10-Q 1 nov3008_10q.htm NOVEMBER 2008, 10-Q nov3008_10q.htm
 

 
   
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 November 30, 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.

       



 
1

 


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
         

 
November 30, 2008
 
May 31, 2008
 
                 
Cash and cash equivalents
$
473,274
   
$
177,809
   
                 
Restricted cash
 
9,086
     
14,460
   
                 
Investments in trading securities
 
11,434
     
-
   
                 
Loans to members
 
19,566,939
     
19,029,040
   
   Less: Allowance for loan losses
 
(648,946
)
   
(514,906
)
 
          Loans to members, net
 
18,917,993
     
18,514,134
   
                 
Accrued interest and other receivables
 
301,788
     
258,315
   
                 
Fixed assets, net
 
19,109
     
21,045
   
                 
Debt service reserve funds
 
50,335
     
54,993
   
                 
Bond issuance costs, net
 
50,411
     
39,618
   
                 
Foreclosed assets, net
 
61,265
     
58,961
   
                 
Derivative assets
 
492,371
     
220,514
   
                 
Other assets
 
31,234
     
19,532
   
                 
 
$
20,418,300
   
$
19,379,381
   
                 
See accompanying notes.




 
2

 

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
         

 
November 30, 2008
   
May 31, 2008
   
                 
Short-term debt
$
5,711,175
   
$
6,327,453
   
                 
Accrued interest payable
 
275,156
     
244,299
   
                 
Long-term debt
 
11,600,921
     
10,173,587
   
                 
Deferred income
 
19,612
     
21,971
   
                 
Guarantee liability
 
32,824
     
15,034
   
                 
Other liabilities
 
32,905
     
27,216
   
                 
Derivative liabilities
 
594,077
     
171,390
   
                 
Subordinated deferrable debt
 
311,440
     
311,440
   
                 
Members' subordinated certificates:
               
     Membership subordinated certificates
 
649,465
     
649,465
   
     Loan and guarantee subordinated certificates
 
815,112
     
757,314
   
            Total members' subordinated certificates
 
1,464,577
     
1,406,779
   
                 
Commitments and contingencies
 
-
     
-
   
                 
Minority interest
 
11,260
     
14,247
   
                 
Equity:
               
     Retained equity
 
355,925
     
657,138
   
     Accumulated other comprehensive income
 
8,428
     
8,827
   
            Total equity
 
364,353
     
665,965
   
                 
 
$
20,418,300
   
$
19,379,381
   
                 
   
See accompanying notes.


 
3

 



NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
         
CONSOLIDATED STATEMENTS OF OPERATIONS
 (UNAUDITED)
(in thousands)
        
For the Three and Six Months Ended November 30, 2008 and 2007
         
 
Three months ended
 
Six months ended
 
November 30,
 
November 30,
 
2008
 
2007
 
2008
 
2007
                               
Interest income
$
269,042
   
$
263,287
   
$
535,560
   
$
531,241
 
Interest expense
 
(234,224
)
   
(240,017
)
   
(454,533
)
   
(487,342
)
                               
Net interest income
 
34,818
     
23,270
     
81,027
     
43,899
 
                               
(Provision for) recovery of loan losses
 
(126,311
)
   
14,301
     
(136,992
)
   
14,301
 
                               
Net interest (loss) income after (provision for) recovery of loan losses
 
(91,493
)
   
37,571
     
(55,965
)
   
58,200
 
                               
Non-interest income:
                             
     Rental and other income
 
441
     
352
     
622
     
703
 
     Derivative cash settlements
 
12,503
     
11,507
     
12,934
     
19,836
 
     Results of operations of foreclosed assets
 
1,211
     
1,856
     
2,457
     
3,816
 
                               
Total non-interest income
 
14,155
     
13,715
     
16,013
     
24,355
 
                               
Non-interest (expense) income:
                             
     Salaries and employee benefits
 
(9,912
)
   
(8,828
)
   
(19,763
)
   
(17,651
)
     Other general and administrative expenses
 
(5,182
)
   
(5,929
)
   
(9,924
)
   
(10,416
)
     (Provision for) recovery of guarantee liability
 
(5,686
)
   
