FORM
10-Q
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
x QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE
SECURITIES EXCHANGE ACT OF 1934
For the
Quarterly Period Ended August 31, 2008
OR
o 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.
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 whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions of "large accelerated filer," "accelerated
filer" and "smaller reporting company" in Rule 12b-2 of the Exchange
Act.
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.
PART
1.
|
FINANCIAL
INFORMATION
|
Item
1.
|
Financial
Statements.
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
BALANCE SHEETS
(UNAUDITED)
(in
thousands)
A
S S E T S
|
August
31, 2008
|
|
May
31, 2008
|
|
|
|
|
|
|
|
|
|
|
Cash
and cash equivalents
|
$
|
1,529,395
|
|
|
$
|
177,809
|
|
|
|
|
|
|
|
|
|
|
|
Restricted
cash
|
|
8,548
|
|
|
|
14,460
|
|
|
|
|
|
|
|
|
|
|
|
Loans
to members
|
|
19,365,351
|
|
|
|
19,029,040
|
|
|
Less:
Allowance for loan losses
|
|
(522,597
|
)
|
|
|
(514,906
|
)
|
|
Loans
to members, net
|
|
18,842,754
|
|
|
|
18,514,134
|
|
|
|
|
|
|
|
|
|
|
|
Accrued
interest and other receivables
|
|
281,180
|
|
|
|
258,315
|
|
|
|
|
|
|
|
|
|
|
|
Fixed
assets, net
|
|
21,435
|
|
|
|
21,045
|
|
|
|
|
|
|
|
|
|
|
|
Debt
service reserve funds
|
|
47,775
|
|
|
|
54,993
|
|
|
|
|
|
|
|
|
|
|
|
Bond
issuance costs, net
|
|
44,956
|
|
|
|
39,618
|
|
|
|
|
|
|
|
|
|
|
|
Foreclosed
assets, net
|
|
60,207
|
|
|
|
58,961
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
assets
|
|
255,283
|
|
|
|
220,514
|
|
|
|
|
|
|
|
|
|
|
|
Other
assets
|
|
23,698
|
|
|
|
19,532
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
21,115,231
|
|
|
$
|
19,379,381
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes.
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
BALANCE SHEETS
(UNAUDITED)
(in
thousands)
L I A B I
L I T I E S A N D E Q U I T Y
|
August
31, 2008
|
|
May
31, 2008
|
|
|
|
|
|
|
|
|
|
|
Short-term
debt
|
$
|
8,098,624
|
|
|
$
|
6,327,453
|
|
|
|
|
|
|
|
|
|
|
|
Accrued
interest payable
|
|
309,200
|
|
|
|
244,299
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
9,987,480
|
|
|
|
10,173,587
|
|
|
|
|
|
|
|
|
|
|
|
Patronage
capital retirement payable
|
|
85,223
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
Deferred
income
|
|
20,540
|
|
|
|
21,971
|
|
|
|
|
|
|
|
|
|
|
|
Guarantee
liability
|
|
14,120
|
|
|
|
15,034
|
|
|
|
|
|
|
|
|
|
|
|
Other
liabilities
|
|
42,753
|
|
|
|
27,216
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
liabilities
|
|
217,391
|
|
|
|
171,390
|
|
|
|
|
|
|
|
|
|
|
|
Subordinated
deferrable debt
|
|
311,440
|
|
|
|
311,440
|
|
|
|
|
|
|
|
|
|
|
|
Members'
subordinated certificates:
|
|
|
|
|
|
|
|
|
Membership
subordinated certificates
|
|
649,465
|
|
|
|
649,465
|
|
|
Loan
and guarantee subordinated certificates
|
|
771,345
|
|
|
|
757,314
|
|
|
Total
members' subordinated certificates
|
|
1,420,810
|
|
|
|
1,406,779
|
|
|
|
|
|
|
|
|
|
|
|
Commitments
and contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest
|
|
13,001
|
|
|
|
14,247
|
|
|
|
|
|
|
|
|
|
|
|
Equity:
|
|
|
|
|
|
|
|
|
Retained
equity
|
|
586,016
|
|
|
|
657,138
|
|
|
Accumulated
other comprehensive income
|
|
8,633
|
|
|
|
8,827
|
|
|
Total
equity
|
|
594,649
|
|
|
|
665,965
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
21,115,231
|
|
|
$
|
19,379,381
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes.
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
STATEMENTS OF OPERATIONS
(UNAUDITED)
(in
thousands)
For the
Three Months Ended August 31, 2008 and 2007
|
Three
months ended
|
|
|
|
August
31,
|
|
|
|
2008
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
$
|
266,518
|
|
|
$
|
267,954
|
|
|
|
Interest
expense
|
|
(220,309
|
)
|
|
|
(247,325
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
46,209
|
|
|
|
20,629
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for loan losses
|
|
(10,681
|
)
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income after provision for loan losses
|
|
35,528
|
|
|
|
20,629
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
181
|
|
|
|
351
|
|
|
|
Derivative
cash settlements
|
|
431
|
|
|
|
8,329
|
|
|
|
Results
of operations from foreclosed assets
|
|
1,246
|
|
|
|
1,960
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-interest income
|
|
1,858
|
|
|
|
10,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
(expense)/income:
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
(9,851
|
)
|
|
|
(8,823
|
)
|
|
|
Other
general and administrative expenses
|
|
(4,742
|
)
|
|
|
(4,487
|
)
|
|
|
Recovery
of guarantee liability
|
|
705
|
|
|
|
2,100
|
|
|
|
Derivative
forward value
|
|
(11,028
|
)
|
|
|
(33,600
|
)
|
|
|
Loss
on sale of loans
|
|
-
|
|
|
|
(518
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-interest expense
|
|
(24,916
|
)
|
|
|
(45,328
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) prior to income taxes and minority interest
|
|
12,470
|
|
|
|
(14,059
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit
|
|
760
|
|
|
|
1,099
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) prior to minority interest
|
|
13,230
|
|
|
|
(12,960
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Minority
interest, net of income taxes
|
|
1,241
|
|
|
|
1,578
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
$
|
14,471
|
|
|
$
|
(11,382
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes.
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
STATEMENTS OF CHANGES IN EQUITY
(UNAUDITED)
(in
thousands)
For the
Three Months Ended August 31, 2008 and 2007
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Patronage
Capital
|
|
|
|
|
|
|
Accumulated
|
|
|
|
|
|
|
|
|
|
|
|
Allocated
|
|
|
|
|
|
|
Other
|
|
Subtotal
|
|
|
|
|
|
|
|
Members'
|
|
General
|
|
|
|
|
|
|
|
|
Comprehensive
|
|
Retained
|
|
Membership
|
|
Unallocated
|
|
Education
|
|
Capital
|
|
Reserve
|
|
|
|
|
|
|
Total
|
|
Income
(Loss)
|
|
Equity
|
|
Fees
|
|
Net
Income
|
|
Fund
|
|
Reserve
|
|
Fund
|
|
Other
|
|
|
Three
months ended August 31, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Balance
as of May 31, 2008
|
$
|
665,965
|
|
$
|
8,827
|
|
|
$
|
657,138
|
|
|
$
|
993
|
|
|
$
|
44,003
|
|
|
$
|
1,484
|
|
|
$
|
187,409
|
|
$
|
496
|
|
|
$
|
422,753
|
|
|
|
Patronage
capital retirement
|
|
(85,238
|
)
|
|
-
|
|
|
|
(85,238
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
(85,238
|
)
|
|
|
Income
prior to income taxes and minority interest
|
|
12,470
|
|
|
-
|
|
|
|
12,470
|
|
|
|
-
|
|
|
|
12,470
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
|
|
Other
comprehensive loss
|
|
(194
|
)
|
|
(194
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
|
|
Income
tax expense
|
|
760
|
|
|
-
|
|
|
|
760
|
|
|
|
-
|
|
|
|
760
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
|
|
Minority
interest
|
|
1,241
|
|
|
-
|
|
|
|
1,241
|
|
|
|
-
|
|
|
|
1,241
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
|
|
Other
|
|
(355
|
)
|
|
-
|
|
|
|
(355
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(355
|
)
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
|
|
Balance
as of August 31, 2008
|
$
|
594,649
|
|
$
|
8,633
|
|
|
$
|
586,016
|
|
|
$
|
993
|
|
|
$
|
58,474
|
|
|
$
|
1,129
|
|
|
$
|
187,409
|
|
$
|
496
|
|
|
$
|
337,515
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
months ended August 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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
|
)
|
|
|
Loss
prior to income taxes and minority interest
|
|
(14,059
|
)
|
|
-
|
|
|
|
(14,059
|
)
|
|
|
-
|
|
|
|
(14,059
|
)
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
|
|
Other
comprehensive loss
|
|
(75
|
)
|
|
(75
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
|
|
Income
tax benefit
|
|
1,099
|
|
|
-
|
|
|
|
1,099
|
|
|
|
-
|
|
|
|
1,099
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
|
|
Minority
interest
|
|
1,578
|
|
|
-
|
|
|
|
1,578
|
|
|
|
-
|
|
|
|
1,578
|
|
|
|
-
|
|
|
|
-
|
|
|
-
|
|
|
|
-
|
|
|
|
Other
|
|
(328
|
)
|
|
-
|
|
|
|
(328
|
)
|
|
|
(2
|
)
|
|
|
-
|
|
|
|
(326
|
)
|
|
|
39
|
|
|
-
|
|
|
|
(39
|
)
|
|
|
Balance
as of August 31, 2007
|
$
|
612,762
|
|
$
|
12,129
|
|
|
$
|
600,633
|
|
|
$
|
995
|
|
|
$
|
120,146
|
|
|
$
|
1,080
|
|
|
$
|
158,347
|
|
$
|
498
|
|
|
$
|
319,567
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes.
|
|
|
|
|
|
|
|
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in
thousands)
For the
Three Months Ended August 31, 2008 and 2007
|
2008
|
|
2007
|
|
CASH
FLOWS PROVIDED BY OPERATING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
$
|
14,471
|
|
|
$
|
(11,382
|
)
|
|
Add
(deduct):
|
|
|
|
|
|
|
|
|
Amortization
of deferred income
|
|
(1,633
|
)
|
|
|
(1,940
|
)
|
|
Amortization
of bond issuance costs and deferred charges
|
|
2,384
|
|
|
|
8,358
|
|
|
Depreciation
|
|
610
|
|
|
|
544
|
|
|
Provision
for loan losses
|
|
10,681
|
|
|
|
-
|
|
|
Recovery
of guarantee liability
|
|
(705
|
)
|
|
|
(2,100
|
)
|
|
Results
of operations from foreclosed assets
|
|
(1,246
|
)
|
|
|
(1,960
|
)
|
|
Derivative
forward value
|
|
11,028
|
|
|
|
33,600
|
|
|
Loss
on sale of loans
|
|
-
|
|
|
|
518
|
|
|
Restricted
interest earned on restricted cash
|
|
(64
|
)
|
|
|
-
|
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accrued
interest and other receivables
|
|
(23,540
|
)
|
|
|
(13,217
|
)
|
|
Accrued
interest payable
|
|
64,901
|
|
|
|
49,340
|
|
|
Other
|
|
8,778
|
|
|
|
(2,019
|
)
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by operating activities
|
|
85,665
|
|
|
|
59,742
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS (USED IN) PROVIDED BY INVESTING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Advances
made on loans
|
|
(2,596,707
|
)
|
|
|
(1,831,171
|
)
|
|
Principal
collected on loans
|
|
2,256,780
|
|
|
|
1,859,582
|
|
|
Net
investment in fixed assets
|
|
(1,000
|
)
|
|
|
(190
|
)
|
|
Net
proceeds from sale of loans
|
|
-
|
|
|
|
39,273
|
|
|
Change
in restricted cash
|
|
5,912
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
Net
cash (used in) provided by investing activities
|
|
(335,015
|
)
|
|
|
67,494
|
|
|
|
|
|
|
|
|
|
|
|
CASH
FLOWS PROVIDED BY (USED IN) FINANCING ACTIVITIES:
|
|
|
|
|
|
|
|
|
Proceeds
from issuances (repayments) of short-term debt, net
|
|
723,544
|
|
|
|
(531,012
|
)
|
|
Proceeds
from issuance of long-term debt, net
|
|
1,450,611
|
|
|
|
600,546
|
|
|
Payments
for retirement of long-term debt
|
|
(595,093
|
)
|
|
|
(107,865
|
)
|
|
Payments
for retirement of subordinated deferrable debt
|
|
-
|
|
|
|
(175,000
|
)
|
|
Proceeds
from issuance of members' subordinated certificates
|
|
29,642
|
|
|
|
8,308
|
|
|
Payments
for retirement of members' subordinated certificates
|
|
(7,768
|
)
|
|
|
(7,689
|
)
|
|
|
|
|
|
|
|
|
|
|
Net
cash provided by (used in) financing activities
|
|
1,600,936
|
|
|
|
(212,712
|
)
|
|
|
|
|
|
|
|
|
|
|
NET
INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
|
|
1,351,586
|
|
|
|
(85,476
|
)
|
|
BEGINNING
CASH AND CASH EQUIVALENTS
|
|
177,809
|
|
|
|
304,107
|
|
|
ENDING
CASH AND CASH EQUIVALENTS
|
$
|
1,529,395
|
|
|
$
|
218,631
|
|
|
|
|
|
|
|
|
|
|
|
See
accompanying notes.
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONSOLIDATED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in
thousands)
For the
Three Months Ended August 31, 2008 and 2007
|
|
2008
|
|
|
|
2007
|
|
|
|
|
|
|
|
|
|
|
|
SUPPLEMENTAL
DISCLOSURE OF CASH FLOW INFORMATION:
|
|
|
|
|
|
|
|
|
Cash
paid for interest
|
$
|
153,025
|
|
|
$
|
189,627
|
|
|
Cash
paid for income taxes
|
|
-
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
Non-cash
financing and investing activities:
|
|
|
|
|
|
|
|
|
Subordinated
certificates applied against loan balances
|
$
|
675
|
|
|
$
|
-
|
|
|
Patronage
capital retirement payable
|
|
85,223
|
|
|
|
85,494
|
|
|
Patronage
capital applied against loan balances
|
|
15
|
|
|
|
-
|
|
|
Net
decrease in debt service reserve funds/debt service reserve
certificates
|
|
(7,218
|
)
|
|
|
-
|
|
|
|
See
accompanying notes.
|
|
NATIONAL
RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(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 1,525 as of August 31, 2008 including 898
utility members, the majority of which are consumer-owned electric cooperatives,
498 telecommunications members, 66 service members and 63 associates in 48
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.
In the
opinion of management, the accompanying consolidated financial statements
contain all adjustments (which consist only of normal recurring accruals)
necessary for a fair statement of the Company's results for the interim periods
presented.
These
interim unaudited consolidated financial statements should be read in
conjunction with the audited consolidated financial statements and notes thereto
included in the Company's Annual Report on Form 10-K for the fiscal year ended
May 31,
2008.
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States ("GAAP") 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.
(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 until December 1,
2016. Under a guarantee agreement, RTFC pays National Rural a fee in
exchange for a reimbursement to RTFC for its 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 reimbursement to NCSC for its
loan losses, excluding losses in the consumer loan program. All loans
that require NCSC board approval also require National Rural
approval. National Rural controls the nomination process for 1 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 August 31, 2008, National Rural had guaranteed $270 million
of NCSC debt and derivative instruments with third parties. The
maturities for NCSC debt guaranteed by National Rural run through
2022. At August 31, 2008, National Rural's maximum potential exposure
totaled $289 million related to guarantees of NCSC debt and
derivatives. Guarantees related to NCSC debt and derivative
instruments are not included in Note 11, Guarantees at August 31, 2008
as the debt and derivatives are reported on the consolidated balance
sheet. At August 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
August 31, 2008, RTFC had total assets of $1,895 million including loans
outstanding to members of $1,705 million and NCSC had total assets of $461
million including loans outstanding of $415 million. At August 31,
2008, National Rural had committed to lend RTFC up to $4 billion of which $1.7
billion was outstanding. At August 31, 2008, National Rural had
committed to provide up to $1 billion of credit to NCSC of which $454 million
was outstanding, representing $184 million of outstanding loans and $270 million
of credit enhancements.
National
Rural has established limited liability corporations and partnerships to hold
foreclosed assets and to effect loan securitization
transactions. National Rural has full ownership and control of
all such entities 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) 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. These
estimates are 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 charged off to the board of directors of
National Rural. In making its recommendation to charge 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 three months ended August 31,
|
|
Year
ended
|
|
(in
thousands)
|
|
2008
|
|
|
|
2007
|
|
|
May
31, 2008
|
|
Balance
at beginning of period
|
$
|
514,906
|
|
|
$
|
561,663
|
|
$
|
561,663
|
|
Provision
for (recovery of) loan losses
|
|
10,681
|
|
|
|
-
|
|
|
(30,262
|
)
|
Charge-offs
|
|
(3,078
|
)
|
|
|
(16,680
|
)
|
|
(16,911
|
)
|
Recoveries
|
|
88
|
|
|
|
96
|
|
|
416
|
|
Balance
at end of period
|
$
|
522,597
|
|
|
$
|
545,079
|
|
$
|
514,906
|
|
(d) Interest
Income
The
following table presents the components of interest income:
|
|
For
the three months ended August 31,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
Interest
on long-term fixed rate loans (1)
|
|
$
|
224,402
|
|
|
$
|
214,560
|
|
|
Interest
on long-term variable rate loans (1)
|
|
|
15,180
|
|
|
|
24,549
|
|
|
Interest
on short-term loans (1)
|
|
|
19,504
|
|
|
|
20,348
|
|
|
Interest
on investments (2)
|
|
|
2,181
|
|
|
|
2,936
|
|
|
Conversion
fees (3)
|
|
|
1,703
|
|
|
|
1,774
|
|
|
Make-whole
and prepayment fees (4)
|
|
|
827
|
|
|
|
1,689
|
|
|
Commitment
and guarantee fees (5)
|
|
|
1,869
|
|
|
|
1,535
|
|
|
Other
fees
|
|
|
852
|
|
|
|
563
|
|
|
Total
interest income
|
|
|
$
|
266,518
|
|
|
$
|
267,954
|
|
|
(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
pro rata basis according to the amount of the loan commitment that is
advanced. Such refundable fees are deferred and then recognized on a
pro rata 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
deferred and amortized using the straight-line method into interest income over
the life of the guarantee.
Deferred
income on the consolidated balance sheets is comprised primarily of deferred
conversion fees totaling $19 million and $20 million at August 31, 2008 and May
31, 2008, respectively.
