional loans and/or guarantees to the current ten
largest borrowers,
|
·
|
its
total loans and/or guarantees outstanding were to decrease, with a
disproportionately large share of the decrease to borrowers not in the
current ten largest, or
|
·
|
it
were to advance large new loans and/or guarantees to one of the borrowers
below the ten largest.
|
We
could jeopardize our federal tax exemption if we fail to conduct our business in
accordance with our exemption from the Internal Revenue Service.
Legislation
that removes or imposes new conditions on the federal tax exemption for
501(c)(4) social welfare organizations could have a negative impact on the
Company's net income. National Rural’s continued exemption depends on
it conducting its business in accordance with its 501(c)(4) status.
Item
1B. Unresolved
Staff Comments.
None.
Item
2. Properties.
National
Rural leases office space that serves as its headquarters in Fairfax County,
Virginia. In October 2005, National Rural entered into a three-year
lease with the building owner for approximately 107,228 square feet of the
facility’s office, meeting and storage space. In September 2007, the
Company exercised the option to extend the lease for an additional one-year
period. The Company has the option to extend the lease for an
additional one-year period in fiscal year 2009. The terms of these
extensions are similar to the initial three-year lease. National
Rural finalized a contract in May 2008 to purchase 42 acres of land located in
Loudoun County, Virginia. National Rural will use the purchased land
in connection with its plans to construct a new headquarters
facility.
Item
3. Legal
Proceedings.
None.
Item
4. Submission
of Matters to a Vote of Security Holders.
None.
PART
II
Item
5.
|
Market
for Registrant's Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities.
|
Inapplicable.
Item
6. Selected
Financial Data.
The
following is a summary of selected financial data for the years ended May
31:
(Dollar
amounts in thousands)
|
|
2008
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
|
For
the year ended May 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
|
$
|
1,069,540
|
|
|
$
|
1,054,224
|
|
|
$
|
1,007,912
|
|
|
$
|
1,030,853
|
|
|
$
|
1,009,856
|
|
|
|
Net
interest income
|
|
|
132,651
|
|
|
|
57,494
|
|
|
|
31,976
|
|
|
|
88,820
|
|
|
|
68,365
|
|
|
|
Derivative
cash settlements (1)
|
|
|
27,033
|
|
|
|
86,442
|
|
|
|
80,883
|
|
|
|
78,287
|
|
|
|
123,363
|
|
|
|
Derivative
forward value (1)
|
|
|
(98,743
|
)
|
|
|
(79,281
|
)
|
|
|
28,805
|
|
|
|
25,849
|
|
|
|
(228,840
|
)
|
|
|
Foreign
currency adjustments (2)
|
|
|
-
|
|
|
|
(14,554
|
)
|
|
|
(22,594
|
)
|
|
|
(22,893
|
)
|
|
|
(65,310
|
)
|
|
|
Income
(loss) prior to income taxes, minority
interest
and cumulative effect of change in
accounting
principle (3)
|
|
|
36,311
|
|
|
|
16,541
|
|
|
|
105,762
|
|
|
|
126,561
|
|
|
|
(194,292
|
)
|
|
|
Cumulative
effect of change in
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
accounting
principle (4)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
22,369
|
|
|
|
Net
income (loss)
|
|
$
|
45,745
|
|
|
$
|
11,701
|
|
|
$
|
95,497
|
|
|
$
|
122,503
|
|
|
$
|
(177,729
|
)
|
|
|
Fixed
charge coverage ratio (TIER) (5)(6)
|
|
|
1.05
|
|
|
|
1.01
|
|
|
|
1.10
|
|
|
|
1.13
|
|
|
|
-
|
|
|
|
Adjusted
fixed charge coverage ratio
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Adjusted
TIER)
(7)
|
|
|
1.15
|
|
|
|
1.12
|
|
|
|
1.11
|
|
|
|
1.14
|
|
|
|
1.12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
of May 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
to members (8)
|
|
$
|
19,029,040
|
|
|
$
|
18,131,873
|
|
|
$
|
18,363,954
|
|
|
$
|
18,974,108
|
|
|
$
|
20,490,021
|
|
|
|
Allowance
for loan losses
|
|
|
(514,906
|
)
|
|
|
(561,663
|
)
|
|
|
(611,443
|
)
|
|
|
(589,749
|
)
|
|
|
(573,939
|
)
|
|
|
Assets
|
|
|
19,379,381
|
|
|
|
18,575,181
|
|
|
|
19,179,621
|
|
|
|
20,060,314
|
|
|
|
21,455,443
|
|
|
|
Short-term
debt (9)
|
|
|
6,327,453
|
|
|
|
4,427,123
|
|
|
|
5,343,824
|
|
|
|
7,952,579
|
|
|
|
5,990,039
|
|
|
|
Long-term
debt (10)
|
|
|
10,173,587
|
|
|
|
11,295,219
|
|
|
|
10,642,028
|
|
|
|
8,701,955
|
|
|
|
12,009,182
|
|
|
|
Subordinated
deferrable debt (11)
|
|
|
311,440
|
|
|
|
311,440
|
|
|
|
486,440
|
|
|
|
685,000
|
|
|
|
550,000
|
|
|
|
Members'
subordinated certificates
|
|
|
1,406,779
|
|
|
|
1,381,447
|
|
|
|
1,427,960
|
|
|
|
1,490,750
|
|
|
|
1,665,158
|
|
|
|
Members'
equity (1)
|
|
|
613,082
|
|
|
|
566,286
|
|
|
|
545,351
|
|
|
|
523,583
|
|
|
|
483,126
|
|
|
|
Total
equity
|
|
|
665,965
|
|
|
|
710,041
|
|
|
|
784,408
|
|
|
|
764,934
|
|
|
|
692,453
|
|
|
|
Guarantees
|
|
$
|
1,037,140
|
|
|
$
|
1,074,374
|
|
|
$
|
1,078,980
|
|
|
$
|
1,157,752
|
|
|
$
|
1,331,299
|
|
|
|
Leverage
ratio (6)
|
|
|
29.64
|
|
|
|
26.64
|
|
|
|
24.80
|
|
|
|
26.71
|
|
|
|
31.88
|
|
|
|
Adjusted
leverage ratio (7)
|
|
|
7.50
|
|
|
|
6.81
|
|
|
|
6.38
|
|
|
|
6.50
|
|
|
|
7.07
|
|
|
|
Debt
to equity ratio (6)
|
|
|
28.08
|
|
|
|
25.13
|
|
|
|
23.42
|
|
|
|
25.20
|
|
|
|
29.95
|
|
|
|
Adjusted
debt to equity ratio (7)
|
|
|
7.06
|
|
|
|
6.37
|
|
|
|
5.97
|
|
|
|
6.07
|
|
|
|
6.58
|
|
|
|
|
|
|
(1)
Derivative cash settlements represent the net settlements received/paid on
interest rate and cross currency exchange agreements that do not qualify for
hedge accounting. The derivative forward value represents the change
in fair value on exchange agreements that do not qualify for hedge accounting,
as well as amortization related to the long-term debt valuation allowance and
related to the transition adjustment recorded as an other comprehensive loss on
June 1, 2001. Members' equity represents total equity excluding
foreign currency adjustments, derivative forward value and accumulated other
comprehensive income. See "Non-GAAP Financial Measures" in
Management's Discussion and Analysis for further explanation of members' equity
and a reconciliation to total equity.
(2)
Foreign currency adjustments represent the change on foreign denominated debt
that is not related to an exchange agreement that qualifies for hedge accounting
during the period. The foreign denominated debt is revalued at each
reporting date based on the current exchange rate. To the extent that
the current exchange rate is different than the exchange rate at the time of
issuance, there will be a change in the value of the foreign denominated
debt. National Rural enters into foreign currency exchange agreements
at the time of each foreign denominated debt issuance to lock in the exchange
rate for all principal and interest payments required through
maturity.
(3)
Includes $43 million gain on sale of building and land at May 31,
2006.
(4) The
cumulative effect of change in accounting principle in 2004 represents the
impact of implementing Financial Accounting Standards Board Interpretation No.
46 (R), Consolidation of Variable Interest Entities, an interpretation of
Accounting Research Bulletin No. 51, effective June 1, 2003.
(5) The
fixed charge coverage ratio is the same calculation as National Rural’s Times
Interest Earned Ratio ("TIER"). For the year ended May 31, 2004,
National Rural’s earnings were insufficient to cover fixed charges by $200
million.
(6) See
"Non-GAAP Financial Measures" in Management's Discussion and Analysis for the
GAAP calculations of these ratios.
(7)
Adjusted ratios include non-GAAP adjustments that National Rural makes to
financial measures in assessing its financial performance. See
"Non-GAAP Financial Measures" in Management's Discussion and Analysis for
further explanation of these calculations and a reconciliation of the
adjustments.
(8)
Certain reclassifications of prior year period amounts have been made to conform
to the current reporting format. See further explanation in Note 1(w)
to the consolidated financial statements.
(9)
Includes the foreign currency valuation account of $245 million and $40 million
at May 31, 2006 and 2005, respectively.
(10)
Excludes $3,177 million, $1,368 million, $1,839 million, $3,591 million, and
$2,365 million in long-term debt that comes due, matures and/or will be redeemed
during fiscal years 2009, 2008, 2007, 2006 and 2005, respectively (see Note 5 to
the consolidated financial statements). Includes the foreign currency
valuation account of $221 million and $234 million at May 31, 2005 and 2004,
respectively.
(11)
Excludes $175 million called in June 2007 and $150 million called in June 2006
at May 31, 2007 and 2006, respectively, reported in short-term
debt.
Item
7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations.
Unless
stated otherwise, references to the Company relate to the consolidation of
National Rural Utilities Cooperative Finance Corporation ("National Rural" or
"the Company"), Rural Telephone Finance Cooperative ("RTFC"), National
Cooperative Services Corporation ("NCSC") and certain entities controlled by
National Rural and created to hold foreclosed assets and effect loan
securitization transactions. The following discussion and analysis is
designed to provide a better understanding of the Company's consolidated
financial condition and results of operations and as such should be read in
conjunction with the consolidated financial statements, including the notes
thereto. National Rural refers to its financial measures that are not in
accordance with generally accepted accounting principles ("GAAP") as "adjusted"
throughout this document. See "Non-GAAP Financial Measures" for
further explanation of why the Non-GAAP measures are useful and for a
reconciliation to GAAP amounts.
Business
Overview
National
Rural was formed in 1969 by rural electric cooperatives to provide a source of
financing to supplement the loan programs of the Rural Utilities Service
("RUS"). National Rural is organized as a cooperative in which each
member (other than associates) is entitled to one vote. Under
National Rural’s bylaws, the board of directors is composed of 23 individuals,
20 of whom must be either general managers or directors of member systems, two
of whom are designated by the National Rural Electric Cooperative Association
and one at-large position who must satisfy the requirements of an audit
committee financial expert as defined by Section 407 of the Sarbanes-Oxley Act
of 2002 and must be a trustee, director, manager, Chief Executive Officer or
Chief Financial Officer of a member. In November 2006, the National
Rural Board elected an at-large director that qualifies as a financial expert
who serves on the audit committee. The director took his seat on the
board following the National Rural annual meeting in March
2007. National Rural is a tax-exempt entity under Section 501(c)(4)
of the Internal Revenue Code.
RTFC is a
not-for-profit private cooperative association created for the purpose of
providing and/or arranging financing for its rural telecommunications members
and their affiliates. NCSC also is a private non-profit cooperative
association. The principal purpose of NCSC is to provide financing to
the for-profit or non-profit entities that are owned, operated or controlled by
or provide substantial benefit to, members of National Rural.
The
Company's primary objective as a cooperative is to provide its members with low
loan and guarantee rates while maintaining sound financial results required to
attain high credit ratings on its debt instruments. As a
not-for-profit, membership owned financial institution, the Company's goal is
not to maximize its profit on loans to members, but rather to find a balance
between charging its members low rates on loans and maintaining the financial
performance required to access the capital markets on behalf of its
members. Thus, the Company marks up its funding costs only to the
extent necessary to cover its operating expenses and a provision for loan losses
and to provide earnings sufficient to preserve interest coverage in light of the
Company's financing objectives.
At May
31, 2008, the Company's consolidated membership was 1,538 including 898 utility
members, the majority of which are consumer-owned electric cooperatives, 511
telecommunications members, 66 service members and 63 associates in 49 states,
the District of Columbia and two U.S. territories. The utility
members included 829 distribution systems and 69 generation and transmission
("power supply") systems.
National
Rural obtains its funding from the capital markets, private placement of debt
and its membership. National Rural enters the capital markets, based
on the combined strength of its members, to borrow the funds required to fulfill
the financing requirements of its members. On a regular basis,
National Rural obtains debt financing in the capital markets by issuing fixed
rate or variable rate secured collateral trust bonds, fixed rate subordinated
deferrable debt, fixed rate or variable rate unsecured medium-term notes,
commercial paper and enters into bank bid note agreements. In
addition, National Rural obtains debt financing from private funding sources
through the issuance of fixed rate and variable rate notes. National
Rural also obtains debt financing from its membership and other qualified
investors through the direct sale of its commercial paper, daily liquidity fund
and unsecured medium-term notes.
Rural
electric cooperatives that join National Rural are generally required to
purchase membership subordinated certificates from National Rural as a condition
of membership. In connection with any long-term loan or guarantee
made by National Rural on behalf of one of its members, National Rural may
require that the member make an additional investment in National Rural by
purchasing loan or guarantee subordinated certificates. The
membership subordinated certificates and the loan and guarantee subordinated
certificates are unsecured and subordinate to other senior debt of National
Rural.
National
Rural is required by law to have a mechanism to allocate its net income to its
members. National Rural allocates its net income excluding the
non-cash effects of Statement of Financial Accounting Standards ("SFAS") 133,
Accounting for Derivative Instruments and Hedging Activities, as amended and
SFAS 52, Foreign Currency Translation annually to a cooperative educational
fund, a members' capital reserve and to members based on each member's patronage
of the loan programs during the year. RTFC annually allocates its net
income to a cooperative educational fund and to its members based on each
member's patronage of the loan programs during the year. NCSC does
not allocate its net income to its members, but does allocate a portion of its
margins to a cooperative educational fund.
The
Company's performance is closely tied to the performance of its member rural
electric and telecommunications systems due to the near 100% concentration of
its loan and guarantee portfolio in those industries.
Financial
Overview
Results
of Operations
The
Company uses a times interest earned ratio (“TIER”) instead of the dollar amount
of net interest income or net income as its primary performance indicator, since
its net income in dollar terms is subject to fluctuation as total loans
outstanding and/or interest rates change. TIER is a measure of the
Company's ability to cover the interest expense on its debt
obligations. TIER is calculated by dividing the sum of interest
expense and the net income prior to the cumulative effect of change in
accounting principle by the interest expense.
For the
year ended May 31, 2008, the Company reported net income of $46 million and TIER
of 1.05, compared to a net income of $12 million and TIER of 1.01 for the prior
year. For the year ended May 31, 2008, the Company reported an
adjusted net income of $138 million and adjusted TIER of 1.15, compared to an
adjusted net income of $108 million and adjusted TIER of 1.12 for the prior
year. The $34 million and $30 million increase in the net income and
adjusted net income, respectively, for the year ended May 31, 2008 was primarily
due to the $23 million increase in the recovery of loan losses resulting from
the decrease in calculated impairments due to lower variable rates and payments
received on impaired loans. Adjusted net income is calculated by
excluding the impact of derivatives and foreign currency adjustments and
including minority interest. Adjusted TIER is calculated by using
adjusted net income and including all derivative cash settlements in the
interest expense. See "Non-GAAP Financial Measures" for more information on
the adjustments the Company makes to its financial results for the purposes of
its own analysis and covenant compliance.
During
the year ended May 31, 2008, the Company's earnings were impacted by the level
of loans on non-accrual status. Holding loans on non-accrual status
resulted in a reduction of $67 million to reported interest income for the year
ended May 31,
2008. During fiscal year 2009, the Company expects the outstanding
balance of loans on non-accrual status to decrease due to principal repayments
and the proceeds from asset sales. In addition, it is expected that
Denton County Electric Cooperative, Inc. d/b/a CoServ Electric (“CoServ”) will
make scheduled quarterly payments totaling $28 million in fiscal year 2009,
which will all be applied as a reduction to principal.
The
reduction to the amount of loans on non-accrual status should contribute to an
increase to the adjusted net interest income yield during fiscal year
2009. Changes to the Company's variable interest rates will be based
on the underlying cost of funding, competition and other factors. The
calculated impairment on the Company's loans increases or decreases with the
increases and decreases to the Company's variable interest
rates. Based on the current balance of impaired loans at May 31,
2008, an increase or decrease of 25 basis points to the Company's variable
interest rates results in an increase or decrease of approximately $9 million,
respectively, to the calculated impairment on loans irrespective of a change in
the credit fundamentals of the impaired borrower.
Financial
Condition
At May
31, 2008, the Company's total loans outstanding increased by $899 million or 5%
as compared to May 31, 2007. At May 31, 2008, National Rural loans
outstanding increased by $1,081 million, RTFC loans outstanding decreased by
$134 million and NCSC loans outstanding decreased by $48 million compared to May
31, 2007. National Rural loans outstanding increased due to net
advances of $1,155 million offset by the sale of $74 million of National Rural
distribution loans at par in loan securitization transactions during the year
ended May 31, 2008. National Rural expects to continue such loan
sales on a periodic basis. See further discussion of the Company’s loan
portfolio in “Loan and Guarantee Portfolio Assessment”.
The
Company expects that the balance of the loan portfolio will remain relatively
stable during fiscal year 2009. Loans from the Federal Financing Bank
("FFB"), a division of the U.S. Treasury Department, with an RUS guarantee,
represent a lower cost option for rural electric utilities compared to loans
from the Company. The Company anticipates that the majority of its
electric loan growth will come from distribution system borrowers that have
fully prepaid their RUS loans and choose not to return to the government loan
program, from distribution system borrowers that do not want to wait the 12 to
24 months it may take RUS to process and fund the loan and from power supply
systems. The Company anticipates that the RTFC loan balance will
continue to slowly decline due to long-term loan amortization, the strong
liquidity position of rural
telecommunications
companies, a general slowdown in merger and acquisition activities and low
demand for capital expenditure financing.
On
December 26, 2007, the President of the United States signed the Appropriations
Act for Fiscal Year 2008 which set the fiscal year 2008 RUS electric and
telephone loan program levels. Electric funding levels for fiscal
year 2008 are $6.5 billion for FFB loans and $100 million for five percent
loans. Telephone funding levels for fiscal year 2008 are $145 million
for five percent loans, $250 million for FFB loans, $295 million for treasury
rate loans and $300 million for broadband loans.
During
the year ended May 31, 2008, short-term debt increased by $1,900 million and
long-term debt decreased by $1,122 million primarily due to an increase of
$1,810 million to the amount of long-term debt that will mature in the next
twelve months. Holders of $2,140 million of the Company’s extendible
debt elected not to extend the maturity of such debt during the year ended May
31, 2008. As a result, $1,845 million of extendible debt was
reclassified from long-term debt to short-term debt based on maturity dates
ranging from August 2008 through February 2009. The remaining $295
million of extendible debt will mature in fiscal year
2010. Additionally, $500 million of secured notes payable was
reclassified to short-term debt based on the July 2008 maturity of the
debt.
Total
equity decreased $44 million from May 31, 2007 to May 31, 2008 primarily due to
the board authorized patronage capital retirement totaling $86 million offset by
net income of $46 million for the year ended May 31, 2008. Under
GAAP, the Company's reported equity balance fluctuates based on the impact of
future expected changes to interest rates on the fair value of its interest rate
exchange agreements. As a result, it is difficult to predict the
future changes in the Company's reported GAAP equity due to the uncertainty of
the movement in future interest rates. In its internal analysis and
for purposes of covenant compliance under its credit agreements, the Company
adjusts equity to exclude the non-cash impacts of SFAS 133 and 52.
Liquidity
At May
31, 2008, the Company had $3,150 million of commercial paper, daily liquidity
fund and bank bid notes and $3,177 million of medium-term notes, collateral
trust bonds and long-term notes payable scheduled to mature during the next
twelve months. Members held commercial paper (including the daily
liquidity fund) totaling $1,404 million or approximately 46% of the total
commercial paper outstanding at May 31, 2008. Commercial paper issued
through dealers and bank bid notes totaled $1,612 million and represented 9% of
total debt outstanding at May 31, 2008. The Company intends to
maintain the balance of dealer commercial paper and bank bid notes at 15% or
less of total debt outstanding during fiscal year 2009. During the
next twelve months, the Company plans to refinance the $3,177 million of
medium-term notes, collateral trust bonds and long-term notes payable and fund
new loan growth by issuing a combination of commercial paper, medium-term notes,
collateral trust bonds and other debt.
National
Rural uses member loan repayments, capital market debt issuance, private debt
issuance, member investments, and net income to fund its
operations. In addition, the Company maintains both short-term and
long-term bank lines in the form of revolving credit agreements with its bank
group. Members pay a small membership fee and are typically required
to purchase subordinated certificates as a condition to receiving a long-term
loan advance and as a condition of membership. National Rural has a
need for funding to make loan advances to its members, to make interest payments
on its public and private debt and to make payments of principal on its maturing
debt. To facilitate open access to the capital markets, National
Rural is a regular issuer of debt, maintains strong credit ratings and has shelf
registration statements on file with the Securities and Exchange Commission
("SEC"). The Company qualifies as a well-known seasoned issuer under
the SEC rules. Additionally, the Company has Board authorization to
issue up to $1 billion of commercial paper and $4 billion of medium-term notes
in the European market and $2 billion of medium-term notes in the Australian
market.
At May
31, 2008, the Company was the guarantor and liquidity provider for $330 million
of tax-exempt bonds issued for its member cooperatives. A total of
$133 million of such tax-exempt bonds were in flexible and weekly mode, which
reprice every seven to thirty-five days. A total of $120 million of
such tax-exempt bonds reprice semi-annually. A total of $77 million
of such bonds were in unit price mode and reprice approximately every 30
days. National Rural has not been required to purchase any of the
bonds in its role as liquidity provider. In addition to these
tax-exempt bonds, National Rural was the guarantor, but not liquidity provider,
for $155 million of tax-exempt bonds that were in the auction rate
mode. National Rural has not been required to perform under the
guarantee of its members’ tax-exempt bonds.
Critical
Accounting Estimates
Allowance
for Loan Losses
At May
31, 2008 and 2007, the Company had a loan loss allowance that totaled $515
million and $562 million, representing 2.71% and 3.10% of total loans
outstanding, respectively. GAAP requires loans receivable to be
reported on the consolidated balance sheets at net realizable
value. The net realizable value is the total principal amount of
loans outstanding less an estimate of the probable losses inherent in the
portfolio. The Company calculates its loss allowance on a quarterly
basis. The
loan loss
allowance is calculated by segmenting the portfolio into three categories of
loans: impaired, high risk and general portfolio. There are
significant subjective assumptions and estimates used in calculating the amount
of the loss allowance required by each of the three
categories. Different assumptions and estimates could also be
reasonable. Changes in these assumptions and estimates could have a
material impact on the Company's financial statements.
Impaired
Exposure
The
Company calculates impairment on certain loans in accordance with SFAS 114,
Accounting by Creditors for Impairment of a Loan - an Amendment of SFAS 5 and
SFAS 15, as amended. SFAS 114 states that a loan is impaired when a
creditor does not expect to collect all principal and interest due under the
original terms of the loan other than an insignificant delay or an insignificant
shortfall in amount. The Company reviews its portfolio to identify
impairments at least on a quarterly basis. Factors considered in
determining an impairment include, but are not limited to: the review of the
borrower's audited financial statements and interim financial statements if
available, the borrower's payment history, communication with the borrower,
economic conditions in the borrower's service territory, pending legal action
involving the borrower, restructure agreements between the borrower and the
Company, and estimates of the value of the borrower's assets that have been
pledged as collateral to secure the Company's loans. The Company
calculates the impairment by comparing the future estimated cash flow,
discounted at the interest rate on the loans at the time the loans became
impaired, against its current investment in the receivable. If the
current investment in the receivable is greater than the net present value of
the future payments discounted at the original contractual interest rate, the
impairment is equal to that difference. If it is not possible
to estimate the future cash flow associated with a loan, then the impairment
calculation is based on the value of the collateral pledged as security for the
loan. At May 31, 2008 and 2007, the Company had a total of $331
million and $397 million reserved specifically against impaired exposure
totaling $1,078 million and $1,099 million, respectively, representing 31% and
36%, respectively, of the total impaired loan exposure. The $331
million and $397 million specific reserves represented 64% and 71% of the total
loan loss allowance at May 31, 2008 and 2007, respectively. The calculated
impairment at May 31, 2008 was lower than at May 31, 2007 due to lower variable
rates and payments received on impaired loans. See further discussion
under “Financial Condition”. The original contract rate on a portion
of the impaired loans at May 31, 2008 will vary with the changes in the
Company's variable interest rates. Based on the current balance of
impaired loans at May 31, 2008, a 25 basis point increase or decrease to the
Company's variable interest rates would result in an increase or decrease,
respectively, of approximately $9 million to the calculated impairment
irrespective of a change in the credit fundamentals of the impaired
borrower.
In
calculating the impairment on a loan, the estimates of the expected future cash
flow or collateral value are the key estimates made by management. Changes in
the estimated future cash flow or collateral value would impact the amount of
the calculated impairment. The change in cash flow required to make
the change in the calculated impairment material will be different for each
borrower and depend on the period covered, the original contract interest rate
and the amount of the loan outstanding. Estimates are not used to
determine the Company's investment in the receivables or the discount rate
since, in all cases, the investment is equal to the loan balance outstanding at
the reporting date and the discount rate is equal to the interest rate on the
loans at the time the loans became impaired.
High
Risk Exposure
Loan
exposures considered to be high risk represent exposure in which the borrower
has had a history of late payments, the borrower's financial results do not
satisfy loan financial covenants, the borrower has contacted the Company to
discuss pending financial difficulties or, for some other reason, the Company
believes that the borrower's financial results could deteriorate resulting in an
elevated potential for loss. The Company's corporate credit committee
is responsible for determining which loans should be classified as high risk and
the level of reserve required for each borrower. The committee meets
at least quarterly to review all loan facilities with an internal risk rating
above a certain level. Once it is determined that exposure to a
borrower should be classified as high risk, the committee sets the required
reserve level based on the facts and circumstances for each borrower, such as
the borrower's financial condition, payment history, the Company's estimate of
the collateral value, pending litigation, if any, and other
factors. This is an objective and subjective exercise in which the
committee uses the available information to make its best estimate as to the
level of loss allowance required. At any reporting date, the reserve
required could vary significantly depending on the facts and circumstances,
which could include, but are not limited to: changes in collateral value,
deterioration in financial condition, the borrower declaring bankruptcy, payment
default on the Company's loans and other factors. The borrowers in
the high risk category will generally either move to the impaired category or
back to the general portfolio within a period of 12 to 24 months. At
May 31, 2008 and 2007, the Company had reserved $3 million and $3 million
against the $8 million and $6 million of exposure classified as high risk,
representing
coverage of 38% and 50%, respectively. The $3 million reserved for
loans in the high risk category represented less than 1% of the total loan loss
allowance at May 31, 2008 and 2007.
General
Portfolio
The
Company's methodology used to determine the required loan loss allowance for the
general portfolio includes the use of an internal risk rating system, historical
Standard & Poor’s default data on corporate bonds and Company specific
loss
recovery
data. The Company uses the following factors, in no particular order,
to determine the level of the loan loss allowance for the general portfolio
category:
·
|
Internal
risk ratings - The Company maintains risk ratings for each credit facility
outstanding to its borrowers. The ratings are updated at least
annually and are based on the
following:
|
o
|
General
financial condition of the
borrower.
|
o
|
The
Company's internal estimated value of the collateral securing its
loans.
|
o
|
The
Company's internal evaluation of the borrower's
management.
|
o
|
The
Company's internal evaluation of the borrower's competitive position
within its service territory.
|
o
|
The
Company's estimate of potential impact of proposed regulation and
litigation.
|
o
|
Other
factors specific to individual borrowers or classes of
borrowers.
|
·
|
Standard
corporate default table - The table provides expected default rates based
on rating level and the remaining maturity of the bond. The
Company uses the standard default table for all corporate bonds published
by Standard and Poor's Corporation to assist in estimating its reserve
levels.
|
·
|
Recovery
rates - Estimated recovery rates based on historical experience of loan
balance at the time of default compared to the total loss on the loan to
date.
|
The
Company aggregates the loans in the general portfolio by borrower type
(distribution, power supply, telecommunications, associate and other member) and
by internal risk rating within borrower type. The Company correlates
its internal risk ratings to the ratings used in the standard default table
based on a comparison of its rating on borrowers that have a rating from one or
more of the recognized credit rating agencies and based on a standard matching
used by banks.
At May
31, 2008 and 2007, the Company had a total of $17,690 million and $16,768
million of loans, respectively, in the general portfolio. This total
does not include $250 million and $256 million of loans at May 31, 2008 and
2007, respectively, that have a U.S. Government guarantee of all principal and
interest payments. The Company does not maintain a loan loss
allowance on loans that are guaranteed by the U.S. Government. At May
31, 2008 and 2007, the Company reserved a total of $155 million and $159
million, respectively, for loans in the general portfolio representing coverage
of approximately 1% of the total loans for the general portfolio at both
dates.
In
addition to the general portfolio reserve requirement as calculated above, the
Company maintains an unallocated reserve to cover the additional risk associated
with large loan exposures and to cover economic and environmental factors that
may be currently impacting the financial results of borrowers, but have not
shown up in the borrower’s annual audited financial statements.
The first
component of the unallocated reserve is a single obligor reserve to cover the
additional risk associated with the inherent risk related to large loan
exposures. The Company had previously set the exposure threshold at
1.5% of total loans and guarantees outstanding and provided coverage equal to
0.5% times the internal risk rating associated with the loan
exposure. During the third quarter of fiscal year 2008, the Company
revised both the exposure threshold and the coverage percentage to better
reflect the level of risk associated with the large loan
exposures. The exposure threshold was reduced from 1.5% to 1.0% to
better match the top ten credit exposures. The reserve coverage was
increased to 1.0% of the internal risk rating times the exposure over the
threshold, to better reflect the Company’s assessment of the additional risk
related to large loan exposures. At May 31, 2008 and 2007, the
Company had a single obligor reserve of $23 million and $3 million,
respectively.
The
second component of the unallocated reserve is an economic and environmental
reserve to cover factors that the Company believes are currently impacting the
financial results of borrowers, but are not reflected in the Company’s internal
risk rating process and therefore present an increased risk of losses incurred
as of the balance sheet date. The Company uses annual audited
financial statements from its borrowers as part of its internal risk rating
process. There could be a lag between the time that various
environmental and economic factors occur and the time when these factors are
reflected in the annual audited financial statements of the borrower and
therefore the internal risk rating determined by the Company for the
borrower. This reserve component may be set at up to 5% of the amount
of the calculated general reserve. The Company’s corporate credit
committee will make a quarterly determination of the percentage of general
reserve to be held and the portions of the loan portfolio that the additional
reserve percentage shall be applied. At May 31, 2008, the corporate
credit committee set the economic and environmental component of the unallocated
reserve to be $3 million or 2% of the amount of the total general
reserve. This amount was set taking into consideration the impact on
electric and telecommunications borrowers from (1) the current economic
downturn, (2) the flooding in parts of the Midwest, (3) the decline in the
housing market that has led to a significant increase in foreclosures, (4) the
impact of rising food and gas prices on consumer spending and (5) the impact of
rising fuel prices on electric utilities and the ability to pass on such
costs. There was no economic and environmental unallocated reserve at
May 31, 2007 as the Company added this component to the unallocated reserve
during the third quarter of fiscal year 2008.
Senior
management reviews the estimates and assumptions used in the calculations of the
loan loss allowance for impaired loans, high risk loans, the general portfolio
and the unallocated reserve on a quarterly basis. Senior management
discusses estimates with the board of directors and audit committee and reviews
all loan loss related disclosures included in the Company's Form 10-Qs and Form
10-Ks filed with the SEC.
Management
makes recommendations regarding loans to be written off to the National Rural
board of directors. In making its recommendation to write off all or
a portion of a loan balance, management considers various factors including cash
flow analysis and collateral securing the borrower's loans.
Derivative
Financial Instruments
The
Company accounts for derivatives in accordance with SFAS 133. SFAS
133, as amended, establishes accounting and reporting standards requiring that
derivative instruments (including certain derivative instruments embedded in
other contracts) be recorded in the consolidated balance sheets as either an
asset or liability measured at fair value. The statement requires
that changes in the derivative instrument's fair value be recognized currently
in earnings unless specific hedge accounting criteria are
met. Special accounting for qualifying hedges allows a derivative
instrument's gains and losses to offset related results on the hedged item in
the consolidated statements of operations or to be recorded as other
comprehensive income, to the extent effective, and requires that a company
formally document, designate, and assess the effectiveness of transactions that
receive hedge accounting. The Company is neither a dealer nor trader
in derivative financial instruments. The Company uses interest rate,
cross currency and cross currency interest rate exchange agreements to manage
its interest rate and foreign currency risk.
Generally,
the Company's derivatives do not qualify for hedge accounting. To
qualify for hedge accounting, there must be a high correlation between the pay
leg of the interest rate exchange agreement and the asset being hedged or
between the receive leg of the interest rate exchange agreement and the
liability being hedged. A large portion of the Company's interest
rate exchange agreements use a 30-day composite commercial paper index as the
receive leg, which would have to be highly correlated to the Company's own
commercial paper rates to qualify for hedge accounting. The Company
sells commercial paper to its members as well as to investors in the capital
markets. The Company sets its commercial paper rates daily based on
its cash requirements. The correlation between the Company's
commercial paper rates and the 30-day composite commercial paper index has not
been consistently high enough to qualify for hedge accounting. At May
31, 2008 and 2007, the Company did not have any interest rate exchange
agreements that were accounted for using hedge accounting.
The
Company does not plan to adjust its practice of using the 30-day composite
commercial paper or a LIBOR index as the receive portion of its interest rate
exchange agreements. The Company sets the variable interest rates on
its loans based on the cost of its short-term debt, which is comprised of
long-term debt due within one year and commercial paper. The Company
believes that it is economically hedging its net interest income on loans by
using the 30-day composite commercial paper or LIBOR index, which are the rates
that are most closely related to the rates it pays on its own commercial
paper. During certain periods, the correlation between the LIBOR
rates or the 30-day composite commercial paper rate and the Company's 90-day and
30-day commercial paper rate has been higher than the required 90% to qualify
for hedge accounting. However, the correlation is not consistently
above the 90% threshold, therefore the interest rate exchange agreements that
use the three-month LIBOR rate or 30-day composite commercial paper rate do not
qualify for hedge accounting. For the purposes of its own analysis,
the Company believes that the correlation is sufficiently high to consider these
agreements effective economic hedges.
As a
result of applying SFAS 133, the Company has recorded derivative assets of $221
million and $223 million and derivative liabilities of $171 million and $72
million at May 31, 2008 and 2007, respectively. From inception to
date, accumulated other comprehensive income related to derivatives was $9
million and $12 million as of May 31, 2008 and 2007, respectively.
The
impact of derivatives on the Company's consolidated statements of operations for
the years ended May 31, 2008, 2007 and 2006 was a loss of $72 million, a gain of
$7 million and a gain of $107 million, respectively. The change in
the fair value of derivatives for the years ended May 31, 2008, 2007 and 2006
was a loss of $99 million, a loss of $79 million and a gain of $29 million,
respectively, recorded in the Company's derivative forward value. For
the years ended May 31, 2008, 2007 and 2006, the derivative forward value
includes amortization income of $3 million and $0.8 million and amortization
expense of $0.4 million, respectively, related to the transition adjustment
recorded as an other comprehensive loss on June 1, 2001, the date the Company
implemented SFAS 133. In addition, income totaling $27 million, $86
million and $79 million was recorded for total net cash settlements received by
the Company during the years ended May 31, 2008, 2007 and 2006, respectively, of
which $27 million, $86 million and $81 million, respectively, relate to interest
rate and cross currency interest rate exchange agreements that do not qualify
for hedge accounting under SFAS 133 and were recorded in derivative cash
settlements. The remaining expense of $2 million for the year ended May 31, 2006
relate to interest rate and cross currency interest rate exchange agreements
that qualify for hedge accounting under SFAS 133 and were recorded in interest
expense.
The
Company is required to determine the fair value of its derivative
instruments. Because there is not an active secondary market for the
types of derivative instruments it uses, the Company obtains market quotes from
its dealer counterparties. The market quotes are based on the
expected future cash flow and estimated yield curves. The Company
performs its own analysis to confirm the values obtained from the
counterparties. The Company records the change in the fair value of
its derivatives for each reporting period in the derivative forward value line
on the consolidated statements of operations for the majority of its derivatives
or in the other comprehensive income account on the consolidated balance sheets
for the derivatives that qualify for hedge accounting. The counterparties are
estimating future interest rates as part of the quotes they provide to the
Company. The Company adjusts all derivatives to fair value on a
quarterly basis. The fair value recorded by the Company will change
as estimates of future interest rates change. To estimate the impact
of changes to interest rates on the forward value of derivatives, the Company
would need to estimate all changes to interest rates through the maturity of its
outstanding derivatives. The Company has derivatives in the current
portfolio that do not mature until 2045. In addition, the Company
excludes the changes to the fair value of derivatives from its internal analysis
since they represent the net present value of all future estimated cash
settlements. Thus, the Company does not estimate the impact of
changes in future interest rates to the fair value of its
derivatives. The Company does not believe that volatility in the
derivative forward value line on the consolidated statements of operations is
meaningful in assessing its current financial condition as it represents an
estimated future value and not a cash impact for the current
period.
Cash
settlements that the Company pays and receives for derivative instruments that
do not qualify for hedge accounting are recorded in the cash settlements line in
the consolidated statements of operations. Each 25 basis point
increase or decrease to the 30-day composite commercial paper index and the
three-month LIBOR rate would result in a $6 million increase or decrease in the
Company's net cash settlements due to the composition of the portfolio at May
31, 2008. The Company's interest rate exchange agreements at May 31,
2008 include $7,660 million notional amount, or 59% of the total interest rate
exchange agreements, in which the Company pays a fixed interest rate and
receives a variable interest rate. For the remaining $5,256 million
notional amount, or 41% of the total interest rate exchange agreements at May
31, 2008, the Company pays a variable interest rate and receives a fixed
interest rate. Based on the interest rate exchange agreements in place at May
31, 2008, an increase to variable interest rates results in an increase to cash
settlements due to National Rural.
New
Accounting Pronouncements
On June
1, 2007, the Company adopted SFAS 155, Accounting for Certain Hybrid Financial
Instruments – an amendment of SFAS 133 and 140. SFAS 155 permits fair value
measurement of any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation. SFAS 155 also clarifies
which interest-only strips and principal-only strips are not subject to the
requirements of SFAS 133. It establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are
freestanding derivatives or that are hybrid financial instruments that contain
an embedded derivative requiring bifurcation. SFAS 155 also clarifies that
concentrations of credit risk in the form of subordination are not embedded
derivatives. SFAS 155 is effective for all financial instruments acquired or
issued after the beginning of an entity’s first fiscal year that begins after
September 15, 2006. The Company’s adoption of SFAS 155 did not have a
material impact on the Company's financial position or results of
operations.
On June
1, 2007, the Company adopted SFAS 156, Accounting for Servicing of Financial
Assets. SFAS 156 requires the initial measurement of all separately
recognized servicing assets and liabilities at fair value and permits, but does
not require, the subsequent measurement of servicing assets and liabilities at
fair value. SFAS 156 is effective as of the beginning of the first fiscal year
that begins after September 15, 2006. The Company’s adoption of SFAS
156 did not have a material impact on the Company's financial position or
results of operations.
On June
1, 2007, the Company adopted Financial Accounting Standards Board (“FASB”)
Interpretation No. (“FIN”) 48, Accounting for Uncertainty in Income Taxes, an
interpretation of SFAS 109. FIN 48 clarifies the accounting for
income taxes by prescribing a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company’s adoption of
FIN 48 did not have a material impact on the Company's financial position or
results of operations.
In
September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157
defines fair value, sets out a framework for measuring fair value and expands on
required disclosures about fair value measurement. SFAS 157 is
effective
as of the beginning of the first fiscal year that begins after November 15,
2007. The Company's adoption of SFAS 157 as of June 1, 2008 is not expected to
have a material impact on the Company's financial position or results of
operations.
In
February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial
Assets and Financial Liabilities. The fair value option established by SFAS 159
permits entities to choose to measure eligible financial instruments at fair
value. The unrealized gains and losses on items for which the fair value option
has been elected should be reported in earnings. The decision to elect the fair
value option is determined on an instrument by instrument basis and is
irrevocable. Assets and
liabilities
measured at fair value pursuant to the fair value option should be reported
separately in the balance sheet from those instruments measured using other
measurement attributes. SFAS 159 is effective as of the beginning of the first
fiscal year that begins after November 15, 2007. As part of the
Company's adoption of SFAS 159 as of June 1, 2008, it has not elected the option
to measure eligible financial instruments at fair value and therefore the
adoption of SFAS 159 is not expected to have a material impact on the Company's
financial position or results of operations.
In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of Accounting Research Bulletin
(“ARB”) 51, Consolidated Financial Statements, to establish accounting and
reporting standards for the noncontrolling interests in a subsidiary and for the
deconsolidation of a subsidiary. It also amends certain of ARB 51’s
consolidation procedures for consistency with the requirements of SFAS 141,
Business Combinations. Noncontrolling interests shall be reclassified
to equity, consolidated net income shall be adjusted to include net income
attributable to noncontrolling interests and consolidated comprehensive income
shall be adjusted to include comprehensive income attributable to the
noncontrolling interests. This statement is effective for fiscal
years beginning on or after December 15, 2008. The Company’s adoption
of SFAS 160 on June 1, 2009 is not expected to have a material impact on the
Company’s financial position or results of operations.
In March
2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and
Hedging Activities. This statement requires enhanced disclosures about an
entity’s derivative and hedging activities. The statement is
effective for fiscal years beginning after November 15, 2008. The
Company’s adoption of SFAS 161 on June 1, 2009 is not expected to have a
material impact on the Company’s financial position or results of
operations.
Results
of Operations
Fiscal
Year 2008 versus 2007 Results
The
following chart presents the results of operations for the year ended May 31,
2008 versus May 31, 2007.
|
|
For
the year ended May 31,
|
|
Increase/
|
|
(Dollar
amounts in thousands)
|
|
2008
|
|
2007
|
|
(Decrease)
|
|
Interest
income
|
|
$
|
1,069,540
|
|
|
$
|
1,054,224
|
|
|
$
|
15,316
|
|
|
Interest
expense
|
|
|
(936,889
|
)
|
|
|
(996,730
|
)
|
|
|
59,841
|
|
|
Net
interest income
|
|
|
132,651
|
|
|
|
57,494
|
|
|
|
75,157
|
|
|
Recovery
of loan losses
|
|
|
30,262
|
|
|
|
6,922
|
|
|
|
23,340
|
|
|
Net
interest income after recovery of loan losses
|
|
|
162,913
|
|
|
|
64,416
|
|
|
|
98,497
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
|
1,461
|
|
|
|
1,533
|
|
|
|
(72
|
)
|
|
Derivative
cash settlements
|
|
|
27,033
|
|
|
|
86,442
|
|
|
|
(59,409
|
)
|
|
Results
of operations of foreclosed assets
|
|
|
7,528
|
|
|
|
9,758
|
|
|
|
(2,230
|
)
|
|
Total
non-interest income
|
|
|
36,022
|
|
|
|
97,733
|
|
|
|
(61,711
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
|
(36,428
|
)
|
|
|
(33,817
|
)
|
|
|
(2,611
|
)
|
|
Other
general and administrative expenses
|
|
|
(24,041
|
)
|
|
|
(18,072
|
)
|
|
|
(5,969
|
)
|
|
Recovery
of guarantee liability
|
|
|
3,104
|
|
|
|
1,700
|
|
|
|
1,404
|
|
|
Market
adjustment on foreclosed assets
|
|
|
(5,840
|
)
|
|
|
-
|
|
|
|
(5,840
|
)
|
|
Derivative
forward value
|
|
|
(98,743
|
)
|
|
|
(79,281
|
)
|
|
|
(19,462
|
)
|
|
Foreign
currency adjustments
|
|
|
-
|
|
|
|
(14,554
|
)
|
|
|
14,554
|
|
|
Loss
on sale of loans
|
|
|
(676
|
)
|
|
|
(1,584
|
)
|
|
|
908
|
|
|
Total
non-interest expense
|
|
|
(162,624
|
)
|
|
|
(145,608
|
)
|
|
|
(17,016
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
prior to income taxes and minority interest
|
|
|
36,311
|
|
|
|
16,541
|
|
|
|
19,770
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit (expense)
|
|
|
3,335
|
|
|
|
(2,396
|
)
|
|
|
5,731
|
|
|
Minority
interest, net of income taxes
|
|
|
6,099
|
|
|
|
(2,444
|
)
|
|
|
8,543
|
|
|
Net
income
|
|
$
|
45,745
|
|
|
$
|
11,701
|
|
|
$
|
34,044
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TIER
|
|
|
1.05
|
|
|
|
1.01
|
|
|
|
|
|
|
Adjusted
TIER (1)
|
|
|
|
1.15
|
|
|
|
1.12
|
|
|
|
|
|
|
5(1) Adjusted to exclude the
impact of the derivative forward value and foreign currency adjustments from net
income, to include minority interest in net income and to include all derivative
cash settlements in the interest expense. See "Non-GAAP Financial
Measures" for further explanation and a reconciliation of these
adjustments.
The
Company’s net interest income will increase or decrease due to changes in loan
volume and the interest rates that it receives on its loans and pays on its
sources of funding. The Company’s loan volume substantially
determines its funding needs. The following Volume Rate Variance Table provides
a breakout of the change to interest income, interest expense and net interest
income due to changes in loan volume versus changes to interest
rates. For comparability purposes, average daily loan volume is used
as the denominator in calculating interest income yield, interest expense rates
and net interest income yield.
The
following table also includes a breakout of the change to derivative cash
settlements due to changes in the average notional amount of its derivative
portfolio versus changes to the net difference between the average rate paid and
the average rate received. Management calculates an adjusted interest
expense, which includes all derivative cash settlements in interest
expense. See "Non-GAAP Financial Measures" for further explanation of
the adjustment the Company makes in its financial analysis to include all
derivative cash settlements in its interest expense.
Volume
Rate Variance Table
(Dollar
amounts in millions)
|
|
|
|
|
|
|
For
the year ended May 31,
|
|
|
|
|
|
|
2008
|
|
|
2007
|
|
Change
due to
|
|
|
|
|
Average
Loan Balance
|
Income/
(Cost)
|
Average
Interest
Rate
|
|
|
Average
Loan Balance
|
Income/
(Cost)
|
Average
Interest
Rate
|
|
Volume
(1)
|
Rate
(2)
|
Total
|
|
|
Interest
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
16,167
|
$
|
947
|
|
5.85
|
%
|
|
$
|
15,803
|
$
|
917
|
|
5.80
|
%
|
|
$
|
21
|
|
$
|
9
|
|
$
|
30
|
|
|
|
RTFC
|
|
1,791
|
|
89
|
|
4.97
|
%
|
|
|
1,994
|
|
106
|
|
5.30
|
%
|
|
|
(11
|
)
|
|
(6
|
)
|
|
(17
|
)
|
|
|
NCSC
|
|
442
|
|
34
|
|
7.68
|
%
|
|
|
396
|
|
31
|
|
8.00
|
%
|
|
|
4
|
|
|
(1
|
)
|
|
3
|
|
|
|
Total
|
$
|
18,400
|
$
|
1,070
|
|
5.81
|
%
|
|
$
|
18,193
|
$
|
1,054
|
|
5.79
|
%
|
|
$
|
14
|
|
$
|
2
|
|
$
|
16
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
|
National
Rural
|
$
|
16,167
|
$
|
(826
|
)
|
(5.11
|
)%
|
|
$
|
15,803
|
$
|
(870
|
)
|
(5.51
|
)%
|
|
$
|
(20
|
)
|
$
|
64
|
|
$
|
44
|
|
|
|
RTFC
|
|
1,791
|
|
(84
|
)
|
(4.68
|
)%
|
|
|
1,994
|
|
(100
|
)
|
(4.98
|
)%
|
|
|
10
|
|
|
6
|
|
|
16
|
|
|
|
NCSC
|
|
442
|
|
(27
|
)
|
(6.19
|
)%
|
|
|
396
|
|
(27
|
)
|
(6.90
|
)%
|
|
|
(3
|
)
|
|
3
|
|
|
-
|
|
|
|
Total
|
$
|
18,400
|
$
|
(937
|
)
|
(5.09
|
)%
|
|
$
|
18,193
|
$
|
(997
|
)
|
(5.48
|
)%
|
|
$
|
(13
|
)
|
$
|
73
|
|
$
|
60
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
|
National
Rural
|
$
|
16,167
|
$
|
121
|
|
0.74
|
%
|
|
$
|
15,803
|
$
|
47
|
|
0.29
|
%
|
|
$
|
1
|
|
$
|
73
|
|
$
|
74
|
|
|
|
RTFC
|
|
1,791
|
|
5
|
|
0.29
|
%
|
|
|
1,994
|
|
6
|
|
0.32
|
%
|
|
|
(1
|
)
|
|
-
|
|
|
(1
|
)
|
|
|
NCSC
|
|
442
|
|
7
|
|
1.49
|
%
|
|
|
396
|
|
4
|
|
1.10
|
%
|
|
|
1
|
|
|
2
|
|
|
3
|
|
|
|
Total
|
$
|
18,400
|
$
|
133
|
|
0.72
|
%
|
|
$
|
18,193
|
$
|
57
|
|
0.31
|
%
|
|
$
|
1
|
|
$
|
75
|
|
$
|
76
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
cash settlements (3)
|
|
|
|
|
National
Rural
|
$
|
12,852
|
$
|
28
|
|
0.22
|
%
|
|
$
|
12,508
|
$
|
86
|
|
0.69
|
%
|
|
$
|
2
|
|
$
|
(60
|
)
|
$
|
(58
|
)
|
|
|
NCSC
|
|
204
|
|
(1
|
)
|
(0.68
|
)%
|
|
|
124
|
|
1
|
|
0.33
|
%
|
|
|
-
|
|
|
(2
|
)
|
|
(2
|
)
|
|
|
Total
|
$
|
13,056
|
$
|
27
|
|
0.21
|
%
|
|
$
|
12,632
|
$
|
87
|
|
0.68
|
%
|
|
$
|
2
|
|
$
|
(62
|
)
|
$
|
(60
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted
interest expense (4)
|
|
|
|
|
Total
|
$
|
18,400
|
$
|
(910
|
)
|
(4.94
|
)%
|
|
$
|
18,193
|
$
|
(910
|
)
|
(5.00
|
)%
|
|
$
|
(11
|
)
|
$
|
11
|
|
$
|
-
|
|
(1)
Variance due to volume is calculated using the following formula: (current
period average balance – prior year period average balance) x prior year period
average rate.
(2)
Variance due to rate is calculated using the following formula: (current period
average rate – prior year period average rate) x current period average
balance.
(3) For
derivative cash settlements, average loan balance represents the average
notional amount of derivative contracts outstanding and the rate represents the
net difference between the average rate paid and the average rate received for
cash settlements during the period.
(4) See
“Non-GAAP Financial Measures” for further explanation of the adjustment the
Company makes in its financial analysis to include the derivative cash
settlements in its interest expense.
Interest
Income
Total
interest income reported on the consolidated statements of operations and shown
in the chart above is summarized as follows by income type and as a percentage
of average loans outstanding:
|
|
For
the year ended May 31,
|
|
|
|
|
|
2008
|
|
2007
|
|
|
|
(Dollar
amounts in thousands)
|
|
|
Amount
|
|
Rate
|
|
|
|
Amount
|
|
Rate
|
|
|
Increase/
(Decrease)
|
|
Interest
on long-term fixed rate loans (1)
|
|
$
|
872,488
|
|
|
|
|
$
|
833,247
|
|
|
|
|
$
|
39,241
|
|
|
Interest
on long-term variable rate loans (1)
|
|
|
86,787
|
|
|
|
|
|
114,786
|
|
|
|
|
|
(27,999
|
)
|
|
Interest
on short-term loans (1)
|
|
|
77,145
|
|
|
|
|
|
72,632
|
|
|
|
|
|
4,513
|
|
|
Total
interest income on loans
|
|
|
1,036,420
|
|
5.63
|
%
|
|
|
1,020,665
|
|
5.61
|
%
|
|
|
15,755
|
|
|
Interest
on investments (2)
|
|
|
7,394
|
|
0.04
|
%
|
|
|
9,662
|
|
0.05
|
%
|
|
|
(2,268
|
)
|
|
Conversion
fees (3)
|
|
|
6,670
|
|
0.04
|
%
|
|
|
9,162
|
|
0.05
|
%
|
|
|
(2,492
|
)
|
|
Make-whole
and prepayment fees (4)
|
|
|
10,759
|
|
0.06
|
%
|
|
|
4,748
|
|
0.03
|
%
|
|
|
6,011
|
|
|
Commitment
and guarantee fees (5)
|
|
|
5,109
|
|
0.03
|
%
|
|
|
9,161
|
|
0.05
|
%
|
|
|
(4,052
|
)
|
|
Other
fees
|
|
|
3,188
|
|
0.01
|
%
|
|
|
826
|
|
-
|
|
|
|
2,362
|
|
|
Total
interest income
|
|
|
$
|
1,069,540
|
|
5.81
|
%
|
|
$
|
1,054,224
|
|
5.79
|
%
|
|
$
|
15,316
|
|
|
(1)
Represents interest income on loans to members.
(2)
Represents interest income on the investment of excess cash.
(3)
Conversion fees are deferred and recognized using the interest method over the
remaining original loan interest rate pricing term, except for a small portion
of the total fee charged to cover administrative costs related to the
conversion, which is recognized immediately.
(4)
Make-whole and prepayment fees are charged for the early repayment of principal
and are recognized when collected.
(5)
Commitment fees for RTFC loan commitments are, in most cases, refundable on a
prorata basis according to the amount of the loan commitment that is
advanced. Such refundable fees are deferred and then recognized on a
prorata basis based on the portion of the loan that is not advanced prior to the
expiration of the commitment. Commitment fees on National Rural loan
commitments are not refundable and are billed and recognized based on the unused
portion of committed lines of credit. Guarantee fees are charged
based on the amount, type and term of the guarantee. Guarantee fees
are deferred and amortized using the straight-line method into interest income
over the life of the guarantee.
The $15
million or 1% increase to the total interest income for the year ended May 31,
2008 as compared to the prior year period was due to the increase in National
Rural and NCSC loan volume and long-term fixed rate loans that repriced at
higher interest rates partly offset by the decrease in RTFC loan volume and
lower variable interest rates. Interest rates for approximately $703
million of National Rural long-term fixed rate loans were repriced in January
2008 with 85% selecting a new fixed rate. The weighted average
interest rate of long-term loans subject to repricing in January 2008 was
approximately 5.37%, which is lower than the National Rural fixed interest rates
available to members at that time of between 5.65% and 7.25% (depending on the
term selected). The increase in interest income was offset by the
impact of the Company decreasing variable interest rates by approximately 215 to
250 basis points, depending on the loan program, since May 31,
2007.
For the
year ended May 31, 2008, the Company had a reduction to interest income of $67
million due to non-accrual loans compared to a reduction of $81 million for the
prior year period. The impact on National Rural interest income of
non-accrual loans was a reduction of $34 million for the year ended May 31, 2008
as compared to $39 million for the prior year period. The impact on
RTFC interest income of non-accrual loans was a reduction of $33 million for the
year ended May 31, 2008 as compared to $42 million for the prior year
period. The impact of non-accrual loans on interest income is
included in the rate variance in the chart above.