1,200
     
(4,981
)
   
3,300
 
     Market adjustment on foreclosed assets
 
(153
)
   
-
     
(153
)
   
-
 
     Derivative forward value
 
(139,383
)
   
(75,412
)
   
(150,411
)
   
(109,012
)
     Loss on sale of loans
 
-
     
-
     
-
     
(518
)
     Fair value adjustment on investments in trading securities
 
(101
)
   
-
     
(101
)
   
-
 
                               
Total non-interest expense
 
(160,417
)
   
(88,969
)
   
(185,333
)
   
(134,297
)
                               
Loss prior to income taxes and minority interest
 
(237,755
)
   
(37,683
)
   
(225,285
)
   
(51,742
)
                               
Income tax benefit
 
6,400
     
2,912
     
7,160
     
4,011
 
                               
Loss prior to minority interest
 
(231,355
)
   
(34,771
)
   
(218,125
)
   
(47,731
)
                               
Minority interest, net of income taxes
 
1,738
     
4,545
     
2,979
     
6,123
 
                               
Net loss
$
(229,617
)
 
$
(30,226
)
 
$
(215,146
)
 
$
(41,608
)
                               
See accompanying notes.
 







 
4

 

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
 
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(UNAUDITED)
(in thousands)
 
For the Six Months Ended November 30, 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
 
 
Six months ended November 30, 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
 
(85,454
)
 
-
     
(85,454
)
   
-
     
-
     
-
     
(217
)
 
-
     
(85,237
)
 
 
  Loss prior to income taxes and minority interest
 
(225,285
)
 
-
     
(225,285
)
   
-
     
(225,285
)
   
-
     
-
   
-
     
-
   
 
  Other comprehensive loss
 
(399
)
 
(399
)
   
-
     
       -
     
-
     
-
     
        -
   
    -
     
          -
   
 
  Income tax benefit
 
7,160
   
       -
     
7,160
     
       -
     
7,160
     
        -
     
        -
   
    -
     
          -
   
 
  Minority interest
 
2,979
   
       -
     
2,979
     
       -
     
2,979
     
        -
     
        -
   
    -
     
          -
   
 
  Other
 
(613
)
 
       -
     
(613
)
   
        -
     
       -
     
(613
)
   
(93
)
 
    -
     
       93
   
 
  Balance as of November 30, 2008
$
364,353
 
$
8,428
   
$
355,925
   
$
993
   
$
(171,143
)
 
$
   871
   
$
187,099
 
$
496
   
$
337,609
   
                                                                       
 
Six months ended November 30, 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
 
(51,742
)
 
-
     
(51,742
)
   
       -
     
(51,742
)
   
-
     
-
   
-
     
-
   
 
  Other comprehensive loss
 
     (331
)
 
(331
)
   
         -
     
       -
     
          -
     
        -
     
        -
   
    -
     
          -
   
 
  Income tax benefit
 
    4,011
   
-
     
   4,011
     
       -
     
   4,011
     
        -
     
        -
   
    -
     
          -
   
 
  Minority interest
 
     6,123
   
-
     
   6,123
     
        -
     
    6,123
     
         -
     
        -
   
    -
     
          -
   
 
  Other
 
      (487
)
 
-
     
     (487
)
   
      (1
)
   
         1
     
(487
)
   
       40
   
    -
     
       (40
)
 
 
  Balance as of November 30, 2007
$
582,121
 
$
11,873
   
$
570,248
   
$
996
   
$
89,921
   
$
   919
   
$
158,348
 
$
498
   
$
319,566
   
                                                                       
See accompanying notes.
       
