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EX-31.2 - EXHIBIT 31.2 - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997v370966_ex31-2.htm
EX-99 - EXHIBIT 99 - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997v370966_ex99.htm
EX-32.2 - EXHIBIT 32.2 - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997v370966_ex32-2.htm
EX-32.1 - EXHIBIT 32.1 - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997v370966_ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997v370966_ex31-1.htm
EX-12 - EXHIBIT 12 - RURAL ELECTRIC COOPERATIVE GRANTOR TRUST KEPCO SERIES 1997v370966_ex12.htm

 

 

 UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

FORM 10-K

 

 

  

x    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2013

 

OR

 

¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from _____to ______

 

Commission File Number: 333-25029

 

 

 

RURAL ELECTRIC COOPERATIVE GRANTOR TRUST

(KEPCO) SERIES 1997

(Exact name of registrant as specified in its charter)

 

 

 

New York   36-7233686
(State or other jurisdiction of incorporation or organization)   (I.R.S. employer identification no.)
     

20701 Cooperative Way,

Dulles, Virginia

 

 

20166

(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code: (703) 467-1800

 

 

 

Securities registered pursuant to Section 12(b) of the Act: None

 

Securities registered pursuant to Section 12(g) of the Act: None

 

 

  

Indicate by check mark if the registrant is a well-known seasoned issuer; as defined in Rule 405 of the Securities Act.    Yes ¨   No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act.       Yes ¨    No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                   Yes x    No ¨

 

Indicate by check mark 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained to the best of the registrant's knowledge in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

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 has no common or voting stock.

 

 

 
 

 

TABLE OF CONTENTS

 

 

    Page
PART I      
Item 1. Business 1  
Item 1A. Risk Factors 1  
Item 1B. Unresolved Staff Comments 1  
Item 2. Properties 1  
Item 3. Legal Proceedings 1  
Item 4. Mine Safety Disclosures 1  
PART II      
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

1

 
Item 6. Selected Financial Data 1  
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 1  
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 1  
Item 8. Financial Statements and Supplementary Data 2  
  Report of KPMG LLP, Independent Registered Public Accounting Firm 2  
  Report of Deloitte & Touche LLP, Independent Registered Public Accounting Firm 3  
  Balance Sheets 4  
  Statements of Comprehensive Income 5  
  Statements of Changes in Deficit 6  
  Statements of Cash Flows 7  
  Notes to Financial Statements 8  
  Note 1—Summary of Significant Accounting Policies 8  
  Note 2—Grantor Trust Certificates 10  
  Note 3—Derivative Instruments and Hedging Activities 10  
  Note 4—Fair Value 11  
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 14  
Item 9A. Controls and Procedures 14  
Item 9B.

Other Information

14  
PART III      
Item 10. Directors, Executive Officers and Corporate Governance 14  
Item 11. Executive Compensation 14  
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 15  
Item 13. Certain Relationships and Related Transactions, and Director Independence 15  
Item 14. Principal Accountant Fees and Services 15  
PART IV      
Item 15. Exhibits and Financial Statement Schedules 15  
SIGNATURES 17  

 

i
 

 

PART I

 

ITEM 1.BUSINESS

 

Not applicable.

 

ITEM 1A.RISK FACTORS

 

Not applicable.

 

ITEM 1B.UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 2.PROPERTIES

 

Not applicable.

 

ITEM 3.LEGAL PROCEEDINGS

 

None.

 

ITEM 4.MINE SAFETY DISCLOSURES

 

Not applicable.

 

PART II

 

ITEM 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

There is no established trading market for the certificates representing ownership of the beneficial interest in the Rural Electric Cooperative Grantor Trust (KEPCO) Series 1997 (the “Trust”).

 

ITEM 6.SELECTED FINANCIAL DATA

 

Not applicable.

 

ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Not applicable.

 

Item 7A.Quantitative and Qualitative Disclosures About Market Risk

 

Not applicable.