Interest
Expense
Total
interest expense reported on the consolidated statements of operations and shown
in the Volume Rate Variance Table above is summarized as follows by
expense type and as a percentage of average loans outstanding:
|
|
For
the year ended May 31,
|
|
|
|
|
|
2008
|
|
2007
|
|
|
|
(Dollar
amounts in thousands)
|
|
|
Amount
|
|
Rate
|
|
|
|
Amount
|
|
Rate
|
|
|
Increase/
(Decrease)
|
|
Interest
expense - commercial paper and bid notes (1)
|
|
$
|
122,786
|
|
|
|
|
$
|
178,687
|
|
|
|
|
$
|
(55,901
|
)
|
|
Interest
expense - medium-term notes (1)
|
|
|
330,193
|
|
|
|
|
|
363,760
|
|
|
|
|
|
(33,567
|
)
|
|
Interest
expense - collateral trust bonds (1)
|
|
|
243,579
|
|
|
|
|
|
218,523
|
|
|
|
|
|
25,056
|
|
|
Interest
expense - subordinated deferrable debt (1)
|
|
|
19,663
|
|
|
|
|
|
33,089
|
|
|
|
|
|
(13,426
|
)
|
|
Interest
expense - subordinated certificates (1)
|
|
|
48,717
|
|
|
|
|
|
47,852
|
|
|
|
|
|
865
|
|
|
Interest
expense - long-term private debt (1)
|
|
|
136,779
|
|
|
|
|
|
118,722
|
|
|
|
|
|
18,057
|
|
|
Total
interest expense on debt
|
|
|
901,717
|
|
4.90
|
%
|
|
|
960,633
|
|
5.28
|
%
|
|
|
(58,916
|
)
|
|
Debt
issuance costs (2)
|
|
|
9,605
|
|
0.05
|
%
|
|
|
12,328
|
|
0.07
|
%
|
|
|
(2,723
|
)
|
|
Commitment
and guarantee fees (3)
|
|
|
17,915
|
|
0.10
|
%
|
|
|
16,023
|
|
0.09
|
%
|
|
|
1,892
|
|
|
Loss
on extinguishment of debt (4)
|
|
|
5,509
|
|
0.03
|
%
|
|
|
4,806
|
|
0.03
|
%
|
|
|
703
|
|
|
Other
fees
|
|
|
2,143
|
|
0.01
|
%
|
|
|
2,940
|
|
0.01
|
%
|
|
|
(797
|
)
|
|
Total
interest expense
|
|
|
$
|
936,889
|
|
5.09
|
%
|
|
$
|
996,730
|
|
5.48
|
%
|
|
$
|
(59,841
|
)
|
|
(1)
Represents interest expense and the amortization of discounts on
debt.
(2)
Includes amortization of all deferred charges related to debt issuance,
principally underwriter's fees, legal fees, printing costs and comfort letter
fees. Amortization is calculated on the effective interest
method. Also includes issuance costs related to dealer commercial
paper.
(3)
Includes various fees related to funding activities, including fees paid to
banks participating in the Company's revolving credit agreements and fees paid
under bond guarantee agreements with RUS as part of the Rural Economic
Development Loan and Grant ("REDLG") program. Fees are recognized as
incurred or amortized on a straight-line basis over the life of the respective
agreement.
(4)
Represents the gain or loss on the early retirement of debt including the
write-off of unamortized discount, premium and issuance costs.
The $60
million or 6% decrease to total interest expense for the year ended May 31, 2008
as compared to the prior year period was due to lower interest expense on
commercial paper and variable rate long-term debt as a result of a 325 basis
point decrease in the federal funds rate from the rate in effect at May 31,
2007. The $500 million borrowed under the REDLG program in August
2007 represents a lower cost compared to the Company's other forms of long-term
debt as a result of the guarantee of repayment by the RUS. In
addition, the $175 million of 7.40% subordinated deferrable debt redeemed in
June 2007 resulted in a 39 basis point decrease in the weighted average cost of
subordinated deferrable debt. The Company redeemed these securities
at par and recorded a charge of $6 million in interest expense for the
unamortized issuance costs in the first quarter of fiscal year
2008. There was a $5 million loss on the extinguishment of debt for
the year ended May 31, 2007 due to the write-off of unamortized debt issuance
costs associated with the early redemption of subordinated deferrable
debt.
The
adjusted interest expense, which includes all derivative cash settlements, was
consistent for the year ended May 31, 2008 with the prior year period based on
changes to interest expense noted above and derivative cash settlements
described below. See "Non-GAAP Financial Measures" for further
explanation of the adjustment the Company makes in its financial analysis to
include all derivative cash settlements in its interest expense.
Net
Interest Income
The
change in the line items described above resulted in an increase in net interest
income of $75 million for the year ended May 31, 2008 compared to the prior year
period. The adjusted net interest income, which includes all
derivative cash settlements, for the year ended May 31, 2008 was $160 million,
an increase of $16 million from the prior year period. See "Non-GAAP
Financial Measures" for further explanation of the adjustment the Company makes
in its financial analysis to include all derivative cash settlements in its
interest expense, and therefore net interest income.
Recovery
of Loan Losses
The $30
million recovery of loan losses for the year ended May 31, 2008 resulted
substantially from the decrease in calculated impairments due to lower variable
rates and payments received on impaired loans.
Non-interest
Income
Non-interest
income decreased by $62 million for the year ended May 31, 2008 compared to the
prior year primarily due to decreases in cash settlements and income from the
operations of foreclosed assets. The $59 million decrease in cash
settlements for the year ended May 31, 2008 from the prior year period is
primarily due to a $31 million payment received during the prior year for the
termination of two exchange agreements compared to $8 million paid during the
year ended May 31, 2008 for the termination of three exchange
agreements. Additionally, cash settlements decreased for the year
ended May 31, 2008 due to the 325 basis point decrease in the federal funds rate
from May 31, 2007 to May 31, 2008 as the Company received a variable rate on 59%
of its interest rate exchange agreements during fiscal year 2008 compared to 41%
of its interest rate exchange agreements for which the Company pays a variable
rate. Income from the operation of foreclosed assets decreased by $2
million for the year ended May 31, 2008 compared to the prior year due to a
lower outstanding balance in foreclosed assets. At May 31, 2008, the
foreclosed assets are comprised of real estate developer notes receivable and
limited partnership interests in certain real estate developments.
Non-interest
Expense
Non-interest
expense increased by $17 million for the year ended May 31, 2008 compared to the
prior year.
Salaries
and employee benefits increased by $3 million for the year ended May 31, 2008 as
compared to the prior year period primarily due to additional headcount and
higher medical insurance rates paid by the Company. The Company had
13 additional employee positions filled at May 31, 2008 as compared to the prior
year period end.
General
and administrative expenses increased by $6 million for the year ended May 31,
2008 compared to the prior year period because of increased expenditures for the
acceleration of information systems projects and the write-off of site work
expenses on property the Company had under contract, but the seller was unable
to meet the conditions to close the sale. Increased membership
meeting expenses, marketing and audit fees also contributed to higher general
and administrative expenses for the year ended May 31, 2008.
For the
year ended May 31, 2008, the Company determined that there was a reduction of $6
million to the market value of the real estate developer notes receivable held
as foreclosed assets. The reduction to the market value was primarily
as a result of the slowdown in lot sales due to residential home market
weakness.
The $19
million decrease in the derivative forward value during the year ended May 31,
2008 compared to the prior year period is due to changes in the estimate of
future interest rates over the remaining life of the derivative
contracts.
There was
no foreign denominated debt outstanding during the year ended May 31, 2008,
therefore resulting in no foreign currency adjustments compared to $15 million
in the prior year period. When the Company issues debt in foreign
currencies, it must adjust the value of the debt reported on the consolidated
balance sheets for changes in foreign currency exchange rates since the date of
issuance. To the extent that the current exchange rate is different
than the exchange rate at the time of issuance, there will be a change in the
value of the foreign denominated debt. The adjustment to the value of the debt
is reported on the consolidated statements of operations as foreign currency
adjustments. At the time of issuance of all foreign denominated debt,
the Company typically enters into a cross currency or cross currency interest
rate exchange agreement to fix the exchange rate on all principal and interest
payments through maturity.
Minority
Interest
Minority
interest represents $0.3 million and $5.8 million of net loss for RTFC and NCSC,
respectively, for the year ended May 31, 2008 compared to $0.1 million and $2.3
million of net income for RTFC and NCSC, respectively, for the prior year
period. The decrease in NCSC net income is primarily due to
fluctuations in the fair value of its derivative instruments.
Net
Income
The
change in the line items described above resulted in an increase in net income
of $34 million for the year ended May 31, 2008 from the prior year
period. The adjusted net income, which excludes the impact of the
derivative forward value and foreign currency adjustments and adds back minority
interest, was $138 million, compared to $108 million for the prior year
period. See "Non-GAAP Financial Measures" for further explanation of
the adjustments the Company makes in its financial analysis to net
income.
Fiscal
Year 2007 versus 2006 Results
The
following chart presents the results for the year ended May 31, 2007 versus
2006.
|
|
For
the year ended May 31,
|
|
|
|
(Dollar
amounts in thousands)
|
|
2007
|
|
2006
|
|
Increase/
(Decrease)
|
|
Interest
income
|
|
$
|
1,054,224
|
|
|
$
|
1,007,912
|
|
|
$
|
46,312
|
|
|
Interest
expense
|
|
|
(996,730
|
)
|
|
|
(975,936
|
)
|
|
|
(20,794
|
)
|
|
Net
interest income
|
|
|
57,494
|
|
|
|
31,976
|
|
|
|
25,518
|
|
|
Recovery
of (provision for) loan losses
|
|
|
6,922
|
|
|
|
(23,240
|
)
|
|
|
30,162
|
|
|
Net
interest income after recovery of (provision for) loan
losses
|
|
|
64,416
|
|
|
|
8,736
|
|
|
|
55,680
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
|
1,533
|
|
|
|
2,398
|
|
|
|
(865
|
)
|
|
Derivative
cash settlements
|
|
|
86,442
|
|
|
|
80,883
|
|
|
|
5,559
|
|
|
Results
of operations of foreclosed assets
|
|
|
9,758
|
|
|
|
15,492
|
|
|
|
(5,734
|
)
|
|
Gain
on sale of building and land
|
|
|
-
|
|
|
|
43,431
|
|
|
|
(43,431
|
)
|
|
Total
non-interest income
|
|
|
97,733
|
|
|
|
142,204
|
|
|
|
(44,471
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
|
(33,817
|
)
|
|
|
(31,494
|
)
|
|
|
(2,323
|
)
|
|
Other
general and administrative expenses
|
|
|
(18,072
|
)
|
|
|
(20,595
|
)
|
|
|
2,523
|
|
|
Recovery
of guarantee liability
|
|
|
1,700
|
|
|
|
700
|
|
|
|
1,000
|
|
|
Derivative
forward value
|
|
|
(79,281
|
)
|
|
|
28,805
|
|
|
|
(108,086
|
)
|
|
Foreign
currency adjustments
|
|
|
(14,554
|
)
|
|
|
(22,594
|
)
|
|
|
8,040
|
|
|
Loss
on sale of loans
|
|
|
(1,584
|
)
|
|
|
-
|
|
|
|
(1,584
|
)
|
|
Total
non-interest expense
|
|
|
(145,608
|
)
|
|
|
(45,178
|
)
|
|
|
(100,430
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
prior to income taxes and minority interest
|
|
|
16,541
|
|
|
|
105,762
|
|
|
|
(89,221
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax expense
|
|
|
(2,396
|
)
|
|
|
(3,176
|
)
|
|
|
780
|
|
|
Minority
interest, net of income taxes
|
|
|
(2,444
|
)
|
|
|
(7,089
|
)
|
|
|
4,645
|
|
|
Net
income
|
|
$
|
11,701
|
|
|
$
|
95,497
|
|
|
$
|
(83,796
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TIER
|
|
|
1.01
|
|
|
|
1.10
|
|
|
|
|
|
|
Adjusted
TIER (1)
|
|
|
|
1.12
|
|
|
|
1.11
|
|
|
|
|
|
|
(1)
Adjusted to exclude the impact of the derivative forward value and foreign
currency adjustments from net income, to include minority interest in net income
and to include all derivative cash settlements in the interest
expense. See "Non-GAAP Financial Measures" for further explanation
and a reconciliation of these adjustments.
The
Company’s net interest income will increase or decrease due to changes in loan
volume and the interest rates that it receives on its loans and pays on its
sources of funding. The Company’s loan volume substantially
determines its funding needs. The following Volume Rate Variance Table provides
a breakout of the change to interest income, interest expense and net interest
income due to changes in loan volume versus changes to interest
rates. For comparability purposes, average daily loan volume is used
as the denominator in calculating interest income yield, interest expense rates
and net interest income yield.
The
following table also includes a breakout of the change to derivative cash
settlements due to changes in the average notional amount of its derivative
portfolio versus changes to the net difference between the average rate paid and
the average rate received. Management calculates an adjusted net
interest income, which includes all derivative cash settlements in interest
expense. See "Non-GAAP Financial Measures" for further explanation of
the adjustment the Company makes in its financial analysis to include all
derivative cash settlements in its interest expense.
Volume
Rate Variance Table
(Dollar
amounts in millions)
|
|
|
|
For
the year ended May 31,
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
Change
due to
|
|
|
|
|
Average
Loan Balance
|
Income/
(Cost)
|
Average
Interest
Rate
|
|
|
Average
Loan Balance
|
Income/
(Cost)
|
Average
Interest
Rate
|
|
Volume
(1)
|
Rate
(2)
|
Total
|
|
|
Interest
income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
15,803
|
$
|
917
|
|
5.80
|
%
|
|
$
|
15,605
|
$
|
847
|
|
5.43
|
%
|
|
$
|
11
|
|
$
|
59
|
|
$
|
70
|
|
|
|
RTFC
|
|
1,994
|
|
106
|
|
5.30
|
%
|
|
|
2,356
|
|
130
|
|
5.50
|
%
|
|
|
(20
|
)
|
|
(4
|
)
|
|
(24
|
)
|
|
|
NCSC
|
|
396
|
|
31
|
|
8.00
|
%
|
|
|
444
|
|
31
|
|
7.08
|
%
|
|
|
(4
|
)
|
|
4
|
|
|
-
|
|
|
|
Total
|
$
|
18,193
|
$
|
1,054
|
|
5.79
|
%
|
|
$
|
18,405
|
$
|
1,008
|
|
5.48
|
%
|
|
$
|
(13
|
)
|
$
|
59
|
|
$
|
46
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
|
|
National
Rural
|
$
|
15,803
|
$
|
(870
|
)
|
(5.51
|
)%
|
|
$
|
15,605
|
$
|
(827
|
)
|
(5.30
|
)%
|
|
$
|
(10
|
)
|
$
|
(33
|
)
|
$
|
(43
|
)
|
|
|
RTFC
|
|
1,994
|
|
(100
|
)
|
(4.98
|
)%
|
|
|
2,356
|
|
(123
|
)
|
(5.21
|
)%
|
|
|
18
|
|
|
5
|
|
|
23
|
|
|
|
NCSC
|
|
396
|
|
(27
|
)
|
(6.90
|
)%
|
|
|
444
|
|
(26
|
)
|
(5.92
|
)%
|
|
|
3
|
|
|
(4
|
)
|
|
(1
|
)
|
|
|
Total
|
$
|
18,193
|
$
|
(997
|
)
|
(5.48
|
)%
|
|
$
|
18,405
|
$
|
(976
|
)
|
(5.30
|
)%
|
|
$
|
11
|
|
$
|
(32
|
)
|
$
|
(21
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
|
National
Rural
|
$
|
15,803
|
$
|
47
|
|
0.29
|
%
|
|
$
|
15,605
|
$
|
20
|
|
0.13
|
%
|
|
$
|
1
|
|
$
|
26
|
|
$
|
27
|
|
|
|
RTFC
|
|
1,994
|
|
6
|
|
0.32
|
%
|
|
|
2,356
|
|
7
|
|
0.29
|
%
|
|
|
(2
|
)
|
|
1
|
|
|
(1
|
)
|
|
|
NCSC
|
|
396
|
|
4
|
|
1.10
|
%
|
|
|
444
|
|
5
|
|
1.16
|
%
|
|
|
(1
|
)
|
|
-
|
|
|
(1
|
)
|
|
|
Total
|
$
|
18,193
|
$
|
57
|
|
0.31
|
%
|
|
$
|
18,405
|
$
|
32
|
|
0.18
|
%
|
|
$
|
(2
|
)
|
$
|
27
|
|
$
|
25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
cash settlements (3)
|
|
|
|
|
National
Rural
|
$
|
12,508
|
$
|
86
|
|
0.69
|
%
|
|
$
|
15,030
|
$
|
82
|
|
0.54
|
%
|
|
$
|
(14
|
)
|
$
|
18
|
|
$
|
4
|
|
|
|
NCSC
|
|
124
|
|
1
|
|
0.33
|
%
|
|
|
110
|
|
(1
|
)
|
(0.84
|
)%
|
|
|
-
|
|
|
2
|
|
|
2
|
|
|
|
Total
|
$
|
12,632
|
$
|
87
|
|
0.68
|
%
|
|
$
|
15,140
|
$
|
81
|
|
0.53
|
%
|
|
$
|
(14
|
)
|
$
|
20
|
|
$
|
6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted
interest expense (4)
|
|
|
|
|
Total
|
$
|
18,193
|
$
|
(910
|
)
|
(5.00
|
)%
|
|
$
|
18,405
|
$
|
(895
|
)
|
(4.86
|
)%
|
|
$
|
(3
|
)
|
$
|
(12
|
)
|
$
|
(15
|
)
|
(1)
Variance due to volume is calculated using the following formula: (current
average balance – prior year average balance) x prior year rate.
(2)
Variance due to rate is calculated using the following formula: (current rate –
prior year rate) x current average balance.
(3) For
derivative cash settlements, average loan balance represents the average
notional amount of derivative contracts outstanding and the rate represents the
net difference between the average rate paid and the average rate received for
cash settlements during the period.
(4) See
“Non-GAAP Financial Measures” for further explanation of the adjustment the
Company makes in its financial analysis to include all derivative cash
settlements in its interest expense.
Interest
Income
Total
interest income reported on the consolidated statements of operations and shown
in the chart above includes the following as a percentage of average loans
outstanding:
|
|
For
the year ended May 31,
|
|
|
|
|
|
2007
|
|
2006
|
|
|
|
(Dollar
amounts in thousands)
|
|
|
Amount
|
|
Rate
|
|
|
|
Amount
|
|
Rate
|
|
|
Increase/
(Decrease)
|
|
Interest
on long-term fixed rate loans (1)
|
|
$
|
833,247
|
|
|
|
|
$
|
759,618
|
|
|
|
|
$
|
73,629
|
|
|
Interest
on long-term variable rate loans (1)
|
|
|
114,786
|
|
|
|
|
|
153,613
|
|
|
|
|
|
(38,827
|
)
|
|
Interest
on short-term loans (1)
|
|
|
72,632
|
|
|
|
|
|
57,636
|
|
|
|
|
|
14,996
|
|
|
Total
interest income on loans
|
|
|
1,020,665
|
|
5.61
|
%
|
|
|
970,867
|
|
5.28
|
%
|
|
|
49,798
|
|
|
Interest
on investments
(2)
|
|
|
9,662
|
|
0.05
|
%
|
|
|
10,391
|
|
0.05
|
%
|
|
|
(729
|
)
|
|
Conversion
fees (3)
|
|
|
9,162
|
|
0.05
|
%
|
|
|
14,444
|
|
0.08
|
%
|
|
|
(5,282
|
)
|
|
Make-whole
and prepayment fees (4)
|
|
|
4,748
|
|
0.03
|
%
|
|
|
5,409
|
|
0.03
|
%
|
|
|
(661
|
)
|
|
Commitment
and guarantee fees (5)
|
|
|
9,161
|
|
0.05
|
%
|
|
|
6,488
|
|
0.04
|
%
|
|
|
2,673
|
|
|
Other
fees
|
|
|
826
|
|
-
|
|
|
|
313
|
|
-
|
|
|
|
513
|
|
|
Total interest
income
|
|
|
$
|
1,054,224
|
|
5.79
|
%
|
|
$
|
1,007,912
|
|
5.48
|
%
|
|
$
|
46,312
|
|
|
(1)
Represents interest income on loans to members.
(2)
Represents interest income on the investment of cash.
(3)
Conversion fees are deferred and recognized using the interest method over the
remaining original loan interest rate pricing term, except for a small portion
of the total fee charged to cover administrative costs related to the
conversion, which is recognized immediately.
(4)
Make-whole and prepayment fees are charged for the early repayment of principal
in full and recognized when collected.
(5)
Commitment fees for RTFC loan commitments are, in most cases, refundable on a
prorata basis according to the amount of the loan commitment that is
advanced. Such refundable fees are deferred and then recognized on a
prorata basis based on the portion of the loan that is not advanced prior to the
expiration of the commitment. Commitment fees on National Rural loan
commitments are not refundable and are billed and recognized based on the unused
portion of committed lines of credit. Guarantee fees are charged
based on the amount, type and term of the guarantee. Guarantee fees
are deferred and amortized using the straight-line method into interest income
over the life of the guarantee.
The $46
million or 5% increase to the total interest income for the year ended May 31,
2007 as compared to the prior year period was due to the increase to National
Rural loan interest rates in the markets offset by lower RTFC loan
volume. During the year ended May 31, 2007, the Company raised
variable interest rates by approximately 15 basis points, while fixed interest
rates remained relatively stable. For the year ended May 31, 2007,
the Company had a reduction to interest income of $81 million due to non-accrual
loans compared to a reduction of $79 million for the prior year
period. The decrease in loan volume is due to the prepayment of RTFC
loans during the year ended May 31, 2007. The $4 million decrease in
fee and investment income earned during the year ended May 31, 2007 was due to
lower conversion fees recognized as compared to the prior year
period.
The $70
million increase in National Rural interest income during the year ended May 31,
2007 as compared to the prior year was due to the increase in interest rates and
loan volume partly offset by the impact of non-accrual loans. The impact on
National Rural interest income of non-accrual loans was a reduction of $39
million for the year ended May 31, 2007 as compared to $36 million for the prior
year period. The impact of non-accrual loans on interest income is
included in the rate variance in the chart above. The $24 million
decrease in RTFC interest income during the year ended May 31, 2007 as compared
to the prior year was due to the reduction in the balance of RTFC loans
outstanding. The impact on RTFC interest income of non-accrual loans
was a reduction of $42 million for the year ended May 31, 2007 as compared to
$43 million for the prior year period.
Interest
Expense
Total
interest expense reported on the consolidated statements of operations and shown
in the Volume Rate Variance Table above includes the following
and the weighted average interest rate thereon:
|
|
For
the year ended May 31,
|
|
|
|
|
|
2007
|
|
2006
|
|
Increase/
|
|
(Dollar
amounts in thousands)
|
|
|
Amount
|
|
Rate
|
|
|
|
Amount
|
|
Rate
|
|
|
(Decrease)
|
|
Interest
expense - commercial paper and bid notes (1)
|
|
$
|
178,687
|
|
|
|
|
$
|
133,035
|
|
|
|
|
$
|
45,652
|
|
|
Interest
expense - medium-term notes (1)
|
|
|
363,760
|
|
|
|
|
|
409,454
|
|
|
|
|
|
(45,694
|
)
|
|
Interest
expense - collateral trust bonds (1)
|
|
|
218,523
|
|
|
|
|
|
271,980
|
|
|
|
|
|
(53,457
|
)
|
|
Interest
expense - subordinated deferrable debt (1)
|
|
|
33,089
|
|
|
|
|
|
45,349
|
|
|
|
|
|
(12,260
|
)
|
|
Interest
expense - subordinated certificates (1)
|
|
|
47,852
|
|
|
|
|
|
47,017
|
|
|
|
|
|
835
|
|
|
Interest
expense - long-term private debt (1)
|
|
|
118,722
|
|
|
|
|
|
46,201
|
|
|
|
|
|
72,521
|
|
|
Total
interest expense on debt
|
|
|
960,633
|
|
5.28
|
%
|
|
|
953,036
|
|
5.18
|
%
|
|
|
7,597
|
|
|
Debt
issuance costs (2)
|
|
|
12,328
|
|
0.07
|
%
|
|
|
9,662
|
|
0.05
|
%
|
|
|
2,666
|
|
|
Derivative
cash settlements, net (3)
|
|
|
-
|
|
-
|
|
|
|
2,278
|
|
0.01
|
%
|
|
|
(2,278
|
)
|
|
Commitment
and guarantee fees (4)
|
|
|
16,023
|
|
0.09
|
%
|
|
|
10,595
|
|
0.06
|
%
|
|
|
5,428
|
|
|
Gain
on extinguishment of debt (5)
|
|
|
4,806
|
|
0.03
|
%
|
|
|
(1,907
|
)
|
(0.01
|
)%
|
|
|
6,713
|
|
|
Other
fees
|
|
|
2,940
|
|
0.01
|
%
|
|
|
2,272
|
|
0.01
|
%
|
|
|
668
|
|
|
Total
interest expense
|
|
|
$
|
996,730
|
|
5.48
|
%
|
|
$
|
975,936
|
|
5.30
|
%
|
|
$
|
20,794
|
|
|
(1)
Represents interest expense and the amortization of discounts on
debt.
(2)
Includes amortization of all deferred charges related to debt issuance,
principally underwriter's fees, legal fees, printing costs and comfort letter
fees. Amortization is calculated on the effective interest
method. Also includes issuance costs related to dealer commercial
paper.
(3)
Represents the net cost related to swaps that qualify for hedge treatment plus
the accrual from the date of the last settlement to the current period
end.
(4)
Includes various fees related to funding activities, including fees paid to
banks participating in the Company's revolving credit agreements and fees paid
under bond guarantee agreements with RUS as part of the REDLG
program. Fees are recognized as incurred or amortized on a
straight-line basis over the life of the respective agreement.
(5)
Represents the gain on the early retirement of debt including the write-off of
unamortized discount, premium and issuance costs.
The $21
million increase to the total interest expense for the year ended May 31, 2007
as compared to the prior year period was due to the increase to interest rates
in the markets and an increase in guarantee fees expensed due to the increase in
REDLG debt outstanding. Additionally, there was a $5 million loss on
the extinguishment of debt for the year ended May 31, 2007 due to the write-off
of unamortized debt issuance costs associated with the early redemption of
subordinated deferrable debt. Debt issuance costs increased due to
the issuance of $1.6 billion of extendible term debt with an initial maturity,
and therefore amortization period, of 13 months.
The
adjusted interest expense, which includes all derivative cash settlements for
the year ended May 31, 2007, increased by $15 million compared to the prior year
period due to the increase to interest expense noted above and the increase to
derivative cash settlements described below. See "Non-GAAP Financial
Measures" for further explanation of the adjustment the Company makes in its
financial analysis to include all derivative cash settlements in its interest
expense.
Net
Interest Income
The
change in the line items described above resulted in an increase in net interest
income of $25 million for the year ended May 31, 2007 compared to the prior year
period. The adjusted net interest income, which includes all
derivative cash settlements, for the year ended May 31, 2007 was $144 million,
an increase of $31 million from the prior year period. See "Non-GAAP
Financial Measures" for further explanation of the adjustment the Company makes
in its financial analysis to include all derivative cash settlements in its
interest expense, and therefore net interest income.
Recovery
of/Provision for Loan Losses
A
recovery from the allowance for loan losses of $7 million was recorded during
the year ended May 31, 2007 due primarily to payments received on impaired
loans. The provision for loan losses of $23 million recorded during
the year ended May 31, 2006 was primarily due to an increase in the calculated
loan impairments during the year.
Non-interest
Income
Non-interest
income decreased by $44 million for the year ended May 31, 2007 compared to the
prior year primarily due to the gain on the sale of the building. On
October 18, 2005, National Rural closed on the sale of its headquarters facility
in Fairfax County, Virginia to an affiliate of Prentiss Properties Acquisition
Partners, L.P. resulting in a gain of $43 million for the year ended May 31,
2006. Cash settlements increased $6 million for the year ended May
31, 2007 compared to the prior year period due to a $31 million payment received
as a result of the termination of two interest rate exchange agreements offset
by both a decrease to the net rate earned by the Company on exchange agreements
and the reduction in the average notional amount of derivatives outstanding as
compared to the prior year period. The results of operations of foreclosed
assets for the year ended May 31, 2007 decreased $6 million compared to the
prior year period primarily due to a gain of $4 million recorded for the
year
ended May
31, 2006 related to the sale of real estate assets in August 2005. At
May 31, 2007, the remaining balance of foreclosed assets is comprised of notes
receivable which the Company continues to service.
Non-interest
Expense
Non-interest
expense increased by $101 million for the year ended May 31, 2007 compared to
the prior year due primarily to a $108 million decrease in the derivative
forward value during the year ended May 31, 2007 compared to the prior
year. The decrease resulted from changes in the estimate of future
interest rates over the remaining life of the derivative contracts and a 17%
reduction in the average notional amount of derivatives
outstanding.
This was
partially offset by an increase to the Company's foreign currency adjustment for
the year ended May 31, 2007 of $8 million compared to the year ended May 31,
2006. Changes in the exchange rate between the U.S. dollar and Euro
and the U.S. dollar and Australian dollar may cause the value of foreign
denominated debt outstanding to fluctuate. An increase in the value
of the Euro or the Australian dollar versus the value of the U.S. dollar results
in an increase in the recorded U.S. dollar value of foreign denominated debt and
therefore a charge to expense on the consolidated statements of operations,
while a decrease in exchange rates results in a reduction in the recorded U.S.
dollar value of foreign denominated debt and income. The Company has entered
into foreign currency exchange agreements to cover all of the cash flows
associated with its foreign denominated debt. Changes in the value of
the foreign currency exchange agreement are approximately offset by changes in
the value of the outstanding foreign denominated debt.
Minority
Interest
For the
year ended May 31, 2007, minority interest decreased by $5 million to $2 million
compared to $7 million for the year ended May 31, 2006. Minority
interest represents the RTFC and NCSC net income.
Net
Income
The
change in the line items described above resulted in a decrease in net income of
$84 million for the year ended May 31, 2007 from the prior year
period. The adjusted net income, which excludes the impact of the
derivative forward value and foreign currency adjustments and adds back minority
interest, was $108 million, compared to $97 million for the prior year
period. The adjusted net income for the year ended May 31, 2006
included a $43 million gain on the sale of building and
land. Adjusted net income for the year ended May 31, 2006 was $54
million excluding the $43 million gain on the sale of the building and
land. See "Non-GAAP Financial Measures" for further explanation of
the adjustments the Company makes in its financial analysis to net
income.
Operating
Results as a Percentage of Average Loans Outstanding
The
Company's operating results as a percentage of average loans outstanding is
summarized as follows:
|
|
For
the year ended May 31,
|
|
|
2008
|
|
2007
|
|
2006
|
Interest
income
|
|
|
5.81
|
%
|
|
|
5.79
|
%
|
|
|
5.48
|
%
|
Interest
expense
|
|
|
(5.09
|
)%
|
|
|
(5.48
|
)%
|
|
|
(5.30
|
)%
|
Net
interest income
|
|
|
0.72
|
%
|
|
|
0.31
|
%
|
|
|
0.18
|
%
|
Recovery
of (provision for) loan losses
|
|
|
0.17
|
%
|
|
|
0.04
|
%
|
|
|
(0.13
|
)%
|
Net
interest income after recovery of (provision for) loan
losses
|
|
|
0.89
|
%
|
|
|
0.35
|
%
|
|
|
0.05
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
|
0.01
|
%
|
|
|
0.01
|
%
|
|
|
0.01
|
%
|
Derivative
cash settlements
|
|
|
0.15
|
%
|
|
|
0.48
|
%
|
|
|
0.44
|
%
|
Results
of operations of foreclosed assets
|
|
|
0.04
|
%
|
|
|
0.05
|
%
|
|
|
0.08
|
%
|
Gain
on sale of building and land
|
|
|
-
|
|
|
|
-
|
|
|
|
0.23
|
%
|
Total
non-interest income
|
|
|
0.20
|
%
|
|
|
0.54
|
%
|
|
|
0.76
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
|
(0.20
|
)%
|
|
|
(0.19
|
)%
|
|
|
(0.17
|
)%
|
Other
general and administrative expenses
|
|
|
(0.14
|
)%
|
|
|
(0.10
|
)%
|
|
|
(0.11
|
)%
|
Recovery
for guarantee liability
|
|
|
0.02
|
%
|
|
|
0.01
|
%
|
|
|
0.01
|
%
|
Market
adjustment of foreclosed assets
|
|
|
(0.03
|
)%
|
|
|
-
|
|
|
|
-
|
|
Derivative
forward value
|
|
|
(0.54
|
)%
|
|
|
(0.43
|
)%
|
|
|
0.16
|
%
|
Foreign
currency adjustments
|
|
|
-
|
|
|
|
(0.08
|
)%
|
|
|
(0.13
|
)%
|
Loss
on sale of loans
|
|
|
-
|
|
|
|
(0.01
|
)%
|
|
|
-
|
|
Total
non-interest expense
|
|
|
(0.89
|
)%
|
|
|
(0.80
|
)%
|
|
|
(0.24
|
)%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
prior to income taxes and minority interest
|
|
|
0.20
|
%
|
|
|
0.09
|
%
|
|
|
0.57
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit (expense)
|
|
|
0.02
|
%
|
|
|
(0.01
|
)%
|
|
|
(0.01
|
)%
|
Minority
interest, net of income taxes
|
|
|
0.03
|
%
|
|
|
(0.01
|
)%
|
|
|
(0.04
|
)%
|
Net
income
|
|
|
0.25
|
%
|
|
|
0.07
|
%
|
|
|
0.52
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted
net interest income (1)
|
|
|
0.87
|
%
|
|
|
0.79
|
%
|
|
|
0.62
|
%
|
Adjusted
income prior to income taxes and minority interest (2)
|
|
|
|
0.74
|
%
|
|
|
0.60
|
%
|
|
|
0.54
|
%
|
(1)
Adjusted to include derivative cash settlements in the interest
expense. See "Non-GAAP Financial Measures" for further explanation
and a reconciliation of these adjustments.
(2)
Adjusted to exclude derivative forward value and foreign currency
adjustments. See "Non-GAAP Financial Measures" for further
explanation and a reconciliation of these adjustments.
Ratio
of Earnings to Fixed Charges
The
following chart provides the calculation of the ratio of earnings to fixed
charges. The ratio of earnings to fixed charges is the same
calculation as TIER. See “Results of Operations” for discussion on
TIER and adjustments that the Company makes to the TIER
calculation.
|
For
the year ended May 31,
|
|
(Dollar
amounts in thousands)
|
|
|
2008
|
|
|
|
2007
|
|
|
|
2006
|
|
|
Income
prior to cumulative effect of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
change
in accounting principle
|
|
$
|
45,745
|
|
|
$
|
11,701
|
|
|
$
|
95,497
|
|
|
Add:
fixed charges
|
|
|
936,889
|
|
|
|
996,730
|
|
|
|
975,936
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings
available for fixed charges
|
|
$
|
982,634
|
|
|
$
|
1,008,431
|
|
|
$
|
1,071,433
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
fixed charges:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
on all debt (including amortization of
|
|
|
|
|
|
|
|
|
|
|
|
|
|
discount
and issuance costs)
|
|
$
|
936,889
|
|
|
$
|
996,730
|
|
|
$
|
975,936
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Ratio
of earnings to fixed charges
|
|
|
1.05
|
|
|
|
1.01
|
|
|
|
1.10
|
|
|
Financial
Condition
Loan
and Guarantee Portfolio Assessment
Loan
Programs
Loans to
members bear interest at rates determined from time to time by the Company after
considering its interest expense, operating expenses, provision for loan losses
and the maintenance of reasonable earnings levels. In keeping with
its not-for-profit cooperative charter, the Company's policy is to set interest
rates at the lowest levels it considers to be consistent with sound financial
management.
The
following chart summarizes loans by type and by segment at May 31:
|
|
Increase/
|
|
(Dollar
amounts in thousands)
|
2008
|
|
2007
|
|
(Decrease)
|
|
Loans
by type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
loans (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
$
|
15,418,662
|
|
81%
|
|
|
$
|
14,881,046
|
|
82%
|
|
|
|
$
|
537,616
|
|
|
Long-term
variable rate loans
|
|
1,918,216
|
|
10%
|
|
|
|
2,031,731
|
|
11%
|
|
|
|
|
(113,515
|
)
|
|
Total
long-term loans
|
|
17,336,878
|
|
91%
|
|
|
|
16,912,777
|
|
93%
|
|
|
|
|
424,101
|
|
|
Short-term
loans (2)
|
|
1,690,117
|
|
9%
|
|
|
|
1,215,430
|
|
7%
|
|
|
|
|
474,687
|
|
|
Total
loans
|
$
|
19,026,995
|
|
100%
|
|
|
$
|
18,128,207
|
|
100%
|
|
|
|
$
|
898,788
|
|
|
|
|
Increase/
|
|
(Dollar
amounts in thousands)
|
2008
|
|
2007
|
|
(Decrease)
|
|
Loans
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution
|
$
|
13,438,370
|
|
71%
|
|
|
$
|
12,827,772
|
|
71%
|
|
|
|
$
|
610,598
|
|
|
Power
supply
|
|
3,339,112
|
|
17%
|
|
|
|
2,858,040
|
|
16%
|
|
|
|
|
481,072
|
|
|
Statewide
and associate
|
|
108,925
|
|
1%
|
|
|
|
119,478
|
|
1%
|
|
|
|
|
(10,553
|
)
|
|
National
Rural Total
|
|
16,886,407
|
|
89%
|
|
|
|
15,805,290
|
|
88%
|
|
|
|
|
1,081,117
|
|
|
RTFC
|
|
1,726,514
|
|
9%
|
|
|
|
1,860,379
|
|
10%
|
|
|
|
|
(133,865
|
)
|
|
NCSC
|
|
414,074
|
|
2%
|
|
|
|
462,538
|
|
2%
|
|
|
|
|
(48,464
|
)
|
|
Total
|
|
$
|
19,026,995
|
|
100%
|
|
|
$
|
18,128,207
|
|
100%
|
|
|
|
$
|
898,788
|
|
|
(1)
Includes loans classified as restructured and non-performing and RUS guaranteed
loans.
(2)
Consists of secured and unsecured short-term loans that are subject to interest
rate adjustment monthly or semi-monthly.
The
Company's loans outstanding increased by 5% during the year ended May 31, 2008.
National Rural loans outstanding increased due to net advances of $1,155 million
offset by the sale of $74 million of National Rural distribution loans in loan
securitization transactions during the year ended May 31, 2008. The
primary reasons for the National Rural loan growth included RUS note buyouts,
funding of capital expenditures, bridge financing to fund projects prior to RUS
funding is received and funding for renewable energy projects.
Long-term
fixed rate loans at May 31, 2008 and 2007 represented 89% and 88%, respectively,
of total long-term loans. Loans converting from a variable rate to a
fixed rate for the year ended May 31, 2008 totaled $711 million, which was
offset by $274 million of loans that converted from a fixed rate to a variable
rate. This resulted in a net conversion of $437 million from a
variable rate to a fixed rate for the year ended May 31, 2008. For
the year ended May 31, 2007, loans converting from a variable rate to a fixed
rate totaled $372 million, which was offset by $190 million of loans that
converted from a fixed rate to a variable rate. This resulted in a
net conversion of $182 million from a variable rate to a fixed rate for the year
ended May 31, 2007.
The
following chart summarizes loans and guarantees outstanding by segment at May
31:
(Dollar
amounts in thousands)
|
2008
|
|
2007
|
|
Increase/
(Decrease)
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution
|
$
|
13,622,829
|
|
68%
|
|
|
$
|
13,039,092
|
|
68%
|
|
|
$
|
583,737
|
|
Power
supply
|
|
4,125,567
|
|
20%
|
|
|
|
3,655,049
|
|
19%
|
|
|
|
470,518
|
|
Statewide
and associate
|
|
131,710
|
|
1%
|
|
|
|
144,837
|
|
1%
|
|
|
|
(13,127
|
)
|
National
Rural Total
|
|
17,880,106
|
|
89%
|
|
|
|
16,838,978
|
|
88%
|
|
|
|
1,041,128
|
|
RTFC
|
|
1,726,774
|
|
9%
|
|
|
|
1,860,379
|
|
10%
|
|
|
|
(133,605
|
)
|
NCSC
|
|
457,255
|
|
2%
|
|
|
|
503,224
|
|
2%
|
|
|
|
(45,969
|
)
|
Total
|
$
|
20,064,135
|
|
100%
|
|
|
$
|
19,202,581
|
|
100%
|
|
|
$
|
861,554
|
|
The
following table summarizes the RTFC segment loans and guarantees outstanding as
of May 31:
(Dollar
amounts in thousands)
|
|
2008
|
|
2007
|
|
Increase/
(Decrease)
|
Rural
local exchange carriers
|
|
$
|
1,518,197
|
|
88%
|
|
|
$
|
1,630,246
|
|
88%
|
|
|
$
|
(112,049
|
)
|
Cable
television providers
|
|
|
153,539
|
|
9%
|
|
|
|
154,738
|
|
8%
|
|
|
|
(1,199
|
)
|
Fiber
optic network providers
|
|
|
16,884
|
|
1%
|
|
|
|
37,422
|
|
2%
|
|
|
|
(20,538
|
)
|
Competitive
local exchange carriers
|
|
|
29,871
|
|
2%
|
|
|
|
21,039
|
|
1%
|
|
|
|
8,832
|
|
Wireless
providers
|
|
|
4,579
|
|
-
|
|
|
|
3,609
|
|
-
|
|
|
|
970
|
|
Long
distance carriers
|
|
|
-
|
|
-
|
|
|
|
9,069
|
|
1%
|
|
|
|
(9,069
|
)
|
Other
|
|
|
3,704
|
|
-
|
|
|
|
4,256
|
|
-
|
|
|
|
(552
|
)
|
Total
|
|
|
$
|
1,726,774
|
|
100%
|
|
|
$
|
1,860,379
|
|
100%
|
|
|
$
|
(133,605
|
)
|
The
Company's members are widely dispersed throughout the United States and its
territories, including 49 states, the District of Columbia and two U.S.
territories. At May 31, 2008, 2007 and 2006, loans and guarantees
outstanding to members in any one state or territory did not exceed 17%, 15% and
16%, respectively, of total loans and guarantees outstanding.
Credit
Concentration
National
Rural, RTFC and NCSC each have policies that limit the amount of credit that can
be extended to individual borrowers or a controlled group of
borrowers. The credit limitation policies set the limit on the total
exposure and unsecured exposure to the borrower based on an assessment of the
borrower's risk profile and the Company's internal risk rating
system. As a member owned cooperative, the Company makes best efforts
to balance meeting the needs of its member/owners and mitigating the risk
associated with concentrations of credit exposure. The respective
boards of directors must approve new credit requests from a borrower with a
total exposure or unsecured exposure in excess of the limits in the
policy. Management of credit concentrations may include the use of
syndicated credit agreements.
Total
exposure, as defined by the policy, includes the following:
·
|
loans
outstanding, excluding loans guaranteed by
RUS,
|
·
|
the
Company's guarantees of the borrower's
obligations,
|
·
|
unadvanced
loan commitments,
|
·
|
borrower
guarantees to the Company of another borrower's debt,
and
|
·
|
other
indebtedness of any kind unless guaranteed by the U.S.
Government.
|
At May
31, 2008 and 2007, the total exposure outstanding to any one borrower or
controlled group did not exceed 2.7% and 3.0%, respectively, of total loans and
guarantees outstanding. At May 31, 2008, the ten largest borrowers
included five distribution systems, four power supply systems and one
telecommunications system. At May 31, 2007, the ten largest borrowers included
six distribution systems, two power supply systems and two telecommunications
systems. The following chart shows the exposure to the ten largest
borrowers as a percentage of total exposure by type and by segment at May
31:
|
|
2008
|
|
|
2007
|
|
Increase/
|
|
(Dollar
amounts in thousands)
|
|
Amount
|
|
%
of Total
|
|
|
Amount
|
|
%
of Total
|
|
(Decrease)
|
|
Total
by type:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
$
|
3,395,865
|
|
|
|
$
|
3,306,986
|
|
|
$
|
88,879
|
|
Guarantees
|
|
164,740
|
|
|
|
|
76,867
|
|
|
|
87,873
|
|
Total
credit exposure to ten largest borrowers
|
$
|
3,560,605
|
|
18%
|
|
$
|
3,383,853
|
|
18%
|
$
|
176,752
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
3,043,905
|
|
|
|
$
|
2,691,060
|
|
|
$
|
352,845
|
|
RTFC
|
|
491,700
|
|
|
|
|
692,793
|
|
|
|
(201,093
|
)
|
NCSC
|
|
25,000
|
|
|
|
|
-
|
|
|
|
25,000
|
|
Total
credit exposure to ten largest borrowers
|
$
|
3,560,605
|
|
18%
|
|
$
|
3,383,853
|
|
18%
|
$
|
176,752
|
|
Security
Provisions
Except
when providing short-term loans, the Company typically lends to its members on a
senior secured basis. Long-term loans are typically secured on a
parity with other secured lenders (primarily RUS), if any, by all assets and
revenues of the borrower with exceptions typical in utility
mortgages. Short-term loans are generally unsecured lines of
credit. Guarantee reimbursement obligations are typically secured on
a parity with other secured creditors by all assets and revenues of the borrower
or by the underlying financed asset. In addition to the collateral
received, borrowers are also required to set rates designed to achieve certain
financial ratios.
The
following table summarizes the Company's unsecured credit exposure as a
percentage of total exposure by type and by segment at May 31:
|
|
2008
|
|
|
2007
|
|
Increase/
|
|
(Dollar
amounts in thousands)
|
|
Amount
|
|
%
of Total
|
|
|
Amount
|
|
%
of Total
|
|
(Decrease)
|
|
Total
by type:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
$
|
2,150,739
|
|
|
|
$
|
1,634,296
|
|
|
$
|
516,443
|
|
Guarantees
|
|
235,816
|
|
|
|
|
220,983
|
|
|
|
14,833
|
|
Total
unsecured credit exposure
|
$
|
2,386,555
|
|
11%
|
|
$
|
1,855,279
|
|
10%
|
$
|
531,276
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
2,100,676
|
|
|
|
$
|
1,559,097
|
|
|
$
|
541,579
|
|
RTFC
|
|
229,287
|
|
|
|
|
230,300
|
|
|
|
(1,013
|
)
|
NCSC
|
|
56,592
|
|
|
|
|
65,882
|
|
|
|
(9,290
|
)
|
Total
unsecured credit exposure
|
$
|
2,386,555
|
|
11%
|
|
$
|
1,855,279
|
|
10%
|
$
|
531,276
|
|
Non-performing
Loans
A
borrower is classified as non-performing when any one of the following criteria
are met:
·
|
principal
or interest payments on any loan to the borrower are past due 90 days or
more,
|
·
|
as
a result of court proceedings, repayment on the original terms is not
anticipated, or
|
·
|
for
some other reason, management does not expect the timely repayment of
principal and interest.
|
Once a
borrower is classified as non-performing, the Company typically places the loan
on non-accrual status and reverses all accrued and unpaid interest back to the
date of the last payment. The Company generally applies all cash
received during the non-accrual period to the reduction of principal, thereby
foregoing interest income recognition. At May 31, 2008 and 2007, the
Company had non-performing loans outstanding in the amount of $507 million and
$502 million, respectively. All loans classified as non-performing
were on a non-accrual status with respect to the recognition of interest
income.
At May
31, 2008 and 2007, non-performing loans include $492 million and $493 million,
respectively, to Innovative Communication Corporation (“ICC”). All
loans to ICC have been on non-accrual status since February 1,
2005. ICC has not made debt service payments to the Company since
June 2005. RTFC is the primary secured lender to ICC.
Beginning
on June 1, 2004, RTFC filed a series of lawsuits against ICC, Jeffrey Prosser
(“Prosser”) and others for failure to comply with the terms of ICC's loan
agreement with RTFC dated August 27, 2001 as amended on April 4,
2003. In response to the lawsuits filed by RTFC, ICC, ICC’s
subsidiary Virgin Islands Telephone Corporation d/b/a Innovative Telephone
("Vitelco"), and Prosser denied liability and asserted claims, by way of
counterclaim and by filing its own lawsuits against RTFC, National Rural and
certain of RTFC's officers, seeking various remedies, including reformation of
the loan agreement, injunctive relief, and damages (together with the RTFC
claims, the “Loan Litigation”).
In
February 2006, involuntary bankruptcy petitions were filed against Prosser,
ICC's immediate parent, Emerging Communication, Inc. ("Emcom") and Emcom's
parent, Innovative Communication Company LLC ("ICC-LLC"); and on April 26, 2006,
RTFC reached a settlement of the Loan Litigation with ICC, Vitelco, ICC-LLC,
Emcom, their directors and Prosser, individually. Under the
settlement, RTFC obtained entry of judgments in the District Court for the
District of the Virgin Islands against ICC for approximately $525 million and
Prosser for approximately $100 million. RTFC also obtained dismissals
with prejudice of all counterclaims, affirmative defenses and other lawsuits
alleging wrongful acts by RTFC, certain of its officers, and National Rural
thereby resolving all the Loan Litigation in RTFC’s favor.
Although
the judgment debtors and others were given an opportunity to satisfy the
judgments at a discount, on July 31, 2006, ICC-LLC, Emcom and Prosser each filed
a voluntary bankruptcy petition for reorganization. The cases are
pending in the United States District Court for the Virgin Island, Bankruptcy
Division (the “Bankruptcy Court”). A Chapter 11 trustee, Stan
Springel, was later appointed for the ICC-LLC and Emcom estates; and Prosser’s
individual case was converted to Chapter 7 liquidation in October
2007. Prosser’s Chapter 7 trustee is in the process of marshaling
Prosser’s non-exempt assets for disposition and eventual payment in respect of
creditor claims.
On
September 21, 2007, the Bankruptcy Court entered an order placing ICC in its own
bankruptcy proceeding, and on October 3, 2007 appointed Stan Springel as its
trustee. The Chapter 11 trustee of ICC has assumed ownership and
control of ICC, including its subsidiaries, and has begun to marshal RTFC
collateral and other assets for disposition, including property in Prosser’s
possession or control, and eventual payment in respect of RTFC’s claims and the
claims of other parties-in-interest.
In most
cases, the sale (as part of the Chapter 11 cases) of ICC or any of its
subsidiaries engaged in a regulated telecommunications or cable television
business, or of the regulated assets of ICC or its subsidiaries, will require
the prior consent of the respective regulators in the United States (including
the Federal Communications Commission and the U.S. Virgin Islands Public
Services Commission), the British Virgin Islands, France and its Caribbean
territories, and the Netherlands Antilles. In certain limited cases,
only a post-transaction notification will be required.
For a
more detailed description of the contingencies related to the non-performing
loans outstanding to ICC, see Note 15 to the consolidated financial
statements. Based on its analysis, the Company believes that it is
adequately reserved for its exposure to ICC at May 31, 2008.
Restructured
Loans
Loans
classified as restructured are loans for which agreements have been executed
that changed the original terms of the loan, generally a change to the
originally scheduled cash flows. The Company will make a
determination on each restructured loan with regard to the accrual of interest
income on the loan. The initial decision is based on the terms of the
restructure agreement and the anticipated performance of the borrower over the
term of the agreement. The Company will periodically review the
decision to accrue or not to accrue interest income on restructured loans based
on the borrower's past performance and current financial condition.
At May
31, 2008 and 2007, restructured loans totaled $577 million and $603 million,
respectively. A total of $519 million and $545 million of
restructured loans were on non-accrual status with respect to the recognition of
interest income at May 31,
2008 and 2007, respectively.
At May
31, 2008 and 2007, the Company had $519 million and $545 million, respectively,
of restructured loans outstanding to CoServ. All restructured CoServ loans have
been on non-accrual status since January 1, 2001. In addition, $20
million was outstanding under the capital expenditure loan facility which was
classified as a performing loan at both May 31, 2008 and 2007. Total
loans to CoServ at May 31, 2008 and 2007 represented 2.7% and 2.9% of the
Company's total loans and guarantees outstanding, respectively.
Under the
terms of a bankruptcy settlement, National Rural restructured its loans to
CoServ. CoServ is scheduled to make quarterly payments to National
Rural through December 2037. As part of the restructuring, National
Rural may be obligated to provide up to $204 million of senior secured capital
expenditure loans to CoServ for electric distribution infrastructure through
December 2012. When CoServ requests capital expenditure loans from
National Rural, these loans are provided at the standard terms offered to all
borrowers and require debt service payments in addition to the quarterly
payments that CoServ is required to make to National Rural. As of May
31, 2008, a total of $20 million had been advanced to CoServ under this loan
facility. To date, CoServ has made all payments required under the
restructure agreement and capital expenditure loan facility. Under the terms of
the restructure agreement, CoServ has the option to prepay the loan for $415
million plus an interest payment true up on or after December 13, 2007 and for
$405 million plus an interest payment true up on or after December 13,
2008. National Rural has received no notice from CoServ that it
intends to prepay the loan.
CoServ
and National Rural have no claims related to any of the legal actions asserted
prior to or during the bankruptcy proceedings. National Rural's legal
claim against CoServ is limited to CoServ's performance under the terms of the
bankruptcy settlement.
Based on
its analysis, the Company believes that it is adequately reserved for its
exposure to CoServ at May 31, 2008.
Pioneer
Electric Cooperative, Inc. ("Pioneer") is an electric distribution cooperative
located in Greenville, Alabama. Pioneer had also invested in a
propane gas operation, which it has sold. Pioneer had experienced
deterioration in its financial condition as a result of losses in the gas
operation. At May 31, 2008 and 2007, National Rural had a total $52
million in loans outstanding to Pioneer. Pioneer was current with
respect to all debt service payments at May 31, 2008. National Rural
is the principal creditor to Pioneer.
On March
9, 2006, National Rural and Pioneer agreed on the terms of a debt modification
that resulted in the loans being classified as restructured. Under
the amended agreement, National Rural extended the maturity of the outstanding
loans and granted a two-year deferral of principal payments. In
addition, National Rural agreed to make available a line of credit for general
corporate purposes. The restructured loans are secured by first liens
on substantially all of the assets and revenues of Pioneer. At this
time, National Rural plans to maintain the loans to Pioneer on accrual
status.
Based on
its analysis, the Company believes that it is adequately reserved for its
exposure to Pioneer at May 31, 2008.
Loan
Impairment
On a
quarterly basis, the Company reviews all non-performing and restructured
borrowers, as well as certain additional borrowers selected based on known facts
and circumstances at the time of the review, to determine if the loans to the
borrower are impaired and/or to update the impairment
calculation. The Company calculates an impairment for a borrower
based on the expected future cash flow or the fair value of any collateral held
by the Company as security for loans to the borrower. In some cases,
to estimate future cash flow, certain assumptions are required regarding, but
not limited to, the following:
·
|
changes
in collateral values,
|
·
|
changes
in economic conditions in the area in which the cooperative operates,
and
|
·
|
changes
to the industry in which the cooperative
operates.
|
As events
related to the borrower take place and economic conditions and the Company's
assumptions change, the impairment calculations will change. The loan
loss allowance specifically reserved to cover the calculated impairments is
adjusted on a quarterly basis based on the most current information available.
At May 31, 2008 and 2007, the Company had impaired loans totaling $1,078 million
and $1,099 million, respectively. At May 31, 2008 and 2007, National
Rural had specifically reserved a total of $331 million and $397 million,
respectively, to cover impaired loans.
