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Rating Action:

MOODY'S AFFIRMS THE RATINGS OF NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION (A2 SR. UNSEC.); RATING OUTLOOK IS STABLE

03 Aug 2005
MOODY'S AFFIRMS THE RATINGS OF NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION (A2 SR. UNSEC.); RATING OUTLOOK IS STABLE

Approximately $18 Billion of Debt Securities Affected.

New York, August 03, 2005 -- Moody's Investors Service affirmed the debt ratings of National Rural Utilities Cooperative Finance Corporation (CFC), including its senior unsecured debt at A2. Moody's also assigned an A1 rating to CFC's $500 million secured medium term note program with Federal Agricultural Mortgage Corporation (FarmerMac) and to the initial issuance of $500 million 4.656% senior secured notes under the program. The rating outlook is stable.

The rating affirmation reflects CFC's stable financial performance, the increasing proportion of loans to lower risk electric distribution cooperatives, and recent actions by CFC to secure additional funding sources that will reduce its reliance on the short-term and long-term capital markets to fund its business and refinance maturing debt. This arrangement with FarmerMac follows the June 14th announcement that CFC had secured access to a financing program from the US government for up to $2.7 billion through the Federal Financing Bank under the Rural Economic Development Loan and Grant (REDL&G) program. Proceeds from the REDL&G program are likely to be utilized over a several year period to refinance maturing debt.

The assignment of the A1 to the senior secured note program reflects the quality of the collateral being pledged to FarmerMac, which is similar to the collateral pledged to creditors under CFC's Collateral Trust Bond (CTB) indenture. The senior secured note program will be secured by eligible loans to electric distribution cooperatives, primarily those located in communities with fewer than 50,000 inhabitants. As is the case under the CTB indenture, CFC will be obligated to provide substitute collateral if loans become ineligible due to the performance of the obligor. CFC's credit agreements limit the amount of additional secured indebtedness to $500 million and the company currently has substantial unencumbered potential substitute collateral.

The rating affirmation acknowledges CFC's strong competitive position in the cooperative sector, a degree of flexibility to raise rates charged to its cooperative membership, a loan loss reserve ($574 million at 02/28/05) that represents nearly 3% of total loans, and the quality of its loan portfolio, which has a strong collateral position and a favorable loan loss history. Over 80% of the loans outstanding are to rural electric cooperatives, a segment which has historically demonstrated stable earnings and cash flow. More than 90% of CFC's loans are secured and CFC's total net losses over its 36-year history aggregate only $115 million. CFC has effectively managed difficult credit situations in the past, supported by its strong security position. Its status as a not-for-profit entity allows management to take a longer-term view towards restructuring difficult credit situations; although Moody's notes that this also has the potential to delay resolution of problems. CFC enjoys a very strong and loyal relationship with its cooperatives, which helps in maintaining its dominant market niche.

The rating affirmation also considers the progress that CFC has made in reducing large single obligor concentration risk during 2005 through the refinancing and syndication of large credits to both the electric cooperative and telecommunication cooperative sectors. Exposure to borrowers in the telecommunications sector, an ongoing rating concern, has materially declined by $1.5 billion to $3.1 billion over the last three quarters, representing 16% of total loans at February 28, 2005.

CFC's portfolio includes two large troubled credits with VarTec Telecom (VarTec), which is operating in bankruptcy, and with Innovative Communications Corporation (ICC), which was placed on non-performing status on February 1, 2005. VarTec, which had exposure to CFC of $188 million at February 28, 2005, continues to make interest payments on its loans with CFC and its total exposure has declined by $152 million during fiscal year 2005 principally through asset sales. ICC, which had exposure to CFC of $482 million at February 28, 2005, continues to be involved with numerous pieces of litigation with CFC. Any payments that CFC receives on its ICC loans are being applied to reduce the principal indebtedness with ICC. In light of the size of CFC's loan loss reserve and its track record in dealing with difficult credits, the rating incorporates the expectation that CFC should be able to adequately manage these two exposures.

CFC's stable outlook considers a continuation of fairly modest loan growth with low risk electric distribution cooperatives representing an increasing portion of its portfolio, maintenance of a significant loan loss reserve, a continued decline in the telecom loan portfolio, and a reasonable outcome for the exposures to VarTec and ICC. In light of the uncertain outcome for these two troubled loans, the existence of single obligor exposure, and the relatively high leverage, an upgrade of the existing rating in the near-term is not likely. Longer term, sustainable improvements in the portfolio in combination with a conservative balance sheet strategy could lead to positive implications for the rating. Conversely, an unfavorable resolution for CFC's two large troubled credits or the appearance of a large new troubled credit could place downward pressure on the rating.

Ratings affirmed include:

- CFC's senior secured debt (Collateral Trust Bonds) at A1;

- CFC's senior unsecured debt at A2 ;

- CFC's subordinate debt (Quics) at A3;

- Secured tax-exempt obligations of rural cooperatives guaranteed by CFC at A1;

- Unsecured tax-exempt obligations of rural cooperatives guaranteed by CFC at A2;

- Senior unsecured debt of National Cooperative Services Corporation (NCSC) guaranteed by CFC at A2;

- Shelf registrations for senior secured debt, senior unsecured debt, and subordinate debt at (P)A1, (P)A2, and (P)A3, respectively for CFC;

- Short-term rating of Prime-1 for CFC's commercial paper;

- Short-term rating of Prime-1 for NCSC's commercial paper (guaranteed by CFC);

- Short-term rating of Prime-1 and VMIG-1 for variable rate demand notes issued by rural cooperatives and guaranteed by CFC.

Headquartered in Herndon, VA, CFC is a non-profit organization that is the principal source of private financing for rural electric cooperatives and rural telephone cooperatives. CFC is owned by its members, which are primarily rural electric cooperatives.

New York
Daniel Gates
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
A.J. Sabatelle
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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