 

1
 

 

Item 8.FINANCIAL INFORMATION AND SUPPLEMENTARY DATA

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Trustee of

Rural Electric Cooperative Grantor Trust

(KEPCO) Series 1997

Dulles, Virginia

 

We have audited the accompanying balance sheet of Rural Electric Cooperative Grantor Trust (“KEPCO”) Series 1997 (the “Trust”) as of December 31, 2013, and the related statements of comprehensive income, changes in deficit and cash flows for the year ended December 31, 2013. These financial statements are the responsibility of the Trust’s Servicer. Our responsibility is to express an opinion on the financial statements based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Servicer, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Trust as of December 31, 2013, and the results of its operations and its cash flows for the year ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.

 

/s/  KPMG LLP  
   
McLean, Virginia  
March 10, 2014  

 

2
 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Trustee of

Rural Electric Cooperative Grantor Trust

(KEPCO) Series 1997

Dulles, Virginia 20166

 

We have audited the accompanying balance sheet of Rural Electric Cooperative Grantor Trust (“KEPCO”) Series 1997 (the “Trust”) as of December 31, 2012, and the related statements of comprehensive income, changes in deficit and cash flows for each of the two years in the period ended December 31, 2012. The financial statements are the responsibility of the Trust’s Servicer. Our responsibility is to express an opinion on the financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Trust is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Trust's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by the Servicer, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Trust as of December 31, 2012, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2012, in conformity with accounting principles generally accepted in the United States of America.

 

 /s/  DELOITTE & TOUCHE LLP  
   
McLean, Virginia  
March 5, 2013  

 

3
 

 

RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

 

BALANCE SHEETS

 

   December 31, 
   2013   2012 
Assets:          
Interest receivable — KEPCO  $120,100   $147,302 
Interest receivable — swap counterparty   6,624    5,022 
Notes receivable   18,440,000    23,240,000 
           
Total assets  $18,566,724   $23,392,324 
           
Liabilities:          
Servicer fees payable  $1,470   $1,803 
Interest payable — Grantor Trust Certificates   6,624    5,022 
Interest payable — swap counterparty   118,630    145,499 
Rural Electric Cooperative Grantor Trust Certificates   18,440,000    23,240,000 
Derivative liability   2,659,203    4,328,016 
           
Total liabilities   21,225,927    27,720,340 
           
Commitments and contingencies        
           
Deficit:          
Accumulated deficit   (2,997,177)   (4,852,735)
Accumulated other comprehensive income   337,974    524,719 
           
Total deficit   (2,659,203)   (4,328,016)
           
Total liabilities and deficit  $18,566,724   $23,392,324 

 

 

The accompanying notes are an integral part of these financial statements.

 

4
 

 

RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

 

STATEMENTS OF COMPREHENSIVE INCOME

 

   Year Ended December  31, 
   2013   2012   2011 
             
Revenues:               
Interest income from notes receivable  $1,748,323   $2,082,599   $2,374,506 
                
Total revenues   1,748,323    2,082,599    2,374,506 
                
Expenses:               
Interest expense to certificateholders   60,883    86,104    155,118 
                
Servicer fees   21,402    25,495    29,068 
                
Total expenses   82,285    111,599    184,186 
                
Derivative gain (loss), net   189,520    (346,673)   (1,164,607)
                
Net income  $1,855,558   $1,624,327   $1,025,713 
                
Other comprehensive income (loss):               
Reclassification of derivative cumulative transition gain to net income   (186,745)   (221,298)   (252,637)
                
Other comprehensive loss   (186,745)   (221,298)   (252,637)
                
Total comprehensive income  $1,668,813   $1,403,029   $773,076 

 

The accompanying notes are an integral part of these financial statements.