The
following chart presents a summary of non-performing and restructured loans as a
percentage of total loans and total loans and guarantees
outstanding:
(Dollar
amounts in thousands)
|
May
31, 2008
|
|
May
31, 2007
|
|
May
31, 2006
|
|
Non-performing
loans
|
$
|
506,864
|
|
|
$
|
501,864
|
|
|
$
|
577,869
|
|
|
Percent
of loans outstanding
|
|
2.67
|
%
|
|
|
2.77
|
%
|
|
|
3.15
|
%
|
|
Percent
of loans and guarantees outstanding
|
|
2.52
|
%
|
|
|
2.61
|
%
|
|
|
2.97
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructured
loans
|
$
|
577,111
|
|
|
$
|
603,305
|
|
|
$
|
630,354
|
|
|
Percent
of loans outstanding
|
|
3.03
|
%
|
|
|
3.33
|
%
|
|
|
3.43
|
%
|
|
Percent
of loans and guarantees outstanding
|
|
2.88
|
%
|
|
|
3.14
|
%
|
|
|
3.24
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-performing and restructured loans
|
$
|
1,083,975
|
|
|
$
|
1,105,169
|
|
|
$
|
1,208,223
|
|
|
Percent
of loans outstanding
|
|
5.70
|
%
|
|
|
6.10
|
%
|
|
|
6.58
|
%
|
|
Percent
of loans and guarantees outstanding
|
|
5.40
|
%
|
|
|
5.75
|
%
|
|
|
6.21
|
%
|
|
Allowance
for Loan Losses
The
Company maintains an allowance for loan losses at a level estimated by
management to provide adequately for probable losses inherent in the loan
portfolio, which are estimated based upon a review of the loan portfolio, past
loss experience, specific problem loans, economic conditions and other pertinent
factors which, in management's judgment, deserve current recognition in
estimating loan losses. The Company reviews and adjusts the allowance
on a quarterly basis to maintain it at a level to cover estimated probable
losses in the portfolio.
Management
makes recommendations to the board of directors of National Rural regarding
write-offs of loan balances. In making its recommendation to write
off all or a portion of a loan balance, management considers various factors
including cash flow analysis and the collateral securing the borrower's
loans. Since inception in 1969, write-offs totaled $212 million and
recoveries totaled $34 million for a net loan loss of $178
million. Management believes that the allowance for loan losses is
adequate to cover estimated probable portfolio losses.
Activity
in the allowance for loan losses is summarized below:
|
For
the year ended May 31,
|
|
(Dollar
amounts in thousands)
|
|
2008
|
|
|
|
2007
|
|
|
|
2006
|
|
|
Beginning
balance
|
$
|
561,663
|
|
|
$
|
611,443
|
|
|
$
|
589,749
|
|
|
(Recovery
of) provision for loan losses
|
|
(30,262
|
)
|
|
|
(6,922
|
)
|
|
|
23,240
|
|
|
Net
write-offs
|
|
(16,495
|
)
|
|
|
(42,858
|
)
|
|
|
(1,546
|
)
|
|
Ending
balance
|
$
|
514,906
|
|
|
$
|
561,663
|
|
|
$
|
611,443
|
|
|
`
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan
loss allowance by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
514,626
|
|
|
$
|
561,113
|
|
|
$
|
610,617
|
|
|
NCSC
|
|
280
|
|
|
|
550
|
|
|
|
826
|
|
|
Total
|
$
|
514,906
|
|
|
$
|
561,663
|
|
|
$
|
611,443
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
a percentage of total loans outstanding
|
|
2.71
|
%
|
|
|
3.10
|
%
|
|
|
3.33
|
%
|
|
As
a percentage of total non-performing loans outstanding
|
|
101.59
|
%
|
|
|
111.95
|
%
|
|
|
105.71
|
%
|
|
As
a percentage of total restructured loans outstanding
|
|
89.22
|
%
|
|
|
93.20
|
%
|
|
|
96.98
|
%
|
|
National
Rural has agreed to indemnify RTFC and NCSC for loan losses, with the exception
of the NCSC consumer loans that are covered by the NCSC loan loss
allowance. Therefore, there is no loan loss allowance required at
RTFC and only a small loan loss allowance is required at NCSC to cover the
exposure to consumer loans.
The
Company's loan loss allowance decreased $47 million from May 31, 2007 to May 31,
2008. Within National Rural’s loan loss allowance at May 31, 2008 as
compared to the prior year end, there was a decrease in the calculated
impairments of $66 million, which was offset by an increase of $23 million to
the unallocated reserve. The decrease to the calculated impairments
was primarily due to a settlement agreement with VarTec resulting in a loan
write-off of $17 million, payments received on impaired loans and lower variable
interest rates at May 31, 2008 as compared to May 31, 2007. The
increase of $23 million to the unallocated reserve was primarily due to a change
in the single obligor component. During the third quarter of fiscal
year 2008, the Company lowered the single obligor threshold from 1.5% to 1.0% of
total outstanding credit. This lower threshold level effectively
aligns the single obligor component with the top ten credit
exposures.
Liabilities,
Minority Interest and Equity
Outstanding
Debt
The
following chart provides a breakout of debt outstanding at May 31:
(Dollar
amounts in thousands)
|
2008
|
|
2007
|
|
Increase/
(Decrease)
|
|
Short-term
debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
paper (1)
|
$
|
3,050,264
|
|
|
$
|
2,784,619
|
|
|
$
|
265,645
|
|
|
Bank
bid notes
|
|
100,000
|
|
|
|
100,000
|
|
|
|
-
|
|
|
Long-term
debt with remaining maturities less than one year
|
|
3,177,189
|
|
|
|
1,367,504
|
|
|
|
1,809,685
|
|
|
Subordinated
deferrable debt with remaining maturities less than one
year
|
|
-
|
|
|
|
175,000
|
|
|
|
(175,000
|
)
|
|
Total
short-term debt
|
|
6,327,453
|
|
|
|
4,427,123
|
|
|
|
1,900,330
|
|
|
Long-term
debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateral
trust bonds
|
|
2,886,580
|
|
|
|
4,017,357
|
|
|
|
(1,130,777
|
)
|
|
Notes
payable
|
|
2,956,403
|
|
|
|
2,532,630
|
|
|
|
423,773
|
|
|
Medium-term
notes
|
|
4,330,604
|
|
|
|
4,745,232
|
|
|
|
(414,628
|
)
|
|
Total
long-term debt
|
|
10,173,587
|
|
|
|
11,295,219
|
|
|
|
(1,121,632
|
)
|
|
Subordinated
deferrable debt
|
|
311,440
|
|
|
|
311,440
|
|
|
|
-
|
|
|
Members'
subordinated certificates:
|
|
|
|
|
|
|
|
|
|
|
|
|
Membership
certificates
|
|
649,465
|
|
|
|
649,424
|
|
|
|
41
|
|
|
Loan
certificates
|
|
654,047
|
|
|
|
624,888
|
|
|
|
29,159
|
|
|
Guarantee
certificates
|
|
103,267
|
|
|
|
107,135
|
|
|
|
(3,868
|
)
|
|
Total
members' subordinated certificates
|
|
1,406,779
|
|
|
|
1,381,447
|
|
|
|
25,332
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
debt outstanding
|
$
|
18,219,259
|
|
|
$
|
17,415,229
|
|
|
$
|
804,030
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage
of fixed rate debt (2)
|
|
82
|
%
|
|
|
83%
|
|
|
|
|
|
|
Percentage
of variable rate debt (3)
|
|
18
|
%
|
|
|
17%
|
|
|
|
|
|
|
Percentage
of long-term debt
|
|
65
|
%
|
|
|
75%
|
|
|
|
|
|
|
Percentage
of short-term debt
|
|
|
35
|
%
|
|
|
25%
|
|
|
|
|
|
|
(1)
Includes $251 million and $250 million related to the daily liquidity fund at
May 31, 2008 and 2007, respectively.
(2)
Includes variable rate debt that has been swapped to a fixed rate less any fixed
rate debt that has been swapped to a variable rate.
(3) The
rate on commercial paper notes does not change once the note has been
issued. However, the rates on new commercial paper notes change daily
and commercial paper notes generally have maturities of less than 90
days. Therefore, commercial paper notes are considered to be variable
rate debt. Also includes fixed rate debt that has been swapped to a
variable rate less any variable rate debt that has been swapped to a fixed
rate.
The
following chart provides additional information on the debt instruments offered
by the Company:
Debt
Instrument
|
Maturity
Range
|
Rate
Options
|
Market
|
Security
|
Credit
Rating (1)
|
Daily
liquidity fund
|
Demand
note
|
Rate
may change daily
|
Members
|
Unsecured
|
NA
|
Bank
bid notes
|
Up
to 3 months
|
Fixed
rate
|
Bank
institutions
|
Unsecured
|
NA
|
Commercial
paper
|
1
to 270 days
|
Fixed
rate
|
Public
capital markets and members
|
Unsecured
|
P-1,
A-1, F-1
|
Collateral
trust bonds
|
Range
from 2 years to 30 years
|
Fixed
or Variable rate
|
Public
capital markets
|
Secured
(2)
|
A1,
A+, A+
|
Medium-term
notes
|
Range
from 9 months to 30 years
|
Fixed
or Variable rate
|
Public
capital markets and members
|
Unsecured
|
A2,
A, A
|
Notes
payable
|
Range
from 2 years to 30 years
|
Fixed
or Variable rate
|
Private
placement
|
Varies
(3)
|
Varies
(3)
|
Subordinated
deferrable debt (4)
|
Up
to 39 yrs
|
Fixed
or Variable rate
|
Public
capital markets
|
Unsecured
(5)
|
A3,
BBB+, A-
|
Subordinated
certificates
|
Up
to 100 years (6)
|
Varies
|
Members
|
Unsecured
(7)
|
NA
|
|
|
|
|
|
|
(1) Based
on rates defined by Moody’s Investors Service, Standard & Poor’s Corporation
and Fitch Ratings, respectively.
(2)
Secured by the pledge of permitted investments and eligible mortgage notes from
distribution system borrowers, in an amount at least equal to the outstanding
principal amount of collateral trust bonds.
(3) At
May 31, 2008, primarily represents secured notes payable to Federal Agricultural
Mortgage Corporation ("Farmer Mac") which are rated A1, A+, A+ by Moody’s
Investors Service, Standard & Poor’s Corporation and Fitch Ratings,
respectively, and unsecured notes payable issued under the REDLG program which
do not have a credit rating. As a requirement, however, National
Rural must obtain a rating for REDLG notes payable without regard to the bond
guarantee agreement with RUS. See further discussion of National
Rural’s private debt issuances under “Sources of Liquidity.”
(4) The
Company has the right at any time and from time to time during the term of the
subordinated deferrable debt to suspend interest payments for a period not
exceeding 20 consecutive quarters. The Company has the right to call
the subordinated deferrable debt any time after five years, at
par. To date, the Company has not exercised its option to suspend
interest payments.
(5)
Subordinate and junior in right of payment to senior debt and the debt
obligations guaranteed by the Company, but senior to subordinated
certificates.
(6)
Membership subordinated certificates generally mature in 100 years from
issuance. Loan and guarantee subordinated certificates have the same
maturity as the related long-term loan. Some certificates may also
amortize annually based on the outstanding loan balance.
(7)
Subordinate and junior in right of payment to senior and subordinated debt and
debt obligations guaranteed by the Company.
Other
information with regard to short-term debt at May 31 is as follows:
(Dollar
amounts in thousands)
|
|
2008
|
|
|
|
2007
|
|
|
|
2006
|
|
Weighted
average maturity outstanding at year-end:
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
debt (1)
|
|
26
days
|
|
|
|
25
days
|
|
|
|
26
days
|
|
Long-term
debt maturing within one year
|
|
116
days
|
|
|
|
192
days
|
|
|
|
203
days
|
|
Total
|
|
71
days
|
|
|
|
83
days
|
|
|
|
92
days
|
|
Average
amount outstanding during the year:
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
debt (1)
|
$
|
2,892,202
|
|
|
$
|
3,372,639
|
|
|
$
|
3,204,852
|
|
Long-term
debt maturing within one year
|
|
2,961,714
|
|
|
|
1,692,083
|
|
|
|
3,502,026
|
|
Total
|
|
5,853,916
|
|
|
|
5,064,722
|
|
|
|
6,706,878
|
|
Maximum
amount outstanding at any month-end during the year:
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
debt (1)
|
|
3,259,556
|
|
|
|
3,847,814
|
|
|
|
4,208,796
|
|
Long-term
debt maturing within one year
|
|
|
3,981,567
|
|
|
|
2,549,356
|
|
|
|
4,031,102
|
|
(1)
Includes the daily liquidity fund and bank bid notes and does not include
long-term debt due in less than one year.
Total
debt outstanding at May 31, 2008 increased as compared to May 31, 2007 due
primarily to the increase of $899 million to loans
outstanding. During fiscal year 2008, $1,595 million of extendible
collateral trust bonds and $250 million of extendible medium-term notes were
reclassified from long-term debt to short-term debt because investors elected
not to extend the maturity of the debt. An additional $500 million
was borrowed under FFB loan facilities with bond guarantee agreements with RUS
as part of the funding mechanism for the REDLG program in August
2007. In January 2008, the Company issued $700 million of 5.45%
collateral trust bonds due February 2018. In March 2008, the Company
sold to Farmer Mac $400 million of floating rate debt due in
2013. Subsequent to the end of the fiscal year in June 2008, the
Company issued $900 million of 5.50% collateral trust bonds due 2013 and $400
million of floating rate collateral trust bonds due 2010.
During
fiscal year 2008, the Company redeemed the 7.40% subordinated deferrable debt
securities due 2050 totaling $175 million reported in short-term debt at May 31,
2007. The Company redeemed these securities at par and recorded a
charge of $6 million in interest expense for the unamortized issuance costs in
the first quarter of fiscal year 2008.
At May
31, 2008 and 2007, there was no foreign denominated debt
outstanding.
The
increase to members' subordinated certificates of $25 million for the year ended
May 31, 2008 is primarily due to $78 million of new loan certificates related to
the increase in loans outstanding offset by loan prepayments, normal
amortization and maturities.
Minority
Interest
At May
31, 2008 and 2007, the Company reported minority interests of $14 million and
$22 million, respectively, on the consolidated balance
sheets. Minority interest represented 100% of RTFC and NCSC equity as
the members of RTFC and NCSC own or control 100% of the interest in their
respective companies.
During
the year ended May 31, 2008, the balance of minority interest decreased by $6
million of minority interest net loss for the year ended May 31, 2008 and the
retirement of $2 million of patronage capital to RTFC members in January
2008.
Equity
The
following chart provides a breakout of the equity balances at May
31:
(in
thousands)
|
2008
|
|
2007
|
|
Increase/
(Decrease)
|
|
Membership
fees
|
$
|
993
|
|
|
$
|
997
|
|
|
$
|
(4
|
)
|
|
Education
fund
|
|
1,484
|
|
|
|
1,406
|
|
|
|
78
|
|
|
Members'
capital reserve
|
|
187,409
|
|
|
|
158,308
|
|
|
|
29,101
|
|
|
Allocated
net income
|
|
423,249
|
|
|
|
405,598
|
|
|
|
17,651
|
|
|
Unallocated
net income (1)
|
|
(53
|
)
|
|
|
(23
|
)
|
|
|
(30
|
)
|
|
Total
members' equity
|
|
613,082
|
|
|
|
566,286
|
|
|
|
46,796
|
|
|
Prior
years cumulative derivative forward
|
|
|
|
|
|
|
|
|
|
|
|
|
value
and foreign currency adjustments
|
|
131,551
|
|
|
|
225,849
|
|
|
|
(94,298
|
)
|
|
Current
period derivative forward value (2)
|
|
(87,495
|
)
|
|
|
(79,744
|
)
|
|
|
(7,751
|
)
|
|
Current
period foreign currency adjustments
|
|
-
|
|
|
|
(14,554
|
)
|
|
|
14,554
|
|
|
Total
retained equity
|
|
657,138
|
|
|
|
697,837
|
|
|
|
(40,699
|
)
|
|
Accumulated
other comprehensive income
|
|
8,827
|
|
|
|
12,204
|
|
|
|
(3,377
|
)
|
|
Total
equity
|
|
$
|
665,965
|
|
|
$
|
710,041
|
|
|
$
|
(44,076
|
)
|
|
(1)
Excludes derivative forward value and foreign currency adjustments.
(2)
Represents the derivative forward value loss recorded by National Rural for the
period.
Applicants
are required to pay a one-time fee to become a member. The fee varies from two
hundred dollars to one thousand dollars depending on the membership
class. National Rural is required by the District of Columbia
cooperative law to have a methodology to allocate its net earnings to its
members. National Rural maintains the current year net earnings as
unallocated through the end of its fiscal year. Subsequent to the end
of the fiscal year, National Rural's board of directors allocates its net
earnings to its members in the form of patronage capital and to board approved
reserves. National Rural calculates net earnings by adjusting net
income to exclude certain non-cash adjustments. Currently, National
Rural has two such board approved reserves, the education fund and the members'
capital reserve. National Rural adjusts the net earnings it allocates
to its members and board approved reserves to exclude the non-cash impacts of
SFAS 133 and 52. National Rural allocates a small portion, less than
1%, of net earnings annually to the education fund as required by cooperative
law. Funds from the education fund are disbursed annually to the
statewide cooperative organizations to fund the teaching of cooperative
principles in the service territories of the cooperatives in each
state. The board of directors determines the amount of net earnings
that is allocated to the members' capital reserve, if any. The
members' capital reserve represents net earnings that are held by National Rural
to increase equity retention. The net earnings held in the members'
capital reserve have not been specifically allocated to any member, but may be
allocated to individual members in the future as patronage capital if authorized
by National Rural's board of directors. All remaining net earnings
are allocated to National Rural's members in the form of patronage
capital. National Rural bases the amount of net earnings allocated to
each member on the members' patronage of the National Rural lending programs in
the year that the net earnings were earned. There is no impact on
National Rural's total equity as a result of allocating net earnings to members
in the form of patronage capital or to board approved
reserves. National Rural annually retires a portion of the patronage
capital allocated to members in prior years. National Rural's total
equity is reduced by the amount of patronage capital retired to its members and
by amounts disbursed from board approved reserves.
At May
31, 2008, total equity decreased by $44 million from May 31,
2007. During the year ended May 31, 2008, National Rural retired $86
million of patronage capital to its members and accumulated other comprehensive
income related to derivatives decreased $3 million which was offset by net
income of $46 million.
Contractual
Obligations
The
following table summarizes the long-term contractual obligations at May 31, 2008
and the scheduled reductions by fiscal year.
(in
millions)
|
|
|
|
|
|
|
|
|
|
|
|
More
than 5
|
|
|
Instrument
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
2013
|
|
Years
|
|
Total
|
|
Long-term
debt due in less than one year
|
|
$
|
3,177
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
3,177
|
|
Long-term
debt
|
|
|
-
|
|
|
|
1,859
|
|
|
|
553
|
|
|
|
1,554
|
|
|
|
441
|
|
|
|
5,767
|
|
|
|
10,174
|
|
Subordinated
deferrable debt
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
311
|
|
|
|
311
|
|
Members'
subordinated certificates
(1)
|
|
|
8
|
|
|
|
37
|
|
|
|
26
|
|
|
|
14
|
|
|
|
14
|
|
|
|
1,055
|
|
|
|
1,154
|
|
Operating
leases (2)
|
|
|
3
|
|
|
|
2
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
5
|
|
Contractual
interest on long-term debt (3)
|
|
|
641
|
|
|
|
527
|
|
|
|
482
|
|
|
|
446
|
|
|
|
359
|
|
|
|
4,265
|
|
|
|
6,720
|
|
Total
contractual obligations
|
|
|
$
|
3,829
|
|
|
$
|
2,425
|
|
|
$
|
1,061
|
|
|
$
|
2,014
|
|
|
$
|
814
|
|
|
$
|
11,398
|
|
|
$
|
21,541
|
|
(1)
Excludes loan subordinated certificates totaling $253 million that amortize
annually based on the outstanding balance of the related loan. There
are many items that impact the amortization of a loan, such as loan conversions,
loan repricing at the end of an interest rate term and prepayments, thus
amortization schedule cannot be maintained for these
certificates. Over the past three years, annual amortization on these
certificates has averaged $30 million. In fiscal year 2008,
amortization represented 12% of amortizing loan subordinated certificates
outstanding.
(2)
Represents the payment obligation related to the Company's lease of office space
for its headquarters facility. In September 2007, the Company
exercised the option to extend the lease for an additional one-year
period. Assuming the Company exercises the option to extend the lease
for an additional one-year period in fiscal year 2009, the future minimum lease
payments for fiscal years 2010 and 2011 would increase to $4 million and $2
million, respectively.
(3)
Represents the interest obligation on the Company's debt based on terms and
conditions at May 31, 2008.
Off-Balance
Sheet Obligations
Guarantees
The
following chart provides a breakout of guarantees outstanding by type and by
segment at May 31:
(in
thousands)
|
2008
|
|
2007
|
|
Increase/
(Decrease)
|
|
Total
by type:
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
tax-exempt bonds
|
$
|
498,495
|
|
|
$
|
526,185
|
|
|
$
|
(27,690
|
)
|
|
Indemnifications
of tax benefit transfers
|
|
94,821
|
|
|
|
107,741
|
|
|
|
(12,920
|
)
|
|
Letters
of credit
|
|
343,424
|
|
|
|
365,766
|
|
|
|
(22,342
|
)
|
|
Other
guarantees
|
|
100,400
|
|
|
|
74,682
|
|
|
|
25,718
|
|
|
Total
|
$
|
1,037,140
|
|
|
$
|
1,074,374
|
|
|
$
|
(37,234
|
)
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
993,699
|
|
|
$
|
1,033,688
|
|
|
$
|
(39,989
|
)
|
|
RTFC
|
|
260
|
|
|
|
-
|
|
|
|
260
|
|
|
NCSC
|
|
43,181
|
|
|
|
40,686
|
|
|
|
2,495
|
|
|
Total
|
$
|
1,037,140
|
|
|
$
|
1,074,374
|
|
|
$
|
(37,234
|
)
|
|
The
decrease in total guarantees outstanding at May 31, 2008 compared to May 31,
2007 is primarily due to the normal amortization on long-term tax-exempt bonds
and tax benefit transfers and a reduction in the amount of letters of credit
offset by a $26 million increase to other guarantees outstanding.
At May
31, 2008 and 2007, the Company had recorded a guarantee liability totaling $15
million and $19 million, respectively, which represents the contingent and
non-contingent exposure related to guarantees of members' debt
obligations.
The
following table summarizes the off-balance sheet obligations at May 31, 2008 and
the related principal amortization and maturities by fiscal year.
(in
thousands)
|
|
|
|
Principal
Amortization and Maturities
|
|
|
|
|
Outstanding
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
Balance
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
Years
|
|
|
|
Guarantees
(1)
|
|
|
$
|
1,037,140
|
|
|
$
|
169,084
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
54,318
|
|
|
$
|
107,278
|
|
|
$
|
356,219
|
|
|
(1) On a
total of $330 million of tax-exempt bonds, National Rural has unconditionally
agreed to purchase bonds tendered or called for redemption at any time if the
remarketing agents have not sold such bonds to other purchasers.
Contingent
Off-Balance Sheet Obligations
Unadvanced
Loan Commitments
At May
31, 2008, the Company had unadvanced loan commitments totaling $13,574 million,
an increase of $670 million compared to the balance of $12,904 million at May
31, 2007. Unadvanced commitments are loans for which loan contracts
have been approved and executed, but funds have not been
advanced. Substantially all credit commitments for long-term loans
contain material adverse change clauses, thus for a borrower to qualify for the
advance of long-term funds, the Company must be satisfied that there has been no
material adverse change since the loan was approved based on National Rural's
credit underwriting policy at that time. The Company offers lines of
credit loans that may or may not contain a material adverse change
clause. The majority of the short-term unadvanced commitments provide
backup liquidity to the Company's borrowers; therefore, it does not anticipate
funding most of these commitments. Approximately 56% of the
outstanding commitments at May 31, 2008 and 2007 were for short-term or line of
credit loans. Based on the information above, unadvanced loan
commitments do not represent off-balance sheet liabilities and have not been
included in the chart summarizing off-balance sheet obligations
above. Therefore, unadvanced commitments are classified as contingent
liabilities.
Ratio
Analysis
Leverage
Ratio
The
leverage ratio is calculated by dividing the sum of total liabilities and
guarantees outstanding by total equity. Based on this formula, the
leverage ratio at May 31, 2008 was 29.64, an increase from 26.64 at May 31,
2007. The increase in the leverage ratio is due to an increase of
$856 million in total liabililities and a decrease of $44 million in total
equity offset by a decrease of $37 million in guarantees as discussed under the
Liabilities, Minority Interest and Equity section and the Off-Balance Sheet
Obligations section of "Financial Condition".
For the
purpose of covenant compliance on its revolving credit agreements and for
internal management purposes, the leverage ratio calculation is adjusted to
exclude derivative liabilities, debt used to fund RUS guaranteed loans,
subordinated deferrable debt and subordinated certificates from liabilities,
uses members' equity rather than total equity and adds subordinated deferrable
debt, subordinated certificates and minority interest to arrive at adjusted
equity. At May 31, 2008 and 2007, the adjusted leverage ratio was
7.50 and 6.81, respectively. See "Non-GAAP Financial Measures" for
further explanation and a reconciliation of the adjustments the Company makes in
its leverage ratio calculation.
The
increase in the adjusted leverage ratio is due to an increase in adjusted
liabilities of $912 million and a decrease of $111 million in adjusted equity
offset by a decrease in guarantees of $37 million as discussed under the
Liabilities, Minority Interest and Equity section and the Off-Balance Sheet
Obligations section of "Financial Condition". In addition to the
adjustments made to the leverage ratio in the "Non-GAAP Financial Measures"
section, guarantees to member systems that have an investment grade rating from
Moody's Investors Service and Standard & Poor's Corporation are excluded
from the calculation of the leverage ratio under the terms of the revolving
credit agreements.
Debt
to Equity Ratio
The debt
to equity ratio is calculated by dividing the sum of total liabilities
outstanding by total equity. The debt to equity ratio, based on this
formula at May 31, 2008 was 28.08, an increase from 25.13 at May 31,
2007. The increase in the debt to equity ratio is due to the decrease
of $44 million in total equity and an increase of $856 million in total
liabilities as discussed under the Liabilities, Minority Interest and Equity
section of "Financial Condition".
For
internal management purposes, the debt to equity ratio calculation is adjusted
to exclude derivative liabilities, debt used to fund RUS guaranteed loans,
subordinated deferrable debt and subordinated certificates from liabilities,
uses members' equity rather than total equity and adds subordinated deferrable
debt, subordinated certificates and minority interest to arrive at
adjusted
equity. At May 31, 2008 and 2007, the adjusted debt to equity ratio
was 7.06 and 6.37, respectively. See "Non-GAAP Financial Measures"
for further explanation and a reconciliation of the adjustments made to the debt
to equity ratio calculation. The increase in the adjusted debt to
equity ratio is due to the decrease of $111 million in adjusted equity and an
increase of $912 million in adjusted liabilities.
Credit
Ratings
The
Company's long- and short-term debt and guarantees are rated by three of the
major credit rating agencies registered with the SEC, Moody's Investors Service,
Standard & Poor's Corporation and Fitch Ratings. The following
table presents the Company's credit ratings at May 31, 2008.
|
Moody's
Investors
|
|
Standard
& Poor's
|
|
|
|
|
Service
|
|
Corporation
|
|
Fitch
Ratings
|
|
Direct:
|
|
|
|
|
|
|
|
|
|
|
|
|
Senior
secured debt
|
|
A1
|
|
|
|
A+
|
|
|
|
A+
|
|
|
Senior
unsecured debt
|
|
A2
|
|
|
|
A
|
|
|
|
A
|
|
|
Subordinated
deferrable debt
|
|
A3
|
|
|
|
BBB+
|
|
|
|
A-
|
|
|
Commercial
paper
|
|
P-1
|
|
|
|
A-1
|
|
|
|
F-1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Guarantees:
|
|
|
|
|
|
|
|
|
|
|
|
|
Pooled
bonds
|
|
A1
|
|
|
|
A
|
|
|
|
A
|
|
|
Other
bonds
|
|
A2
|
|
|
|
A
|
|
|
|
A
|
|
|
Short-term
|
|
P-1
|
|
|
|
A-1
|
|
|
|
F-1
|
|
|
The
ratings listed above have the meaning as defined by each of the respective
rating agencies, are not recommendations to buy, sell or hold securities and are
subject to revision or withdrawal at any time by the rating
organizations.
At May
31, 2008, Standard & Poor’s Corporation and Fitch Ratings had the Company’s
ratings on positive outlook and Moody's Investors Service had the Company's
ratings on stable outlook.
Liquidity
and Capital Resources
The
following section discusses the Company's sources and uses of
liquidity. The Company's primary sources of liquidity include capital
market debt issuance, private debt issuance, member loan principal repayments,
member loan interest payments, a revolving bank line facility and member
investments. The Company's primary uses of liquidity include loan
advances, interest payments on debt, principal repayments on debt and patronage
capital retirements. The Company believes that its sources of
liquidity are adequate to cover the uses of liquidity.
Sources
of Liquidity
Capital
Market Debt Issuance
At May
31, 2008, the Company had effective registration statements for the issuance of
$2,788 million of medium-term notes and $165 million of subordinated deferrable
debt. The Company qualifies as a well-known seasoned issuer
under SEC rules and filed an automatic shelf registration statement for
collateral trust bonds in October 2007. This automatic shelf
registration statement is effective for three years for an unlimited amount of
collateral trust bonds. The Company has Board authorization to
issue up to $1 billion of commercial paper and $4 billion of medium-term notes
in the European market. The Company also has Board authorization to
issue $2 billion of medium-term notes in the Australian market. At
May 31, 2008, the Company has not utilized any of the European or Australian
market authorizations. In addition, the Company has a commercial
paper program under which it sells commercial paper to investors in the capital
markets. The Company limits the amount of commercial paper that can
be sold to the amount of backup liquidity available under the Company's
revolving credit agreements. The Company also obtains short-term
funding from the sale of floating rate demand notes under its daily liquidity
fund program. The registration statement for the daily liquidity fund program is
effective for a three-year period ending April 2010 for a total of $20 billion
with a limitation on the aggregate principal amount outstanding at one time of
$3 billion.
Subsequent
to fiscal year 2008, the Company issued $900 million of 5.50% collateral trust
bonds due 2013 and $400 million of floating rate collateral trust bonds due 2010
in June 2008.
Private
Debt Issuance
Beginning
in fiscal year 2006, the Company made use of two sources of private debt
issuance. In July 2005, the Company issued a total of $500 million of
4.656% notes to Farmer Mac which matured in July 2008. In March 2008,
the Company issued to Farmer Mac $400 million of floating rate debt due in
2013. Both notes payable issued to Farmer Mac are secured by the
pledge of mortgage notes in an amount at least equal to the principal balance of
the notes outstanding. At May 31, 2008, the Company was also
authorized to borrow up to $2.5 billion under FFB loan facilities with bond
guarantee
agreements
with RUS as part of the funding mechanism for the REDLG program, of which $2.5
billion was outstanding. National
Rural is required to place on deposit mortgage notes in an amount at least equal
to the principal balance of the notes outstanding.
On
December 26, 2007, the President of the United States signed the Appropriations
Act for Fiscal Year 2008 which provides $500 million in additional funding from
the FFB with a guarantee of repayment by the RUS as part of the funding
mechanism for REDLG. In May 2008, legislation was passed which
removed a limitation based on the amount of loans the Company has issued on a
concurrent basis with RUS. As a result, on May 28, 2008, National
Rural submitted an application to borrow an additional $500 million available
under FFB loan facilities.
Member
Loan Repayments
There has
been significant prepayment activity over the past three fiscal years in the
telecommunications loan programs. It is not anticipated that there
will be significant loan prepayments over the next few
years. Amortization of the Company’s long-term loans in each of the
five fiscal years following May 31, 2008 and thereafter are as
follows:
(in
thousands)
|
|
Amortization
(1)
|
2009
|
$
|
800,630
|
|
2010
|
|
1,538,267
|
|
2011
|
|
839,040
|
|
2012
|
|
1,118,767
|
|
2013
|
|
805,275
|
|
Thereafter
|
|
|
12,234,899
|
|
(1)
Represents scheduled amortization based on current rates without consideration
for loans that reprice.
Member
Loan Interest Payments
During
the year ended May 31, 2008, interest income on the loan portfolio was $1,036
million, representing an average yield of 5.63% as compared to 5.61% and 5.28%
for the years ended May 31, 2007 and 2006, respectively. At May 31,
2008, 81% of the total loans outstanding had a fixed rate of interest and 19% of
loans outstanding had a variable rate of interest. At May 31,
2008, a total of 5% of loans outstanding were on a non-accrual basis with
respect to the recognition of interest income.
Bank
Revolving Credit Facility
The
following is a summary of the Company's revolving credit agreements at May
31:
(Dollar
amounts in thousands)
|
|
|
2008
|
|
2007
|
|
Termination
Date
|
|
Facility
fee per annum (1)
|
|
|
364-day
agreement
|
|
$
|
-
|
$
|
1,125,000
|
|
March
14, 2008
|
|
0.05
of 1%
|
|
|
Five-year
agreement
|
|
|
1,125,000
|
|
1,125,000
|
|
March
16, 2012
|
|
0.06
of 1%
|
|
|
Five-year
agreement
|
|
|
1,025,000
|
|
1,025,000
|
|
March
22, 2011
|
|
0.06
of 1%
|
|
|
364-day
agreement (2)
|
|
|
1,500,000
|
|
-
|
|
March
13, 2009
|
|
0.05
of 1%
|
|
|
Total
|
|
|
$
|
3,650,000
|
$
|
3,275,000
|
|
|
|
|
|
|
(1)
Facility fee determined by National Rural’s senior unsecured credit ratings
based on the pricing schedules put in place at the initiation of the related
agreement.
(2) Any
amount outstanding under these agreements may be converted to a one-year term
loan at the end of the revolving credit periods. If converted to a
term loan, the fee on the outstanding principal amount of the term loan is 0.10
of 1% per annum.
Upfront
fees of between 0.03 and 0.05 of 1% were paid to the banks based on their
commitment level to the five-year agreements in place at May 31, 2008, totaling
in aggregate $1 million, which will be amortized on a straight-line basis over
the life of the agreements. Upfront fees were paid to the banks for
their commitment to the 364-day facility in place at May 31, 2008, totaling $0.1
million, which will be amortized on a straight-line basis over the life of the
agreement. Each agreement contains a provision under which if
borrowings exceed 50% of total commitments, a utilization fee must be paid on
the outstanding balance. The utilization fees are 0.05 of 1% for all
three agreements in place at May 31, 2008.
At May
31, 2008 and 2007, the Company was in compliance with all covenants and
conditions under its revolving credit agreements in place at that time and there
were no borrowings outstanding under such agreements.
For the
purpose of calculating the required financial covenants contained in its
revolving credit agreements, the Company adjusts net income, senior debt and
total equity to exclude the non-cash adjustments related to SFAS 133 and SFAS
52, Foreign Currency Translation. The adjusted TIER, as defined by
the agreements, represents the interest expense adjusted to include the
derivative cash settlements, plus minority interest net income, plus net income
prior to the cumulative effect of change in accounting principle and dividing
that total by the interest expense adjusted to include the derivative cash
settlements. In addition to the non-cash adjustments related to SFAS
133 and 52, senior debt also excludes RUS guaranteed loans, subordinated
deferrable debt,
members'
subordinated certificates and minority interest. Total equity is
adjusted to include subordinated deferrable debt, members' subordinated
certificates and minority interest. Senior debt includes guarantees;
however, it excludes:
·
|
guarantees
for members where the long-term unsecured debt of the member is rated at
least BBB+ by Standard & Poor's Corporation or Baa1 by Moody's
Investors Service; and
|
·
|
the
payment of principal and interest by the member on the guaranteed
indebtedness if covered by insurance or reinsurance provided by an insurer
having an insurance financial strength rating of AAA by Standard &
Poor's Corporation or a financial strength rating of Aaa by Moody's
Investors Service.
|
The
following represents the Company's required and actual financial ratios under
the revolving credit agreements at or for the year ended May 31:
|
|
|
|
Actual
|
|
|
|
Requirement
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
|
Minimum
average adjusted TIER over the six most recent fiscal
quarters
|
|
1.025
|
|
1.16
|
|
1.09
|
|
|
|
|
|
|
|
|
|
Minimum
adjusted TIER at fiscal year end (1)
|
|
1.05
|
|
1.15
|
|
1.12
|
|
|
|
|
|
|
|
|
|
Maximum
ratio of senior debt to total equity
|
|
|
10.00
|
|
7.33
|
|
6.65
|
|
(1) The
Company must meet this requirement in order to retire patronage
capital.
The
revolving credit agreements do not contain a material adverse change clause or
ratings triggers that limit the banks' obligations to fund under the terms of
the agreements, but National Rural must be in compliance with their other
requirements, including financial ratios, in order to draw down on the
facilities.
Member
Investments
At May
31, 2008 and 2007, members funded 19.7% and 20.9%, respectively, of total assets
as follows:
|
|
2008
|
|
2007
|
|
Increase/
|
|
(Dollar
amounts in thousands)
|
Amount
|
|
%
of Total (1)
|
|
Amount
|
|
%
of Total (1)
|
|
(Decrease)
|
Commercial
paper (2)
|
$
|
1,403,960
|
|
|
46%
|
|
|
$
|
1,633,653
|
|
|
59%
|
|
$
|
(229,693
|
)
|
|
Medium-term
notes
|
|
392,739
|
|
|
8%
|
|
|
|
307,622
|
|
|
6%
|
|
|
85,117
|
|
|
Members'
subordinated certificates
|
|
1,406,779
|
|
|
100%
|
|
|
|
1,381,447
|
|
|
100%
|
|
|
25,332
|
|
|
Members'
equity (3)
|
|
613,082
|
|
|
100%
|
|
|
|
566,286
|
|
|
100%
|
|
|
46,796
|
|
|
Total
|
$
|
3,816,560
|
|
|
|
|
|
$
|
3,889,008
|
|
|
|
|
$
|
(72,448
|
)
|
|
Percentage
of total assets
|
|
19.7
|
%
|
|
|
|
|
|
20.9
|
%
|
|
|
|
|
|
|
|
Percentage
of total assets less derivative assets (3)
|
|
19.9
|
%
|
|
|
|
|
|
21.2
|
%
|
|
|
|
|
|
|
|
(1)
Represents the percentage of each line item outstanding to the Company’s
members.
(2)
Includes $251 million and $250 million related to the daily liquidity fund at
May 31, 2008 and 2007, respectively.
(3) See
"Non-GAAP Financial Measures" for further explanation and a reconciliation of
the adjustments made to total capitalization and a breakout of members'
equity.
Uses
of Liquidity
Loan
Advances
Loan
advances are the result of new loans approved to members and from the unadvanced
portion of loans that were approved prior to May 31, 2008. At May 31,
2008, the Company had unadvanced loan commitments totaling $13,574
million. The Company does not expect to advance the full amount of
the unadvanced commitments at May 31, 2008. Unadvanced commitments
generally expire within five years of the first advance on a loan and the
majority of short-term unadvanced commitments are used as backup liquidity for
member operations. Approximately 56% of the outstanding commitments
at May 31, 2008 were for short-term or line of credit loans. The
Company anticipates that over the next twelve months, loan advances will be
approximately equal to the scheduled loan repayments.
Interest
Expense on Debt
For the
year ended May 31, 2008, interest expense on debt was $902 million, representing
4.90% of the average loan volume for which the debt was used as
funding. The interest expense on debt represented 5.28% and 5.18% of
the average loan volume for which the debt was used as funding for the years
ended May 31, 2007 and 2006, respectively. At May 31, 2008, a total
of 82% of outstanding debt had a fixed interest rate and 18% of outstanding debt
had a variable interest rate.
Principal
Repayments on Long-term Debt
The
principal amount of medium-term notes, collateral trust bonds, long-term notes
payable, subordinated deferrable debt and membership subordinated certificates
maturing in each of the five fiscal years following May 31, 2008 and thereafter
is as follows:
|
Amount
|
|
Weighted
Average
|
(Dollar
amounts in thousands)
|
Maturing
(1)
|
|
Interest
Rate
|
2009
|
$
|
3,185,351
|
|
|
|
3.77
|
%
|
2010
|
|
1,895,923
|
|
|
|
5.18
|
%
|
2011
|
|
578,508
|
|
|
|
4.46
|
%
|
2012
|
|
1,568,240
|
|
|
|
7.13
|
%
|
2013
|
|
454,843
|
|
|
|
3.47
|
%
|
Thereafter
|
|
7,133,617
|
|
|
|
5.55
|
%
|
Total
|
|
$
|
14,816,482
|
|
|
|
5.18
|
%
|
(1)
Excludes loan subordinated certificates totaling $253 million that amortize
annually based on the outstanding balance of the related loan. There
are many items that impact the amortization of a loan, such as loan conversions,
loan repricing at the end of an interest rate term and prepayments, thus an
amortization schedule cannot be maintained for these
certificates. Over the past three years, annual amortization on these
certificates has averaged $30 million. In fiscal year 2008,
amortization represented 12% of amortizing loan subordinated certificates
outstanding.
Patronage
Capital Retirements
The
Company has made annual retirements of its allocated patronage capital in 28 of
the last 29 years. In July 2008, the National Rural board of
directors approved the allocation of a total of $103 million from fiscal year
2008 net earnings to the National Rural members. National Rural is
scheduled to make a cash payment of $85 million to its members in September 2008
as retirement of 70% of the amount allocated for fiscal year 2008 and 1/9th of
the amount allocated for fiscal years 1991, 1992 and 1993.
Market
Risk
The
Company's primary market risks are interest rate risk and liquidity
risk. The Company is also exposed to counterparty risk as a result of
entering into interest rate exchange agreements.
Interest
Rate Risk
The
interest rate risk exposure is related to the funding of the fixed rate loan
portfolio. The Company does not match fund the majority of its fixed
rate loans with a specific debt issuance at the time the loans are
advanced. The Company aggregates fixed rate loans until the volume
reaches a level that will allow an economically efficient issuance of
debt. The Company uses fixed rate collateral trust bonds, medium-term
notes, subordinated deferrable debt, members' subordinated certificates,
members' equity and variable rate debt to fund fixed rate loans. The
Company allows borrowers flexibility in the selection of the period for which a
fixed interest rate will be in effect. Long-term loans typically have
maturities of up to 35 years. Borrowers may select fixed interest
rates for periods of one year through the life of the loan. To
mitigate interest rate risk in the funding of fixed rate loans, the Company
performs a monthly gap analysis, a comparison of fixed rate assets repricing or
maturing by year to fixed rate liabilities and members' equity maturing by year
(see chart on page 47). The interest rate risk is deemed minimal on
variable rate loans, since the loans may be repriced either monthly or
semi-monthly to reflect the cost of the debt used to fund the
loans. At May 31, 2008 and 2007, 19% and 18%, respectively, of loans
carried variable interest rates.
Matched
Funding Policy
To
monitor interest rate risk in the funding of fixed rate loans, the Company
performs a monthly gap analysis (see chart on page 47). It is the
Company's funding objective to manage the matched funding of asset and liability
repricing terms within a range of 3% of total assets excluding derivative
assets. At May 31, 2008, the Company had $15,203 million of fixed
rate assets amortizing or repricing, funded by $13,124 million of fixed rate
liabilities maturing during the next 30 years and $1,771 million of members'
equity and members' subordinated certificates, a portion of which does not have
a scheduled maturity. The difference of $308 million, or less than 2%
of total assets and total assets excluding derivative assets, represents the
fixed rate assets maturing during the next 30 years in excess of the fixed rate
debt and equity. Fixed rate loans are funded with fixed rate
collateral trust bonds, medium-term notes, long-term notes payable, subordinated
deferrable debt, members' subordinated certificates and members'
equity. With the exception of members' subordinated certificates,
which are generally issued at rates below the Company's long-term cost of
funding and with extended maturities, and commercial paper, the Company's
liabilities have average maturities that closely match the repricing terms (but
not the maturities) of its fixed interest rate loans. The Company
also uses commercial paper supported by interest rate exchange agreements to
fund its portfolio
of fixed rate loans. Variable rate assets which reprice monthly or
semi-monthly are funded with short-term liabilities, primarily commercial paper,
collateral trust bonds, long-term notes payable and medium-term notes issued
with a fixed rate and swapped to a variable rate, medium-term notes issued at a
variable rate, subordinated certificates, members’ equity and bank bid
notes. The schedule allows the Company to analyze the impact on the
overall adjusted TIER of issuing a
certain
amount of debt at a fixed rate for various maturities, prior to issuance of the
debt. See "Non-GAAP Financial Measures" for further explanation and a
reconciliation of the adjustments to TIER.
Certain
of the Company's collateral trust bonds, subordinated deferrable debt and
medium-term notes were issued with early redemption provisions. To
the extent borrowers are allowed to convert their fixed rate loans to a variable
interest rate and to the extent it is beneficial, the Company takes advantage of
these early redemption provisions. However, because conversions and
prepayments can take place at different intervals from early redemptions, the
Company charges conversion fees designed to compensate for any additional
interest rate risk it assumes.
The
following chart shows the scheduled amortization and repricing of fixed rate
assets and liabilities outstanding at May 31,
2008.
INTEREST
RATE GAP ANALYSIS
|
(Fixed
Rate Assets/Liabilities)
|
As
of May 31, 2008
|
|
May
31,
|
|
June
1,
|
|
June
1,
|
|
June
1,
|
|
June
1,
|
|
|
|
|
|
|
2009
|
|
2009
to
|
|
2011
to
|
|
2013
to
|
|
2018
to
|
|
Beyond
|
|
|
|
|
or
|
|
May
31,
|
|
May
31,
|
|
May
31,
|
|
May
31,
|
|
June
1,
|
|
|
|
(Dollar
amounts in millions)
|
prior
|
|
2011
|
|
2013
|
|
2018
|
|
2028
|
|
2028
|
|
Total
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Amortization
and repricing
|
$
|
2,044
|
|
|
$
|
3,437
|
|
|
$
|
2,784
|
|
|
$
|
3,359
|
|
|
$
|
2,622
|
|
|
$
|
957
|
|
|
$
|
15,203
|
|
Total
assets
|
$
|
2,044
|
|
|
$
|
3,437
|
|
|
$
|
2,784
|
|
|
$
|
3,359
|
|
|
$
|
2,622
|
|
|
$
|
957
|
|
|
$
|
15,203
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and members' equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
$
|
1,766
|
|
|
$
|
3,103
|
|
|
$
|
3,455
|
|
|
$
|
3,763
|
|
|
$
|
782
|
|
|
$
|
255
|
|
|
$
|
13,124
|
|
Subordinated
certificates
|
|
26
|
|
|
|
55
|
|
|
|
79
|
|
|
|
67
|
|
|
|
535
|
|
|
|
490
|
|
|
|
1,252
|
|
Members'
equity (1)
|
|
15
|
|
|
|
25
|
|
|
|
31
|
|
|
|
127
|
|
|
|
109
|
|
|
|
212
|
|
|
|
519
|
|
Total
liabilities and members' equity
|
$
|
1,807
|
|
|
$
|
3,183
|
|
|
$
|
3,565
|
|
|
$
|
3,957
|
|
|
$
|
1,426
|
|
|
$
|
957
|
|
|
$
|
14,895
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gap (2)
|
$
|
237
|
|
|
$
|
254
|
|
|
$
|
(781
|
)
|
|
$
|
(598
|
)
|
|
$
|
1,196
|
|
|
$
|
-
|
|
|
$
|
308
|
|
Cumulative
gap
|
$
|
237
|
|
|
$
|
491
|
|
|
$
|
(290
|
)
|
|
$
|
(888
|
)
|
|
$
|
308
|
|
|
$
|
308
|
|
|
|
|
|
Cumulative
gap as a % of total assets
|
|
1.22
|
%
|
|
|
2.53
|
%
|
|
|
(1.50
|
)%
|
|
|
(4.58
|
)%
|
|
|
1.59
|
%
|
|
|
1.59
|
%
|
|
|
|
|
Cumulative
gap as a % of adjusted total assets (3)
|
|
1.24
|
%
|
|
|
2.56
|
%
|
|
|
(1.51
|
)%
|
|
|
(4.63
|
)%
|
|
|
1.61
|
%
|
|
|
1.61
|
%
|
|
|
|
|
(1)
Includes the portion of the loan loss allowance and subordinated deferrable debt
allocated to fund fixed rate assets. See "Non-GAAP Financial
Measures" for further explanation of why National Rural uses members' equity in
its analysis of the funding of its loan portfolio.
(2)
Assets less liabilities and members' equity.
(3)
Adjusted total assets represents total assets in the consolidated balance sheet
less derivative assets.
Use
of Derivatives
At May
31, 2008 and 2007, the Company was a party to interest rate exchange agreements
with a total notional amount of $12,916 million and $12,533 million,
respectively. The Company uses interest rate exchange agreements as
part of its overall interest rate matching strategy. Interest rate
exchange agreements are used when they provide a lower cost of funding or
minimize interest rate risk. The Company will enter into interest
rate exchange agreements only with highly rated financial
institutions. National Rural used interest rate exchange agreements
to synthetically change the interest rate from a variable rate to a fixed rate
on $7,660 million as of May 31, 2008 and $7,277 million as of May 31, 2007 of
debt used to fund long-term fixed rate loans. Interest rate exchange
agreements were used to synthetically change the interest rates from fixed to
variable on $5,256 million of long-term debt as of May 31, 2008 and
2007. The Company has not invested in derivative financial
instruments for trading purposes in the past and does not anticipate doing so in
the future.
At May
31, 2008 and 2007, there were no foreign currency exchange agreements
outstanding.
Counterparty
Risk
The
Company is exposed to counterparty risk related to the performance of the
parties with which it has entered into interest rate exchange
agreements. To mitigate this risk, the Company only enters into these
agreements with financial institutions with investment grade
ratings. At May 31, 2008 and 2007, the Company was a party to
interest rate exchange agreements with notional amounts totaling $12,916 million
and $12,533 million, respectively. To date, the Company has not
experienced a failure of a counterparty to perform as required under any of
these agreements. At the time counterparties are selected to
participate in the Company's exchange agreements, the counterparty must be a
participant in one of its revolving credit agreements. At May 31,
2008, the Company's interest rate exchange agreement counterparties had credit
ratings ranging from AAA to A- as assigned by Standard & Poor's
Corporation.
The
Company currently uses two types of interest rate exchange
agreements: (1) the Company pays a fixed rate and receives a variable
rate and (2) the Company pays a variable rate and receives a fixed
rate. The following chart provides a breakout of the interest rate
exchange agreements at May 31, 2008 by type of agreement.
(Dollar
amounts in thousands)
|
|
Notional
Amount
|
|
Weighted
Average
Rate
Paid
|
|
Weighted
Average
Rate
Received
|
|
Pay
fixed / receive variable
|
|
$
|
7,659,973
|
|
|
|
4.59
|
%
|
|
|
2.64
|
%
|
|
Pay
variable / receive fixed
|
|
|
5,256,440
|
|
|
|
3.50
|
%
|
|
|
6.15
|
%
|
|
Total
|
|
$
|
12,916,413
|
|
|
|
4.15
|
%
|
|
|
4.07
|
%
|
|
Foreign
Currency Risk
The
Company may issue commercial paper, medium-term notes or bonds denominated in
foreign currencies. At May 31, 2008 and 2007, there was no foreign
denominated debt outstanding. When the Company issues foreign
denominated debt, it typically mitigates foreign currency risk by entering into
an exchange agreement to lock in the exchange rate for all interest and
principal payments through maturity.
Rating
Triggers
The
Company has certain interest rate exchange agreements that contain a condition
that will allow one counterparty to terminate the agreement if the credit rating
of the other counterparty drops to a certain level. This
condition is commonly called a rating trigger. Under the rating
trigger, if the credit rating for either counterparty falls to the level
specified in the agreement, the other counterparty may, but is not
obligated to, terminate the agreement. If either counterparty
terminates the agreement, a net payment may be due from one counterparty to the
other based on the fair value of the underlying derivative
instrument. Rating triggers are not separate financial instruments
and are not separate derivatives under SFAS 133.
At May
31, 2008, the Company had the following notional amount and fair values
associated with exchange agreements that contain rating triggers. For
the purpose of the presentation, the Company has grouped the rating triggers
into two categories: (1) ratings from Moody's Investors Service falls to Baa1 or
from Standard & Poor's Corporation falls to BBB+ and (2) ratings from
Moody's Investors Service falls below Baa1 or from Standard & Poor's
Corporation falls below BBB+. In calculating the required payments
and collections required upon termination, the Company netted the agreements for
each counterparty, as allowed by the underlying master agreement.
(in
thousands)
|
|
Notional
Amount
|
|
|
Required
Company Payment
|
|
|
Amount
Company Would Collect
|
|
|
Net
Total
|
|
Rating
Level:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fall
to Baa1/BBB+
|
$
|
1,851,658
|
|
$
|
(637
|
)
|
$
|
38,492
|
|
$
|
37,855
|
|
Fall
below Baa1/BBB+
|
|
7,028,358
|
|
|
(31,472
|
)
|
|
30,584
|
|
|
(888
|
)
|
Total
|
$
|
8,880,016
|
|
$
|
(32,109
|
)
|
$
|
69,076
|
|
$
|
36,967
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See chart
on page 43 for National Rural's senior unsecured credit ratings as of May 31,
2008.
In
addition to the rating triggers listed above, at May 31, 2008, the Company had
$717 million of notional amount of exchange agreements, with one counterparty,
that would require the pledging of collateral in an amount equal to the fair
value of the exchange agreements if the Company’s senior secured ratings from
Moody's Investors Service fall below Baa2 or from Standard & Poor's
Corporation fall below BBB. At May 31, 2008, the net obligation
totaled $9 million for the $717 million notional amount of exchange agreements
subject to this rating trigger.
Liquidity
Risk
The
Company faces liquidity risk in the funding of its loan portfolio and
refinancing its maturing obligations. The Company offers long-term
loans with maturities of up to 35 years and line of credit loans that are
generally required to be paid down annually. On long-term loans, the
Company offers a variety of interest rate options including the ability to fix
the interest rate for terms of one year through maturity. At May 31,
2008, the Company has a total of $3,177 million of long-term debt maturing
during the next twelve months. The Company funds the loan portfolio
with a variety of debt instruments and its members' equity. The
Company typically does not match fund each of its loans with a debt instrument
of similar final maturity. Debt instruments such as subordinated
certificates have maturities that vary from the term of the associated loan or
guarantee to 100 years and subordinated deferrable debt has been issued with
maturities of up to 49 years.
The
Company may issue collateral trust bonds and medium-term notes for periods of up
to 30 years, but typically issues such debt instruments with maturities of 2, 3,
5, 7 and 10 years. Debt instruments such as commercial paper and bank
bid notes typically have maturities of 90 days or less. Therefore, the Company
is at risk if it is not able to issue new debt instruments to replace
debt
that
matures prior to the maturity of the loans for which they are used as
funding. Factors that mitigate liquidity risk include the Company
maintenance of back-up liquidity through revolving credit agreements with
domestic and foreign banks and a large volume of scheduled principal repayments
received on an annual basis. At May 31, 2008 and 2007, the Company
had a total of $3,650
million and $3,275 million, respectively, in revolving credit agreements and
bank lines of credit. In addition, the Company limits the amount of dealer
commercial paper and bank bid notes used in the funding of loans. The
Company's objective is to maintain the amount of dealer commercial paper and
bank bid notes used to 15% or less of total debt outstanding. At May
31, 2008 and 2007, there was a total of $1,612 million and $1,118 million,
respectively, of dealer commercial paper and bank bid notes outstanding,
representing 9% and 6%, respectively, of the Company's total debt
outstanding.
National
Rural continues to see significant investment support from its members with $3.2
billion of commercial paper, daily liquidity fund, medium-term notes and
subordinated certificate investments outstanding at May 31, 2008. The
member debt investments represented 18% of the total debt outstanding at May 31,
2008. In addition, National Rural had a total of $3.5 billion of
privately placed debt outstanding at May 31, 2008, $2.5 billion of which was
guaranteed by the U.S. Government under the REDLG program. The
private placements of debt represented 19% of total debt outstanding at May 31,
2008. National Rural did not experience any difficulty issuing its
commercial paper in the capital markets during fiscal year 2008, although there
was a slight widening of the spread demanded by investors at certain times
during the year. NCSC did experience some issues with the issuance of
its commercial paper, which carries a guarantee from National
Rural. Due to the significant increase in spread demanded by
investors, NCSC was limited to issuing very short maturities for a period of
time during the year ended May 31, 2008. The slightly higher spread
paid on dealer commercial paper did not have a significant impact on National
Rural's funding cost, as dealer commercial paper represented 8% of total debt at
May 31, 2008. At the time of this filing, neither National Rural or
NCSC are experiencing any difficulties issuing commercial paper and current
spreads are consistent with National Rural’s historic trading
levels.