(e) Interest
Expense
The
following table presents the components of interest expense:
|
|
For
the three months ended August 31,
|
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
|
Interest
expense (1):
|
|
|
|
|
|
|
|
|
|
Commercial
paper and bid notes
|
|
$
|
16,438
|
|
|
$
|
38,286
|
|
|
Medium-term
notes
|
|
|
80,458
|
|
|
|
83,186
|
|
|
Collateral
trust bonds
|
|
|
62,920
|
|
|
|
65,350
|
|
|
Subordinated
deferrable debt
|
|
|
4,916
|
|
|
|
4,915
|
|
|
Subordinated
certificates
|
|
|
12,417
|
|
|
|
12,124
|
|
|
Long-term
private debt
|
|
|
35,596
|
|
|
|
30,783
|
|
|
Debt
issuance costs (2)
|
|
|
2,135
|
|
|
|
2,530
|
|
|
Commitment
and guarantee fees (3)
|
|
|
4,767
|
|
|
|
4,070
|
|
|
Loss
on extinguishment of debt (4)
|
|
|
-
|
|
|
|
5,509
|
|
|
Other
fees
|
|
|
662
|
|
|
|
572
|
|
|
Total interest expense |
|
|
$
|
220,309
|
|
|
$
|
247,325
|
|
|
(1)
Represents interest expense and the amortization of discounts on
debt.
(2)
Includes amortization of all deferred charges related to the issuance of debt,
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 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.
(f) Comprehensive
Income
Comprehensive
income includes the Company's net income, as well as other comprehensive income
related to derivatives. Comprehensive income is calculated as
follows:
|
|
For
the three months ended August 31,
|
|
(in
thousands)
|
|
2008
|
|
2007
|
|
Net
income (loss)
|
|
$
|
14,471
|
|
|
$
|
(11,382
|
)
|
|
Other
comprehensive income:
|
|
|
|
|
|
|
|
|
|
Reclassification
adjustment for realized gains on derivatives
|
|
|
(194
|
)
|
|
|
(75
|
)
|
|
Comprehensive
income (loss)
|
|
$
|
14,277
|
|
|
$
|
(11,457
|
)
|
|
(g) New
Accounting Pronouncements
In
December 2007, the FASB issued Statement of Financial Accounting Standards
(“SFAS”) 160, Noncontrolling
Interests in Consolidated Financial Statements, an amendment of ARB 51
(“SFAS 160”), 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 (“SFAS 161”). 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 an impact on the Company’s financial position or
results of operations.
(2) Loans
and Commitments
Loans
outstanding to members and unadvanced commitments by loan type and by segment
are summarized as follows:
|
August
31, 2008
|
|
May
31, 2008
|
|
|
|
|
|
Unadvanced
|
|
|
|
Unadvanced
|
|
(in
thousands)
|
|
Loans
Outstanding
|
|
Commitments
(1)
|
|
Loans
Outstanding
|
|
Commitments
(1)
|
|
Total
by loan type (2)
(3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
$
|
15,209,819
|
|
|
$
|
-
|
|
|
$
|
15,204,614
|
|
|
$
|
-
|
|
|
Long-term
variable rate loans
|
|
1,931,468
|
|
|
|
5,936,480
|
|
|
|
1,882,095
|
|
|
|
5,975,541
|
|
|
Loans
guaranteed by RUS
|
|
249,191
|
|
|
|
491
|
|
|
|
250,169
|
|
|
|
491
|
|
|
Short-term
loans
|
|
1,972,006
|
|
|
|
7,624,220
|
|
|
|
1,690,117
|
|
|
|
7,597,712
|
|
|
Total
loans outstanding
|
|
19,362,484
|
|
|
|
13,561,191
|
|
|
|
19,026,995
|
|
|
|
13,573,744
|
|
|
Deferred
origination fees
|
|
2,867
|
|
|
|
-
|
|
|
|
2,045
|
|
|
|
-
|
|
|
Less:
Allowance for loan losses
|
|
(522,597
|
)
|
|
|
-
|
|
|
|
(514,906
|
)
|
|
|
-
|
|
|
Net
loans outstanding
|
$
|
18,842,754
|
|
|
$
|
13,561,191
|
|
|
$
|
18,514,134
|
|
|
$
|
13,573,744
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment (2):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution
|
$
|
13,614,736
|
|
|
$
|
9,668,309
|
|
|
$
|
13,438,370
|
|
|
$
|
9,579,213
|
|
|
Power
supply
|
|
3,519,985
|
|
|
|
2,904,009
|
|
|
|
3,339,112
|
|
|
|
2,960,693
|
|
|
Statewide
and associate
|
|
107,743
|
|
|
|
166,414
|
|
|
|
108,925
|
|
|
|
158,293
|
|
|
National
Rural total
|
|
17,242,464
|
|
|
|
12,738,732
|
|
|
|
16,886,407
|
|
|
|
12,698,199
|
|
|
RTFC
|
|
1,705,004
|
|
|
|
510,806
|
|
|
|
1,726,514
|
|
|
|
562,389
|
|
|
NCSC
|
|
415,016
|
|
|
|
311,653
|
|
|
|
414,074
|
|
|
|
313,156
|
|
|
Total
loans outstanding
|
|
$
|
19,362,484
|
|
|
$
|
13,561,191
|
|
|
$
|
19,026,995
|
|
|
$
|
13,573,744
|
|
|
|
|
(1)
Unadvanced loan commitments include loans for which loan contracts have been
approved and executed, but funds have not been advanced. Prior to
advancing funds, 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. Because the interest rate on unadvanced commitments is not
set until drawn, long-term unadvanced loan commitments have been classified in
this table 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 table.
(3) Loans
are classified as long-term or short-term based on their original
maturity.
Non-performing
and restructured loans outstanding to members and unadvanced commitments by loan
type and by segment are summarized as follows:
|
August
31, 2008
|
|
May
31, 2008
|
|
(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
|
$
|
212,984
|
|
|
$
|
-
|
|
|
$
|
219,912
|
|
|
$
|
-
|
|
|
Long-term
variable rate loans
|
|
261,114
|
|
|
|
2,160
|
|
|
|
261,109
|
|
|
|
2,160
|
|
|
Short-term
loans
|
|
17,487
|
|
|
|
-
|
|
|
|
25,843
|
|
|
|
-
|
|
|
Total
non-performing loans
|
$
|
491,585
|
|
|
$
|
2,160
|
|
|
$
|
506,864
|
|
|
$
|
2,160
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restructured
loans (3):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
$
|
52,196
|
|
|
$
|
-
|
|
|
$
|
52,309
|
|
|
$
|
-
|
|
|
Long-term
variable rate loans
|
|
512,150
|
|
|
|
186,673
|
|
|
|
519,257
|
|
|
|
186,673
|
|
|
Short-term
loans
|
|
-
|
|
|
|
12,500
|
|
|
|
-
|
|
|
|
12,500
|
|
|
National
Rural total restructured loans
|
|
564,346
|
|
|
|
199,173
|
|
|
|
571,566
|
|
|
|
199,173
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
RTFC:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
|
5,376
|
|
|
|
-
|
|
|
|
5,545
|
|
|
|
-
|
|
|
Total restructured loans
|
|
$
|
569,722
|
|
|
$
|
199,173
|
|
|
$
|
577,111
|
|
|
$
|
199,173
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1)
Unadvanced loan commitments include loans for which loan contracts have been
approved and executed, but funds have not been advanced. Prior to
advancing funds, 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. Because the interest rate on unadvanced commitments is not
set until drawn, long-term unadvanced loan commitments have been classified in
this table 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 table.
(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.
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 type and by segment:
|
(dollar
amounts in thousands)
|
|
August
31, 2008
|
|
May
31, 2008
|
Total
by loan type:
|
|
Secured
|
|
%
|
|
Unsecured
|
|
%
|
|
Secured
|
|
%
|
|
Unsecured
|
|
%
|
|
Long-term
fixed rate loans
|
$
|
14,722,766
|
|
97
|
%
|
$
|
487,053
|
|
3
|
%
|
$
|
14,732,058
|
|
97
|
%
|
$
|
472,556
|
|
3
|
%
|
|
Long-term
variable rate loans
|
|
1,761,517
|
|
91
|
|
169,951
|
|
9
|
|
1,728,803
|
|
92
|
|
153,292
|
|
8
|
|
|
Loans
guaranteed by RUS
|
|
249,191
|
|
100
|
|
-
|
|
-
|
|
250,169
|
|
100
|
|
-
|
|
-
|
|
|
Short-term
loans
|
|
199,783
|
|
10
|
|
1,772,223
|
|
90
|
|
165,226
|
|
10
|
|
1,524,891
|
|
90
|
|
|
Total
loans
|
$
|
16,933,257
|
|
87
|
|
$
|
2,429,227
|
|
13
|
|
$
|
16,876,256
|
|
89
|
|
$
|
2,150,739
|
|
11
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
15,105,074
|
|
88
|
%
|
$
|
2,137,390
|
|
12
|
%
|
$
|
15,021,067
|
|
89
|
%
|
$
|
1,865,340
|
|
11
|
%
|
|
RTFC
|
|
1,472,667
|
|
86
|
|
232,337
|
|
14
|
|
1,497,487
|
|
87
|
|
229,027
|
|
13
|
|
|
NCSC
|
|
355,516
|
|
86
|
|
59,500
|
|
14
|
|
357,702
|
|
86
|
|
56,372
|
|
14
|
|
|
Total
loans
|
$
|
16,933,257
|
|
87
|
|
$
|
2,429,227
|
|
13
|
|
$
|
16,876,256
|
|
89
|
|
$
|
2,150,739
|
|
11
|
|
Pledging
of Loans
The
following table summarizes the Company’s collateral pledged to secure its
collateral trust bonds and notes payable to the Federal Agricultural Mortgage
Corporation ("Farmer Mac") and the amount of the corresponding
debt:
(in
thousands)
|
August
31, 2008
|
|
May
31, 2008
|
2007
indenture:
|
|
|
|
Distribution
system mortgage notes
|
$
|
2,534,075
|
|
$
|
917,925
|
Collateral
trust bonds outstanding
|
2,000,000
|
|
700,000
|
|
|
|
|
1994
indenture:
|
|
|
|
Distribution
system mortgage notes
|
$
|
3,959,373
|
|
$
|
3,989,443
|
RUS
guaranteed loans qualifying as permitted investments
|
214,351
|
|
215,329
|
Total
pledged collateral
|
$
|
4,173,724
|
|
$
|
4,204,772
|
Collateral
trust bonds outstanding
|
$
|
4,005,000
|
|
$
|
4,015,000
|
|
|
|
|
1972
indenture:
|
|
|
|
Cash
pledged
|
$
|
2,032
|
|
$
|
2,032
|
Collateral
trust bonds outstanding
|
1,927
|
|
1,927
|
|
|
|
|
Farmer
Mac:
|
|
|
|
Distribution
system mortgage notes
|
$
|
492,663
|
|
$
|
1,042,564
|
Farmer
Mac notes payable
|
400,000
|
|
900,000
|
The
following table shows the collateral on deposit for the notes payable to the
Federal Financing Bank ("FFB") of the United States Treasury as part of the
REDLG program (see Note 5, Long-Term Debt) and the
amount of the corresponding debt:
(in
thousands)
|
August
31, 2008
|
|
May
31, 2008
|
REDLG:
|
|
|
|
Mortgage
notes on deposit
|
$
|
3,225,319
|
|
$
|
3,191,292
|
REDLG
notes payable
|
2,500,000
|
|
2,500,000
|
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 $3,225 million at August 31, 2008, would be pledged as collateral rather
than held on deposit. At August 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 the membership of a financial expert on National Rural’s board of
directors. A financial expert 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 trigger, the mortgage notes on
deposit at that time, which totaled $1,881 million at August 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.
(3) Foreclosed
Assets, Net
Assets
received in satisfaction of loan receivables are recorded at cost in accordance
with SFAS 144, Accounting for
the Impairment or Disposal of Long-Lived Assets (“SFAS 144”) and are
evaluated periodically for impairment. These assets are classified on
the consolidated balance sheets as foreclosed assets, net. These
assets do not meet the criteria to be classified as held for sale at August 31,
2008 and 2007 or May 31, 2008. At August 31, 2008 and May 31, 2008,
the balance of foreclosed assets included real estate developer notes
receivables and limited partnership interests in certain real estate
developments.
The
activity for foreclosed assets is summarized below:
|
|
Three
months ended August 31,
|
|
Year
ended
|
(in
thousands)
|
|
2008
|
|
2007
|
|
May
31, 2008
|
Beginning
balance
|
|
$
|
58,961
|
|
|
$
|
66,329
|
|
|
$
|
66,329
|
|
Results
of operations
|
|
|
1,246
|
|
|
|
1,960
|
|
|
|
7,528
|
|
Net
cash provided by foreclosed assets
|
|
|
-
|
|
|
|
-
|
|
|
|
(9,056
|
)
|
Market
adjustment
|
|
|
-
|
|
|
|
-
|
|
|
|
(5,840
|
)
|
Ending
balance
|
|
$
|
60,207
|
|
|
$
|
68,289
|
|
|
$
|
58,961
|
|
(4) Short-Term
Debt and Credit Arrangements
The
following is a summary of short-term debt outstanding:
(in
thousands)
|
|
August
31, 2008
|
|
May
31, 2008
|
Short-term
debt:
|
|
|
|
|
|
|
Commercial
paper sold through dealers, net of discounts
|
$
|
1,993,783
|
|
$
|
1,511,953
|
|
Commercial
paper sold directly to members, at par
|
|
1,179,170
|
|
|
1,153,210
|
|
Commercial
paper sold directly to non-members, at par
|
|
133,938
|
|
|
134,351
|
|
Total
commercial paper
|
|
3,306,891
|
|
|
2,799,514
|
|
Daily
liquidity fund sold directly to members
|
|
266,917
|
|
|
250,750
|
|
Bank
bid notes
|
|
300,000
|
|
|
100,000
|
|
Subtotal
short-term debt
|
|
3,873,808
|
|
|
3,150,264
|
|
|
|
|
|
|
|
|
Long-term
debt maturing within one year:
|
|
|
|
|
|
|
Medium-term
notes sold through dealers
|
|
2,040,760
|
|
|
558,776
|
|
Medium-term
notes sold to members
|
|
364,548
|
|
|
288,634
|
|
Secured
collateral trust bonds
|
|
1,814,998
|
|
|
1,824,995
|
|
Secured
notes payable
|
|
-
|
|
|
500,000
|
|
Unsecured
notes payable
|
|
4,510
|
|
|
4,784
|
|
Total
long-term debt maturing within one year
|
|
4,224,816
|
|
|
3,177,189
|
|
|
|
|
|
|
|
|
Total
short-term debt
|
$
|
8,098,624
|
|
$
|
6,327,453
|
|
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 notes are
short-term loans for which National Rural does not pay a commitment
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:
(dollar
amounts in thousands)
|
|
|
August
31, 2008
|
|
|
May
31, 2008
|
|
|
Termination
Date
|
|
|
Facility
fee per
annum
(1)
|
|
|
Five-year
agreement
|
|
$
|
1,125,000
|
|
$
|
1,125,000
|
|
|
March
16, 2012
|
|
|
6
basis points
|
|
|
Five-year
agreement
|
|
|
1,025,000
|
|
|
1,025,000
|
|
|
March
22, 2011
|
|
|
6
basis points
|
|
|
364-day
agreement (2)
|
|
|
1,500,000
|
|
|
1,500,000
|
|
|
March
13, 2009
|
|
|
5
basis points
|
|
|
Total
|
|
|
$
|
3,650,000
|
|
$
|
3,650,000
|
|
|
|
|
|
|
|
|
(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 the agreement 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 10 basis
points per annum.
Upfront
fees of between three and five basis points were paid to the banks based on
their commitment level to the five-year agreements in place at August 31,
2008. These fees totaled approximately $1 million and will be
amortized on a straight-line basis over the life of the
agreements. In addition, the Company paid $0.1 million in upfront
fees to the banks for their commitment to the 364-day facility in place at
August 31, 2008, 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 percent of total commitments, a utilization fee must be
paid on the outstanding balance. The utilization fees are five basis
points for all three agreements in place at August 31, 2008.
At August
31, 2008 and May 31, 2008, 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, Accounting for Derivative
Instruments and Hedging Activities, as amended (“SFAS 133”), and SFAS 52,
Foreign Currency
Translation (“SFAS 52”). 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 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 SFAS 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 three months ended August 31, 2008
and May 31, 2008:
|
|
|
|
|
|
Actual
|
|
|
|
|
|
Requirement
|
|
August
31, 2008
|
|
May
31, 2008
|
|
|
|
|
|
|
|
|
|
|
|
Minimum
average adjusted TIER over the six most recent fiscal
quarters
|
|
1.025
|
|
1.14
|
|
1.16
|
|
|
|
|
|
|
|
|
|
|
|
Minimum
adjusted TIER at fiscal year end (1)
|
|
|
|
1.05
|
|
1.15
|
|
1.15
|
|
|
|
|
|
|
|
|
|
|
|
Maximum
ratio of senior debt to total equity
|
|
|
|
10.00
|
|
8.23
|
|
7.33
|
|
|
|
|
|
|
|
|
|
|
|
|
(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, to draw down on the
facilities.
See Note
15, Subsequent Events,
for a description of subsequent events related to such agreements.
(5) Long-Term
Debt
The
following is a summary of long-term debt outstanding:
(in
thousands)
|
August
31, 2008
|
|
|
May
31, 2008
|
|
Unsecured
long-term debt:
|
|
|
|
|
|
|
|
|
|
Medium-term
notes sold through dealers
|
$
|
2,753,630
|
|
|
|
$
|
4,231,982
|
|
|
Medium-term
notes sold to members
|
|
95,546
|
|
|
|
|
104,105
|
|
|
Subtotal
|
|
2,849,176
|
|
|
|
|
4,336,087
|
|
|
Unamortized
discount
|
|
(3,633
|
)
|
|
|
|
(5,483
|
)
|
|
Total
unsecured medium-term notes
|
|
2,845,543
|
|
|
|
|
4,330,604
|
|
|
|
|
|
|
|
|
|
|
|
|
Unsecured
notes payable
|
|
2,558,362
|
|
|
|
|
2,558,362
|
|
|
Unamortized
discount
|
|
(1,867
|
)
|
|
|
|
(1,959
|
)
|
|
Total
unsecured notes payable
|
|
2,556,495
|
|
|
|
|
2,556,403
|
|
|
Total
unsecured long-term debt
|
|
5,402,038
|
|
|
|
|
6,887,007
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured
long-term debt:
|
|
|
|
|
|
|
|
|
|
Collateral
trust bonds
|
|
4,191,927
|
|
|
|
|
2,891,927
|
|
|
Unamortized
discount
|
|
(6,485
|
)
|
|
|
|
(5,347
|
)
|
|
Total
secured collateral trust bonds
|
|
4,185,442
|
|
|
|
|
2,886,580
|
|
|
Secured
notes payable
|
|
400,000
|
|
|
|
|
400,000
|
|
|
Total
secured long-term debt
|
|
4,585,442
|
|
|
|
|
3,286,580
|
|
|
Total
long-term debt
|
$
|
9,987,480
|
|
|
|
$
|
10,173,587
|
|
|
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, Loans and Commitments, for
additional information on the collateral pledged to secure National Rural’s
collateral trust bonds.