 

5
 

 

RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

 

STATEMENTS OF CHANGES IN DEFICIT

  

       Accumulated     
       Other     
   Accumulated   Comprehensive   Total 
   Deficit   Income   Deficit 
Balance at December 31, 2010  $(7,502,775)  $998,654   $(6,504,121)
Comprehensive income:               
Net income   1,025,713        1,025,713 
Reclassification of  derivative cumulative transition gain to net income       (252,637)   (252,637)
Comprehensive income   1,025,713    (252,637)   773,076 
Balance at December 31, 2011  $(6,477,062)  $746,017   $(5,731,045)
Comprehensive income:               
Net income   1,624,327        1,624,327 
Reclassification of  derivative cumulative transition gain to net income       (221,298)   (221,298)
Comprehensive income   1,624,327    (221,298)   1,403,029 
Balance at  December 31, 2012  $(4,852,735)  $524,719   $(4,328,016)
Comprehensive income:               
Net income   1,855,558        1,855,558 
Reclassification of  derivative cumulative transition gain to net income       (186,745)   (186,745)
Comprehensive income   1,855,558    (186,745)   1,668,813 
Balance at December 31, 2013  $(2,997,177)  $337,974   $(2,659,203)

 

The accompanying notes are an integral part of these financial statements. 

 

6
 

 

RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

 

STATEMENTS OF CASH FLOWS

  

   Year Ended December  31, 
   2013   2012   2011 
Cash flows from operating activities:               
Net income  $1,855,558   $1,624,327   $1,025,713 
Adjustments to reconcile net income to net cash provided by operating activities:               
Reclassification of derivative cumulative transition gain to net income   (186,745)   (221,298)   (252,637)
Decrease in interest receivable — KEPCO   27,202    24,479    22,116 
(Increase) decrease in interest receivable — swap counterparty   (1,602)   3,018    13,286 
Decrease in servicer fees payable   (333)   (300)   (271)
Increase (decrease) in interest payable — Grantor Trust Certificates   1,602    (3,018)   (13,286)
Decrease in interest payable — swap counterparty   (26,869)   (24,179)   (21,845)
Decrease in derivative liability   (1,668,813)   (1,403,029)   (773,076)
Net cash provided by operating activities            
                
Cash flows from investing activities:               
Proceeds from principal payments on notes receivable   4,800,000    4,300,000    3,900,000 
Net cash provided by investing activities   4,800,000    4,300,000    3,900,000 
                
Cash flows from financing activities:               
Principal payments to certificateholders   (4,800,000)   (4,300,000)   (3,900,000)
Net cash used in financing activities   (4,800,000)   (4,300,000)   (3,900,000)
                
Net change in cash            
Cash at beginning of year            
Cash at end of year  $   $   $ 
                
Supplemental cash flow information:               
Cash payments of interest expense to certificateholders  $59,281   $89,122   $168,404 

 

The accompanying notes are an integral part of these financial statements. 

 

7
 

 

RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

NOTES TO FINANCIAL STATEMENTS

 

NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The Trust

 

Creation of the Trust

 

Rural Electric Cooperative Grantor Trust (KEPCO) Series 1997 (the “Trust”) was formed under a Trust Agreement dated December 20, 1996, among National Rural Utilities Cooperative Finance Corporation (“CFC”), Kansas Electric Power Cooperative, Inc. (the “Cooperative”) and Bank One, formerly The First National Bank of Chicago (the “Trustee”).

 

Trust Assets

 

The assets of the Trust consist of lender loan notes (the “1997 Notes”) bearing interest at 7.597 percent and maturing in 2017. The 1997 Notes originated from a transaction whereby CFC refinanced loans from the Federal Financing Bank, guaranteed by the Rural Utilities Service (“RUS”) and, in exchange, CFC received from the Cooperative the 1997 Notes. CFC subsequently placed the 1997 Notes into two trusts, which have since been terminated and replaced by the Trust. The 1997 Notes are guaranteed (the “Guarantee”) as to timely payment of principal and interest by the United States Government (“U.S. Government”), acting through the Administrator of RUS. The General Counsel of the United States Department of Agriculture has issued an opinion that the Guarantee is supported by the full faith and credit of the U.S. Government. The Trust issued certificates of beneficial interests (the “Series 1997 Certificates”) that bear interest at a variable rate and mature in 2017.