At May
31, 2008, the Company was the guarantor and liquidity provider for $330 million
of tax-exempt bonds issued for its member cooperatives. A total of
$133 million of such tax-exempt bonds were in flexible and weekly mode, which
reprice every seven to thirty-five days. A total of $120 million of
such tax-exempt bonds reprice semi-annually. A total of $77 million
of such bonds were in unit price mode and reprice approximately every 30
days. National Rural has not been required to purchase any of the
bonds in its role as liquidity provider. In addition to these
tax-exempt bonds, National Rural was the guarantor, but not liquidity provider,
for $155 million of tax-exempt bonds that were in the auction rate
mode. National Rural has not been required to perform under the
guarantee of its members’ tax-exempt bonds.
For
additional information about the risks related to the Company's business, see
Item 1A. "Risk Factors".
Financial
Instruments and Derivatives
All
financial instruments to which the Company was a party at May 31, 2008 were
entered into or contracted for purposes other than trading. The
following table provides the significant balances and contract terms related to
the financial instruments at May 31, 2008.
|
|
|
|
|
|
|
|
|
|
|
Principal
Amortization and Maturities
|
(Dollar
amounts in millions)
|
Outstanding
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
Instrument
|
|
Balance
|
|
Fair
Value
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
2013
|
|
Years
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans (1)
|
|
15,141
|
|
|
|
14,384
|
|
|
|
704
|
|
|
|
933
|
|
|
|
718
|
|
|
|
1,046
|
|
|
|
718
|
|
|
11,022
|
|
Average
rate
|
|
6.17
|
%
|
|
|
|
|
|
|
5.98
|
%
|
|
|
5.96
|
%
|
|
|
6.03
|
%
|
|
|
6.07
|
%
|
|
|
6.04
|
%
|
|
6.22
|
%
|
Long-term
variable rate loans (2)
|
|
1,103
|
|
|
|
1,103
|
|
|
|
76
|
|
|
|
117
|
|
|
|
106
|
|
|
|
57
|
|
|
|
71
|
|
|
676
|
|
Average
rate (3)
|
|
5.15
|
%
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
Short-term
loans (4)
|
|
1,664
|
|
|
|
1,664
|
|
|
|
1,664
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
Average
rate (3)
|
|
4.23
|
%
|
|
|
|
|
|
|
4.23
|
%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
RUS
Guaranteed FFB Refinance
|
|
35
|
|
|
|
35
|
|
|
|
2
|
|
|
|
3
|
|
|
|
3
|
|
|
|
3
|
|
|
|
3
|
|
|
21
|
|
Average
rate (3)
|
|
2.46
|
%
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
Non-performing
loans (5)
|
|
507
|
|
|
|
281
|
|
|
|
8
|
|
|
|
499
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
Average
rate (5)
|
|
-
|
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
Restructured
loans (5)
|
|
577
|
|
|
|
377
|
|
|
|
12
|
|
|
|
12
|
|
|
|
12
|
|
|
|
13
|
|
|
|
13
|
|
|
515
|
|
Average
rate (5)
|
|
0.60
|
%
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
Liabilities
and equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
debt (6)
|
|
6,327
|
|
|
|
6,334
|
|
|
|
6,327
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
Average
rate
|
|
3.02
|
%
|
|
|
|
|
|
|
3.02
|
%
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
Medium-term
notes
|
|
4,331
|
|
|
|
4,600
|
|
|
|
-
|
|
|
|
1,646
|
|
|
|
44
|
|
|
|
1,547
|
|
|
|
32
|
|
|
1,062
|
|
Average
rate
|
|
6.52
|
%
|
|
|
|
|
|
|
|
|
|
|
5.14
|
%
|
|
|
4.64
|
%
|
|
|
7.16
|
%
|
|
|
4.73
|
%
|
|
7.84
|
%
|
Collateral
trust bonds
|
|
2,887
|
|
|
|
2,876
|
|
|
|
-
|
|
|
|
210
|
|
|
|
506
|
|
|
|
5
|
|
|
|
5
|
|
|
2,161
|
|
Average
rate
|
|
5.29
|
%
|
|
|
|
|
|
|
|
|
|
|
5.67
|
%
|
|
|
4.42
|
%
|
|
|
7.35
|
%
|
|
|
7.35
|
%
|
|
5.45
|
%
|
Long-term
notes payable
|
|
2,956
|
|
|
|
3,072
|
|
|
|
-
|
|
|
|
3
|
|
|
|
3
|
|
|
|
3
|
|
|
|
403
|
|
|
2,544
|
|
Average
rate
|
|
4.83
|
%
|
|
|
|
|
|
|
|
|
|
|
8.11
|
%
|
|
|
8.11
|
%
|
|
|
8.11
|
%
|
|
|
3.32
|
%
|
|
5.06
|
%
|
Subordinated
deferrable debt
|
|
311
|
|
|
|
292
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
311
|
|
Average
rate
|
|
6.31
|
%
|
|
|
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
6.31
|
%
|
Membership
sub certificates (7)
|
|
1,154
|
|
|
|
N/A
|
|
|
|
8
|
|
|
|
37
|
|
|
|
26
|
|
|
|
14
|
|
|
|
14
|
|
|
1,055
|
|
Average
rate
|
|
|
4.35
|
%
|
|
|
|
|
|
|
2.18
|
%
|
|
|
3.88
|
%
|
|
|
4.71
|
%
|
|
|
4.02
|
%
|
|
|
3.71
|
%
|
|
4.39
|
%
|
(1) The
principal amount of fixed rate loans is the total of scheduled principal
amortizations without consideration for loans that reprice. Includes
$214 million of loans guaranteed by RUS.
(2)
Long-term variable rate loans include $1 million of loans guaranteed by
RUS.
(3)
Variable rates are set the first day of each month.
(4) The
principal amount of line of credit loans are generally required to be paid down
for a period of five consecutive days each year. These loans do not
have a principal amortization schedule.
(5)
Amortization based on expected repayment schedule. Average rate
represents current accrual rate. Interest accrual rate cannot be
estimated for future periods.
(6)
Short-term debt includes commercial paper, bank bid notes and long-term debt due
in less than one year.
(7) Fair
value has not been included as it is impracticable to develop a discount rate
that measures fair value (see Note 14 to the consolidated financial statements).
Excludes loan subordinated certificates totaling $253 million that amortize
annually based on the outstanding balance of the related loan, therefore there
is no scheduled amortization. Over the past three years, annual amortization on
these certificates has averaged $30 million. In fiscal year 2008,
amortization represented 12% of amortizing loan subordinated certificates
outstanding.
The
following table provides the notional amount, average rate paid, average rate
received and maturity dates for the interest rate exchange agreements to which
the Company was a party at May 31, 2008.
(Dollar
amounts in millions)
|
|
Notional
|
|
|
|
Notional
Amortization and Maturities
|
|
|
Principal
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
Instruments
|
|
|
Amount
|
|
Fair
Value
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
2013
|
|
Years
|
Interest
rate exchange agreements
|
|
$
|
12,916
|
|
|
$
|
49
|
|
|
$
|
1,004
|
|
|
$
|
2,363
|
|
|
$
|
477
|
|
|
$
|
2,971
|
|
|
$
|
1,089
|
|
|
$
|
5,012
|
Average
rate paid
|
|
|
4.15
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Average
rate received
|
|
|
4.07
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
There
were no cross currency or cross currency interest rate exchange agreements to
which the Company was a party at May 31, 2008 and 2007.
Non-GAAP
Financial Measures
The
Company makes certain adjustments to financial measures in assessing its
financial performance that are not in accordance with GAAP. These
non-GAAP adjustments fall primarily into two categories: (1)
adjustments related to the calculation of the TIER ratio, and (2) adjustments
related to the calculation of leverage and debt to equity
ratios. These adjustments reflect management's perspective on the
Company's operations, and in several cases adjustments used to measure covenant
compliance under its revolving credit agreements, and thus the Company believes
these are useful financial measures for investors. The Company refers
to its non-GAAP financial measures as "adjusted" throughout this
document.
Adjustments
to Net Income and the Calculation of the TIER Ratio
The
Company's primary performance measure is TIER. TIER is calculated by
adding the interest expense to net income prior to the cumulative effect of
change in accounting principle and dividing that total by the interest
expense. The TIER is a measure of the Company's ability to cover
interest expense requirements on its debt. The Company adjusts the
TIER calculation to add the derivative cash settlements to the interest expense,
to add minority interest net income back to total net income and to remove the
derivative forward value and foreign currency adjustments from total net
income. Adding the cash settlements back to the interest expense also
has a corresponding effect on the Company's adjusted net interest income and
adjusted income prior to income taxes and minority interest. The
Company makes these adjustments to its TIER calculation for the purpose of
covenant compliance on its revolving credit agreements. The revolving
credit agreements require the Company to achieve an average adjusted TIER ratio
over the six most recent fiscal quarters of at least 1.025 and prohibit the
retirement of patronage capital unless the Company has achieved an adjusted TIER
ratio of at least 1.05 for the preceding fiscal year.
The
Company uses derivatives to manage interest rate and foreign currency exchange
risk on its funding of the loan portfolio. The derivative cash
settlements represent the amount that the Company receives from or pays to its
counterparties based on the interest rate indexes in its derivatives that do not
qualify for hedge accounting. The Company adjusts the reported cost of funding
to include the derivative cash settlements. The Company uses the
adjusted cost of funding to set interest rates on loans to its members and
believes that the interest expense adjusted to include derivative cash
settlements represents its total cost of funding for the period. For
the purpose of computing compliance with its revolving credit agreement
covenants, the Company is required to adjust its interest expense to include the
derivative cash settlements. TIER calculated by adding the derivative
cash settlements to the interest expense reflects management's perspective on
its operations and thus, the Company believes that it represents a useful
financial measure for investors.
The
derivative forward value and foreign currency adjustments do not represent cash
inflows or outflows to the Company during the current period. The
derivative forward value represents a present value estimate of the future cash
inflows or outflows that will be recognized as net cash settlements for all
periods through the maturity of its derivatives that do not qualify for hedge
accounting. Foreign currency adjustments represent the change in
value of foreign denominated debt resulting from the change in foreign currency
exchange rates during the current period. The derivative forward
value and foreign currency adjustments do not represent cash inflows or outflows
that affect the Company's current ability to cover its debt service
obligations. The forward value calculation is based on future
interest rate expectations that may change daily creating volatility in the
estimated forward value. The change in foreign currency exchange
rates adjusts the debt balance to the amount that would be due at the reporting
date. At the issuance date, the Company enters into a foreign
currency exchange agreement for all foreign denominated debt that effectively
fixes the exchange rate for all interest and principal payments. For
the purpose of making operating decisions, the Company subtracts the derivative
forward value and foreign currency adjustments from its net income when
calculating TIER and for other net income presentation purposes. The
covenants in the Company's revolving credit agreements also exclude the effects
of derivative forward value and foreign currency adjustments. In
addition, since the derivative forward value and foreign currency adjustments do
not represent current period cash flows, the Company does not allocate such
funds to its members and thus excludes the derivative forward value and foreign
currency adjustments from net income when making certain presentations to its
members and in calculating the amount of net income to be allocated to its
members. TIER calculated by excluding the derivative forward value
and foreign currency adjustments from net income reflects management's
perspective on its operations and thus, the Company believes that it represents
a useful financial measure for investors.
The
implementation of SFAS 133 and foreign currency adjustments have also impacted
the Company's total equity. The derivative forward value and foreign
currency adjustments flow through the consolidated statements of operations as
income or expense, increasing or decreasing the total net income for the
period. The total net income or net loss for the period represents an
increase or decrease, respectively, to total equity. As a result of
implementing SFAS 133, the Company's total equity includes other comprehensive
income, which represents unrecognized gains and losses on
derivatives. The other comprehensive income component of equity
related to derivatives that qualify for hedge accounting does not flow through
the consolidated statements of operations. As stated above, the
derivative forward value and foreign currency adjustments do not represent
current cash inflow or outflow. The other comprehensive income is
also an estimate of future gains and losses and
as such
does not represent earnings that the Company can use to fund its loan
portfolio. Financial measures calculated with members' equity, which
is total equity excluding the impact of SFAS 133 and foreign currency
adjustments, reflect management's perspective on its operations and thus, the
Company believes that they represent a useful measure of its financial
condition.
The
following chart provides a reconciliation between interest expense, net interest
income, income prior to income taxes and minority interest and net income and
these financial measures adjusted to exclude the impact of deriviatives and
foreign currency adjustments and to include minority interest in net income for
the years ended May 31, 2008, 2007, 2006, 2005 and 2004.
|
For
the year ended May 31,
|
|
|
|
2008
|
|
|
|
2007
|
|
|
|
2006
|
|
|
|
2005
|
|
|
|
2004
|
|
(in
thousands)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
$
|
(936,889
|
)
|
|
$
|
(996,730
|
)
|
|
$
|
(975,936
|
)
|
|
$
|
(942,033
|
)
|
|
$
|
(941,491
|
)
|
Adjusted
to include: Derivative cash settlements
|
|
27,033
|
|
|
|
86,442
|
|
|
|
80,883
|
|
|
|
78,287
|
|
|
|
123,363
|
|
Adjusted
interest expense
|
$
|
(909,856
|
)
|
|
$
|
(910,288
|
)
|
|
$
|
(895,053
|
)
|
|
$
|
(863,746
|
)
|
|
$
|
(818,128
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
$
|
132,651
|
|
|
$
|
57,494
|
|
|
$
|
31,976
|
|
|
$
|
88,820
|
|
|
$
|
68,365
|
|
Adjusted
to include: Derivative cash settlements
|
|
27,033
|
|
|
|
86,442
|
|
|
|
80,883
|
|
|
|
78,287
|
|
|
|
123,363
|
|
Adjusted
net interest income
|
$
|
159,684
|
|
|
$
|
143,936
|
|
|
$
|
112,859
|
|
|
$
|
167,107
|
|
|
$
|
191,728
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) prior to income taxes and minority interest
|
$
|
36,311
|
|
|
$
|
16,541
|
|
|
$
|
105,762
|
|
|
$
|
126,561
|
|
|
$
|
(194,292
|
)
|
Adjusted
to exclude: Derivative forward value
|
|
98,743
|
|
|
|
79,281
|
|
|
|
(28,805
|
)
|
|
|
(25,849
|
)
|
|
|
228,840
|
|
Foreign
currency adjustments
|
|
-
|
|
|
|
14,554
|
|
|
|
22,594
|
|
|
|
22,893
|
|
|
|
65,310
|
|
Adjusted
income prior to income taxes and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
minority
interest
|
$
|
135,054
|
|
|
$
|
110,376
|
|
|
$
|
99,551
|
|
|
$
|
123,605
|
|
|
$
|
99,858
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss) prior to cumulative effect of change in accounting
principle
|
$
|
45,745
|
|
|
$
|
11,701
|
|
|
$
|
95,497
|
|
|
$
|
122,503
|
|
|
$
|
(200,098
|
)
|
Adjusted
to include: Minority interest net income
|
|
(6,099
|
)
|
|
|
2,444
|
|
|
|
7,089
|
|
|
|
2,540
|
|
|
|
1,989
|
|
Adjusted
to exclude: Derivative forward value
|
|
98,743
|
|
|
|
79,281
|
|
|
|
(28,805
|
)
|
|
|
(25,849
|
)
|
|
|
228,840
|
|
Foreign
currency adjustments
|
|
-
|
|
|
|
14,554
|
|
|
|
22,594
|
|
|
|
22,893
|
|
|
|
65,310
|
|
Adjusted
net income
|
$
|
138,389
|
|
|
$
|
107,980
|
|
|
$
|
96,375
|
|
|
$
|
122,087
|
|
|
$
|
96,041
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TIER
using GAAP financial measures is calculated as follows:
|
|
Interest
expense + net income prior to cumulative
|
|
|
TIER
=
|
effect
of change in accounting principle
|
|
|
|
Interest
expense
|
|
Adjusted
TIER is calculated as follows:
|
Adjusted
TIER =
|
Adjusted
interest expense + adjusted net income
|
|
|
|
Adjusted
interest expense
|
|
The
following chart provides the TIER and adjusted TIER for the years ended May 31,
2008, 2007, 2006, 2005 and 2004.
|
For
the year ended May 31,
|
|
|
2008
|
|
2007
|
|
2006
|
|
2005
|
|
2004
(1)
|
|
TIER (1)
|
|
1.05
|
|
|
|
1.01
|
|
|
|
1.10
|
|
|
|
1.13
|
|
|
|
-
|
|
|
Adjusted
TIER
|
|
1.15
|
|
|
|
1.12
|
|
|
|
1.11
|
|
|
|
1.14
|
|
|
|
1.12
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) For
the year ended May 31, 2004, the Company reported a net loss prior to the
cumulative effect of change in accounting principle of $200 million, thus the
TIER calculation results in a value below 1.00.
Adjustments
to the Calculation of Leverage and Debt to Equity
The
Company calculates the leverage ratio by adding total liabilities to total
guarantees and dividing by total equity. The Company calculates the
debt to equity ratio by dividing total liabilities by total
equity. The Company adjusts these ratios to (i) subtract debt used to
fund loans that are guaranteed by RUS from total debt, (ii) subtract from total
debt, and add to total equity, debt with equity characteristics issued to its
members and in the capital markets, (iii) include minority interest as equity
and (iv) to exclude the impact of non-cash SFAS 133 and foreign currency
adjustments from its total liabilities and total equity. For the
purpose of computing compliance with its revolving credit agreement covenants,
the Company is required to make these adjustments to its leverage ratio
calculation. The revolving credit agreements prohibit the Company
from incurring senior debt in an amount in excess of ten times the sum of
equity, members' subordinated certificates, minority interest and subordinated
deferrable debt, as defined by the agreements. The Company makes
these same adjustments to its debt to equity ratio as the only difference
between the leverage ratio and the debt to equity ratio is the addition of
guarantees to liabilities in the leverage ratio. In addition to the
adjustments the Company makes to calculate the adjusted leverage ratio,
guarantees to the Company member systems that have an investment grade rating
from Moody's Investors Service and Standard & Poor's Corporation are
excluded from the calculation of the leverage ratio under the terms of the
revolving credit agreements.
The
Company is an eligible lender under the RUS loan guarantee
program. Loans issued under this program carry the U.S. Government's
guarantee of all interest and principal payments. Thus, the Company
has little or no risk associated with the collection of principal and interest
payments on these loans. Therefore, the Company believes that there
is little or no risk related to the repayment of the liabilities used to fund
RUS guaranteed loans and subtracts such liabilities from total liabilities for
the purpose of calculating its leverage and debt to equity
ratios. For the purpose of computing compliance with its revolving
credit agreement covenants, the Company is required to adjust its leverage ratio
by subtracting liabilities used to fund RUS guaranteed loans from total
liabilities. The leverage and debt to equity ratios adjusted to
subtract debt used to fund RUS guaranteed loans from total liabilities reflect
management's perspective on its operations and thus, the Company believes that
these are useful financial measures for investors.
The
Company requires that its members purchase subordinated certificates as a
condition of membership and as a condition to obtaining a loan or
guarantee. The subordinated certificates are accounted for as debt
under GAAP. The subordinated certificates have long-dated maturities
and pay no interest or pay interest that is below market and under certain
conditions the Company is prohibited from making interest payments to members on
the subordinated certificates. For the purpose of computing
compliance with its revolving credit agreement covenants, the Company is
required to adjust its leverage ratio by subtracting members' subordinated
certificates from total liabilities and adding members' subordinated
certificates to total equity. The leverage and debt to equity ratios
adjusted to treat members' subordinated certificates as equity rather than debt
reflect management's perspective on its operations and thus, the Company
believes that these are useful financial measures for investors.
The
Company also sells subordinated deferrable debt in the capital markets with
maturities of up to 39 years and the option to defer interest
payments. The characteristics of subordination, deferrable interest
and long-dated maturity are all equity characteristics. For the
purpose of computing compliance with its revolving credit agreement covenants,
the Company is required to adjust its leverage ratio by subtracting subordinated
deferrable debt from total liabilities and adding it to total
equity. The leverage and debt to equity ratios adjusted to treat
subordinated deferrable debt as equity rather than debt reflect management's
perspective on its operations and thus, the Company believes that these are
useful financial measures for investors.
As a
result of implementing SFAS 133, the Company's consolidated balance sheets
include the fair value of its derivative instruments. As noted above,
the amounts recorded are estimates of the future gains and losses that the
Company may incur related to its derivatives. The amounts do not
represent current cash flows and are not available to fund current
operations. For the purpose of computing compliance with its
revolving credit agreement covenants, the Company is required to adjust its
leverage ratio by excluding the impact of implementing SFAS 133 from liabilities
and equity. The leverage and debt to equity ratios adjusted to
exclude the impact of SFAS 133 from liabilities and equity reflect management's
perspective on its operations and thus, the Company believes that these are
useful financial measures for investors.
As a
result of issuing foreign denominated debt and the implementation of SFAS 133
which discontinued the practice of recording the foreign denominated debt and
the related currency exchange agreement as one transaction, the Company must
adjust the value of such debt reported on the consolidated balance sheets for
changes in foreign currency exchange rates since the date of issuance in
accordance with SFAS 52. At the time of issuance of all foreign
denominated debt, the Company enters into a foreign currency exchange agreement
to fix the exchange rate on all principal and interest payments through
maturity. The adjustments to the value of the debt on the
consolidated balance sheets are reported on the consolidated statements of
operations as foreign currency adjustments. The adjusted debt value
at the reporting date does not represent the amount that the Company will
ultimately pay to retire the debt unless the current exchange rate is equal to
the exchange rate in
the
related foreign currency exchange agreement or the counterparty fails to honor
its obligations under the agreement. For the purpose of computing
compliance with its revolving credit agreement covenants, the Company is
required to adjust its leverage ratio by excluding the impact of foreign
currency valuation adjustments from liabilities and equity. The leverage and
debt to equity ratios adjusted to exclude the impact of SFAS 52 reflect
management's perspective on its operations and thus, the Company believes that
these are useful financial measures for investors.
FIN
46(R), Consolidation of Variable Interest Entities, an interpretation of
Accounting Research Bulletin No. 51, requires the Company to consolidate
the results of operations and financial condition of RTFC and NCSC even
though the Company has no financial interest or voting control over either
company. In consolidation, the amount of the subsidiary equity that is
owned or due to investors other than the parent company is shown as
minority interest. Prior to consolidation, the RTFC members'
equity was combined with the Company's equity and therefore included in
total equity. For the purpose of computing compliance with its
revolving credit agreement covenants, the Company is required to adjust
total equity to include minority interest. The leverage and
debt to equity ratio adjusted to treat minority interest as equity reflect
management's perspective on its operations and thus, the Company believes
that these are useful financial measures for
investors.
|
The
following chart provides a reconciliation between the liabilities and equity
used to calculate the leverage and debt to equity ratios and these financial
measures reflecting the adjustments noted above, as of the five years ended May
31, 2008.
|
|
May
31,
|
|
(in
thousands)
|
|
2008
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
Liabilities
|
|
$
|
18,699,169
|
|
|
$
|
17,843,151
|
|
|
$
|
18,373,319
|
|
|
$
|
19,276,728
|
|
|
$
|
20,741,825
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
liabilities
|
|
|
(171,390
|
)
|
|
|
(71,934
|
)
|
|
|
(85,198
|
)
|
|
|
(78,471
|
)
|
|
|
(129,915
|
)
|
|
Foreign
currency valuation account
|
|
|
-
|
|
|
|
-
|
|
|
|
(244,955
|
)
|
|
|
(260,978
|
)
|
|
|
(233,990
|
)
|
|
Debt
used to fund loans guaranteed by RUS
|
|
|
(250,169
|
)
|
|
|
(255,903
|
)
|
|
|
(261,330
|
)
|
|
|
(258,493
|
)
|
|
|
(263,392
|
)
|
|
Subordinated
deferrable debt (2)
|
|
|
(311,440
|
)
|
|
|
(486,440
|
)
|
|
|
(636,440
|
)
|
|
|
(685,000
|
)
|
|
|
(550,000
|
)
|
|
Subordinated
certificates
|
|
|
(1,406,779
|
)
|
|
|
(1,381,447
|
)
|
|
|
(1,427,960
|
)
|
|
|
(1,490,750
|
)
|
|
|
(1,665,158
|
)
|
|
Adjusted
liabilities
|
|
$
|
16,559,391
|
|
|
$
|
15,647,427
|
|
|
$
|
15,717,436
|
|
|
$
|
16,503,036
|
|
|
$
|
17,899,370
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
equity
|
|
$
|
665,965
|
|
|
$
|
710,041
|
|
|
$
|
784,408
|
|
|
$
|
764,934
|
|
|
$
|
692,453
|
|
|
Less:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prior
year cumulative derivative forward value and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
foreign
currency adjustments
|
|
|
(131,551
|
)
|
|
|
(225,849
|
)
|
|
|
(225,730
|
)
|
|
|
(221,868
|
)
|
|
|
(520,083
|
)
|
|
Current
period derivative forward value (1)
|
|
|
87,495
|
|
|
|
79,744
|
|
|
|
(22,713
|
)
|
|
|
(26,755
|
)
|
|
|
232,905
|
|
|
Current
period foreign currency adjustments
|
|
|
-
|
|
|
|
14,554
|
|
|
|
22,594
|
|
|
|
22,893
|
|
|
|
65,310
|
|
|
Accumulated
other comprehensive (income) loss
|
|
|
(8,827
|
)
|
|
|
(12,204
|
)
|
|
|
(13,208
|
)
|
|
|
(15,621
|
)
|
|
|
12,541
|
|
|
Subtotal
members' equity
|
|
|
613,082
|
|
|
|
566,286
|
|
|
|
545,351
|
|
|
|
523,583
|
|
|
|
483,126
|
|
|
Plus:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subordinated
certificates
|
|
|
1,406,779
|
|
|
|
1,381,447
|
|
|
|
1,427,960
|
|
|
|
1,490,750
|
|
|
|
1,665,158
|
|
|
Subordinated
deferrable debt (2)
|
|
|
311,440
|
|
|
|
486,440
|
|
|
|
636,440
|
|
|
|
685,000
|
|
|
|
550,000
|
|
|
Minority
interest
|
|
|
14,247
|
|
|
|
21,989
|
|
|
|
21,894
|
|
|
|
18,652
|
|
|
|
21,165
|
|
|
Adjusted
equity
|
|
$
|
2,345,548
|
|
|
$
|
2,456,162
|
|
|
$
|
2,631,645
|
|
|
$
|
2,717,985
|
|
|
$
|
2,719,449
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Guarantees
|
|
$
|
1,037,140
|
|
|
$
|
1,074,374
|
|
|
$
|
1,078,980
|
|
|
$
|
1,157,752
|
|
|
$
|
1,331,299
|
|
|
(1)
Represents the derivative forward value loss (gain) recorded by National Rural
for the period.
(2) At
May 31, 2007 and 2006, includes $175 million and $150 million, respectively, of
subordinated deferrable debt classified in short-term debt.
The
leverage and debt to equity ratios using GAAP financial measures are
calculated as follows:
|
|
Leverage
ratio =
|
Liabilities
+ guarantees outstanding
|
|
|
|
Total
equity
|
|
|
|
|
|
|
Debt
to equity ratio =
|
Liabilities
|
|
|
|
Total
equity
|
|
The
adjusted leverage and debt to equity ratios are calculated as
follows:
|
|
Adjusted
leverage ratio =
|
Adjusted
liabilities + guarantees outstanding
|
|
|
|
|
Adjusted
equity
|
|
|
|
Adjusted
debt to equity ratio =
|
Adjusted
liabilities
|
|
|
|
|
Adjusted
equity
|
|
|
The
following chart provides the calculated ratio for leverage and debt to equity,
as well as the adjusted ratio calculations, as of the five years ended May 31,
2008. The adjusted leverage ratio and the adjusted debt to equity
ratio are the same calculation except for the addition of guarantees to adjusted
liabilities in the adjusted leverage ratio.
|
|
|
May
31,
|
|
|
|
|
2008
|
|
|
2007
|
|
|
|
2006
|
|
|
|
2005
|
|
|
|
2004
|
|
|
|
Leverage
ratio
|
|
|
29.64
|
|
|
|
26.64
|
|
|
|
|
24.80
|
|
|
|
|
26.71
|
|
|
|
|
31.88
|
|
|
|
|
Adjusted
leverage ratio
|
|
|
7.50
|
|
|
|
6.81
|
|
|
|
|
6.38
|
|
|
|
|
6.50
|
|
|
|
|
7.07
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt
to equity ratio
|
|
|
28.08
|
|
|
|
25.13
|
|
|
|
|
23.42
|
|
|
|
|
25.20
|
|
|
|
|
29.95
|
|
|
|
|
Adjusted
debt to equity ratio
|
|
|
7.06
|
|
|
|
6.37
|
|
|
|
|
5.97
|
|
|
|
|
6.07
|
|
|
|
|
6.58
|
|
|
|
|
Item
7A.
|
Quantitative
and Qualitative Disclosures About Market
Risk.
|
See
Market Risk discussion beginning on page 46.
Item
8.
|
Financial
Statements and Supplementary Data.
|
The
consolidated financial statements, auditors' reports and quarterly financial
results are included on pages 80 through 120 (see Note 18 to consolidated
financial statements for a summary of the quarterly results of the Company’s
operations).
Item
9.
|
Changes
in and Disagreements with Accountants on Accounting and Financial
Disclosure.
|
None.
Item
9A(T).
|
Controls
and Procedures.
|
Evaluation
of Disclosure Controls and Procedures
Senior
management, including the Chief Executive Officer and Chief Financial Officer,
evaluated the effectiveness of the Company's disclosure controls and procedures
as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of
1934 ("the Exchange Act"). At the end of the period covered by this
report, based on this evaluation process, the Chief Executive Officer and Chief
Financial Officer have concluded that the Company's disclosure controls and
procedures are effective.
Management's
Report on Internal Control Over Financial Reporting
The
management of National Rural Utilities Cooperative Finance Corporation ("the
Company") is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and
15d-15(f) under the Securities Exchange Act of 1934. The Company's internal
control system over financial reporting is designed under the supervision of
management, including the Chief Executive Officer and Chief Financial Officer,
to provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. The Company's internal control
over financial reporting includes those policies and procedures
that:
(i)
|
pertain
to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the
assets;
|
(ii)
|
provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with U.S. generally
accepted accounting principles, and that receipts and expenditures of the
Company are being made only in accordance with authorizations of
management and directors of the Company;
and
|
(iii)
|
provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or dispositions of the assets of the
Company.
|
Any
system of internal control, no matter how well designed, has inherent
limitations, including but not limited to the possibility that a control can be
circumvented or overridden and misstatements due to error or fraud may occur and
not be detected. Also, because of changes in conditions, internal control
effectiveness may vary over time. Therefore, even those systems determined to be
effective can provide only reasonable assurance with respect to financial
statement preparation and presentation.
A
material weakness (as defined in PCAOB Auditing Standard No. 5) is a
deficiency or combination of deficiencies, in internal control over financial
reporting, such that there is a reasonable possibility that a material
misstatement in financial statements will not be prevented or detected on a
timely basis.
The
Company's management assessed the effectiveness of its internal controls over
financial reporting as of May 31, 2008. In making this assessment, management
used the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission ("COSO") in Internal Control-Integrated
Framework.
Based on
management's assessment and those criteria, management believes that the Company
maintained effective internal control over financial reporting as of May 31,
2008.
This
annual report on Form 10-K does not include an attestation report of the
Company’s registered public accounting firm regarding internal control over
financial reporting. Management’s report was not subject to attestation by the
Company’s registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the Company to furnish only
management’s report with this annual report on Form 10-K.
Changes in Internal Controls over
Financial Reporting
There
were no changes in the Company's internal control over financial reporting that
occurred during our last fiscal quarter that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
By:
|
|
/s/
SHELDON C. PETERSEN
|
By:
|
|
/s/
STEVEN L. LILLY
|
|
|
Sheldon
C. Petersen
|
|
|
Steven
L. Lilly
|
|
|
Governor
and Chief Executive Officer
|
|
|
Senior
Vice President and Chief Financial Officer
|
|
|
August
29, 2008
|
|
|
August
29, 2008
|
|
|
|
|
|
|
|
|
|
|
|
|
By:
|
|
/s/
ROBERT E. GEIER
|
|
|
|
|
|
Robert
E. Geier
|
|
|
|
|
|
Vice
President and Controller
|
|
|
|
|
|
August
29, 2008
|
|
|
|
Item
9B. Other
Information.
None.
PART
III
Item
10. Directors,
Executive Officers and Corporate Governance.
(a)
Directors
|
|
|
|
|
|
|
|
Director
|
|
Date
present
|
|
|
|
Age
|
|
|
since
|
|
term
expires
|
Roger
Arthur (President of National Rural)
|
|
61
|
|
|
|
2003
|
|
2009
|
Darryl
Schriver (Vice President of National Rural)
|
|
43
|
|
|
|
2004
|
|
2010
|
Reuben
McBride (Secretary – Treasurer of National Rural)
|
|
61
|
|
|
|
2005
|
|
2011
|
Fred
Anderson
|
|
56
|
|
|
|
2008
|
|
2011
|
Roger
A. Ball
|
|
63
|
|
|
|
2003
|
|
2009
|
Raphael
A. Brumbeloe
|
|
67
|
|
|
|
2007
|
|
2010
|
Delbert
Cranford
|
|
64
|
|
|
|
2007
|
|
2010
|
Jim
L. Doerstler
|
|
60
|
|
|
|
2008
|
|
2011
|
Jimmy
Ewing, Jr.
|
|
60
|
|
|
|
2007
|
|
2010
|
Harold
Foley
|
|
74
|
|
|
|
2004
|
|
2010
|
Steven
J. Haaven
|
|
57
|
|
|
|
2003
|
|
2009
|
Jim
Herron
|
|
51
|
|
|
|
2005
|
|
2011
|
Martin
Hillert, Jr.
|
|
53
|
|
|
|
2004
|
|
2010
|
William
A. Kopacz
|
|
61
|
|
|
|
2006
|
|
2009
|
Burns
E. Mercer
|
|
57
|
|
|
|
2008
|
|
2011
|
Gale
Rettkowski
|
|
62
|
|
|
|
2001
|
|
2009
|
Dwight
Rossow
|
|
46
|
|
|
|
2008
|
|
2011
|
Ronald
P. Salyer
|
|
43
|
|
|
|
2003
|
|
2009
|
R.
Wayne Stratton
|
|
60
|
|
|
|
2007
|
|
2010
|
J.
David Wasson, Jr.
|
|
62
|
|
|
|
2006
|
|
2009
|
Charles
Wayne Whitaker
|
|
58
|
|
|
|
2003
|
|
2009
|
Jack
F. Wolfe, Jr.
|
|
64
|
|
|
|
2006
|
|
2009
|
F.
E. Wolski
|
|
57
|
|
|
|
2007
|
|
2010
|
(b)
Executive Officers
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Held
present
|
Title
|
|
|
Name
|
|
|
Age
|
|
office
since
|
President
and Director
|
|
Roger
Arthur
|
|
|
61
|
|
2008
|
Vice
President and Director
|
|
Darryl
Schriver
|
|
|
43
|
|
2008
|
Secretary
– Treasurer and Director
|
|
Reuben
McBride
|
|
|
61
|
|
2008
|
Governor
and Chief Executive Officer
|
|
Sheldon
C. Petersen
|
|
|
55
|
|
1995
|
Senior
Vice President of Member Services and General Counsel
|
|
John
J. List
|
|
|
61
|
|
1997
|
Senior
Vice President and Chief Financial Officer
|
|
Steven
L. Lilly
|
|
|
58
|
|
1994
|
Senior
Vice President of Operations
|
|
John
T. Evans
|
|
|
58
|
|
1997
|
Senior
Vice President of Corporate Relations
|
|
Richard
E. Larochelle
|
|
|
55
|
|
1998
|
Senior
Vice President of RTFC
|
|
Lawrence
Zawalick
|
|
|
50
|
|
2000
|
Senior
Vice President of Credit Risk Management
|
|
John
M. Borak
|
|
|
63
|
|
2002
|
The
President, Vice President and Secretary-Treasurer are elected annually by the
board of directors at its first organizational meeting immediately following
National Rural’s annual membership meeting, each to serve a term of one year;
the Governor and Chief Executive Officer serves at the pleasure of the Board of
Directors; and the other Executive Officers serve at the pleasure of the
Governor and Chief Executive Officer.
(c)
Identification of Certain Significant Employees.
Inapplicable.
(d)
Family Relationships.
No family
relationship exists between any director or executive officer and any other
director or executive officer of the registrant.
(e) (1)
and (2) Business Experience and Directorships.
In
accordance with Article IV of National Rural’s Bylaws, each candidate for
election to the board of directors must be a trustee, director or manager of a
member of National Rural with the exception of the at-large position for the
audit committee financial expert who may also be a chief financial officer or
has a comparable position of a member of National Rural.
Mr.
Arthur has been a board member of Allamakee-Clayton Electric Cooperative in
Postville, IA since 1992 and has served as president since 1993. Mr.
Arthur is a director and former president of the Iowa Association of Electric
Cooperatives and chairs the Regulatory Affairs Committee. He is a board member
and secretary of the Cooperative Development Services of Iowa, Wisconsin and
Minnesota and a director of the Fayette County Economic Development
Commission. Since 1972, Mr. Arthur has been owner and operator
of Arthur’s Country Place Inc., a family farm corporation.
Mr.
Schriver has been General Manager and CEO of Taylor Electric Cooperative, Inc.
in Merkel, TX since 2002. Prior to 2002, he held staff positions at
the Texas House of Representatives, Texas Legislative Council and Texas
Senate. He serves as a director on the Golden Spread Electric
Cooperative Board, the Golden Spread Electric Generating Cooperative Board, the
Oklaunion Electric Generating Cooperative Board, the Yoakum Electric Generating
Cooperative Board, the Mid-Tex Cooperative Board and the Texas Agricultural
Cooperative Council. Mr. Schriver is a Group 4 member of the Governmental
Relations Committee of Texas Electric Cooperatives. Mr. Schriver
formerly served as director of Government Affairs of Brazos Electric Power
Cooperative from 1996 to 1998 and of Governmental Relations of Texas Electric
Cooperative from 1998 to 2002.
Mr.
McBride has been a director of Graham County Electric Cooperative in Pima, AZ
since 1991 and vice president since 1993. Mr. McBride is
owner/operator of Reuben McBride Farms in Pima, AZ since 1980. Mr.
McBride currently serves as president on the board of Arizona Electric Power
Co-op., Inc. and chairman of the Executive Committee. In addition,
Mr. McBride is a member of both the National and Arizona Action Committees for
Rural Electrification.
Mr.
Anderson has been the president and CEO of New Hampshire Electric Cooperative,
Inc. in Plymouth, NH since 1981. He is a founding board member of the NHEC
Foundation. Mr. Anderson is also a board member of the Cooperative Research
Council and a former board member of Northway Bank and former member of Northway
Bank’s audit committee. Mr. Anderson is the former director of
Finance and Administration/CFO, New Hampshire Electric Cooperative, Inc.;
systems accountant, Rural Electrification Administration; president, vice
president and treasurer, Northeast Association of Electric Cooperatives;
president, Northeast Public Power Association; and president, Consumer-Owned
Energy Foundation.
Mr. Ball
has been a board member of Powell Valley Electric Cooperative in New Tazewell,
TN since 1988 and has served as president since 1995. Mr. Ball serves
as vice chairman of the Claiborne County Industrial Development Board and is a
member of the Claiborne County Planning Commission. He served as
president of the Workforce Investment Board for Service Delivery Area 2 of
Tennessee. Since 1976, Mr. Ball has been owner/ broker of Ball Realty
& Auction, Inc., specializing in development and management of commercial
property.
Mr.
Brumbeloe has served as a board director of Upson Electric Membership
Corporation in Thomaston, GA since 1978 and has been board president since
1998. Mr. Brumbeloe has served as a board member of Georgia Electric
Membership Corporation since 1983 and served as chairman from 1988 to
1989. He is also a member representative of Oglethorpe Power
Corporation. He is currently the owner of the Red Rock
Armory. Mr. Brumbeloe is retired from the Georgia State
Patrol.
Mr.
Cranford has served as a board director of Randolph Electric Membership
Corporation in Asheboro, NC since 1989 and was president from 1995 to 2002 and
vice president from 1994 to 1995. He is a director and former
president of the North Carolina Association of Electric Cooperatives, Inc. and
also served on the North Carolina Electrical Cooperative Board. Mr.
Cranford also serves as a director of First Bank Corp, a member of the North
Carolina Pharmaceutical Association and a board member and former president of
the Farmer Volunteer Fire Department. Mr. Cranford is currently a
retail pharmacist and an owner of retail pharmacies.
Mr.
Doerstler has served as a board director and assistant secretary-treasurer
of Whitewater Valley REMC in Liberty, IN since 1994. He is
secretary-treasurer of Indiana Statewide Association of Rural Electric
Cooperatives and vice president of Indiana ACRE. Mr. Doerstler has served
as vice president of Farm Credit Banks of Louisville, vice president of Credit
for Wabash Valley Production Credit Association and branch manager of
Greencastle Production Credit Association. Mr. Doerstler owned Louie’s Boot
Barn from 1987 until it was sold in June 2008.
Mr. Ewing
has served as a board director of Pointe Coupee Electric Membership Corporation
in New Roads, LA since 1989 and has been board president since
1995. He served as secretary/treasurer from 1990 to
1995. Mr. Ewing also serves as a board member of the Association of
Louisiana Electric Cooperatives, Inc. and has been secretary/treasurer since
2006. He is a member of the Action Committee for Rural
Electrification, a board member of the Louisiana Landowners Association and a
former board member of Cajun Electric Power Cooperative. Mr. Ewing is
currently a restaurant owner and farm manager.
Mr. Foley
has served as a director of Brown-Atchison Electric Cooperative Association,
Inc. in Horton, KS since 1984. He has been board president of
Brown-Atchison Electric Cooperative Association since 1991 and held the position
of board vice president in 1990. He is a former alternate trustee
representative to Kansas Electric Power Cooperative, Inc. (KEPCo) and former
vice president of the KEPCo Services, Inc., Board of Directors. He
was a real estate broker with Jepson & Associates in Valley Falls, KS from
1991 until his retirement in June 2003.
Mr.
Haaven has been president and Chief Executive Officer ("CEO") of Wild Rice
Electric Cooperative Inc. in Mahnomen, MN since 1987 and serves on the Minnkota
Power Cooperative Manager Advisory Committee. He is also a member of
the Karian/Peterson Powerline Contracting Board and president of Carr's Tree
Service Board. He previously served as CEO, under a shared management
agreement, of Wild Rice Electric Cooperative/Red River Valley Cooperative in
Halstad, MN. Mr. Haaven is a former member of the Rural Electric
Political Action Committee Board at Minnesota Rural Electric
Association.
Mr.
Herron has served as General Manager of Mountain View Electric Association, Inc.
in Limon, CO since 1996. Prior to that position, Mr. Herron was
General Manager at Farmers' Electric Cooperative in Clovis, NM from 1993 to
1996. Mr. Herron currently serves on the Colorado Electric Education
Institute. Previously, he served as chair of the Colorado Rural
Electric Managers Association and as board member of the New Mexico Rural
Electric Association.
Mr.
Hillert has been CEO and General Manager of Adams-Columbia Electric Cooperative
in Friendship, WI since 1996. In addition, he serves on the board of
Badger Energy Services in Oconto Falls, WI, board vice president of Network 2010
in Oxford, WI and as a board member of Badger Unified Cooperative Services in
Fall Creek, WI since 2001. Mr. Hillert also serves as treasurer of
Wisconsin Cooperative Managers Association and is a board member of the Electric
Coalition of Wisconsin. Mr. Hillert serves as chairman of Adams
County Economic Development and is a member of the Advisory Board of Directors
for the University of Wisconsin Center for Cooperatives.
Mr.
Kopacz has been the General Manager of Midstate Electric Cooperative, Inc. in La
Pine, OR since 1990. He is currently a board director of Northwest
Requirement Utilities, Northwest Irrigation Utilities, Mid Oregon Credit Union
and Economic Development for Central Oregon. He is also a former
board president of Economic Development for Central Oregon. He is a
former director of Ruralite Services, a northwest electric cooperative
publication, and former president of the Oregon Rural Electric Cooperative
Association.
Mr.
Mercer has served as president and CEO of Meade County R.E.C.C. in Brandenburg,
KY since 1976. He serves as a board member for Kentucky Association
of Electric Cooperatives, United Utility Supply Cooperative and Farmers
Bank. Mr. Mercer is a former NCSC board member and was a member of
the Kentucky Society of Public Accountants.
Mr.
Rettkowski has served as a board director of Inland Power and Light Company in
Spokane, WA since March 2000 and was president of the board through March
2003. He has served as board secretary-treasurer for Northwest
Irrigation Utilities since August 1992. Mr. Rettkowski has been the
president of Citizens for Irrigation for the state of Washington since September
1991. He is a former trustee of Lincoln Electric and Graingrowers
Warehouse Co-op. Mr. Rettkowski has also been president of Rettkowski
Brothers, Inc., a farming corporation in Wilbur, WA, since 1998.
Mr.
Rossow has served as a board director of Cam Wal Electric Cooperative in
Herreid, SD since 1996. Mr. Rossow is also a board member of
South Dakota Rural Electric Association. Mr. Rossow has been self-employed
as a rancher in Herreid, SD since 1980.
Mr.
Salyer has served as the president and CEO of Pioneer Rural Electric Cooperative
in Piqua, OH since 2001 and served as executive vice president from 1999 to
2000. In addition, he is a member of the Ohio Rural Electric
Cooperatives (OREC) Facilities Attachment Committee, chairman of the OREC
Communications Systems Task Force, a member of the OREC Safety Committee and a
trustee of Buckeye Power, Inc. where he serves on the Policy
Committee. In addition, he is also a director of Rural Electric
Supply Cooperative of Ohio.
Mr.
Stratton has been a board director of East Kentucky Power Cooperative in
Winchester, KY since 1990 and currently serves as Chairman of the Board. He has
served as a director of Shelby Energy Cooperative since 1987, ACES Power
Marketing since 2004, Shelbyville Municipal Water & Sewer Commission since
2000 and Republic Bancorp since 1995. Mr. Stratton is an at- large
director that serves as the Audit Committee Financial Expert as defined by the
Securities and Exchange Commission. He is a certified public
accountant in Kentucky, accredited in Business Valuation by the AICPA, a
Certified Forensic Accountant, Certified Fraud Examiner and a Credentialed
Cooperative Director through National Rural Electric Cooperative Association
(“NRECA”). Mr. Stratton has been a member/owner of Jones, Nale &
Mattingly PLC, a full-service accounting and auditing practice since
1970. He currently serves as the Audit Committee Chairman and Audit
Committee Financial Expert of Republic Bancorp, a $2.8 billion bank traded on
NASDAQ. He is the former Audit Committee Chairman of East Kentucky
Power Cooperative, former team captain for AICPA peer reviews of other
accounting firms and former board member of Kentucky Higher Education Assistance
Authority (1985 to 2001) where as Chairman for eight years, he participated
in
various
finance transactions. He served on the AICPA Uniform Accountancy Act
Committee and is the past president of the Kentucky Society of
CPAs.
Mr.
Wasson has been the president and CEO of Laurens Electric Cooperative, Inc. in
Laurens, SC since 1973. He has served on the board of directors of
New Horizon Electric Cooperative since 1997 and has served as chairman since
2005. Mr. Wasson has been a board member of the South Carolina
Electric Cooperative Association since 1975 and served as chairman from December
1983 to December 1985. He also serves as a director of The Palmetto
Bank.
Mr.
Whitaker has served as the president and General Manager of Southwest Arkansas
Electric Cooperative in Texarkana, AR since 1986. In addition, Mr.
Whitaker has been director and former chairman of Arkansas Electric Cooperative
Corporation, Arkansas Electric Cooperative, Inc., and the Arkansas Rural
Electric Self-Insurance Trust since 1986. He is also a former
director of the National Information Solutions Cooperative.
Mr. Wolfe
has been the president and CEO of Mid-Carolina Electric Cooperative, Inc. in
Lexington, SC since 1975. He has also represented South Carolina's
electric cooperatives on the NRECA Board of Directors since 1999, serving as
secretary treasurer in 2005, vice president from 2005 to 2006 and currently
serving as president. Mr. Wolfe serves as a director of The Electric
Cooperatives of South Carolina, Inc. and the Central Electric Power Cooperative
and has chaired a variety of statewide committees.
Mr.
Wolski has served as a board director of Wyrulec Company in Lingle, WY since
1986. Mr. Wolski has represented Wyoming's cooperative electric
utilities on the NRECA Board of Directors since 1999 and was recently elected as
NRECA vice president. Prior to his election to vice president, Mr.
Wolski served as secretary-treasurer of the NRECA board. He has
served as a director of Tri-State Generation & Transmission since
2001. He served on the board of the Wyoming Rural Electric
Association for nine years, including three years as president. Mr.
Wolski is also a former board member of the Wyoming Rural Telecommunication
Cooperative. Mr. Wolski is the owner/manager of a family farm with a
commercial hunting operation and is the owner/agent of an insurance
business.
Mr.
Petersen joined National Rural in August 1983 as an area
representative. He became the director of Policy Development and
Internal Audit in January 1990, director of Credit Analysis in November 1990 and
Corporate Secretary on June 1, 1992. He became Assistant to the
Governor on May 1, 1993. He became Assistant to the Governor and
Acting Administrative Officer on June 1, 1994. He became Governor and
CEO on March 1, 1995. Mr. Petersen began his career in the rural
electrification program in 1976 as staff assistant for Nishnabotna Rural
Electric Cooperative in Harlan, IA. He later served as General Manager of Rock
County Electric Cooperative Association in Janesville, WI.
Mr. List
joined National Rural as a staff attorney in February 1972. He served
as Corporate Counsel from June 1980 to 1991. He became Senior Vice
President and General Counsel on June 1, 1992, and became Senior Vice President,
Member Services and General Counsel on February 1, 1997.
Mr. Lilly
joined National Rural as a Senior Financial Consultant in October
1983. He became director of Special Finance in June 1985 and director
of Corporate Finance in June 1986. He became Treasurer and Principal
Finance Officer on June 1, 1993, and became Senior Vice President and Chief
Financial Officer on January 1, 1994.
Mr. Evans
joined National Rural as Senior Vice President of Operations in November
1997. He was Senior Vice President and Chief Operating Officer of
Suburban Hospital Healthcare System, Bethesda, MD from 1994 to
1997. He was Senior Vice President and Chief Operating Officer for
Geisinger Medical Center, Danville, PA from 1991 to 1994.
Mr.
Larochelle joined National Rural as director of Corporate Relations in May
1996. He became Senior Vice President of Corporate Relations in
August 1998. Prior to joining National Rural, he was the Legislative
director at NRECA where he worked for 12 years. He also worked at the
U.S. Department of Agriculture in the Rural Electrification Administration and
the Farmers Home Administration.
Mr.
Zawalick joined National Rural in 1980. Throughout his career with
National Rural, Mr. Zawalick has held various positions. In April
1995, he was appointed Vice President of Business Development for National Rural
and Administrative Coordinator of RTFC. In February 2000, Mr.
Zawalick was named National Rural’s Senior Vice President of RTFC.
Mr. Borak
joined National Rural in June 2002 as Senior Vice President, Credit Risk
Management. Previously, he was with Fleet National Bank, Boston, MA
from 1992 to 2001 where he was a Senior Credit Officer with risk management and
loan approval responsibility for several industry banking portfolios including
investor owned utilities. Prior assignments at Fleet in Hartford, CT
included Manager of Credit Review and Manager of Loan Workout in the Connecticut
bank.
(f)
Involvement in Certain Legal Proceedings.
None to
the knowledge of the Company.
(g)
Promoters and Control Persons.
Inapplicable.
(h) Code
of Ethics
The
Company has adopted a Code of Ethics within the meaning of Item 406(b) of
Regulation S-K. This Code of Ethics applies to our principal executive officer,
our principal financial officer and principal accounting officer. This Code of
Ethics is publicly available on our website at http://www.nrucfc.coop/aboutcfc/pdfs/ethicsPolicyCEO-SFO.pdf.
(i) Audit
Committee
Our Audit
Committee currently consists of thirteen directors: Mr. Stratton
(Chairperson), Mr. Anderson (Vice-Chairperson), Mr. Arthur, Mr. Wasson, Mr.
Ball, Mr. Salyer, Mr. Haaven, Mr. Herron, Mr. Whitaker, Mr. Rettkowski, Mr.
McBride, Mr. Schriver and Mr. Wolfe. Mr. Stratton was designated by
the Board as the “audit committee financial expert” as defined by Section 407 of
the Sarbanes-Oxley Act of 2002 ("SOX"). The members of the Audit Committee are
"independent" as that term is defined in Rule 10A-3 under the Securities
Exchange Act. Among other things, the Audit Committee reviews the
Company's financial statements and the disclosure under Management's Discussion
and Analysis in our Annual Report on Form 10-K. The Committee meets with
our independent registered public accounting firm, internal auditors, Chief
Executive Officer and financial management executives to review the scope and
results of audits and recommendations made by those persons with respect to
internal and external accounting controls and specific accounting and financial
reporting issues and to assess corporate risk. The Board has adopted a written
charter for the Audit Committee.
The Audit
Committee completed its review and discussions with management regarding the
Company’s audited financial statements for the year ended May 31, 2008. The
Audit Committee has discussed with the independent auditors the matters required
to be discussed by Statement on Auditing Standards No. 61, as amended, and
received from the independent accountants written disclosures and the letter
regarding their independence required by Independence Standards Board Standard
No. 1, and discussed with the independent accountants their
independence.
Based on
the review and discussions noted above, the Audit Committee recommended to the
Board that the audited financial statements be included in the Company’s Annual
Report on Form 10-K for the year ended May 31, 2008 for filing with the
Securities and Exchange Commission.
(j)
Compensation Committee
Role
of the Compensation Committee
The
Executive Committee of the Board of Directors has historically served as the
compensation committee, making recommendations on the compensation for the Chief
Executive Officer (“CEO”) and recommending the overall compensation and benefits
package for all executive officers and other employees to the full Board of
Directors. On May 25, 2007, the Board of Directors established a
Compensation Committee to review and make appropriate recommendations to the
full Board of Directors regarding National Rural’s total compensation philosophy
and pay components, including, but not limited to, base and incentive pay
programs. The Compensation Committee is also responsible for
approving the compensation, employment agreements and perquisites for the
CEO. The Compensation Committee annually reviews all approved
corporate goals and objectives relevant to compensation, evaluates performance
in light of those goals and approves the CEO’s compensation based on this
evaluation, all of which is then ratified by the full Board of
Directors. The Compensation Committee has delegated authority to the
CEO for evaluating the performance and approving the annual base compensation
for all of the other named executive officers as identified in the Summary
Compensation Table below. Other than the CEO, no other named
executive officer makes decisions regarding executive compensation.
The
Compensation Committee reports to the Board of Directors on its actions and
recommendations following committee meetings and meets in executive session
without members of management present when making specific compensation
decisions. Although the Board has delegated authority to the
Compensation Committee with respect to National Rural’s executive and general
employee compensation programs and practices, the full Board of Directors also
reviews and ratifies National Rural’s compensation and benefits programs each
year.
The
Compensation Committee’s charter can be found on National Rural’s website,
www.nrucfc.coop.
The
Compensation Committee’s Processes
The
Compensation Committee has established a process to assist it in ensuring that
National Rural’s executive compensation program is achieving its
objectives. Prior to the start of each fiscal year, the Board of
Directors approves performance measures for the corporate balanced scorecard,
which is the basis of the short-term incentive plan, and the specific goal and
metrics for the long-term incentive plan. After the end of the fiscal
year, the Compensation Committee meets with the CEO in executive session to
review his performance based on his individual achievements, contribution to
National Rural’s performance and other leadership
accomplishments. In determining Mr. Petersen’s base pay, the
Compensation Committee subjectively considers a variety of corporate performance
measures, including financial metrics, portfolio management, customer
satisfaction and market share, industry leadership, and peer group compensation
data provided by the compensation consultant, as discussed below.