Unsecured
Notes Payable
At August
31, 2008 and May 31, 2008, National Rural had $2.5 billion outstanding 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. As part of the
REDLG program, National Rural pays to RUS a fee of 30 basis points per annum on
the total amount borrowed. At August 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, Loans and Commitments, for additional information
on the mortgage notes held on deposit.
Secured
Notes Payable
At August
31, 2008 and May 31, 2008, National Rural had a total of $400 million and $900
million, respectively, outstanding to Farmer Mac. Notes to Farmer Mac
totaling $500 million and reported in short-term debt at May 31, 2008 matured on
July 29, 2008. 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, Loans and Commitments, for additional information
on the collateral pledged to secure National Rural's notes payable.
(6) Subordinated
Deferrable Debt
The
following table is a summary of subordinated deferrable debt
outstanding:
(in
thousands)
|
|
August
31, 2008
|
|
|
May
31, 2008
|
|
|
6.75% due 2043
(1)
|
|
|
125,000
|
|
$
|
|
125,000
|
|
|
6.10%
due 2044 (2)
|
$ |
|
88,201
|
|
|
|
88,201
|
|
|
5.95%
due 2045 (3)
|
|
|
98,239
|
|
|
|
98,239
|
|
|
Total
|
|
$
|
|
311,440
|
|
$
|
|
311,440
|
|
|
|
|
(1)
Callable by National Rural at par starting on February 15, 2008.
(2)
Callable by National Rural at par starting on February 1, 2009.
(3)
Callable by National Rural at par starting on February 15, 2010.
(7) Derivative
Financial Instruments
The
Company is neither a dealer nor a trader in derivative financial
instruments. The Company utilizes derivatives such as interest rate
swaps and cross currency interest rate swaps to mitigate its interest rate risk
and foreign currency exchange risk.
Consistent
with SFAS 133, the Company records derivative instruments on the consolidated
balance sheet as either an asset or liability measured at fair
value. Changes in the fair value of derivative instruments are
recognized in the derivative forward value line item of the consolidated
statement of operations unless specific hedge accounting criteria are
met. Generally, the Company's derivative instruments do not qualify
for hedge accounting under SFAS 133. At August 31, 2008 and 2007 and
May 31, 2008, the Company did not have any derivative instruments that were
accounted for using hedge accounting.
The
Company was a party to the following interest rate swaps:
|
|
Notional
Amounts Outstanding
|
(in
thousands)
|
|
August
31, 2008
|
|
May
31, 2008
|
Pay
fixed and receive variable
|
$
|
7,720,557
|
$
|
7,659,973
|
Pay
variable and receive fixed
|
|
5,906,440
|
|
5,256,440
|
Total
derivative instruments
|
$
|
13,626,997
|
$
|
12,916,413
|
Derivative
instruments had the following impact on the Company:
|
|
For
the three months ended August 31,
|
(in
thousands)
|
|
2008
|
|
|
2007
|
|
Statement
of Operations:
|
|
|
|
|
|
|
Agreements
that do not qualify for hedge accounting:
|
|
|
|
|
|
|
Derivative
cash settlements
|
$
|
431
|
|
$
|
8,329
|
|
Derivative
forward value
|
|
(11,028
|
)
|
|
(33,600
|
)
|
Total
loss on derivative instruments
|
$
|
(10,597
|
)
|
$
|
(25,271
|
)
|
|
|
|
|
|
|
|
Comprehensive
Income:
|
|
|
|
|
|
|
Amortization
of transition adjustment
|
$
|
(194
|
)
|
$
|
(75
|
)
|
Cash
settlements includes periodic amounts that were paid and received related to the
Company’s derivative instruments.
A
transition adjustment of $62 million was recorded as an other comprehensive loss
on June 1, 2001, the date the Company implemented SFAS 133. The
transition adjustment will be amortized into earnings over the remaining life of
the related derivative instruments. Approximately $0.7 million of the
transition adjustment is expected to be amortized to income over the next 12
months and will continue through 2029.
The
Company has classified cash activity associated with derivatives as an operating
activity in the consolidated statements of cash flows.
Rating
Triggers
The
Company has certain derivative contracts 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 instruments are based on its senior unsecured credit rating from
Standard & Poor's Corporation and Moody's Investors Service.
At August
31, 2008, the Company had the following notional amount and fair values
associated with derivative instruments 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 payments and collections required upon termination, the Company netted the
agreements for each counterparty, as allowed by the associated master netting
agreements.
(in
thousands)
|
|
Notional
Amount
|
|
|
Required
Company Payment
|
|
|
Amount
Company Would Collect
|
|
|
Net
Total
|
|
Rating
Level:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fall
to Baa1/BBB+
|
$
|
1,919,918
|
|
$
|
(535
|
)
|
$
|
37,908
|
|
$
|
37,373
|
|
Fall
below Baa1/BBB+
|
|
7,313,977
|
|
|
(36,025
|
)
|
|
29,128
|
|
|
(6,897
|
)
|
Total
|
$
|
9,233,895
|
|
$
|
(36,560
|
)
|
$
|
67,036
|
|
$
|
30,476
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
In
addition to the rating triggers listed above, at August 31, 2008, the Company
had $717 million of notional derivative instruments, with one counterparty that
would require the pledging of collateral in an amount equal to the fair value of
the derivative instruments if the Company’s senior secured ratings from Moody's
Investors Service were to fall below Baa2 or if the rating from Standard &
Poor's Corporation were to fall below BBB. At August 31, 2008, the
fair value of the derivative instruments associated with this rating trigger was
a $13 million net obligation.
(8) 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 five percent semi-annually. The weighted-average maturity for all
membership subordinated certificates outstanding at August 31, 2008 and May 31,
2008 was 68 years.
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
two percent for distribution systems and seven percent for power supply
systems. National Rural associates and RTFC members are required to
purchase loan subordinated certificates in an amount equal to 10 percent 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
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 11, Guarantees). 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.
(9) Minority
Interest
At August
31, 2008 and May 31, 2008, the Company reported minority interests of $13
million and $14 million, respectively, on the consolidated balance
sheets. Minority interest represents 100 percent of RTFC and NCSC
equity as the members of RTFC and NCSC own or control 100 percent of the
interest in their respective companies.
(10) 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 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 one
percent, of net earnings annually to the education fund. The
allocation to the education fund must be at least 0.25 percent of net earnings
as required by National Rural’s bylaws. 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 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
during the year. 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.
In July
2008, National Rural’s board of directors allocated 2008 fiscal year net
earnings as follows: $1 million to the education fund, $103 million to members
in the form of patronage capital, and $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
percent of the fiscal year 2008 allocation and one-ninth of the fiscal years
1991, 1992 and 1993 allocated net earnings. This amount was paid to
members in cash in October 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 August
31, 2008 and May 31, 2008, equity included the following
components:
(in
thousands)
|
|
August
31, 2008
|
|
|
May
31, 2008
|
|
Membership
fees
|
$
|
993
|
|
|
$
|
993
|
|
|
Education
fund
|
|
1,129
|
|
|
|
1,484
|
|
|
Members'
capital reserve
|
|
187,409
|
|
|
|
187,409
|
|
|
Allocated
net income
|
|
338,011
|
|
|
|
423,249
|
|
|
Unallocated
net income (1)
|
|
23,156
|
|
|
|
(53
|
)
|
|
Total
members' equity
|
|
550,698
|
|
|
|
613,082
|
|
|
Prior
years' cumulative derivative forward
|
|
|
|
|
|
|
|
|
value
and foreign currency adjustments
|
|
44,056
|
|
|
|
131,551
|
|
|
Current
period derivative forward value (2)
|
|
(8,738
|
)
|
|
|
(87,495
|
)
|
|
Total
retained equity
|
|
586,016
|
|
|
|
657,138
|
|
|
Accumulated
other comprehensive income
|
|
8,633
|
|
|
|
8,827
|
|
|
Total equity |
|
$
|
594,649
|
|
|
$
|
665,965
|
|
|
(1)
Excludes derivative forward value and foreign currency adjustments.
(2)
Represents the derivative forward value loss recorded by National Rural for the
year-to-date period.
(11) 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 August
31, 2008 and May 31, 2008, the Company recorded a guarantee liability totaling
$14 million and $15 million, respectively, which represents the contingent and
non-contingent exposure related to guarantees of members' debt obligations. The
contingent guarantee liability at August 31, 2008 and May 31, 2008 totaled $9
million and $10 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 at August 31, 2008 and May 31, 2008 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, 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
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 three months ended August 31,
|
|
Year
ended May 31,
|
(dollar
amounts in thousands)
|
|
2008
|
|
|
|
2007
|
|
|
|
2008
|
|
Beginning
balance
|
$
|
15,034
|
|
|
$
|
18,929
|
|
|
$
|
18,929
|
|
Net
change in non-contingent liability
|
|
(209
|
)
|
|
|
131
|
|
|
|
(791
|
)
|
Recovery
of contingent guarantee losses
|
|
(705
|
)
|
|
|
(2,100
|
)
|
|
|
(3,104
|
)
|
Ending
balance
|
$
|
14,120
|
|
|
$
|
16,960
|
|
|
$
|
15,034
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liability
as a percentage of total guarantees
|
|
1.37
|
%
|
|
|
1.57
|
%
|
|
|
1.45
|
%
|
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, classified as long-term tax-exempt bonds
in the table below. 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 $48 million and $55 million at
August 31, 2008 and May 31, 2008, respectively, on deposit with the bond trustee
that can only be used for 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 member 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 member system is required to repay, on demand, any amount
advanced by National Rural with interest, pursuant to the documents evidencing
the member system's reimbursement obligation.
Of the
amounts shown in the table below, $329 million and $330 million as of August 31,
2008 and May 31, 2008, 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 of tax-exempt bonds
that were in the auction rate mode at August 31, 2008 and May 31,
2008. 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. See footnote (1) to the table below for
further information about this type of guarantee.
The
following table summarizes total guarantees by type and segment:
(in
thousands)
|
August
31, 2008
|
|
May
31, 2008
|
|
|
|
|
Total
by type:
|
|
|
|
|
|
|
|
|
|
|
Long-term
tax-exempt bonds (1)
|
$
|
496,770
|
|
|
$
|
498,495
|
|
|
|
|
Indemnifications
of tax benefit transfers (2)
|
|
91,519
|
|
|
|
94,821
|
|
|
|
|
Letters
of credit (3)
|
|
344,790
|
|
|
|
343,424
|
|
|
|
|
Other
guarantees (4)
|
|
100,407
|
|
|
|
100,400
|
|
|
|
|
Total
|
$
|
1,033,486
|
|
|
$
|
1,037,140
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
Distribution
|
$
|
196,232
|
|
|
$
|
184,459
|
|
|
|
|
Power
supply
|
|
779,596
|
|
|
|
786,455
|
|
|
|
|
Statewide
and associate
|
|
20,382
|
|
|
|
22,785
|
|
|
|
|
National
Rural total
|
|
996,210
|
|
|
|
993,699
|
|
|
|
|
RTFC
|
|
260
|
|
|
|
260
|
|
|
|
|
NCSC
|
|
37,016
|
|
|
|
43,181
|
|
|
|
|
Total
|
$
|
1,033,486
|
|
|
$
|
1,037,140
|
|
|
|
(1) The
maturities for this type of guarantee run through 2037. At August 31,
2008, National Rural's maximum potential exposure for the $13 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. The amounts
shown represent National Rural’s maximum potential exposure for guaranteed
indemnity payments. 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 August 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). At August 31, 2008, the Company's maximum
potential exposure is $345 million, of which $193 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 $21 million of letters of credit would be
reduced to $6 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 $422
million in letters of credit to third parties for the benefit of its members at
August 31, 2008. At May 31, 2008, this amount was $415
million.
(4) The
maturities for this type of guarantee run through 2025. Of National
Rural’s maximum potential exposure for guaranteed principal and interest
totaling $100 million at August 31, 2008, $3 million is secured by a mortgage
lien on substantially all of the system's assets and future revenues and the
remaining $97 million is unsecured.
The
Company uses the same credit policies and monitoring procedures in providing
guarantees as it does for loans and commitments.
At August
31, 2008 and May 31, 2008, National Rural had a total of $249 million and $236
million of guarantees, representing 24 percent and 23 percent, respectively, of
total guarantees, under which its right of recovery from its members was not
secured.
(12) Fair
Value of Financial Instruments
Effective
June 1, 2008, the Company adopted SFAS 157, Fair Value Measurement (“SFAS
157”), and SFAS 159, The Fair
Value Option for Financial Assets and Financial Liabilities —Including an amendment of FASB
Statement No. 115 (“SFAS 159”).
SFAS
157
SFAS 157
defines fair value, sets out a framework for measuring fair value, and expands
disclosure requirements about fair value measurement. SFAS 157, among
other things, requires the Company to maximize the use of observable inputs and
minimize the use of unobservable inputs when measuring fair value.
SFAS 157
establishes the following fair value hierarchy:
·
|
Level
1 – Quoted prices for identical instruments in active
markets.
|
·
|
Level
2 – Quoted prices for similar instruments in active markets; quoted prices
for identical or similar instruments in markets that are not active; and
model-derived valuations whose inputs are observable or whose significant
value drivers are observable.
|
·
|
Level
3 – Instruments whose significant value drivers are
unobservable.
|
The
Company’s only assets and liabilities that are measured at fair value on a
recurring or nonrecurring basis are derivative instruments, foreclosed assets
and collateral dependent non-performing loans. When a valuation
includes inputs from multiple sources resulting in various levels, the Company
classifies the valuation category at the lowest level for which the input has a
significant effect on the overall valuation.
Assets
and Liabilities Measured at Fair Value on a Recurring Basis
The
Company accounts for derivatives in accordance with SFAS 133, which 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. Because there is not an active secondary
market for the types of derivative instruments the Company uses, it obtains
market quotes from the derivative counterparties to adjust all derivatives to
fair value on a quarterly basis. The market quotes are based on the
expected future cash flow and estimated yield curves.
The
Company performs its own analysis to validate the market quotes obtained from
the derivative counterparties. The Company adjusts the market values
received from the derivative counterparties using credit default swap levels for
the counterparties and the Company. The credit
default swap levels represent the credit risk premium required by a market
participant based on the available information related to the counterparty and
the Company. The Company only enters into exchange agreements with
highly rated counterparties that participate in the Company’s revolving credit
agreements. All exchange agreements contain master netting
arrangements as part of their ISDA agreements.
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 as currently all of its derivatives do not qualify for
hedge accounting.
The
Company’s valuation techniques for derivatives are based upon observable inputs,
which reflect market data. Fair value for the Company’s derivative
instruments falls under Level 2, as described above.
The
following table presents the Company’s assets and liabilities that are measured
at fair value on a recurring basis at August 31, 2008:
(in
thousands)
|
|
Level
1
|
|
|
Level
2
|
|
Level
3
|
Derivative
assets
|
$
|
-
|
|
$
|
255,283
|
$
|
-
|
|
|
|
|
|
|
|
|
Derivative
liabilities
|
|
-
|
|
|
217,391
|
|
-
|
|
|
|
|
|
|
|
|
Assets
and Liabilities Measured at Fair Value on a Nonrecurring Basis
The
Company may be required, from time to time, to measure certain assets at fair
value on a nonrecurring basis in accordance with GAAP. Any
adjustments to fair value usually result from application of lower-of-cost or
fair value accounting or write-downs of individual assets.
The
Company’s foreclosed assets do not meet the criteria to be classified as held
for sale at August 31, 2008 and therefore are required to be carried at cost in
accordance with SFAS 144. Foreclosed assets are evaluated periodically for
impairment by performing a fair value analysis based on estimated future cash
flows or in some instances, an assessment of the fair value of the asset or
business, which may be provided by a third party
consultant. Estimates of future cash flows are subjective and are
considered to be a significant input in the valuation. A review for
significant changes in the key assumptions and estimates of the fair value
analysis is performed on a quarterly basis.
In
certain instances when a loan is non-performing, the Company utilizes the
collateral fair value underlying non-performing loans, which may be provided by
a third party consultant, in estimating the specific reserve to be
applied. In these instances, the valuation is considered to be a
nonrecurring item.
For
assets measured at fair value on a nonrecurring basis that were still held in
the balance sheet at quarter end, the following table provides the level of
valuation assumptions used to determine each adjustment, the carrying value of
the related individual assets at August 31, 2008, and the total losses for the
quarter ended August 31, 2008.
(in
thousands)
|
|
Level
1
|
|
|
Level
2
|
|
Level
3
|
|
Total
losses for
the
quarter ended August 31, 2008
|
Foreclosed
assets, net
|
$
|
-
|
|
$
|
-
|
$
|
60,207
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
Non-performing
loans, net of specific reserves
|
|
-
|
|
|
-
|
|
264,554
|
|
3,873
|
SFAS
159
SFAS 159
established the fair value option, which permits entities to choose to measure
eligible financial instruments at fair value. The Company elected not to measure
eligible financial instruments at fair value and therefore the adoption of SFAS
159 did not have an impact on the Company's financial position or results of
operations.
(13) Restructured/Non-performing
Loans and Contingencies
The
Company had the following loans outstanding classified as non-performing and
restructured:
(in
thousands)
|
|
August
31, 2008
|
|
|
May
31, 2008
|
|
August
31, 2007
|
Non-performing
loans
|
$
|
491,585
|
|
$
|
506,864
|
$
|
493,951
|
|
|
|
|
|
|
|
|
Restructured
loans
|
|
569,722
|
|
|
577,111
|
|
597,038
|
|
|
|
|
|
|
|
|
Total
|
$
|
1,061,307
|
|
$
|
1,083,975
|
$
|
1,090,989
|
(a) At
August 31, 2008, May 31, 2008 and August 31, 2007, all loans classified as
non-performing were on a non-accrual status with respect to the recognition of
interest income. At August 31, 2008 and May 31, 2008, $512 million
and $519 million, respectively, of restructured loans were on non-accrual status
with respect to the recognition of interest income. At August 31,
2007, $539 million of restructured loans were on non-accrual
status. A total of $1 million of interest income was accrued on
restructured loans during the three months ended August 31, 2008 and
2007.
