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 May 31, 2001
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 1-7102

NATIONAL RURAL UTILITIES COOPERATIVE
FINANCE CORPORATION
(Exact name of registrant as specified in its charter)

DISTRICT OF COLUMBIA
(State or other jurisdiction of incorporation or organization)

52-0891669
(I.R.S. Employer Identification Number)

2201 COOPERATIVE WAY, HERNDON, VA 20171
(Address of principal executive offices)
(Registrant’s telecommunications number, including area code, is 703-709-6700)

Securities registered pursuant to Section 12(b) of the Act:

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 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 IV of this Form 10-K or any amendment to this Form 10-K. Yes X   No    .

The Registrant has no stock.

TABLE OF CONTENTS

Part I

Item 1. Business.

General
National Rural Utilities Cooperative Finance Corporation (“CFC”) was incorporated as a private, not-for-profit cooperative association under the laws of the District of Columbia in April 1969. The principal purpose of CFC is to provide its members with a dependable source of low cost capital and state-of-the-art financial products and services. CFC provides its members with a source of financing to supplement the loan programs of the Rural Utilities Service (“RUS”) of the United States Department of Agriculture. CFC will also lend 100% of the loan requirement for those distribution utility members electing not to borrow from RUS. CFC is owned by and makes loans primarily to its rural utility system members (“utility members”) to enable them to acquire, construct and operate electric distribution, generation, transmission and related facilities. CFC also provides guarantees to its members for tax-exempt financings of pollution control facilities and other properties constructed or acquired by its members, debt in connection with certain leases and various other transactions. CFC is exempt from federal income taxes under the provisions of Internal Revenue Code section 501(c)(4).

CFC formed an affiliated corporation, Rural Telephone Finance Cooperative (“RTFC”), which was incorporated as a taxable cooperative association in the State of South Dakota in September 1987. RTFC is a controlled affiliate of CFC and was created for the purpose of providing financing to its rural telecommunication members and affiliates. RTFC’s bylaws and voting members’ agreement require that the majority of RTFC’s board of directors be elected from individuals designated by CFC. CFC is the sole source of external funding for RTFC. RTFC is a taxable entity under Subchapter T of the Internal Revenue Code.

Except as indicated, financial information presented herein includes CFC and RTFC on a combined basis.

CFC provides financing for rural utility cooperatives and telecommunications companies. There are two primary segments of CFC’s business, rural electric lending and rural telecommunications lending. Lending to electric cooperatives is done through CFC and lending to telecommunications organizations is done through RTFC. In many cases, the customers of the electric cooperatives are also the customers of the telecommunications organizations, as both sets of members serve the rural areas of the United States.

Members
CFC had 1,045 members as of May 31, 2001, including 900 utility members, virtually all of which are consumer-owned cooperatives, 73 service members and 72 associate members. The utility members included 830 distribution systems and 70 generation and transmission (“power supply”) systems operating in 49 states and four U.S. territories.

CFC currently has five classes of members:

•		Class A–cooperative or not-for-profit distribution systems;
•		Class B–cooperative or not-for-profit power supply systems;
•		Class C–statewide and regional associations which are wholly-owned or controlled by Class A or Class B members;
•		Class D–national associations of cooperatives; and
•		Class E–associate members–not-for-profit groups or entities organized on a cooperative basis which are owned, controlled or operated by Class A, B or C members and which provide non-electric services primarily for the benefit of ultimate consumers. Associate members are not entitled to vote at any meeting of the members and are not eligible to be represented on CFC’s board of directors.

RTFC had 516 members as of May 31, 2001. Membership in RTFC is limited to CFC and commercial (for-profit) or cooperative (not-for-profit) telecommunications systems eligible to receive loans or other assistance from RUS, which are engaged (or plan to be engaged) in providing telecommunication services to ultimate users and affiliates of such corporations.

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Set forth below is a table showing by state or U.S. territory the total number of CFC and RTFC members (memberships in each other have been eliminated and corporations which belong to both CFC and RTFC have been counted only once), the percentage of total loans and the percentage of total loans and guarantees outstanding at May 31, 2001.

Distribution Systems
Distribution systems are utilities engaged in retail sales of electricity to consumers in their service areas. Most distribution systems have all-requirements power contracts with their power supply systems, which are owned and controlled by the member systems. The wholesale power contracts between the distribution systems and the power supply systems provide for rate adjustments to cover the costs of supplying power, although in certain cases such adjustments must be approved by regulatory agencies. Wholesale power for resale also comes from other sources, including power supply system contracts with government agencies, investor-owned utilities and other entities, and in rare cases, the cooperative’s own generating facilities.

