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EX-31.1 - CERTIFICATION PURSUANT TO SECTION 302 - PETERSEN - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/exhibit31_1.htm
EX-31.2 - CERTIFICATION PURSUANT TO SECTION 302 - LILLY - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/exhibit31_2.htm
EX-32.1 - CERTIFICATION PURSUANT TO SECTION 906 - PETERSEN - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/exhibit32_1.htm
EX-32.2 - CERTIFICATION PURSUANT TO SECTION 906 - LILLY - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/exhibit32_2.htm
10-Q - AS PRINTED AUGUST 31, 2012 FORM 10-Q - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/aug312012_10q.pdf
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

x     QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 2012
       
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)

20701 COOPERATIVE WAY, DULLES, VA 20166
(Address of principal executive offices)
(Registrant’s telephone number, including area code, is 703-467-1800)



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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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 the 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 does not issue capital stock because it is a tax-exempt cooperative.


 
 

 

PART 1.
FINANCIAL INFORMATION

Item 1.
Financial Statements.

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
         
CONDENSED CONSOLIDATED BALANCE SHEETS
 (UNAUDITED)
(in thousands)
       
  A S S E T S
          

   
August 31, 2012
     
May 31, 2012
   
                 
Cash and cash equivalents
$
  575,119
   
$
  191,167
   
                 
Restricted cash
 
 8,171
     
 7,694
   
                 
Investments in equity securities
 
 59,039
     
 59,045
   
                 
Loans to members
 
 19,475,653
     
 18,919,612
   
   Less: Allowance for loan losses
 
 (152,501)
     
 (143,326
)
 
Loans to members, net
 
 19,323,152
     
 18,776,286
   
                 
Accrued interest and other receivables
 
 171,223
     
 185,827
   
                 
Fixed assets, net
 
 102,841
     
 102,770
   
                 
Debt service reserve funds
 
 39,803
     
 39,803
 
 
                 
Debt issuance costs, net
 
 42,386
     
 43,515
   
                 
Foreclosed assets, net
 
 235,009
     
 223,476
   
                 
Derivative assets
 
 293,221
     
 296,036
   
                 
Other assets
 
 27,676
     
 25,716
   
                 
 
$
 20,877,640
   
$
 19,951,335
   
                 
See accompanying notes.




 
2

 

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
        
CONDENSED 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, 2012
     
May 31, 2012
   
                 
Short-term debt
$
 5,641,100
   
$
 4,493,434
   
                 
Accrued interest payable
 
 227,804
     
 161,817
   
                 
Long-term debt
 
 11,791,604
     
 12,151,967
   
                 
Patronage capital retirement payable
 
 35,345
     
-
   
                 
Deferred income
 
 24,601
     
 26,131
   
                 
Other liabilities
 
 75,191
     
 63,922
   
                 
Derivative liabilities
 
 662,193
     
 654,125
   
                 
Subordinated deferrable debt
 
 186,440
     
 186,440
   
                 
Members’ subordinated certificates:
               
Membership subordinated certificates
 
 646,279
     
 646,279
   
Loan and guarantee subordinated certificates
 
 721,189
     
 678,115
   
Member capital securities
 
 398,350
     
 398,350
   
Total members’ subordinated certificates
 
 1,765,818
     
 1,722,744
   
                 
Commitments and contingencies
               
                 
CFC equity:
               
Retained equity
 
 451,006
     
 473,964
   
Accumulated other comprehensive income
 
 8,947
     
 9,199
   
Total CFC equity
 
 459,953
     
 483,163
   
Noncontrolling interest
 
 7,591
     
 7,592
   
Total equity
 
 467,544
     
 490,755
   
                 
 
$
 20,877,640
   
$
 19,951,335
   
                 
   
See accompanying notes.


 
3

 



NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
         
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(in thousands)


   
For the three months ended August 31,
             
   
2012
   
2011
             
Interest income
$
 240,085
 
$
247,250
             
Interest expense
 
 (176,596)
   
(202,044
)
           
                         
Net interest income
 
 63,489
   
45,206
             
                         
(Provision for) recovery of loan losses
 
 (9,122)
   
9,130
             
Net interest income after (provision for) recovery of loan losses
 54,367
   
54,336
             
                         
Non-interest income:
                       
Fee and other income
 
 4,958
   
4,723
             
Derivative losses
 
 (24,592)
   
(111,571
)
           
Results of operations of foreclosed assets
 
        (4,765)
   
(9,818
)
           
                         
Total non-interest income
 
 (24,399)
   
(116,666
)
           
                         
Non-interest expense:
                       
Salaries and employee benefits
 
 (10,405)
   
(10,399
)
           
Other general and administrative expenses
 
 (6,765)
   
(5,990
)
           
Recovery of guarantee liability
 
 9
   
60
             
Loss on early extinguishment of debt
 
 -
   
(9,267
)
           
Other
 
 (163)
   
(397
)
           
                         
Total non-interest expense
 
 (17,324)
   
(25,993
)
           
                         
Income (loss) prior to income taxes
 
 12,644
   
(88,323
)
           
                         
Income tax benefit
 
 2
   
1,701
             
                         
Net income (loss)
 
 12,646
   
(86,622
)
           
                       
Less: Net (income) loss attributable to the noncontrolling interest
 (5)
   
2,590
             
                         
Net income (loss) attributable to CFC
$
 12,641
 
$
(84,032
)
           
                         

See accompanying notes.
 


 
4

 


NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
         
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
(in thousands)

   
For the three months ended August 31,
         
   
2012
 
2011
         
                   
                   
Net income (loss)
$
 12,646
$
(86,622
)
       
                   
Other comprehensive loss:
                 
Add: Unrealized (losses) gains on securities
 
 (6)
 
  61
         
Less: Realized gains on derivatives
 
 (252)
 
(259
)
       
Other comprehensive loss
 
 (258)
 
(198
)
       
                   
Total comprehensive income (loss)
 
 12,388
 
(86,820
)
       
                   
Less: Total comprehensive loss attributable to noncontrolling interest
 
 1
 
 2,597
         
                   
Total comprehensive income (loss) attributable to CFC
$
 12,389
$
 (84,223
)
       
                   

See accompanying notes.
 



 
5

 

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
 
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(UNAUDITED)
(in thousands)

For the three months ended August 31, 2012 and 2011


               
Accumulated
                 
Membership
 
           
Total
 
other
 
CFC
 
Unallocated
 
Members’
 
Patronage
 
fees and
 
       
Noncontrolling
 
CFC
 
comprehensive
 
retained
 
net income
 
capital
 
capital
 
education
 
   
Total
 
interest
 
equity
 
income
 
equity
 
(loss)
 
reserve
 
allocated
 
fund
 
Balance as of May 31, 2012
$
 490,755
 
$   7,592
$
 483,163
 
$    9,199
$
 473,964
 
$   (346,941)
 
$    272,126
$
 546,366
 
$    2,413
 
Patronage capital retirement
 
 (35,345)
 
 -
 
 (35,345)
 
 -
 
 (35,345)
 
 -
 
 -
 
 (35,345)
 
 -
 
Net income
 
 12,646
 
 5
 
 12,641
 
 -
 
 12,641
 
 12,641
 
 -
 
 -
 
 -
 
  Other comprehensive loss
 
 (258)
 
 (6)
 
 (252)
 
 (252)
 
 -
 
 -
 
 -
 
 -
 
 -
 
Other
 
 (254)
 
 -
 
 (254)
 
 -
 
 (254)
 
 -
 
 -
 
 -
 
 (254)
 
Balance as of August 31, 2012
$
 467,544
 
$    7,591
$
 459,953
 
$    8,947
$
 451,006
 
$   (334,300)
 
$    272,126
$
 511,021
 
$    2,159
 
                                       
                                       
                                       
Balance as of May 31, 2011
$
687,309
 
$  11,786
$
675,523
 
$   9,758
$
665,765
 
$   (130,689)
 
$   272,126
$
521,897
 
$   2,431
 
Patronage capital retirement
 
(46,086)
 
-
 
(46,086)
 
-
 
(46,086)
 
-
 
-
 
(46,086)
 
-
 
Net loss
 
(86,622)
 
(2,590)
 
(84,032)
 
-
 
(84,032)
 
(84,032)
 
-
 
-
 
-
 
Other comprehensive loss
 
(198)
 
(7)
 
(191)
 
(191)
 
-
 
-
 
-
 
-
 
-
 
Other
 
(297)
 
(4)
 
(293)
 
-
 
(293)
 
-
 
-
 
-
 
(293)
 
Balance as of August 31, 2011
$
554,106
 
$   9,185
$
 544,921
 
$   9,567
$
535,354
 
$   (214,721)
 
$   272,126
$
475,811
 
$   2,138
 


See accompanying notes.