         


 
5

 


NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
   
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
 
For the Six Months Ended November 30, 2008 and 2007

   
2008
     
2007
 
CASH FLOWS FROM OPERATING ACTIVITIES:
             
     Net loss
$
(215,146
)
 
$
(41,608
)
     Add (deduct):
             
Amortization of deferred income
 
(3,273
)
   
(4,240
)
Amortization of bond issuance costs and deferred charges
 
5,102
     
11,463
 
Depreciation
 
1,176
     
1,118
 
Provision for (recovery of) loan losses
 
136,992
     
(14,301
)
Provision for (recovery of) guarantee liability
 
4,981
     
(3,300
)
Results of operations of foreclosed assets
 
(2,457
)
   
(3,816
)
Market adjustment on foreclosed assets
 
153
     
-
 
Derivative forward value
 
150,411
     
109,012
 
Fair value adjustment on investments in trading securities
 
101
     
-
 
Loss on sale of loans
 
-
     
518
 
Restricted interest earned on restricted cash
 
(100
)
   
-
 
Purchases of trading securities
 
(71,405
)
   
-
 
Sales of trading securities
 
59,870
     
-
 
Changes in operating assets and liabilities:
             
                     Accrued interest and other receivables
 
(49,542
)
   
(9,068
)
                     Accrued interest payable
 
30,856
     
98
 
                     Other
 
3,783
     
(5,264
)
               
     Net cash provided by operating activities
 
51,502
     
40,612
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
             
     Advances made on loans
 
(4,943,573
)
   
(3,595,700
)
     Principal collected on loans
 
4,402,006
     
3,403,193
 
     Net investment in fixed assets
 
760
     
(744
)
     Net proceeds from sale of loans
 
-
     
39,580
 
     Change in restricted cash
 
5,374
     
-
 
               
     Net cash used in investing activities
 
(535,433
)
   
(153,671
)
               
CASH FLOWS FROM FINANCING ACTIVITIES:
             
     Proceeds from issuances (repayments) of short-term debt, net
 
253,271
     
(103,653
)
     Proceeds from issuance of long-term debt, net
 
3,237,972
     
668,890
 
     Payments for retirement of long-term debt
 
(2,695,698
)
   
(346,590
)
     Payments for retirement of subordinated deferrable debt
 
-
     
(175,000
)
     Proceeds from issuance of members' subordinated certificates
 
71,675
     
43,189
 
 Payments for retirement of members' subordinated certificates
 
(9,345
)
   
(11,851
)
 Payments for retirement of patronage capital
 
(78,479
)
   
(77,378
)
     
             
     Net cash provided by (used in) financing activities
 
779,396
     
(2,393
)
               
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
 
295,465
     
(115,452
)
BEGINNING CASH AND CASH EQUIVALENTS
 
177,809
     
304,107
 
ENDING CASH AND CASH EQUIVALENTS
$
473,274
   
$
188,655
 
               
See accompanying notes.
 


 
6

 


NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
  
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (UNAUDITED)
(in thousands)
  
For the Six Months Ended November 30, 2008 and 2007
  
   
2008
     
2007
   
                 
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
               
Cash paid for interest
$
418,575
   
$
475,781
   
Cash paid for income taxes
 
52
     
767
   
                 
Non-cash financing and investing activities:
               
Net decrease in debt service reserve funds/debt service reserve certificates
$
(4,658
)
 
$
-
   
                 
See accompanying notes.
 



 
7

 


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 1,526 as of November 30, 2008 including 898 utility members, the majority of which are consumer-owned electric cooperatives, 499 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.

 
8

 


(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, (“FIN 46(R)”) 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 board 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 board 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 November 30, 2008, National Rural had guaranteed $79 million of NCSC debt and derivative instruments with third parties.  The maturities for NCSC debt guaranteed by National Rural run through 2022.  At November 30, 2008, National Rural's maximum potential exposure totaled $97 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 November 30, 2008 as the debt and derivatives are reported on the consolidated balance sheet.  At November 30, 2008, National Rural had less than $1 million of 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 November 30, 2008, RTFC had total assets of $1,881 million including loans outstanding to members of $1,698 million and NCSC had total assets of $496 million including loans outstanding of $447 million.  At November 30, 2008, National Rural had committed to lend RTFC up to $4.0 billion of which $1.7 billion was outstanding.  At November 30, 2008, National Rural had committed to provide up to $1 billion of credit to NCSC of which $498 million was outstanding, representing $419 million of outstanding loans and $79 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 sheets and the subsidiary earnings controlled by RTFC and NCSC as minority interest on the consolidated statements 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.