Interest
income was reduced as follows as a result of holding loans on non-accrual
status:
|
|
For
the three months ended August 31,
|
(in
thousands)
|
|
|
2008
|
|
|
2007
|
|
Non-performing
loans
|
|
$
|
7,434
|
|
$
|
9,214
|
|
Restructured
loans
|
|
|
6,704
|
|
|
9,341
|
|
Total
|
|
$
|
14,138
|
|
$
|
18,555
|
|
(b) The
Company classified $1,056 million and $1,078 million of loans as impaired
pursuant to the provisions of SFAS 114, Accounting by Creditors for
Impairment of a Loan - an Amendment of SFAS 5 and SFAS 15, as amended, at
August 31, 2008 and May 31, 2008, respectively. The Company reserved
$326 million and $331 million of the loan loss allowance for such impaired loans
at August 31, 2008 and May 31, 2008, 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 $1 million of interest income on impaired loans for the three
months ended August 31, 2008 and 2007. The average recorded
investment in impaired loans for the three months ended August 31, 2008 and 2007
was $1,061 million and $1,099 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:
·
|
changes
to collateral values, and
|
·
|
changes
to expected future cash flows both as to timing and
amount.
|
(c) At
August 31, 2008 and May 31, 2008, National Rural had a total of $512 million and
$519 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 August 31, 2008 and May 31, 2008. Total loans to CoServ at
August 31, 2008 and May 31, 2008 represented 2.6 percent and 2.7 percent,
respectively, of the Company's total loans and guarantees
outstanding.
Under the
terms of a bankruptcy settlement from 2002, 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. At August 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 August 31, 2008.
(d)
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.
At August
31, 2008 and May 31, 2008, RTFC had $484 million and $492 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 percent 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 August 31, 2008.
(e) At
August 31, 2008 and May 31, 2008, National Rural had a total of $52 million in
restructured loans outstanding to Pioneer Electric Cooperative, Inc.
("Pioneer"). Pioneer was current with respect to all debt service
payments at August 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.
Based on
its analysis, the Company believes that it is adequately reserved for its
exposure to Pioneer at August 31, 2008.
(14) 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 facilitate loan securitization transactions and
intercompany transaction elimination entries. The segment
presentation for the three months ended August 31, 2008 and 2007 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.
The
following table contains consolidated statements of operations for the three
months ended August 31, 2008, and consolidated balance sheets at August 31,
2008.
(in
thousands)
|
National
Rural
|
|
RTFC
|
|
NCSC
|
|
Consolidated
|
|
Statement
of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
$
|
239,420
|
|
|
$
|
19,572
|
|
|
$
|
7,526
|
|
|
$
|
266,518
|
|
|
Interest
expense
|
|
(197,006
|
)
|
|
|
(18,246
|
)
|
|
|
(5,057
|
)
|
|
|
(220,309
|
)
|
|
Net
interest income
|
|
42,414
|
|
|
|
1,326
|
|
|
|
2,469
|
|
|
|
46,209
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Provision
for loan losses
|
|
(10,681
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(10,681
|
)
|
|
Net
interest income after provision for loan losses
|
|
31,733
|
|
|
|
1,326
|
|
|
|
2,469
|
|
|
|
35,528
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
41
|
|
|
|
-
|
|
|
|
140
|
|
|
|
181
|
|
|
Derivative
cash settlements
|
|
1,625
|
|
|
|
-
|
|
|
|
(1,194
|
)
|
|
|
431
|
|
|
Results
of operations from foreclosed assets
|
|
1,246
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,246
|
|
|
Total
non-interest income
|
|
2,912
|
|
|
|
-
|
|
|
|
(1,054
|
)
|
|
|
1,858
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
(expense) income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses
|
|
(12,141
|
)
|
|
|
(1,325
|
)
|
|
|
(1,127
|
)
|
|
|
(14,593
|
)
|
|
Recovery
of guarantee liability
|
|
705
|
|
|
|
-
|
|
|
|
-
|
|
|
|
705
|
|
|
Derivative
forward value
|
|
(8,738
|
)
|
|
|
-
|
|
|
|
(2,290
|
)
|
|
|
(11,028
|
)
|
|
Total
non-interest expense
|
|
(20,174
|
)
|
|
|
(1,325
|
)
|
|
|
(3,417
|
)
|
|
|
(24,916
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) prior to income taxes and minority
interest
|
|
14,471
|
|
|
|
1
|
|
|
|
(2,002
|
)
|
|
|
12,470
|
|
|
Income
tax benefit
|
|
-
|
|
|
|
-
|
|
|
|
760
|
|
|
|
760
|
|
|
Income
(loss) per segment reporting
|
$
|
14,471
|
|
|
$
|
1
|
|
|
$
|
(1,242
|
)
|
|
$
|
13,230
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation
of net income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income per segment reporting
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
13,230
|
|
|
Minority
interest, net of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,241
|
|
|
Net
income per consolidated statement of operations
|
|
|
|
|
|
|
|
|
|
|
|
$
|
14,471
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
loans outstanding
|
$
|
17,242,464
|
|
|
$
|
1,705,004
|
|
|
$
|
415,016
|
|
|
$
|
19,362,484
|
|
|
Deferred
origination fees
|
|
2,867
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,867
|
|
|
Less: Allowance
for loan losses
|
|
(522,351
|
)
|
|
|
-
|
|
|
|
(246
|
)
|
|
|
(522,597
|
)
|
|
Loans
to members, net
|
|
16,722,980
|
|
|
|
1,705,004
|
|
|
|
414,770
|
|
|
|
18,842,754
|
|
|
Other
assets
|
|
2,036,560
|
|
|
|
189,604
|
|
|
|
46,313
|
|
|
|
2,272,477
|
|
|
Total
assets
|
$
|
18,759,540
|
|
|
$
|
1,894,608
|
|
|
$
|
461,083
|
|
|
$
|
21,115,231
|
|
|
The
following table contains the consolidated statement of operations for the three
months ended August 31, 2007 and consolidated balance sheet information at
August 31, 2007.
(in
thousands)
|
National
Rural
|
|
RTFC
|
|
NCSC
|
|
Consolidated
|
|
Statement
of Operations:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
income
|
$
|
234,806
|
|
|
$
|
24,029
|
|
|
$
|
9,119
|
|
|
$
|
267,954
|
|
|
Interest
expense
|
|
(216,761
|
)
|
|
|
(22,630
|
)
|
|
|
(7,934
|
)
|
|
|
(247,325
|
)
|
|
Net
interest income
|
|
18,045
|
|
|
|
1,399
|
|
|
|
1,185
|
|
|
|
20,629
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
189
|
|
|
|
-
|
|
|
|
162
|
|
|
|
351
|
|
|
Derivative
cash settlements
|
|
8,165
|
|
|
|
-
|
|
|
|
164
|
|
|
|
8,329
|
|
|
Results
of operations from foreclosed assets
|
|
1,960
|
|
|
|
-
|
|
|
|
-
|
|
|
|
1,960
|
|
|
Total
non-interest income
|
|
10,314
|
|
|
|
-
|
|
|
|
326
|
|
|
|
10,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
(expense) income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
General
and administrative expenses
|
|
(11,261
|
)
|
|
|
(1,179
|
)
|
|
|
(870
|
)
|
|
|
(13,310
|
)
|
|
Recovery
of guarantee liability
|
|
2,100
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,100
|
|
|
Derivative
forward value
|
|
(30,062
|
)
|
|
|
-
|
|
|
|
(3,538
|
)
|
|
|
(33,600
|
)
|
|
Loss
on sale of loans
|
|
(518
|
)
|
|
|
-
|
|
|
|
-
|
|
|
|
(518
|
)
|
|
Total
non-interest expense
|
|
(39,741
|
)
|
|
|
(1,179
|
)
|
|
|
(4,408
|
)
|
|
|
(45,328
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss)
income prior to income taxes and minority
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
interest
|
|
(11,382
|
)
|
|
|
220
|
|
|
|
(2,897
|
)
|
|
|
(14,059
|
)
|
|
Income
taxes
|
|
-
|
|
|
|
(1
|
)
|
|
|
1,100
|
|
|
|
1,099
|
|
|
Net
(loss) income per segment reporting
|
$
|
(11,382
|
)
|
|
$
|
219
|
|
|
$
|
(1,797
|
)
|
|
$
|
(12,960
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Reconciliation
of net loss:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
loss per segment reporting
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(12,960
|
)
|
|
Minority
interest, net of income taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
1,578
|
|
|
Net
loss per consolidated statement of operations
|
|
|
|
|
|
|
|
|
|
|
|
|
$
|
(11,382
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
to members
|
$
|
15,758,812
|
|
|
$
|
1,812,947
|
|
|
$
|
465,555
|
|
|
$
|
18,037,314
|
|
|
Less: Allowance
for loan losses
|
|
(544,561
|
)
|
|
|
-
|
|
|
|
(518
|
)
|
|
|
(545,079
|
)
|
|
Loans
to members, net
|
|
15,214,251
|
|
|
|
1,812,947
|
|
|
|
465,037
|
|
|
|
17,492,235
|
|
|
Other
assets
|
|
650,732
|
|
|
|
198,876
|
|
|
|
45,484
|
|
|
|
895,092
|
|
|
Total
assets
|
$
|
15,864,983
|
|
|
$
|
2,011,823
|
|
|
$
|
510,521
|
|
|
$
|
18,387,327
|
|
|
(15) Subsequent
Events
In
September 2008, the Company closed on a $500 million FFB loan facility under the
REDLG program and received an advance for the full amount available under the
facility. The $500 million advance has a 2028 maturity
date.
In
September 2008, Lehman Brothers Holding Company Inc. (“LBHI”) announced that it
had filed a petition under Chapter 11 of the U.S. Bankruptcy Code with the
United States Bankruptcy Court for the Southern District of New
York. LBHI also announced that none of the broker dealer or other
subsidiaries of LBHI were included in the Chapter 11 filing. The
directors of certain United Kingdom affiliates of LBHI also have taken steps to
place those companies into administration. On September 19, 2008, the
United States District Court ordered the liquidation of Lehman Brothers Inc.
under the Securities Investor Protection Act of 1970. The liquidation
is now being administered under the auspices of United States Bankruptcy Court,
along with the bankruptcy of LBHI.
As an
active participant in the capital markets, National Rural has numerous business
relationships with LBHI and its subsidiaries. Among those
relationships, Lehman Brothers Specialty Finance Inc. (“LBSF”), is the
counterparty (with an LBHI guarantee) to seven interest rate swaps, and Lehman
Brothers Bank, FSB (“LBB”) is a participant for up to $239 million of National
Rural’s $3.65 billion revolving credit facility.
At August
31, 2008, the seven interest rate swaps to which LBSF was a counterparty had a
recorded fair market value of $27 million. As a result of the
bankruptcy filing of LBHI, National Rural terminated the interest rate swaps
with LBSF on September 26, 2008. A payment is due to National Rural
from LBSF totaling $26 million representing the termination net settlement
amount on that day, in accordance with the terms of the contract. On
October 3, 2008, LBSF filed a petition under Chapter 11 of the U.S. Bankruptcy
Code with the United States Bankruptcy Court for the Southern District of New
York. National
Rural is currently evaluating the collectability of the required payments under
the contractual terms of the interest rate swaps.
At August
31, 2008, there were no amounts outstanding under the revolving credit facility
or due to LBB. On October 7, 2008, the Company was unable to issue
the amount of commercial paper necessary to fund its needs as a result of the
instability in the overall credit markets. As a result, the Company
drew down $418.5 million of its $3.65 billion revolving credit facility by
borrowing from the $1.5 billion 364-day agreement. As the amount
borrowed did not exceed 50 percent of total commitments, there is no utilization
fee on the outstanding balance. LBB did not
fund their portion of the draw and the Company does not believe that LBB’s $239
million portion of the credit facility will be available in the
future. The Company believes that if accessing the credit markets
continues to be difficult, the remaining amounts in the credit facility will be
adequate to fund its operations in the near term.
In
September and October 2008, the Company was required to purchase a total of $57
million of tax-exempt bonds pursuant to its obligation as liquidity
provider. As a result, the Company will be required to hold the bonds
until the remarketing agent is able to place them with third-party
investors. During this period, the Company is entitled to receive a default
rate of interest on many of the bonds that is higher than the rate investors
typically receive on similar bonds in the tax-exempt market. On
October 15, 2008, $8 million of the tax-exempt bonds held by the Company will be
redeemed as a result of a mandatory sinking fund payment.
Item
2. 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.
This Form
10-Q 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, 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-Q, in addition to Part I, Item 1A,
Risk Factors in the Company's Form 10-K for the year ended May 31,
2008.
Business
Overview
In this
report the Company will provide analysis on its results of operations, financial
condition, liquidity and market risk. The Company will also provide
analysis of trends and significant transactions completed in the period covered
by the report.
The
Company provides financial products to its rural electric and telecommunications
members at a low cost in relation to the financial performance and strength
required to maintain strong credit ratings. The Company's access to
the capital markets at levels that allow it to keep cost to the members low is
dependent on maintaining strong credit ratings. See page 44 for
detail on the current ratings for the Company's public debt.
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. Adjusted net income is
calculated by excluding the impact of derivatives 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.
For the
three months ended August 31, 2008, the Company reported net income of $14
million and TIER of 1.07, compared with a net loss of $11 million and therefore
a TIER calculation resulting in a value below 1.00 for the prior-year
period. For the three months ended August 31, 2008, the Company
reported an adjusted net income of $24 million and adjusted TIER of 1.11,
compared with an adjusted net income of $20 million and adjusted TIER of 1.09
for the prior-year period. The $26 million increase in net income for
the three months ended August 31, 2008 compared with the prior-year period was
primarily due to the $23 million increase in the derivative forward
value.
For the
three months ended August 31, 2008, the Company's earnings were negatively
affected by the level of loans on non-accrual status. Holding loans
on non-accrual status resulted in foregone interest of $14 million for the three
months ended August 31, 2008 compared with $19 million for the three months
ended August 31, 2007. The Company expects the outstanding balance of
loans on non-accrual status to decrease during fiscal year 2009 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 margin during fiscal year
2009. The calculated impairment on the Company's loans increases or
decreases with changes in interest rates because the impairment amount is
calculated by discounting future cash flows using the original contract rate on
the loan, a portion of which is based on the Company’s variable interest
rate. Changes to the Company's variable interest rates will be based
on the underlying cost of funding, competition and other
factors. Based on the current balance of impaired loans at August 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. On October 1, 2008,
National Rural increased variable interest rates by 50 basis
points.
Financial
Condition
At August
31, 2008, the Company's total loans outstanding increased by $335 million or two
percent as compared with May 31, 2008 primarily as a result of a $356 million
increase in National Rural’s loan portfolio, partially offset by a $22 million
decrease in RTFC’s loan portfolio. The reduction to the
telecommunications total exposure has also resulted in a reduction in the
average exposure per RTFC borrower. 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 a Rural Utilities
Service (“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 a 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.
For the
three months ended August 31, 2008, short-term debt increased by $1,771 million
and long-term debt decreased by $186 million. The increase in
short-term debt was due to a combination of a $1,048 million shift of long-term
debt to short-term debt as the debt reached its final year to maturity and the
prefunding of the majority of $1,545 million of debt scheduled to mature in
September and October 2008. The proceeds of this prefunding of debt
contributed to the $1,352 million increase in cash and cash equivalents during
the three months ended August 31, 2008. The decrease in long-term
debt due to the shift to short-term debt was offset by the issuance of $1,300
million of long-term collateral trust bonds. In September 2008, the
Company received $500 million in additional funding from the FFB under a loan
facility with a guarantee of repayment by the RUS as part of the funding
mechanism for the Rural Economic Development Loan and Grant ("REDLG")
program. The $500 million advance has a 2028 maturity
date.
Total
equity decreased $71 million from May 31, 2008 to August 31, 2008 primarily due
to the board authorized patronage capital retirement totaling $85 million offset
by net income of $14 million for the three months ended August 31,
2008. The Company's reported equity balance fluctuates based on the
changes in earnings which are significantly affected by changes in the fair
value of the Company’s derivative instruments. The fair values of
these derivative instruments are very sensitive to changes in interest
rates. As a result, it is difficult to predict the future changes in
the Company's reported 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 Statement of Financial Accounting Standards (“SFAS”)
133, Accounting for Derivative
Instruments and Hedging Activities, as amended (“SFAS 133”), and SFAS 52,
Foreign Currency Translation
(“SFAS 52”).
Liquidity
At August
31, 2008, the Company had $3,874 million of commercial paper, daily liquidity
fund and bank bid notes and $4,225 million of medium-term notes, collateral
trust bonds and long-term notes payable scheduled to mature during the next 12
months. Members held commercial paper (including the daily liquidity
fund) totaling $1,446 million or approximately 40 percent of the total
commercial paper outstanding at August 31, 2008. Commercial paper
issued through dealers and bank bid
notes
totaled $2,294 million and represented 12 percent of total debt outstanding at
August 31, 2008. The Company intends to maintain the balance of
dealer commercial paper and bank bid notes at 15 percent or less of total debt
outstanding during fiscal year 2009. During the next 12 months, the
Company plans to replace the maturing $4,225 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.
The
Company uses member loan repayments, capital market debt issuances, private debt
issuances, member investments, and net income to fund its
operations. In addition, National Rural maintains both short-term and
long-term bank lines in the form of revolving credit
agreements. 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
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. In addition, the Company had $3.65 billion in unused lines of
credit with financial institutions available to draw upon at August 31,
2008.
The
turmoil in the credit markets subsequent to August 31, 2008 has had an effect on
the Company’s ability and cost of raising debt. The ability of
companies to raise short-term debt (commercial paper) has been hampered by the
credit crunch resulting from the overall economic environment. While
the Company has been able to meet its funding needs, the debt issued since
August 31, 2008 has been at a higher cost and, in many instances, the debt
raised has had a shorter tenor than anticipated. The slightly higher
spread paid on dealer commercial paper since August 31, 2008 has not had a
significant impact on National Rural's funding cost, as dealer commercial paper
represented only 10 percent of total debt at August 31, 2008.
In the
first quarter of fiscal year 2009, the Company was able to prefund much of its
debt scheduled to mature in September and October 2008. One of the
strategies the Company may employ to decrease its reliance on the commercial
paper market is to seek to issue long-term funding to members, in the capital
markets or in private debt placements.
In
September 2008, Lehman Brothers Holding Company Inc. (“LBHI”) announced that it
had filed a petition under Chapter 11 of the U.S. Bankruptcy Code with the
United States Bankruptcy Court for the Southern District of New
York. LBHI also announced that none of the broker dealer or other
subsidiaries of LBHI were included in the Chapter 11 filing. The
directors of certain United Kingdom affiliates of LBHI also have taken steps to
place those companies into administration. On September 19, 2008, the
United States District Court ordered the liquidation of Lehman Brothers Inc.
under the Securities Investor Protection Act of 1970. The liquidation
is now being administered under the auspices of United States Bankruptcy Court,
along with the bankruptcy of LBHI.