 
6

 


NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
   
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)

   
For the three months ended August 31,
   
   
2012
 
2011
   
CASH FLOWS FROM OPERATING ACTIVITIES
           
     Net income (loss)
$
 12,646
$
(86,622
)
 
     Adjustments to reconcile net income (loss) to net cash provided by operating activities
         
Amortization of deferred income
 
 (3,925)
 
(3,204
)
 
Amortization of debt issuance costs and deferred charges
 
 1,978
 
3,139
   
Depreciation
 
 1,310
 
725
   
Provision for (recovery of) loan losses
 
 9,122
 
(9,130
)
 
Recovery of guarantee liability
 
 (9)
 
(60
)
 
Results of operations of foreclosed assets
 
 4,765
 
9,818
   
Derivative forward value
 
 10,729
 
111,739
   
Changes in operating assets and liabilities:
           
Accrued interest and other receivables
 
 14,047
 
(5,218
)
 
Accrued interest payable
 
 65,987
 
92,974
   
Other
 
 17,162
 
17,139
   
 
           
    Net cash provided by operating activities
 
 133,812
 
131,300
   
 
           
CASH FLOWS FROM INVESTING ACTIVITIES
           
     Advances made on loans
 
 (2,096,528)
 
(1,685,983
)
 
     Principal collected on loans
 
 1,526,701
 
2,386,760
   
     Net investment in fixed assets
 
 (1,381)
 
(5,253
)
 
     Proceeds from foreclosed assets
 
 18,986
 
7,004
   
     Investments in foreclosed assets
 
 (35,284)
 
(12,036
)
 
     Net proceeds from sale of loans
 
 13,589
 
11,339
   
     Change in restricted cash
 
 (477)
 
(478
)
 
             
     Net cash (used in) provided by investing activities
 
 (574,394)
 
701,353
   
 
           
CASH FLOWS FROM FINANCING ACTIVITIES
           
  Proceeds from (repayments of) issuances of short-term debt, net
 
 130,301
 
(257,784
)
 
  Issuance costs for revolving bank lines of credit
 
 (703)
 
-
   
  Proceeds from issuance of long-term debt
 
 973,425
 
106,191
   
  Payments for retirement of long-term debt
 
 (320,772)
 
(369,925
)
 
  Proceeds from issuance of members’ subordinated certificates
 
 46,304
 
15,833
   
  Payments for retirement of members’ subordinated certificates
 
 (4,021)
 
(52,911
)
 
             
     Net cash provided by (used in) financing activities
 
 824,534
 
(558,596
)
 
             
NET INCREASE IN CASH AND CASH EQUIVALENTS
 
 383,952
 
274,057
   
BEGINNING CASH AND CASH EQUIVALENTS
 
 191,167
 
293,615
   
ENDING CASH AND CASH EQUIVALENTS
$
 575,119
$
567,672
   


See accompanying notes.

 
7

 


NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
  
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(in thousands)
  

   
For the three months ended August 31,
   
   
2012
 
2011
   
             
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
           
Cash paid for interest
$
108,631
$
105,931
   
Cash paid for income taxes
 
81
 
-
   
             
Non-cash financing and investing activities:
           
Increase to patronage capital retirement payable
$
35,345
$
46,086
   
Net decrease in debt service reserve funds/debt service reserve certificates
 
-
 
(490
)
 
             


See accompanying notes.


 
8

 

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(1)        General Information and Accounting Policies

(a)       Basis of Presentation

The accompanying financial statements include the consolidated accounts of National Rural Utilities Cooperative Finance Corporation (“CFC”), Rural Telephone Finance Cooperative (“RTFC”), National Cooperative Services Corporation (“NCSC”) and certain entities created and controlled by CFC to hold foreclosed assets and accommodate loan securitization transactions, after elimination of intercompany accounts and transactions.

Unless stated otherwise, references to “we,” “our” or “us” represent the consolidation of CFC, RTFC, NCSC and certain entities created and controlled by CFC to hold foreclosed assets and accommodate loan securitization transactions. Foreclosed assets are held by two groups of subsidiaries wholly-owned by CFC. Our Denton Realty Partners entities (“DRP”) hold assets, including a land development loan, limited partnership interests in certain real estate developments and developed lots and land and raw land in Texas. Caribbean Asset Holdings LLC (“CAH”) holds our investment in cable and telecommunications operating entities in the United States Virgin Islands (“USVI”), British Virgin Islands and St. Maarten.

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, revenue and expenses reported in the financial statements, as well as amounts included in the notes thereto, including discussion and disclosure of contingent liabilities. The accounting estimates that require our most significant and subjective judgments include the allowance for loan losses and the determination of the fair value of our derivatives and certain aspects of our foreclosed assets. While we use our 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.

These interim unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended May 31, 2012.

In the opinion of management, the accompanying condensed consolidated financial statements contain all adjustments (which consist only of normal recurring accruals) necessary for a fair presentation of our results of operations and financial position for the interim periods presented.

 
(b)
Variable Interest Entities

We are required to consolidate the financial results of RTFC and NCSC because CFC is the primary beneficiary of variable interests in RTFC and NCSC due to its exposure to absorbing the majority of their expected losses and because CFC manages the business activities of RTFC and NCSC. Under separate guarantee agreements, RTFC and NCSC pay CFC a fee to indemnify against loan losses. CFC manages the business activities of RTFC and NCSC through separate management agreements. Additionally, CFC is the sole lender to RTFC and the primary source of funding to NCSC. NCSC funds its lending programs through loans from CFC and debt guaranteed by CFC.

RTFC and NCSC creditors have no recourse against CFC in the event of a default by RTFC and NCSC, unless there is a guarantee agreement under which CFC has guaranteed NCSC or RTFC debt obligations to a third party. At August 31, 2012, CFC had guaranteed $77 million of NCSC debt, derivative instruments and guarantees with third parties, and CFC’s maximum potential exposure for these instruments totaled $86 million. The maturities for NCSC obligations guaranteed by CFC run through 2031. Guarantees of NCSC debt and derivative instruments are not included in Note 9, Guarantees, as the debt and derivatives are reported on the consolidated balance sheet. At August 31, 2012, CFC guaranteed $1 million of RTFC guarantees with third parties. The maturities for RTFC obligations guaranteed by CFC run through 2013. All CFC loans to RTFC and NCSC are secured by all assets and revenue of RTFC and NCSC. At August 31, 2012, RTFC had total assets of $679 million and NCSC had total assets of $671 million. At August 31, 2012, CFC had committed to lend RTFC up to $4,000 million, of which $540 million was outstanding. At August 31, 2012, CFC had committed to provide up to $2,000 million of credit to NCSC, of which $699 million was outstanding, representing $622 million of outstanding loans and $77 million of credit enhancements.

 
9

 

 
(c)
Loan Sales

We account for the sale of loans resulting from direct loan sales to third parties and securitization transactions by removing the financial assets from our consolidated balance sheets when control has been surrendered. We recognize related servicing fees on an accrual basis over the period for which servicing activity is provided. Deferred transaction costs and unamortized deferred loan origination costs related to the loans sold are included in the calculation of the gain or loss on the sale. We do not hold any continuing interest in the loans sold to date other than servicing performance obligations. We have no obligation to repurchase loans from the purchaser, except in the case of breaches of representations and warranties. We retain the servicing performance obligations on these loans. We have not recorded a servicing asset or liability.

During the three months ended August 31, 2012 and 2011, we sold CFC loans with outstanding balances totaling $14 million and $11 million, respectively, at par for cash. We recorded a loss on sale of loans, representing the unamortized deferred loan origination costs and transaction costs for the loans sold, which was immaterial during the three months ended August 31, 2012 and 2011.

(d)          Interest Income

Interest income on loans is recognized using the effective interest method. The following table presents the components of interest income:

   
For the three months ended August 31,
           
(dollar amounts in thousands)
 
2012
     
2011
           
Interest on long-term fixed-rate loans
$
 217,940
   
$
 225,346
           
Interest on long-term variable-rate loans
 
              6,025
     
 8,252
           
Interest on line of credit loans
 
 7,692
     
 9,626
           
Interest on restructured loans
 
 5,462
     
692
           
Interest on investments
 
 938
     
 928
           
Fee income (1)
 
 2,028
     
 2,406
           
Total interest income
 
$
 240,085
   
$
247,250
           
(1) Primarily related to conversion fees that are deferred and recognized using the effective 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.