 
9

 

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 six months ended
November 30,
 
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
 
136,992
     
(14,301
)
 
(30,262
)
     Charge-offs
 
(3,118
)
   
(16,755
)
 
(16,911
)
     Recoveries
 
166
     
195
   
416
 
Balance at end of period
$
648,946
   
$
530,802
 
$
514,906
 

(d)           Interest Income

The following table presents the components of interest income:

   
For the three months ended
November 30,
   
For the six months ended
November 30,
(in thousands)
 
2008
   
2007
   
2008
   
2007
Interest on long-term fixed rate loans (1)
$
224,261
   
$
215,183
   
$
448,663
   
$
429,743
 
Interest on long-term variable rate loans (1)
 
18,469
     
22,690
     
33,649
     
47,239
 
Interest on short-term loans (1)
 
20,942
     
19,244
     
40,446
     
39,592
 
Interest on investments (2)
 
1,444
     
1,900
     
3,625
     
4,836
 
Conversion fees (3)
 
1,536
     
1,735
     
3,239
     
3,509
 
Make-whole and prepayment fees (4)
 
40
     
65
     
867
     
1,754
 
Commitment and guarantee fees (5)
 
1,767
     
1,385
     
3,636
     
2,920
 
Other fees
 
583
     
1,085
     
1,435
     
1,648
 
     Total interest income
 
$
269,042
   
$
263,287
   
$
535,560
   
$
531,241
 
(1) Represents interest income on loans to members.
(2) Represents interest income on the investment of cash and trading securities.
(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 $17 million and $20 million at November 30, 2008 and May 31, 2008, respectively.

(e)          Interest Expense

The following table presents the components of interest expense:
 
   
For the three months ended
November 30,
   
For the six months ended
November 30,
(in thousands)
 
2008
     
2007
     
2008
     
2007
 
Interest expense (1):
                             
Commercial paper and bank bid notes
$
23,638
   
$
33,192
   
$
40,076
   
$
71,478
 
Medium-term notes
 
81,055
     
83,681
     
161,513
     
166,867
 
Collateral trust bonds
 
68,035
     
63,405
     
130,955
     
128,755
 
Subordinated deferrable debt
 
4,915
     
4,916
     
9,831
     
9,831
 
Subordinated certificates
 
12,831
     
12,030
     
25,248
     
24,154
 
Long-term private debt
 
34,534
     
34,960
     
70,130
     
65,743
 
Debt issuance costs (2)
 
2,391
     
2,767
     
4,526
     
5,297
 
Commitment and guarantee fees (3)
 
5,246
     
4,605
     
10,013
     
8,675
 
Loss on early extinguishment of debt (4)
 
-
     
-
     
-
     
5,509
 
Other fees
 
1,579
     
461
     
2,241
     
1,033
 
     Total interest expense
 
$
234,224
   
$
240,017
   
$
454,533
   
$
487,342
 
(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 which are recognized as incurred.

 
10

 

(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 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 Loss

Comprehensive loss includes the Company's net loss, as well as other comprehensive income resulting from a transition adjustment recorded upon the initial adoption of Statement of Financial Accounting Standards (“SFAS”) 133, Accounting for Derivative Financial Instruments and Hedging Activities, as amended (“SFAS 133”).  Comprehensive loss is calculated as follows:

   
For the three months ended
November 30,
   
For the six months ended
November 30,
(in thousands)
 
2008
   
2007
   
2008
   
2007
 
Net loss
$
(229,617
)
 
$
(30,226
)
 
$
(215,146
)
 
$
(41,608
)
 
Other comprehensive income:
                               
    Reclassification adjustment for realized gain on derivatives
 
(205
)
   
(256
)
   
(399
)
   
(331
)
 
Comprehensive loss
$
(229,822
)
 
$
(30,482
)
 
$
(215,545
)
 
$
(41,939
)
 

(g)           New Accounting Pronouncements

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 both interim and annual reporting periods beginning after November 15, 2008.  The Company’s adoption of SFAS 161 on December 1, 2008 will not have an impact on the Company’s financial position or results of operations.