Role
of Compensation Consultant
In fiscal
year 2008, the Compensation Committee hired Mercer Human Resource Consulting
(“Mercer”) to advise it on the CEO’s compensation as compared to the
compensation of CEOs of peer group organizations. Through individual
interviews with each member of the Compensation Committee, Mercer established a
peer group of companies to use in assessing the competitiveness of the CEO’s
compensation (see “Compensation Analysis” in the Compensation Discussion and
Analysis section below). Mercer advised the Compensation Committee
through an assessment of compensation data from this peer group using both a
one-year compensation analysis – which assesses National Rural’s CEO
compensation and the compensation of peer CEOs for the most recent fiscal year,
and a three-year compensation analysis – which assesses average peer CEO pay for
the last three fiscal years. Compensation analyses include peer group
CEO base pay, annual incentives, total cash compensation, long-term incentives
and total direct compensation. Mercer did not determine or provide
the Compensation Committee with a specific recommendation on any component of
executive compensation.
Role
of Executive Officers
As
described above, the Compensation Committee has delegated the authority for
making annual base pay decisions for the other named executive officers to the
CEO. The CEO exercises his judgment to set annual base pay rates,
based on general market data, overall corporate performance and leadership
accomplishments. For additional information about the CEO’s role in
compensation decisions, see “Base Pay” under the Compensation Discussion and
Analysis section below.
Item
11. Executive
Compensation.
Compensation
Discussion and Analysis
Executive
Compensation Philosophy and Objectives
The
components of National Rural’s compensation package for the named executive
officers (consisting of Messrs. Petersen, Lilly, List, Evans and Larochelle) are
consistent with those offered to all employees and consist of base pay,
short-term (one-year) incentive, tied to the achievement of annual corporate
goals, and long-term (three-year) incentive, tied to the achievement of
strategic objectives, plus retirement and other benefits. We believe
that all four elements of compensation work together to provide a competitive
compensation package that drives performance and supports executive
retention.
Performance –Named
executive officers receive base pay that is both market competitive and
reflective of the strategic management they provide to National
Rural. Other components of compensation – short-term and long-term
incentive bonuses – reflect the performance of the organization and the success
in achieving performance metrics established by the Board of
Directors.
Retention – The
relationship between National Rural and its members makes the retention of
employees, including the named executive officers, vital to our business and
long-term success. The compensation package, particularly the
long-term incentive plan and the retirement benefits, assist in the retention of
a highly qualified management team.
Compensation
Analysis
In fiscal
year 2008, Mercer was engaged by the Compensation Committee to conduct a
compensation survey to provide compensation data for the Chief Executive Officer
(“CEO”) position using peer organizations identified by Mercer through
interviews with each member of the Compensation Committee. Mercer
included companies in the compensation comparison group that were similar to
National Rural in asset size, industry and business description. The
group included financial institutions that are premier private market,
commercial and/or mission-driven lenders, offering full service financing,
investment and related services. The companies targeted as peer
companies had assets ranging from $12.9 billion to $29.5 billion with a median
of $22.9 billion, as compared to National Rural’s December 2006 total assets of
$18.6 billion. The comparator group consisted of financial services
organizations New York Community Bancorp, Inc., Student Loan Corp., Astoria
Financial Corp, Nelnet, Inc., Indymac Bancorp, Webster Financial Corp., and
Flagstar Bancorp, as well as three Farm Credit System peers.
Mercer
led the Compensation Committee through an assessment of compensation data using
both a one-year and a three-year compensation analysis. Peer CEO
compensation data analyzed included base pay, annual incentives, total cash
compensation (the sum of base salary and annual incentives for the last fiscal
year), long-term incentives (including stock awards valued at market value on
the date of grant and stock options valued at grant date utilizing the
Black-Scholes option pricing model) and cash awards valued at actual payout on
date of award (if target value is not disclosed), as well as sign-on awards and
total direct compensation (the sum of total cash compensation and the long-term
incentive award
paid in the most recent fiscal year for the one-year
analysis, or the sum of total cash compensation and the three-year average of
long-term incentives for the three-year analysis), each as reported in the
annual report or proxy statement for the most recent fiscal year and
Compensation Committee reviewed total compensation data for the peer group for
informational purposes and used this data solely to determine the
competitiveness of National Rural’s CEO base pay.
In
determining the base compensation paid to our other named executive officers,
the CEO reviewed national, credible compensation surveys for financial services
organizations of similar asset size to obtain a general understanding of current
compensation practices and to ensure that the base pay component of compensation
for the other named executive officers is competitive, meaning generally within
the 50th
percentile of comparative pay for similar positions. The CEO did not
review or consider the underlying organizations comprising the survey
information, but instead considered only the aggregate compensation
data.
Elements
of Compensation
National
Rural’s executive compensation program provides a balanced mix of compensation
that incorporates the following key components:
o
|
An
annual incentive cash bonus which is based on the achievement of
short-term (one-year) corporate
goals
|
o
|
A
three year incentive cash bonus which is based on the achievement of
longer-term corporate goals
|
o
|
Retirement,
health and welfare and other benefit programs provided generally to all
National Rural employees
|
While all
elements of executive compensation work together to provide a competitive
compensation package, each element of compensation is determined independently
of the other elements.
National
Rural’s compensation philosophy is to target total compensation for employees –
base pay, short-term incentive, long-term incentive and benefits – at the
75th
percentile of market for the general employee population. However,
due to the cooperative nature of the organization, National Rural cannot match
the compensation levels of named executive officers of other financial services
organizations at the 75th
percentile since we do not offer stock or other equity
compensation. It is important to National Rural, however, to pay the
named executive officers of National Rural competitively in base pay to retain
key talent.
Base Pay – National
Rural’s philosophy is to provide annual base pay that reflects the value of the
job in the marketplace, targeted at the 50th
percentile. To attract and retain a highly-skilled work force,
National Rural must remain competitive with the pay of other employers that
compete with us for talent. Because National Rural cannot match
the compensation levels of named executive officers of other financial services
organizations at the 75th
percentile, as described above, the Compensation Committee targeted the base pay
for Mr. Petersen, CEO, at the 55th
percentile of base pay for the peer group CEOs. In reaching the
decision to target the CEO’s base pay at the 55th
percentile of peer base pay, the Compensation Committee acknowledged the strong
performance of the CEO and the Company.
As
discussed under “Role of the Compensation Committee” above, the CEO exercised
his judgment to set the annual base pay for the other named executive officers
based on general market data, overall performance and leadership
accomplishments. In fiscal year 2008, because all named executive
officers were performing well in their individual roles, Mr. Petersen focused on
the comparable market pay for similar positions, at the 50th percentile of
market base pay, and because base pay of the named executive officers was within
the 50th
percentile of the market, raised base pay for each named executive officer by
4%, reflecting the general merit increase for executives in the Washington, DC
metropolitan area.
Short-Term Incentive
– National Rural’s short-term cash incentive program is a one-year bonus that is
tied to the annual performance of the organization as a
whole. National Rural believes that by paying a short-term incentive
tied to the achievement of annual operating goals, all employees, including
named executive officers, will focus their efforts on the most important
strategic objectives which help National Rural to fulfill its mission to its
members and the financial markets. Additionally, the short-term
incentive pay enhances National Rural’s ability to provide competitive
compensation while at the same time tying actual incentive compensation paid to
the achievement of corporate goals. All employees are eligible to
participate in the short-term incentive program.
The
short-term incentive program provides annual cash bonus opportunities based upon
the level of the position within National Rural’s base pay structure, ranging
from 15% - 25% of base pay. Named executive officers participate in
the
corporate
short-term incentive program and are eligible to receive short-term bonus
compensation up to 25% of their base pay. While 25% of base pay is
below market for incentive pay for the Company’s named executive officers, it is
reflective of the cooperative nature of National Rural.
Corporate
performance is measured using a balanced scorecard approved by the Board of
Directors prior to the start of the fiscal year. The balanced
scorecard is a performance management tool that articulates the corporate
strategy of National Rural into specific, quantifiable, measurable
goals. By focusing goals in four quadrants, the scorecard ensures
that proper attention is paid to all crucial areas of business
performance. The scorecard provides balanced management indicators of
business success and a focus for all employees as to the target results and
measures that must be achieved if National Rural is to succeed at realizing its
strategic plan. The intent is to align organizational, departmental
and individual initiatives to achieve a common goal.
The four
quadrants for fiscal year 2008, which were the basis for the short-term
incentive payment, were Customer Engagement, Financial Ratios, Internal Process
and Operations, and Learning, Growth and Innovation. The Board of
Directors establishes corporate goals and measures that they believe are
achievable only if each individual performs well in his or her role and the
Company meets its internal business plan goals. Since its inception
in 1999, the actual payout percentage has ranged from 61% to 94% of total
opportunity, with an average over the ten years of 84%. For fiscal
year 2008, it is expected that four out of seven goals will be achieved,
equating to 61% of the total opportunity. Goals successfully achieved
were within the Customer Engagement, Financial Ratios, and Learning, Growth and
Innovation quadrants of the balanced scorecard. Payments under the short-term
incentive plan are subject to approval by the Board of Directors at a date
subsequent to the filing of this Form 10-K.
Long-Term Incentive –
the long-term incentive program is a three-year plan that is tied to National
Rural’s long-term strategic objectives. The long-term incentive
program was implemented to create dynamic tension between short-term objectives
and long-term goals. It is also an effective retention tool, helping
the Company keep key employees, and supports National Rural’s efforts to pay at
market competitive levels. All employees employed on the first day of
the fiscal year, June 1, are eligible to participate in the plan cycle and will
receive performance units that are calculated at 15% - 25% of base
pay. Similar to the short-term incentive program, while 25% of base
pay is below market for incentive pay for the Company’s named executive
officers, it is reflective of the cooperative nature of National
Rural.
Performance
units are issued at the start of each fiscal year for a three-year
cycle. Performance units for named executive officers are
calculated by dividing 25% of base pay on June 1 by the plan payout unit value
assigned to the target rating level of AA- stable, valued at $100 per
performance unit for the plan cycle ending May 31, 2008. The measure
for all active long-term incentive plans is the achievement of bond rating
targets for our senior secured debt by three rating
agencies: Standard & Poor’s Corporation, Fitch Ratings, and
Moody’s Investors Service. The value of the performance units will
range from $0 to $150 per performance unit according to the level of National
Rural’s secured debt ratings by the three rating agencies. To achieve
the highest value of $150, which exceeds the targeted value, all three agencies
would have to raise National Rural’s long-term secured debt rating to
AA. If this rating level is achieved, the long-term incentive pay for
named executive officers is 37.5% of the base pay for the year in which the
units were issued. The chart below indicates the performance unit
values for the plan cycle ending May 31, 2008.
Senior
Secured Debt Rating - Incentive-Performance Linkage
Rating
|
A+
|
AA-
|
AA
|
Outlook
|
negative
|
stable
|
positive
|
negative
|
stable
|
positive
|
|
Numerical
Score
|
1
|
2
|
3
|
4
|
5
|
6
|
|
Plan
Pay-Out Unit Value
|
$0
|
$40
|
$60
|
$60
|
$100
|
$120
|
$150
|
* The
target objective is in bold.
The
senior secured debt rating was selected as the measure for the long-term
incentive plan because, as a financial services company, National Rural is
dependent on the capital markets and stronger ratings lead to lower interest
cost and more reliable access to the capital markets.
The
long-term incentive is paid out in one lump sum after the end of the performance
period. Payments made to named executive officers in fiscal year 2008
were for performance units issued in June 2005 and were based on the May 31,
2008 senior secured debt rating level of A+ stable outlook, which has a value of
$40 per performance unit, which is 40% of the targeted
opportunity. As of May 31, 2008, there were three active long-term
incentive plans in which named executive officers are
participants. Performance units issued to named executive officers in
June 2006 will have a value based on senior secured debt ratings in place on May
31, 2009; performance units issued to named executive officers in June 2007 will
have a value based on senior secured debt ratings in place on May 31, 2010; and
performance units issued to named executive officers in June 2008 will have a
value based on senior secured debt ratings in place on May 31,
2011. The methodology for determining the number of performance units
issued to named executive officers for all active long-term incentive plans is
consistent with the process described above.
Benefits
An
important retention tool is National Rural’s defined benefit pension plan, the
Retirement Security Plan. National Rural participates in a multiple
employer pension plan managed by National Rural Electric Cooperative Association
(“NRECA”). We balance the effectiveness of this plan as a
compensation and retention tool with the cost of the annual premium incurred to
participate in this pension plan. The value of the pension benefit is
determined by base pay only and does not include other cash
compensation.
National
Rural also offers a Pension Restoration Plan, which is a component of the NRECA
Retirement Security Plan, to a select group of management, including the named
executive officers, to increase their retirement benefits above amounts
available under the Retirement Security Plan, which is restricted by IRS
limitations on annual pay levels and maximum annual annuity
benefits. The Pension Restoration Plan restores the value of the
Retirement Security Plan for named executive officers to the level it would be
if the IRS limits on annual pay and annual annuity benefits were not in place.
Unlike the Retirement Security Plan, the Pension Restoration Plan is an
unfunded, unsecured obligation of National Rural and is not qualified for tax
purposes. National Rural pays the amount owed to the named executive
officers for the pension restoration benefit; amounts paid are then deducted
from the premium due for the next Retirement Security Plan invoice from
NRECA.
For more
information on the Retirement Security Plan and the Pension Restoration Plan,
see the Pension Benefits Table and accompanying narrative below.
As an
additional retention tool designed to assist named executive officers in
deferring compensation for use in retirement, each named executive officer is
also eligible to participate in National Rural’s non-qualified 457(b) deferred
compensation savings plan. Contributions to the plan are limited by
IRS regulations. The calendar year 2008 cap for contributions is
$15,500. There is no National Rural contribution to the deferred
compensation plan. For more information see “Nonqualified Deferred
Compensation” below.
Other
Compensation
National
Rural provides named executive officers with other benefits, as reflected in the
All Other Compensation column in the Summary Compensation Table below, that we
believe are reasonable and consistent with National Rural’s compensation
philosophy. National Rural does not provide significant perquisites
or personal benefits to the named executive officers.
The
Compensation Committee considers perquisites for the CEO in connection with its
annual review of the CEO’s total compensation package described
above. The perquisites provided to Mr. Petersen are limited to an
annual automobile allowance as well as an annual spousal air travel
allowance. To provide these perquisites in an efficient fashion, the
Board of Directors authorizes an annual allowance rather than providing
unlimited reimbursement or use of a company-owned vehicle. The amount
of each allowance is authorized annually by the Board of Directors and is
determined based on the estimated cost for operation and maintenance of an
automobile and the anticipated cost of air travel by the CEO’s
spouse. For fiscal year 2008, the Board authorized an annual
aggregate perquisite allowance of $25,100. Additionally, Mr. Petersen
received an annual executive physical paid for by National Rural.
Severance/Change
In Control Agreements
Mr.
Petersen, CEO, and Mr. Evans, SVP, Operations, each have an executive agreement
with National Rural under which they may continue to receive base salary and
benefits in certain circumstances after resignation or termination of
employment. The value of Mr. Petersen’s severance package was
determined to be customary for a CEO and approved by the Compensation Committee
as part of his employment contract. The value of Mr. Evans’ severance
package was negotiated by the CEO and Mr. Evans as part of Mr. Evans’ employment
offer. No other named executive officers have termination or change
in control agreements. For more information on these severance
arrangements, see “Termination of Employment and Change In Control Arrangements”
below.
Compensation
Committee Report
The
Compensation Committee of the Board of Directors oversees National Rural’s
compensation program on behalf of the Board. In fulfilling its
oversight responsibilities, the Compensation Committee reviewed and discussed
with management the Compensation Discussion and Analysis set forth in this Form
10-K. Based upon this review and discussion, the Compensation
Committee recommended to the Board of Directors that the Compensation Discussion
and Analysis be included in this Form 10-K.
Submitted by the Compensation
Committee
Roger Arthur
Darryl Schriver
Reuben McBride
Delbert Cranford
J. David Wasson, Jr.
Steven J. Haaven
Wayne Stratton
Summary
Compensation Table
The
summary compensation table below sets forth the aggregate compensation for the
years ended May 31, 2008 and 2007 earned by the named executive officers and two
additional executive officers of National Rural that meet the definition of
“related persons” pursuant to SEC disclosure requirements.
Name
and
Principal
Position
|
Year
|
Salary
|
Non-Equity
Incentive Plan Compensation (1)
|
Change
in Pension Value and Non-qualified Deferred Compensation
Earnings
(2)
|
All
Other Compensation (3)
|
Total
|
Sheldon
C. Petersen
|
2008
|
$
|
689,583
|
$
|
162,681
|
|
$
|
475,626
|
|
$
|
112,698
|
|
$
|
1,440,588
|
|
Governor
& CEO
|
2007
|
|
643,125
|
|
204,212
|
|
|
428,799
|
|
|
132,577
|
|
|
1,408,713
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Steven
L. Lilly
|
2008
|
|
378,750
|
|
92,759
|
|
|
294,967
|
|
|
14,219
|
|
|
780,695
|
|
Senior
Vice President &
|
2007
|
|
364,000
|
|
117,513
|
|
|
266,788
|
|
|
50,938
|
|
|
799,239
|
|
Chief
Financial Officer
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John
J. List
|
2008
|
|
378,750
|
|
92,759
|
|
|
523,478
|
|
|
9,848
|
|
|
1,004,835
|
|
Senior
Vice President of
|
2007
|
|
364,000
|
|
113,233
|
|
|
477,364
|
|
|
51,830
|
|
|
1,006,427
|
|
Member
Services and
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
Counsel
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John
T. Evans
|
2008
|
|
378,750
|
|
92,759
|
|
|
167,845
|
|
|
14,218
|
|
|
653,572
|
|
Senior
Vice President of
|
2007
|
|
364,000
|
|
113,233
|
|
|
146,285
|
|
|
16,833
|
|
|
640,351
|
|
Operations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Richard
E. Larochelle
|
2008
|
|
276,000
|
|
67,610
|
|
|
180,744
|
|
|
12,189
|
|
|
536,543
|
|
Senior
Vice President of
|
2007
|
|
265,500
|
|
85,507
|
|
|
161,864
|
|
|
18,581
|
|
|
531,452
|
|
Corporate
Relations
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lawrence
Zawalick (4)
|
2008
|
|
276,000
|
|
67,610
|
|
|
177,749
|
|
|
12,189
|
|
|
533,548
|
|
Senior
Vice President of
|
2007
|
|
265,500
|
|
85,507
|
|
|
147,479
|
|
|
46,494
|
|
|
544,980
|
|
RTFC
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John
M. Borak (4)
|
2008
|
|
242,800
|
|
59,547
|
|
|
69,951
|
|
|
11,535
|
|
|
383,833
|
|
Senior
Vice President of
|
2007
|
|
233,500
|
|
75,927
|
|
|
106,490
|
|
|
10,860
|
|
|
426,777
|
|
Credit
Risk Management
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Includes amounts earned during fiscal year 2008 and 2007 under the long-term and
short-term incentive plans. Payments under the fiscal year 2008
short-term incentive plan are subject to approval by the Board of Directors at a
date subsequent to the filing of this Form 10-K.
(2)
Represents solely the change in the net present value of the accumulated pension
benefit under the NRECA Retirement Security Plan, the multiple employer defined
benefit pension plan in which National Rural participates during each respective
fiscal year.
(3) For
Mr. Petersen, includes $27,560 of perquisites comprised of $13,400 pursuant to
Mr. Petersen’s automobile allowance and $11,700 pursuant to his spousal air
travel allowance for fiscal year 2008. The annual automobile
allowance is calculated based on estimated costs associated with maintenance,
use and insurance of a personal automobile for company business. The
annual spousal travel allowance is calculated based on the anticipated air
travel for Mrs. Petersen during the fiscal year. The remaining
perquisite amount in fiscal year 2008 was for an annual physical
examination. Additionally, for Mr. Petersen, includes $67,315 related
to Rural Telephone Finance Cooperative (“RTFC”) contributions to the RTFC
deferred compensation plan. For more information on this arrangement,
see “Employment Contracts” and “Nonqualified Deferred Compensation”
below. For Mr. Petersen, also includes $10,923 related to a sick
leave incentive bonus for fiscal year 2008. The remaining amounts
included in this column represent sick leave incentive bonuses for each named
executive officer other than Mr. Petersen, and National Rural contributions on
behalf of each named executive officer pursuant to the National Rural 401(k)
defined contribution plan.
(4)
These executives are “related persons” as defined by the SEC’s disclosure
requirements and are included in the Summary Compensation Table as we generally
treat all of our executive officers equally.
Grants
of Plan-Based Awards
The
Company has a long-term and a short-term incentive plan for all employees, under
which the named executive officers may receive a bonus of up to 37.5% and 25% of
salary, respectively. The incentive payouts are based on the
executive officer’s salary at the date the program becomes
effective. See the “Compensation Discussion and Analysis” above for
further information on these incentive plans.
The
following table contains the estimated possible payouts under the Company’s
short-term incentive plan and possible future payouts for grants under the
Company’s long-term incentive plan during the year ended May 31,
2008.
|
|
|
Estimated
Future Payouts Under Non-Equity Incentive Plan Awards
|
|
|
|
Threshold
|
Target
|
Max
|
Sheldon
C. Petersen
|
|
|
|
|
|
Long-term
Incentive Plan (1)
|
$
|
-
|
$
|
168,800
|
$
|
253,200
|
|
Short-term
Incentive Plan (2)
|
|
-
|
|
172,396
|
|
172,396
|
Steven
L. Lilly
|
|
|
|
|
|
|
|
Long-term
Incentive Plan (1)
|
|
-
|
|
94,700
|
|
142,050
|
|
Short-term
Incentive Plan (2)
|
|
-
|
|
94,688
|
|
94,688
|
John
J. List
|
|
|
|
|
|
|
|
Long-term
Incentive Plan (1)
|
|
-
|
|
94,700
|
|
142,050
|
|
Short-term
Incentive Plan (2)
|
|
-
|
|
94,688
|
|
94,688
|
John
T. Evans
|
|
|
|
|
|
|
|
Long-term
Incentive Plan (1)
|
|
-
|
|
94,700
|
|
142,050
|
|
Short-term
Incentive Plan (2)
|
|
-
|
|
94,688
|
|
94,688
|
Richard
E. Larochelle
|
|
|
|
|
|
|
|
Long-term
Incentive Plan (1)
|
|
-
|
|
69,000
|
|
103,500
|
|
Short-term
Incentive Plan (2)
|
|
-
|
|
69,000
|
|
69,000
|
Lawrence
Zawalick
|
|
|
|
|
|
|
|
Long-term
Incentive Plan (1)
|
|
-
|
|
69,000
|
|
103,500
|
|
Short-term
Incentive Plan (2)
|
|
-
|
|
69,000
|
|
69,000
|
John
M. Borak
|
|
|
|
|
|
|
|
Long-term
Incentive Plan (1)
|
|
-
|
|
60,700
|
|
91,050
|
|
Short-term
Incentive Plan (2)
|
|
-
|
|
60,700
|
|
60,700
|
(1)
Target payouts are calculated using unit values of $100 based on the Company’s
goal of achieving an average long-term senior secured credit rating
of AA- stable at May 31, 2010.
(2)
Target and maximum payouts represent 25% of May 31, 2008 base
salary. For the expected payout under the fiscal year 2008 short-term
incentive plan, see the Non-Equity Incentive Plan Compensation column of the
Summary Compensation Table above.
As
discussed in the Compensation Discussion and Analysis above, the Board of
Directors has approved a new long-term incentive plan with terms similar to the
plan in effect during fiscal year 2008. As a result, the executives
included in the chart above received grants on June 1, 2008 with a payout to be
determined on May 31, 2011.
Employment
Contracts
Pursuant
to an employment agreement effective as of January 1, 2008, National Rural has
agreed to employ Mr. Petersen as Chief Executive Officer through February 29,
2012 (with automatic one-year extensions unless either party objects) at no less
than his base salary at the time, or $710,000 per annum, plus such incentive
payments (if any) as may be awarded him. In addition, pursuant to the
employment agreement, Mr. Petersen is entitled to certain payments in the event
of his termination other than for cause (e.g., Mr. Petersen leaving for good
reason, disability or termination due to death). See “Termination of
Employment and Change In Control Arrangements” below for a description of these
provisions and for information on these amounts.
Pursuant
to a separate independent contractor agreement effective as of January 1, 2008,
Mr. Petersen has agreed to provide service to RTFC for a period coterminous to
the National Rural agreement that is automatically extended at each March 1,
after 2012, for an additional year unless RTFC or Mr. Petersen does not wish to
extend or further extend the term of the contractor agreement with
RTFC. As compensation, RTFC must credit $30,000 to a deferred
compensation account on January 1 of each year of the term. For
additional information, see “Nonqualified Deferred Compensation”
below.
For
information about Mr. Evans’ termination agreement, see “Termination of
Employment and Change In Control Arrangements.”
Pension
Benefits Table
The
Company is a participant in a multiple employer defined benefit pension plan,
the Retirement Security Plan, which is administered by NRECA. Since the plan is
a multiple employer plan in which National Rural participates, National
Rural
is not
liable for the amounts shown and such amounts are not reflected in National
Rural's audited financial statements. National Rural’s expense
is limited to the annual premium to participate in the plan. There is
no funding liability for National Rural for the plan.
The
Retirement Security Plan is a qualified plan in which all employees are eligible
to participate upon completion of one year of service. Each of the
named executive officers participates in the qualifed pension plan component of
the Retirement Security Plan. Under the plan, participants are entitled to
receive annually, under a 50% joint and surviving spouse annuity, 1.90% of the
average of their five highest base salaries during their last ten years of
employment, multiplied by the number of years of participation in the
plan. The value of the pension benefit is determined by base pay only
and does not include other cash compensation. Normal retirement age
under the qualified pension plan is age 62; however, the plan does allow for
early retirement with reduced benefits. For early retirement, the
pension benefit will be reduced by 1/15 for each of the first five years and
1/30 for each of the next five years by which the elected early retirement date
precedes the normal retirement date. Each of the named executive
officers is eligible for early retirement under the plan.
National
Rural also offers a Pension Restoration Plan which is a component of the
Retirement Security Plan. Each of the named executive officers
participates in the Pension Restoration Plan component of the Retirement
Security Plan, the purpose of which is to increase their retirement benefits
above amounts available under the Retirement Security Plan, which is restricted
by IRS limitations on annual pay levels and maximum annual annuity
benefits. The Pension Restoration Plan restores the value of the
Retirement Security Plan for each officer to the level it would be if the IRS
limits on annual pay and annual annuity benefits were not in
place. The benefit and payout formula under the restoration component
of the Retirement Security Plan is similar to that under the qualified plan
component. However, each of the named executive officers has
satisfied the provisions established to receive the benefit from this
plan. Since there is no longer a risk of forfeiture of the benefit
under the Pension Restoration Plan, distributions will be made from the plan to
each named executive officer annually.
The
following table contains the years of service, the present value of the
accumulated benefit for the executive officers listed in the Summary
Compensation Table at May 31, 2008 and distributions from the plan for the
fiscal year then ended.
Name
|
Plan Name
|
Number
of Years
Credited Service (1)
|
|
Present
Value of
Accumulated Benefit (2)
|
|
Payments
During
Last
Fiscal Year (3)
|
Sheldon
C. Petersen
|
NRECA
Retirement Security Plan
|
24.75
|
|
|
$2,316,804
|
|
$844,312
|
Steven
L. Lilly
|
NRECA
Retirement Security Plan
|
23.58
|
|
|
1,696,835
|
|
397,069
|
John
J. List
|
NRECA
Retirement Security Plan
|
35.42
|
|
|
2,713,970
|
|
762,176
|
John
T. Evans
|
NRECA
Retirement Security Plan
|
9.50
|
|
|
638,556
|
|
155,187
|
Richard
E. Larochelle
|
NRECA
Retirement Security Plan
|
24.00
|
|
|
1,098,277
|
|
101,155
|
Lawrence
Zawalick
|
NRECA
Retirement Security Plan
|
27.67
|
|
|
1,122,227
|
|
101,590
|
John
M. Borak (4)
|
NRECA
Retirement Security Plan
|
1.92
|
|
|
125,137
|
|
2,368
|
(1)
National Rural is a participant in a multiple employer pension
plan. Credited years of service, therefore, includes not only years
of service with National Rural, but also years of service with another
cooperative participant in the multiple employer pension plan. Mr.
Larochelle has 12 credited years of service with another cooperative in addition
to National Rural. All other executives have credited years of
service only with National Rural.
(2)
Amount represents the actuarial present value of the executive officer's
accumulated benefit under the plan as of May 31, 2008 as
provided
by the plan administrator, NRECA, using interest rates ranging from 4.52% to
4.91% per annum and mortality according to tables prescribed by the IRS as
published in Revenue Rulings 2001-62 and 2007-67.
(3)
Distributions during fiscal year 2008 were as a result of the executive officers
no longer being at risk of forfeiture with respect to these amounts provided
under the restoration component of the Retirement Security Plan.
(4) At
May 31, 2008, Mr. Borak is the only named executive officer that is eligible for
retirement based on the normal retirement age of 62. Due to Mr.
Borak’s quasi-retirement in January 2007, his credited years of service were
reduced to zero at that time. Subsequent to the quasi-retirement, Mr.
Borak received credited years of service for the remainder of the 2007 calendar
year and receives 12 months of credited service in January of each year
thereafter.
Nonqualified
Deferred Compensation
National
Rural Deferred Compensation Plan
The
National Rural deferred compensation plan is a nonqualified deferred
compensation savings program for the senior executive group, including each of
the named executive officers, and other selected management or highly
compensated employees designated by National Rural. Participants may
elect to defer up to the lesser of 100% of their compensation for the year or
the applicable IRS statutory dollar limit in effect for that calendar
year. The calendar year 2008 cap for contributions is
$15,500. Compensation for the purpose of this plan is defined as the
total amount of compensation, including incentive pay, if any, paid by National
Rural. National Rural does not make any contributions to the
plan.
The
accounts are credited with “earnings” based on the participants’ selection of
available investment options (currently, eight options) within the Homestead
Funds. When a participant ceases to be an employee for any reason,
distribution of the account will generally be made in 15 substantially equal
annual payments beginning approximately 60 days after termination (unless an
election is made to change the form and timing of the payout). The
participant may elect either a single lump sum or substantially equal annual
installments paid over no less than two and no more than 14
years. The amount paid is based on the accumulated value of the
account.
RTFC
Deferred Compensation Plan
As
described under “Employment Contracts” above, RTFC contributes a sum of $30,000
annually to a deferred compensation account for Mr. Petersen on January 1 of
each year that Mr. Petersen is contracted by RTFC. Interest will be
credited to the account on December 31 of each such year at a rate equal to
National Rural’s 20-year medium-term note rate on that date. On
December 31, 2007, the applicable interest rate was 6.42%. As
approved by the RTFC Board of Directors, Mr. Petersen, at his option, may
request that the deferred component of his compensation be directed into
alternative investment vehicles that could offer the opportunity to earn a
return that is greater than the National Rural 20-year medium-term note
rate. Mr. Petersen has not yet chosen to exercise that
option. If Mr. Petersen's service to RTFC is terminated by RTFC other
than for cause, or by Mr. Petersen for any reason, or by his death or
disability, the account will be deemed continued for the remainder of the term
of the contractor agreement with RTFC (but in no event less than six months nor
more than a year), interest will be credited on a proportional basis for the
calendar year during which the continuation ends and the balance in the account
will be paid to Mr. Petersen or his beneficiaries in a lump sum.
The
following table summarizes information related to the nonqualified deferred
compensation plans in which the executive officers listed in the Summary
Compensation Table were eligible to participate during the year ended May 31,
2008.
Name
|
|
Executive
Contributions
in
Last
Fiscal
Year
(1)
|
Registrant
Contributions
in
Last
Fiscal
Year
|
Aggregate
Earnings
in Last
Fiscal
Year
|
Aggregate
Withdrawals/
Distributions
|
Aggregate
Balance
at Last
Fiscal
Year End (3)
|
Sheldon
C. Petersen
|
|
|
|
|
|
|
|
National
Rural Deferred Compensation
|
15,500
|
|
-
|
|
(30,602
|
)
|
|
-
|
270,943
|
|
|
RTFC
Deferred Compensation (2)
|
-
|
|
67,315
|
|
-
|
|
|
-
|
648,548
|
|
|
|
|
|
|
|
|
|
|
|
|
Steven
L. Lilly
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural Deferred Compensation
|
15,500
|
|
-
|
|
(12,632
|
)
|
|
-
|
184,270
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John
J. List
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural Deferred Compensation
|
15,500
|
|
-
|
|
(6,153
|
)
|
|
-
|
63,228
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John
T. Evans
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural Deferred Compensation
|
14,250
|
|
-
|
|
(7,456
|
)
|
|
-
|
126,878
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Richard
E. Larochelle
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural Deferred Compensation
|
15,500
|
|
-
|
|
(3,919
|
)
|
|
-
|
212,681
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Lawrence
Zawalick
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural Deferred Compensation
|
16,958
|
|
-
|
|
(10,811
|
)
|
|
-
|
103,642
|
|
|
|
|
|
|
|
|
|
|
|
|
|
John
M. Borak
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural Deferred Compensation
|
15,500
|
|
-
|
|
2,178
|
|
|
-
|
57,396
|
|
|
(1)
Executive contributions are also included in the fiscal year 2008 Salary column
in the Summary Compensation Table above.
(2) If
Mr. Petersen's employment were terminated at May 31, 2008 by RTFC other than for
cause, or by Mr. Petersen for any reason, or by his death or disability,
interest would accrue under the RTFC deferred compensation plan through May 31,
2009 at the National Rural 20-year medium-term note rate on December 31,
2007. On December 31, 2007, the applicable interest rate was 6.42%
which would result in additional RTFC contributions of $90,902 through May 31,
2009. RTFC’s contribution of $67,315 for fiscal year 2008 is also
included in the fiscal year 2008 All Other Compensation column in the Summary
Compensation Table above.
(3) The
aggregate balance for the RTFC Deferred Compensation plan includes $581,233
reported in the Summary Compensation Table in prior years.
Termination
of Employment and Change In Control Arrangements
Each of
Mr. Petersen and Mr. Evans have an executive agreement with National Rural (and,
for Mr. Petersen only, with RTFC) under which each such officer may continue to
receive base salary and benefits in certain circumstances after resignation or
termination of employment. No other named executive officers have
termination or change in control agreements.
Mr.
Petersen
Under the
executive agreement with Mr. Petersen, if National Rural terminates his
employment without “cause,” or Mr. Petersen terminates his employment for “good
reason” (each term as defined below), National Rural is obligated to pay him a
lump sum
payment equal to the product of three times his annual base salary at the rate
in effect at the time of termination, and his short-term incentive bonus, if
any, for the previous year (or an amount equal to the short-term incentive
bonus for fiscal year 2007). Assuming a triggering event of May 31,
2008, the compensation payable to Mr. Petersen for termination without cause
would be $2,582,196. The actual payments due on a termination without
cause on different dates could materially differ from this
estimate.
For
purposes of Mr. Petersen’s executive agreement, “cause” generally means (i) the
willful and continued failure by Mr. Petersen to perform his duties under the
agreement or comply with written policies of National Rural, (ii) willful
conduct materially injurious to National Rural, or (iii) conviction of a felony
involving moral turpitude. “Good reason” generally means (i) a
reduction in the rate of Mr. Petersen’s base salary, (ii) a decrease in his
titles, duties or responsibilities, or the assignment of new responsibilities
which, in either case, is materially less favorable to Mr. Petersen when
compared to his titles, duties and responsibilities which were in effect
immediately prior to such assignment, or (iii) the relocation of National
Rural’s principal office, or the relocation of Mr. Petersen to a
location more than 50 miles from the principal office of National
Rural.
Under the
executive agreement between Mr. Petersen and RTFC, if RTFC terminates his
employment without cause, or if Mr. Petersen terminates his service to RTFC for
any reason, or due to his death or disability, RTFC is required to pay a lump
sum payment equivalent to the amount in his deferred compensation
account. However, the account will be deemed to be continued in
effect for the lesser of (i) a period of 12 months, or (ii) the remaining period
of the “term of service” of the executive agreement prior to such termination,
which is currently February 29, 2012, but in no case less than six months (the
“Extended Period”) and all credits (payment and interest) outlined in the
agreement will continue to be made. If the Extended Period ends other
than on a December 31st, when normal interest calculations are made and added to
the account, RTFC will further credit the account with simple interest for the
period from January 1 to the end of the Extended Period at the same rate that
was used to credit interest on the prior December 31st. For details
on the value of this compensation payable to Mr. Petersen under the RTFC
executive agreement, see the Nonqualified Deferred Compensation Table
above.
Under the
terms of the agreement, if RTFC terminates his service for cause, the term of
service will terminate immediately thereafter, and Mr. Petersen will not be
entitled to any payment with respect to the account.
Mr.
Evans
Under the
executive agreement with Mr. Evans, if National Rural terminates his employment
without cause, Mr. Evans would receive nine months of continued annual base
salary in effect at the time of termination, incentive compensation for the
additional nine-month period, and nine months of payment for all health and
welfare and retirement plans. Assuming a termination date of May 31,
2008, the compensation payable to Mr. Evans for termination without cause would
be $415,174. The actual payments due for a termination without cause
on different dates could materially differ from this estimate.
The
estimates do not include amounts to which the named executive officers would be
entitled to upon termination, such as base salary to date, unpaid bonuses
earned, unreimbursed expenses, paid vacation time and any other earned benefits
under company plans.
Director Compensation
Table
Directors
receive a fixed sum of $4,000 for each of the scheduled board meetings attended
and $150 for each conference call attended. Additionally, the
directors receive reimbursement for reasonable travel expenses. The
fixed amounts are paid following the conclusion of each board meeting or
conference call attended. The following chart summarizes the total
fees earned by National Rural directors during the year ended May 31,
2008.
Name
|
|
Fees
Earned
|
|
Total
|
Roger
Arthur
|
$
|
38,550
|
$
|
38,550
|
Darryl
Schriver
|
|
37,650
|
|
37,650
|
Reuben
McBride
|
|
40,350
|
|
40,350
|
Fred
Anderson
|
|
8,000
|
|
8,000
|
Roger
A. Ball
|
|
37,800
|
|
37,800
|
Raphael
A. Brumbeloe
|
|
37,650
|
|
37,650
|
Delbert
Cranford
|
|
29,350
|
|
29,350
|
Jim
L. Doesrstler
|
|
8,150
|
|
8,150
|
Jimmy
Ewing Jr.
|
|
37,950
|
|
37,950
|
Harold
Foley
|
|
41,800
|
|
41,800
|
Steven
J. Haaven
|
|
36,750
|
|
36,750
|
Gary
Harrison
|
|
28,900
|
|
28,900
|
Craig
A. Harting
|
|
33,500
|
|
33,500
|
Jim
Herron
|
|
36,150
|
|
36,150
|
Martin
Hillert, Jr.
|
|
37,050
|
|
37,050
|
Terryl
Jacobs
|
|
32,900
|
|
32,900
|
Tom
Kirby
|
|
28,300
|
|
28,300
|
William
A. Kopacz
|
|
41,650
|
|
41,650
|
Burns
Mercer
|
|
4,000
|
|
4,000
|
Gale
Rettkowski
|
|
36,900
|
|
36,900
|
Dwight
Rossow
|
|
8,150
|
|
8,150
|
Ronald
P. Salyer
|
|
36,000
|
|
36,000
|
R.
Wayne Stratton
|
|
39,150
|
|
39,150
|
J.
David Wasson, Jr.
|
|
37,950
|
|
37,950
|
Charles
Wayne Whitaker
|
|
36,600
|
|
36,600
|
Jack
F. Wolfe, Jr.
|
|
28,150
|
|
28,150
|
F.
E. Wolski
|
|
32,450
|
|
32,450
|
Compensation
Committee Interlocks and Insider Participation
During
the year ended May 31, 2008, there were no compensation committee interlocks or
insider participation related to executive compensation.
Item
12. Security
Ownership of Certain Beneficial Owners and Management and Related Stockholder
Matters.
Inapplicable.
Item
13. Certain
Relationships and Related Transactions, and Director Independence.
Review and Approval of Transactions
with Related Persons
The Board
of Directors has adopted a policy for review and approval in writing and
monitoring of transactions involving National Rural and “related persons”
(directors and executive officers or their immediate family members). The policy
covers any related person transaction that meets the minimum threshold for
disclosure under SEC disclosure requirements (generally, transactions involving
amounts exceeding $120,000 in which a related person had, has or will have a
direct or indirect material interest).
Policy
and Procedures
·
|
Each
director and executive officer is required to promptly notify the General
Counsel in writing of any material interest that such person or an
immediate family member of such person had, has or will have in a related
person transaction.
|
·
|
The
General Counsel of National Rural is responsible for the review, approval
or ratification of any related person transaction, unless the General
Counsel refers any related person transaction to the Board of Directors
for its review, approval or ratification. If such related person
transaction involves a director, the director may not participate in the
deliberations or vote with respect to such approval or
ratification.
|
·
|
The
General Counsel will notify the Board of Directors at each regularly
scheduled Board meeting of any action taken by the General Counsel with
respect to a related person transaction since the last regularly scheduled
meeting of the Board of Directors.
|
·
|
In
the event the General Counsel becomes aware of a related person
transaction that has not been approved under the Board policy prior to its
consummation, the General Counsel will notify the Board of Directors. The
Board of Directors will consider all of the relevant facts and
circumstances with respect to such transaction, and will evaluate all
options available to National Rural, including ratification, revision or
termination of such transaction, and shall take such course of action as
the Board of Directors deems appropriate under the
circumstances.
|
·
|
The
General Counsel will determine whether a related person has a material
interest in a transaction on the basis of the significance of the
information to investors in National Rural securities in light of all the
circumstances. Factors to be considered in determining whether a related
person’s interest in a transaction is material may include the importance
of the interest to the related person (financially or otherwise), the
relationship of the related person to the transaction and of related
persons with each other, and the dollar amount involved in the
transaction.
|
·
|
The
General Counsel, and where applicable, the Board of Directors, will not
approve or ratify a related person transaction unless the General Counsel,
or the Board, as the case may be, reasonably determines, based on a review
of the available information, that the transaction is fair and reasonable
to National Rural and consistent with the best interests of National
Rural.
|
·
|
Factors
to be taken into account in making the determination may include (i) the
business purpose of the transaction, (ii) whether the transaction is
entered into on an arms-length basis on terms fair to National Rural, and
(iii) whether such a transaction would violate other National Rural
policies.
|
Related
Person Transactions
See the
Summary Compensation Table in Item 11 for a description of compensation paid to
Larry Zawalick and John Borak, National Rural’s executive officers who are not
named executive officers, but meet the definition of a “related person” as
described above.
Independence
Determinations
The Board
of Directors has determined the independence of each Director based on a review
by the full Board. The Audit Committee is subject to the independence
requirements of Rule 10A-3 under the Securities Exchange Act. To
evaluate the independence of our directors, the Board has voluntarily adopted
categorical independence standards consistent with the New York Stock Exchange
(“NYSE”) standards. However, because we only list debt securities on the NYSE,
the Company is not subject to most of the corporate governance listing standards
of the NYSE, including the independence requirements.
No
Director is considered independent unless the Board has determined that he or
she has no material relationship with National Rural, either directly or as a
partner, shareholder, or officer of an organization that has a material
relationship with National Rural. Material relationships can include banking,
legal, accounting, charitable, and familial relationships, among others. A
Director is not considered independent if any of the following relationships
existed:
|
(i)
|
the
director is, or has been within the last three years, an employee of
National Rural, or an immediate family member is, or has been within the
last three years, an executive officer of National
Rural;
|
|
(ii)
|
the
director has received, or has an immediate family member who has received,
during any twelve-month period within the last three years, more than
$100,000 in direct compensation from National Rural, other than director
and committee fees and pension or other forms of deferred compensation for
prior service (provided that such compensation is not contingent in any
way on continued service);
|
|
(iii)
|
(a)
the director or an immediate family member is a current partner of a firm
that is National Rural’s external auditor; (b) the director is a current
employee of such a firm; (c) the director has an immediate family member
who is a current employee of such a firm and who participates in the
firm’s audit, assurance or tax compliance (but not tax planning) practice
for National Rural; or (d) the director or an immediate family member was
within the last three years (but is no longer) a partner or employee of
such a firm and personally worked on National Rural’s audit within that
time;
|
|
(iv)
|
the
director or an immediate family member is, or has been within the last
three years, employed as an executive officer of another company where any
of National Rural’s present executive officers at the same time serves or
served on that company’s compensation
committee;
|
|
(v)
|
the
director is a current employee, or an immediate family member is a current
executive officer, of a company that has made payments to, or received
payments from, National Rural for property or services in an amount which,
in any of the last three fiscal years, exceeds the greater of $1 million,
or 2% of such other company’s consolidated gross
revenues.
|
The Board
of Directors also reviewed directors’ responses to a questionnaire asking about
their relationships with National Rural and its affiliates (and those of their
immediate family members) and other potential conflicts of
interest.
In
reaching a determination that the directors are independent, the Board
considered that in addition to the categories or types of transactions described
above, loans and guarantees were made to member systems of which directors of
National Rural are members, employees, officers or directors. As a
cooperative, National Rural was established for the very purpose of extending
financing to its members (from whose ranks its directors must be drawn). Loans
and guarantees to members with which Directors are affiliated were made in the
ordinary course of National Rural business on the same terms, including interest
rates and collateral, as those prevailing at the time for comparable
transactions with other members and did not involve more than normal risk of
uncollectibility or present other unfavorable features. It is anticipated that,
consistent with its loan and guarantee policies in effect from time to time,
additional loans and guarantees will be made by National Rural to member systems
and trade and service organizations of which directors of National Rural are
members, employees, officers or directors. National Rural has adopted
a policy whereby substantially all extensions of credit to entities related to
directors or their immediate family members are approved only by the
disinterested directors.
Based on
the criteria above, the Board of Directors has determined that the directors
listed below are independent for the period of time served by such Directors
during fiscal year 2008. The Board determined that none of the directors listed
below had any of the relationships listed in (i) - (v) above or any other
material relationship that would compromise his or her
independence.
Independent
Directors
|
Roger
Arthur
|
Steven
J. Haaven
|
Burns
E. Mercer
|
Roger
A. Ball
|
Gary
Harrison (1)
|
Gale
Rettkowski
|
Raphael
A. Brumbeloe
|
Craig
A. Harting (1)
|
Dwight
Rossow
|
Delbert
Cranford
|
Jim
Herron
|
R.
Wayne Stratton
|
Jim
L. Doerstler
|
Terryl
Jacobs (1)
|
J.
David Wasson, Jr.
|
Jimmy
Ewing, Jr.
|
Tom
Kirby (1)
|
Jack
F. Wolfe, Jr.
|
Harold
Foley
|
|
Reuben
McBride
|
F.
E. Wolski
|
(1)
These directors served during the year ended May 31, 2008, however they
were no longer a director at May 31,
2008.
|
Item
14. Principal
Accountant Fees and Services.
The
following table summarizes the aggregate professional fees for the audit of the
financial statements for the years ended May 31,
2008 and 2007 and fees for other services during that period by Deloitte &
Touche, LLP.
|
2008
|
|
2007
|
|
Audit
fees (1)
|
$
|
1,641,790
|
|
|
$
|
1,636,815
|
|
|
Audit-related
fees
|
|
-
|
|
|
|
-
|
|
|
Tax
fees (2)
|
|
111,571
|
|
|
|
29,650
|
|
|
All
other fees (3)
|
|
28,500
|
|
|
|
33,000
|
|
|
Total
|
$
|
1,781,861
|
|
|
$
|
1,699,465
|
|
|
|
|
|
(1) Audit
fees in 2008 and 2007 consist of fees for the audit of the consolidated
financial statements of National Rural, including RTFC and NCSC in accordance
with FIN 46(R), totaling $1,315,450 and $1,205,928, respectively, fees for the
preparation of the stand-alone financial statements for RTFC and NCSC totaling
$185,000 and $242,408, respectively, and fees for the audit of management's
assessment of the effectiveness of National Rural’s internal control over
financial reporting in compliance with Section 404 of the Sarbanes-Oxley Act of
2002 totaling $0 and $24,900 respectively. Additionally, audit fees
in 2008 and 2007 include comfort letter fees and consents related to debt
issuances and compliance work required by the independent auditors.
(2) Tax
fees consist of assistance with matters related to tax compliance and
consulting.
(3) These
fees relate to the audit of a trust serviced by National Rural.
National
Rural’s Audit Committee is solely responsible for the nomination, approval,
compensation, evaluation and discharge of the independent public
accountants. The independent registered public accountants report
directly to the Audit Committee and the Audit Committee is responsible for the
resolution of disagreements between management and the independent registered
public accountants. Consistent with Securities and Exchange
Commission requirements, the Audit Committee has adopted a policy to pre-approve
all audit and permissible non-audit services provided by the independent
registered public accountants. Under the policy, the Audit
Committee's pre-approval for permissible non-audit services is not required if
all such services 1) do not aggregate to more than five percent of total revenue
paid to the independent registered public accountants in the fiscal year when
services are provided, 2) were not recognized as non-audit services at the time
of the engagement and 3) are promptly brought to the attention of the Audit
Committee and approved by the Audit Committee prior to the
completion of the audit. This policy was followed during the years
ended May 31, 2008 and 2007. National Rural’s independent registered
public accountants for the current fiscal year have been appointed by the Audit
Committee.
PART
IV
Item
15. Exhibits
and Financial Statement Schedules.
|
|
(a)
|
Documents
filed as a part of this report.
|
|
1.
|
Consolidated
financial statements
|
Page
|
|
|
Report
of Independent Registered Public Accounting Firm
|
80
|
|
|
Consolidated
Balance Sheets
|
81
|
|
|
Consolidated
Statements of Operations
|
83
|
|
|
Consolidated
Statements of Changes in Equity
|
84
|
|
|
Consolidated
Statements of Cash Flows
|
85
|
|
|
Notes
to Consolidated Financial Statements
|
87
|
|
|
|
|
|
2.
|
Financial
statement schedules
|
|
|
All
schedules are omitted because they are not required, are inapplicable or the
information is included in the financial statements or notes
thereto.
3.
|
Exhibits
|
|
3.1
|
-
|
Articles
of Incorporation. Incorporated by reference to Exhibit 3.1
to Registration Statement No. 2-46018, filed October 12,
1972.
|
|
3.2
|
-
|
Amended
Bylaws as approved by National Rural’s board of directors and members on
March 1, 2005. Incorporated by reference to Exhibit 3.2 to
National Rural’s Form 10-Q filed on April 14, 2005.
|
|
4.1
|
-
|
Form
of Capital Term Certificate. Incorporated by reference to
Exhibit 4.3 to Registration Statement No. 2-46018 filed October 12,
1972.
|
|
4.2
|
-
|
Indenture
dated as of February 15, 1994, between the Registrant and U.S. Bank
National Association, successor trustee. Incorporated by
reference to Exhibit 4.2 to National Rural’s Form 10-Q filed on October
15, 2007.
|
|
4.3
|
-
|
Revolving
Credit Agreement dated as of March 22, 2006 for $1,000,000,000 maturing on
March 22, 2011. Incorporated by reference to Exhibit 4.3 to
National Rural’s Form 10-Q filed on April 14, 2006.
|
|
4.4
|
-
|
Revolving
Credit Agreement dated as of March 16, 2007 for $1,125,000,000 maturing on
March 16, 2012. Incorporated by reference to Exhibit 4.4 to
National Rural’s Form 10-Q filed on April 12, 2007.
|
|
4.5
|
-
|
Revolving
Credit Agreement dated as of March 14, 2008 for $1,500,000,000 expiring on
March 13, 2009. Incorporated by reference to Exhibit 4.5 to
National Rural’s Form 10-Q filed on April 14, 2008.
|
|
4.6
|
-
|
Indenture
between National Rural and Mellon Bank, N.A., as Trustee. Incorporated by
reference to Exhibit 4.1 to Registration Statement on Form S-3 filed on
November 14, 1995 (Registration No. 33-64231).
|
|
4.7
|
-
|
Indenture
between National Rural and Chemical Bank, as
Trustee. Incorporated by reference to Exhibit 4.7 to Amendment
No. 1 to Registration Statement on Form S-3 filed on December 15, 1987
(Registration No. 33-34927).
|
|
4.8
|
-
|
First
Supplemental Indenture between National Rural and Chemical Bank, as
Trustee. Incorporated by reference to Exhibit 4.8 to
Registration Statement on Form S-3 filed on October 1, 1990 (Registration
No. 33-58445).
|
|
4.9
|
-
|
Bond
Purchase Agreement between the Registrant, Federal Financing Bank and
Rural Utilities Service dated as of April 28, 2006 for up to
$1,500,000,000. Incorporated by reference to Exhibit 4.11 to
National Rural’s Form 10-K filed on August 25, 2006.
|
|
4.10
|
-
|
Series
B Bond Guarantee Agreement between the Registrant and the Rural Utilities
Service dated as of April 28, 2006 for up to
$1,500,000,000. Incorporated by reference to Exhibit 4.12 to
National Rural’s Form 10-K filed on August 25, 2006.
|
|
4.11
|
-
|
Pledge
Agreement dated as of April 28, 2006, between the Registrant, the Rural
Utilities Service and U.S. Bank Trust National
Association. Incorporated by reference to Exhibit 4.13 to
National Rural’s Form 10-K filed on August 25, 2006.
|
|
4.12
|
-
|
Series
B Future Advance Bond from the Registrant to the Federal Financing Bank
dated as of April 28, 2006 for up to $1,500,000,000 maturing on July 15,
2029. Incorporated by reference to Exhibit 4.14 to National
Rural’s Form 10-K filed on August 25, 2006.
|
|
4.13
|
-
|
Bond
Purchase Agreement between the Registrant, Federal Financing Bank and
Rural Utilities Service dated as of June 14, 2005 for up to
$1,000,000,000. Incorporated by reference to Exhibit 4.12 to
National Rural’s Form 10-K filed on August 24, 2005.
|
|
4.14
|
-
|
Series
A Bond Guarantee Agreement between the Registrant and the Rural Utilities
Service dated as of June 14, 2005 for up to
$1,000,000,000. Incorporated by reference to Exhibit 4.13 to
National Rural’s Form 10-K filed on August 24,
2005.
|
|
4.15
|
-
|
Pledge
Agreement dated as of June 14, 2005, between the Registrant, the Rural
Utilities Service and U.S. Bank Trust National
Association. Incorporated by reference to Exhibit 4.14 to
National Rural’s Form 10-K filed on August 24, 2005.
|
|
4.16
|
-
|
Series
A Future Advance Bond from the Registrant to the Federal Financing Bank
dated as of June 14, 2005 for up to $1,000,000,000 maturing on July 15,
2028. Incorporated by reference to Exhibit 4.15 to National
Rural’s Form 10-K filed on August 24, 2005.
|
|
4.17
|
-
|
Note
Purchase Agreement dated as of July 28, 2005 for $500,000,000 between the
Registrant and Federal Agricultural Mortgage
Corporation. Incorporated by reference to Exhibit 4.16 to
National Rural’s Form 10-K filed on August 24, 2005.
|
|
4.18
|
-
|
Pledge
Agreement dated as of July 28, 2005, between the Registrant, Federal
Agricultural Mortgage Corporation and U.S. Bank Trust National
Association. Incorporated by reference to Exhibit 4.17 to
National Rural’s Form 10-K filed on August 24, 2005.
|
|
4.19
|
-
|
Registration
Rights Agreement dated as of July 28, 2005 between the Registrant and
Federal Agricultural Mortgage Corporation. Incorporated by
reference to Exhibit 4.18 to National Rural’s Form 10-K filed on August
24, 2005.
|
|
4.20
|
-
|
4.656%
Senior Notes due 2008 dated as of July 29, 2005 from the Registrant to
Federal Agricultural Mortgage Corporation. Incorporated by
reference to Exhibit 4.19 to National Rural’s Form 10-K filed on August
24, 2005.
|
|
4.21
|
-
|
Indenture
dated as of May 15, 2000, between the Registrant and Bank One Trust
Company, National Association, as trustee. Incorporated by
reference to Exhibit 4.1 to Registration Statement on Form S-3 filed on
May 25, 2000 (Registration No. 333-37940).
|
|
4.22
|
-
|
First
Supplemental Indenture dated as of March 12, 2007, between the Registrant
and U.S. Bank National Association, as trustee. Incorporated by
reference to Exhibit 4.2 to Registration Statement on Form S-3ASR filed on
April 19, 2007 (Registration No. 333-142230).
|
|
4.23
|
-
|
Indenture
for Clean Renewable Energy Bonds, Tax Credit Series dated as of January 1,
2008, between the Registrant and U.S. Bank Trust National
Association. The Indenture has been omitted and will be
furnished supplementally to the Securities and Exchange Commission upon
request. Incorporated by reference to Exhibit 4.21 to National
Rural’s Form 10-Q filed on April 14, 2008.
|
|
4.24
|
-
|
Note
Purchase Agreement dated as of March 27, 2008, for $400,000,000 between
the Registrant and Federal Agricultural Mortgage Corporation. Incorporated
by reference to Exhibit 4.22 to National Rural’s Form 10-Q filed on April
14, 2008.
|
|
4.25
|
-
|
Pledge
Agreement dated as of March 27, 2008, between the Registrant, Federal
Agricultural Mortgage Corporation and U.S. Bank Trust National
Association. Incorporated by reference to Exhibit 4.23 to National Rural’s
Form 10-Q filed on April 14, 2008.
|
|
4.26
|
-
|
Registration
Rights Agreement dated as of March 27, 2008, between the Registrant and
Federal Agricultural Mortgage Corporation. Incorporated by reference to
Exhibit 4.24 to National Rural’s Form 10-Q filed on April 14,
2008.
|
|
4.27
|
-
|
Variable
Rate Senior Note due 2013 dated as of March 27, 2008, from the Registrant
to Federal Agricultural Mortgage Corporation. Incorporated by reference to
Exhibit 4.25 to National Rural’s Form 10-Q filed on April 14,
2008.
|
|
4.28
|
-
|
Indenture
dated as of October 25, 2007, between the Registrant and U.S. Bank
National Association, as trustee. Incorporated by reference to
Exhibit 4.1 to Registration Statement on Form S-3ASR filed on October 26,
2007 (Registration No. 333-146960).
|
|
|
-
|
Registrant
agrees to furnish to the Commission a copy of all other instruments
defining the rights of holders of its long-term debt upon
request.
|
|
10.1
|
-
|
Plan
Document for National Rural’s Deferred Compensation Program amended and
restated as of July 1, 2003. Incorporated by reference to
Exhibit 10.1 to National Rural’s Form 10-K filed on August 24,
2005.
|
|
10.2
|
-
|
Employment
Contract between National Rural and Sheldon C. Petersen, effective as of
January 1, 2008. Incorporated by reference to Exhibit 10.2 to
National Rural’s Form 10-Q filed on January 11, 2008.
|
|
10.3
|
-
|
Supplemental
Benefit Agreement between Rural Telephone Finance Cooperative and Sheldon
C. Petersen, dated as of July 22, 2004. Incorporated by
reference to Exhibit 10.3 to National Rural’s Form 10-K filed on August
20, 2004.
|
|
10.4
|
-
|
Amended
and Restated Supplemental Benefit Agreement between RTFC and Sheldon C.