Deferred income on the consolidated balance sheets primarily includes deferred conversion fees totaling $19 million and $20 million at August 31, 2012 and May 31, 2012, respectively.

(e)          Interest Expense

The following table presents the components of interest expense:

   
For the three months ended August 31,
           
(dollar amounts in thousands)
 
2012
     
2011
           
Interest expense on debt (1):
                       
Commercial paper and bank bid notes
$
 1,619
   
$
 1,769
           
Medium-term notes
 
 27,883
     
 53,841
           
Collateral trust bonds
 
 81,439
     
 77,272
           
Subordinated deferrable debt
 
 2,806
     
 2,806
           
Subordinated certificates
 
 20,354
     
 18,301
           
Long-term notes payable
 
 38,396
     
 39,827
           
Debt issuance costs (2)
 
 1,937
     
 5,125
           
Fee expense (3)
 
 2,162
     
 3,103
           
Total interest expense
 
$
 176,596
   
$
202,044
           
(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 underwriters’ fees, legal fees, printing costs and comfort letter fees. Amortization is calculated using the effective interest method or a method approximating the effective interest method. Also includes issuance costs related to dealer commercial paper, which are recognized as incurred.
(3) Includes various fees related to funding activities, including fees paid to banks participating in our revolving credit agreements. Fees are recognized as incurred or amortized on a straight-line basis over the life of the respective agreement.

We exclude indirect costs, if any, related to funding activities from interest expense.

 
10

 

(f)         Derivative Financial Instruments

We are an end user of financial derivative instruments. We use derivatives such as interest rate swaps and treasury locks to mitigate interest rate risk. Consistent with the accounting standards for derivative financial instruments, we record derivative instruments on the consolidated balance sheets as either an asset or liability measured at fair value. In recording the fair value of derivative assets and liabilities, we do not net our positions under contracts with individual counterparties. Changes in the fair value of derivative instruments along with realized gains and losses from cash settlements are recognized in the derivative gains (losses) line item of the consolidated statement of operations unless specific hedge accounting criteria are met.

We formally document, designate and assess the effectiveness of transactions that receive hedge accounting treatment. If applicable hedge accounting criteria are satisfied, the change in fair value of derivative instruments is recorded to other comprehensive income, and net cash settlements are recorded in interest expense. The gain or loss on derivatives used as a cash flow hedge of a forecasted debt transaction is recorded as a component of other comprehensive income (loss) and amortized through interest expense using the effective interest method over the term of the hedged debt. Any ineffectiveness in the hedging relationship is recognized in the derivative gains (losses) line of the statement of operations.

A transition adjustment was recorded as an other comprehensive loss on June 1, 2001, the date we implemented the accounting standards for derivative financial instruments. This amount will be amortized into earnings through April 2029 in the derivative gains (losses) line of the statement of operations.

Cash activity associated with interest rate swaps is classified as an operating activity in the consolidated statements of cash flows.

(g)         Early Extinguishment of Debt

We redeem outstanding debt early from time to time to manage liquidity and interest rate risk. When we redeem outstanding debt early, we recognize a gain or loss related to the difference between the amount paid to redeem the debt and the net book value of the extinguished debt as a component of non-interest expense in the gain (loss) on early extinguishment of debt line item.

In August 2011, we redeemed $250 million of our $1,500 million, 7.25 percent Series C medium-term notes with an original maturity of March 1, 2012 at a premium. Both the premium and unamortized issuance costs totaling $9 million were recorded as a loss on extinguishment of debt during the quarter ended August 31, 2011.

(h)         Reclassifications

Reclassifications of prior period amounts have been made to conform to the current reporting format and the presentation in our Form 10-Q for the quarter ended August 31, 2012. Specifically, the fair value adjustments on DRP foreclosed assets have been reclassified into results of operations of foreclosed assets in the condensed consolidated statement of operations for the quarter ended August 31, 2011. The corresponding non-cash adjustments were reclassified to the results of operations of foreclosed assets on the condensed consolidated statement of cash flows for the quarter ended August 31, 2011.

 
11

 

(2)         Loans and Commitments

Loans outstanding to members and unadvanced commitments by loan type and by member class are summarized as follows:

   
August 31, 2012
   
May 31, 2012
 
(dollar amounts in thousands)
 
Loans
outstanding
   
Unadvanced
commitments (1)
   
Loans
outstanding
   
Unadvanced
commitments (1)
 
Total by loan type (2):
                       
Long-term fixed-rate loans
$
 17,216,940
 
$
 -
 
$
 16,742,914
 
$
 -
 
Long-term variable-rate loans
 
 749,199
   
 5,497,952
   
 764,815
   
 5,437,881
 
Loans guaranteed by RUS (3)
 
 217,895
   
 -
   
 219,084
   
 -
 
Line of credit loans
 
 1,283,702
   
 9,049,334
   
 1,184,929
   
 8,691,543
 
Total loans outstanding
 
 19,467,736
   
 14,547,286
   
 18,911,742
   
 14,129,424
 
Deferred origination costs
 
 7,917
   
 -
   
 7,870
   
 -
 
Less: Allowance for loan losses
 
  (152,501)
   
 -
   
  (143,326
)
 
 -
 
Net loans outstanding
$
 19,323,152
 
$
 14,547,286
 
$
 18,776,286
 
$
 14,129,424
 
                         
Total by member class (2):
                       
CFC:
                       
Distribution
$
 14,270,152
 
$
 9,206,328
 
$
 14,075,471
 
$
 9,191,227
 
Power supply
 
 3,924,024
   
 3,721,366
   
 3,596,820
   
 3,714,241
 
Statewide and associate
 
 79,209
   
 118,145
   
 73,606
   
 123,189
 
CFC total
 
 18,273,385
   
 13,045,839
   
 17,745,897
   
 13,028,657
 
RTFC
 
 553,011
   
 327,372
   
 571,566
   
 341,792
 
NCSC
 
 641,340
   
 1,174,075
   
 594,279
   
 758,975
 
Total loans outstanding
 
$
 19,467,736
 
$
 14,547,286
 
$
18,911,742
 
$
 14,129,424
 
(1) The interest rate on unadvanced commitments is not set until drawn, therefore, the 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) Includes non-performing and restructured loans.
(3) “RUS” is the Rural Utilities Service.

Non-performing and restructured loans outstanding and unadvanced commitments to members included in the table above are summarized as follows by loan type and by company:

   
August 31, 2012
   
May 31, 2012
 
   
Loans
   
Unadvanced
   
Loans
   
Unadvanced
 
(dollar amounts in thousands)
 
outstanding
   
commitments (1)
   
outstanding
   
commitments (1)
 
Non-performing and restructured loans:
                       
Non-performing loans:
CFC:
                       
Long-term variable-rate loans
$
 8,194
 
$
 -
 
$
 8,194
 
$
 -
 
Line of credit loans (2)
 
 27,401
   
 2,538
   
 26,049
   
 -
 
RTFC:
                       
Long-term fixed-rate loans
 
 6,849
   
 -
   
 6,970
   
 -
 
Total non-performing loans
$
 42,444
 
$
 2,538
 
$
 41,213
 
$
 -
 
                         
Restructured loans:
                       
CFC:
                       
Long-term fixed-rate loans
$
 453,513
 
$
 -
 
$
 455,689
 
$
 -
 
Long-term variable-rate loans (3)
 
  -
   
 45,918
   
  -
   
 45,918
 
Line of credit loans (3)
 
 -
   
 5,000
   
 -
   
 5,000
 
Total restructured loans
 
$
 453,513
 
$
 50,918
 
$
 455,689
 
$
50,918
 
(1) The interest rate on unadvanced commitments is not set until drawn, therefore, the 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) The unadvanced commitment is available under a debtor-in-possession facility for which the principal and interest has priority over all other claims.
(3) The unadvanced commitment is part of the terms outlined in the related restructure agreement. Loans advanced under these commitments would be classified as performing. Principal and interest due under these performing loans would be in addition to scheduled payments due under the restructured loan agreement.

Unadvanced Loan Commitments
A total of $1,442 million and $1,303 million of unadvanced commitments at August 31, 2012 and May 31, 2012, respectively, represented unadvanced commitments related to committed lines of credit loans that are not subject to a material adverse change clause at the time of each loan advance. As such, we will be required to advance amounts on these committed facilities as long as the borrower is in compliance with the terms and conditions of the facility.

