Approximately $18 Billion of Debt Securities Affected
New York, November 12, 2003 -- Moody's Investors Service confirmed the debt ratings of National Rural
Utilities Cooperative Finance Corporation (CFC), including its senior
unsecured debt at A2, and revised the rating outlook of CFC to stable
The rating action reflects the following developments that have strengthened
CFC's credit quality:
1. Signs of significant improvement in the quality of CFC's loan
portfolio. The gradual and sustained improvement in the Western
US wholesale power market has improved the prospects for Deseret Generation
& Transmission Cooperative (Deseret), which is one of CFC's
largest borrowers. CFC has reclassified approximately $536
million in loans to Deseret to performing status. A restructuring
of approximately $1 billion of loans to Denton County Electric
Cooperative (CoServ), related to CoServ's emergence from bankruptcy
during fiscal year 2003, allowed CFC to reclassify its largest problem
loan. CFC has only $3 million in loans classified as non-performing
as of August 31, 2003.
2. An increase in the loan loss reserve to $565 million
at May 31, 2003 from $228 million at May 31, 2000.
With the increase in the loan loss reserve, CFC's loan loss reserve
to total loans stands at 2.90% at year-end 2003,
representing a substantial improvement from the 1.37% level
at year-end 2000. At August 31, 2003, CFC's
loan loss reserve was $541 million.
3. A shift in funding strategy that has resulted in a substantially
reduced reliance upon short-term debt. Short-term
debt represented 13.5% of total adjusted debt at May 31,
2002 and 5.4% of total adjusted debt at May 31, 2003,
a sharp contrast to past periods when short term debt represented a majority
of total adjusted debt.
4. More measured loan growth during the past two years as weighted
average loans grew by 0.1% in 2003 and by 5.1%
in 2002, after growing more than 20% in each of the previous
years dating back to fiscal year 1998.
5. A decline in leverage. Adjusted funded debt (including
Quics) to equity is 8.21x at May 31, 2003, a decline
of 86 basis points from the fiscal year end 2000 level of 9.07x.
Management has targeted additional reductions in leverage over the next
The confirmation of CFC's ratings considers its strong competitive position,
a degree of flexibility to raise rates charged to its cooperative membership,
and the quality of its loan portfolio, which has a strong collateral
position and a favorable loan loss history. More than 90%
of CFC's loans are secured and CFC's total losses over its 34-year
history aggregate only $115 million at August 31, 2003.
As evidenced by the results at Deseret and CoServ, CFC has historically
demonstrated an ability to effectively manage difficult credit situations,
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 also incorporates the large single obligor concentration risk,
and the sector concentration with approximately 75% of its loans
being made to electric cooperatives. The single obligor concentration
could result in a lumpy problem loan portfolio, with the potential
for large changes in portfolio quality based upon the trends of a few
borrowers. While CFC sets aside incremental loan loss reserves
for single obligor exposures, this remains a long standing concern
of Moody's, particularly given the lack of liquidity on the asset
side of the balance sheet. The rating further considers CFC's $4.9
billion loan exposure to the rural telecommunications industry.
While 78% of CFC's telecommunications portfolio represents loans
to rural local exchange carriers, a lower risk segment of the industry,
Moody's views this portfolio as having higher risk features than CFC's
electric portfolio, as these borrowers are more exposed to risks
related to competition and changes in technology. Additionally,
the rating recognizes that the success of CoServ debt restructuring depends,
in part, upon the performance of a $325 million of real estate
notes, which while amortizing quickly, could pose potential
impairment issues for CFC in subsequent reporting periods. Moody's
notes that subsequent to the end of the first quarter fiscal year 2004,
CFC sold the telecom assets acquired in the Coserv restructuring with
no net balance sheet impact.
While CFC has reduced its reliance on the commercial paper market,
CFC remains highly reliant on the capital markets for funding its business
and for refinancing maturing debt. CFC's principal source of liquidity
is $3.95 billion in credit facilities, all of which
expire during differing times in calendar year 2004. The credit
facilities do not have material adverse change clause representation for
fundings, have fairly relaxed covenants and $2.92
billion of the facilities have one-year term out provisions.
CFC intends to extend the expiry date of these facilities during the first
part of calendar year 2004, and would be expected to space the maturities
of the renewed facilities over a broader timeframe.
During 2003, CFC introduced a dynamic risk scoring system which
CFC believes helps it to determine the appropriate level of loan loss
reserves for the portfolio. Moody's views the introduction and
implementation of this system as supportive to credit quality given that
its existence may help to better match future reserve levels against the
size and the credit quality of the loan portfolio. While changes
to the portfolio risk scoring and subsequent loan loss reserves are likely
to occur over time due to changes in an individual borrower's credit quality
or due to changes in the portfolio composition, Moody's does not
expect the loan loss reserve to appreciably change from its current level
in the near term. Maintenance of a reasonable loan loss reserve
reserve is an important factor in maintaining CFC's current rating.
This is particularly true due to the high degree of single obligor exposure
and the relatively illiquid nature of the majority of CFC's loans.
Moreover, Moody's notes the existence of potential credit weakness
in more than one of CFC's larger borrowers. As such, an unjustifiable
and material decline in CFC's loan loss reserve, if implemented,
could be detrimental to both CFC's outlook and rating.
CFC's stable outlook incorporates the continued expected gradual decline
in leverage, fairly modest loan growth, and assumes that the
loan portfolio continues to perform as expected, including all elements
of the CoServ debt restructuring, that there are no material changes
in credit quality and that CFC maintains an ample loan loss reserve.
CFC's rating outlook also incorporates the view that the inherent characteristics
of CFC's business make a rating upgrade unlikely in the absence of a substantial
deleveraging or change in business risk. As a non-profit
entity, CFC is operated with relatively thin coverages. CFC
manages its business to earn a sufficient margin to maintain at least
1.10 TIER (Times Interest Earned Ratio). With large single
obligor risks, significant deterioration in the loan portfolio can
occur with only a few problem borrowers, which may have higher correlation
in common risks due to their industry concentration. The lack of
liquidity on the asset side of the balance sheet is also likely to continue,
reflecting the limited number of active participants lending to the electric
cooperative sector and the tight margins associated with most of CFC's
Ratings confirmed 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,
- Short-term rating of Prime-1 for CFC's commercial
paper and extendible commercial notes;
- 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
Headquartered in Herndon, VA, CFC is a non-profit organization
that is the principal source of private financing for rural electric and
rural telephone cooperatives. CFC is owned by its members,
which are primarily rural electric cooperatives.
Corporate Finance Group
Moody's Investors Service
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service