As an
active participant in the capital markets, National Rural has numerous business
relationships with LBHI and its subsidiaries. Among those
relationships, Lehman Brothers Specialty Finance Inc. (“LBSF”), is the
counterparty (with an LBHI guarantee) to seven interest rate swaps, and Lehman
Brothers Bank, FSB (“LBB”) is a participant for up to $239 million of National
Rural’s $3.65 billion revolving credit facility. At August 31, 2008,
there were no amounts outstanding under the revolving credit facility or due to
LBB.
At August
31, 2008, the seven interest rate swaps to which LBSF was a counterparty had a
recorded fair market value of $27 million. As a result of the
bankruptcy filing of LBHI, National Rural terminated the interest rate swaps
with LBSF on September 26, 2008. A payment is due to National Rural
from LBSF totaling $26 million representing the termination net settlement
amount on that day, in accordance with the terms of the contract. On
October 3, 2008, LBSF filed a petition under Chapter 11 of the U.S. Bankruptcy
Code with the United States Bankruptcy Court for the Southern District of New
York. National Rural is currently evaluating the collectability of
the required payments under the contractual terms of the interest rate
swaps.
On
October 7, 2008, the Company was unable to issue the amount of commercial paper
necessary to fund its needs as a result of the instability in the overall credit
markets. As a result, the Company drew down $418.5 million of its
$3.65 billion revolving credit facility by borrowing from the $1.5 billion
364-day agreement. LBB did not fund their portion of the draw and the
Company does not believe that LBB’s $239 million portion of the credit facility
will be available in the future. The Company believes that if
accessing the credit markets continues to be difficult, the remaining amounts in
the credit facility will be adequate to fund its operations in the near
term. As the amount borrowed did not exceed 50 percent of total
commitments, there is no utilization fee on the outstanding balance.
At August
31, 2008 and May 31, 2008 the Company was the guarantor and liquidity provider
for $329 million and $330 million, respectively of tax-exempt bonds issued for
its member cooperatives. In September and October 2008, the Company
was required to purchase a total of $57 million of tax-exempt bonds pursuant to
its obligation as liquidity provider. As a
result,
the Company will be required to hold the bonds until the remarketing agent is
able to place them with third-party investors. During this period,
the Company is entitled to receive a default rate of interest on many of the
bonds that is higher than the rate investors typically receive on similar bonds
in the tax-exempt market. On October 15, 2008, $8 million of the
tax-exempt bonds held by the Company will be redeemed as a result of a mandatory
sinking fund payment.
New
Accounting Pronouncements
In
December 2007, the FASB issued SFAS 160, Noncontrolling Interests in
Consolidated Financial Statements, an amendment of Accounting Research Bulletin
(“ARB”) No. 51, Consolidated Financial
Statements (“SFAS 160”), 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 (“SFAS 161”). 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 an impact on the Company’s financial position or
results of operations.
Results
of Operations
Three
Months Ended August 31, 2008 versus August 31, 2007
The
following table presents the results of operations for the three months ended
August 31, 2008 versus 2007.
|
|
For
the three months ended August 31,
|
|
Increase/
|
|
(dollar
amounts in thousands)
|
|
2008
|
|
2007
|
|
(Decrease)
|
|
Interest
income
|
|
$
|
266,518
|
|
|
$
|
267,954
|
|
|
$
|
(1,436
|
)
|
|
Interest
expense
|
|
|
(220,309
|
)
|
|
|
(247,325
|
)
|
|
|
27,016
|
|
|
Net
interest income
|
|
|
46,209
|
|
|
|
20,629
|
|
|
|
25,580
|
|
|
Provision
for loan losses
|
|
|
(10,681
|
)
|
|
|
-
|
|
|
|
(10,681
|
)
|
|
Net
interest income after provision for loan losses
|
|
|
35,528
|
|
|
|
20,629
|
|
|
|
14,899
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental
and other income
|
|
|
181
|
|
|
|
351
|
|
|
|
(170
|
)
|
|
Derivative
cash settlements
|
|
|
431
|
|
|
|
8,329
|
|
|
|
(7,898
|
)
|
|
Results
of operations from foreclosed assets
|
|
|
1,246
|
|
|
|
1,960
|
|
|
|
(714
|
)
|
|
Total
non-interest income
|
|
|
1,858
|
|
|
|
10,640
|
|
|
|
(8,782
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
(expense) income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
|
(9,851
|
)
|
|
|
(8,823
|
)
|
|
|
(1,028
|
)
|
|
Other
general and administrative expenses
|
|
|
(4,742
|
)
|
|
|
(4,487
|
)
|
|
|
(255
|
)
|
|
Recovery
of guarantee liability
|
|
|
705
|
|
|
|
2,100
|
|
|
|
(1,395
|
)
|
|
Derivative
forward value
|
|
|
(11,028
|
)
|
|
|
(33,600
|
)
|
|
|
22,572
|
|
|
Loss
on sale of loans
|
|
|
-
|
|
|
|
(518
|
)
|
|
|
518
|
|
|
Total
non-interest expense
|
|
|
(24,916
|
)
|
|
|
(45,328
|
)
|
|
|
20,412
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) prior to income taxes and minority interest
|
|
|
12,470
|
|
|
|
(14,059
|
)
|
|
|
26,529
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
tax benefit
|
|
|
760
|
|
|
|
1,099
|
|
|
|
(339
|
)
|
|
Minority
interest, net of income taxes
|
|
|
1,241
|
|
|
|
1,578
|
|
|
|
(337
|
)
|
|
Net
income (loss)
|
|
$
|
14,471
|
|
|
$
|
(11,382
|
)
|
|
$
|
25,853
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
TIER
|
|
|
1.07
|
|
|
|
-
|
|
|
|
|
|
|
Adjusted
TIER (1)
|
|
|
|
1.11
|
|
|
|
1.09
|
|
|
|
|
|
|
5(1) Adjusted to exclude the
impact of the derivative forward value 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
following table summarizes the Company's operating results expressed as an
annualized percentage of average loans outstanding.
|
|
For
the three months ended August 31,
|
|
Increase/
|
|
|
|
2008
|
|
2007
|
|
(Decrease)
|
|
Interest
income
|
|
|
5.52
|
%
|
|
|
5.86
|
%
|
|
|
(0.34
|
)%
|
|
Interest
expense
|
|
|
(4.56
|
)
|
|
|
(5.40
|
)
|
|
|
0.84
|
|
|
Net
interest income
|
|
|
0.96
|
|
|
|
0.46
|
|
|
|
0.50
|
|
|
Provision
for loan losses
|
|
|
(0.22
|
)
|
|
|
-
|
|
|
|
(0.22
|
)
|
|
Net
interest income after provision for loan losses
|
|
|
0.74
|
|
|
|
0.46
|
|
|
|
0.28
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
cash settlements
|
|
|
0.01
|
|
|
|
0.17
|
|
|
|
(0.16
|
)
|
|
Results
of operations from foreclosed assets
|
|
|
0.03
|
|
|
|
0.05
|
|
|
|
(0.02
|
)
|
|
Total
non-interest income
|
|
|
0.04
|
|
|
|
0.22
|
|
|
|
(0.18
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Non-interest
(expense) income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Salaries
and employee benefits
|
|
|
(0.20
|
)
|
|
|
(0.19
|
)
|
|
|
(0.01
|
)
|
|
Other
general and administrative expenses
|
|
|
(0.10
|
)
|
|
|
(0.09
|
)
|
|
|
(0.01
|
)
|
|
Recovery
of guarantee liability
|
|
|
0.01
|
|
|
|
0.04
|
|
|
|
(0.03
|
)
|
|
Derivative
forward value
|
|
|
(0.23
|
)
|
|
|
(0.72
|
)
|
|
|
0.49
|
|
|
Loss
on sale of loans
|
|
|
-
|
|
|
|
(0.02
|
)
|
|
|
0.02
|
|
|
Total
non-interest expense
|
|
|
(0.52
|
)
|
|
|
(0.98
|
)
|
|
|
0.46
|
|
|
Income
(loss) prior to income taxes and minority interest
|
|
|
0.26
|
|
|
|
(0.30
|
)
|
|
|
0.56
|
|
|
Income
tax benefit
|
|
|
0.02
|
|
|
|
0.02
|
|
|
|
-
|
|
|
Minority
interest, net of income taxes
|
|
|
0.02
|
|
|
|
0.04
|
|
|
|
(0.02
|
)
|
|
Net
income (loss)
|
|
|
0.30
|
%
|
|
|
(0.24
|
)%
|
|
|
0.54
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted
net interest income (1)
|
|
|
0.97
|
%
|
|
|
0.63
|
%
|
|
|
0.34
|
%
|
|
Adjusted
income prior to income taxes and minority interest (2)
|
|
|
|
0.49
|
%
|
|
|
0.42
|
%
|
|
|
0.07
|
%
|
|
(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. 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 Rate Volume 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 margin.
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.
Rate
Volume Variance Table
(Dollar
amounts in millions)
|
|
|
|
|
For
the three months ended August 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
|
$
|
17,045
|
$
|
239
|
|
5.57
|
%
|
|
$
|
15,820
|
$
|
235
|
|
5.89
|
%
|
|
$
|
18
|
|
$
|
(14
|
)
|
$
|
4
|
|
|
RTFC
|
|
1,711
|
|
20
|
|
4.54
|
|
|
|
1,855
|
|
24
|
|
5.14
|
|
|
|
(2
|
)
|
|
(2
|
)
|
|
(4
|
)
|
|
NCSC
|
|
415
|
|
7
|
|
7.20
|
|
|
|
462
|
|
9
|
|
7.84
|
|
|
|
(1
|
)
|
|
(1
|
)
|
|
(2
|
)
|
|
Total
|
$
|
19,171
|
$
|
266
|
|
5.52
|
|
|
$
|
18,137
|
$
|
268
|
|
5.86
|
|
|
$
|
15
|
|
$
|
(17
|
)
|
$
|
(2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
17,045
|
$
|
(197
|
)
|
(4.59
|
)%
|
|
$
|
15,820
|
$
|
(217
|
)
|
(5.44
|
)%
|
|
$
|
(17
|
)
|
$
|
37
|
|
$
|
20
|
|
|
RTFC
|
|
1,711
|
|
(18
|
)
|
(4.23
|
)
|
|
|
1,855
|
|
(22
|
)
|
(4.84
|
)
|
|
|
2
|
|
|
2
|
|
|
4
|
|
|
NCSC
|
|
415
|
|
(5
|
)
|
(4.84
|
)
|
|
|
462
|
|
(8
|
)
|
(6.82
|
)
|
|
|
1
|
|
|
2
|
|
|
3
|
|
|
Total
|
$
|
19,171
|
$
|
(220
|
)
|
(4.56
|
)
|
|
$
|
18,137
|
$
|
(247
|
)
|
(5.40
|
)
|
|
$
|
(14
|
)
|
$
|
41
|
|
$
|
27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income:
|
|
National
Rural
|
$
|
17,045
|
$
|
42
|
|
0.98
|
%
|
|
$
|
15,820
|
$
|
18
|
|
0.45
|
%
|
|
$
|
1
|
|
$
|
23
|
|
$
|
24
|
|
|
RTFC
|
|
1,711
|
|
2
|
|
0.31
|
|
|
|
1,855
|
|
2
|
|
0.30
|
|
|
|
-
|
|
|
-
|
|
|
-
|
|
|
NCSC
|
|
415
|
|
2
|
|
2.36
|
|
|
|
462
|
|
1
|
|
1.02
|
|
|
|
-
|
|
|
1
|
|
|
1
|
|
|
Total
|
$
|
19,171
|
$
|
46
|
|
0.96
|
|
|
$
|
18,137
|
$
|
21
|
|
0.46
|
|
|
$
|
1
|
|
$
|
24
|
|
$
|
25
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Derivative
cash settlements (3):
|
|
National
Rural
|
$
|
13,482
|
$
|
1
|
|
0.05
|
%
|
|
$
|
12,424
|
$
|
8
|
|
0.26
|
%
|
|
$
|
-
|
|
$
|
(7
|
)
|
$
|
(7
|
)
|
|
NCSC
|
|
196
|
|
(1
|
)
|
(2.42
|
)
|
|
|
210
|
|
-
|
|
-
|
|
|
|
-
|
|
|
(1
|
)
|
|
(1
|
)
|
|
Total
|
$
|
13,678
|
$
|
-
|
|
-
|
|
|
$
|
12,634
|
$
|
8
|
|
0.26
|
|
|
$
|
-
|
|
$
|
(8
|
)
|
$
|
(8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted
interest expense (4):
|
|
Total
|
$
|
19,171
|
$
|
(220
|
)
|
(4.56
|
)%
|
|
$
|
18,137
|
$
|
(239
|
)
|
(5.23
|
)%
|
|
$
|
(14
|
)
|
$
|
33
|
|
$
|
19
|
|
(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 instruments 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 Rate Volume Variance Table above is summarized as follows by income type
and as a percentage of average loans outstanding:
|
|
For
the three months ended August 31,
|
|
|
|
|
|
2008
|
|
2007
|
|
|
|
(dollar
amounts in thousands)
|
|
|
Amount
|
|
Rate
|
|
|
|
Amount
|
|
Rate
|
|
|
Increase/
(Decrease)
|
|
Interest
on long-term fixed rate loans (1)
|
|
$
|
224,402
|
|
|
|
|
$
|
214,560
|
|
|
|
|
$
|
9,842
|
|
|
Interest
on long-term variable rate loans (1)
|
|
|
15,180
|
|
|
|
|
|
24,549
|
|
|
|
|
|
(9,369
|
)
|
|
Interest
on short-term loans (1)
|
|
|
19,504
|
|
|
|
|
|
20,348
|
|
|
|
|
|
(844
|
)
|
|
Total
interest income on loans
|
|
|
259,086
|
|
5.36
|
%
|
|
|
259,457
|
|
5.67
|
%
|
|
|
(371
|
)
|
|
Interest
on investments (2)
|
|
|
2,181
|
|
0.04
|
|
|
|
2,936
|
|
0.07
|
|
|
|
(755
|
)
|
|
Conversion
fees (3)
|
|
|
1,703
|
|
0.04
|
|
|
|
1,774
|
|
0.04
|
|
|
|
(71
|
)
|
|
Make-whole
and prepayment fees (4)
|
|
|
827
|
|
0.02
|
|
|
|
1,689
|
|
0.04
|
|
|
|
(862
|
)
|
|
Commitment
and guarantee fees (5)
|
|
|
1,869
|
|
0.04
|
|
|
|
1,535
|
|
0.02
|
|
|
|
334
|
|
|
Other
fees
|
|
|
852
|
|
0.02
|
|
|
|
563
|
|
0.02
|
|
|
|
289
|
|
|
Total
interest income
|
|
|
$
|
266,518
|
|
5.52
|
%
|
|
$
|
267,954
|
|
5.86
|
%
|
|
$
|
(1,436
|
)
|
|
(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
pro rata basis according to the amount of the loan commitment that is
advanced. Such refundable fees are deferred and then recognized on a
pro rata 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
deferred and amortized using the straight-line method into interest income over
the life of the guarantee.
The $1
million or one percent decline in interest income for the three months ended
August 31, 2008, as compared with the prior-year period was due to a 34 basis
point decline in the yield earned due to lower variable interest rates mostly
offset by a $1,034 million increase in average loans outstanding.
For the
three months ended August 31, 2008, the Company had a reduction to interest
income of $14 million due to non-accrual loans compared with a reduction of $19
million for the prior-year period. The impact on National Rural
interest income of non-accrual loans was a reduction of $7 million for the three
months ended August 31, 2008 as compared with $10 million for the comparable
prior-year period. RTFC interest income was reduced by $7 million for
the three months ended August 31, 2008 as compared with $9 million for the
prior-year period as a result of non-accrual loans. The effect of
non-accrual loans on interest income is included in the rate variance in the
table above.
Interest
Expense
Total
interest expense reported on the consolidated statements of operations and shown
in the Rate Volume Variance Table above is summarized as follows by expense type
and as a percentage of average loans outstanding:
|
|
For
the three months ended August 31,
|
|
|
|
|
|
2008
|
|
2007
|
|
|
|
(dollar
amounts in thousands)
|
|
|
Amount
|
|
Rate
|
|
|
|
Amount
|
|
Rate
|
|
|
Increase/
(Decrease)
|
|
Interest
expense (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
paper and bid notes
|
|
$
|
16,438
|
|
|
|
|
$
|
38,286
|
|
|
|
|
$
|
(21,848
|
)
|
|
Medium-term
notes
|
|
|
80,458
|
|
|
|
|
|
83,186
|
|
|
|
|
|
(2,728
|
)
|
|
Collateral
trust bonds
|
|
|
62,920
|
|
|
|
|
|
65,350
|
|
|
|
|
|
(2,430
|
)
|
|
Subordinated
deferrable debt
|
|
|
4,916
|
|
|
|
|
|
4,915
|
|
|
|
|
|
1
|
|
|
Subordinated
certificates
|
|
|
12,417
|
|
|
|
|
|
12,124
|
|
|
|
|
|
293
|
|
|
Long-term
private debt
|
|
|
35,596
|
|
|
|
|
|
30,783
|
|
|
|
|
|
4,813
|
|
|
Total
interest expense on debt
|
|
|
212,745
|
|
4.40
|
%
|
|
|
234,644
|
|
5.12
|
%
|
|
|
(21,899
|
)
|
|
Debt
issuance costs (2)
|
|
|
2,135
|
|
0.05
|
|
|
|
2,530
|
|
0.04
|
|
|
|
(395
|
)
|
|
Commitment
and guarantee fees (3)
|
|
|
4,767
|
|
0.10
|
|
|
|
4,070
|
|
0.09
|
|
|
|
697
|
|
|
Loss
on extinguishment of debt (4)
|
|
|
-
|
|
-
|
|
|
|
5,509
|
|
0.13
|
|
|
|
(5,509
|
)
|
|
Other
fees
|
|
|
662
|
|
0.01
|
|
|
|
572
|
|
0.02
|
|
|
|
90
|
|
|
Total
interest expense
|
|
|
$
|
220,309
|
|
4.56
|
%
|
|
$
|
247,325
|
|
5.40
|
%
|
|
$
|
(27,016
|
)
|
|
(1)
Represents interest expense and the amortization of discounts on
debt.
(2)
Includes amortization of all deferred charges related to debt issuances,
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 REDLG
program. Fees are recognized as incurred or amortized on a
straight-line basis over the life of the respective agreement.
(4)
Represents the loss on the early retirement of debt including the write-off of
unamortized discount, premium and issuance costs.
The $27
million or 11 percent decline in total interest expense for the three months
ended August 31, 2008 compared with the prior-year period was due to an 84 basis
point decline in the overall cost of the Company’s debt. This decline
in debt costs was primarily attributable to a decline in short-term 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 August 31, 2007. The decrease
in interest expense was partly offset by an increase in interest expense due to
a higher level of debt outstanding to fund loan growth, including $500 million
borrowed under the REDLG program in August 2007 which was outstanding during the
full three months ended August 31, 2008.