 
12

 

The following table summarizes the available balance under committed lines of credit at August 31, 2012, and the related maturities by fiscal year and thereafter as follows:

 
Available
 
Notional maturities of committed lines of credit
 
(dollar amounts in thousands)
balance
 
2013
 
2014
 
2015
 
2016
 
2017
 
Thereafter
 
Committed lines of  credit
$1,442,202
 
$16,800
 
$307,183
 
$120,254
 
$223,662
 
$554,365
 
$219,938
 

The remaining unadvanced commitments totaling $13,105 million and $12,826 million at August 31, 2012 and May 31, 2012, respectively, were generally subject to material adverse change clauses. Prior to making an advance on these facilities, we confirm that there has been no material adverse change in the business or condition, financial or otherwise, of the borrower since the time the loan was approved and confirm that the borrower is currently in compliance with loan terms and conditions. In some cases, the borrower’s access to the full amount of the facility is further constrained by the imposition of borrower-specific restrictions, or by additional conditions that must be met prior to advancing funds.

Unadvanced commitments related to line of credit loans are typically for periods not to exceed five years and are generally revolving facilities used for working capital and backup liquidity purposes. Historically, we have experienced a very low utilization rate on line of credit loan facilities, whether or not there is a material adverse change clause. Since we generally do not charge a fee on the unadvanced portion of the majority of our loan facilities, our borrowers will typically request long-term facilities to cover maintenance and capital expenditure work plans for periods of up to five years and draw down on the facility over that time. In addition, borrowers will typically request an amount in excess of their immediate estimated loan requirements to avoid the expense related to seeking additional loan funding for unexpected items.

The above items all contribute to our expectation that the majority of the unadvanced commitments will expire without being fully drawn upon and that the total unadvanced amount does not necessarily represent future cash funding requirements.

Payment Status of Loans
The tables below show an analysis of the age of the recorded investment in loans outstanding by member class:

   
August 31, 2012
(dollar amounts in thousands)
 
30-89 days past due
 
90 days or more
past due (1)
 
Total
past due
 
Current
 
Total financing
receivables
 
Non-accrual loans
CFC:
                       
Distribution
$
 3,332
$
 27,263
$
 30,595
$
 14,239,557
$
 14,270,152
$
 30,595
Power supply
 
 -
 
 5,000
 
 5,000
 
 3,919,024
 
 3,924,024
 
 5,000
Statewide and associate
 
 -
 
 -
 
 -
 
 79,209
 
 79,209
 
 -
CFC total
 
 3,332
 
 32,263
 
 35,595
 
 18,237,790
 
 18,273,385
 
 35,595
RTFC
 
 -
 
 4,306
 
 4,306
 
 548,705
 
 553,011
 
 6,849
NCSC
 
 -
 
 -
 
 -
 
 641,340
 
 641,340
 
 -
Total loans outstanding
$
 3,332
$
 36,569
$
 39,901
$
 19,427,835
$
 19,467,736
$
 42,444
                         
As a % of total loans
 
0.01%
 
0.19%
 
0.20%
 
99.80%
 
100.00%
 
0.22%
(1) All loans 90 days or more past due are on non-accrual status.

   
May 31, 2012
(dollar amounts in thousands)
 
30-89 days past due
 
90 days or more
past due (1)
 
Total
past due
 
Current
 
Total financing
receivables
 
Non-accrual loans
CFC:
                       
Distribution
$
 -
$
 29,243
$
 29,243
$
 14,046,228
$
 14,075,471
$
 29,243
Power supply
 
 -
 
 5,000
 
 5,000
 
 3,591,820
 
 3,596,820
 
 5,000
Statewide and associate
 
 -
 
 -
 
 -
 
 73,606
 
 73,606
 
 -
CFC total
 
 -
 
 34,243
 
 34,243
 
 17,711,654
 
 17,745,897
 
 34,243
RTFC
 
 -
 
 4,306
 
 4,306
 
 567,260
 
 571,566
 
 6,970
NCSC
 
 -
 
 -
 
 -
 
 594,279
 
 594,279
 
 -
Total loans outstanding
$
 -
$
 38,549
$
 38,549
$
 18,873,193
$
 18,911,742
$
 41,213
                         
As a % of total loans
 
 -
%
0.20%
 
0.20%
 
99.80%
 
100.00%
 
0.22%
(1) All loans 90 days or more past due are on non-accrual status.

 
13

 

Credit Quality
We monitor the credit quality and performance statistics of our financing receivables in an ongoing manner to provide a balance between the credit needs of our members and the requirements for sound credit quality of the loan portfolio. We evaluate the credit quality of our loans using an internal risk rating system that employs similar criteria for all member classes.

Our internal risk rating system is based on a determination of a borrower’s risk of default utilizing both quantitative and qualitative measurements.

We have grouped our risk ratings into the categories of pass and criticized based on the criteria below.
(i)  Pass:  Borrowers that are not experiencing difficulty and/or not showing a potential or well-defined credit weakness.
(ii) Criticized:  Includes borrowers categorized as special mention, substandard and doubtful as described below:
·  
Special mention:  Borrowers that may be characterized by a potential credit weakness or deteriorating financial condition that is not sufficiently serious to warrant a classification of substandard or doubtful.
·  
Substandard:  Borrowers that display a well-defined credit weakness that may jeopardize the full collection of principal and interest.
·  
Doubtful:  Borrowers that have a well-defined weakness and the full collection of principal and interest is questionable or improbable.

Each risk rating is reassessed annually based on the receipt of the borrower’s audited financial statements; however, interim downgrades and upgrades may take place at any time as significant events or trends occur.

The following table presents our loan portfolio by risk rating category and member class based on available data as of:

   
August 31, 2012
 
May 31, 2012
(dollar amounts in thousands)
 
Pass
 
Criticized
 
Total
 
Pass
 
Criticized
 
Total
CFC:
                       
   Distribution
$
 14,239,557
$
 30,595
$
 14,270,152
$
 14,046,228
$
 29,243
$
 14,075,471
   Power supply
 
 3,919,024
 
  5,000
 
 3,924,024
 
 3,591,820
 
  5,000
 
 3,596,820
   Statewide and associate
 
 79,209
 
 -
 
  79,209
 
 73,606
 
 -
 
  73,606
CFC total
 
   18,237,790
 
  35,595
 
 18,273,385
 
   17,711,654
 
  34,243
 
 17,745,897
RTFC
 
 545,592
 
 7,419
 
 553,011
 
 564,596
 
 6,970
 
 571,566
NCSC
 
 641,340
 
 -
 
 641,340
 
 594,279
 
 -
 
 594,279
Total loans outstanding
$
  19,424,722
$
  43,014
$
 19,467,736
$
  18,870,529
$
  41,213
$
 18,911,742

Loan Security
Except when providing line of credit loans, we typically lend to our 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 revenue of the borrower with exceptions typical in utility mortgages. Line of credit loans are generally unsecured. In addition to the lien and security interest we receive under the mortgage, our member borrowers are also required to achieve certain financial ratios as required by loan covenants.

The following table summarizes our secured and unsecured loans outstanding by loan type and by company:

(dollar amounts in thousands)
 
August 31, 2012
   
May 31, 2012
 
Total by loan type:
 
Secured
 
%
   
Unsecured
 
%
   
Secured
 
%
   
Unsecured
 
%
 
 
Long-term fixed-rate loans
$
 16,621,368
 
 97
%
$
 595,572
 
 3
%
$
 16,168,857
 
 97
%
$
 574,057
 
 3
%
 
Long-term variable-rate loans
 
 642,915
 
 86
   
 106,284
 
 14
   
 661,115
 
 86
   
 103,700
 
 14
 
 
Loans guaranteed by RUS
 
 217,895
 
 100
   
 -
 
 -
   
 219,084
 
 100
   
 -
 
 -
 
 
Line of credit loans
 
 203,431
 
 16
   
 1,080,271
 
 84
   
 205,143
 
 17
   
 979,786
 
 83
 
 
  Total loans outstanding
$
 17,685,609
 
 91
 
$
 1,782,127
 
 9
 
$
 17,254,199
 
 91
 
$
 1,657,543
 
 9
 
                                           
Total by company:
                                       
 
CFC
$
 16,751,168
 
 92
%
$
 1,522,217
 
 8
%
$
 16,317,195
 
 92
%
$
 1,428,702
 
 8
%
 
RTFC
 
 530,855
 
 96
   
 22,156
 
 4
   
 549,085
 
 96
   
 22,481
 
 4
 
 
NCSC
 
 403,586
 
 63
   
 237,754
 
 37
   
 387,919
 
 65
   
 206,360
 
 35
 
 
  Total loans outstanding
$
 17,685,609
 
 91
 
$
 1,782,127
 
   9
 
$
 17,254,199
 
 91
 
$
 1,657,543
 
9
 

 
14

 

Loan Loss Allowance
We maintain an allowance for loan losses at a level estimated by management to provide for probable losses inherent in the loan portfolio. Under a guarantee agreement, CFC reimburses RTFC and NCSC for loan losses, therefore, RTFC and NCSC do not maintain separate loan loss allowances.