In December 2008, the FASB issued FASB Staff Position (“FSP”) SFAS 140-4 and FIN 46(R)-8, Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities (“FSP 140-4 and FIN 46(R)-8”).  FSP 140-4 and FIN 46(R)-8 amends SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities and FIN 46(R) to require public entities to provide additional disclosures about transfers of financial assets and their involvement with variable interest entities.  FSP 140-4 and FIN 46(R)-8 is effective for the first interim or annual reporting period ending after December 15, 2008.   The Company's adoption of FSP 140-4 and FIN 46(R)-8 for the quarter ended February 28, 2009 will not have a material 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:

 
November 30, 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
$
15,194,040
   
$
-
   
$
15,204,614
   
$
                     -
   
   Long-term variable rate loans
 
2,122,837
     
6,128,736
     
1,882,095
     
        5,975,541
   
   Loans guaranteed by RUS
 
246,020
     
491
     
250,169
     
                  491
   
   Short-term loans
 
2,000,645
     
7,629,905
     
1,690,117
     
        7,597,712
   
Total loans outstanding
 
19,563,542
     
13,759,132
     
19,026,995
     
      13,573,744
   
Deferred origination fees
 
3,397
     
-
     
2,045
     
                     -
   
   Less: Allowance for loan losses
 
(648,946
)
   
-
     
(514,906
)
   
                     -
   
Net loans outstanding
$
18,917,993
   
$
13,759,132
   
$
18,514,134
   
$
      13,573,744
   
                                 
Total by segment (2):
                               
   National Rural:
                               
      Distribution
$
13,736,544
   
$
9,859,393
   
$
13,438,370
   
$
        9,579,213
   
      Power supply
 
3,572,555
     
2,988,634
     
3,339,112
     
        2,960,693
   
      Statewide and associate
 
110,032
     
163,061
     
108,925
     
           158,293
   
 National Rural total
 
17,419,131
     
13,011,088
     
16,886,407
     
      12,698,199
   
   RTFC
 
1,697,907
     
468,428
     
1,726,514
     
           562,389
   
   NCSC
 
446,504
     
279,616
     
414,074
     
           313,156
   
  Total loans outstanding
 
$
19,563,542
   
$
13,759,132
   
$
19,026,995
   
$
      13,573,744
   

 
11

 


   

(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 the advance of funds have been fully met and 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 of National Rural.  Collateral and security requirements for advances on commitments are identical to those required at the time of the 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 on the new loan.
(2) Table includes non-performing and restructured loans.
(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 included in the table above are summarized as follows:

   
November 30, 2008
 
May 31, 2008
 
(in thousands)
     
Unadvanced
     
Unadvanced
 
Non-performing and restructured loans:
 
Loans Outstanding
 
Commitments (1)
 
Loans Outstanding
 
Commitments (1)
 
                                 
Non-performing loans (2):
                               
RTFC:
                               
     Long-term fixed rate loans
$
212,984
   
$
-
   
$
219,912
   
$
                     -
   
     Long-term variable rate loans
 
261,142
     
-
     
261,109
     
               -
   
     Short-term loans
 
18,898
     
-
     
25,843
     
                     -
   
         Total non-performing loans
$
493,024
   
$
-
   
$
506,864
   
$
               -
   
                                 
Restructured loans (2):
                               
National Rural:
                               
     Long-term fixed rate loans
$
52,082
   
$
-
   
$
52,309
   
$
                     -
   
     Long-term variable rate loans
 
505,042
     
186,673
     
519,257
     
           186,673
   
     Short-term loans
 
-
     
12,500
     
-
     
             12,500
   
         National Rural total restructured loans
 
557,124
     
199,173
     
571,566
     
           199,173
   
                                 
RTFC:
                               
     Long-term fixed rate loans
 
5,205
     
-
     
5,545
     
                     -
   
           Total restructured loans
 
$
562,329
   
$
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 the advance of funds have been fully met and 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 of National Rural.  Collateral and security requirements for advances on commitments are identical to those required at the time of the 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 on the new loan.
(2) 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 assets, 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.