 

Swap Agreement

 

The Trust also holds certain rights the Cooperative assigned to the Trust under an interest rate swap agreement (the “Swap Agreement”). The Swap Agreement was entered into to hedge the interest rate exposure associated with the fixed-rate 1997 Notes and a variable-rate obligation. The counterparty to the Swap Agreement is JP Morgan Chase & Co. (“JP Morgan”), successor to Morgan Guaranty Trust Company of New York. Pursuant to the Swap Agreement, the Trust pays to JP Morgan a fixed rate of interest on the outstanding notional amount, and JP Morgan pays the Trust a variable rate of interest on the outstanding notional amount. The structure is designed such that the interest amounts paid by the Cooperative to the Trust are the same amounts paid to JP Morgan, pursuant to the Swap Agreement, plus the amounts payable to CFC, as servicer. The amounts paid by JP Morgan to the Trust under the Swap Agreement are the same as the interest payable by the Trust to the Series 1997 Certificateholders.

 

The initial notional amount of the Swap Agreement, which is not included on the Trust’s balance sheet, was $57,390,000. The notional amount of the Swap Agreement decreases over time in an amount such that the outstanding notional amount is always equal to the outstanding balance of the 1997 Notes and the Series 1997 Certificates. The Swap Agreement terminates in 2017, but is subject to early termination upon the early redemption of the Series 1997 Certificates.

 

Liquidity Facility

 

JP Morgan provides a liquidity facility with respect to the Series 1997 Certificates until such time as all outstanding Series 1997 Certificates have been paid in full. Investors have the right to put the certificates back to the remarketing agent in the event they are unable to resell the certificates. The remarketing agent is Goldman, Sachs & Co. as successor to the original remarketing agent, Alex Brown & Sons, Incorporated.

 

Trustee

 

Effective September 2, 2004, U. S. Bank Trust National Association (“U.S. Bank Trust”) replaced Bank One as Trustee.

 

8
 

 

RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

 

Servicer

 

CFC is the servicer of the Trust and is paid a servicing fee of 9.30 basis points under the Loan Guarantee and Servicing Agreement dated as of February 15, 1988, as amended (the “Guarantee and Servicing Agreement”). CFC, however, no longer holds a retained interest in the trust. No delinquency in payment under either the Note, the Guarantee or the Swap Agreement has occurred and no Event of Servicing Termination, or, to the best of the Servicer's knowledge, event that with notice or lapse of time or both would become an Event of Servicing Termination, has occurred and is continuing.

 

Basis of Presentation and Use of Estimates

 

The accompanying financial statements have been prepared in accordance with generally accepted accounting principles in the U.S. (“U.S. GAAP”). The preparation of financial statements in conformity with U.S. GAAP requires the Trust’s servicer to make estimates and assumptions with respect to, among other things, various future factors which are difficult to predict and are beyond the control of the Trust. These estimates, which are based on information available as of the date of the financial statements, affect the amounts reported in the financial statements and related disclosures. Areas in which estimates have been made include, but are not limited to, the fair value of derivative financial instruments. While the Trust’s servicer makes its best judgment, actual amounts or results could differ from these estimates.

 

Notes Receivable

 

The Trust accounts for the notes receivable based on historical cost. No allowance for loan losses has been recorded because the timely payment of principal and interest is guaranteed by the U.S. Government. Interest income is recognized on the notes as earned on an accrual basis.

 

Grantor Trust Certificates

 

The Trust accrues and recognizes interest expense on the trust certificates as incurred.

 

Servicer Fee Expense

 

CFC is the depositor of the Trust and acts as servicer of the 1997 Notes. The Trust accrues and recognizes servicer fee expense based on a rate of 0.093 percent of the outstanding principal balance of the 1997 Notes.

 

Derivative Instruments and Hedging Activities

 

The Trust is neither a dealer nor a trader in derivative financial instruments. The Trust entered into an interest rate swap derivative instrument to hedge its interest rate risk exposure related to the 1997 Notes. Derivatives are reported at fair value on the balance sheet. Derivatives in a gain position are recorded as a derivative asset, while derivatives in a loss position are reported as a derivative liability. Changes in fair value and interest accruals on derivatives are recorded as a component of derivative gain (loss), net in the statements of comprehensive income.