Petersen, dated as of December 4, 2006.
|
|
10.5
|
-
|
First
Amendment to Amended and Restated Supplemental Agreement between Rural
Telephone Finance Cooperative and Sheldon C. Petersen, effective as of
January 1, 2008. Incorporated by reference to Exhibit 10.5 to
National Rural’s Form 10-Q filed on January 11, 2008.
|
|
10.6
|
-
|
Employment
Contract between National Rural and John T. Evans, dated as of September
17, 1997 including termination of employment
arrangement. Incorporated by reference to Exhibit 10.4 to
National Rural’s Form 10-K filed on August 27, 2007.
|
|
10.7
|
-
|
Agreement
of Purchase and Sale between National Rural and Loudoun Land Venture, LLC
dated as of November 28, 2007. Exhibit C to the Agreement of
Purchase and Sale has been omitted and will be furnished supplementally to
the Securities and Exchange Commission upon
request. Incorporated by reference to Exhibit 10.6 to National
Rural’s Form 10-Q filed on January 11,
2008.
|
|
10.8
|
-
|
First
Amendment to Agreement of Purchase and Sale between National Rural and
Loudoun Land Venture, LLC dated as of December 17,
2007. Incorporated by reference to Exhibit 10.7 to National
Rural’s Form 10-Q filed on January 11, 2008.
|
|
10.9
|
-
|
Second
Amendment to Agreement of Purchase and Sale between National Rural and
Loudoun Land Venture, LLC dated as of December 21,
2007. Exhibits A and C to the Second Amendment to Agreement of
Purchase and Sale have been omitted and will be furnished supplementally
to the Securities and Exchange Commission upon
request. Incorporated by reference to Exhibit 10.8 to National
Rural’s Form 10-Q filed on January 11, 2008.
|
|
10.10
|
-
|
Agreement
of Purchase and Sale between National Rural and DTC Partners, LLC dated as
of May 2, 2008. Exhibits A, E and G to the Agreement of
Purchase and Sale have been omitted and will be furnished supplementally
to the Securities and Exchange Commission upon request.
|
|
10.11
|
-
|
First
Amendment to Agreement of Purchase and Sale between National Rural and DTC
Partners, LLC dated as of June 30, 2008.
|
|
10.12
|
-
|
Second
Amendment to Agreement of Purchase and Sale between National Rural and DTC
Partners, LLC dated as of July 29, 2008.
|
|
12
|
-
|
Computations
of ratio of margins to fixed charges.
|
|
14.1
|
-
|
Ethics
Policy for CEO and Senior Financial Officers. Incorporated by
reference to Exhibit 14.1 to National Rural’s Form 10-Q filed on October
14, 2004.
|
|
23
|
-
|
Consent
of Deloitte & Touche LLP.
|
|
31.1
|
-
|
Certification
of the Chief Executive Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2
|
-
|
Certification
of the Chief Financial Officer required by Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
32.1
|
-
|
Certification
of the Chief Executive Officer required by Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
32.2
|
-
|
Certification
of the Chief Financial Officer required by Section 906 of the
Sarbanes-Oxley Act of 2002.
|
SIGNATURES
Pursuant to the requirements of
Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned, thereunto
duly authorized, in the County of Fairfax, Commonwealth of Virginia, on the
29th
day of August 2008.
NATIONAL RURAL UTILITIES
COOPERATIVE
FINANCE CORPORATION
By: /s/ SHELDON C.
PETERSEN
Sheldon C. Petersen
Governor and Chief Executive
Officer
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the date indicated.
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
|
|
/s/ SHELDON
C. PETERSEN
|
|
Governor
and Chief Executive Officer
|
|
|
|
Sheldon
C. Petersen
|
|
|
|
|
|
|
|
|
|
|
|
/s/ STEVEN
L. LILLY
|
|
Senior
Vice President and Chief Financial
|
|
|
|
Steven
L. Lilly
|
|
Officer
|
|
|
|
|
|
|
|
|
|
/s/ ROBERT
E. GEIER
|
|
Vice
President and Controller
|
|
|
|
Robert
E. Geier
|
|
|
|
|
|
|
|
|
|
|
|
/s/ ROGER
ARTHUR
|
|
President
and Director
|
|
|
|
Roger
Arthur
|
|
|
|
|
|
|
|
|
|
|
|
/s/ DARRYL
SCHRIVER
|
|
Vice
President and Director
|
|
|
|
Darryl
Schriver
|
|
|
|
|
|
|
|
|
|
|
|
/s/ REUBEN
MCBRIDE
|
|
Secretary-Treasurer
and Director
|
|
|
|
Reuben
McBride
|
|
|
|
|
|
|
|
|
|
|
|
/s/ FRED
ANDERSON
|
|
Director
|
|
|
|
Fred
Anderson
|
|
|
|
|
|
|
|
|
|
|
|
/s/ ROGER
A. BALL
|
|
Director
|
|
August
29, 2008
|
|
Roger
A. Ball
|
|
|
|
|
|
|
|
|
|
|
|
/s/ RAPHAEL
A. BRUMBELOE
|
|
Director
|
|
|
|
Raphael
A. Brumbeloe
|
|
|
|
|
|
|
|
|
|
|
|
/s/ DELBERT
CRANFORD
|
|
Director
|
|
|
|
Delbert
Cranford
|
|
|
|
|
|
|
|
|
|
|
|
/s/ JIM
L. DOERSTLER
|
|
Director
|
|
|
|
Jim
L. Doerstler
|
|
|
|
|
|
|
|
|
|
|
|
/s/ JIMMY
EWING, JR.
|
|
Director
|
|
|
|
Jimmy
Ewing, Jr.
|
|
|
|
|
|
|
|
|
|
|
|
/s/ HAROLD
FOLEY
|
|
Director
|
|
|
|
Harold
Foley
|
|
|
|
|
|
|
|
|
|
|
|
/s/ STEVEN
J. HAAVEN
|
|
Director
|
|
|
|
Steven
J. Haaven
|
|
|
|
|
|
|
|
|
|
|
|
Signature
|
|
Title
|
|
Date
|
|
|
|
|
|
|
|
/s/ JIM
HERRON
|
|
Director
|
|
|
|
Jim
Herron
|
|
|
|
|
|
|
|
|
|
|
|
/s/ MARTIN
HILLERT, JR.
|
|
Director
|
|
|
|
Martin
Hillert, Jr.
|
|
|
|
|
|
|
|
|
|
|
|
/s/ WILLIAM
A. KOPACZ
|
|
Director
|
|
|
|
William
A. Kopacz
|
|
|
|
|
|
|
|
|
|
|
|
/s/ BURNS
E. MERCER
|
|
Director
|
|
|
|
Burns
E. Mercer
|
|
|
|
|
|
|
|
|
|
|
|
/s/ GALE
RETTKOWSKI
|
|
Director
|
|
August
29, 2008
|
|
Gale
Rettkowski
|
|
|
|
|
|
|
|
|
|
|
|
/s/ DWIGHT
ROSSOW
|
|
Director
|
|
|
|
Dwight
Rossow
|
|
|
|
|
|
|
|
|
|
|
|
/s/ RONALD
P. SALYER
|
|
Director
|
|
|
|
Ronald
P. Salyer
|
|
|
|
|
|
|
|
|
|
|
|
/s/ R.
WAYNE STRATTON
|
|
Director
|
|
|
|
R.
Wayne Stratton
|
|
|
|
|
|
|
|
|
|
|
|
/s/ J.
DAVID WASSON, JR.
|
|
Director
|
|
|
|
J.
David Wasson, Jr.
|
|
|
|
|
|
|
|
|
|
|
|
/s/ CHARLES
WAYNE WHITAKER
|
|
Director
|
|
|
|
Charles
Wayne Whitaker
|
|
|
|
|
|
|
|
|
|
|
|
/s/ JACK
F. WOLFE, JR.
|
|
Director
|
|
|
|
Jack
F. Wolfe, Jr.
|
|
|
|
|
|
|
|
|
|
|
|
/s/ F.
E. WOLSKI
|
|
Director
|
|
|
|
F.
E. Wolski
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the
Board of Directors and Members of
National
Rural Utilities Cooperative Finance Corporation
Herndon,
Virginia
We have
audited the accompanying consolidated balance sheets of National Rural Utilities
Cooperative Finance Corporation and subsidiaries (the "Company") as of May 31,
2008 and 2007, and the related consolidated statements of operations, changes in
equity, and cash flows for each of the three years in the period ended May 31,
2008. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on the financial
statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that
we plan and perform the audit to obtain reasonable assurance about whether the
financial statements are free of material misstatement. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion.
An audit also includes examining, on a test basis, evidence supporting the
amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our
opinion, such consolidated financial statements present fairly, in all material
respects, the financial position of National Rural Utilities Cooperative Finance
Corporation and subsidiaries as of May 31, 2008 and 2007, and the results of
their operations and their cash flows for
each of the three years in the period ended May 31, 2008, in conformity
with accounting principles generally accepted in the United States of
America.
/s/
DELOITTE & TOUCHE LLP
McLean,
Virginia
August
27, 2008
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
BALANCE SHEETS
May
31, 2008 and 2007
(in
thousands)
A
S S E T S
|
|
2008
|
|
|
|
2007
|
|
|
Cash
and cash equivalents
|
$
|
177,809
|
|
|
$
|
304,107
|
|
|
|
|
|
|
|
|
|
|
|
Restricted
cash
|
|
14,460
|
|
|
|
2,032
|
|
|
|
|
|
|
|
|
|
|
|
Loans
to members
|
|
19,029,040
|
|
|
|
18,131,873
|
|
|
Less: Allowance
for loan losses
|
|
(514,906
|
)
|
|
|
(561,663
|
)
|
|
Loans
to members, net
|
|
18,514,134
|
|
|
|
17,570,210
|
|
|
|
|
|
|
|
|
|
|
|
Accrued
interest and other receivables
|
|
258,315
|
|
|
|
291,637
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
assets, net
|
|
21,045
|
|
|
|
4,555
|
|
|
|
|
|
|
|
|
|
|
|
Debt
service reserve funds
|
|
54,993
|
|
|
|
54,993
|
|
|
|
|
|
|
|
|
|
|
|
Bond
issuance costs, net
|
|
39,618
|
|
|
|
45,611
|
|
|
|
|
|
|
|
|
|
|
|
Foreclosed
assets
|
|
58,961
|
|
|
|
66,329
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
assets
|
|
220,514
|
|
|
|
222,774
|
|
|
|
|
|
|
|
|
|
|
|
Other
assets
|
|
19,532
|
|
|
|
12,933
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
19,379,381
|
|
|
$
|
18,575,181
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
BALANCE SHEETS
May
31, 2008 and 2007
(in
thousands)
L
I A B I L I T I E S A N D E Q U I T
Y
|
|
|
2008
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
Short-term
debt
|
|
$
|
6,327,453
|
|
|
$
|
4,427,123
|
|
|
|
|
|
|
|
|
|
|
Accrued
interest payable
|
|
|
244,299
|
|
|
|
281,458
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
10,173,587
|
|
|
|
11,295,219
|
|
|
|
|
|
|
|
|
|
|
Deferred
income
|
|
|
21,971
|
|
|
|
27,990
|
|
|
|
|
|
|
|
|
|
|
Guarantee
liability
|
|
|
15,034
|
|
|
|
18,929
|
|
|
|
|
|
|
|
|
|
|
Other
liabilities
|
|
|
27,216
|
|
|
|
27,611
|
|
|
|
|
|
|
|
|
|
|
Derivative
liabilities
|
|
|
171,390
|
|
|
|
71,934
|
|
|
|
|
|
|
|
|
|
|
Subordinated
deferrable debt
|
|
|
311,440
|
|
|
|
311,440
|
|
|
|
|
|
|
|
|
|
|
Members'
subordinated certificates:
|
|
|
|
|
|
|
|
|
Membership
subordinated certificates
|
|
|
649,465
|
|
|
|
649,424
|
|
Loan
and guarantee subordinated certificates
|
|
|
757,314
|
|
|
|
732,023
|
|
Total
members' subordinated certificates
|
|
|
1,406,779
|
|
|
|
1,381,447
|
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
|
14,247
|
|
|
|
21,989
|
|
|
|
|
|
|
|
|
|
|
Equity:
|
|
|
|
|
|
|
|
|
Retained
equity
|
|
|
657,138
|
|
|
|
697,837
|
|
Accumulated
other comprehensive income
|
|
|
8,827
|
|
|
|
12,204
|
|
Total
equity
|
|
|
665,965
|
|
|
|
710,041
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
19,379,381
|
|
|
$
|
18,575,181
|
|
|
|
|
|
|
|
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
STATEMENTS OF OPERATIONS
(in
thousands)
For
the Years Ended May 31, 2008, 2007 and 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
2008
|
|
|
|
2007
|
|
|
|
2006
|
Interest
income
|
$
|
1,069,540
|
|
|
$
|
1,054,224
|
|
|
$
|
1,007,912
|
|
Interest
expense
|
|
(936,889
|
)
|
|
|
(996,730
|
)
|
|
|
(975,936
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
132,651
|
|
|
|
57,494
|
|
|
|
31,976
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recovery
of (provision for) loan losses
|
|
30,262
|
|
|
|
6,922
|
|
|
|
(23,240
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income after recovery of (provision for) loan
losses
|
|
162,913
|
|
|
|
64,416
|
|
|
|
8,736
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
1,461
|
|
|
|
1,533
|
|
|
|
2,398
|
|
Derivative
cash settlements
|
|
27,033
|
|
|
|
86,442
|
|
|
|
80,883
|
|
Results
of operations of foreclosed assets
|
|
7,528
|
|
|
|
9,758
|
|
|
|
15,492
|
|
Gain
on sale of building and land
|
|
-
|
|
|
|
-
|
|
|
|
43,431
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-interest income
|
|
36,022
|
|
|
|
97,733
|
|
|
|
142,204
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
(36,428
|
)
|
|
|
(33,817
|
)
|
|
|
(31,494
|
)
|
Other
general and administrative expenses
|
|
(24,041
|
)
|
|
|
(18,072
|
)
|
|
|
(20,595
|
)
|
Recovery
of guarantee liability
|
|
3,104
|
|
|
|
1,700
|
|
|
|
700
|
|
Market
adjustment of foreclosed assets
|
|
(5,840
|
)
|
|
|
-
|
|
|
|
-
|
|
Derivative
forward value
|
|
(98,743
|
)
|
|
|
(79,281
|
)
|
|
|
28,805
|
|
Foreign
currency adjustments
|
|
-
|
|
|
|
(14,554
|
)
|
|
|
(22,594
|
)
|
Loss
on sale of loans
|
|
(676
|
)
|
|
|
(1,584
|
)
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-interest expense
|
|
(162,624
|
)
|
|
|
(145,608
|
)
|
|
|
(45,178
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
prior to income taxes and minority interest
|
|
36,311
|
|
|
|
16,541
|
|
|
|
105,762
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit (expense)
|
|
3,335
|
|
|
|
(2,396
|
)
|
|
|
(3,176
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
prior to minority interest
|
|
39,646
|
|
|
|
14,145
|
|
|
|
102,586
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest, net of income taxes
|
|
6,099
|
|
|
|
(2,444
|
)
|
|
|
(7,089
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
$
|
45,745
|
|
|
$
|
11,701
|
|
|
$
|
95,497
|
|
|
|
|
|
|
|
|
|
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
STATEMENTS OF CHANGES IN EQUITY
(in
thousands)
For
the Years Ended May 31, 2008, 2007 and 2006
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Patronage
Capital
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
Allocated
|
|
|
|
|
Other
|
|
Subtotal
|
|
|
|
|
|
|
|
Members'
|
|
General
|
|
|
|
|
|
|
Comprehensive
|
|
Retained
|
|
Membership
|
|
Unallocated
|
|
Education
|
|
Capital
|
|
Reserve
|
|
|
|
|
Total
|
|
(Loss)
Income
|
|
Equity
|
|
Fees
|
|
Net
Income
|
|
Fund
|
|
Reserve
|
|
Fund
|
|
Other
|
Balance
as of May 31, 2005
|
$
|
764,934
|
|
$
|
15,621
|
|
|
$
|
749,313
|
|
|
$
|
993
|
|
|
$
|
225,730
|
|
|
$
|
1,200
|
|
|
$
|
164,067
|
|
$
|
497
|
|
|
$
|
356,826
|
|
Patronage
capital retirement
|
|
(72,912
|
)
|
|
-
|
|
|
|
(72,912
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
(72,912
|
)
|
Income
prior to income taxes and minority interest
|
|
105,762
|
|
|
-
|
|
|
|
105,762
|
|
|
|
-
|
|
|
|
10,384
|
|
|
|
780
|
|
|
|
-
|
|
|
-
|
|
|
|
94,598
|
|
Other
comprehensive loss
|
|
(2,413
|
)
|
|
(2,413
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Income
tax expense
|
|
(3,176
|
)
|
|
-
|
|
|
|
(3,176
|
)
|
|
|
-
|
|
|
|
(3,176
|
)
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Minority
interest
|
|
(7,089
|
)
|
|
-
|
|
|
|
(7,089
|
)
|
|
|
-
|
|
|
|
(7,089
|
)
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Other
|
|
(698
|
)
|
|
-
|
|
|
|
(698
|
)
|
|
|
1
|
|
|
|
-
|
|
|
|
(699
|
)
|
|
|
(7,223
|
)
|
|
-
|
|
|
|
7,223
|
|
Balance
as of May 31, 2006
|
$
|
784,408
|
|
$
|
13,208
|
|
|
$
|
771,200
|
|
|
$
|
994
|
|
|
$
|
225,849
|
|
|
$
|
1,281
|
|
|
$
|
156,844
|
|
$
|
497
|
|
|
$
|
385,735
|
|
Patronage
capital retirement
|
|
(84,247
|
)
|
|
-
|
|
|
|
(84,247
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
(84,247
|
)
|
Income
prior to income taxes and minority interest
|
|
16,541
|
|
|
-
|
|
|
|
16,541
|
|
|
|
-
|
|
|
|
(89,481
|
)
|
|
|
945
|
|
|
|
1,464
|
|
|
1
|
|
|
|
103,612
|
|
Other
comprehensive loss
|
|
(1,004
|
)
|
|
(1,004
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Income
tax expense
|
|
(2,396
|
)
|
|
-
|
|
|
|
(2,396
|
)
|
|
|
-
|
|
|
|
(2,396
|
)
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Minority
interest
|
|
(2,444
|
)
|
|
-
|
|
|
|
(2,444
|
)
|
|
|
-
|
|
|
|
(2,444
|
)
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Other
|
|
(817
|
)
|
|
-
|
|
|
|
(817
|
)
|
|
|
3
|
|
|
|
-
|
|
|
|
(820
|
)
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Balance
as of May 31, 2007
|
$
|
710,041
|
|
$
|
12,204
|
|
|
$
|
697,837
|
|
|
$
|
997
|
|
|
$
|
131,528
|
|
|
$
|
1,406
|
|
|
$
|
158,308
|
|
$
|
498
|
|
|
$
|
405,100
|
|
Patronage
capital retirement
|
|
(85,494
|
)
|
|
-
|
|
|
|
(85,494
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
(85,494
|
)
|
Income
prior to income taxes and minority interest
|
|
36,311
|
|
|
-
|
|
|
|
36,311
|
|
|
|
-
|
|
|
|
(96,959
|
)
|
|
|
1,024
|
|
|
|
29,061
|
|
|
(2
|
)
|
|
|
103,187
|
|
Other
comprehensive loss
|
|
(3,377
|
)
|
|
(3,377
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Income
tax benefit
|
|
3,335
|
|
|
-
|
|
|
|
3,335
|
|
|
|
-
|
|
|
|
3,335
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Minority
interest
|
|
6,099
|
|
|
-
|
|
|
|
6,099
|
|
|
|
-
|
|
|
|
6,099
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
Other
|
|
(950
|
)
|
|
-
|
|
|
|
(950
|
)
|
|
|
(4
|
)
|
|
|
-
|
|
|
|
(946
|
)
|
|
|
40
|
|
|
-
|
|
|
|
(40
|
)
|
Balance
as of May 31, 2008
|
$
|
665,965
|
|
$
|
8,827
|
|
|
$
|
657,138
|
|
|
$
|
993
|
|
|
$
|
44,003
|
|
|
$
|
1,484
|
|
|
$
|
187,409
|
|
$
|
496
|
|
|
$
|
422,753
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands)
For
the Years Ended May 31, 2008, 2007 and 2006
|
2008
|
|
2007
|
|
2006
|
CASH
FLOWS FROM OPERATING ACTIVITIES:
|
|
|
Net
income
|
$
|
45,745
|
|
$
|
11,701
|
|
$
|
95,497
|
|
Add
(deduct):
|
|
|
|
|
|
|
|
|
|
Amortization
of deferred income
|
|
(6,954
|
)
|
|
(12,248
|
)
|
|
(14,444
|
)
|
Amortization
of bond issuance costs and deferred charges
|
|
16,241
|
|
|
17,406
|
|
|
12,124
|
|
Depreciation
|
|
2,274
|
|
|
2,182
|
|
|
2,154
|
|
(Recovery
of) provision for loan losses
|
|
(30,262
|
)
|
|
(6,922
|
)
|
|
23,240
|
|
Recovery
of guarantee liability
|
|
(3,104
|
)
|
|
(1,700
|
)
|
|
(700
|
)
|
Results
of operations of foreclosed assets
|
|
(7,528
|
)
|
|
(9,758
|
)
|
|
(15,492
|
)
|
Market
adjustment on foreclosed assets
|
|
5,840
|
|
|
-
|
|
|
-
|
|
Derivative
forward value
|
|
98,743
|
|
|
79,281
|
|
|
(28,805
|
)
|
Foreign
currency adjustments
|
|
-
|
|
|
14,554
|
|
|
22,594
|
|
Gain
on sale of building and land
|
|
-
|
|
|
-
|
|
|
(43,431
|
)
|
Loss
on sale of loans
|
|
676
|
|
|
1,584
|
|
|
-
|
|
Restricted
interest earned on restricted cash
|
|
(123
|
)
|
|
-
|
|
|
-
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
Accrued
interest and other receivables
|
|
24,816
|
|
|
27,203
|
|
|
(12,626
|
)
|
Accrued
interest payable
|
|
(37,159
|
)
|
|
(21,501
|
)
|
|
28,895
|
|
Other
|
|
(7,696
|
)
|
|
(702
|
)
|
|
4,902
|
|
Net
cash provided by operating activities
|
|
101,509
|
|
|
101,080
|
|
|
73,908
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Advances
made on loans
|
|
(8,013,327
|
)
|
|
(7,228,143
|
)
|
|
(6,162,154
|
)
|
Principal
collected on loans
|
|
7,019,075
|
|
|
7,052,334
|
|
|
6,768,252
|
|
Net
investment in fixed assets
|
|
(17,253
|
)
|
|
(591
|
)
|
|
(4,665
|
)
|
Net
cash provided by foreclosed assets
|
|
9,056
|
|
|
63,831
|
|
|
6,401
|
|
Net
proceeds from sale of foreclosed assets
|
|
-
|
|
|
487
|
|
|
29,152
|
|
Net
proceeds from sale of building and land
|
|
-
|
|
|
-
|
|
|
83,428
|
|
Net
proceeds from sale of loans
|
|
73,972
|
|
|
364,100
|
|
|
-
|
|
Change
in restricted cash
|
|
(12,428
|
)
|
|
-
|
|
|
-
|
|
Net
cash (used in) provided by investing activities
|
|
(940,905
|
)
|
|
252,018
|
|
|
720,414
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS FROM FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
|
Proceeds
from (repayments of) issuances of short-term debt, net
|
|
265,645
|
|
|
(470,591
|
)
|
|
(1,005,995
|
)
|
Proceeds
from issuance of long-term debt, net
|
|
2,061,744
|
|
|
2,066,332
|
|
|
3,792,566
|
|
Payments
for retirement of long-term debt
|
|
(1,380,423
|
)
|
|
(1,645,848
|
)
|
|
(3,580,731
|
)
|
Payments
for retirement of subordinated deferrable debt
|
|
(175,000
|
)
|
|
(150,000
|
)
|
|
(48,560
|
)
|
Proceeds
from issuance of members' subordinated certificates
|
|
76,589
|
|
|
45,605
|
|
|
77,081
|
|
Payments
for retirement of members' subordinated certificates
|
|
(48,308
|
)
|
|
(68,319
|
)
|
|
(113,819
|
)
|
Payments
for retirement of patronage capital
|
|
(77,378
|
)
|
|
(74,094
|
)
|
|
(57,328
|
)
|
Payments
for retirement of RTFC patronage capital
|
|
(9,771
|
)
|
|
(12,414
|
)
|
|
(15,712
|
)
|
Net
cash provided by (used in) financing activities
|
|
713,098
|
|
|
(309,329
|
)
|
|
(952,498
|
)
|
|
|
|
|
|
|
|
|
|
|
NET
(DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS
|
|
(126,298
|
)
|
|
43,769
|
|
|
(158,176
|
)
|
BEGINNING
CASH AND CASH EQUIVALENTS
|
|
304,107
|
|
|
260,338
|
|
|
418,514
|
|
ENDING
CASH AND CASH EQUIVALENTS
|
$
|
177,809
|
|
$
|
304,107
|
|
$
|
260,338
|
|
|
|
|
|
|
|
|
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(in
thousands)
For
the Years Ended May 31, 2008, 2007 and 2006
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
|
|
Cash
paid during year for interest
|
$
|
957,806
|
|
$
|
1,000,826
|
|
$
|
945,303
|
|
Cash
paid for income taxes
|
|
1,429
|
|
|
1,376
|
|
|
760
|
|
Non-cash
financing and investing activities:
|
|
|
|
|
|
|
|
|
|
Patronage
capital applied against loan balances
|
$
|
-
|
|
$
|
-
|
|
$
|
1,829
|
|
Minority
interest patronage capital applied against loan balances
|
|
-
|
|
|
-
|
|
|
1,689
|
|
Net
decrease in debt service reserve funds/debt service
|
|
|
|
|
|
|
|
|
|
reserve
certificates
|
|
-
|
|
|
(25,166
|
)
|
|
(13,023
|
)
|
|
|
|
|
|
|
|
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
(1) General
Information and Accounting Policies
(a) General
Information
National
Rural Utilities Cooperative Finance Corporation ("National Rural" or "the
Company") is a private, not-for-profit cooperative association incorporated
under the laws of the District of Columbia in April 1969. The
principal purpose of National Rural is to provide its members with a source of
financing to supplement the loan programs of the Rural Utilities Service ("RUS")
of the United States Department of Agriculture. National Rural makes
loans to its rural utility system members ("utility members") to enable them to
acquire, construct and operate electric distribution, generation, transmission
and related facilities. National Rural also provides its members with
credit enhancements in the form of letters of credit and guarantees of debt
obligations. National Rural is exempt from payment of federal income
taxes under the provisions of Section 501(c)(4) of the Internal Revenue
Code. National Rural is a not-for-profit member-owned finance
cooperative, thus its objective is not to maximize its net income, but to offer
its members low cost financial products and services consistent with sound
financial management.
Rural
Telephone Finance Cooperative ("RTFC") was incorporated as a private
not-for-profit cooperative association in the state of South Dakota in September
1987. In February 2005, RTFC reincorporated as a not-for-profit
cooperative association in the District of Columbia. The principal
purpose of RTFC is to provide and arrange financing for its rural
telecommunications members and their affiliates. RTFC's results of
operations and financial condition are consolidated with those of National Rural
in the accompanying financial statements. RTFC is headquartered with
National Rural in Herndon, Virginia. RTFC is a taxable cooperative
that pays income tax based on its net income, excluding net income allocated to
its members, as allowed by law under Subchapter T of the Internal Revenue
Code.
National
Cooperative Services Corporation ("NCSC") was incorporated in 1981 in the
District of Columbia as a private non-profit cooperative
association. The principal purpose of NCSC is to provide financing to
the for-profit or non-profit entities that are owned, operated or controlled by
or provide substantial benefit to, members of National Rural. NCSC
also markets, through its cooperative members, a consumer loan program for home
improvements and an affinity credit card program. NCSC's membership
consists of National Rural and distribution systems that are members of National
Rural or are eligible for such membership. NCSC's results of
operations and financial condition are consolidated with those of National Rural
in the accompanying financial statements. NCSC is headquartered with
National Rural in Herndon, Virginia. NCSC is a taxable
corporation.
The
Company's consolidated membership was 1,538 as of May 31, 2008 including 898
utility members, the majority of which are consumer-owned electric cooperatives,
511 telecommunications members, 66 service members and 63 associates in 49
states, the District of Columbia and two U.S. territories. The
utility members included 829 distribution systems and 69 generation and
transmission ("power supply") systems. Memberships among National
Rural, RTFC and NCSC have been eliminated in consolidation. All
references to members within this document include members and
associates.
(b) Principles
of Consolidation
The
accompanying financial statements include the consolidated accounts of National
Rural, RTFC and NCSC and certain entities controlled by National Rural and
created to hold foreclosed assets and effect loan securitization transactions,
after elimination of intercompany accounts and
transactions. Financial Accounting Standards Board ("FASB")
Interpretation No. ("FIN") 46(R), Consolidation of Variable Interest Entities,
an interpretation of Accounting Research Bulletin (“ARB”) No. 51, requires
National Rural to consolidate the financial results of RTFC and
NCSC. National Rural is the primary beneficiary of variable interests
in RTFC and NCSC due to its exposure to absorbing the majority of expected
losses.
National
Rural is the sole lender to and manages the lending and financial affairs of
RTFC through a management agreement in effect through December 1,
2016. Under a guarantee agreement, RTFC pays National Rural a fee in
exchange for which National Rural reimburses RTFC for loan
losses. All loans that require RTFC board approval also require
National Rural approval. National Rural is not a member of RTFC and does not
elect directors to the RTFC board. RTFC has a non-voting associate
relationship with National Rural.
National
Rural is the primary source of funding to and manages the lending and financial
affairs of NCSC through a management agreement which is automatically renewable
on an annual basis unless terminated by either party. NCSC funds its
programs either through loans from National Rural or commercial paper and
long-term notes issued by NCSC and guaranteed by National Rural. In
connection with these guarantees, NCSC must pay a guarantee fee and purchase
from National Rural interest-bearing subordinated term certificates in
proportion to the related guarantee. Under a guarantee agreement,
NCSC pays National Rural a fee in exchange for which National Rural reimburses
NCSC for loan losses, excluding losses in the
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
consumer
loan program. All loans that require NCSC board approval also require
National Rural approval. National Rural controls the nomination
process for one out of 11 NCSC directors. The full membership of NCSC
elects directors on the basis of one vote for each member. NCSC is a
service organization member of National Rural.
RTFC and
NCSC creditors have no recourse against National Rural in the event of a default
by RTFC and NCSC, unless there is a guarantee agreement under which National
Rural has guaranteed NCSC or RTFC debt obligations to a third
party. At May 31, 2008, National Rural had guaranteed $265 million of
NCSC debt and derivative instruments with third parties. The
maturities for NCSC debt guaranteed by National Rural run through
2022. As of May 31, 2008, National Rural's maximum potential exposure
totaled $281 million related to guarantees of NCSC debt and
derivatives. Guarantees related to NCSC debt and derivative
instruments are not included in Note 13 at May 31, 2008 as the debt and
derivatives are reported on the consolidated balance sheet. At May
31, 2008, National Rural had no guarantees of RTFC debt to third party
creditors. All National Rural loans to RTFC and NCSC are secured by
all assets and revenues of RTFC and NCSC. At May 31, 2008, RTFC had
total assets of $1,909 million including loans outstanding to members of $1,727
million and NCSC had total assets of $458 million including loans outstanding of
$414 million. At May 31, 2008 and 2007, National Rural had committed
to lend RTFC up to $4 billion of which $2 billion was outstanding at both period
ends. At May 31, 2008, National Rural had committed to provide credit
to NCSC of up to $1 billion. At May 31, 2008, National Rural had
provided a total of $450 million of credit to NCSC, representing $185 million of
outstanding loans and $265 million of credit enhancements.
National
Rural established limited liability corporations and partnerships to hold
foreclosed assets and effect loan securitization
transactions. National Rural has full ownership and control of
all such companies and thus consolidates their financial
results. National Rural presents the companies formed to hold
foreclosed assets in one line on the consolidated balance sheets and the
consolidated statements of operations. A full consolidation is
presented for the company formed to effect loan securitization
transactions.
Unless
stated otherwise, references to the Company relate to the consolidation of
National Rural, RTFC, NCSC and certain entities controlled by National Rural and
created to hold foreclosed assets and effect loan securitization
transactions.
In
accordance with ARB 51, the Company presents the amount of subsidiary equity
controlled by RTFC and NCSC as minority interest on the consolidated balance
sheet and the subsidiary earnings controlled by RTFC and NCSC as minority
interest on the consolidated statement of operations.
|
(c)
|
Cash
and Cash Equivalents
|
The
Company includes cash, certificates of deposit and other investments with
remaining maturities of less than 90 days as cash and cash
equivalents.
Restricted
cash represents cash and cash equivalents for which use is contractually
restricted. Restricted cash is disclosed separately on the balance
sheet. At May 31, 2008, the Company has four different contractual
restrictions on the use of certain cash. Three of the restricted cash
accounts totaling $12 million are related to the issuance of the Clean Renewable
Energy Bonds (“CREBs”) in February 2008. The fourth restricted cash
account represents cash pledged as collateral for collateral trust bonds issued
under the Company’s 1972 indenture. At May 31, 2007, the $2 million
of cash pledged as collateral under the 1972 indenture was the only restricted
cash, which was classified in other assets due to immateriality.
Restricted
cash at May 31, 2008 represents:
·
|
cash
proceeds from the issuance of CREBs that may only be used for the funding
of CREBs loan advances to participating members to reimburse them for
costs related to qualifying
projects;
|
·
|
cash
proceeds from the issuance of CREBs that may only be used to reimburse the
Company for the costs of issuing the
CREBs;
|
·
|
cash
from principal payments from members on CREBs loans that may only be used
to make debt service payments to bond investors;
and
|
·
|
cash
held as collateral for the Company’s collateral trust bonds issued under
the 1972 indenture.
|
The
Company uses the proceeds from the issuance of CREBs to make loans to borrowers
for the construction, refinancing, and reimbursement of capital expenditures
related to qualified projects. These funds may be invested by the
Company. The interest earned is restricted and may only be used to
fund qualifying projects.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The
Company also uses the proceeds from the issuance of CREBs to cover all costs
associated with the issuance of the CREBs. These funds are held by
the trustee and may only be released to the Company to cover the cost of
issuance. The Company must submit invoices to support the issuance
costs for which it is seeking reimbursement. These funds may be
invested by the Company. The interest earned is restricted and may
only be used to cover issuance expenses and to fund qualifying
projects.
The
Company collects principal and interest payments from borrowers
quarterly. The Company may withdraw the interest collected on CREBs
loans at any time. The principal collected on CREBs loans may only be
used to repay principal to bond investors. These funds may be
invested by the Company. The interest earned is not restricted and
may be withdrawn by the Company at any time.
At May
31, 2008 and 2007, $2 million of cash was pledged to secure the Company’s
collateral trust bonds under the 1972 indenture. This cash is
classified in restricted cash because the funds are pledged with the Company’s
collateral trust bond trustee. These funds may be invested by the
Company. The interest earned is not restricted and may be withdrawn
by the Company at any time.
Interest
for which use is contractually restricted earned on restricted cash accounts is
presented as an investing activity in the statement of cash
flows. Interest for which use is not contractually restricted on
restricted cash accounts is presented as an operating activity in the statement
of cash flows. Changes in the principal balances of restricted cash
accounts are reported as investing activities in the statement of cash
flows.
(e) Loan
Securitizations
The
Company accounts for the sale of loans in securitization transactions according
to the provisions of Statement of Financial Accounting Standards ("SFAS") 140,
Accounting for Transfers and Servicing of Financial Assets and Extinguishments
of Liabilities, as amended. The Company derecognizes financial assets
when control has been surrendered. The Company has no retained
interest in securitized loans. The Company services the loans in
return for a market fee and therefore does not record a servicing asset or
liability. The Company recognizes the service fee on an accrual basis
over the period for which servicing activity is provided. Deferred
transactions costs and unamortized deferred loan origination costs related to
the loans sold are included in the calculation of the gain or loss on the
sale.
(f) Allowance
for Loan Losses
The
Company maintains an allowance for loan losses at a level estimated by
management to provide for probable losses inherent in the loan portfolio, which
are estimated based upon a review of the loan portfolio, past loss experience,
specific problem loans, economic conditions and other pertinent factors which,
in management's judgment, deserve current recognition in estimating loan losses.
On a quarterly basis, the Company prepares an analysis of the loan loss
allowance and makes adjustments to the allowance as necessary. The
allowance is based on estimates and, accordingly, actual loan losses may differ
from the allowance amount.
Management
makes recommendations of loans to be written off to the board of directors of
National Rural. In making its recommendation to write off all or a
portion of a loan balance, management considers various factors including cash
flow analysis and collateral securing the borrower's loans.
Activity
in the loan loss allowance account is summarized below for the years ended May
31:
(in
thousands)
|
|
2008
|
|
|
|
2007
|
|
|
2006
|
|
|
|
Balance
at beginning of year
|
$
|
561,663
|
|
|
$
|
611,443
|
|
$
|
589,749
|
|
|
|
(Recovery
of) provision for loan losses
|
|
(30,262
|
)
|
|
|
(6,922
|
)
|
|
23,240
|
|
|
|
Write-offs
|
|
(16,911
|
)
|
|
|
(44,668
|
)
|
|
(2,197
|
)
|
|
|
Recoveries
|
|
416
|
|
|
|
1,810
|
|
|
651
|
|
|
|
Balance
at end of year
|
$
|
514,906
|
|
|
$
|
561,663
|
|
$
|
611,443
|
|
|
|
(g) Non-performing
Loans
The
Company classifies a borrower as non-performing when any one of the following
criteria are met:
· principal
or interest payments on any loan to the borrower are past due 90 days or
more,
· as
a result of court proceedings, repayment on the original terms is not
anticipated, or
· for
some other reason, management does not expect the timely repayment of principal
and interest.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Once a
borrower is classified as non-performing, the Company typically places the loan
on non-accrual status and reverses all accrued and unpaid
interest. The Company generally applies all cash received during the
non-accrual period to the reduction of principal, thereby foregoing interest
income recognition. The decision to return a loan to accrual status
is determined on a case by case basis.
The
Company reviews the loan portfolio on a quarterly basis for
impairments. A loan is considered to be impaired when the Company
does not expect to collect all principal and interest payments as scheduled per
the original loan terms other than an insignificant delay or an insignificant
shortfall in amount. The Company calculates impairment of loans
receivable by comparing the present value of the estimated future cash flows
associated with the loan discounted at the interest rate on the loans at the
time the loans became impaired and/or the estimated fair value of the collateral
securing the loan to the recorded investment in the loan in accordance with the
provisions of SFAS 114, Accounting by Creditors for Impairment of a Loan - an
Amendment of SFAS 5 and SFAS 15, as amended. Loss reserves are
specifically recorded based on the calculated impairment.
(i) Fixed
Assets
Land,
furniture and fixtures and related equipment are stated at cost less accumulated
depreciation and amortization of $11 million and $10 million as of May 31, 2008
and 2007, respectively. Depreciation expense ($2 million in fiscal
years 2008, 2007 and 2006) is computed primarily on the straight-line method
over estimated useful lives ranging from 2 to 40 years.
(j) Foreclosed
Assets
The
Company records foreclosed assets received in satisfaction of loan receivables
at fair value or fair value less costs to sell and maintains these assets on the
consolidated balance sheets as foreclosed assets. Generally, it is
the Company's intent to sell foreclosed assets. The Company evaluates
whether assets meet the conditions to qualify for assets held for sale under
SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets on a
case by case basis. If the foreclosed assets qualify as assets held
for sale, the Company records such assets at the lower of the carrying amount or
fair value at each reporting date with changes for the period recorded in the
consolidated statement of operations. Gains for any subsequent
increase in fair value may not exceed the cumulative loss recognized for
previous write-downs to fair value. If the assets do not qualify as
assets held for sale, the Company periodically evaluates such assets for
impairment. Any loss due to impairment for the period is recorded in
the consolidated statement of operations and establishes a new cost
basis. If applicable, no depreciation is recorded on such foreclosed
assets. The results of operations from foreclosed assets are shown
separately on the consolidated statements of operations.
(k) Derivative
Financial Instruments
The
Company is neither a dealer nor a trader in derivative financial
instruments. The Company uses interest rate, cross currency and cross
currency interest rate exchange agreements to manage its interest rate and
foreign currency exchange risk.
In
accordance with SFAS 133, Accounting for Derivative Instruments and Hedging
Activities, and SFAS 138, Accounting for Certain Derivative Instruments and
Certain Hedging Activities, an amendment of SFAS 133, the Company records
derivative instruments on the consolidated balance sheets as either an asset or
liability measured at fair value. In recording the fair value of its
derivative assets and liabilities, the Company does not net its positions under
contracts with individual counterparties. Changes in the fair value of
derivative instruments are recognized in the derivative forward value line of
the consolidated statements of operations unless specific hedge accounting
criteria are met. The change to the fair value is recorded to other
comprehensive income if cash flow hedge accounting criteria are
met. In the case of certain foreign currency exchange agreements that
meet hedge accounting criteria, the change in fair value is recorded to other
comprehensive income and then reclassified to offset the related change in the
dollar value of foreign denominated debt in the consolidated statements of
operations. The Company formally documents, designates, and assesses
the effectiveness of transactions that receive hedge accounting.
Net
settlements for derivative instruments that qualify for hedge accounting are
recorded in interest expense. The Company records net settlements
related to derivative instruments that do not qualify for hedge accounting in
derivative cash settlements.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(l) Guarantee
Liability
The
Company guarantees certain contractual obligations of its members so that they
may obtain various forms of financing. With the exception of letters of credit,
the underlying obligations may not be accelerated so long as the Company
performs under its guarantee. The Company records a guarantee liability which
represents its contingent and non-contingent exposure related to its guarantees
of its members’ debt obligations. The Company’s contingent guarantee liability
is based on management’s estimate of the Company’s exposure to losses within the
guarantee portfolio. The Company uses factors such as borrower risk
rating, remaining maturity, corporate bond default probabilities and historical
recovery rates in estimating its contingent guarantee
liability. Adjustments to the contingent guarantee liability are
recorded in the Company’s provision for guarantee losses. The Company
has recorded a non-contingent guarantee liability for all new or modified
guarantees since January 1, 2003 in accordance with FIN 45, Guarantor's
Accounting and Disclosure Requirement for Guarantees, Including Indirect
Guarantees of Indebtedness of Others (an interpretation of FASB Statements No.
5, 57, and 107 and rescission of FASB Interpretation No. 34). The
Company’s non-contingent guarantee liability represents the Company’s obligation
to stand ready to perform pursuant to the terms of its guarantees that it has
entered into since January 1, 2003. The Company’s non-contingent
obligation is estimated based on guarantee fees charged for guarantees issued,
which represents management's estimate of the fair value of its obligation to
stand ready to perform. The fees are deferred and amortized using the
straight-line method into interest income over the term of the
guarantee.
(m) Amortization
of Bond Discounts and Bond Issuance Costs
Bond
discounts and bond issuance costs are deferred and amortized as interest expense
using the effective interest method or a method approximating the effective
interest method over the initial legal maturity of each bond issue.
(n) Membership
Fees
Members
are charged a one-time membership fee based on member class. National
Rural distribution system members, power supply system members and national
associations of cooperatives pay a $1,000 membership fee. National
Rural service organization members pay a $200 membership
fee. National Rural associates pay a $1,000 fee. RTFC
voting members pay a $1,000 membership fee. RTFC associates pay a
$100 fee. NCSC members pay a $100 membership
fee. Membership fees are accounted for as members'
equity.
(o) Financial
Instruments with Off-Balance Sheet Risk
In the
normal course of business, the Company is a party to financial instruments with
off-balance sheet risk to meet the financing needs of its member
borrowers. These financial instruments include commitments to extend
credit, standby letters of credit and guarantees of members'
obligations. The expected inherent loss related to the Company’s
off-balance sheet financial instruments is covered in its guarantee
liability.
(p) Interest
Income
Interest
income includes the following for the years ended May 31:
(in
thousands)
|
|
2008
|
|
2007
|
|
2006
|
|
Interest
on long-term fixed rate loans (1)
|
|
$
|
872,488
|
|
|
$
|
833,247
|
|
|
$
|
759,618
|
|
|
Interest
on long-term variable rate loans (1)
|
|
|
86,787
|
|
|
|
114,786
|
|
|
|
153,613
|
|
|
Interest
on short-term loans (1)
|
|
|
77,145
|
|
|
|
72,632
|
|
|
|
57,636
|
|
|
Interest
on investments (2)
|
|
|
7,394
|
|
|
|
9,662
|
|
|
|
10,391
|
|
|
Conversion
fees (3)
|
|
|
6,670
|
|
|
|
9,162
|
|
|
|
14,444
|
|
|
Make-whole
and prepayment fees (4)
|
|
|
10,759
|
|
|
|
4,748
|
|
|
|
5,409
|
|
|
Commitment
and guarantee fees (5)
|
|
|
5,109
|
|
|
|
9,161
|
|
|
|
6,488
|
|
|
Other
fees
|
|
|
3,188
|
|
|
|
826
|
|
|
|
313
|
|
|
Total
interest income
|
|
|
$
|
1,069,540
|
|
|
$
|
1,054,224
|
|
|
$
|
1,007,912
|
|
|
(1)
Represents interest income on loans to members.
(2)
Represents interest income on the investment of cash.
(3)
Conversion fees are deferred and recognized using the interest method over the
remaining original loan interest rate pricing term, except for a small portion
of the total fee charged to cover administrative costs related to the
conversion, which is recognized immediately.
(4)
Make-whole and prepayment fees are charged for the early repayment of principal
in full and recognized when collected.
(5)
Commitment fees for RTFC loan commitments are, in most cases, refundable on a
prorata basis according to the amount of the loan commitment that is
advanced. Such refundable fees are deferred and then recognized on a
prorata basis based on the portion of the loan that is not advanced prior to the
expiration of the commitment. Commitment fees on National Rural loan
commitments are not refundable and are billed and recognized based on the unused
portion of committed lines of credit. Guarantee fees are charged
based on the amount, type and term of the guarantee. Guarantee fees
are deferred and amortized using the straight-line method into interest income
over the life of the guarantee.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Deferred
income on the consolidated balance sheets is comprised primarily of deferred
conversion fees totaling $20 million and $25 million at May 31, 2008 and 2007,
respectively.
(q) Interest
Expense
Interest
expense includes the following for the years ended May 31:
(in
thousands)
|
|
2008
|
|
2007
|
|
2006
|
|
Interest
expense - commercial paper and bid notes (1)
|
|
$
|
122,786
|
|
|
$
|
178,687
|
|
|
$
|
133,035
|
|
|
Interest
expense - medium-term notes (1)
|
|
|
330,193
|
|
|
|
363,760
|
|
|
|
409,454
|
|
|
Interest
expense - collateral trust bonds (1)
|
|
|
243,579
|
|
|
|
218,523
|
|
|
|
271,980
|
|
|
Interest
expense - subordinated deferrable debt (1)
|
|
|
19,663
|
|
|
|
33,089
|
|
|
|
45,349
|
|
|
Interest
expense - subordinated certificates (1)
|
|
|
48,717
|
|
|
|
47,852
|
|
|
|
47,017
|
|
|
Interest
expense - long-term private debt (1)
|
|
|
136,779
|
|
|
|
118,722
|
|
|
|
46,201
|
|
|
Debt
issuance costs (2)
|
|
|
9,605
|
|
|
|
12,328
|
|
|
|
9,662
|
|
|
Derivative
cash settlements, net (3)
|
|
|
-
|
|
|
|
-
|
|
|
|
2,278
|
|
|
Commitment
and guarantee fees (4)
|
|
|
17,915
|
|
|
|
16,023
|
|
|
|
10,595
|
|
|
Loss
(gain) on extinguishment of debt (5)
|
|
|
5,509
|
|
|
|
4,806
|
|
|
|
(1,907
|
)
|
|
Other
fees
|
|
|
2,143
|
|
|
|
2,940
|
|
|
|
2,272
|
|
|
Total
interest expense
|
|
$
|
936,889
|
|
|
$
|
996,730
|
|
|
$
|
975,936
|
|
|
|
|
(1)
Represents interest expense and the amortization of discounts on
debt.
(2)
Includes amortization of all deferred charges related to debt issuance,
principally underwriter's fees, legal fees, printing costs and comfort letter
fees. Amortization is calculated on the effective interest
method. Also includes issuance costs related to dealer commercial
paper.
(3)
Represents the net cost related to swaps that qualify for hedge accounting
treatment plus the accrual from the date of the last settlement to the current
period end.
(4)
Includes various fees related to funding activities, including fees paid to
banks participating in the Company's revolving credit agreements and fees paid
under bond guarantee agreements with RUS as part of the Rural Economic
Development Loan and Grant ("REDLG") program. Fees are recognized as incurred or
amortized on a straight-line basis over the life of the respective
agreement.
(5)
Represents the gain or loss on the early retirement of debt including the
write-off of unamortized discount, premium and issuance costs.
The
Company does not include indirect costs, if any, related to funding activities
in interest expense.
(r) Income
Taxes
While
National Rural is exempt under Section 501(c)(4) of the Internal Revenue Code,
it is subject to tax on its unrelated business taxable income. RTFC
is allowed to exclude the amount of the net income that it allocates to its
members. Approximately 99% of the RTFC net income is allocated to its
members annually. NCSC pays tax on the full amount of its net
income.
The
income tax expense recorded in the consolidated statement of operations for the
years ended May 31, 2008, 2007 and 2006 represents the income tax expense for
RTFC and NCSC at the combined federal and state of Virginia income tax rate of
approximately 38%. Additionally, any fines or penalties assessed
against RTFC and NCSC are recorded in income tax expense.
(s) Allocation
of Net Income
National
Rural is required by the District of Columbia cooperative law to have a
methodology to allocate its net income to its members. Annually,
National Rural’s board of directors allocates its net earnings, which is net
income excluding certain non-cash adjustments, to its members in the form of
patronage capital and to board approved reserves. Currently, National
Rural has two such board approved reserves, the education fund and the members'
capital reserve. National Rural allocates a small portion, less than
1%, of net earnings annually to the education fund to further the teaching of
cooperative principles as required by cooperative law. Funds from the
education fund are disbursed annually to the statewide cooperative organizations
to fund the teaching of cooperative principles in the service territories of the
cooperatives in each state. The board of directors will determine the
amount of net earnings that is allocated to the members' capital reserve, if
any. The members' capital reserve represents net earnings held by
National Rural to increase equity retention.
The net
earnings held in the members' capital reserve have not been specifically
allocated to any member, but may be allocated to individual members in the
future as patronage capital if authorized by National Rural’s board of
directors. All remaining net earnings are annually allocated to
National Rural’s members in the form of patronage capital. National
Rural bases the amount of net earnings allocated to each member on the members'
patronage of the National Rural lending programs
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
in the
year in which such net earnings were reported. There is no impact on
National Rural’s total equity as a result of allocating net earnings to members
in the form of patronage capital or to board approved
reserves. National Rural’s board of directors has annually voted to
retire a portion of the patronage capital allocated to members in prior
years. National Rural’s total equity is reduced by the amount of
patronage capital retired to its members and by disbursements from the education
fund.
(t) Comprehensive
Income
Comprehensive
income includes the Company's net income, as well as other comprehensive income
related to derivatives. Comprehensive income for the years ended May
31, 2008, 2007 and 2006 is calculated as follows:
(in
thousands)
|
|
2008
|
|
2007
|
|
2006
|
|
Net
income
|
|
$
|
45,745
|
|
|
$
|
11,701
|
|
|
$
|
95,497
|
|
|
Other
comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized
loss on derivatives
|
|
|
-
|
|
|
|
-
|
|
|
|
(2,639
|
)
|
|
Reclassification
adjustment for realized (gains) losses on derivatives
|
|
|
(3,377
|
)
|
|
|
(1,004
|
)
|
|
|
226
|
|
|
Comprehensive
income
|
|
$
|
42,368
|
|
|
$
|
10,697
|
|
|
$
|
93,084
|
|
|
(u) Operating
Lease Obligations
On
October 18, 2005, the Company entered into an agreement to lease 107,228 square
feet of office, meeting and storage space in two office buildings located in
Herndon, Virginia. The lease is for three years, terminating on
October 17, 2008. In September 2007, the Company exercised the
option to extend the lease for an additional one-year period. The
Company has the option to extend the lease for an additional one-year period in
fiscal year 2009. The terms of these extensions are similar to the
initial three-year lease. The Company had previously owned these two
buildings which were sold at the commencement of the agreement (see Note
16).
The
following represents the future minimum lease payments related to the Company’s
three-year lease of office space for the years ended May 31:
(in
thousands)
|
2009
|
|
2010
|
|
Lease
Payments (1)
|
$3,301
|
|
$1,484
|
|
|
|
(1) In
September 2007, the Company exercised the option to extend the lease for an
additional one-year period. Assuming the Company exercises the option
to extend the lease for an additional one-year period in fiscal year 2009, the
future minimum lease payments for fiscal years 2010 and 2011 would increase to
$3,503 thousand and $1,505 thousand, respectively.