The activity in the loan loss allowance summarized in the tables below reflects a disaggregation by company of the allowance for loan losses held at CFC based on borrower type:

   
As of and for the three months ended August 31, 2012
 
(dollar amounts in thousands)
 
 CFC
 
RTFC
 
NCSC
 
Total
 
Balance as of May 31, 2012
$
 126,941
$
 8,562
$
 7,823
$
 143,326
 
 Provision for (recovery of) loan losses
 
 9,787
 
 315
 
 (980)
 
 9,122
 
 Recoveries of loans previously charged-off
 
 53
 
 -
 
 -
 
 53
 
Balance as of August 31, 2012
$
 136,781
$
 8,877
$
 6,843
$
 152,501
 
                   
   
As of and for the three months ended August 31, 2011
 
(dollar amounts in thousands)
 
 CFC
 
RTFC
 
NCSC
 
Total
 
Balance as of May 31, 2011
$
143,706
$
8,389
$
9,082
$
161,177
 
 (Recovery of) provision for loan losses
 
(9,302)
 
260
 
(88
)
(9,130
)
 Recoveries of loans previously charged-off
 
53
 
-
 
-
 
53
 
Balance as of August 31, 2011
$
134,457
$
8,649
$
8,994
$
152,100
 

Our allowance for loan losses includes a specific valuation allowance related to individually-evaluated impaired loans, as well as a general reserve for other probable incurred losses for loans that are collectively evaluated. The tables below present the loan loss allowance and the recorded investment in outstanding loans by impairment methodology and by company:

   
August 31, 2012
(dollar amounts in thousands)
 
 CFC
 
RTFC
 
NCSC
 
Total
Ending balance of the allowance:
               
Collectively evaluated
$
 113,490
$
 7,215
$
 6,843
$
 127,548
Individually evaluated
 
  23,291
 
  1,662
 
 -
 
 24,953
Total ending balance of the allowance
$
 136,781
$
 8,877
$
 6,843
$
 152,501
                 
Recorded investment in loans:
               
Collectively evaluated
$
 17,784,277
$
 546,162
$
 641,340
$
 18,971,779
Individually evaluated
 
 489,108
 
 6,849
 
 -
 
 495,957
Total recorded investment in loans
$
 18,273,385
$
 553,011
$
 641,340
$
 19,467,736
                 
Loans to members, net (1)
$
 18,136,604
$
 544,134
$
 634,497
$
 19,315,235

   
May 31, 2012
(dollar amounts in thousands)
 
 CFC
 
RTFC
 
NCSC
 
Total
Ending balance of the allowance:
               
Collectively evaluated
$
 103,681
$
 6,561
$
 7,823
$
 118,065
Individually evaluated
 
  23,260
 
  2,001
 
 -
 
 25,261
Total ending balance of the allowance
$
 126,941
$
 8,562
$
 7,823
$
 143,326
                 
Recorded investment in loans:
               
Collectively evaluated
$
 17,255,965
$
 564,596
$
 594,279
$
 18,414,840
Individually evaluated
 
 489,932
 
 6,970
 
 -
 
 496,902
Total recorded investment in loans
$
 17,745,897
$
 571,566
$
 594,279
$
 18,911,742
                 
Loans to members, net (1)
$
 17,618,956
$
 563,004
$
 586,456
$
 18,768,416
(1) Excludes deferred origination costs of $8 million at August 31, 2012 and May 31, 2012.

 
15

 

Impaired Loans
Our recorded investment in individually-impaired loans and the related specific valuation allowance is summarized below by member class:

   
August 31, 2012
 
May 31, 2012
 
(dollar amounts in thousands)
 
Recorded
investment
 
Related
allowance
 
Recorded
investment
 
Related
allowance
 
With no specific allowance recorded:
                 
CFC/Distribution
$
 413,625
$
 -
$
 415,692
$
 -
 
                   
With a specific allowance recorded:
                 
CFC/Distribution
 
 70,483
 
 23,040
 
 69,240
 
 23,009
 
CFC/Power Supply
 
 5,000
 
 251
 
 5,000
 
 251
 
RTFC
 
 6,849
 
  1,662
 
 6,970
 
  2,001
 
Total
 
  82,332
 
  24,953
 
  81,210
 
  25,261
 
Total impaired loans
$
 495,957
$
  24,953
$
 496,902
$
  25,261
 

The recorded investment for impaired loans was equal to the total unpaid principal balance for impaired loans as of August 31, 2012 and May 31, 2012. The table below represents the average recorded investment in impaired loans and the interest income recognized by member class:

   
For the three months ended August 31,
       
   
2012
 
2011
 
2012
 
2011
       
(in thousands)
 
Average recorded investment
 
Interest income recognized 
       
CFC/Distribution
$
 485,077
$
 498,139
$
 5,462
$
 692
       
CFC/Power Supply
 
 5,000
 
-
 
 -
 
-
       
RTFC
 
 6,890
 
 2,681
 
 -
 
 -
       
   Total impaired loans
$
 496,967
$
 500,820
$
 5,462
$
 692
       

Non-performing and Restructured Loans
Interest income was reduced as a result of holding loans on non-accrual status as follows:

   
For the three months ended August 31,
           
(dollar amounts in thousands)
 
2012
 
2011
           
Non-performing loans
$
 407
 
$
 417
           
Restructured loans
 
 -
   
 5,330
           
     Total
$
 407
 
$
 5,747
           

At August 31, 2012 and May 31, 2012, non-performing loans included $42 million, or 0.2 percent, of loans outstanding and $41 million or 0.2 percent, of loans outstanding, respectively. Two borrowers in this group are currently in bankruptcy. In one of the bankruptcy cases, the borrower has until November 16, 2012 to file a plan of reorganization. The other bankruptcy case does not yet have a scheduled date for the borrower to file a plan of reorganization. There are two other borrowers that are currently seeking buyers for their systems, as it is not anticipated that they will have sufficient cash flow to repay their loans without the proceeds from the sale of the business. It is currently anticipated that even with the sale of the business, there will not be sufficient funds to repay the full amount owed.

At August 31, 2012 and May 31, 2012, we had restructured loans totaling $454 million, or 2.3 percent, of loans outstanding and $456 million, or 2.4 percent, of loans outstanding, respectively, all of which were performing according to their restructured terms. Approximately $5 million of interest income was accrued on restructured loans during the three months ended August 31, 2012 compared with $1 million of interest income in the prior-year period. One of the restructured loans totaling $40 million at August 31, 2012 and May 31, 2012, has been on accrual status since the time of restructuring. The other restructured loan totaling $414 million and $416 million at August 31, 2012 and May 31, 2012, respectively, was on non-accrual status through September 30, 2011, with all amounts collected being applied against the principal balance. On October 1, 2011, the principal balance of the loan was reduced below the level of a buyout option and as such we placed the loan on accrual status at that time at a rate based on the effective rate returned by the future scheduled cash flows. This loan was paid-off early by the borrower on September 13, 2012 (see Note 13, Subsequent Events).

We believe our allowance for loan loss is adequate to cover the losses inherent in our loan portfolio at August 31, 2012.

 
16

 

Pledging of Loans and Loans on Deposit
We are required to pledge eligible mortgage notes in an amount at least equal to the outstanding balance of our secured debt.

The following table summarizes our loans outstanding as collateral pledged to secure our collateral trust bonds, Clean Renewable Energy Bonds and notes payable to the Federal Agricultural Mortgage Corporation and the amount of the corresponding debt outstanding (see Note 4, Short-Term Debt and Credit Arrangements and Note 5, Long-Term Debt).