 

The Trust did not have any derivatives in hedge accounting relationships at December 31, 2013 or 2012. The trust, however, recorded a cumulative derivative transition gain of $4,628,105 in accumulated other comprehensive income (“AOCI”) at January 1, 2001 as a result of the adoption of the derivative accounting guidance that required derivatives to be reported at fair value on the balance sheet. The transition adjustment represents the difference between the carrying amount of the interest rate swap derivative prior to the January 1, 2001 adoption of the derivative accounting guidance and its fair value at the date of initial adoption. The transition gain is being reclassified into earnings and reported in the statement of comprehensive income as a component of derivative gain (loss), net. Cash flows related to the interest rate swap are classified in operating activities in the statements of cash flows.

 

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RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

NOTES TO FINANCIAL STATEMENTS (CONTINUED) 

 

Comprehensive Income

 

Comprehensive income for the Trust consists of net income (loss) plus changes in the cumulative derivative transition gain related to the transition adjustment recorded upon the January 1, 2001 adoption of the derivative accounting guidance.

 

Tax Status of the Trust

 

The Trust is a pass-through entity, which is not subject to income taxes. Therefore, it is expected that the Trust will not have any liability for federal or state income taxes for the current or future years.

 

NOTE 2—GRANTOR TRUST CERTIFICATES 

 

Each Series 1997 Certificate represents an undivided fractional interest in the Trust. The Trust Certificates are subject to redemption by the Cooperative, through the Trust, at any time based on the remaining principal amount plus accrued interest. In the event of a continuing default, the RUS, as guarantor, may prepay or purchase the 1997 Notes at that time.

 

The principal payments received on the 1997 Notes from the Cooperative coincide with the payments due to the Series 1997 Certificateholders. Principal payments on the Trust Certificates began in 1998 and extend over a period of twenty years. Principal payments due each fiscal year through maturity of the 1997 Notes in fiscal year 2017 are presented below.

 

Due  Amount 
     
2014  $5,300,000 
2015   5,900,000 
2016   4,000,000 
2017   3,240,000 
   $18,440,000 

 

NOTE 3—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

Effective January 1, 2001, the Trust adopted the accounting guidance which required that derivatives be recorded on the balance sheet at fair value. At adoption, the Trust had an interest rate swap agreement that had been entered into to hedge the interest rate exposure associated with the fixed-rate 1997 Notes and a variable-rate obligation. As noted above in “Note 1—Summary of Significant Accounting Policies,” the Trust recorded a cumulative derivative transition gain of $4,628,105 in AOCI upon adoption of the derivative accounting guidance. The interest rate swap was not designated as a qualifying hedge for accounting purposes on January 1, 2001, and has not been designated as a qualifying hedge since that date. Therefore, all changes in the fair value of the interest rate swap subsequent to January 1, 2001 have been recorded in the statements of comprehensive income as a component of derivative gain (loss), net.

 

The table below summarizes the outstanding notional amount and fair value of the Swap Agreement at December 31, 2013 and 2012. The Swap Agreement, which is with a highly rated counterparty, contains master netting arrangements as part of the International Swaps and Derivatives Association (“ISDA”). The Swap agreement does not require collateral posting.

 

   December 31, 
   2013   2012 
   Notional   Derivatives at Fair Value   Notional   Derivatives at Fair Value 
   Amount   Asset   Liability   Amount   Asset   Liability 
Derivatives not designated as accounting hedges:                              
Interest rate swaps  $18,440,000   $   $2,659,203   $23,240,000   $   $4,328,016 
Total derivatives  $18,440,000   $   $2,659,203   $23,240,000   $   $4,328,016 

 

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RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

 

The table below displays the components of derivative gain (loss), net presented in the statements of comprehensive income.

 

   Year Ended December  31, 
   2013   2012   2011 
Derivative settlement interest income (expense):               
Receive-variable interest rate swap  $60,883   $86,104   $155,118 
Pay-fixed interest rate swap   (1,726,921)   (2,057,104)   (2,345,438)
Derivative settlement interest expense, net(1)   (1,666,038)   (1,971,000)   (2,190,320)
Change in derivative fair value, net(2)   1,668,813    1,403,029    773,076 
Reclassification of cumulative derivative transition gain to net income(3)   186,745    221,298    252,637 
Derivative gain (loss), net  $189,520   $(346,673)  $(1,164,607)

 

 

(1) Represents the net accrued interest amounts received from/(paid to) the swap counterparty.