Contingent
rental payments may be due if the building operating expenses exceed the base
year amount included in the lease agreement. The Company would be
required to pay contingent rental payments based on the amount of space leased
in the building divided by total rentable space in the building times the amount
that operating expenses exceeded the base year amount in the lease
agreement. To date, the Company has not been required to make
contingent rental payments.
The
Company recognizes rental expense on a straight-line basis, which requires
taking the total scheduled payments and dividing by the number of months in the
lease term. During the years ended May 31, 2008, 2007 and 2006, the
Company recognized rental expense of $3 million, $3 million and $2 million,
respectively.
(v) Use
of Estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the assets, liabilities, revenues and expenses
reported in the financial statements, as well as amounts included in the notes
thereto, including discussion and disclosure of contingent
liabilities. While the Company uses its best estimates and judgments
based on the known facts at the date of the financial statements, actual results
could differ from these estimates as future events occur.
The
Company does not believe it is vulnerable to the risk of a near-term severe
impact as a result of any concentrations of its activities.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(w) Reclassifications
Reclassifications
of prior period amounts have been made to conform to the current reporting
format for the following two items. The May 31, 2007 balance of
deferred loan origination costs totaling $4 million has been reclassified from
other assets to loans to members on the consolidated balance sheet to conform
with the May 31, 2008 presentation. The May 31, 2007 balance of cash
held as collateral totaling $2 million has been reclassified from other assets
to restricted cash on the consolidated balance sheet to conform with the May 31,
2008 presentation.
(x) New
Accounting Pronouncements
On June
1, 2007, the Company adopted SFAS 155, Accounting for Certain Hybrid Financial
Instruments – an amendment of SFAS 133 and 140. SFAS 155 permits fair value
measurement of any hybrid financial instrument that contains an embedded
derivative that otherwise would require bifurcation. SFAS 155 also clarifies
which interest-only strips and principal-only strips are not subject to the
requirements of SFAS 133. It establishes a requirement to evaluate
interests in securitized financial assets to identify interests that are
freestanding derivatives or that are hybrid financial instruments that contain
an embedded derivative requiring bifurcation. SFAS 155 also clarifies that
concentrations of credit risk in the form of subordination are not embedded
derivatives. SFAS 155 is effective for all financial instruments acquired or
issued after the beginning of an entity’s first fiscal year that begins after
September 15, 2006. The Company’s adoption of SFAS 155 did not have a
material impact on the Company's financial position or results of
operations.
On June
1, 2007, the Company adopted SFAS 156, Accounting for Servicing of Financial
Assets. SFAS 156 requires the initial measurement of all separately
recognized servicing assets and liabilities at fair value and permits, but does
not require, the subsequent measurement of servicing assets and liabilities at
fair value. SFAS 156 is effective as of the beginning of the first fiscal year
that begins after September 15, 2006. The Company’s adoption of SFAS
156 did not have a material impact on the Company's financial position or
results of operations.
On June
1, 2007, the Company adopted FIN 48, Accounting for Uncertainty in Income Taxes,
an interpretation of SFAS 109. FIN 48 clarifies the accounting for
income taxes by prescribing a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position taken
or expected to be taken in a tax return. FIN 48 also provides guidance on
derecognition, classification, interest and penalties, accounting in interim
periods, disclosure and transition. FIN 48 is effective for fiscal
years beginning after December 15, 2006. The Company’s adoption of
FIN 48 did not have a material impact on the Company's financial position or
results of operations.
In
September 2006, the FASB issued SFAS 157, Fair Value Measurements. SFAS 157
defines fair value, sets out a framework for measuring fair value and expands on
required disclosures about fair value measurement. SFAS 157 is
effective as of the beginning of the first fiscal year that begins after
November 15, 2007. The Company's adoption of SFAS 157 as of June 1, 2008 is not
expected to have a material impact on the Company's financial position or
results of operations.
In
February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial
Assets and Financial Liabilities. The fair value option established by SFAS 159
permits entities to choose to measure eligible financial instruments at fair
value. The unrealized gains and losses on items for which the fair value option
has been elected should be reported in earnings. The decision to elect the fair
value option is determined on an instrument by instrument basis and is
irrevocable. Assets and liabilities measured at fair value pursuant to the fair
value option should be reported separately in the balance sheet from those
instruments measured using other measurement attributes. SFAS 159 is effective
as of the beginning of the first fiscal year that begins after November 15,
2007. As part of the Company's adoption of SFAS 159 as of June 1,
2008, it has not elected to measure eligible financial instruments at fair value
and therefore the adoption of SFAS 159 is not expected to have a material impact
on the Company's financial position or results of operations.
In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB 51, to establish
accounting and reporting standards for the noncontrolling interests in a
subsidiary and for the deconsolidation of a subsidiary. It also amends certain
of ARB 51’s consolidation procedures for consistency with the requirements of
SFAS 141, Business Combinations. Noncontrolling interests shall be
reclassified to equity, consolidated net income shall be adjusted to include net
income attributable to noncontrolling interests and consolidated comprehensive
income shall be adjusted to include comprehensive income attributable to the
noncontrolling interests. This statement is effective for fiscal
years beginning on or after December 15, 2008. The Company’s adoption
of SFAS 160 on June 1, 2009 is not expected to have a material impact on the
Company’s financial position or results of operations.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
In March
2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and
Hedging Activities. This statement requires enhanced disclosures about an
entity’s derivative and hedging activities. The statement is
effective for fiscal years beginning after November 15, 2008. The
Company’s adoption of SFAS 161 on June 1, 2009 is not expected to have a
material impact on the Company’s financial position or results of
operations.
(2) Loans and
Commitments
Loans to
members bear interest at rates determined from time to time by the Company after
considering its interest expense, operating expenses, provision for loan losses
and the maintenance of reasonable earnings levels. In keeping with
its not-for-profit, cooperative charter, the Company's policy is to set interest
rates at the lowest levels it considers to be consistent with sound financial
management.
Loans
outstanding to members and unadvanced commitments by loan type and by segment
are summarized as follows at May
31:
|
2008
|
|
2007
|
|
|
|
|
|
Unadvanced
|
|
|
|
Unadvanced
|
|
(in
thousands)
|
|
Loans
Outstanding
|
|
Commitments
(1)
|
|
Loans
Outstanding
|
|
Commitments
(1)
|
|
Total
by loan type (2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
$
|
15,204,614
|
|
|
$
|
-
|
|
|
$
|
14,663,340
|
|
|
$
|
-
|
|
|
Long-term
variable rate loans
|
|
1,882,095
|
|
|
|
5,975,541
|
|
|
|
1,993,534
|
|
|
|
5,703,313
|
|
|
Loans
guaranteed by RUS
|
|
250,169
|
|
|
|
491
|
|
|
|
255,903
|
|
|
|
491
|
|
|
Short-term
loans
|
|
1,690,117
|
|
|
|
7,597,712
|
|
|
|
1,215,430
|
|
|
|
7,200,156
|
|
|
Total
loans outstanding
|
|
19,026,995
|
|
|
|
13,573,744
|
|
|
|
18,128,207
|
|
|
|
12,903,960
|
|
|
Deferred
origination fees
|
|
2,045
|
|
|
|
-
|
|
|
|
3,666
|
|
|
|
|
|
|
Less:
Allowance for loan losses
|
|
(514,906
|
)
|
|
|
-
|
|
|
|
(561,663
|
)
|
|
|
-
|
|
|
Net
loans outstanding
|
$
|
18,514,134
|
|
|
$
|
13,573,744
|
|
|
$
|
17,570,210
|
|
|
$
|
12,903,960
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution
|
$
|
13,438,370
|
|
|
$
|
9,579,213
|
|
|
$
|
12,827,772
|
|
|
$
|
9,176,686
|
|
|
Power
supply
|
|
3,339,112
|
|
|
|
2,960,693
|
|
|
|
2,858,040
|
|
|
|
2,798,124
|
|
|
Statewide
and associate
|
|
108,925
|
|
|
|
158,293
|
|
|
|
119,478
|
|
|
|
139,156
|
|
|
National
Rural total
|
|
16,886,407
|
|
|
|
12,698,199
|
|
|
|
15,805,290
|
|
|
|
12,113,966
|
|
|
RTFC
|
|
1,726,514
|
|
|
|
562,389
|
|
|
|
1,860,379
|
|
|
|
473,762
|
|
|
NCSC
|
|
414,074
|
|
|
|
313,156
|
|
|
|
462,538
|
|
|
|
316,232
|
|
|
Total
loans outstanding
|
$
|
19,026,995
|
|
|
$
|
13,573,744
|
|
|
$
|
18,128,207
|
|
|
$
|
12,903,960
|
|
|
|
|
|
2008
|
|
2007
|
|
(in
thousands)
|
|
|
|
Unadvanced
|
|
|
|
Unadvanced
|
|
Non-performing
and restructured loans (2):
|
|
Loans
Outstanding
|
|
Commitments
(1)
|
|
Loans
Outstanding
|
|
Commitments
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-performing
loans (3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RTFC:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
$
|
219,912
|
|
|
$
|
-
|
|
|
$
|
212,984
|
|
|
$
|
-
|
|
|
Long-term
variable rate loans
|
|
261,109
|
|
|
|
2,160
|
|
|
|
261,081
|
|
|
|
-
|
|
|
Short-term
loans
|
|
25,843
|
|
|
|
-
|
|
|
|
27,799
|
|
|
|
418
|
|
|
Total
non-performing loans
|
$
|
506,864
|
|
|
$
|
2,160
|
|
|
$
|
501,864
|
|
|
$
|
418
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructured
loans (3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
$
|
52,309
|
|
|
$
|
-
|
|
|
$
|
52,420
|
|
|
$
|
-
|
|
|
Long-term
variable rate loans
|
|
519,257
|
|
|
|
186,673
|
|
|
|
544,697
|
|
|
|
186,673
|
|
|
Short-term
loans
|
|
-
|
|
|
|
12,500
|
|
|
|
-
|
|
|
|
12,500
|
|
|
National
Rural total restructured loans
|
|
571,566
|
|
|
|
199,173
|
|
|
|
597,117
|
|
|
|
199,173
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RTFC:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
|
5,545
|
|
|
|
-
|
|
|
|
6,188
|
|
|
|
-
|
|
|
Total restructured loans
|
|
$
|
577,111
|
|
|
$
|
199,173
|
|
|
$
|
603,305
|
|
|
$
|
199,173
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(1)
Unadvanced loan commitments include loans for which loan contracts have been
approved and executed, but funds have not been advanced. Additional
information may be required to assure that all conditions for advance of funds
have been fully met and that there has been no material change in the member's
condition as represented in the supporting documents. Since
commitments may expire without being fully drawn upon and a significant amount
of the commitments are for standby liquidity purposes, the total unadvanced loan
commitments do not necessarily represent future cash
requirements. Collateral and security requirements for advances on
commitments are identical to those on initial loan approval. As the
interest rate on unadvanced commitments is not set, long-term unadvanced loan
commitments have been classified in this chart as variable rate unadvanced
commitments. However, at the time of the advance, the borrower may
select a fixed or a variable rate.
(2)
Non-performing and restructured loans are included in loans outstanding by loan
type chart.
(3) Loans
are classified as long-term or short-term based on their original
maturity.
Loan
origination costs are deferred and amortized using the straight-line method,
which approximates the interest method, over the life of the loan as a reduction
to interest income.
Credit
Concentration
The
Company's loan portfolio is widely dispersed throughout the United States and
its territories, including 48 states, the District of Columbia, American Samoa
and the U.S. Virgin Islands. At May 31, 2008 and 2007, loans
outstanding to borrowers in any state or territory did not exceed 16% and 15%,
respectively, of total loans outstanding. In addition to the
geographic diversity of the portfolio, the Company limits its exposure to any
one borrower. At May 31, 2008 and 2007, the total exposure
outstanding to any one borrower or controlled group did not exceed 2.7% and
3.0%, respectively, of total loans and guarantees outstanding. At May
31, 2008, the ten largest borrowers included five distribution systems, four
power supply systems and one telecommunications system. At May 31, 2007, the ten
largest borrowers included six distribution systems, two power supply systems
and two telecommunications systems. The following chart shows the
exposure to the ten largest borrowers as a percentage of total exposure by type
and by segment at May 31:
|
|
2008
|
|
2007
|
|
|
|
|
|
(Dollar
amounts in thousands)
|
|
Amount
|
|
%
of Total
|
|
Amount
|
|
%
of Total
|
|
|
|
|
|
Total
by type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
$
|
3,395,865
|
|
|
$
|
3,306,986
|
|
|
|
|
|
|
|
Guarantees
|
|
164,740
|
|
|
|
76,867
|
|
|
|
|
|
|
|
Total
credit exposure to ten largest borrowers
|
$
|
3,560,605
|
|
18%
|
$
|
3,383,853
|
|
18%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
3,043,905
|
|
|
$
|
2,691,060
|
|
|
|
|
|
|
|
RTFC
|
|
491,700
|
|
|
|
692,793
|
|
|
|
|
|
|
|
NCSC
|
|
25,000
|
|
|
|
-
|
|
|
|
|
|
|
|
Total
credit exposure to ten largest borrowers
|
$
|
3,560,605
|
|
18%
|
$
|
3,383,853
|
|
18%
|
|
|
|
|
|
Interest
Rates
Set forth
below is the weighted average interest rate earned on all loans outstanding
during the fiscal years ended May 31:
|
|
2008
|
|
|
|
2007
|
|
|
|
2006
|
|
|
Long-term
fixed rate
|
|
6.05%
|
|
|
|
5.87%
|
|
|
|
5.64%
|
|
|
Long-term
variable rate
|
|
6.94%
|
|
|
|
7.58%
|
|
|
|
6.43%
|
|
|
Loans
guaranteed by RUS
|
|
5.49%
|
|
|
|
5.59%
|
|
|
|
5.34%
|
|
|
Short-term
|
|
5.89%
|
|
|
|
7.06%
|
|
|
|
6.07%
|
|
|
Non-performing
|
|
0.01%
|
|
|
|
0.02%
|
|
|
|
0.01%
|
|
|
Restructured
|
|
0.64%
|
|
|
|
0.61%
|
|
|
|
0.08%
|
|
|
Total
|
|
5.81%
|
|
|
|
5.79%
|
|
|
|
5.48%
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
|
5.85%
|
|
|
|
5.80%
|
|
|
|
5.43%
|
|
|
RTFC
|
|
4.97%
|
|
|
|
5.30%
|
|
|
|
5.50%
|
|
|
NCSC
|
|
7.68%
|
|
|
|
8.00%
|
|
|
|
7.08%
|
|
|
Total
|
|
5.81%
|
|
|
|
5.79%
|
|
|
|
5.48%
|
|
|
In
general, a borrower can select a fixed interest rate on long-term loans for
periods of one to 35 years or the variable rate. Upon expiration of
the selected fixed interest rate term, the borrower must select the variable
rate or select another fixed rate term for a period that does not exceed the
remaining loan maturity. The Company sets long-term fixed rates daily
and variable rates monthly. On notification to borrowers, the Company
may adjust the variable interest rate semi-monthly. Under the
policies in effect for each company, the maximum interest rate which may be
charged on short-term loans for National Rural is the prevailing bank prime rate
plus 1% per annum; for RTFC, it is the prevailing bank prime rate plus 11/2% per
annum; and for NCSC, it is the prevailing bank prime rate plus 1% per
annum.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Loan
Repricing
Long-term
fixed rate loans outstanding at May 31, 2008, which will be subject to the
repricing of their interest rates during the next five fiscal years, are
summarized as follows (due to principal repayments, amounts subject to interest
rate repricing may be lower at the actual time of interest rate
repricing):
|
Weighted
Average
|
|
|
|
|
(Dollar
amounts in thousands)
|
Interest
Rate
|
|
Amount
Repricing
|
|
|
2009
|
|
|
5.50%
|
|
|
$
|
1,419,472
|
|
|
|
2010
|
|
|
5.74%
|
|
|
|
1,131,699
|
|
|
|
2011
|
|
|
5.88%
|
|
|
|
1,172,515
|
|
|
|
2012
|
|
|
6.30%
|
|
|
|
1,191,951
|
|
|
|
2013
|
|
|
6.10%
|
|
|
|
666,842
|
|
|
|
Thereafter
|
|
|
6.27%
|
|
|
|
2,592,841
|
|
|
|
During
the year ended May 31, 2008, long-term fixed rate loans totaling $866 million
had their interest rates repriced.
Loan
Amortization
On most
long-term loans, level quarterly payments are required with respect to principal
and interest in amounts sufficient to repay the loan principal, generally over
periods of up to 35 years from the date of the secured promissory
note.
Amortization
of long-term loans in each of the five fiscal years following May 31, 2008 and
thereafter are as follows:
|
|
(in
thousands)
|
Amortization
(1)
|
2009
|
|
$
|
800,630
|
|
2010
|
|
|
1,538,267
|
|
2011
|
|
|
839,040
|
|
2012
|
|
|
1,118,767
|
|
2013
|
|
|
805,275
|
|
Thereafter
|
|
|
12,234,899
|
|
(1)
Represents scheduled amortization based on current rates without consideration
for loans that reprice.
Loan
Security
The
Company evaluates each borrower's creditworthiness on a case-by-case
basis. It is generally the Company's policy to require collateral for
long-term loans. Such collateral usually consists of a first mortgage
lien on the borrower's total system, including plant and equipment, and a pledge
of future revenues. The loan and security documents also contain
various provisions with respect to the mortgaging of the borrower's property and
debt service coverage ratios, maintenance of adequate insurance coverage as well
as certain other restrictive covenants.
The
following tables summarize the Company's secured and unsecured loans outstanding
by loan program and by segment at May
31:
|
(Dollar
amounts in thousands)
|
|
2008
|
|
2007
|
Total
by loan program:
|
|
Secured
|
|
%
|
|
Unsecured
|
|
%
|
|
Secured
|
|
%
|
|
Unsecured
|
|
%
|
|
Long-term
fixed rate loans
|
$
|
14,732,058
|
|
97%
|
$
|
472,556
|
|
3%
|
$
|
14,180,956
|
|
97%
|
$
|
482,384
|
|
3%
|
|
Long-term
variable rate loans
|
|
1,728,803
|
|
92%
|
|
153,292
|
|
8%
|
|
1,865,821
|
|
94%
|
|
127,713
|
|
6%
|
|
Loans
guaranteed by RUS
|
|
250,169
|
|
100%
|
|
-
|
|
-
|
|
255,903
|
|
100%
|
|
-
|
|
-
|
|
Short-term
loans
|
|
165,226
|
|
10%
|
|
1,524,891
|
|
90%
|
|
191,231
|
|
16%
|
|
1,024,199
|
|
84%
|
|
Total
loans
|
$
|
16,876,256
|
|
89%
|
$
|
2,150,739
|
|
11%
|
$
|
16,493,911
|
|
91%
|
$
|
1,634,296
|
|
9%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
15,021,067
|
|
89%
|
$
|
1,865,340
|
|
11%
|
$
|
14,462,448
|
|
92%
|
$
|
1,342,842
|
|
8%
|
|
RTFC
|
|
1,497,487
|
|
87%
|
|
229,027
|
|
13%
|
|
1,630,079
|
|
88%
|
|
230,300
|
|
12%
|
|
NCSC
|
|
357,702
|
|
86%
|
|
56,372
|
|
14%
|
|
401,384
|
|
87%
|
|
61,154
|
|
13%
|
|
Total
loans
|
$
|
16,876,256
|
|
89%
|
$
|
2,150,739
|
|
11%
|
$
|
16,493,911
|
|
91%
|
$
|
1,634,296
|
|
9%
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Concurrent
Loans
National
Rural makes loans to borrowers both as the sole lender of the loan commitment
and on a concurrent basis with RUS. Under default provisions of
common mortgages securing long-term National Rural loans to distribution system
members that also borrow from RUS, RUS has the sole right to act within 30 days
or, if RUS is not legally entitled to act on behalf of all noteholders, National
Rural may exercise remedies. Under common default provisions of
mortgages securing long-term National Rural loans to, or guarantee reimbursement
obligations of, power supply members, RUS retains substantial control over the
exercise of mortgage remedies. As of May 31, 2008 and 2007, National
Rural had $2,159 million and $2,302 million, respectively, of loans outstanding
issued on a concurrent basis with RUS.
Pledging
of Loans
As of May
31, 2008 and 2007, distribution system mortgage notes related to outstanding
long-term loans totaling $3,990 million and $5,797 million, respectively, and
RUS guaranteed loans qualifying as permitted investments totaling $215 million
and $219 million, respectively, were pledged as collateral to secure National
Rural’s collateral trust bonds under the 1994 indenture totaling $4,015 million
and $5,020 million, respectively. Under the 2007 indenture,
distribution system mortgage notes related to outstanding long-term loans
totaling $918 million as of May 31, 2008 were pledged as collateral to secure
National Rural's collateral trust bonds totaling $700 million. In
addition, $2 million of cash was pledged to secure $2 million of collateral
trust bonds outstanding under the 1972 indenture at May 31, 2008 and
2007.
As of May
31, 2008 and 2007, distribution system mortgage notes totaling $1,043 million
and $592 million, respectively, were pledged as collateral to secure National
Rural’s notes to the Federal Agricultural Mortgage Corporation ("Farmer Mac")
totaling $900 million and $500 million, respectively.
In
addition to the loans pledged as collateral at May 31, 2008 and 2007, National
Rural had $3,191 million and $2,765 million, respectively, of mortgage notes on
deposit with the trustee for the $2.5 billion and $2 billion, respectively, of
notes payable to the Federal Financing Bank ("FFB") of the United States
Treasury as part of the REDLG program (see Note 6). The $2.5 billion
of notes payable to the FFB contain a rating trigger related to the Company's
senior secured credit ratings from Standard & Poor's Corporation, Moody's
Investors Service and Fitch Ratings. A rating trigger event exists if the
Company's senior secured debt does not have at least two of the following
ratings: (i) A- or higher from Standard & Poor's Corporation, (ii) A3 or
higher from Moody's Investors Service, (iii) A- or higher from Fitch Ratings and
(iv) an equivalent rating from a successor rating agency to any of the above
rating agencies. If the Company's senior secured credit ratings fall
below the levels listed above, the mortgage notes on deposit at that time, which
totaled $3,191 million at May 31, 2008, would be pledged as collateral rather
than held on deposit. At May 31, 2008, National Rural’s senior
secured debt ratings were above the rating trigger threshold.
A total
of $1.5 billion of notes payable to the FFB has a second trigger event related
to a financial expert to the Company's board of directors. A rating
trigger event will exist if the financial expert position (as defined by Section
407 of the Sarbanes-Oxley Act of 2002) remains vacant for more than
90 consecutive days. If the Company does not satisfy the
financial expert rating trigger, the mortgage notes on deposit at that time,
which totaled $1,842 million at May 31, 2008, would be pledged as collateral
rather than held on deposit. The financial expert position on
National Rural’s board of directors has been filled since March
2007.
RUS
Guaranteed Loans
At May
31, 2008 and 2007, National Rural had a total of $250 million and $256 million,
respectively, of loans outstanding on which RUS had guaranteed the repayment of
principal and interest. There are two programs under which these
loans were advanced. At May 31, 2008 and 2007, National Rural had a
total of $35 million and $37 million, respectively, under a program in which RUS
previously allowed certain qualifying cooperatives to repay loans held by the
FFB early and allowed the transfer of the guarantee to the new
lender. At May 31, 2008 and 2007, National Rural had a total of $215
million and $219 million, respectively, under a program in which RUS approved
National Rural, in February 1999, as a lender under its current loan guarantee
program.
(3) Loan
Securitizations
On
February 15, 2007, the Company sold National Rural distribution loans with
outstanding principal balances totaling $366 million in a loan securitization
transaction. The transaction qualified for sale treatment under SFAS
140. The Company received $366 million of cash in exchange for the
loans, which represents the full principal amount of the loans
sold. The Company incurred $0.7 million of costs associated with the
transaction and had $0.9 million of unamortized deferred loan origination costs
for the loans sold and accordingly, the Company recorded a loss on sale of loans
totaling $1.6 million.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
On August
10, 2007, the Company entered into an agreement to sell $74 million of
distribution mortgage loans to Farmer Mac for $74 million. The
transaction qualified for sale treatment under SFAS 140. The distribution
mortgage loans were sold at 100% of the outstanding principal balance on that
date. A total of $40 million of the distribution mortgage loans were
transferred on August 10, 2007 and the remaining $34 million were transferred on
January 2, 2008. The Company recorded a loss on sale of loans
totaling $0.7 million related to costs associated with the transaction and
unamortized deferred loan origination costs for the loans sold. The
Company does not hold any continuing interest in the loans sold and has no
obligation to repurchase loans from the purchaser. The holders of the
certificates of beneficial interest issued by the purchaser have no claim
against the Company or any of the Company’s assets in the event of a default on
the loans held by the purchaser.
The
Company services the loans for the purchaser in exchange for a fee of 30 basis
points of the outstanding loan principal. The Company considers the
30 basis point fee to be a market fee as it is consistent with market quotes
from other providers and the fee covers the cost of servicing the
loans. As a result, the Company has not recorded a servicing asset or
liability. The servicing fee has a payment priority over any other
disbursement made by the trust holding the assets.
During
the year ended May 31, 2008 and 2007, the Company recognized $1.2 million and
$0.3 million, respectively, in servicing fees on all loan securitization
transactions.
(4) Foreclosed
Assets
Assets
received in satisfaction of loan receivables are recorded at the lower of cost
or market and classified on the consolidated balance sheets as foreclosed
assets. These assets do not meet the criteria to be classified as
held for sale at May 31, 2008, 2007 or 2006. At May 31, 2008, 2007
and 2006, the balance of foreclosed assets included real estate developer notes
receivable and limited partnership interests in certain real estate
developments.
For the
year ended May 31, 2008, the Company determined that there was a reduction of $6
million to the market value of one of the land development loans held as a
foreclosed asset. The reduction to the market value was primarily as
a result of the slow down in lot sales due to residential home market
weakness.
The
activity for foreclosed assets is summarized below for the years ended May
31:
(in
thousands)
|
|
2008
|
|
2007
|
|
2006
|
Beginning
balance
|
|
$
|
66,329
|
|
|
$
|
120,889
|
|
|
$
|
140,950
|
|
Results
of operations
|
|
|
7,528
|
|
|
|
9,758
|
|
|
|
15,492
|
|
Net
cash provided by foreclosed assets
|
|
|
(9,056
|
)
|
|
|
(63,831
|
)
|
|
|
(6,401
|
)
|
Market
adjustment
|
|
|
(5,840
|
)
|
|
|
-
|
|
|
|
-
|
|
Sale
of foreclosed assets
|
|
|
-
|
|
|
|
(487
|
)
|
|
|
(29,152
|
)
|
Ending
balance of foreclosed assets
|
|
$
|
58,961
|
|
|
$
|
66,329
|
|
|
$
|
120,889
|
|
Net cash
provided by foreclosed assets increased significantly during the year ended May
31, 2007 due to full and partial paydowns of notes primarily by two limited
partnership interests in certain real estate developments. The
balance of foreclosed assets at May 31, 2005 also included partnership interests
in real estate properties before selling such properties in August 2005 for $30
million. A gain of $4 million was included in the results of
operations of foreclosed assets during the year ended May 31, 2006.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(5) Short-Term
Debt and Credit Arrangements
The
following is a summary of short-term debt and the effective interest rates
thereon at May 31:
|
|
|
2008
|
|
2007
|
|
(Dollar
amounts in thousands)
|
|
Debt
Outstanding
|
|
Effective
Interest
Rate
|
|
Debt
Outstanding
|
|
Effective
Interest
Rate
|
|
Short-term
debt:
|
|
|
|
|
|
|
|
|
|
Commercial
paper sold through dealers, net of discounts
|
$
|
1,511,953
|
|
2.33%
|
$
|
1,017,879
|
|
5.36%
|
|
Commercial
paper sold directly to members, at par
|
|
1,153,210
|
|
2.30%
|
|
1,383,090
|
|
5.29%
|
|
Commercial
paper sold directly to non-members, at par
|
|
134,351
|
|
2.59%
|
|
133,087
|
|
5.31%
|
|
Total
commercial paper
|
|
2,799,514
|
|
2.33%
|
|
2,534,056
|
|
5.32%
|
|
Daily
liquidity fund
|
|
250,750
|
|
2.05%
|
|
250,563
|
|
5.23%
|
|
Bank
bid notes
|
|
100,000
|
|
2.80%
|
|
100,000
|
|
5.43%
|
|
Subtotal
short-term debt
|
|
3,150,264
|
|
2.32%
|
|
2,884,619
|
|
5.32%
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt maturing within one year:
|
|
|
|
|
|
|
|
|
|
Medium-term
notes sold through dealers
|
|
558,776
|
|
4.40%
|
|
133,801
|
|
4.47%
|
|
Medium-term
notes sold through members
|
|
288,634
|
|
4.77%
|
|
231,158
|
|
5.37%
|
|
Secured
collateral trust bonds
|
|
1,824,995
|
|
3.27%
|
|
999,560
|
|
4.65%
|
|
Secured
notes payable
|
|
500,000
|
|
4.66%
|
|
-
|
|
-
|
|
Subordinated
deferrable debt (1)
|
|
-
|
|
-
|
|
175,000
|
|
7.65%
|
|
Unsecured
notes payable
|
|
4,784
|
|
5.50%
|
|
2,985
|
|
8.52%
|
|
Total
long-term debt maturing within one year
|
|
3,177,189
|
|
3.83%
|
|
1,542,504
|
|
5.09%
|
|
|
|
|
|
|
|
|
|
|
|
Total
short-term debt
|
$
|
6,327,453
|
|
3.08%
|
$
|
4,427,123
|
|
5.24%
|
|
|
|
(1) Redeemed in June
2007.
National
Rural issues commercial paper for periods of one to 270
days. National Rural also enters into short-term bank bid note
agreements, which are unsecured obligations of National Rural and do not require
backup bank lines for liquidity purposes. Bank bid note facilities
are uncommitted lines of credit for which National Rural does not pay a
fee. The commitments are generally subject to termination at the
discretion of the individual banks.
Revolving
Credit Agreements
The
following is a summary of the amounts available under the Company's revolving
credit agreements at May 31:
(Dollar
amounts in thousands)
|
|
|
2008
|
|
|
2007
|
|
|
Termination
Date
|
|
|
Facility
fee per
annum
(1)
|
|
|
Five-year
agreement
|
|
$
|
1,125,000
|
|
$
|
1,125,000
|
|
|
March
16, 2012
|
|
|
0.06
of 1%
|
|
|
Five-year
agreement
|
|
|
1,025,000
|
|
|
1,025,000
|
|
|
March
22, 2011
|
|
|
0.06
of 1%
|
|
|
364-day
agreement (2)
|
|
|
1,500,000
|
|
|
-
|
|
|
March
13, 2009
|
|
|
0.05
of 1%
|
|
|
364-day
agreement
|
|
|
-
|
|
|
1,125,000
|
|
|
March
14, 2008
|
|
|
0.05
of 1%
|
|
|
Total
|
|
|
$
|
3,650,000
|
|
$
|
3,275,000
|
|
|
|
|
|
|
|
|
(1)
Facility fee determined by National Rural’s senior unsecured credit ratings
based on the pricing schedules put in place at the initiation of the related
agreement.
(2) Any
amount outstanding under these agreements may be converted to a one-year term
loan at the end of the revolving credit periods. If converted to a
term loan, the fee on the outstanding principal amount of the term loan is 0.10
of 1% per annum.
Upfront
fees of between 0.03 and 0.05 of 1% were paid to the banks based on their
commitment level to the five-year agreements in place at May 31, 2008, totaling
in aggregate $1 million, which will be amortized on a straight-line basis over
the life of the agreements. Upfront fees were paid to the banks for
their commitment to the 364-day facility in place at
May 31,
2008, totaling $0.1 million, which will be amortized on a straight-line basis
over the life of the agreements. Each agreement contains a provision
under which if borrowings exceed 50% of total commitments, a utilization fee
must be paid on the outstanding balance. The utilization fees are
0.05 of 1% for all three agreements in place at May 31, 2008.
At May
31, 2008 and 2007, the Company was in compliance with all covenants and
conditions under its revolving credit agreements in place at that time and there
were no borrowings outstanding under such agreements.
For the
purpose of calculating the required financial covenants contained in its
revolving credit agreements, the Company adjusts net income, senior debt and
total equity to exclude the non-cash adjustments related to SFAS 133 and SFAS
52, Foreign Currency Translation. The adjusted times interest earned
ratio ("TIER"), as defined by the agreements, represents the interest expense
adjusted to include the derivative cash settlements, plus minority interest net
income, plus net income prior to
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
the
cumulative effect of change in accounting principle and dividing that total by
the interest expense adjusted to include the derivative cash
settlements. In addition to the non-cash adjustments related to SFAS
133 and 52, senior debt also excludes RUS guaranteed loans, subordinated
deferrable debt, members' subordinated certificates and minority
interest. Total equity is adjusted to include subordinated deferrable
debt, members' subordinated certificates and minority
interest. Senior debt includes guarantees; however, it
excludes:
·
|
guarantees
for members where the long-term unsecured debt of the member is rated at
least BBB+ by Standard & Poor's Corporation or Baa1 by Moody's
Investors Service; and
|
·
|
the
payment of principal and interest by the member on the guaranteed
indebtedness if covered by insurance or reinsurance provided by an insurer
having an insurance financial strength rating of AAA by Standard &
Poor's Corporation or a financial strength rating of Aaa by Moody's
Investors Service.
|
The
following represents the Company's required and actual financial ratios under
the revolving credit agreements at or for the year ended May 31:
|
|
|
|
|
|
Actual
|
|
|
|
|
|
Requirement
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
Minimum
average adjusted TIER over the six most recent fiscal
quarters
|
|
1.025
|
|
1.16
|
|
1.09
|
|
|
|
|
|
|
|
|
|
|
|
Minimum
adjusted TIER at fiscal year end (1)
|
|
|
|
1.05
|
|
1.15
|
|
1.12
|
|
|
|
|
|
|
|
|
|
|
|
Maximum
ratio of senior debt to total equity
|
|
|
|
10.00
|
|
7.33
|
|
6.65
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) The
Company must meet this requirement in order to retire patronage
capital.
The
revolving credit agreements do not contain a material adverse change clause or
ratings triggers that limit the banks' obligations to fund under the terms of
the agreements, but the Company must be in compliance with their other
requirements, including financial ratios, in order to draw down on the
facilities.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(6) Long-Term
Debt
The
following is a summary of long-term debt and the effective interest rates
thereon at May 31:
|
2008
|
|
2007
|
|
|
|
Debt
|
|
Effective
|
|
Debt
|
|
Effective
|
|
|
(Dollar
amounts in thousands)
|
Outstanding
|
|
Interest
Rate
|
|
Outstanding
|
|
Interest
Rate
|
|
|
Unsecured
long-term debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Medium-term
notes, sold through dealers (1)
|
$
|
4,231,982
|
|
|
|
6.70%
|
|
|
$
|
4,676,176
|
|
|
|
6.78%
|
|
|
|
Medium-term
notes, sold directly to members (2)
|
|
104,105
|
|
|
|
4.77%
|
|
|
|
76,464
|
|
|
|
5.37%
|
|
|
|
Subtotal
|
|
4,336,087
|
|
|
|
6.65%
|
|
|
|
4,752,640
|
|
|
|
6.75%
|
|
|
|
Unamortized
discount
|
|
(5,483
|
)
|
|
|
|
|
|
|
(7,408
|
)
|
|
|
|
|
|
|
Total
unsecured medium-term notes
|
|
4,330,604
|
|
|
|
|
|
|
|
4,745,232
|
|
|
|
|
|
|
|
Unsecured
notes payable
|
|
2,558,362
|
|
|
|
5.09%
|
|
|
|
2,032,630
|
|
|
|
5.12%
|
|
|
|
Unamortized
discount
|
|
(1,959
|
)
|
|
|
|
|
|
|
-
|
|
|
|
|
|
|
|
Total
unsecured notes payable
|
|
2,556,403
|
|
|
|
|
|
|
|
2,032,630
|
|
|
|
|
|
|
|
Total
unsecured long-term debt
|
|
6,887,007
|
|
|
|
6.07%
|
|
|
|
6,777,862
|
|
|
|
6.26%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured
long-term debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateral
trust bonds:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Floating
Rate Bonds, due 2008 (3)
|
|
-
|
|
|
|
-
|
|
|
|
600,000
|
|
|
|
5.73%
|
|
|
|
5.75%,
Bonds, due 2008 (3)
|
|
-
|
|
|
|
-
|
|
|
|
225,000
|
|
|
|
5.85%
|
|
|
|
Floating
Rate Bonds, due 2009 (4)
|
|
5,000
|
|
|
|
2.93%
|
|
|
|
1,000,000
|
|
|
|
5.76%
|
|
|
|
Floating
Rate Bonds, Series E-2, due 2010
|
|
1,927
|
|
|
|
7.50%
|
|
|
|
1,953
|
|
|
|
7.50%
|
|
|
|
5.70%,
Bonds, due 2010
|
|
200,000
|
|
|
|
5.80%
|
|
|
|
200,000
|
|
|
|
5.80%
|
|
|
|
4.375%,
Bonds, due 2010
|
|
500,000
|
|
|
|
4.60%
|
|
|
|
500,000
|
|
|
|
4.60%
|
|
|
|
4.75%,
Bonds, due 2014
|
|
600,000
|
|
|
|
4.84%
|
|
|
|
600,000
|
|
|
|
4.84%
|
|
|
|
7.20%,
Bonds, due 2015
|
|
50,000
|
|
|
|
7.32%
|
|
|
|
50,000
|
|
|
|
7.32%
|
|
|
|
5.45%,
Bonds, due 2017
|
|
570,000
|
|
|
|
5.58%
|
|
|
|
570,000
|
|
|
|
5.58%
|
|
|
|
5.45%,
Bonds, due 2018
|
|
700,000
|
|
|
|
5.57%
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6.55%,
Bonds, due 2018
|
|
175,000
|
|
|
|
6.68%
|
|
|
|
175,000
|
|
|
|
6.68%
|
|
|
|
7.35%,
Bonds, due 2026 (5)
|
|
90,000
|
|
|
|
7.45%
|
|
|
|
100,000
|
|
|
|
7.44%
|
|
|
|
Subtotal
|
|
2,891,927
|
|
|
|
5.42%
|
|
|
|
4,021,953
|
|
|
|
5.56%
|
|
|
|
Unamortized
discount
|
|
(5,347
|
)
|
|
|
|
|
|
|
(4,596
|
)
|
|
|
|
|
|
|
Total
secured collateral trust bonds
|
|
2,886,580
|
|
|
|
|
|
|
|
4,017,357
|
|
|
|
|
|
|
|
Secured
notes payable
|
|
400,000
|
|
|
|
3.38%
|
|
|
|
500,000
|
|
|
|
4.66%
|
|
|
|
Total
secured long-term debt
|
|
3,286,580
|
|
|
|
5.17%
|
|
|
|
4,517,357
|
|
|
|
5.46%
|
|
|
|
Total
long-term debt
|
$
|
10,173,587
|
|
|
|
5.78%
|
|
|
$
|
11,295,219
|
|
|
|
5.94%
|
|
|
|
(1)
Medium-term notes sold through dealers mature through 2032 as of May 31, 2008
and 2007. Does not include $559 million and $134 million of
medium-term notes sold through dealers that were reclassified as short-term debt
at May 31, 2008 and 2007, respectively.
(2)
Medium-term notes sold directly to members mature through 2023 as of May 31,
2008 and 2007. Does not include $289 million and $231 million of
medium-term notes sold to members that were reclassified as short-term debt at
May 31, 2008 and 2007, respectively.
(3)
Amounts outstanding at May 31, 2008 are included as short-term
debt.
(4)
Amounts outstanding at May 31, 2008 are included in short-term debt with the
exception of $5 million for which holders of the bonds elected to continue to
extend the maturity to June 1, 2009 as of May 31, 2008.
(5)
National Rural is required to make mandatory sinking fund payments for these
bonds on November 1 of each year through 2025 totaling $5 million to retire 95%
of the principal amount prior to maturity.
The
principal amount of medium-term notes, collateral trust bonds and long-term
notes payable maturing in each of the five fiscal years following May 31, 2008
and thereafter is as follows:
|
Amount
|
|
Weighted
Average
|
|
|
(Dollar
amounts in thousands)
|
Maturing
|
|
Interest
Rate
|
|
|
2009
(1)
|
$
|
-
|
|
|
|
-
|
|
|
|
2010
|
|
1,859,014
|
|
|
|
5.21%
|
|
|
|
2011
|
|
552,480
|
|
|
|
4.45%
|
|
|
|
2012
|
|
1,554,344
|
|
|
|
7.16%
|
|
|
|
2013
|
|
440,575
|
|
|
|
3.47%
|
|
|
|
Thereafter
|
|
5,767,174
|
|
|
|
5.72%
|
|
|
|
Total
|
$
|
10,173,587
|
|
|
|
5.68%
|
|
|
|
____________________
|
(1) The
amount scheduled to mature in fiscal year 2009 has been presented as long-term
debt due in one year under short-term debt.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Medium-term
notes are unsecured obligations of National Rural. Collateral trust
bonds are secured by the pledge of mortgage notes or eligible securities in an
amount at least equal to the principal balance of the bonds
outstanding. See Note 2 for additional information on the collateral
pledged to secure National Rural’s collateral trust bonds.
Unsecured
Notes Payable
At May
31, 2008 and 2007, National Rural had outstanding a total of $2.5 billion and $2
billion, respectively, under a bond purchase agreement with the FFB and a bond
guarantee agreement with RUS as part of the funding mechanism for the REDLG
program. On August 7, 2007, National Rural received the advance of
the remaining $500 million under the REDLG program. The $500 million
advance has a July 2027 maturity date. As part of the REDLG program,
National Rural will pay to RUS a fee of 30 basis points per annum on the total
amount borrowed. At May 31, 2008, the $2.5 billion of unsecured notes
payable issued as part of the REDLG program require National Rural to place on
deposit mortgage notes in an amount at least equal to the principal balance of
the notes outstanding. See Note 2 for additional information on the
mortgage notes held on deposit.
Secured
Notes Payable
At May
31, 2008, National Rural had a total of $900 million outstanding to Farmer
Mac. At May 31, 2007, National Rural had outstanding a total of $500
million of 4.656% notes to Farmer Mac. Based on the July 29, 2008
maturity, this debt is reported in short-term debt at May 31,
2008. In March 2008, National Rural sold to Farmer Mac $400 million
of floating rate debt due in 2013. Both notes payable sold to Farmer
Mac are secured by the pledge of mortgage notes in an amount at least equal to
the principal balance of the notes outstanding. See Note 2 for
additional information on the collateral pledged to secure National Rural's
notes payable.
(7) Subordinated
Deferrable Debt
Subordinated
deferrable debt represents quarterly income capital securities and subordinated
notes that are long-term obligations subordinated to National Rural’s
outstanding debt and senior to subordinated certificates held by National
Rural’s members. National Rural’s outstanding subordinated deferrable debt was
issued for terms of up to 49 years. This debt pays interest
quarterly, may be called at par after five years, and allows National Rural to
defer the payment of interest for up to 20 consecutive quarters. To
date, National Rural has not exercised its right to defer interest
payments. The following table is a summary of subordinated deferrable
debt outstanding at May 31:
|
|
2008
|
|
2007
|
|
|
|
Amounts
|
|
Effective
|
|
Amounts
|
|
Effective
|
|
(Dollar
amounts in thousands)
|
|
Outstanding
|
|
Interest
Rate
|
|
Outstanding
|
|
Interest
Rate
|
|
6.75%
due 2043
|
|
$
|
125,000
|
|
|
|
7.00%
|
|
|
$
|
125,000
|
|
|
|
7.00%
|
|
|
6.10%
due 2044
|
|
|
88,201
|
|
|
|
6.33%
|
|
|
|
88,201
|
|
|
|
6.33%
|
|
|
5.95%
due 2045
|
|
|
98,239
|
|
|
|
6.14%
|
|
|
|
98,239
|
|
|
|
6.14%
|
|
|
Total
|
|
|
$
|
311,440
|
|
|
|
6.54%
|
|
|
$
|
311,440
|
|
|
|
6.54%
|
|
|
|
|
(1) The
6.75% subordinated deferrable securities due 2043 are callable by National Rural
at par starting on February 15, 2008.
(2) The
6.10% subordinated deferrable securities due 2044 are callable by National Rural
at par starting on February 1, 2009.
(3) The
5.95% subordinated deferrable securities due 2045 are callable by National
Rural at par starting on February 15, 2010.
(8) Derivative
Financial Instruments
The
Company is neither a dealer nor a trader in derivative financial
instruments. The Company utilizes derivatives such as interest rate
and cross currency interest rate exchange agreements to mitigate its interest
rate risk and foreign currency exchange risk.
Interest
Rate Exchange Agreements
Generally,
the Company's interest rate exchange agreements do not qualify for hedge
accounting under SFAS 133. The majority of the Company's interest
rate exchange agreements use a 30-day composite commercial paper index as either
the pay or receive leg. The 30-day composite commercial paper index
is the best match for the commercial paper that is the underlying debt used as
the cost basis in setting the Company's variable interest
rates. However, the correlation between movement in the 30-day
composite commercial paper index and movement in the Company's commercial paper
rates is not consistently high enough to qualify for hedge
accounting. The Company's commercial paper rates are not indexed to
the 30-day composite commercial paper index and the Company does not solely
issue its commercial paper with maturities of 30 days. At May 31,
2008 and 2007, the Company did not have any interest rate exchange agreements
that were accounted for using hedge accounting.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The
Company was a party to the following interest rate exchange agreements at May
31:
|
|
Notional
Amounts Outstanding
|
(in
thousands)
|
|
2008
|
|
2007
|
Pay
fixed and receive variable
|
$
|
7,659,973
|
$
|
7,276,473
|
Pay
variable and receive fixed
|
|
5,256,440
|
|
5,256,440
|
Total
interest rate exchange agreements
|
$
|
12,916,413
|
$
|
12,532,913
|
Interest
rate exchange agreements had the following impact on the Company for the years
ended May 31:
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Statement
of Operations Impact
|
|
|
|
|
|
|
|
|
|
Agreements
that qualify for hedge accounting:
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
$
|
-
|
|
$
|
-
|
|
$
|
2,688
|
|
|
|
|
|
|
|
|
|
|
|
Agreements
that do not qualify for hedge accounting:
|
|
|
|
|
|
|
|
|
|
Derivative
cash settlements
|
|
27,033
|
|
|
77,342
|
|
|
61,690
|
|
Derivative
forward value
|
|
(98,743
|
)
|
|
(83,322
|
)
|
|
28,744
|
|
Total
(loss) gain on interest rate exchange agreements
|
$
|
(71,710
|
)
|
$
|
(5,980
|
)
|
$
|
93,122
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
Income Impact
|
|
|
|
|
|
|
|
|
|
Agreements
that qualify for hedge accounting:
|
|
|
|
|
|
|
|
|
|
Unrealized
loss on derivatives
|
$
|
-
|
|
$
|
-
|
|
$
|
(2,322
|
)
|
|
|
|
|
|
|
|
|
|
|
Amortization
of transition adjustment
|
|
(3,377
|
)
|
|
(1,004
|
)
|
|
226
|
|
Total
comprehensive loss
|
$
|
(3,377
|
)
|
$
|
(1,004
|
)
|
$
|
(2,096
|
)
|
Cash
settlements include periodic amounts that were paid and received related to its
interest rate exchange agreements.
During
the year ended May 31, 2008, cash settlements included a payment of $8 million
paid to counterparties representing the fair value of interest rate exchange
agreements terminated by the Company. These agreements were
terminated due to the prepayment of RTFC loans during the year ended May 31,
2008, the proceeds of which were used to pay down the underlying debt for the
terminated interest rate exchange agreements. A make-whole payment of
$8 million was paid to the Company for the cost of unwinding these swaps, which
was recorded in interest income for the year ended May 31, 2008.
During
the year ended May 31, 2007, the Company terminated two $500 million pay
variable and receive fixed interest rate exchange agreements prior to the
maturity dates. The early termination resulted in the Company
receiving a payment of $31 million, the fair value of the agreements on that
date. At termination, the Company also recorded a charge to the
derivative fair value line to reduce the derivative asset by $31 million, the
fair value of the agreements on that date. The payment received and
the reduction to the recorded derivative asset are offsetting, thus there was no
impact to reported net income as a result of this transaction.
During
the year ended May 31, 2006, cash settlements included a payment of $1 million
received from counterparties representing the fair value of interest rate
exchange agreements terminated by the Company. These agreements were
terminated
due to the prepayment of RTFC loans during the year ended May 31, 2006, the
proceeds of which were used to pay down the underlying debt for the terminated
interest rate exchange agreements.
A
transition adjustment of $62 million was recorded as an other comprehensive loss
on June 1, 2001, the date the Company implemented SFAS
133. Approximately $2 million of the amortization of the transition
adjustment for the year ended May 31, 2008 related to the early termination of
two swaps which were in place on June 1, 2001. The unamortized amount
for these swaps was amortized when the swaps were terminated. The
transition adjustment will be amortized into earnings over the remaining life of
the related interest rate exchange agreements. Approximately $0.8
million of the transition adjustment is expected to be amortized to income over
the next twelve months and will continue through April 2029.
The
Company has classified cash activity associated with derivatives as an operating
activity in the consolidated statements of cash flows.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Cross
Currency Interest Rate Exchange Agreements
There
were no cross currency or cross currency interest rate exchange agreements
outstanding at May 31, 2008 and 2007. At May 31, 2006, the Company
was a party to cross currency interest rate exchange agreements totaling $716
million, none of which were used for hedge accounting. Cross currency
interest rate exchange agreements had the following impact on the Company for
the years ended May 31:
(in
thousands)
|
|
2007
|
|
|
2006
|
|
|
|
|
Statement
of Operations Impact
|
|
|
|
|
|
|
|
|
|
Agreements
that qualify for hedge accounting:
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
$
|
-
|
|
$
|
(4,966
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agreements
that do not qualify for hedge accounting:
|
|
|
|
|
|
|
|
|
|
Derivative
cash settlements
|
|
9,100
|
|
|
19,193
|
|
|
|
|
Derivative
forward value
|
|
4,041
|
|
|
61
|
|
|
|
|
Total
gain on cross currency exchange agreements
|
$
|
13,141
|
|
$
|
14,288
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive
Income Impact
|
|
|
|
|
|
|
|
|
|
Agreements
that qualify for hedge accounting:
|
|
|
|
|
|
|
|
|
|
Unrealized
loss on derivatives
|
$
|
-
|
|
$
|
(317
|
)
|
|
|
|
Rating
Triggers
The
Company has certain interest rate exchange agreements that contain a provision
called a rating trigger. Under a rating trigger, if the credit rating
for either counterparty falls to the level specified in the agreement, the other
counterparty may, but is not obligated to, terminate the
agreement. If either counterparty terminates the agreement, a net
payment may be due from one counterparty to the other based on the fair value of
the underlying derivative instrument. Rating triggers are not
separate financial instruments and are not separate derivatives under SFAS
133. The rating triggers contained in certain of the Company's
derivative contracts are based on its senior unsecured credit rating from
Standard & Poor's Corporation and Moody's Investors Service.
At May
31, 2008, the Company had the following notional amount and fair values
associated with exchange agreements that contain rating triggers. For
the purpose of the presentation, the Company has grouped the rating triggers
into two categories: (1) ratings from Moody's Investors Service falls to Baa1 or
from Standard & Poor's Corporation falls to BBB+ and (2) ratings from
Moody's Investors Service falls below Baa1 or from Standard & Poor's
Corporation falls below BBB+. In calculating the required payments
and collections required upon termination, the Company netted the agreements for
each counterparty, as allowed by the underlying master agreement.
(in
thousands)
|
|
Notional
Amount
|
|
|
Required
Company Payment
|
|
|
Amount
Company Would Collect
|
|
|
Net
Total
|
|
Rating
Level:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fall
to Baa1/BBB+
|
$
|
1,851,658
|
|
$
|
(637
|
)
|
$
|
38,492
|
|
$
|
37,855
|
|
Fall
below Baa1/BBB+
|
|
7,028,358
|
|
|
(31,472
|
)
|
|
30,584
|
|
|
(888
|
)
|
Total
|
$
|
8,880,016
|
|
$
|
(32,109
|
)
|
$
|
69,076
|
|
$
|
36,967
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In
addition to the rating triggers listed above, at May 31, 2008, the Company had
$717 million of notional amount of exchange agreements, with one counterparty,
that would require the pledging of collateral in an amount equal to the fair
value of the exchange agreements if the Company’s senior secured ratings from
Moody's Investors Service fall below Baa2 or from Standard &
Poor's Corporation fall below BBB. At May 31, 2008, the net
obligation totaled $9 million for the $717 million notional amount of exchange
agreements subject to this rating trigger.
(9) Members' Subordinated
Certificates
Membership
Subordinated Certificates
National
Rural's members are required to purchase membership certificates as a condition
of membership. Such certificates are interest-bearing, unsecured,
subordinated debt of National Rural. Members may purchase the
certificates over time as a percentage of the amount they borrow from National
Rural. RTFC and NCSC members are not required to purchase membership
certificates as a condition of membership. National Rural membership
certificates typically have an original maturity of 100 years and pay interest
at 5% semi-annually. The weighted average maturity for all membership
subordinated certifcates outstanding at May 31, 2008 and 2007 was 68 and 69
years, respectively.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Loan
and Guarantee Subordinated Certificates
Members
obtaining long-term loans, certain short-term loans or guarantees are generally
required to purchase additional loan or guarantee subordinated certificates with
each such loan or guarantee based on the members' debt to equity ratio with
National Rural. These certificates are unsecured, subordinated debt
of the Company.
Certificates
currently purchased in conjunction with long-term loans are generally
non-interest bearing. National Rural’s policy regarding the purchase
of loan subordinated certificates requires members with a debt to equity ratio
with National Rural in excess of the limit in the policy to purchase a
non-amortizing/non-interest bearing subordinated certificate in the amount of 2%
for distribution systems and 7% for power supply systems. National
Rural associates and RTFC members are required to purchase loan subordinated
certificates of 10% of each long-term loan advance. For non-standard
credit facilities, the borrower is required to purchase interest bearing
certificates in amounts determined appropriate by National Rural based on the
circumstances of the transaction. Loan and guarantee subordinated
certificates have the same maturity as the related long-term
loan. Some certificates may also amortize annually based on the
outstanding loan balance.
The
maturity dates and the interest rates payable on guarantee subordinated
certificates purchased in conjunction with National Rural’s guarantee program
vary in accordance with applicable National Rural policy. Members may
be required to purchase non-interest bearing debt service reserve subordinated
certificates in connection with National Rural’s guarantee of long-term
tax-exempt bonds (see Note 13). National Rural pledges proceeds from
the sale of such certificates to the debt service reserve fund established in
connection with the bond issue and any earnings from the investments of the fund
inure solely to the benefit of the members for whom the bonds are
issued. These certificates have varying maturities not exceeding the
longest maturity of the guaranteed obligation.