The
adjusted interest expense, which includes all derivative cash settlements, was
$220 million for the three months ended August 31, 2008 compared with $239
million for 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 $25
million increase in net interest income for the three months ended August 31,
2008 compared with the prior-year period was primarily the result of an 84 basis
point decline in the overall cost of debt which was only partially offset by a
34 basis point decline in the yield of the Company’s loan
portfolio. The adjusted net interest income, which includes all
derivative cash settlements, for the three months ended August 31, 2008 was $47
million, an increase of $18 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 determining
its adjusted interest expense which, in turn, affects adjusted net interest
income.
Provision
for Loan Losses
The
Company recorded an $11 million provision for loan losses for the three months
ended August 31, 2008 compared with no provision for the three months ended
August 31, 2007. The increase to the loan loss allowance was
primarily due to the increase in loans outstanding during the quarter and
secondarily to an adjustment to the Company’s historical recovery percentages
based on current estimates, both offset by a reduction to calculated impairments
due to payments received.
Non-interest
Income
Non-interest
income decreased by $9 million for the three months ended August 31, 2008
compared with the prior-year period primarily due to the decrease in cash
settlements on derivative financial instruments. The $8 million
decrease in cash settlements for the three months ended August 31, 2008 from the
prior-year period resulted from lower short-term interest rates during the
quarter ended August 31, 2008 compared with the quarter ended August 31, 2007 as
the Company paid a variable rate on the majority of its derivative contracts
during both periods.
Non-interest
Expense
Non-interest
expense decreased by $20 million for the three months ended August 31, 2008
compared with the prior-year period primarily due to the $23 million decrease in
the derivative forward value as a result of changes in the estimate of future
interest rates as well as credit risk over the remaining life of the derivative
instruments.
Net
Income
The
change in the items described above resulted in an increase in net income of $26
million for the three months ended August 31, 2008 from the comparable
prior-year period. The adjusted net income, which excludes the impact
of the derivative forward value and adds back minority interest, was $24
million, compared with $20 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.
Ratio
of Earnings to Fixed Charges
The
following table 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 three months ended August 31,
|
(dollar
amounts in thousands)
|
|
|
2008
|
|
|
|
2007
|
|
Income
(loss) prior to cumulative effect of
|
|
|
|
|
|
|
|
|
change
in accounting principle
|
|
$
|
14,471
|
|
|
$
|
(11,382
|
)
|
Add:
fixed charges
|
|
|
220,309
|
|
|
|
247,325
|
|
|
|
|
|
|
|
|
|
|
Earnings
available for fixed charges
|
|
$
|
234,780
|
|
|
$
|
235,943
|
|
|
|
|
|
|
|
|
|
|
Total
fixed charges:
|
|
|
|
|
|
|
|
|
Interest
on all debt (including amortization of
|
|
|
|
|
|
|
|
|
discount
and issuance costs)
|
|
$
|
220,309
|
|
|
$
|
247,325
|
|
|
|
|
|
|
|
|
|
|
Ratio
of earnings to fixed charges (1)
|
|
|
|
1.07
|
|
|
|
-
|
|
(1) For
the three months ended August 31, 2007, earnings were insufficient to cover
fixed charges by $11 million.
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 table summarizes loans outstanding by type and by
segment:
|
|
Increase/
|
|
(dollar
amounts in thousands)
|
August
31, 2008
|
|
May
31, 2008
|
|
(Decrease)
|
|
Loans
by type:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
loans (1):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
fixed rate loans
|
$
|
15,422,921
|
|
80
|
%
|
|
$
|
15,418,662
|
|
81
|
%
|
|
|
$
|
4,259
|
|
|
Long-term
variable rate loans
|
|
1,967,557
|
|
10
|
|
|
|
1,918,216
|
|
10
|
|
|
|
|
49,341
|
|
|
Total
long-term loans
|
|
17,390,478
|
|
90
|
|
|
|
17,336,878
|
|
91
|
|
|
|
|
53,600
|
|
|
Short-term
loans (2)
|
|
1,972,006
|
|
10
|
|
|
|
1,690,117
|
|
9
|
|
|
|
|
281,889
|
|
|
Total
loans
|
$
|
19,362,484
|
|
100
|
%
|
|
$
|
19,026,995
|
|
100
|
%
|
|
|
$
|
335,489
|
|
|
|
|
Increase/
|
|
(dollar
amounts in thousands)
|
August
31, 2008
|
|
May
31, 2008
|
|
(Decrease)
|
|
Loans
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution
|
$
|
13,614,736
|
|
70
|
%
|
|
$
|
13,438,370
|
|
71
|
%
|
|
|
$
|
176,366
|
|
|
Power
supply
|
|
3,519,985
|
|
18
|
|
|
|
3,339,112
|
|
17
|
|
|
|
|
180,873
|
|
|
Statewide
and associate
|
|
107,743
|
|
1
|
|
|
|
108,925
|
|
1
|
|
|
|
|
(1,182
|
)
|
|
National
Rural total
|
|
17,242,464
|
|
89
|
|
|
|
16,886,407
|
|
89
|
|
|
|
|
356,057
|
|
|
RTFC
|
|
1,705,004
|
|
9
|
|
|
|
1,726,514
|
|
9
|
|
|
|
|
(21,510
|
)
|
|
NCSC
|
|
415,016
|
|
2
|
|
|
|
414,074
|
|
2
|
|
|
|
|
942
|
|
|
Total
|
|
$
|
19,362,484
|
|
100
|
%
|
|
$
|
19,026,995
|
|
100
|
%
|
|
|
$
|
335,489
|
|
|
(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 2 percent for the three months ended
August 31, 2008. The primary reasons for the National Rural loan
growth were an increase in RUS note buyouts, funding of capital expenditures,
bridge financing to fund projects prior to receipt of RUS funding and funding
for renewable energy projects.
Loans
converting from a variable rate to a fixed rate for the three months ended
August 31, 2008 totaled $73 million, which was partially offset by $49 million
of loans that converted from a fixed rate to a variable rate. For the
three months ended August 31, 2007, loans converting from a fixed rate to a
variable rate totaled $57 million, which was partially offset by $19 million of
loans that converted from a variable rate to a fixed rate.
The
following table summarizes loans and guarantees outstanding by
segment:
(dollar
amounts in thousands)
|
August
31, 2008
|
|
May
31, 2008
|
|
Increase/
(Decrease)
|
National
Rural:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Distribution
|
$
|
13,810,968
|
|
68
|
%
|
|
$
|
13,622,829
|
|
68
|
%
|
|
$
|
188,139
|
|
Power
supply
|
|
4,299,581
|
|
21
|
|
|
|
4,125,567
|
|
20
|
|
|
|
174,014
|
|
Statewide
and associate
|
|
128,125
|
|
1
|
|
|
|
131,710
|
|
1
|
|
|
|
(3,585
|
)
|
National
Rural total
|
|
18,238,674
|
|
90
|
|
|
|
17,880,106
|
|
89
|
|
|
|
358,568
|
|
RTFC
|
|
1,705,264
|
|
8
|
|
|
|
1,726,774
|
|
9
|
|
|
|
(21,510
|
)
|
NCSC
|
|
452,032
|
|
2
|
|
|
|
457,255
|
|
2
|
|
|
|
(5,223
|
)
|
Total
|
$
|
20,395,970
|
|
100
|
%
|
|
$
|
20,064,135
|
|
100
|
%
|
|
$
|
331,835
|
|
The
following table summarizes the RTFC segment loans and guarantees
outstanding:
(dollar
amounts in thousands)
|
|
August
31, 2008
|
|
May
31, 2008
|
|
Increase/
(Decrease)
|
Rural
local exchange carriers
|
|
$
|
1,501,389
|
|
88
|
%
|
|
$
|
1,518,197
|
|
88
|
%
|
|
$
|
(16,808
|
)
|
Cable
television providers
|
|
|
153,237
|
|
9
|
|
|
|
153,539
|
|
9
|
|
|
|
(302
|
)
|
Fiber
optic network providers
|
|
|
11,473
|
|
1
|
|
|
|
16,884
|
|
1
|
|
|
|
(5,411
|
)
|
Competitive
local exchange carriers
|
|
|
31,653
|
|
2
|
|
|
|
29,871
|
|
2
|
|
|
|
1,782
|
|
Wireless
providers
|
|
|
4,672
|
|
-
|
|
|
|
4,579
|
|
-
|
|
|
|
93
|
|
Other
|
|
|
2,840
|
|
-
|
|
|
|
3,704
|
|
-
|
|
|
|
(864
|
)
|
Total
|
|
|
$
|
1,705,264
|
|
100
|
%
|
|
$
|
1,726,774
|
|
100
|
%
|
|
$
|
(21,510
|
)
|
The
Company's members are widely dispersed throughout the United States and its
territories, including 48 states, the District of Columbia and two U.S.
territories. At August 31, 2008 and May 31, 2008, loans and
guarantees outstanding to members in any one state or territory did not exceed
17 percent 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 attempts 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
policies. Management may utilize syndicated credit arrangements to
help mitigate the risk associated with credit concentrations.
Total
exposure, as defined by the policies, generally include 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 August
31, 2008 and May 31, 2008, the total exposure outstanding to any one borrower or
controlled group did not exceed 2.6 percent and 2.7 percent, respectively, of
total loans and guarantees outstanding. At August 31, 2008, the ten
largest borrowers included four distribution systems, five power supply systems
and one telecommunications system. At May 31, 2008, the ten largest borrowers
included five distribution systems, four power supply systems and one
telecommunications system. Over the past five years, the Company has
reduced its single obligor concentrations in the telecommunications portfolio
resulting in outstanding loans at August 31, 2008 averaging less than $10
million per active, performing telecommunications
borrower.
The
following table shows the exposure to the ten largest borrowers as a percentage
of total exposure by type and by segment:
|
|
August
31, 2008
|
|
|
May
31, 2008
|
|
Increase/
|
|
(dollar
amounts in thousands)
|
|
Amount
|
|
%
of Total
|
|
|
Amount
|
|
%
of Total
|
|
(Decrease)
|
|
Total
by type:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
$
|
3,394,013
|
|
|
|
$
|
3,395,865
|
|
|
$
|
(1,852
|
)
|
Guarantees
|
|
265,967
|
|
|
|
|
164,740
|
|
|
|
101,227
|
|
Total
credit exposure to ten largest borrowers
|
$
|
3,659,980
|
|
18%
|
|
$
|
3,560,605
|
|
18%
|
$
|
99,375
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
3,143,829
|
|
|
|
$
|
3,043,905
|
|
|
$
|
99,924
|
|
RTFC
|
|
483,951
|
|
|
|
|
491,700
|
|
|
|
(7,749
|
)
|
NCSC
|
|
32,200
|
|
|
|
|
25,000
|
|
|
|
7,200
|
|
Total
credit exposure to ten largest borrowers
|
$
|
3,659,980
|
|
18%
|
|
$
|
3,560,605
|
|
18%
|
$
|
99,375
|
|
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:
|
|
August
31, 2008
|
|
|
May
31, 2008
|
|
Increase/
|
|
(dollar
amounts in thousands)
|
|
Amount
|
|
%
of Total
|
|
|
Amount
|
|
%
of Total
|
|
(Decrease)
|
|
Total
by type:
|
|
|
|
|
|
|
|
|
|
|
|
|
Loans
|
$
|
2,429,227
|
|
|
|
$
|
2,150,739
|
|
|
$
|
278,488
|
|
Guarantees
|
|
249,062
|
|
|
|
|
235,816
|
|
|
|
13,246
|
|
Total
unsecured credit exposure
|
$
|
2,678,289
|
|
13%
|
|
$
|
2,386,555
|
|
11%
|
$
|
291,734
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
2,385,972
|
|
|
|
$
|
2,100,676
|
|
|
$
|
285,296
|
|
RTFC
|
|
232,597
|
|
|
|
|
229,287
|
|
|
|
3,310
|
|
NCSC
|
|
59,720
|
|
|
|
|
56,592
|
|
|
|
3,128
|
|
Total
unsecured credit exposure
|
$
|
2,678,289
|
|
13%
|
|
$
|
2,386,555
|
|
11%
|
$
|
291,734
|
|
Non-performing
Loans
A
borrower is classified as non-performing when any one of the following criteria
is 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 August 31, 2008 and May 31,
2008, the Company had non-performing loans outstanding in the amount of $492
million and $507 million, respectively. All loans classified as
non-performing were on a non-accrual status with respect to the recognition of
interest income.
At August
31, 2008 and May 31, 2008, non-performing loans include $484 million and $492
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 13, Restructured/Non-performing Loans
and Contingencies, to the consolidated financial
statements. Based on its analysis, the Company believes that it is
adequately reserved for its exposure to ICC at August 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 August
31, 2008 and May 31, 2008, restructured loans totaled $570 million and $577
million, respectively. A total of $512 million and $519 million of
restructured loans were on non-accrual status at August 31, 2008 and May 31,
2008, respectively. At August 31, 2007, $539 million of restructured
loans were on non-accrual status.
At August
31, 2008 and May 31, 2008, the Company had $512 million and $519 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 August
31, 2008 and May 31, 2008. Total loans to CoServ at August 31, 2008
and May 31, 2008 represented 2.6 percent and 2.7 percent of the Company's total
loans and guarantees outstanding, respectively.
Under the
terms of a bankruptcy settlement from 2002, 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. At August
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 August 31, 2008.
At August
31, 2008 and May 31, 2008, National Rural had a total $52 million in loans
outstanding to Pioneer Electric Cooperative, Inc.
("Pioneer"). Pioneer was current with respect to all debt service
payments at August 31, 2008. All loans to Pioneer remain on accrual
status. National Rural is the principal creditor to
Pioneer.
Based on
its analysis, the Company believes that it is adequately reserved for its
exposure to Pioneer at August 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 August 31, 2008 and May 31, 2008, the Company had impaired loans totaling
$1,056 million and $1,078 million, respectively. At August 31, 2008
and May 31, 2008, National Rural had specifically reserved $326 million and $331
million, respectively, to cover impaired loans.
The
following table 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)
|
August
31, 2008
|
|
May
31, 2008
|
|
Non-performing
loans
|
$
|
491,585
|
|
|
$
|
506,864
|
|
|
Percent
of loans outstanding
|
|
2.54
|
%
|
|
|
2.67
|
%
|
|
Percent
of loans and guarantees outstanding
|
|
2.41
|
|
|
|
2.52
|
|
|
|
|
|
|
|
|
|
|
|
Restructured
loans
|
$
|
569,722
|
|
|
$
|
577,111
|
|
|
Percent
of loans outstanding
|
|
2.94
|
%
|
|
|
3.03
|
%
|
|
Percent
of loans and guarantees outstanding
|
|
2.79
|
|
|
|
2.88
|
|
|
|
|
|
|
|
|
|
|
|
Total
non-performing and restructured loans
|
$
|
1,061,307
|
|
|
$
|
1,083,975
|
|
|
Percent
of loans outstanding
|
|
5.48
|
%
|
|
|
5.70
|
%
|
|
Percent
of loans and guarantees outstanding
|
|
5.20
|
|
|
|
5.40
|
|
|
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. The allowance for loan losses is determined based upon
evaluation 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
charge-offs of loan balances. In making its recommendation to charge
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, charge-offs totaled $215 million and
recoveries totaled $34 million for a net loan loss of $181
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 three months ended and as of
|
For
the year ended
and
as of
|
(dollar
amounts in thousands)
|
|
August
31, 2008
|
|
|
|
August
31, 2007
|
|
|
May
31, 2008
|
|
Beginning
balance
|
$
|
514,906
|
|
|
$
|
561,663
|
|
|
$
|
561,663
|
|
|
Provision
|
|
10,681
|
|
|
|
-
|
|
|
|
(30,262
|
)
|
|
Net
charge-offs
|
|
(2,990
|
)
|
|
|
(16,584
|
)
|
|
|
(16,495
|
)
|
|
Ending
balance
|
$
|
522,597
|
|
|
$
|
545,079
|
|
|
$
|
514,906
|
|
|
`
|
|
|
|
|
|
|
|
|
|
|
|
|
Loan
loss allowance by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
522,351
|
|
|
$
|
544,561
|
|
|
$
|
514,626
|
|
|
NCSC
|
|
246
|
|
|
|
518
|
|
|
|
280
|
|
|
Total
|
$
|
522,597
|
|
|
$
|
545,079
|
|
|
$
|
514,906
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As
a percentage of total loans outstanding
|
|
2.70
|
%
|
|
|
3.02
|
%
|
|
|
2.71
|
%
|
|
As
a percentage of total non-performing loans outstanding
|
|
106.31
|
|
|
|
110.32
|
|
|
|
101.59
|
|
|
As
a percentage of total restructured loans outstanding
|
|
91.73
|
|
|
|
91.29
|
|
|
|
89.22
|
|
|
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.
Liabilities, Minority Interest and
Equity
Outstanding
Debt
The
following table provides a breakout of debt outstanding:
(dollar
amounts in thousands)
|
August
31, 2008
|
|
May
31, 2008
|
|
Increase/
(Decrease)
|
|
Short-term
debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
Commercial
paper (1)
|
$
|
3,573,808
|
|
|
$
|
3,050,264
|
|
|
$
|
523,544
|
|
|
Bank
bid notes
|
|
300,000
|
|
|
|
100,000
|
|
|
|
200,000
|
|
|
Long-term
debt with remaining maturities less than one year
|
|
4,224,816
|
|
|
|
3,177,189
|
|
|
|
1,047,627
|
|
|
Total
short-term debt
|
|
8,098,624
|
|
|
|
6,327,453
|
|
|
|
1,771,171
|
|
|
Long-term
debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
Collateral
trust bonds
|
|
4,185,442
|
|
|
|
2,886,580
|
|
|
|
1,298,862
|
|
|
Notes
payable
|
|
2,956,495
|
|
|
|
2,956,403
|
|
|
|
92
|
|
|
Medium-term
notes
|
|
2,845,543
|
|
|
|
4,330,604
|
|
|
|
(1,485,061
|
)
|
|
Total
long-term debt
|
|
9,987,480
|
|
|
|
10,173,587
|
|
|
|
(186,107
|
)
|
|
Subordinated
deferrable debt
|
|
311,440
|
|
|
|
311,440
|
|
|
|
-
|
|
|
Members'
subordinated certificates:
|
|
|
|
|
|
|
|
|
|
|
|
|
Membership
certificates
|
|
649,465
|
|
|
|
649,465
|
|
|
|
-
|
|
|
Loan
certificates
|
|
664,264
|
|
|
|
654,047
|
|
|
|
10,217
|
|
|
Guarantee
certificates
|
|
107,081
|
|
|
|
103,267
|
|
|
|
3,814
|
|
|
Total
members' subordinated certificates
|
|
1,420,810
|
|
|
|
1,406,779
|
|
|
|
14,031
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
debt outstanding
|
$
|
19,818,354
|
|
|
$
|
18,219,259
|
|
|
$
|
1,599,095
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Percentage
of fixed rate debt (2)
|
|
75
|
%
|
|
|
82
|
%
|
|
|
|
|
|
Percentage
of variable rate debt (3)
|
|
25
|
|
|
|
18
|
|
|
|
|
|
|
Percentage
of long-term debt
|
|
59
|
|
|
|
65
|
|
|
|
|
|
|
Percentage
of short-term debt
|
|
|
41
|
|
|
|
35
|
|
|
|
|
|
|
(1)
Includes $267 million and $251 million related to the daily liquidity fund at
August 31, 2008 and May 31, 2008, 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.