(2) Represents the change in the fair value of the interest rate swaps, excluding interest accruals.

(3) Represents reclassification of cumulative derivative transition gain from AOCI to earnings.

 

The remaining cumulative derivative transition gain of $337,974 at December 31, 2013 will continue to be reclassified from AOCI into earnings over the remaining life of the interest rate swap, which matures on December 4, 2017. A total of $148,175 is expected to be reclassified over the next twelve months.

 

NOTE 4—FAIR VALUE

 

Fair value is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date (also referred to as an exit price). The fair value accounting guidance provides a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Fair value measurement of an asset or liability is assigned to a level based on the lowest level of any input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are as follows:

 

Level 1: Valuation based on quoted prices in active markets for identical assets or liabilities.
   
Level 2: Valuation based on quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, or models using inputs that are observable or can be corroborated by observable market data of substantially the full term of the assets or liabilities.
   
Level 3: Valuation based on at least one significant unobservable input or model assumption requiring significant management judgment or estimation.

 

The accounting guidance for fair value requires maximizing the use of observable inputs and minimizing the use of unobservable inputs in determining fair value.

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The interest rate swap derivative is the only asset/liability of the Trust that is measured and reported at fair value on a recurring basis in the financial statements. Because the interest rate swap held by the Trust is not an exchange-traded derivative, quoted market prices are not readily available. The Trust obtains the fair value measurement of the derivative from the derivative counterparty, which determines the fair value based on the net present value of expected future cash flows calculated using observable market inputs, such as interest rate yield curves and current market interest rates.

  

The Trust performs independent validation procedures to corroborate the fair value measures obtained from the derivative counterparty using pricing models based on observable market inputs. Accordingly, the valuation technique for the interest rate swap is classified as Level 2.

 

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RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

 

The following fair value hierarchy table presents information about the Trust’s assets and liabilities measured and reported at fair value on a recurring basis at December 31, 2013 and December 31, 2012.

 

   December 31, 
   2013   2012 
   Level 1   Level 2   Level 3   Total   Level 1   Level 2   Level 3   Total 
Liabilities:                                        
Derivative liability  $   $2,659,203   $   $2,659,203   $   $4,328,016   $   $4,328,016 

  

Transfers Between Level 1 and Level 2

 

There were no transfers between Levels 1 and 2 during 2013 or 2012.

 

Level 3 Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The Trust did not have any assets or liabilities measured at fair value on a recurring basis using Level 3 valuation techniques at December 31, 2013 or 2012.

 

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

 

The Trust did not have any assets or liabilities measured at fair value on a nonrecurring basis during 2013 or 2012.

 

Fair Value of Financial Instruments

 

The tables below present the carrying value, fair value and fair value hierarchy of financial instruments, whether or not they are measured and reported at fair value on Trust’s balance sheets at December 31, 2013 and 2012.

 

   December 31, 2013 
   Carrying   Fair   Fair Value Measurements Using 
   Value   Value   Level 1   Level 2   Level 3 
Financial assets:                         
Interest receivable — KEPCO  $120,100   $120,100   $   $120,100   $ 
Interest receivable — swap counterparty   6,624    6,624        6,624     
Notes receivable   18,440,000    20,955,745            20,955,745 
                          
Financial liabilities:                         
Servicer fees payable  $1,470   $1,470   $   $1,470   $ 
Interest payable — Grantor Trust Certificates   6,624    6,624        6,624     
Interest payable — swap counterparty   118,630    118,630        118,630     
Rural Electric Cooperative Grantor Trust Certificates   18,440,000    18,440,000        18,440,000     
Derivative liability   2,659,203    2,659,203        2,659,203     

 

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RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997

NOTES TO FINANCIAL STATEMENTS (CONTINUED)

 