(dollar amounts in thousands)
 
August 31, 2012
 
May 31, 2012
Collateral trust bonds:
       
2007 indenture
       
Distribution system mortgage notes
$
 5,795,177
$
 5,833,475
RUS guaranteed loans qualifying as permitted investments
 
 168,996
 
 170,024
Total pledged collateral
$
 5,964,173
$
 6,003,499
Collateral trust bonds outstanding
 
 4,850,000
 
 4,850,000
         
1994 indenture
       
Distribution system mortgage notes
$
 1,755,907
$
 1,574,823
Collateral trust bonds outstanding
 
 1,470,000
 
 1,470,000
         
Federal Agricultural Mortgage Corporation:
       
Distribution and power supply system mortgage notes
$
 1,357,757
$
 1,379,989
Notes payable outstanding
 
  1,165,100
 
  1,165,100
         
Clean Renewable Energy Bonds Series 2009A:
       
Distribution and power supply system mortgage notes
$
 24,951
$
 25,640
Cash
 
 7,724
 
 7,669
Total pledged collateral
$
 32,675
$
 33,309
Notes payable outstanding
   
 21,545
 
 23,487

We are required to maintain collateral on deposit in an amount at least equal to the balance of debt outstanding to the Federal Financing Bank of the United States Treasury issued under the Guaranteed Underwriter program of the U.S. Department of Agriculture (see Note 5, Long-Term Debt).

The following table shows the collateral on deposit and the amount of the corresponding debt outstanding:

(dollar amounts in thousands)
 
August 31, 2012
 
May 31, 2012
Federal Financing Bank
       
Distribution and power supply system mortgage notes on deposit
$
 4,162,032
$
 3,814,311
Notes payable outstanding
   
  3,674,000
 
  3,419,000
 
(3)        Foreclosed Assets

Assets received in satisfaction of loan receivables are initially recorded at fair value when received and are subsequently evaluated periodically for impairment. These assets are classified on the consolidated balance sheets as foreclosed assets. At August 31, 2012 all foreclosed assets were held by DRP and CAH, which are wholly-owned subsidiaries of CFC.

The activity for foreclosed assets is summarized below:

   
As of and for the three months
ended August 31, 2012
               
(dollar amounts in thousands)
 
CAH
 
DRP
 
Total
               
Balance as of May 31, 2012
$
 201,558
$
 21,918
$
 223,476
               
Results of operations:
                           
   Operating loss
 
 (4,497)
 
 (136)
 
 (4,633)
               
   Impairment
 
 -
 
 (132)
 
 (132)
               
Cash investments
 16,298
 
 -
 
 16,298
               
Balance as of August 31, 2012
$
 213,359
$
 21,650
$
 235,009
               


 
17

 

(4)         Short-Term Debt and Credit Arrangements

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

(dollar amounts in thousands)
 
August 31, 2012
   
May 31, 2012
 
Short-term debt:
           
Commercial paper sold through dealers, net of discounts
$
 1,274,891
 
$
 1,404,901
 
Commercial paper sold directly to members, at par
 
 1,249,575
   
 997,778
 
Commercial paper sold directly to non-members, at par
 
 34,769
   
 70,479
 
        Total commercial paper
 
 2,559,235
   
 2,473,158
 
Daily liquidity fund notes sold directly to members
 
 522,630
   
 478,406
 
Bank bid notes
 
 295,000
   
 295,000
 
        Subtotal short-term debt
 
 3,376,865
   
 3,246,564
 
             
Long-term debt maturing within one year:
           
Medium-term notes sold through dealers
 
 588,214
   
 232,830
 
Medium-term notes sold to members
 
 423,832
   
 409,961
 
Secured collateral trust bonds
 
 1,154,733
   
 254,962
 
Member subordinated certificates
 
 15,195
   
 16,710
 
Secured notes payable
 
 76,857
   
 327,006
 
Unsecured notes payable
 
 5,404
   
 5,401
 
        Total long-term debt maturing within one year
 
 2,264,235
   
 1,246,870
 
Total short-term debt
$
 5,641,100
 
$
 4,493,434
 

Revolving Credit Agreements
At August 31, 2012 and May 31, 2012, we had $2,845 million of commitments under revolving credit agreements. We may request letters of credit for up to $100 million under each agreement in place at August 31, 2012, which then reduces the amount available under the facility. The following table presents the total available and the outstanding letters of credit under our revolving credit agreements:

   
Total available
 
Letters of credit outstanding
       
(dollar amounts in thousands)
August 31,
2012
 
May 31,
2012
 
August 31,
2012
 
May 31,
2012
 
Original maturity
 
Facility fee per
year (1)
Three-year agreement
$
1,125,000
$
1,125,000
$
-
$
-
 
March 21, 2014
 
15 basis points
Four-year agreement
 
883,875
 
883,875
 
1,000
 
1,000
 
October 21, 2015
 
10 basis points
Five-year agreement
 
834,875
 
834,875
 
-
 
-
 
October 21, 2016
 
10 basis points
Total
 
$
2,843,750
$
2,843,750
$
1,000
$
1,000
       
(1) Facility fee determined by CFC’s senior unsecured credit ratings based on the pricing schedules put in place at the inception of the related agreement.

The following represents our required and actual financial ratios under the revolving credit agreements:

           
Actual
 
       
Requirement
 
August 31, 2012
 
May 31, 2012
 
                   
Minimum average adjusted TIER over the six most recent fiscal quarters (1)
1.025
 
1.21
 
1.21
 
                   
Minimum adjusted TIER for the most recent fiscal year (1) (2)
 
1.05
 
1.18
 
1.18
 
                   
Maximum ratio of adjusted senior debt to total equity (1)
     
10.00
 
6.20
 
5.97
 
(1) In addition to the adjustments made to the leverage ratio set forth in the Non-GAAP Financial Measures section, senior debt excludes guarantees to member systems that have certain investment-grade ratings from Moody’s Investors Service and Standard & Poor’s Corporation. The TIER and debt-to-equity calculations include the adjustments set forth in the Non-GAAP Financial Measures section and exclude the results of operations for CAH.
(2) We must meet this requirement to retire patronage capital.

At August 31, 2012 and May 31, 2012, we were in compliance with all covenants and conditions under our revolving credit agreements and there were no borrowings outstanding under these agreements.

 
18

 

(5)         Long-Term Debt

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

(dollar amounts in thousands)
 
August 31, 2012
 
May 31, 2012
   
Unsecured long-term debt:
           
Medium-term notes sold through dealers
$
 1,684,500
$
 1,692,605
   
Medium-term notes sold to members
 
 132,916
 
 89,261
   
    Subtotal
 
 1,817,416
 
 1,781,866
   
Unamortized discount
 
 (966)
 
 (971
)
 
    Total unsecured medium-term notes
 
 1,816,450
 
 1,780,895
   
             
Unsecured notes payable
 
 3,712,982
 
 3,457,982
   
Unamortized discount
 
 (1,051)
 
 (1,093
)
 
    Total unsecured notes payable
 
 3,711,931
 
 3,456,889
   
Total unsecured long-term debt
 
 5,528,381
 
 5,237,784
   
             
Secured long-term debt:
           
Collateral trust bonds
 
   5,165,000
 
6,065,000
   
Unamortized discount
 
 (11,565)
 
 (12,398
)
 
     Total secured collateral trust bonds
 
   5,153,435
 
   6,052,602
   
Secured notes payable
 
 1,109,788
 
 861,581
   
     Total secured long-term debt
 
 6,263,223
 
 6,914,183
   
Total long-term debt
 
$
 11,791,604
$
12,151,967
 

At August 31, 2012 and May 31, 2012, we had unsecured notes payable totaling $3,674 million and $3,419 million, respectively, outstanding under a bond purchase agreement with the Federal Financing Bank and a bond guarantee agreement with RUS issued under the Guaranteed Underwriter program of the U.S. Department of Agriculture, which provides guarantees to the Federal Financing Bank. During the quarter ended August 31, 2012, we borrowed $255 million under our committed loan facilities with the Federal Financing Bank. In the aggregate at August 31, 2012, we had up to $325 million available under committed loan facilities from the Federal Financing Bank as part of this program.