Information
with respect to members' subordinated certificates at May 31, is as
follows:
|
2008
|
|
2007
|
|
|
|
Weighted
|
|
|
|
Weighted
|
|
|
Amounts
|
|
Average
|
|
Amounts
|
|
Average
|
|
(Dollar
amounts in thousands)
|
Outstanding
|
|
Interest
Rate
|
|
Outstanding
|
|
Interest
Rate
|
|
Number
of subscribing members
|
|
898
|
|
|
|
|
|
|
|
899
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Membership
subordinated certificates:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Certificates
maturing 2020 through 2095
|
$
|
628,471
|
|
|
|
|
|
|
$
|
627,875
|
|
|
|
|
|
|
Subscribed
and unissued (1)
|
|
20,994
|
|
|
|
|
|
|
|
21,549
|
|
|
|
|
|
|
Total
membership subordinated certificates
|
|
649,465
|
|
|
|
4.88%
|
|
|
|
649,424
|
|
|
|
4.88%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan
and guarantee subordinated certificates:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3%
certificates maturing through 2040
|
|
111,095
|
|
|
|
|
|
|
|
113,501
|
|
|
|
|
|
|
3%
to 12% certificates maturing through 2042
|
|
239,079
|
|
|
|
|
|
|
|
200,779
|
|
|
|
|
|
|
Non-interest
bearing certificates maturing through 2043
|
|
362,085
|
|
|
|
|
|
|
|
369,037
|
|
|
|
|
|
|
Subscribed
and unissued (1)
|
|
45,055
|
|
|
|
|
|
|
|
48,706
|
|
|
|
|
|
|
Total
loan and guarantee subordinated certificates
|
|
757,314
|
|
|
|
2.24%
|
|
|
|
732,023
|
|
|
|
2.07%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
members' subordinated certificates
|
|
$
|
1,406,779
|
|
|
|
3.46%
|
|
|
$
|
1,381,447
|
|
|
|
3.39%
|
|
|
(1) The
subscribed and unissued subordinated certificates represent subordinated
certificates that members are required to purchase, but are not yet paid
for. Upon collection of the full amount of the subordinated
certificate, the amount of the certificate will be reclassified from subscribed
and unissued to outstanding.
(10) Minority
Interest
At May
31, 2008 and 2007, the Company reported minority interests of $14 million and
$22 million, respectively, on the consolidated balance
sheets. Minority interest represents 100% of RTFC and NCSC equity as
the members of RTFC and NCSC own or control 100% of the interest in their
respective companies.
During
the year ended May 31, 2008, the balance of minority interest decreased by $6
million of minority interest net loss for the year ended May 31, 2008 and the
retirement of $2 million of patronage capital to RTFC members in January
2008.
(11) Equity
National
Rural is required by the District of Columbia cooperative law to have a
methodology to allocate its net earnings to its members. National
Rural maintains the current year net earnings as unallocated through the end of
its fiscal year. National Rural calculates net earnings by adjusting
net income to exclude certain non-cash adjustments. Subsequent to the
end of the fiscal year, National Rural’s board of directors allocates its net
earnings to members in the form of patronage capital and to board
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
approved
reserves. Currently, National Rural has two such board approved
reserves, the education fund and the members' capital
reserve. National Rural allocates a small portion, less than 1%, of
net earnings annually to the education fund. The allocation to the
education fund must be at least 0.25% of net earnings as required by National
Rural’s bylaws. Funds from the education fund are disbursed annually
to fund cooperative education in the service territories of each
state. The board of directors determines the amount of net earnings
that is allocated to the members' capital reserve, if any. The
members' capital reserve represents net earnings that are held by National Rural
to increase equity retention. The net earnings held in the members'
capital reserve have not been allocated to any member, but may be allocated to
individual members in the future as patronage capital if authorized by National
Rural’s board of directors. All remaining net earnings are allocated
to National Rural’s members in the form of patronage
capital. National Rural bases the amount of net earnings allocated to
each member on the members' patronage of the National Rural lending programs in
the year that the net earnings were earned. There is no impact on
National Rural’s total equity as a result of allocating net earnings to members
in the form of patronage capital or to board approved
reserves. National Rural’s board of directors has annually voted to
retire a portion of the patronage capital allocated to members in prior
years. National Rural’s total equity is reduced by the amount of
patronage capital retired to members and by amounts disbursed from board
approved reserves.
National
Rural’s board of directors authorized the retirement of $86 million of allocated
net earnings in July 2007, representing 70% of the allocated net earnings for
fiscal year 2007 and one-ninth of the allocated net earnings for fiscal years
1991, 1992 and 1993. This amount was retired in August 2007. Under
current practice, the remaining 30% of the fiscal year 2007 allocated net
earnings will be retained by National Rural and used to fund operations for 15
years and then may be retired. The retirement of allocated net
earnings for fiscal years 1991, 1992 and 1993 is done as part of the transition
to the current retirement cycle adopted in 1994 and will last through fiscal
year 2008. After that time and under current practice, retirements
will be comprised of the 70% of allocated net earnings from the prior year as
approved by the board of directors and the remaining portion of allocated net
earnings retained by National Rural from prior years (50% for 1994 and 30% for
all years thereafter).
In July
2008, National Rural’s board of directors authorized the allocation of the
fiscal year 2008 net earnings as follows: $1 million to the education fund and
$103 million to members in the form of patronage capital. The board
of directors also authorized the allocation of $29 million to the members'
capital reserve. In July 2008, National Rural’s board of directors
authorized the retirement of allocated net earnings totaling $85 million,
representing 70% of the fiscal year 2008 allocation and one-ninth of the fiscal
years 1991, 1992 and 1993 allocated net earnings. This amount will be
returned to members in cash at the end of August 2008. Future
allocations and retirements of net earnings will be made annually as determined
by National Rural’s board of directors with due regard for National Rural’s
financial condition. The board of directors for National Rural has
the authority to change the current practice for allocating and retiring net
earnings at any time, subject to applicable cooperative law.
At May
31, 2008 and 2007, equity included the following components:
(in
thousands)
|
2008
|
|
2007
|
|
Membership
fees
|
$
|
993
|
|
|
$
|
997
|
|
|
Education
fund
|
|
1,484
|
|
|
|
1,406
|
|
|
Members'
capital reserve
|
|
187,409
|
|
|
|
158,308
|
|
|
Allocated
net income
|
|
423,249
|
|
|
|
405,598
|
|
|
Unallocated
net income (1)
|
|
(53
|
)
|
|
|
(23
|
)
|
|
Total
members' equity
|
|
613,082
|
|
|
|
566,286
|
|
|
Prior
years cumulative derivative forward
|
|
|
|
|
|
|
|
|
value
and foreign currency adjustments
|
|
131,551
|
|
|
|
225,849
|
|
|
Current
period derivative forward value (2)
|
|
(87,495
|
)
|
|
|
(79,744
|
)
|
|
Current
period foreign currency adjustments
|
|
-
|
|
|
|
(14,554
|
)
|
|
Total
retained equity
|
|
657,138
|
|
|
|
697,837
|
|
|
Accumulated
other comprehensive income
|
|
8,827
|
|
|
|
12,204
|
|
|
Total
equity
|
$
|
665,965
|
|
|
$
|
710,041
|
|
|
(1)
Excludes derivative forward value and foreign currency adjustments.
(2)
Represents the derivative forward value loss recorded by National Rural for the
period.
(12) Employee
Benefits
National
Rural is a participant in the National Rural Electric Cooperative Association
("NRECA") Retirement Security Plan. This plan is available to all
qualified National Rural employees. Under the plan, participating
employees are entitled to receive annually, under a 50% joint and surviving
spouse annuity, 1.90% of the average of their five highest base salaries during
their last ten years of employment, multiplied by the number of years of
participation in the plan. National Rural contributed $3.8 million,
$3.3 million and $3.0 million to the Retirement Security Plan during fiscal
years 2008, 2007 and 2006, respectively. Funding requirements that
are billed are charged to general and administrative expenses on a monthly
basis. This is a multiple employer
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
plan,
available to all member cooperatives of NRECA, and therefore the projected
benefit obligation and plan assets are not determined or allocated separately by
individual employer.
The
Economic Growth and Tax Relief Act of 2001 set a limit of $230,000 for calendar
year 2008 on the compensation to be used in the calculation of pension
benefits. In order to restore potential lost benefits, National Rural
has adopted a Pension Restoration Plan administered by NRECA. Under
the plan, the amount that NRECA invoices National Rural for the Retirement
Security Plan will continue to be based on the full compensation paid to each
employee. Upon the retirement of a covered employee, NRECA will
calculate the retirement and security benefit to be paid with consideration of
the compensation limits and will pay the maximum benefit
thereunder. NRECA will also calculate the retirement and security
benefit that would have been available without consideration of the compensation
limits and National Rural will pay the difference. NRECA will then
give National Rural a credit against future retirement and security contribution
liabilities in the amount paid by National Rural to the covered
employee.
National
Rural has paid such additional benefits to the covered employee through two
components of the Pension Restoration Plan, a Severance Pay Plan and a Deferred
Compensation Plan. Under the Severance Pay Plan, the employee was
paid an amount equal to the lost pension benefits but not exceeding twice the
employee's annual compensation for the prior year. The benefit was
paid within 24 months of termination of employment. To the extent
that the Severance Pay Plan could not pay all of the lost pension benefits, the
remainder was paid under a Deferred Compensation Plan in a lump sum or in
installments of up to 60 months.
The
Severance Pay Plan component of the Pension Restoration Plan has been eliminated
effective January 1, 2005. Any benefit earned as of December 31, 2004
will be held for the employee and will be paid out as outlined
above. Benefits earned as of January 1, 2005, however, will be paid
solely under the Deferred Compensation component of the Pension Restoration
Plan, which carries a substantial risk of forfeiture. The executive
officers of the Company have satisfied the provisions established to receive the
benefit from this plan. Since there is no longer a risk of forfeiture
of the Pension Restoration benefit, distributions will be made from the Deferred
Compensation component of the plan to each executive officer
annually.
As of
December 31, 2007, the NRECA Retirement Security Plan meets the ERISA standards
for a funded plan and National Rural was current with regard to its obligations
to NRECA, the plan provider.
National
Rural offers a 401(k) defined contribution savings program, the 401(k) Pension
Plan, to all employees that have completed a minimum of 1,000 hours of service
in either the first 12 consecutive months or first full calendar year of
employment. National Rural contributes an amount up to 3% of an
employee's salary each year for all employees participating in the program with
a minimum 2% employee contribution. During the years ended May 31,
2008, 2007 and 2006, National Rural contributed $0.6 million, $0.5 million and
$0.5 million, respectively, each year under the program.
(13) Guarantees
The
Company guarantees certain contractual obligations of its members so that they
may obtain various forms of financing. With the exception of letters
of credit, the underlying obligations may not be accelerated so long as the
Company performs under its guarantee. At May 31, 2008 and 2007, the Company had
recorded a guarantee liability totaling $15 million and $19 million,
respectively, which represents the contingent and non-contingent exposure
related to guarantees of members' debt obligations. The contingent guarantee
liability at May 31, 2008 and 2007 totaled $10 million and $13 million,
respectively, based on management's estimate of exposure to losses within the
guarantee portfolio. The Company uses factors such as internal risk rating,
remaining term of guarantee, corporate bond default probabilities and estimated
recovery rates in estimating its contingent exposure. The remaining
balance of the total guarantee liability of $5 million and $6 million at May 31,
2008 and 2007, respectively, relates to the Company's non-contingent obligation
to stand ready to perform over the term of its guarantees that it has entered
into or modified since January 1, 2003 in accordance with FIN 45. The
non-contingent obligation is estimated based on guarantee fees collectible over
the life of the guarantee. The fees are deferred and amortized using
the straight-line method into interest income over the term of the
guarantees.
Activity
in the guarantee liability account is summarized below for the years ended May
31:
(Dollar
amounts in thousands)
|
2008
|
|
2007
|
|
2006
|
|
Beginning
balance
|
$
|
18,929
|
|
|
$
|
16,750
|
|
|
$
|
16,094
|
|
|
Net
change in non-contingent liability
|
|
(791
|
)
|
|
|
3,879
|
|
|
|
1,356
|
|
|
Recovery
of contingent guarantee losses
|
|
(3,104
|
)
|
|
|
(1,700
|
)
|
|
|
(700
|
)
|
|
Ending
balance
|
$
|
15,034
|
|
|
$
|
18,929
|
|
|
$
|
16,750
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liability
as a percentage of total guarantees
|
|
1.45%
|
|
|
|
1.76%
|
|
|
|
1.55%
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The
following chart summarizes total guarantees by type and segment at May
31:
(in
thousands)
|
2008
|
|
2007
|
|
|
|
|
Total
by type:
|
|
|
|
|
|
|
|
|
|
|
Long-term
tax exempt bonds
(1)
|
$
|
498,495
|
|
|
$
|
526,185
|
|
|
|
|
Indemnifications
of tax benefit transfers (2)
|
|
94,821
|
|
|
|
107,741
|
|
|
|
|
Letters
of credit (3)
|
|
343,424
|
|
|
|
365,766
|
|
|
|
|
Other
guarantees (4)
|
|
100,400
|
|
|
|
74,682
|
|
|
|
|
Total
|
$
|
1,037,140
|
|
|
$
|
1,074,374
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
Distribution
|
$
|
184,459
|
|
|
$
|
211,320
|
|
|
|
|
Power
supply
|
|
786,455
|
|
|
|
797,009
|
|
|
|
|
Statewide
and associate
|
|
22,785
|
|
|
|
25,359
|
|
|
|
|
National
Rural total
|
|
993,699
|
|
|
|
1,033,688
|
|
|
|
|
RTFC
|
|
260
|
|
|
|
-
|
|
|
|
|
NCSC
|
|
43,181
|
|
|
|
40,686
|
|
|
|
|
Total
|
$
|
1,037,140
|
|
|
$
|
1,074,374
|
|
|
|
(1) The
maturities for this type of guarantee run through 2037. National
Rural has guaranteed debt issued in connection with the construction or
acquisition of pollution control, solid waste disposal, industrial development
and electric distribution facilities. National Rural has unconditionally
guaranteed to the holders or to trustees for the benefit of holders of these
bonds the full principal, premium, if any, and interest on each bond when
due. National Rural has debt service reserve funds in the amount of
$55 million at May 31, 2008 and 2007, on deposit with the bond trustee that can
only be used for the purpose of covering any deficiencies in the bond principal,
premium or interest payments. The member systems have agreed to make
up deficiencies in the debt service reserve funds for certain of these issues of
bonds. In the event of default by a system for non-payment of debt
service, National Rural is obligated to pay any required amounts under its
guarantees, which will prevent the acceleration of the bond
issue. The system is required to repay, on demand, any amount
advanced by National Rural and interest thereon pursuant to the documents
evidencing the system's reimbursement obligation.
Of the
amounts shown above, $330 million and $277 million as of May 31, 2008 and 2007,
respectively, are adjustable or floating/fixed rate bonds that may be converted
to a fixed rate as specified in the indenture for each bond
offering. During the variable rate period (including at the time of
conversion to a fixed rate), National Rural has unconditionally agreed to
purchase bonds tendered or put for redemption if the remarketing agents have not
previously sold such bonds to other purchasers. National Rural's
maximum potential exposure includes guaranteed principal and interest related to
the bonds. In addition to these tax-exempt bonds, National Rural was
the guarantor, but not liquidity provider, for $155 million and $224 million of
tax-exempt bonds that were in the auction rate mode at May 31, 2008 and 2007,
respectively. National Rural is unable to determine the maximum
amount of interest that it could be required to pay related to the adjustable,
floating and auction rate bonds. As of May 31, 2008, National Rural's
maximum potential exposure for the $14 million of fixed rate tax-exempt bonds is
$20 million representing principal and interest. Many of these bonds
have a call provision that in the event of a default would allow National Rural
to trigger the call provision. This would limit National Rural's
exposure to future interest payments on these bonds. National Rural's
maximum potential exposure is secured by a mortgage lien on all of the system's
assets and future revenues. However, if the debt is accelerated
because of a determination that the interest thereon is not tax-exempt, the
system's obligation to reimburse National Rural for any guarantee payments will
be treated as a long-term loan.
(2) The
maturities for this type of guarantee run through 2015. National
Rural has unconditionally guaranteed to lessors certain indemnity payments,
which may be required to be made by the lessees in connection with tax benefit
transfers. In the event of default by a system for non-payment of
indemnity payments, National Rural is obligated to pay any required amounts
under its guarantees, which will prevent the acceleration of the indemnity
payments. The member is required to repay any amount advanced by
National Rural and interest thereon pursuant to the documents evidencing the
system's reimbursement obligation. The amounts shown represent
National Rural’s maximum potential exposure for guaranteed indemnity
payments. A member's obligation to reimburse National Rural for any
guarantee payments would be treated as a long-term loan to the extent of any
cash received by the member at the outset of the transaction. This
amount is secured by a mortgage lien on substantially all of the system's assets
and future revenues. The remainder would be treated as a short-term
loan secured by a subordinated mortgage on substantially all of the member's
property. Due to changes in federal tax law, no further guarantees of
this nature are anticipated.
(3) The
maturities for this type of guarantee run through 2018. Additionally,
letters of credit totaling $6 million at May 31, 2008 have a term of one year
and automatically extend for a period of one year unless the Company cancels the
agreement within 120 days of maturity (in which case, the beneficiary may draw
on the letter of credit). The Company issues irrevocable letters of
credit to support members' obligations to energy marketers and other third
parties and to the Rural Business and Cooperative Development Service with
issuance fees as may be determined from time to time. Each letter of
credit issued is supported by a reimbursement agreement with the member on whose
behalf the letter of credit was issued. In the event a beneficiary
draws on a letter of credit, the agreement generally requires the member to
reimburse the Company within one year from the date of the
draw. Interest would accrue from the date of the draw at the line of
credit variable rate of interest in effect on such date. The
agreement also requires the member to pay, as applicable, a late payment charge
and all costs of collection, including reasonable attorneys' fees. As
of May 31, 2008, the Company's maximum potential exposure is $343 million, of
which $205 million is secured. When taking into consideration
reimbursement obligation agreements that National Rural has in place with other
lenders, National Rural’s maximum potential exposure related to $25 million of
letters of credit would be reduced to $7 million in the event of
default. Security provisions include a mortgage lien on substantially
all of the system's assets, future revenues, and the system's commercial paper
invested at the Company. In addition to the letters of credit listed in the
table, under master letter of credit facilities, the Company may be required to
issue up to an additional $415 million in letters of credit to third parties for
the benefit of its members at May 31, 2008. At May 31, 2007, this
amount was $339 million.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(4) The
maturities for this type of guarantee run through 2025. National
Rural provides other guarantees for its members. In the event of
default by a system for non-payment of the obligation, National Rural must pay
any required amounts under its guarantees, which will prevent the acceleration
of the obligation. Such guarantees may be made on a secured or
unsecured basis with guarantee fees set to cover National Rural’s general and
administrative expenses, a provision for losses and a reasonable
margin. The member is required to repay any amount advanced by
National Rural and interest thereon pursuant to the documents evidencing the
system's reimbursement obligation. Of National Rural’s maximum
potential exposure for guaranteed principal and interest totaling $101 million
at May 31, 2008, $3 million is secured by a mortgage lien on substantially all
of the system's assets and future revenues and the remaining $98 million is
unsecured.
The
Company uses the same credit policies and monitoring procedures in providing
guarantees as it does for loans and commitments.
The
following table details the scheduled reductions of the Company’s outstanding
guarantees in each of the fiscal years following May 31, 2008:
(in
thousands)
|
|
Amount
|
2009
|
$
|
169,084
|
2010
|
|
191,214
|
2011
|
|
159,027
|
2012
|
|
54,318
|
2013
|
|
107,278
|
Thereafter
|
|
356,219
|
Total
|
$
|
1,037,140
|
At May
31, 2008 and 2007, National Rural had a total of $236 million and $221 million
of guarantees, representing 23% and 21%, respectively, of total guarantees,
under which its right of recovery from its members was not secured.
(14) Fair
Value of Financial Instruments
The
following disclosure of the estimated fair value of financial instruments is
made in accordance with SFAS 107, Disclosure about Fair Value of Financial
Instruments. Whenever possible, the estimated fair value amounts have
been determined using quoted market information as of May 31, 2008 and
2007. The estimated fair value information presented is not
necessarily indicative of amounts the Company could realize currently in a
market sale since it may be unable to sell such instruments due to contractual
restrictions or to the lack of an established market. The estimated
market values have not been updated since May 31, 2008; therefore, current
estimates of fair value may differ significantly from the amounts
presented. With the exception of redeeming collateral trust bonds and
subordinated deferrable debt under early redemption provisions, terminating
derivative instruments under early termination provisions and allowing borrowers
to prepay their loans, the Company has held and intends to hold all financial
instruments to maturity. Below is a summary of significant
methodologies used in estimating fair value amounts and a schedule of fair
values at May 31, 2008 and 2007.
Cash
and Cash Equivalents
Includes
cash and certificates of deposit with remaining maturities of less than 90 days,
which are valued at the carrying value.
Restricted
Cash
Restricted
cash consists of cash and cash equivalents for which use is contractually
restricted. Restricted cash is valued at the carrying value.
Loans
to Members
The
Company’s loans to its members contain many features that are not included in
most loan terms, such as the right to receive a patronage capital allocation,
the requirement to purchase subordinated certificates, the option to select
fixed rates from one year to maturity with the fixed rate resetting or repricing
at the end of each selected rate term, the ability to convert from a fixed rate
to another fixed rate or the variable rate at any time and certain discounts
that are specific to the borrower’s activity with the Company. These
features make it difficult to find market data for similar
loans. Thus, the Company must use other methods to estimate the fair
value. Fair values are estimated by discounting the future cash flows
using the current rates at which similar loans would be made by the Company to
borrowers with similar credit ratings and for the same remaining
maturities. Loans with different risk characteristics, specifically
non-performing and restructured loans, are valued by discounting cash flows
using a discount rate commensurate with the risk involved or by using collateral
valuations. Loans with interest rate repricing scheduled within 90
days of year end are valued at carrying value, which approximates fair
value. Variable rate loans are valued at cost, which approximates
fair value since the Company has the option to reset rates every 30
days.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Debt
Service Reserve Funds
The
Company considers the carrying value of debt service reserve funds to be equal
to fair value. Debt service reserve funds represent cash on deposit
with the bond trustee for pollution control bonds that National Rural guarantees
and thus, carrying value is considered to be equal to fair value.
Short-Term
Debt
Short-term
debt consists of commercial paper, bank bid notes and other debt due within one
year. The fair value of short-term debt with maturities greater than
90 days is estimated based on quoted market rates for debt with similar
maturities. The fair value of short-term debt with maturities less
than or equal to 90 days is carrying value, which is a reasonable estimate of
fair value.
Long-Term
Debt
Long-term
debt consists of collateral trust bonds, medium-term notes and long-term notes
payable. The Company issues all collateral trust bonds and some
medium-term notes in underwritten public transactions. There is
secondary trading for the underwritten collateral trust bonds and medium-term
notes from which the fair value may be estimated. There is no
secondary market for the medium-term notes issued to the Company’s members or in
transactions that are not underwritten, thus fair value is estimated based on
quoted market prices for similar instruments supplied by the
underwriters. The long-term notes payable are issued in private
placement transactions and there is no secondary trading of such
debt. Thus, the fair value is estimated based on underwriter quotes
for similar instruments, if available, or based on discounted cash
flow.
Long-term
debt with a variable interest rate is valued at carrying value, which
approximates fair value since rates may be adjusted every 30 days to 90
days.
Subordinated
Deferrable Debt
The
Company’s subordinated deferrable debt is traded on the New York Stock Exchange,
thus daily market quotes are available. However, there is typically
limited trading volume and thus, the Company bases the fair value estimate on
tender offer prices supplied by the underwriters of the
securities. The use of the tender offer prices results in a slightly
different valuation than the use of the closing market quote from the last day
of the reporting period.
Members'
Subordinated Certificates
As it is
impracticable to develop a discount rate that measures fair value, subordinated
certificates have not been valued. Members' subordinated certificates
are extended long-term obligations of the Company; many have original maturities
of 70 to 100 years. These certificates are issued to the Company's
members as a condition of membership or as a condition of obtaining loan funds
or guarantees and are non-transferable. As these certificates were
not issued primarily for their future payment stream but mainly as a condition
of membership and to receiving future loan funds, there is no ready market from
which to obtain fair value quotes.
Interest
Rate and Cross Currency Interest Rate Exchange Agreements
Derivative
instruments are recorded in the consolidated balance sheets at fair
value. The fair value of the interest rate and cross currency
interest rate exchange agreements is estimated taking into account the expected
future market rate of interest and the current creditworthiness of the exchange
counterparties. The fair value of cross currency interest rate
exchange agreements additionally takes into account the expected future currency
exchange rate. The fair value of the cross currency exchange agreements is
estimated taking into account the expected future currency exchange rate and the
current creditworthiness of the exchange counterparties.
Commitments
The fair
value is estimated as the carrying value, or zero. Extensions of
credit under these commitments, if exercised, would result in loans priced at
market rates.
Guarantees
It is
impracticable to supply fair value information related to guarantees based on
market comparisons as there is no other company that provides guarantees to
rural electric utility companies from which to obtain market rate
information. The fair value of the Company’s guarantees shown is
based on the amount recorded as a guarantee liability which represents the
Company’s contingent and non-contingent exposure related to its
guarantees.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
Carrying
and fair values as of May 31, 2008 and 2007 are presented as
follows:
|
|
2008
|
|
2007
|
|
(in
thousands)
|
|
Carrying
Value
|
|
Fair
Value
|
|
Carrying
Value
|
|
Fair
Value
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
|
$
|
177,809
|
|
|
$
|
177,809
|
|
|
$
|
304,107
|
|
|
$
|
304,107
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted
cash
|
|
|
14,460
|
|
|
|
14,460
|
|
|
|
2,032
|
|
|
|
2,032
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
to members, net
|
|
|
18,514,134
|
|
|
|
17,659,808
|
|
|
|
17,570,210
|
|
|
|
15,743,632
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt
service reserve funds
|
|
|
54,993
|
|
|
|
54,993
|
|
|
|
54,993
|
|
|
|
54,993
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flow interest rate exchange agreements
|
21,448
|
|
|
|
21,448
|
|
|
|
212,143
|
|
|
|
212,143
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
value interest rate exchange agreements
|
199,066
|
|
|
|
199,066
|
|
|
|
10,631
|
|
|
|
10,631
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Short-term
debt
|
|
|
6,327,453
|
|
|
|
6,334,426
|
|
|
|
4,427,123
|
|
|
|
4,404,590
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
10,173,587
|
|
|
|
10,548,133
|
|
|
|
11,295,219
|
|
|
|
11,492,645
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Guarantee
liability (1)
|
|
|
15,034
|
|
|
|
15,034
|
|
|
|
18,929
|
|
|
|
18,929
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
flow interest rate exchange agreement
|
167,417
|
|
|
|
167,417
|
|
|
|
12,869
|
|
|
|
12,869
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair
value interest rate exchange agreement
|
3,973
|
|
|
|
3,973
|
|
|
|
59,065
|
|
|
|
59,065
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Subordinated
deferrable debt
|
|
|
311,440
|
|
|
|
291,551
|
|
|
|
311,440
|
|
|
|
299,964
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Off-balance
sheet instruments:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commitments
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
(1) The
carrying value represents the Company’s exposure related to its guarantees and
therefore will not equal total guarantees shown in Note 13.
(15) Restructured/Non-performing
Loans and Contingencies
The
Company had the following loans outstanding classified as non-performing and
restructured at May 31:
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
Non-performing
loans
|
$
|
506,864
|
|
$
|
501,864
|
|
|
|
|
|
|
|
|
|
|
Restructured
loans
|
|
577,111
|
|
|
603,305
|
|
|
|
|
|
|
|
|
|
|
Total
|
$
|
1,083,975
|
|
$
|
1,105,169
|
|
|
(a) At
May 31, 2008 and 2007, all loans classified as non-performing were on a
non-accrual status with respect to the recognition of interest
income. At May 31, 2008 and 2007, $519 million and $545 million,
respectively, of restructured loans were on non-accrual status with respect to
the recognition of interest income. A total of $4 million of interest
income was accrued on restructured loans during the year ended May 31, 2008 and
2007.
Interest
income was reduced as follows as a result of holding loans on non-accrual status
for the years ended May 31:
|
|
Reduction
to interest income
|
|
(in
thousands)
|
|
|
2008
|
|
|
2007
|
|
|
2006
|
|
Non-performing
loans
|
|
$
|
33,492
|
|
$
|
41,448
|
|
$
|
42,725
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructured
loans
|
|
|
33,400
|
|
|
39,177
|
|
|
35,947
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
66,892
|
|
$
|
80,625
|
|
$
|
78,672
|
|
(b) The
Company classified $1,078 million and $1,099 million of loans as impaired
pursuant to the provisions of SFAS 114 at May 31, 2008 and 2007,
respectively. The Company reserved $331 million and $397 million of
the loan loss allowance for such impaired loans at May 31, 2008 and 2007,
respectively. The amount included in the loan loss allowance for such
loans was based on a comparison of the present value of the expected future cash
flow associated with the loan discounted at the original contract interest rate
and/or the estimated fair value of the collateral securing the loan to the
recorded investment in the loan. Impaired loans may be on accrual or
non-accrual status with respect to the recognition of interest income based on a
review of the terms of the restructure agreement and borrower
performance. The Company accrued a total of $3 million,
$3
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
million
and $1 million of interest income on impaired loans for the years ended May 31,
2008, 2007 and 2006, respectively. The average recorded investment in
impaired loans for the year ended May 31, 2008 and 2007 was $1,083 million and
$1,144 million, respectively.
The
Company updates impairment calculations on a quarterly basis. Since a
borrower's original contract rate may include a variable rate component,
calculated impairment could vary with changes to the Company's variable rate,
independent of a borrower's underlying financial performance or
condition. In addition, the calculated impairment for a borrower will
fluctuate based on changes to certain assumptions. Changes to
assumptions include, but are not limited to the following:
· court
rulings,
· changes
to collateral values, and
· changes
to expected future cash flows both as to timing and amount.
(c) At
May 31, 2008 and 2007, National Rural had a total of $519 million and $545
million, respectively, of restructured loans outstanding to Denton County
Electric Cooperative, d/b/a CoServ Electric ("CoServ"), a large electric
distribution cooperative located in Denton County, Texas, that provides retail
electric service to residential and business customers. All
restructured loans have been on non-accrual status since January 1,
2001. In addition, a total of $20 million was outstanding under the
capital expenditure loan facility which was classified as a performing loan at
both May 31, 2008 and 2007. Total loans to CoServ at May 31, 2008 and
2007 represented 2.7% and 2.9%, respectively, of the Company's total loans and
guarantees outstanding.
Under the
terms of a bankruptcy settlement, National Rural restructured its loans to
CoServ. CoServ is scheduled to make quarterly payments to National
Rural through December 2037. As part of the restructuring, National
Rural may be obligated to provide up to $204 million of senior secured capital
expenditure loans to CoServ for electric distribution infrastructure through
December 2012. When CoServ requests capital expenditure loans from
National Rural, these loans are provided at the standard terms offered to all
borrowers and require debt service payments in addition to the quarterly
payments that CoServ is required to make to National Rural. As of May
31, 2008, $20 million had been advanced to CoServ under this loan
facility. To date, CoServ has made all payments required under the
restructure agreement and capital expenditure loan facility. Under the terms of
the restructure agreement, CoServ has the option to prepay the loan for $415
million plus an interest
payment true up on or after December 13, 2007 and for $405 million plus an
interest payment true up on or after December 13, 2008. National
Rural has received no notice from CoServ that it intends to prepay the
loan.
CoServ
and National Rural have no claims related to any of the legal actions asserted
prior to or during the bankruptcy proceedings. National Rural’s legal
claim against CoServ is limited to CoServ's performance under the terms of the
bankruptcy settlement.
Based on
its analysis, the Company believes that it is adequately reserved for its
exposure to CoServ at May 31, 2008.
(d)
VarTec Telecom, Inc. ("VarTec") was a telecommunications company and RTFC
borrower located in Dallas, Texas. The Company was VarTec's principal
senior secured creditor. VarTec and 16 of its U.S.-based affiliates,
which were guarantors of VarTec's debt to RTFC, filed voluntary petitions under
Chapter 11 of the United States Bankruptcy Code on November 1, 2004 in Dallas,
Texas. The cases were converted in 2006 to Chapter 7 proceedings,
administered by a Chapter 7 trustee.
Non-performing
loans at May 31, 2007 included $9 million to VarTec. On June 4, 2007,
the Bankruptcy Court approval of a settlement of litigation against the Company
became final, pursuant to which (a) all claims against the Company were
dismissed with prejudice and fully released, (b) a portion of the proceeds from
the collateral that had been provisionally applied to the Company’s secured debt
was reallocated to VarTec creditors, including the Company, and (c) an
administrative debtor-in-possession (“DIP”) financing facility owed by the
VarTec bankruptcy estates to the Company was reduced to $6
million. The Company’s remaining DIP and unsecured claims will share
in further recoveries by the bankruptcy estates. As a result of the
settlement of the litigation, the Company wrote off $44 million of pre-petition
debt during the fourth quarter of fiscal year 2007 and wrote off $17 million in
the first quarter of fiscal year 2008.
On
December 26, 2007, the Company received $3 million, which is a share of the
settlement proceeds from the VarTec estates’ litigation against certain former
directors and officers. At May 31, 2008, the Company had a receivable
for $3 million, which has a payment priority from the bankruptcy estates; in
addition, the Company will share in recoveries that are in excess of the amount
required to repay the DIP financing and cover expenses of the
estates.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(e)
Innovative Communication Corporation ("ICC") is a diversified telecommunications
company and RTFC borrower headquartered in St. Croix, United States Virgin
Islands ("USVI"). In the USVI, through its subsidiary Virgin Islands
Telephone Corporation d/b/a Innovative Telephone ("Vitelco"), ICC provides
cellular, wireline local and long-distance telephone, cable television, and
Internet access services. Through other subsidiaries, ICC provides
telecommunications, cable television, and Internet access services in the
eastern and southern Caribbean and mainland France.
As of May
31, 2008 and 2007, RTFC had $492 million and $493 million, respectively, in
loans outstanding to ICC. All loans to ICC have been on non-accrual
status since February 1, 2005. ICC has not made debt service payments
to RTFC since June 2005.
RTFC is
the primary secured lender to ICC. RTFC's collateral for the loans
included (i) a series of mortgages, security agreements, financing statements,
pledges and guaranties creating liens in favor of RTFC on substantially all of
the assets and voting stock of ICC, (ii) a direct pledge of 100% of the voting
stock of ICC's USVI local exchange carrier subsidiary, Vitelco, (iii) secured
guaranties, mortgages and direct and indirect stock pledges encumbering the
assets and ownership interests in substantially all of ICC's other operating
subsidiaries and certain of its parent entities, including ICC's immediate
parent, Emerging Communication, Inc., a Delaware corporation ("Emcom") and
Emcom's parent, Innovative Communication Company LLC, a Delaware limited
liability company ("ICC-LLC"), and (iv) a personal guaranty of the loans from
ICC's indirect majority shareholder and chairman, Jeffrey Prosser
("Prosser").
Beginning
on June 1, 2004, RTFC filed a series of lawsuits against ICC, Prosser and others
for failure to comply with the terms of ICC's loan agreement with RTFC dated
August 27, 2001 as amended on April 4, 2003. In response to the
lawsuits filed by RTFC, ICC, Vitelco and Prosser denied liability and asserted
claims, by way of counterclaim and by filing its own lawsuits against RTFC,
National Rural and certain of RTFC's officers, seeking various remedies,
including reformation of the loan agreement, injunctive relief, and damages
(together with the RTFC claims, the “Loan Litigation”).
In
February 2006, involuntary bankruptcy petitions were filed against Prosser,
Emcom and ICC-LLC; and on April 26, 2006, RTFC reached a settlement of the Loan
Litigation with ICC, Vitelco, ICC-LLC, Emcom, their directors and Prosser,
individually. Under the settlement, RTFC obtained entry of judgments
in the District Court for the District of the Virgin Islands against ICC for
approximately $525 million and Prosser for approximately $100
million. RTFC also obtained dismissals
with prejudice of all counterclaims, affirmative defenses and other lawsuits
alleging wrongful acts by RTFC, certain of its officers, and National Rural,
thereby resolving all the Loan Litigation in RTFC’s favor.
Although
the judgment debtors and others were given an opportunity to satisfy the
judgments at a discount, on July 31, 2006, ICC-LLC, Emcom and Prosser each filed
a voluntary bankruptcy petition for reorganization. The cases are
pending in the United States District Court for the Virgin Island, Bankruptcy
Division (the “Bankruptcy Court”). A Chapter 11 trustee, Stan
Springel, was later appointed for the ICC-LLC and Emcom estates; and Prosser’s
individual case was converted to Chapter 7 liquidation in October
2007. Prosser’s Chapter 7 trustee is in the process of marshaling
Prosser’s non-exempt assets for disposition and eventual payment in respect of
creditor claims.
On
September 21, 2007, the Bankruptcy Court entered an order placing ICC in its own
bankruptcy proceeding, and on October 3, 2007 appointed Stan Springel as its
trustee. The Chapter 11 trustee of ICC has assumed ownership and
control of ICC, including its subsidiaries, and has begun to marshal RTFC
collateral and other assets, including property in Prosser’s possession or
control, for disposition and eventual payment in respect of RTFC’s claims and
the claims of other parties-in-interest.
In most
cases, the sale (as part of the Chapter 11 cases) of ICC or any of its
subsidiaries engaged in a regulated telecommunications or cable television
business, or of the regulated assets of ICC or its subsidiaries, will require
the prior consent of the respective regulators in the United States (including
the Federal Communications Commission and the U.S. Virgin Islands Public
Services Commission), the British Virgin Islands, France and its Caribbean
territories, and the Netherlands Antilles. In certain limited cases,
only a post-transaction notification will be required.
Based on
its analysis, the Company believes that it is adequately reserved for its
exposure to ICC at May 31, 2008.
(f)
Pioneer Electric Cooperative, Inc. ("Pioneer") is an electric distribution
cooperative located in Greenville, Alabama. Pioneer had also invested
in a propane gas operation, which it has sold. Pioneer has
experienced deterioration in its financial condition as a result of losses in
the gas operation. At May 31, 2008 and 2007, National Rural had a
total of $52 million in loans outstanding to Pioneer. Pioneer was
current with respect to all debt service payments at May 31,
2008. All loans to Pioneer remain on accrual status with respect to
the recognition of interest income. National Rural is the principal
creditor to Pioneer.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
On March
9, 2006, National Rural and Pioneer agreed on the terms of a debt modification
that resulted in the loans being classified as restructured. Under
the amended agreement, National Rural extended the maturity of the outstanding
loans and granted a two-year deferral of principal payments. In
addition, National Rural agreed to make available a line of credit for general
corporate purposes. The restructured loans are secured by first liens
on substantially all of the assets and revenues of Pioneer.
Based on
its analysis, the Company believes that it is adequately reserved for its
exposure to Pioneer at May 31, 2008.
(16) Gain
on Sale of Building and Land
On
October 18, 2005, National Rural sold its headquarters facility in Fairfax
County, Virginia to an affiliate of Prentiss Properties Acquisition Partners,
L.P. for $85 million. The assets had a net book value of $40 million,
thus generating a total gain of $43 million during the year ended May 31, 2006,
net of $2 million in closing and other related costs. The
headquarters facility consists of two six-story buildings and adjacent parking
garages situated on ten acres of land and two acres of unimproved land adjacent
to the office buildings. On the sale date, National Rural entered
into a three-year lease with the new building owner for approximately one-third
of the office space. In September 2007, the Company exercised the
option to extend the lease for an additional one-year period. The
Company has the option to extend the lease for an additional one-year period in
fiscal year 2009. The terms of these extensions are similar to the
initial three-year lease.
(17) Segment
Information
The
Company's consolidated financial statements include the financial results of
National Rural, RTFC and NCSC. Financial statements are produced for
each of the three companies and are the primary reports that management reviews
in evaluating performance. The National Rural segment includes the
consolidation of entities controlled by National Rural and created to hold
foreclosed assets and effect loan securitization transactions and intercompany
transaction elimination entries. The segment presentation for the
years ended May 31, 2008, 2007 and 2006 reflect the operating results of each of
the three companies as a separate segment.
National
Rural is the sole lender to RTFC and the primary source of funding for
NCSC. NCSC also obtains funding from third parties with a National
Rural guarantee. Thus, National Rural takes all of the risk related
to the funding of the loans to RTFC and NCSC, and in return, National Rural
earns a net interest income on the loans to RTFC and NCSC.
Pursuant
to guarantee agreements, National Rural has agreed to indemnify RTFC and NCSC
for loan losses, with the exception of the NCSC consumer loan
program. Thus, National Rural maintains the majority of the total
consolidated loan loss allowance. A small loan loss allowance is
maintained by NCSC to cover its consumer loan exposure.
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
The
following chart contains consolidated statements of operations for the years
ended May 31, 2008, 2007 and 2006 and consolidated balance sheets as of May 31,
2008 and 2007.
|
For
the year ended May 31, 2008
|
|
(in
thousands)
|
National
Rural
|
|
RTFC
|
|
NCSC
|
|
Consolidated
|
|
Statement
of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
$
|
946,550
|
|
|
$
|
89,072
|
|
|
$
|
33,918
|
|
|
$
|
1,069,540
|
|
|
Interest
expense
|
|
(825,796
|
)
|
|
|
(83,767
|
)
|
|
|
(27,326
|
)
|
|
|
(936,889
|
)
|
|
Net
interest income
|
|
120,754
|
|
|
|
5,305
|
|
|
|
6,592
|
|
|
|
132,651
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recovery
of loan losses
|
|
30,097
|
|
|
|
-
|
|
|
|
165
|
|
|
|
30,262
|
|
|
Net
interest income after recovery of loan losses
|
|
150,851
|
|
|
|
5,305
|
|
|
|
6,757
|
|
|
|
162,913
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
834
|
|
|
|
-
|
|
|
|
627
|
|
|
|
1,461
|
|
|
Derivative
cash settlements
|
|
28,416
|
|
|
|
-
|
|
|
|
(1,383
|
)
|
|
|
27,033
|
|
|
Results
of operations of foreclosed assets
|
|
7,528
|
|
|
|
-
|
|
|
|
-
|
|
|
|
7,528
|
|
|
Total
non-interest income
|
|
36,778
|
|
|
|
-
|
|
|
|
(756
|
)
|
|
|
36,022
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses
|
|
(50,976
|
)
|
|
|
(5,366
|
)
|
|
|
(4,127
|
)
|
|
|
(60,469
|
)
|
|
Recovery
of guarantee liability
|
|
3,104
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,104
|
|
|
Market
adjustment of foreclosed assets
|
|
(5,840
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(5,840
|
)
|
|
Derivative
forward value
|
|
(87,496
|
)
|
|
|
-
|
|
|
|
(11,247
|
)
|
|
|
(98,743
|
)
|
|
Foreign
currency adjustments
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
Loss
on sale of loans
|
|
(676
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(676
|
)
|
|
Total
non-interest expense
|
|
(141,884
|
)
|
|
|
(5,366
|
)
|
|
|
(15,374
|
)
|
|
|
(162,624
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) prior to income taxes and minority
interest
|
|
45,745
|
|
|
|
(61
|
)
|
|
|
(9,373
|
)
|
|
|
36,311
|
|
|
Income
tax (expense) benefit
|
|
-
|
|
|
|
(231
|
)
|
|
|
3,566
|
|
|
|
3,335
|
|
|
Income
per segment reporting
|
$
|
45,745
|
|
|
$
|
(292
|
)
|
|
$
|
(5,807
|
)
|
|
$
|
39,646
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation
of net income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per segment reporting
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
39,646
|
|
|
Minority
interest, net of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6,099
|
|
|
Net
income per consolidated statement of operations
|
|
|
|
|
|
|
|
|
|
|
|
$
|
45,745
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans outstanding
|
$
|
16,886,407
|
|
|
$
|
1,726,514
|
|
|
$
|
414,074
|
|
|
$
|
19,026,995
|
|
|
Deferred
origination fees
|
|
2,045
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,045
|
|
|
Less: Allowance
for loan losses
|
|
(514,626
|
)
|
|
|
-
|
|
|
|
(280
|
)
|
|
|
(514,906
|
)
|
|
Loans
to members, net
|
|
16,373,826
|
|
|
|
1,726,514
|
|
|
|
413,794
|
|
|
|
18,514,134
|
|
|
Other
assets
|
|
639,115
|
|
|
|
182,388
|
|
|
|
43,744
|
|
|
|
865,247
|
|
|
Total
assets
|
$
|
17,012,941
|
|
|
$
|
1,908,902
|
|
|
$
|
457,538
|
|
|
$
|
19,379,381
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
|
For
the year ended May 31, 2007
|
|
(in
thousands)
|
National
Rural
|
|
RTFC
|
|
NCSC
|
|
Consolidated
|
|
Statement
of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
$
|
916,913
|
|
|
$
|
105,614
|
|
|
$
|
31,697
|
|
|
$
|
1,054,224
|
|
|
Interest
expense
|
|
(870,186
|
)
|
|
|
(99,224
|
)
|
|
|
(27,320
|
)
|
|
|
(996,730
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
46,727
|
|
|
|
6,390
|
|
|
|
4,377
|
|
|
|
57,494
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Recovery
of loan losses
|
|
5,499
|
|
|
|
-
|
|
|
|
1,423
|
|
|
|
6,922
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income after recovery of loan losses
|
|
52,226
|
|
|
|
6,390
|
|
|
|
5,800
|
|
|
|
64,416
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
888
|
|
|
|
-
|
|
|
|
645
|
|
|
|
1,533
|
|
|
Derivative
cash settlements
|
|
86,040
|
|
|
|
-
|
|
|
|
402
|
|
|
|
86,442
|
|
|
Results
of operations of foreclosed assets
|
|
9,758
|
|
|
|
-
|
|
|
|
-
|
|
|
|
9,758
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-interest income
|
|
96,686
|
|
|
|
-
|
|
|
|
1,047
|
|
|
|
97,733
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses
|
|
(43,029
|
)
|
|
|
(5,373
|
)
|
|
|
(3,487
|
)
|
|
|
(51,889
|
)
|
|
Recovery
of guarantee liability
|
|
1,700
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,700
|
|
|
Derivative
forward value
|
|
(79,744
|
)
|
|
|
-
|
|
|
|
463
|
|
|
|
(79,281
|
)
|
|
Foreign
currency adjustments
|
|
(14,554
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(14,554
|
)
|
|
Loss
on sale of loans
|
|
(1,584
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(1,584
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-interest expense
|
|
(137,211
|
)
|
|
|
(5,373
|
)
|
|
|
(3,024
|
)
|
|
|
(145,608
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
prior to income taxes and minority
interest
|
|
11,701
|
|
|
|
1,017
|
|
|
|
3,823
|
|
|
|
16,541
|
|
|
Income
tax expense
|
|
-
|
|
|
|
(945
|
)
|
|
|
(1,451
|
)
|
|
|
(2,396
|
)
|
|
Income
per segment reporting
|
$
|
11,701
|
|
|
$
|
72
|
|
|
$
|
2,372
|
|
|
$
|
14,145
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation
of net income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per segment reporting
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
14,145
|
|
|
Minority
interest, net of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(2,444
|
)
|
|
Net
income per consolidated statement of operations
|
|
|
|
|
|
|
|
|
|
|
|
$
|
11,701
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans outstanding
|
$
|
15,805,290
|
|
|
$
|
1,860,379
|
|
|
$
|
462,538
|
|
|
$
|
18,128,207
|
|
|
Deferred
origination fees
|
|
3,666
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,666
|
|
|
Less: Allowance
for loan losses
|
|
(561,113
|
)
|
|
|
-
|
|
|
|
(550
|
)
|
|
|
(561,663
|
)
|
|
Loans
to members, net
|
|
15,247,843
|
|
|
|
1,860,379
|
|
|
|
461,988
|
|
|
|
17,570,210
|
|
|
Other
assets
|
|
764,528
|
|
|
|
189,716
|
|
|
|
50,727
|
|
|
|
1,004,971
|
|
|
Total
assets
|
$
|
16,012,371
|
|
|
$
|
2,050,095
|
|
|
$
|
512,715
|
|
|
$
|
18,575,181
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
|
For
the year ended May 31, 2006
|
|
(in
thousands)
|
National
Rural
|
|
RTFC
|
|
NCSC
|
|
Consolidated
|
|
Statement
of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
$
|
846,806
|
|
|
$
|
129,665
|
|
|
$
|
31,441
|
|
|
$
|
1,007,912
|
|
|
Interest
expense
|
|
(826,836
|
)
|
|
|
(122,824
|
)
|
|
|
(26,276
|
)
|
|
|
(975,936
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
19,970
|
|
|
|
6,841
|
|
|
|
5,165
|
|
|
|
31,976
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Provision
for) recovery of loan losses
|
|
(23,452
|
)
|
|
|
-
|
|
|
|
212
|
|
|
|
(23,240
|
)
|
|
Net
interest (loss) income after (provision for) recovery of loan
losses
|
|
(3,482
|
)
|
|
|
6,841
|
|
|
|
5,377
|
|
|
|
8,736
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
2,017
|
|
|
|
-
|
|
|
|
381
|
|
|
|
2,398
|
|
|
Derivative
cash settlements
|
|
81,809
|
|
|
|
-
|
|
|
|
(926
|
)
|
|
|
80,883
|
|
|
Results
of operations of foreclosed assets
|
|
15,492
|
|
|
|
-
|
|
|
|
-
|
|
|
|
15,492
|
|
|
Gain
on sale of building and land
|
|
43,431
|
|
|
|
-
|
|
|
|
-
|
|
|
|
43,431
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-interest income
|
|
142,749
|
|
|
|
-
|
|
|
|
(545
|
)
|
|
|
142,204
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses
|
|
(44,589
|
)
|
|
|
(4,849
|
)
|
|
|
(2,651
|
)
|
|
|
(52,089
|
)
|
|
Recovery
of guarantee liability
|
|
700
|
|
|
|
-
|
|
|
|
-
|
|
|
|
700
|
|
|
Derivative
forward value
|
|
22,713
|
|
|
|
-
|
|
|
|
6,092
|
|
|
|
28,805
|
|
|
Foreign
currency adjustments
|
|
(22,594
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(22,594
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-interest expense
|
|
(43,770
|
)
|
|
|
(4,849
|
)
|
|
|
3,441
|
|
|
|
(45,178
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
prior to income taxes and minority interest
|
|
95,497
|
|
|
|
1,992
|
|
|
|
8,273
|
|
|
|
105,762
|
|
|
Income
tax expense
|
|
-
|
|
|
|
(36
|
)
|
|
|
(3,140
|
)
|
|
|
(3,176
|
)
|
|
Income
per segment reporting
|
$
|
95,497
|
|
|
$
|
1,956
|
|
|
$
|
5,133
|
|
|
$
|
102,586
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation
of net income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per segment reporting
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
102,586
|
|
|
Minority
interest, net of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(7,089
|
)
|
|
Net
income per consolidated statement of operations
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
95,497
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(18) Selected
Quarterly Financial Data (Unaudited)
Summarized
results of operations for the four quarters of fiscal years 2008 and 2007 are as
follows:
|
Fiscal
Year 2008
|
|
Quarters
Ended
|
(in
thousands)
|
|
August
31,
|
|
|
November
30,
|
|
|
February
29,
|
|
|
May
31,
|
|
|
Total
Year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
$
|
267,954
|
|
$
|
263,287
|
|
$
|
266,576
|
|
$
|
271,723
|
|
$
|
1,069,540
|
|
Interest
expense
|
|
(247,325
|
|
|
(240,017
|
)
|
|
(233,468
|
)
|
|
(216,079
|
)
|
|
(936,889
|
)
|
Net
interest income
|
|
20,629
|
|
|
23,270
|
|
|
33,108
|
|
|
55,644
|
|
|
132,651
|
|
Recovery
of (provision for) loan losses
|
|
-
|
|
|
14,301
|
|
|
33,599
|
|
|
(17,638
|
)
|
|
30,262
|
|
Net
interest income after recovery of (provision for) loan
losses
|
|
20,629
|
|
|
37,571
|
|
|
66,707
|
|
|
38,006
|
|
|
162,913
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
cash settlements
|
|
8,329
|
|
|
11,507
|
|
|
10,463
|
|
|
(3,266
|
)
|
|
27,033
|
|
Other
non-interest income
|
|
2,311
|
|
|
2,208
|
|
|
2,768
|
|
|
1,702
|
|
|
8,989
|
|
Total
non-interest income
|
|
10,640
|
|
|
13,715
|
|
|
13,231
|
|
|
(1,564
|
)
|
|
36,022
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
forward value
|
|
(33,600
|
)
|
|
(75,412
|
)
|
|
(64,266
|
)
|
|
74,535
|
|
|
(98,743
|
)
|
Other
non-interest expense
|
|
(11,728
|
)
|
|
(13,557
|
)
|
|
(20,258
|
)
|
|
(18,338
|
)
|
|
(63,881
|
)
|
Total
non-interest expense
|
|
(45,328
|
)
|
|
(88,969
|
)
|
|
(84,524
|
)
|
|
56,197
|
|
|
(162,624
|
)
|
(Loss)
income prior to income taxes and minority interest
|
|
(14,059
|
)
|
|
(37,683
|
)
|
|
(4,586
|
)
|
|
92,639
|
|
|
36,311
|
|
Income
tax benefit (expense)
|
|
1,099
|
|
|
2,912
|
|
|
2,175
|
|
|
(2,851
|
)
|
|
3,335
|
|
Minority
interest, net of income taxes
|
|
1,578
|
|
|
4,545
|
|
|
2,088
|
|
|
(2,112
|
)
|
|
6,099
|
|
Net
(loss) income
|
$
|
(11,382
|
)
|
$
|
(30,226
|
)
|
$
|
(323
|
)
|
$
|
87,676
|
|
$
|
45,745
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fiscal
Year 2007
|
|
Quarters
Ended
|
(in
thousands)
|
|
August
31,
|
|
|
November
30,
|
|
|
February
28,
|
|
|
May
31,
|
|
|
Total
Year
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
$
|
264,689
|
|
$
|
260,244
|
|
$
|
264,873
|
|
$
|
264,418
|
|
$
|
1,054,224
|
|
Interest
expense
|
|
(256,004
|
|
|
(248,591
|
)
|
|
(247,441
|
)
|
|
(244,694
|
)
|
|
(996,730
|
)
|
Net
interest income
|
|
8,685
|
|
|
11,653
|
|
|
17,432
|
|
|
19,724
|
|
|
57,494
|
|
Recovery
of loan losses
|
|
-
|
|
|
-
|
|
|
-
|
|
|
6,922
|
|
|
6,922
|
|
Net
interest income after recovery of loan losses
|
|
8,685
|
|
|
11,653
|
|
|
17,432
|
|
|
26,646
|
|
|
64,416
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
cash settlements
|
|
15,255
|
|
|
16,493
|
|
|
44,442
|
|
|
10,252
|
|
|
86,442
|
|
Other
non-interest income
|
|
3,319
|
|
|
3,297
|
|
|
2,313
|
|
|
2,362
|
|
|
11,291
|
|
Total
non-interest income
|
|
18,574
|
|
|
19,790
|
|
|
46,755
|
|
|
12,614
|
|
|
97,733
|
|
Non-interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
forward value
|
|
(63,351
|
)
|
|
(53,239
|
)
|
|
(4,189
|
)
|
|
41,498
|
|
|
(79,281
|
)
|
Foreign
currency adjustments
|
|
3,321
|
|
|
(20,620
|
)
|
|
1,886
|
|
|
859
|
|
|
(14,554
|
)
|
Other
non-interest expense
|
|
(11,328
|
)
|
|
(14,577
|
)
|
|
(13,188
|
)
|
|
(12,680
|
)
|
|
(51,773
|
)
|
Total
non-interest expense
|
|
(71,358
|
)
|
|
(88,436
|
)
|
|
(15,491
|
)
|
|
29,677
|
|
|
(145,608
|
)
|
(Loss)
income prior to income taxes and minority interest
|
|
(44,099
|
)
|
|
(56,993
|
)
|
|
48,696
|
|
|
68,937
|
|
|
16,541
|
|
Income
tax benefit (expense)
|
|
714
|
|
|
486
|
|
|
(627
|
)
|
|
(2,969
|
)
|
|
(2,396
|
)
|
Minority
interest, net of income taxes
|
|
366
|
|
|
312
|
|
|
566
|
|
|
(3,688
|
)
|
|
(2,444
|
)
|
Net
(loss) income
|
$
|
(43,019
|
)
|
$
|
(56,195
|
)
|
$
|
48,635
|
|
$
|
62,280
|
|
$
|
11,701
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(19) Subsequent
Events
In June 2008, the Company issued $900
million of 5.50% collateral trust bonds due 2013 and $400 million of floating
rate collateral trust bonds due 2010.