   December 31, 2012 
   Carrying   Fair   Fair Value Measurements Using 
   Value   Value   Level 1   Level 2   Level 3 
Financial assets:                         
Interest receivable — KEPCO  $147,302   $147,302   $   $147,302   $ 
Interest receivable — swap counterparty   5,022    5,022        5,022     
Notes receivable   23,240,000    27,204,777            27,204,777 
                          
Financial liabilities:                         
Servicer fees payable  $1,803   $1,803   $   $1,803   $ 
Interest payable — Grantor Trust Certificates   5,022    5,022        5,022     
Interest payable — swap counterparty   145,499    145,499        145,499     
Rural Electric Cooperative Grantor Trust Certificates   23,240,000    23,240,000        23,240,000      
Derivative liability   4,328,016    4,328,016        4,328,016     

 

Below is a summary of the valuation techniques used in estimating the fair value amounts of the financial instruments of the Trust at December 31, 2013 and 2012. As required under the accounting guidance for fair value, the valuation techniques have used quoted market prices and maximized the observable inputs whenever possible and minimized the use of unobservable inputs.

 

Interest Receivable — KEPCO and Swap Counterparty

 

The carrying amounts of interest receivable approximate fair value because of the relatively short period of time between their accrual and expected receipt of payment.

 

Notes Receivable

 

The fair value for notes receivable is estimated by discounting the expected future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Notes receivable are categorized in Level 3 of the fair value hierarchy.

 

Servicer Fees Payable

 

The carrying amount of servicer fees payable approximates fair value because of the relatively short period of time between their accrual and expected payment.

 

Interest Payable — Grantor Trust Certificates and Swap Counterparty

 

The carrying amounts of interest payable approximate fair value because of the relatively short period of time between their accrual and expected payment.

 

Rural Electric Cooperative Grantor Trust Certificates

 

The Series 1997 Trust Certificates pay a variable rate of interest that is reset weekly, and as such are considered to be carried at fair value. Rural Electric Cooperative Grantor Trust Certificates are categorized in Level 2 of the fair value hierarchy.

 

Derivative Liability

 

As noted above, the fair value of the derivative is obtained from the derivative counterparty, which determines the fair value based on the net present value of expected future cash flows calculated using observable market inputs, such as interest rate yield curves and current market interest rates, and is categorized in Level 2 of the fair value hierarchy.

 

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ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

Dismissal of Independent Registered Public Accounting Firm

 

As previously disclosed in the Trust’s Current Report on Form 8-K filed on November 18, 2013, on November 12, 2013, the Audit Committee of CFC, as servicer for the Rural Electric Cooperative Grantor Trust (KEPCO) Series 1997, approved the dismissal of Deloitte and Touche LLP (“Deloitte”) as the Trust’s independent registered public accounting firm.

 

Deloitte was notified of this action on November 15, 2013. Deloitte’s report on the Trust’s financial statements as of and for the years ended December 31, 2012 and 2011 did not contain an adverse opinion or a disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope or accounting principles.

 

During the years ended December 31, 2012 and 2011, and through November 12, 2013, the date of Deloitte’s dismissal, (i) there were no disagreements between the Company and Deloitte on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which, if not resolved to the satisfaction of Deloitte, would have caused Deloitte to make reference to the subject matter of the disagreement in its reports on the financial statements for such years, and (ii) there were no “reportable events” as that term is defined in Item 304(a)(1)(v) of Regulation S-K.

 

Engagement of New Independent Registered Public Accounting Firm

 

As previously disclosed in the Trust’s current report on Form 8-K filed on December 16, 2013, on December 10, 2013, the Audit Committee of CFC, as servicer for the Rural Electric Cooperative Grantor Trust (KEPCO) Series 1997, approved the appointment of KPMG LLP (“KPMG”) as the Trust’s independent registered public accounting firm to perform independent audit services for the year ended December 31, 2013. During the years ended December 31, 2012 and 2011, and in the period through December 10, 2013, neither CFC, nor anyone on its behalf, consulted KPMG on any matters or events set forth in Item 304(a)(1)(v) of Regulation S-K.

 

The Audit Committee has approved the audit services that KPMG provides the Trust in accordance with applicable SEC independence rules.

