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Announcement:

Moody's affirms National Rural Utilities ratings; outlook stable

20 Oct 2010

Approximately $10 Billion of Debt Securities Affected.

New York, October 20, 2010 -- Moody's has affirmed all of National Rural Utilities Cooperative Finance Corporation (NRUC) ratings, including its A1 senior secured collateral trust bond rating, its A2 senior unsecured rating, and its Prime-1 short-term rating. Concurrent with this rating affirmation, Moody's has a assigned a (P)A1 rating to the shelf registration for NRUC's issuance of senior secured collateral trust bonds. NRUC's rating outlook is stable.

The rating affirmation reflects the high quality of NRUC's loan portfolio, its unique market position as the dominant lender to electric distribution cooperatives, an ability to continue producing margins consistent with its targeted adjusted TIER, a good track record in managing credit restructurings, an improved risk management program, and declining exposure to the more volatile telecommunications sector.

A core element of NRUC's credit strength is the durability of its loan portfolio as the dominant secured lender to electric distribution cooperatives. Moody's views this segment as being low risk and capable of producing highly predictable cash flows due to most cooperatives monopoly position as well as the cooperatives ability to pass along most cost increases to their electric customers when needed, without the approval of state regulators. Loans to electric distribution cooperatives represent 71% of NRUC's loan portfolio at 08/31/2010 and loans to rural electric cooperatives represent more than 90% of the total portfolio. Adding to the strength of NRUC's loan portfolio is the fact that 89% of its loans are secured, which together with the portfolio's low historic default probability, result in a loan portfolio that has historically produced very modest net loan losses.

The affirmation acknowledges continued progress made by NRUC in working to resolve a large nonperforming loan to a bankrupt Virgin Islands telecommunications company. To that end, Moody's observes that on October 6th NRUC completed the transfer of control of the borrower's US Virgin Islands operating companies to NRUC, and will operate these businesses through a wholly owned subsidiary. While the transfer of control will result in the recognition of a sizable loan loss during fiscal year second quarter, completion of the transfer is viewed an important step toward reducing NRUC's exposure to the more risky telecommunications industry.

The rating affirmation factors in the credit benefits of NRUC's unique role as a tax-exempt cooperative providing a supplemental source of low-cost capital to its cooperative membership. Unlike other finance companies, NRUC is a cost-plus lender with a business model that tends to exhibit an overall lower credit risk profile as its success is not determined by achieving earnings targets, balance sheet expansion, or profitability objectives.

Balancing these factors is the degree of concentration risk that remains within NRUC's operations as well as its degree of single obligor risk within the loan portfolio. While NRUC has made some headway to deal with single obligor risk, particularly within its telecommunications portfolio, single obligor risk is likely to remain a characteristic of the NRUC lending platform.

Moody's also observes that NRUC's leverage, while on a slowly declining trend, remains relatively high particularly given the lack of liquidity on the asset side of the balance sheet relative to other financial institutions. During fiscal year 2009, NRUC implemented two initiatives that we believe should reduce leverage over time. Specifically, NRUC sold $398 million of member capital securities to its owners, the member cooperatives, as a means of bolstering the equity component of NRUC's capital structure, and in June 2009, as a means of increasing equity retention, NRUC revised its guidelines related to the timing and amount of patronage capital to be distributed. Under the new guidelines, NRUC will retire 50% of prior year's allocated net earnings and hold the remaining 50% for 25 years. We calculate that the change in the patronage capital cycle coupled with better margins should increase members' equity by less than $200 million over the next three years.

NRUC's ratings consider the continuing but reducing reliance that it has on wholesale funding as a source of capital. In NRUC's case, the member cooperatives continue to provide more than 20% of NRUC's total funding, and access to private financing exists from the Federal Financing Bank as part of the Rural Economic Development Loan and Grant program (REDLG) and from Federal Agricultural Mortgage Corporation (Farmer Mac). Together, both arrangements have provided NRUC with long-term funding and commitments that approaches $6 billion which Moody's views favorably from a credit perspective. To that end, we observe that in September 2010, NRUC obtained a commitment from FFB to provide additional funding of up to $500 million under the REDLG program. Notwithstanding these funding sources, NRUC is still reliant on the capital markets in most years to principally meet maturing debt obligations. Within the last year, NRUC accessed the long-term capital markets through the sale of collateral trust bonds and has in the recent past been an active issuer of unsecured medium term notes, principally through a retail InterNotes program. Moody's observes that in most years, NRUC's amortizing loan portfolio provides around $1 billion of cash flow to the cooperative.

The stable rating outlook incorporates our view that modest loan growth among rural electric cooperatives will help maintain strong asset quality within the loan portfolio. To that end, the stable outlook factors in our belief that the telecom portfolio, a source of loan portfolio weakness, will continue to represent less than 10% of the total loan portfolio. The stable outlook also factors in NRUC's plans to gradually lower leverage, and an expectation that NRUC will maintain sufficient liquidity as well as access to private sources of funding to mitigate the firm's reliance on wholesale funding.

In light of the relatively high leverage and the firm's exposure to potential impairments from certain foreclosed assets, the prospect of a higher rating is limited within the next twelve months.

The rating could be downgraded if a new meaningful problem loan surfaced within NRUC's portfolio, if recently implemented capital raising and capital retention efforts do not reduce NRUC's leverage over the next twelve to eighteen months, if NRUC fails to maintain an adequate liquidity profile, including ample access to multi-year bank credit facilities, or if the lending strategy began to deemphasize the core electric cooperative market.

Ratings affirmed include all of NRUC's senior secured collateral trust bonds and notes at A1, all of NRUC's senior unsecured debt at A2, all of NRUC's subordinate debt (quarterly income capital securities) at A3, and shelf registrations for all of NRUC's senior secured debt, senior unsecured debt and subordinate debt at (P)A1, (P)A2, and (A3), respectively. Also affirmed are NRUC's Prime-1 short-term rating as well as the Prime-1 short-term rating for National Cooperative Services Corporation (NCSC). NRUC guarantees NCSC's commercial paper. Additionally, Moody's affirmed the A2 and VMIG-1 ratings assigned to all NRUC guaranteed, tax-exempt debt issued by municipal entities for the benefit of individual member electric cooperatives.

Assignments:

..Issuer: National Rural Utilities Coop. Finance Corp.

....Senior Secured Shelf, Assigned (P)A1

The principal methodologies used in rating NRUC are Analyzing the Credit Risks of Finance Companies published in October 2000, and U.S. Electric Generation & Transmission Cooperatives,published in May 2006. Other methodologies and factors that may have been considered in the process of rating these issuers can also be found in the Rating Methodologies sub-directory on Moody's website.

Based in Herndon, Virginia, NRUC is a private, tax-exempt cooperative association exclusively serving rural electric and telecommunication utilities. The principal purpose of NRUC is to provide its members with a source of financing to supplement the loan programs of the Rural Utilities Service of the US Department of Agriculture. At August 31, 2010, NRUC had total assets of approximately $20.15 billion, of which loans to members represented about $19.29 billion. At August 31, 2010, approximately 90% of NRUC's total loan portfolio was with rural electric cooperatives.

New York
A.J. Sabatelle
Senior Vice President
Infrastructure Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
William L. Hess
MD - Utilities
Infrastructure Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

Moody's Investors Service
250 Greenwich Street
New York, NY 10007
U.S.A.

Moody's affirms National Rural Utilities ratings; outlook stable
No Related Data.
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