Total
debt outstanding at August 31, 2008 increased compared with May 31, 2008 in
order to prefund $1,545 million of debt scheduled to mature in September and
October 2008 and to fund the $335 million increase to loans
outstanding. The proceeds of this prefunding of debt contributed to
the $1,352 million increase in cash and cash equivalents at August 31,
2008. The amount of short-term debt increased and long-term debt
decreased by $1,048 million due to a shift of long-term debt to short-term debt
as it reached its final year to maturity. The Company issued $900
million of 5.50 percent collateral trust bonds due 2013 and $400 million of
floating rate collateral trust bonds due 2010 in June 2008. In
September 2008, the Company received $500 million in additional funding from the
FFB under a loan facility with a guarantee of repayment by the RUS as part of
the REDLG program. The $500 million advance has a 2028 maturity
date.
At August
31, 2008 and May 31, 2008, there was no foreign denominated debt
outstanding.
The
increase to members' subordinated certificates of $14 million for the three
months ended August 31, 2008 is primarily due to $30 million of new loan
certificates related to the increase in loans outstanding partially offset by
loan prepayments, normal amortization and maturities.
Minority
Interest
At August
31, 2008 and May 31, 2008, the Company reported minority interests of $13
million and $14 million, respectively, on the consolidated balance
sheets. Minority interest represented 100 percent of RTFC and NCSC
equity as the members of RTFC and NCSC own or control 100 percent of the
interest in their respective companies.
For the
three months ended August 31, 2008, the balance of minority interest decreased
by $1 million as a result of a combined net loss by RTFC and
NCSC.
Equity
The
following table provides a breakout of the equity balances:
(in
thousands)
|
August
31, 2008
|
|
May
31, 2008
|
|
Increase/
(Decrease)
|
|
Membership
fees
|
$
|
993
|
|
|
$
|
993
|
|
|
$
|
-
|
|
|
Education
fund
|
|
1,129
|
|
|
|
1,484
|
|
|
|
(355
|
)
|
|
Members'
capital reserve
|
|
|
|
|
|
187,409
|
|
|
|
-
|
|
|
Allocated
net income
|
|
338,011
|
|
|
|
423,249
|
|
|
|
(85,238
|
)
|
|
Unallocated
net income (1)
|
|
23,156
|
|
|
|
(53
|
)
|
|
|
23,209
|
|
|
Total
members' equity
|
|
550,698
|
|
|
|
613,082
|
|
|
|
(62,384
|
)
|
|
Prior
years’ cumulative derivative forward
|
|
|
|
|
|
|
|
|
|
|
|
|
value
and foreign currency adjustments
|
|
44,056
|
|
|
|
131,551
|
|
|
|
(87,495
|
)
|
|
Current
period derivative forward value (2)
|
|
(8,738
|
)
|
|
|
(87,495
|
)
|
|
|
78,757
|
|
|
Total
retained equity
|
|
586,016
|
|
|
|
657,138
|
|
|
|
(71,122
|
)
|
|
Accumulated
other comprehensive income
|
|
8,633
|
|
|
|
8,827
|
|
|
|
(194
|
)
|
|
Total
equity
|
|
$
|
594,649
|
|
|
$
|
665,965
|
|
|
$
|
(71,316
|
)
|
|
(1)
Excludes derivative forward value and foreign currency adjustments.
(2)
Represents the derivative forward value loss recorded by National Rural for the
year-to-date period.
To become
a member, applicants are required to pay a one-time fee. 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. 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 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 adjusts the net earnings it
allocates to its members and board approved reserves to exclude the non-cash
impacts of SFAS 133 and SFAS 52. National Rural allocates a small
portion, less than one percent, of net earnings annually to the education
fund. The allocation to the education fund must be at least 0.25
percent of net earnings as required by National Rural’s bylaws. 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 during the
year. 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 amounts disbursed from
board approved reserves.
At August
31, 2008, total equity decreased by $71 million from May 31, 2008 due to the
board authorized patronage capital retirement offset by net income of $14
million. In July 2008, National Rural's board of directors authorized
the retirement of allocated net earnings totaling $85 million, representing 70
percent of the fiscal year 2008 allocation and one-ninth of the fiscal years
1991, 1992 and 1993 allocated net earnings. This amount was paid to
members in October 2008.
Contractual
Obligations
The
following table summarizes the long-term contractual obligations at August 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
|
|
$
|
2,604
|
|
|
$
|
1,621
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
4,225
|
|
Long-term
debt
|
|
|
-
|
|
|
|
325
|
|
|
|
981
|
|
|
|
1,555
|
|
|
|
441
|
|
|
|
6,685
|
|
|
|
9,987
|
|
Subordinated
deferrable debt
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
311
|
|
|
|
311
|
|
Members'
subordinated certificates
(1)
|
|
|
7
|
|
|
|
38
|
|
|
|
18
|
|
|
|
16
|
|
|
|
15
|
|
|
|
1,073
|
|
|
|
1,167
|
|
Operating
leases (2)
|
|
|
2
|
|
|
|
2
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
4
|
|
Contractual
interest on long-term debt (3)
|
|
|
510
|
|
|
|
594
|
|
|
|
535
|
|
|
|
497
|
|
|
|
410
|
|
|
|
4,189
|
|
|
|
6,735
|
|
Total
contractual obligations
|
|
|
$
|
3,123
|
|
|
$
|
2,580
|
|
|
$
|
1,534
|
|
|
$
|
2,068
|
|
|
$
|
866
|
|
|
$
|
12,258
|
|
|
$
|
22,429
|
|
(1)
Excludes loan subordinated certificates totaling $254 million that amortize
annually based on the outstanding balance of the related loan. There
are many items that affect 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 percent 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 2008, the Company
exercised the option to extend the lease for an additional one-year period so
the future minimum lease payments for fiscal years 2010 and 2011 will increase
to $4 million and $2 million, respectively.
(3)
Represents the interest obligation on the Company's debt based on terms and
conditions at August 31, 2008.
Off-Balance
Sheet Obligations
Guarantees
The
following table provides a breakout of guarantees outstanding by type and by
segment:
|
|
|
|
|
Increase/
|
|
(in
thousands)
|
August
31, 2008
|
|
May
31, 2008
|
|
(Decrease)
|
|
Total
by type:
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
tax-exempt bonds
|
$
|
496,770
|
|
|
$
|
498,495
|
|
|
$
|
(1,725
|
)
|
|
Indemnifications
of tax benefit transfers
|
|
91,519
|
|
|
|
94,821
|
|
|
|
(3,302
|
)
|
|
Letters
of credit
|
|
344,790
|
|
|
|
343,424
|
|
|
|
1,366
|
|
|
Other
guarantees
|
|
100,407
|
|
|
|
100,400
|
|
|
|
7
|
|
|
Total
|
$
|
1,033,486
|
|
|
$
|
1,037,140
|
|
|
$
|
(3,654
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
by segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
National
Rural
|
$
|
996,210
|
|
|
$
|
993,699
|
|
|
$
|
2,511
|
|
|
RTFC
|
|
260
|
|
|
|
260
|
|
|
|
-
|
|
|
NCSC
|
|
37,016
|
|
|
|
43,181
|
|
|
|
(6,165
|
)
|
|
Total
|
$
|
1,033,486
|
|
|
$
|
1,037,140
|
|
|
$
|
(3,654
|
)
|
|
The
decrease in total guarantees outstanding at August 31, 2008 compared with May
31, 2008 is primarily due to the normal amortization on long-term tax-exempt
bonds and tax benefit transfers partially offset by an increase in the amount of
letters of credit.
At August
31, 2008 and May 31, 2008, the Company had recorded a guarantee liability
totaling $14 million and $15 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 August 31, 2008
and the related principal amortization and maturities by fiscal
year.
(in
thousands)
|
|
|
|
Principal
Amortization and Maturities
|
|
|
|
|
Outstanding
|
|
|
|
|
|
|
|
|
|
|
|
Remaining
|
|
|
|
|
Balance
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
2013
|
|
Years
|
|
|
|
Guarantees
(1)
|
|
|
$
|
1,033,486
|
$
|
240,368
|
|
$
|
109,654
|
|
$
|
158,959
|
|
$
|
54,536
|
|
$
|
107,360
|
|
$
|
362,609
|
|
(1) On a
total of $329 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 August
31, 2008, the Company had unadvanced loan commitments totaling $13,561 million,
a decrease of $13 million compared with the balance of $13,574 million at May
31, 2008. 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
are conditioned on the absence of any material adverse change with respect to
the borrower’s financial condition. Therefore, 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 the time the advance is
approved. The Company offers lines of credit loans that may or may
not contain a material adverse change condition. The majority of the
short-term unadvanced commitments provide backup liquidity to the Company's
borrowers; therefore, the Company does not anticipate funding most of these
commitments. Approximately 56 percent of the outstanding commitments
at August 31, 2008 and May 31, 2008 were for short-term and line of credit
loans. Based on the conditions to the advance of funds
described above, unadvanced loan commitments do not represent off-balance sheet
liabilities and have not been included in the table 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 August 31, 2008 was 36.22, an increase from 29.64 at May 31,
2008. The increase in the leverage ratio is due to an increase of
$1,808 million in total liabilities and a decrease of $71 million in total
equity offset by a decrease of $4 million in guarantees as discussed under the
Liabilities, Minority Interest
and Equity section and the Off-Balance Sheet Obligations
section of Financial
Condition. The primary reason for the increase in total
liabilities during the quarter was an increase to the Company’s short-term debt
of $1,771 million, the majority of which was issued to prefund debt scheduled to
rollover in September and October 2008.
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 determine “adjusted
equity.” At August 31, 2008 and May 31, 2008, the adjusted leverage
ratio was 8.42 and 7.50, 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 $1,749 million and a decrease of $50 million in adjusted equity
offset by a decrease in guarantees of $4 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 August 31, 2008 was 34.49, an increase from 28.08 at May 31,
2008. The increase in the debt to equity ratio is due to the decrease
of $71 million in total equity and an increase of $1,808 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 determine adjusted
equity. At August 31, 2008 and May 31, 2008, the adjusted debt to
equity ratio was 7.97 and 7.06, 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 $50 million in adjusted equity and an
increase of $1,749 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 August 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 August
31, 2008 and through the date of this filing, 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
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. At
August 31, 2008, the Company had effective registration statements for the
issuance of $2,449 million of medium-term notes and $165 million of subordinated
deferrable debt. The Company expects to file an automatic shelf
registration statement for an unlimited amount of medium-term notes and
subordinated deferrable debt prior to the expiration of the related effective
registration statements in December 2008. 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 August 31, 2008, the Company had 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 automatic shelf 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.
In June
2008, the Company issued $900 million of 5.50 percent collateral trust bonds due
2013 and $400 million of floating rate collateral trust bonds due
2010.
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 percent 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. 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 August 31, 2008, the Company had $2.5
billion outstanding under FFB loan facilities with bond guarantee agreements
with RUS as part of the funding mechanism for the REDLG program. In
September 2008, the Company received $500 million in additional funding from the
FFB under the REDLG program. The $500 million advance has a 2028
maturity date. National Rural is required to place on deposit
mortgage notes in an amount at least equal to the principal balance of the notes
outstanding issued under the REDLG program.
Member
Loan Repayments
Scheduled
repayments on long-term loans are expected to average $1,020 million a year for
fiscal years 2009 to 2013. 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.
Member
Loan Interest Payments
For the
three months ended August 31, 2008, interest income on the loan portfolio was
$259 million, representing an average yield of 5.36 percent as compared with
5.67 percent for the three months ended August 31, 2007. At August
31, 2008, 80 percent of total loans outstanding had a fixed rate of interest and
20 percent of loans outstanding had a variable rate of interest. At
August 31, 2008, a total of 5 percent 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:
(dollar
amounts in thousands)
|
|
|
August
31, 2008
|
|
May
31, 2008
|
|
Termination
Date
|
|
Facility
fee per annum (1)
|
|
|
Five-year
agreement
|
|
$
|
1,125,000
|
$
|
1,125,000
|
|
March
16, 2012
|
|
6
basis points
|
|
|
Five-year
agreement
|
|
|
1,025,000
|
|
1,025,000
|
|
March
22, 2011
|
|
6
basis points
|
|
|
364-day
agreement (2)
|
|
|
1,500,000
|
|
1,500,000
|
|
March
13, 2009
|
|
5
basis points
|
|
|
Total
|
|
|
$
|
3,650,000
|
$
|
3,650,000
|
|
|
|
|
|
|
(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 the agreement 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
percent per annum.
Upfront
fees of between three and five basis points were paid to the banks based on
their commitment level to the five-year agreements in place at August 31,
2008. These fees totaled approximately $1 million and will be
amortized on a straight-line basis over the life of the
agreements. In addition, the Company paid $0.1 million in upfront
fees to the banks for their commitment to the 364-day facility in place at
August 31, 2008, 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 percent of total commitments, a utilization fee must be
paid on the outstanding balance. The utilization fees are five basis
points for all three agreements in place at August 31, 2008.
At August
31, 2008 and May 31, 2008, 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.
LBB, a
subsidiary of LBHI, which has filed a petition under Chapter 11 of the U.S.
Bankruptcy Code, is a participant for up to $239 million of National Rural’s
$3.65 billion revolving credit facility. At August 31, 2008, there
were no amounts under the revolving credit facility due to LBB. On
October 7, 2008, the Company was unable to issue the amount of commercial paper
necessary to fund its needs as a result of the instability in the overall credit
markets. As a result, the Company drew down $418.5 million of its
$3.65 billion revolving credit facility by borrowing from the $1.5 billion
364-day agreement. As the amount borrowed did not exceed 50 percent
of total commitments, there is no utilization fee on the outstanding
balance. LBB did not fund their portion of the draw. As a
result, the Company does not believe that LBB’s $239 million portion of the
credit facility will be available in the future. The Company believes
that if accessing the credit markets continues to be difficult, the remaining
amounts in the credit facility will be adequate to fund its operations in the
near term. See the Liquidity section of Financial Overview for
additional information.
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. 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 SFAS 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 three months ended August 31, 2008
and at or for the year ended May 31, 2008:
|
|
|
|
Actual
|
|
|
|
Requirement
|
|
August
31, 2008
|
|
May
31, 2008
|
|
|
|
|
|
|
|
|
|
Minimum
average adjusted TIER over the six most recent fiscal
quarters
|
1.025
|
|
1.14
|
|
1.16
|
|
|
|
|
|
|
|
|
|
Minimum
adjusted TIER at fiscal year end (1)
|
1.05
|
|
1.15
|
|
1.15
|
|
|
|
|
|
|
|
|
|
Maximum
ratio of senior debt to total equity
|
|
|
10.00
|
|
8.23
|
|
7.33
|
|
(1) The
Company must meet this requirement 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, to draw down on the
facilities.
Member
Investments
At August
31, 2008 and May 31, 2008, members funded 18.4 percent and 19.7 percent,
respectively, of total assets as follows:
|
August
31, 2008
|
|
May
31, 2008
|
|
Increase/
(Decrease)
|
|
(dollar
amounts in thousands)
|
Amount
|
|
%
of Total (1)
|
|
Amount
|
|
%
of Total (1)
|
|
|
|
Commercial
paper (2)
|
$
|
1,446,087
|
|
|
40
|
%
|
|
$
|
1,403,960
|
|
|
46
|
%
|
|
$
|
42,127
|
|
|
Medium-term
notes
|
|
460,094
|
|
|
9
|
|
|
|
392,739
|
|
|
8
|
|
|
|
67,355
|
|
|
Members'
subordinated certificates
|
|
1,420,810
|
|
|
100
|
|
|
|
1,406,779
|
|
|
100
|
|
|
|
14,031
|
|
|
Members'
equity (3)
|
|
550,698
|
|
|
100
|
|
|
|
613,082
|
|
|
100
|
|
|
|
(62,384
|
)
|
|
Total
|
$
|
3,877,689
|
|
|
|
|
|
$
|
3,816,560
|
|
|
|
|
|
$
|
61,129
|
|
|
Percentage
of total assets
|
|
18.4
|
%
|
|
|
|
|
|
19.7
|
%
|
|
|
|
|
|
|
|
|
Percentage
of total assets less derivative assets (3)
|
|
18.6
|
%
|
|
|
|
|
|
19.9
|
%
|
|
|
|
|
|
|
|
(1)
Represents the percentage of each line item outstanding to the Company’s
members.
(2)
Includes $267 million and $251 million related to the daily liquidity fund at
August 31, 2008 and May 31, 2008, 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.
The
Company has viewed member commercial paper investments as a more stable source
of funding for the Company than investor purchased commercial
paper. Member commercial paper investments have averaged $1,319
million outstanding since January 1, 2007.
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 August 31, 2008. At
August 31, 2008, the Company had unadvanced loan commitments totaling $13,561
million. The Company does not expect to advance the full amount of
the unadvanced commitments at August 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 percent of the outstanding
commitments at August 31, 2008 were for short-term or line of credit
loans. The Company anticipates that over the next 12 months, loan
advances will be approximately equal to the scheduled loan
repayments.
Interest
Expense on Debt
For the
three months ended August 31, 2008, interest expense on debt was $213 million,
at a weighted-average cost of 4.40 percent for the period compared with 5.12
percent for the quarter ended August 31, 2007. At August 31, 2008, a
total of 75 percent of outstanding debt had a fixed interest rate and 25 percent
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 August 31, 2008 and
thereafter is as follows:
|
Amount
|
|
(in
thousands)
|
Maturing
(1)
|
|
2009
|
$
|
2,611
|
|
|
2010
|
|
1,984
|
|
|
2011
|
|
999
|
|
|
2012
|
|
1,571
|
|
|
2013
|
|
456
|
|
|
Thereafter
|
|
8,069
|
|
|
Total
|
|
$
|
15,690
|
|
|
(1)
Excludes loan subordinated certificates totaling $254 million that amortize
annually based on the outstanding balance of the related loan. There
are many items that affect 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 percent of amortizing loan subordinated certificates
outstanding.
The
$2,611 million of debt scheduled to mature in the next 12 months included $1,545
million maturing in September and October 2008 of which the Company had
prefunded 88 percent at August 31, 2008.