At August 31, 2012 and May 31, 2012, secured notes payable include $1,165 million in debt outstanding to the Federal Agricultural Mortgage Corporation under note purchase agreements totaling $3,900 million. All note purchase agreements previously entered into with the Federal Agricultural Mortgage Corporation were consolidated into one agreement in March 2011. Under the terms of the March 2011 note purchase agreement, we can borrow up to $3,900 million at any time from the date of the agreement through January 11, 2016 and thereafter automatically extend the agreement on each anniversary date of the closing for an additional year, unless prior to any such anniversary date, the Federal Agricultural Mortgage Corporation provides CFC with a notice that the draw period will not be extended beyond the then-remaining term. The agreement with the Federal Agricultural Mortgage Corporation is a revolving credit facility that allows us to borrow, repay and re-borrow funds at any time through maturity or from time to time as market conditions permit, provided that the principal amount at any time outstanding under the note purchase agreement is not more than the total available under the agreement.

(6)         Subordinated Deferrable Debt

The following table is a summary of subordinated deferrable debt outstanding:

(dollar amounts in thousands)
 
August 31, 2012
   
May 31, 2012
 
NRC 6.10% due 2044
$
88,201
 
$
88,201
 
NRU 5.95% due 2045
 
98,239
   
98,239
 
     Total
 
$
186,440
 
$
186,440
 

All subordinated deferrable debt currently outstanding is callable at par at any time.

 
19

 

(7)          Derivative Financial Instruments

We are an end-user of financial derivative instruments. We utilize derivatives such as interest rate swaps and treasury locks for forecasted transactions to mitigate interest rate risk. The following table shows the notional amounts outstanding and the weighted average interest rate paid and received for our interest rate swaps by type:

   
August 31, 2012
 
May 31, 2012
(dollar amounts in thousands)
Notional
amount
 
Weighted-
average
rate paid
 
Weighted-
average
rate received
   
Notional
amount
 
Weighted-
average
rate paid
 
Weighted-
average
rate received
 
Pay fixed-receive variable
$
 5,606,153
 
3.68
%
0.41
%
$
 5,275,553
 
3.78
%
0.45
%
Pay variable-receive fixed
 
 3,750,440
 
1.23
 
4.62
   
 3,720,440
 
1.29
 
4.68
 
  Total interest rate swaps
$
 9,356,593
 
2.70
 
2.10
 
$
 8,995,993
 
2.75
 
2.20
 

The derivative losses line item of the consolidated statement of operations includes cash settlements and derivative forward value for derivative instruments that do not meet hedge accounting criteria. Cash settlements includes periodic amounts paid and received related to our interest rate swaps, as well as amounts accrued from the prior settlement date. Derivative forward value includes changes in the fair value of derivative instruments unless specific hedge accounting criteria are met. If applicable hedge accounting criteria are satisfied, the change to the fair value is recorded to other comprehensive income (loss) and net cash settlements are recorded in interest expense. Gains and losses recorded on the consolidated statements of operations for our interest rate swaps are summarized below:

     
For the three months ended August 31,
       
(dollar amounts in thousands)
   
2012
   
2011
             
Derivative cash settlements
 
$
 (13,863)
 
$
168
             
Derivative forward value
   
 (10,729)
   
 (111,739
)
           
  Derivative losses
   
$
 (24,592)
 
$
(111,571
)
           

Rating Triggers
Some of our interest rate swaps have credit risk-related contingent features referred to as rating triggers. Rating triggers are not separate financial instruments and are not required to be accounted for separately as derivatives. At August 31, 2012, the following notional amounts of derivative instruments had rating triggers based on our senior unsecured credit ratings from Moody’s Investors Service or Standard & Poor’s Corporation falling to a level specified in the applicable agreements and are grouped into the categories below. In calculating the payments and collections required upon termination, we netted the agreements for each counterparty, as allowed by the underlying master agreements. At August 31, 2012, our senior unsecured credit ratings from Moody’s Investors Service and Standard & Poor’s Corporation were A2 and A, respectively. At August 31, 2012, both Moody’s Investors Service and Standard & Poor’s Corporation had our ratings on stable outlook.

(dollar amounts in thousands)
 
Notional
amount
   
Our required
payment
 
Amount we
would collect
 
Net
total
 
Mutual rating trigger if ratings:
                   
fall to Baa1/BBB+ (1)
$
 3,000
 
$
 (157)
$
 -
$
  (157)
 
fall below Baa1/BBB+ (1)
 
 7,015,937
   
 (306,294)
 
 44,238
 
 (262,056)
 
    Total
 
$
 7,018,937
 
$
 (306,451)
$
 44,238
$
 (262,213)
 
(1) Stated senior unsecured credit ratings are for Moody’s Investors Service and Standard & Poor’s Corporation, respectively. Under these rating triggers, 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, excluding credit risk, of the underlying derivative instrument.

In addition to the rating triggers listed above, at August 31, 2012 we had a total notional amount of $650 million of derivative instruments with one counterparty that would require the pledging of collateral totaling $16 million (the fair value of such derivative instruments excluding credit risk) if our senior unsecured ratings from Moody’s Investors Service were to fall below Baa2 or if the ratings from Standard & Poor’s Corporation were to fall below BBB. The aggregate fair value of all interest rate swaps with rating triggers that were in a net liability position at August 31, 2012 was $314 million.

(8)          Equity

In July 2012, the CFC Board of Directors authorized the allocation of the fiscal year 2012 net earnings as follows: $1 million to the cooperative educational fund and $71 million to members in the form of patronage. In July 2012, the CFC Board of Directors authorized the retirement of allocated net earnings totaling $35 million, representing 50 percent of the fiscal year 2012 allocation. This amount was returned to members in cash in September 2012. Future allocations and retirements of net earnings may be made annually as determined by the CFC Board of Directors with due regard for its financial condition. The

 
20

 

CFC Board of Directors has the authority to change the current practice for allocating and retiring net earnings at any time, subject to applicable laws and regulations.

(9)         Guarantees

The following table summarizes total guarantees by type of guarantee and member class:

(dollar amounts in thousands)
 
August 31, 2012
 
May 31, 2012
Total by type:
       
Long-term tax-exempt bonds
$
 571,445
$
 573,110
Indemnifications of tax benefit transfers
 
 2,565
 
 49,771
Letters of credit
 
 456,012
 
 504,920
Other guarantees
 
 118,969
 
 121,529
Total
$
 1,148,991
$
 1,249,330
         
Total by member class:
       
CFC:
       
Distribution
$
 315,374
$
 340,385
Power supply
 
 798,723
 
 854,444
Statewide and associate
 
 6,964
 
 7,202
CFC total
 
 1,121,061
 
 1,202,031
RTFC
 
 1,026
 
 1,026
NCSC
 
 26,904
 
 46,273
Total
 
$
 1,148,991
$
1,249,330

The maturities for the long-term tax-exempt bonds and the related guarantees run through calendar year 2042. Amounts in the table represent the outstanding principal amount of the guaranteed bonds. At August 31, 2012, our maximum potential exposure for the $74 million of fixed-rate tax-exempt bonds is $126 million, representing principal and interest. Of the amounts shown in the table above for long-term tax-exempt bonds, $497 million and $498 million as of August 31, 2012 and May 31, 2012, respectively, are adjustable or floating-rate bonds that may be converted to a fixed rate as specified in the applicable indenture for each bond offering. During the variable-rate period (including at the time of conversion to a fixed rate), we have, in return for a fee, unconditionally agreed to purchase bonds tendered or put for redemption if the remarketing agents have not previously sold such bonds to other investors. We are unable to determine the maximum amount of interest that we could be required to pay related to the remaining adjustable and floating-rate bonds. Many of these bonds have a call provision that in the event of a default allow us to trigger the call provision. This would limit our exposure to future interest payments on these bonds. Our maximum potential exposure is secured by a mortgage lien on all of the system’s assets and future revenue. If the debt is accelerated because of a determination that the interest thereon is not tax-exempt, the system’s obligation to reimburse us for any guarantee payments will be treated as a long-term loan.

The maturities for the indemnifications of tax benefit transfers run through calendar year 2015. The amounts shown represent our maximum potential exposure for guaranteed indemnity payments. A member’s obligation to reimburse CFC for any guarantee payments would be treated as a long-term loan to the extent of any cash received by the member at the outset of the transaction. This amount is secured by a mortgage lien on substantially all of the system’s assets and future revenue. The remainder would be treated as a line of credit loan secured by a subordinated mortgage on substantially all of the member’s property. Due to changes in federal tax law, no further guarantees of this nature are anticipated.