 

ITEM 9A. CONTROLS AND PROCEDURES

 

Not applicable.

 

ITEM 9B. OTHER INFORMATION

 

Not applicable.

 

PART III

 

Item 10.Directors, Executive Officers and Corporate Governance

 

Not applicable.

 

Item 11.Executive Compensation

 

Not applicable.

 

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Item 12.Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

Not applicable.

 

Item 13.Certain Relationships and Related Transactions, and Director Independence

 

Not applicable.

 

Item 14.Principal Accountant Fees and Services

 

Not applicable.

 

PART IV

 

Item 15.Exhibits and Financial Statement Schedules

 

(a)Documents filed as part of this report:

 

(1)Financial Statements and Report of Independent Registered Public Accounting Firm

 

The financial statements required to be filed in this Form 10-K are included in “Part II, Item 8.”

 

(2)Financial Statement Schedules

 

None.

 

(3)Exhibits

 

Exhibit

No.

 

 

Description

     
4.1   Form of Trust Agreement, including the form of Rural Electric Cooperative Grantor Trust Certificate (incorporated by reference to Exhibit 4.1 to Registration Statement on Form S-1 [No. 333-25029]).
     
4.2   First Amendment to Trust Agreement (incorporated by reference to Exhibit 4.2 to Registration Statement on Form S-1 [No. 333-25029]).
     
10.1   Loan Agreement dated as of February 15, 1988 between National Rural Utilities Cooperative Finance Corporation (“CFC”) and the Cooperative (including form of Note and Guarantee) (incorporated by reference to Exhibit 10.1 to Registration Statement on Form S-1 [No. 33-16789 filed on August 27, 1987]).
     
10.2   First Amendment to Loan Agreement (incorporated by reference to Exhibit 10.2 to Registration Statement on Form S-1 [No. 333-25029]).
     
10.3   Loan Guarantee and Servicing Agreement, dated as of February 15, 1988, among the Administrator of the RUS, the Cooperative, the Servicer, the Lender and the Trustee (incorporated by reference to Exhibit 10.2 to Registration Statement on Form S-1 [No. 33-16789 filed on August 27, 1987]).
     
10.4   First Amendment to Loan Guarantee and Servicing Agreement (incorporated by reference to Exhibit 10.4 to Registration Statement on Form S-1 [No. 333-25029]).

 

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Exhibit

No.

 

 

Description

10.5   Remarketing Agreement (incorporated by reference to Exhibit 10.5 to Registration Statement on Form S-1 [No. 333-25029]).
     
10.6   Swap Agreement (incorporated by reference to Exhibit 10.6 to Registration Statement on Form S-1 [No. 333-25029]).
     
10.7   Liquidity Protection (incorporated by reference to Exhibit 10.7 to Registration Statement on Form S-1 [No. 333-25029]).
     
10.8   Form of Standby Certificate Purchase Agreement (incorporated by reference to Exhibit 10.8 to Registration Statement on Form S-1 [No. 333-25029]).
     
12*   Computation of Ratio of Earnings to Fixed Charges.
     
99*   JP Morgan Chase & Co. (successor to Morgan Guaranty Trust Co. of NY) and Morgan Guaranty Trust Company of New York (Swap Counterparty) Financial Information.  
     
31.1*   Certification of the Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2*   Certification of the Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1†   Certification of the Chief Executive Officer required by Section 906 of the Sarbanes-Oxley Act of 2002.
     
32.2†   Certification of the Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002.

 

 

* Indicates a document being filed with this Report.

† Indicates a document that is furnished with this Report, which shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that Section.

 

Supplemental information to be furnished with reports filed pursuant to Section 15(d) of the Act by Registrants which have not registered securities pursuant to Section 12 of the Act.

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

  RURAL ELECTRIC COOPERATIVE GRANTOR TRUST (KEPCO) SERIES 1997
   
 

By: NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION, as Servicer

   
Date: March 10, 2014 /s/ SHELDON C. PETERSEN
  Sheldon C. Petersen
  Governor & Chief Executive Officer

 

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