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

 

 

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.

 

 

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

 

 

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

 

 

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.

 

 

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.

 

 

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. 

 

 

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. 

 

 

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.

 

 

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.

 

 

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

 

 

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.

 

 

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				—

 

 

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.

 

 

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.

 

 

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]).

 

  

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.

 

 

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