The maturities for letters of credit run through calendar year 2024. The amounts shown in the table above represent our maximum potential exposure, of which $213 million is secured at August 31, 2012. When taking into consideration reimbursement obligation agreements that we have in place with other lenders, our maximum potential exposure is $11 million. At August 31, 2012, and May 31, 2012, the letters of credit include $125 million to provide the standby liquidity for adjustable and floating-rate tax-exempt bonds issued for the benefit of our members. We are unable to determine the maximum amount of interest that we could be required to pay related to these adjustable and floating-rate bonds. Security provisions include a mortgage lien on substantially all of the system’s assets, future revenue and the system’s investment in our commercial paper.

In addition to the letters of credit listed in the table, under master letter of credit facilities in place at August 31, 2012, we may be required to issue up to an additional $824 million in letters of credit to third parties for the benefit of our members. Of this amount, $644 million represents commitments that may be used for the issuance of letters of credit or line of credit loan advances, at the option of the borrower, and are included in unadvanced loan commitments for line of credit loans reported in Note 2, Loans and Commitments. Master letter of credit facilities subject to material adverse change clauses at the time of

 
21

 

issuance totaled $495 million at August 31, 2012. Prior to issuing a letter of credit, we would confirm that there has been no material adverse change in the business or condition, financial or otherwise, of the borrower since the time the loan was approved and confirm that the borrower is currently in compliance with the letter of credit terms and conditions. The remaining commitment under master letter of credit facilities of $329 million may be used for the issuance of letters of credit as long as the borrower is in compliance with the terms and conditions of the facility.

The maturities for other guarantees run through calendar year 2025. The maximum potential exposure for these guarantees is $120 million, all of which is unsecured.

At August 31, 2012 and May 31, 2012, we had $362 million and $385 million of guarantees, respectively, representing 31 percent of total guarantees, under which our right of recovery from our members was not secured.

Guarantee Liability
At August 31, 2012 and May 31, 2012, we recorded a guarantee liability of $28 million and $29 million, respectively, which represents the contingent and non-contingent exposures related to guarantees and liquidity obligations associated with our members’ debt. The contingent guarantee liability at August 31, 2012 and May 31, 2012 was $6 million based on management’s estimate of exposure to losses within the guarantee portfolio. The remaining balance of the total guarantee liability of $22 million and $23 million at August 31, 2012 and May 31, 2012, respectively, relates to our non-contingent obligation to stand ready to perform over the term of our guarantees and liquidity obligations that we have entered into or modified since January 1, 2003.

Activity in the guarantee liability account is summarized below:

(dollar amounts in thousands)
 
As of and for the
three months ended August 31,2012
                 
Beginning balance as of May 31, 2012
$
 28,663
                 
Net change in non-contingent liability
 (939)
                 
Recovery of contingent guarantee liability
 (9)
                 
Ending balance as of August 31, 2012
$
 27,715
                 
 
                     
Liability as a percentage of total guarantees
 
2.41
%
               

(10)         Fair Value Measurement

Assets and liabilities measured at fair value on either a recurring or non-recurring basis on the consolidated balance sheets at August 31, 2012 and May 31, 2012 consisted of investments in common stock, derivative instruments, and collateral-dependent non-performing loans.

Assets and Liabilities Measured at Fair Value on a Recurring Basis
We account for derivative instruments (including certain derivative instruments embedded in other contracts) in the consolidated balance sheets as either an asset or liability measured at fair value. Since there is not an active secondary market for the types of interest rate swaps we use, we obtain market quotes from the interest rate swap counterparties to adjust all swaps to fair value on a quarterly basis. The market quotes are based on the expected future cash flow and the estimated yield curve.

We perform analysis to validate the market quotes obtained from our swap counterparties. We adjust the market values received from the counterparties using credit default swap levels for us and the counterparties. The credit default swap levels represent the credit risk premium required by a market participant based on the available information related to us and the counterparty. We only enter into exchange agreements with counterparties that are participating in our revolving lines of credit at the time the exchange agreements are executed. All of our exchange agreements are subject to master netting agreements.

Our valuation techniques for interest rate swaps are based on observable inputs, which reflect market data. Fair values for our interest rate swaps are classified as a Level 2 valuation. We record the change in the fair value of our derivatives for each reporting period in the derivative gains (losses) line, included in non-interest income in the consolidated statements of operations, as currently none of our derivatives qualify for hedge accounting.

At August 31, 2012 and May 31, 2012, our investments in equity securities included investments in the Federal Agricultural Mortgage Corporation Series A common stock that is recorded in the consolidated balance sheets at fair value. We calculate

 
22

 

fair value based on the quoted price on the stock exchange where the stock is traded. That stock exchange is an active market based on the volume of shares transacted. Fair values for these securities are classified as a Level 1 valuation.

The following table presents our assets and liabilities that are measured at fair value on a recurring basis:

   
August 31, 2012
 
May 31, 2012
 
(dollar amounts in thousands)
 
Level 1
 
Level 2
 
Level 1
 
Level 2
 
Derivative assets
$
 -
$
 293,221
$
 -
$
 296,036
 
Derivative liabilities
 
 -
 
 662,193
 
 -
 
 654,125
 
Investments in common stock
 
 1,461
 
 -
 
 1,467
 
 -
 

Assets and Liabilities Measured at Fair Value on a Non-recurring Basis
We may be required, from time to time, to measure certain assets at fair value on a non-recurring 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. At August 31, 2012 and May 31, 2012, we measured certain collateral-dependent non-performing loans at fair value. In certain instances when a loan is non-performing, we utilize the collateral fair value underlying the loan in estimating the specific loan loss allowance. To estimate the fair value of the collateral, we may use third party valuation specialists, we may use internal estimates or a combination of both. The approaches used by both our internal staff and third party specialists include the discounted cash flow, market multiple and replacement cost methods. The material inputs used in estimating the fair value of such collateral, by both internal staff and third party specialists, are Level 3 within the fair value hierarchy. In these instances, the valuation is considered to be a non-recurring item. The significant unobservable inputs for Level 3 assets that are valued using fair values obtained from third party specialists are reviewed by our Credit Risk Management group to assess the reasonableness of the assumptions used and the accuracy of the work performed. In cases where we rely on third party inputs, we use the final unadjusted third party valuation analysis as support for any financial statement adjustments and disclosures to the financial statements. The valuation techniques and significant unobservable inputs for assets classified as Level 3 in the fair value hierarchy, which are measured using an internal model, are independently reviewed by other internal staff.

For assets measured at fair value on a non-recurring basis at August 31, 2012 and May 31, 2012 that are classified as Level 3 within the fair value hierarchy, any increase or decrease to significant unobservable inputs used in the determination of fair value, will not have a material impact on the fair value measurement of those assets or to the results of operations of the Company.

Assets measured at fair value on a non-recurring basis at August 31, 2012 and May 31, 2012 were classified as Level 3 within the fair value hierarchy. The following table provides the carrying/fair value of the related individual assets at August 31, 2012 and May 31, 2012 and the total losses for the three months ended August 31, 2012 and 2011:

 
Level 3 Fair Value
 
Total losses for the
three months ended August 31,
         
(dollar amounts in thousands)
August 31, 2012
 
May 31, 2012
 
2012
 
2011
         
Non-performing loans,
                         
net of specific reserves
$
 17,542
$
16,517
$
 (206)
$
(2,053)
         


 
23

 

(11)         Fair Value of Financial Instruments

Carrying and fair values for our financial instruments are presented as follows:

     
August 31, 2012
   
May 31, 2012
   
(dollar amounts in thousands)
   
Carrying value
   
Fair value
   
Carrying value
   
Fair value
   
Assets:
                           
Cash and cash equivalents
 
$
 575,119
 
$
 575,119
 
$
 191,167
 
$
 191,167
   
Restricted cash
   
 8,171
   
 8,171
   
 7,694
   
 7,694
   
Investments in equity securities
   
 59,039
   
 59,039
   
 59,045
   
 59,045
   
Loans to members, net
   
 19,323,152
   
 20,778,781
   
 18,776,286
   
 20,405,353
   
Debt service reserve funds
   
 39,803
   
 39,803
   
 39,803
   
 39,803
   
Derivative instruments
   
 293,221
   
 293,221
   
 296,036
   
 296,036
   
                             
Liabilities:
                           
Short-term debt
   
 5,641,100
   
 5,679,086
   
 4,493,434
   
 4,498,565
   
Long-term debt
   
 11,791,604
   
 13,400,035
   
 12,151,967
   
 13,936,540
   
Guarantee liability
   
 27,715
   
 30,583
   
 28,663
   
 31,518
   
Derivative instruments
 662,193
   
 662,193
   
654,125
 
 
654,125
  <