 
12

 

The following tables summarize the Company's secured and unsecured loans outstanding by loan type and by segment:
 
(dollar amounts in thousands)
 
November 30, 2008
   
May 31, 2008
 
Total by loan type:
 
Secured
 
%
   
Unsecured
 
%
   
Secured
 
%
   
Unsecured
 
%
 
 
Long-term fixed rate loans
$
14,675,338
 
97
%
$
518,702
 
3
%
$
14,732,058
 
97
%
$
472,556
 
3
%
 
Long-term variable rate loans
 
1,949,979
 
92
 
172,858
 
8
 
1,728,803
 
92
 
153,292
 
8
 
 
Loans guaranteed by RUS
 
246,020
 
100
 
-
 
-
 
250,169
 
100
 
-
 
-
 
 
Short-term loans
 
175,735
 
9
 
1,824,910
 
91
 
165,226
 
10
 
1,524,891
 
90
 
 
  Total loans
$
17,047,072
 
87
 
$
2,516,470
 
13
 
$
16,876,256
 
89
 
$
2,150,739
 
11
 
                                     
 
Total by segment:
                                 
 
National Rural
$
15,190,580
 
87
%
$
2,228,551
 
13
%
$
15,021,067
 
89
%
$
1,865,340
 
11
%
 
RTFC
 
1,469,347
 
87
 
228,560
 
13
 
1,497,487
 
87
 
229,027
 
13
 
 
NCSC
 
387,145
 
87
 
59,359
 
13
 
357,702
 
86
 
56,372
 
14
 
 
       Total loans
$
17,047,072
 
87
 
$
2,516,470
 
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 outstanding:

(in thousands)
November 30, 2008
 
May 31, 2008
2007 indenture:
     
Distribution system mortgage notes
$
3,718,474
 
$
917,925
Collateral trust bonds
3,000,000
 
700,000
       
1994 indenture:
     
Distribution system mortgage notes
$
3,030,956
 
$
3,989,443
RUS guaranteed loans qualifying as permitted investments
 
213,360
   
215,329
Total pledged collateral
$
3,244,316
 
$
4,204,772
Collateral trust bonds
$
2,218,000
 
$
4,015,000
       
1972 indenture:
     
Cash
$
2,032
 
$
2,032
Collateral trust bonds
1,919
 
1,927
       
Farmer Mac:
     
Distribution system mortgage notes
$
495,391
 
$
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 Rural Economic Development Loan and Grant (“REDLG”) program (see Note 5, Long-Term Debt) and the amount of the corresponding debt outstanding:
 
(in thousands)
November 30, 2008
 
May 31, 2008
REDLG:
     
Utility System mortgage notes on deposit
$3,810,963
 
$3,191,292
REDLG notes payable
3,000,000
 
2,500,000
 
The $3.0 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 $3,811 million at November 30, 2008, would be pledged as collateral rather than held on deposit.  At November 30, 2008, National Rural’s senior secured debt ratings were above the rating trigger threshold.

A total of $2.0 billion of notes payable to the FFB has a second trigger requiring that there be a director on the National Rural board that satisfies the requirements of a financial expert as defined by Section 407 of the Sarbanes-Oxley Act of 2002.  A financial expert trigger event will occur if the financial expert position remains vacant for more than 90 consecutive days.  If the Company does not satisfy the financial expert requirement, the mortgage notes on deposit at that time, which totaled $2,481 million at November 30, 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.

 
13

 

(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 November 30, 2008 and 2007 or May 31, 2008.  At November 30, 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:
 
     
Six months ended November 30,
 
Year ended
(in thousands)
   
2008
     
2007
 
May 31, 2008
Beginning balance
 
$
58,961
   
$
66,329
   
$
66,329
 
Results of operations
   
2,457
     
3,816
     
7,528
 
Net cash provided by foreclosed assets
   
-
     
-
     
(9,056
)
Market value adjustment
   
(153
)
   
-
     
(5,840
)
Ending balance
 
$
61,265
   
$
70,145
   
$
58,961
 
 
(4)         Short-Term Debt and Credit Arrangements

The following is a summary of short-term debt outstanding:

(in thousands)
 
November 30,
2008
 
May 31,
2008
   
Short-term debt:
             