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 made
cash payments totaling $85 million to its members in October 2008 as retirement
of 70 percent of the amount allocated for fiscal year 2008 and one-ninth of the
amount allocated for fiscal years 1991, 1992 and 1993.
Market
Risk
The
Company's primary market risks are interest rate risk, counterparty risk as a
result of entering into derivative financial instruments and liquidity
risk.
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.
Matched
Funding Policy
To
monitor and 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 table on page 49). 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 August 31, 2008 and May 31, 2008, 20 percent and 19
percent, respectively, of loans carried variable interest rates.
It is the
Company's funding objective to manage the matched funding of asset and liability
repricing terms within a range of three percent of total assets excluding
derivative assets. At August 31, 2008, the Company had $15,215
million of fixed rate assets amortizing or repricing, funded by $12,943 million
of fixed-rate liabilities maturing during the next 30 years and $1,758 million
of members' equity and members' subordinated certificates, a portion of which
does not have a scheduled maturity. The difference of $514 million,
or less than three percent 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 derivative instruments 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 table shows the scheduled amortization and repricing of fixed rate
assets and liabilities outstanding at August 31, 2008.
INTEREST
RATE GAP ANALYSIS
|
(Fixed
Rate Assets/Liabilities)
|
At
August 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
|
$
|
1,790
|
|
|
$
|
3,490
|
|
|
$
|
2,834
|
|
|
$
|
3,437
|
|
|
$
|
2,676
|
|
|
$
|
988
|
|
|
$
|
15,215
|
|
Total
assets
|
$
|
1,790
|
|
|
$
|
3,490
|
|
|
$
|
2,834
|
|
|
$
|
3,437
|
|
|
$
|
2,676
|
|
|
$
|
988
|
|
|
$
|
15,215
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and members' equity:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term
debt
|
$
|
1,416
|
|
|
$
|
3,144
|
|
|
$
|
3,563
|
|
|
$
|
3,777
|
|
|
$
|
782
|
|
|
$
|
261
|
|
|
$
|
12,943
|
|
Subordinated
certificates
|
|
18
|
|
|
|
56
|
|
|
|
79
|
|
|
|
65
|
|
|
|
506
|
|
|
|
525
|
|
|
|
1,249
|
|
Members'
equity (1)
|
|
15
|
|
|
|
25
|
|
|
|
31
|
|
|
|
127
|
|
|
|
109
|
|
|
|
202
|
|
|
|
509
|
|
Total
liabilities and members' equity
|
$
|
1,449
|
|
|
$
|
3,225
|
|
|
$
|
3,673
|
|
|
$
|
3,969
|
|
|
$
|
1,397
|
|
|
$
|
988
|
|
|
$
|
14,701
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gap (2)
|
$
|
341
|
|
|
$
|
265
|
|
|
$
|
(839
|
)
|
|
$
|
(532
|
)
|
|
$
|
1,279
|
|
|
$
|
-
|
|
|
$
|
514
|
|
Cumulative
gap
|
|
341
|
|
|
|
606
|
|
|
|
(233
|
)
|
|
|
(765
|
)
|
|
|
514
|
|
|
|
514
|
|
|
|
|
|
Cumulative
gap as a % of total assets
|
|
1.61
|
%
|
|
|
2.87
|
%
|
|
|
(1.10
|
)%
|
|
|
(3.62
|
)%
|
|
|
2.43
|
%
|
|
|
2.43
|
%
|
|
|
|
|
Cumulative
gap as a % of adjusted total assets (3)
|
|
1.63
|
|
|
|
2.91
|
|
|
|
(1.12
|
)
|
|
|
(3.67
|
)
|
|
|
2.46
|
|
|
|
2.46
|
|
|
|
|
|
(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 August
31, 2008 and May 31, 2008, the Company was a party to derivative instruments
with a total notional amount of $13,627 million and $12,916 million,
respectively. The Company uses derivative instruments as part of its
overall interest rate matching strategy. Derivative instruments are
used when they provide a lower cost of funding or minimize interest rate
risk. The Company will enter into derivative instruments only with
highly rated financial institutions. National Rural used derivative
instruments to economically convert the interest rate on $7,721 million and
$7,660 million of variable rate debt as of August 31, 2008 and May 31, 2008,
respectively, to better match the funding of long-term fixed rate
loans. Derivative instruments were used to economically convert the
interest rates from fixed to variable on $5,906 million and $5,256 million fixed
rate of long-term debt as of August 31, 2008 and May 31, 2008,
respectively. 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 August
31, 2008 and May 31, 2008, 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 derivative instruments. To
mitigate this risk, the Company only enters into these agreements with financial
institutions with investment grade ratings. At August 31, 2008 and
May 31, 2008, the Company was a party to derivative instruments with notional
amounts totaling $13,627 million and $12,916 million,
respectively. 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 August 31, 2008 and at the
date of this filing, the Company's derivative instrument counterparties had
credit ratings ranging from AAA to A- as assigned by Standard & Poor's
Corporation.
At August
31, 2008, the seven interest rate swaps to which LBSF was a counterparty had a
recorded fair market value of $27 million. As a result of the
bankruptcy filing of LBHI, National Rural terminated the interest rate swaps
with LBSF on September 26, 2008. A payment is due to National Rural
from LBSF totaling $26 million representing the termination net settlement
amount on that day, in accordance with the terms of the contract. On
October 3, 2008, LBSF filed a petition under Chapter 11 of the U.S. Bankruptcy
Code with the United States Bankruptcy Court for the Southern District of New
York. National Rural is currently evaluating the collectability of
the required payments under the contractual terms of the interest rate
swaps.
Rating
Triggers
The
Company has certain derivative instruments 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 August
31, 2008, the Company had the following notional amount and fair values
associated with derivative instruments 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 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+
|
$
|
1,919,918
|
|
$
|
(535
|
)
|
$
|
37,908
|
|
$
|
37,373
|
|
Fall
below Baa1/BBB+
|
|
7,313,977
|
|
|
(36,025
|
)
|
|
29,128
|
|
|
(6,897
|
)
|
Total
|
$
|
9,233,895
|
|
$
|
(36,560
|
)
|
$
|
67,036
|
|
$
|
30,476
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
See table
on page 44 for National Rural's senior unsecured credit ratings as of
August 31, 2008.
In
addition to the rating triggers listed above, at August 31, 2008, the Company
had $717 million of notional amount of derivative instruments, with one
counterparty, that would require the pledging of collateral in an amount equal
to the fair value of the derivative instruments if the Company’s senior secured
ratings from Moody's Investors Service were to fall below Baa2 or if the rating
from Standard & Poor's Corporation were to fall below BBB. At
August 31, 2008, the fair value of the derivative instruments associated with
this rating trigger was a $13 million net obligation.
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. 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. At August 31, 2008,
the Company had a total of $4,225 million of long-term debt maturing during the
next 12 months. 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. 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 percent or less of total debt
outstanding. At August 31, 2008 and May 31, 2008, there was a total
of $2,294 million and $1,612 million, respectively, of dealer commercial paper
and bank bid notes outstanding, representing 12 percent and 9 percent,
respectively, of the Company's total debt outstanding. The Company had
$3.65 billion in unused lines of credit with financial institutions available to
draw upon at August 31, 2008.
National
Rural continues to see significant investment support from its members with $3.3
billion of commercial paper, daily liquidity fund, medium-term notes and
subordinated certificate investments outstanding at August 31,
2008. The member debt investments represented 17 percent of the total
debt outstanding at August 31, 2008. In addition, National Rural had
a total of $3.0 billion of privately placed debt outstanding at August 31, 2008,
$2.5 billion of which was guaranteed by the U.S. Government under the REDLG
program. The private placements of debt represented 15 percent of
total debt outstanding at August 31, 2008. In September 2008, the
Company closed on a $500 million FFB loan facility under the REDLG program and
received an advance for the full amount available under the
facility.
The
turmoil in the credit markets subsequent to August 31, 2008 has had an effect on
the Company’s ability and cost of raising debt. The ability of
companies to raise short-term debt (commercial paper) has been hampered by the
credit crunch resulting from the overall economic environment. While
the Company has been able to meet its funding needs, the debt issued since
August 31, 2008 has been at a higher cost and, in many instances, the debt
raised has had a shorter tenor than anticipated. The slightly
higher
spread
paid on dealer commercial paper and bank bid notes since August 31, 2008 has not
had a significant impact on National Rural's funding cost, as dealer commercial
paper and bank bid notes represented only 12 percent of total debt at August 31,
2008.
In the
first quarter of fiscal year 2009, the Company was able to prefund 88 percent of
its $1,545 million debt scheduled to mature in September and October
2008. One of the strategies the Company may employ to decrease its
reliance on the commercial paper market is to seek to issue long-term funding to
members, in the capital markets or in private placements to reduce the
short-term commercial paper needs of the Company.
On
October 7, 2008, the Company was unable to issue the amount of commercial paper
necessary to fund its needs as a result of the instability in the overall credit
markets. As a result, the Company drew down $418.5 million of its
$3.65 billion revolving credit facility by borrowing from the $1.5 billion
364-day agreement. LBB did not fund their portion of the draw and the
Company does not believe that LBB’s $239 million portion of the credit facility
will be available in the future. As the amount borrowed did not
exceed 50 percent of total commitments, there is no utilization fee on the
outstanding balance.
At August
31, 2008, the Company was the guarantor and liquidity provider for $329 million
of tax-exempt bonds issued for its member cooperatives. A total of
$210 million of such tax-exempt bonds were in flexible and weekly mode, which
reprice every seven to thirty-five days. A total of $119 million of
such tax-exempt bonds reprice semi-annually. 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.
Subsequent
to August 31, 2008, the Company entered into agreements as the guarantor and
liquidity provider for an additional $176 million of tax-exempt bonds issued for
its member cooperatives that reprice semi-annually.
In
September and October 2008, the Company was required to purchase a total of $57
million of tax-exempt bonds pursuant to its obligation as liquidity
provider. As a result, the Company will be required to hold the bonds
until the remarketing agent is able to place them with third-party
investors. During this period, the Company is entitled to receive a
default rate of interest on most of the bonds that is higher than the rate
investors typically receive on similar bonds in the tax-exempt
market. On October 15, 2008, $8 million of the tax-exempt bonds held
by the Company will be redeemed as a result of a mandatory sinking fund
payment.
For
additional information about the risks related to the Company's business, see
Item 1A. Risk Factors.
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
following table 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 three months ended August 31, 2008 and
2007. Refer to Non-GAAP Financial Measures in Item 7, Management's Discussion and Analysis
of Financial Condition and Results of Operations, in the Company's Form
10-K for the year ended May 31, 2008 for an explanation of why these adjustments
to net income and the calculation of the TIER ratio reflect management's
perspective on the Company's operations and why the Company believes these are
useful financial measures for investors.
|
|
|
|
|
Three
months ended
|
|
|
|
|
|
|
August
31,
|
|
|
(in
thousands)
|
|
|
|
|
|
2008
|
|
2007
|
|
Interest
expense
|
|
|
|
|
|
|
|
|
|
$
|
(220,309
|
)
|
|
$
|
(247,325
|
)
|
|
|
Derivative
cash settlements
|
|
|
|
|
|
|
|
|
|
|
431
|
|
|
|
8,329
|
|
|
|
Adjusted
interest expense
|
|
|
|
|
|
|
|
|
|
$
|
(219,878
|
)
|
|
$
|
(238,996
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
interest income
|
|
|
|
|
|
|
|
|
|
$
|
46,209
|
|
|
$
|
20,629
|
|
|
|
Derivative
cash settlements
|
|
|
|
|
|
|
|
|
|
|
431
|
|
|
|
8,329
|
|
|
|
Adjusted
net interest income
|
|
|
|
|
|
|
|
|
|
$
|
46,640
|
|
|
$
|
28,958
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) prior to income taxes and minority interest
|
|
|
|
|
|
|
|
|
|
$
|
12,470
|
|
|
$
|
(14,059
|
)
|
|
Derivative
forward value
|
|
|
|
|
|
|
|
|
|
|
11,028
|
|
|
|
33,600
|
|
|
Adjusted
income prior to income taxes and minority interest
|
|
|
|
|
|
|
$
|
23,498
|
|
|
$
|
19,541
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income (loss)
|
|
|
|
|
|
|
|
|
|
$
|
14,471
|
|
|
$
|
(11,382
|
)
|
|
Minority
interest net loss
|
|
|
|
|
|
|
|
|
|
|
(1,241
|
)
|
|
|
(1,578
|
)
|
|
Derivative
forward value
|
|
|
|
|
|
|
|
|
|
|
11,028
|
|
|
|
33,600
|
|
|
Adjusted
net income
|
|
|
|
|
|
|
|
|
|
$
|
24,258
|
|
|
$
|
20,640
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 table provides the TIER and adjusted TIER for the three months ended
August 31, 2008 and 2007.
|
Three
months ended August 31,
|
|
2008
|
|
2007
|
TIER
(1)
|
|
1.07
|
|
|
|
-
|
|
Adjusted
TIER
|
|
|
1.11
|
|
|
|
1.09
|
|
(1) For
the three months ended August 31, 2007, the Company reported a net loss of $11
million, thus the TIER calculation results in a value below 1.00.
Adjustments
to the Calculation of Leverage and Debt to Equity
The
following table provides a reconciliation between the liabilities and equity
used to calculate the leverage and debt to equity ratios and these financial
measures adjusted to exclude the non-cash impacts of derivatives and foreign
currency adjustments, to subtract debt used to fund loans that are guaranteed by
RUS from total liabilities, to subtract from total liabilities, and add to total
equity, debt with equity characteristics and to include minority interest as
equity. Refer to Non-GAAP Financial Measures
in Item 7, Management's
Discussion and Analysis of Financial Condition and Results of Operations,
in the Company's Form 10-K for the year ended May 31, 2008 for an explanation of
why these adjustments to the calculation of leverage and debt to equity ratios
reflect management's perspective on the Company's operations and why the Company
believes these are useful financial measures for investors.
(in
thousands)
|
August
31, 2008
|
|
May
31, 2008
|
|
Liabilities
|
$
|
20,507,581
|
|
|
$
|
18,699,169
|
|
|
Less:
|
|
|
|
|
|
|
|
|
Derivative
liabilities
|
|
(217,391
|
)
|
|
|
(171,390
|
)
|
|
Debt
used to fund loans guaranteed by RUS
|
|
(249,191
|
)
|
|
|
(250,169
|
)
|
|
Subordinated
deferrable debt
|
|
(311,440
|
)
|
|
|
(311,440
|
)
|
|
Subordinated
certificates
|
|
(1,420,810
|
)
|
|
|
(1,406,779
|
)
|
|
Adjusted
liabilities
|
$
|
18,308,749
|
|
|
$
|
16,559,391
|
|
|
|
|
|
|
|
|
|
|
|
Total
equity
|
$
|
594,649
|
|
|
$
|
665,965
|
|
|
Less:
|
|
|
|
|
|
|
|
|
Prior
year cumulative derivative forward value and
|
|
|
|
|
|
|
|
foreign
currency adjustments
|
|
(44,056
|
)
|
|
|
(131,551
|
)
|
|
Current
period derivative forward value (1)
|
|
8,738
|
|
|
|
87,495
|
|
|
Accumulated
other comprehensive income
|
|
(8,633
|
)
|
|
|
(8,827
|
)
|
|
Subtotal
members' equity
|
|
550,698
|
|
|
|
613,082
|
|
|
Plus:
|
|
|
|
|
|
|
|
|
Subordinated
certificates
|
|
1,420,810
|
|
|
|
1,406,779
|
|
|
Subordinated
deferrable debt
|
|
311,440
|
|
|
|
311,440
|
|
|
Minority
interest
|
|
13,001
|
|
|
|
14,247
|
|
|
Adjusted
equity
|
$
|
2,295,949
|
|
|
$
|
2,345,548
|
|
|
|
|
|
|
|
|
|
|
|
Guarantees
|
|
$
|
1,033,486
|
|
|
$
|
1,037,140
|
|
|
(1)
Represents the derivative forward value loss recorded by National Rural for the
year-to-date period.
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 table provides the calculated ratio for leverage and debt to
equity, as well as the adjusted ratio calculations. 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.
|
|
|
August
31, 2008
|
|
May
31, 2008
|
Leverage
ratio
|
|
|
36.22
|
|
|
|
29.64
|
|
Adjusted
leverage ratio
|
|
|
8.42
|
|
|
|
7.50
|
|
|
|
|
|
|
|
|
|
|
Debt
to equity ratio
|
|
|
34.49
|
|
|
|
28.08
|
|
Adjusted
debt to equity ratio
|
|
|
7.97
|
|
|
|
7.06
|
|
Item
3. Quantitative
and Qualitative Disclosures About Market Risk
See
Market Risk discussion beginning on page 48.
Item
4T.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. 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.
PART
II.
|
OTHER
INFORMATION
|
Refer to Part I, Item 1A. Risk Factors
in the Company's Form 10-K for the year ended May 31, 2008 for information
regarding factors that could affect the Company's results of operations,
financial condition and liquidity. There have been no changes to the
Company's risk factors during the quarter ended August 31, 2008.
|
|
|
|
|
|
4.29
|
–
|
Bond
Purchase Agreement between the Registrant, Federal Financing Bank and
Rural Utilities Service dated as of September 19, 2008 for up to
$500,000,000.
|
|
|
|
4.30
|
–
|
Series
C Bond Guarantee Agreement between the Registrant and the Rural Utilities
Service dated as of September 19, 2008 for up to
$500,000,000.
|
|
|
|
4.31
|
–
|
Pledge
Agreement dated as of September 19, 2008, between the Registrant, the
Rural Utilities Service and U.S. Bank Trust National
Association.
|
|
|
|
4.32
|
–
|
Series
C Future Advance Bond from the Registrant to the Federal Financing Bank
dated as of September 19, 2008 for up to $500,000,000 maturing on October
15, 2031.
|
|
|
|
4.33
|
–
|
Amendment
No. 1 dated as of September 19, 2008 to the Pledge Agreement dated as of
April 28, 2006, between the Registrant, the Rural Utilities Service and
U.S. Bank Trust National Association.
|
|
|
|
10.13
|
–
|
Third
Amendment to Agreement of Purchase and Sale between National Rural and DTC
Partners, LLC dated as of August 25, 2008. Graphics to the
Third Amendment to Agreement of Purchase and Sale have been omitted and
will be furnished supplementally to the Securities and Exchange Commission
upon request.
|
|
|
|
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 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.
NATIONAL RURAL UTILITIES
COOPERATIVE
FINANCE
CORPORATION
/s/ STEVEN L.
LILLY
Steven L. Lilly
Chief Financial Officer
/s/ ROBERT E.
GEIER
Robert E. Geier
Controller
(Principal Accounting
Officer)
October
14, 2008