   Commercial paper sold through dealers, net of discounts
 
$
1,565,255
$
1,511,953
   
   Commercial paper sold directly to members, at par
   
1,310,378
 
1,275,809
   
   Commercial paper sold directly to non-members, at par
   
8,626
 
11,752
   
           Total commercial paper
   
2,884,259
 
2,799,514
   
   Daily liquidity fund sold directly to members
   
339,276
 
250,750
   
   Bank bid notes
   
180,000
 
100,000
   
           Subtotal short-term debt
   
3,403,535
 
3,150,264
   
               
Long-term debt maturing within one year:
             
    Medium-term notes sold through dealers
   
1,830,823
 
558,776
   
    Medium-term notes sold to members
   
439,305
 
288,634
   
    Secured collateral trust bonds
   
33,000
 
1,824,995
   
    Secured notes payable
   
-
 
500,000
   
    Unsecured notes payable
   
4,512
 
4,784
   
           Total long-term debt maturing within one year
   
2,307,640
 
3,177,189
   
Total short-term debt
 
$
5,711,175
$
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)
   
November 30,
2008 (3)
 
May 31,
 2008
   
Termination Date
   
Facility fee per
year (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 year.
(3) Amounts include the portion of the credit facility for Lehman Brothers Bank, FSB totaling $239 million allocated as follows: $76 million under the 5-year facility maturing 2012, $58 million under the 5-year facility maturing in 2011, and $105 million under the 364-day facility maturing in 2009.  The Company does not expect Lehman Brothers Bank, FSB to fund its portion of the credit facility according to the agreements.  See further discussion below.

 
14

 

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 November 30, 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 November 30, 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 November 30, 2008.

At November 30, 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.

In September 2008, Lehman Brothers Holdings 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.  As an active participant in the capital markets, National Rural has numerous business relationships with LBHI and its subsidiaries.  Among those relationships, Lehman Brothers Bank, FSB (“LBB”) is a participant for up to $239 million of National Rural’s revolving credit facilities of which no amount has been advanced.

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 under the $1.5 billion 364-day agreement.  As the amount borrowed did not exceed 50 percent of total commitments, there was no utilization fee on the outstanding balance. LBB did not fund its 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 repaid the $418.5 million borrowed under the revolving credit facility on November 13, 2008.

For the purpose of calculating the required financial covenants contained in its revolving credit agreements, the Company adjusts net income, senior debt and total equity to exclude the non-cash adjustments related to SFAS 133 and SFAS 52, Foreign Currency Translation (“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 six months ended November 30, 2008 and May 31, 2008:

           
Actual
 
       
Requirement
 
November 30, 2008
 
May 31, 2008
 
                   
Minimum average adjusted TIER over the six most recent fiscal quarters
 
1.025
 
1.05
 
1.16
 
                   
Minimum adjusted TIER at prior fiscal year end (1)
     
1.05
 
1.15
 
1.15
 
                   
Maximum ratio of senior debt to total equity
     
10.00
 
8.11
 
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.

 
15

 

(5)           Long-Term Debt

The following is a summary of long-term debt outstanding:

(in thousands)
 
November 30,
2008
       
May 31,
2008
   
Unsecured long-term debt:
                 
Medium-term notes sold through dealers
$
2,834,652
     
$
4,231,982
   
Medium-term notes sold to members
 
140,054
       
104,105
   
    Subtotal
 
2,974,706
       
4,336,087
   
Unamortized discount
 
(3,465
)
     
     (5,483
)
 
    Total unsecured medium-term notes
 
2,971,241
       
4,330,604
   
                   
Unsecured notes payable
 
3,058,362
       
2,558,362
   
Unamortized discount
 
(1,811
)
     
(1,959
)
 
    Total unsecured notes payable
 
3,056,551
       
2,556,403
   
Total unsecured long-term debt
 
6,027,792
       
6,887,007
   
                   
Secured long-term debt:
                 
Collateral trust bonds
 
5,186,919
       
2,891,927
   
Unamortized discount
 
(13,790
)
     
      (5,347
)
 
     Total secured collateral trust bonds
 
5,173,129
       
2,886,580
   
Secured notes payable
 
400,000