Wholesale power supply contracts ordinarily guarantee neither an uninterrupted supply nor a constant cost of power. Contracts with RUS financed power supply systems (which generally require the distribution system to purchase all its power requirements from the power supply system) provide for rate increases to pass along increases in sellers’ costs. The wholesale power contracts permit the power supply system, subject to approval by RUS and, in certain circumstances, regulatory agencies, to establish rates to its members so as to produce revenues sufficient, with revenues from all other sources, to meet the costs of operation and maintenance (including replacements, insurance, taxes and administrative and general overhead expenses) of all generating, transmission and related facilities, to pay the cost of any power and energy purchased for resale, to pay the costs of generation and transmission, to make all payments on account of all indebtedness and leases of the power supply system and to provide for the establishment and maintenance of reasonable reserves. The board of directors of the power supply system reviews the rates under the wholesale power contracts at least annually.

Power contracts with investor-owned utilities and power supply systems which do not borrow from RUS generally have rates subject to regulation by the Federal Energy Regulatory Commission (“FERC”). Contracts with federal agencies generally permit rate changes by the selling agency (subject, in some cases, to federal regulatory approval).

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Power Supply Systems
Power supply systems are utilities that purchase or generate electric power and provide it on a wholesale basis to distribution systems for delivery to the ultimate retail consumer. Of the 62 operating power supply systems financed in whole or in part by RUS or CFC at December 31, 1999, 61 were cooperatives owned directly or indirectly by groups of distribution systems and one was government owned. Of this number, 37 had generating capacity of at least 100 megawatts, and ten had no generating capacity. The systems with no generating capacity generally operate transmission lines to supply certain distribution systems. Certain other power supply systems have been formed but do not yet own generating or transmission facilities. (2000 data not yet available).

At December 31, 1999, the 54 power supply systems reporting to CFC owned interests in 141 generating plants representing generating capacity of approximately 31,058 megawatts, or approximately 4.1% of the nation’s estimated electric generating capacity, and served 649 RUS distribution system borrowers. Certain of the power supply systems which lease generating plants from others operate these facilities to produce their power requirements. Of the power supply systems’ total generating capacity in place as of December 31, 1999, steam plants accounted for 89.5% (including nuclear capacity representing approximately 8.6% of such total generating capacity), internal combustion plants accounted for 8.1% and hydroelectric plants accounted for 2.4%. (2000 data not yet available).

Service Organizations and Associate Member Systems
Service organizations include the National Rural Electric Cooperative Association (“NRECA”), statewide cooperative associations, and the National Cooperative Service Corporation (“NCSC”). NRECA represents cooperatives nationally. The statewide cooperative associations represent the cooperatives within a state. NCSC is owned and governed by its electric cooperative members. NCSC’s membership is composed of certain CFC distribution members. NCSC is operated by CFC staff under a management agreement. NCSC’s board is composed of 11 directors, ten of whom are elected from its member cooperative organizations and one is selected by CFC. NCSC lends to the for-profit subsidiaries and customers of its members and to organizations that provide substantial benefit to a NCSC member. NCSC obtains all of its funding through direct loans from CFC, private placement debt issuance with a guarantee from CFC and by the sale of commercial paper with a CFC guarantee.

Associate members include organizations that are owned, controlled or operated by, or provide significant benefit to, class A, B or C members and that provide non-electric services primarily for the benefit of ultimate consumers.

Telecommunications Systems
Telecommunications systems include not-for-profit cooperative organizations and for-profit commercial organizations that provide telecommunications services to rural areas.

Independent rural telecommunications companies provide service in the majority of America’s rural areas. These companies, which number approximately 1,020, are called independent because they are not affiliated with the Regional Bell Operating Companies or other large holding companies. The majority of these independent rural telecommunications companies are small family-owned or privately-held commercial companies. Six of these commercial companies are publicly traded. Included in the total are approximately 275 not-for-profit cooperative telecommunications companies.

Rural telecommunications companies serve approximately 1.2 million business customers and 4.7 million residential customers in 48 states and U.S. territories, and range in size from fewer than 50 customers to more than 100,000. Rural telecommunications companies’ annual operating revenues range from less than $100,000 to $100 million. In addition to basic telecommunications service, most independents offer other communications services including wireless, cable television and internet access. Most rural telecommunications companies’ networks are state-of-the-art, incorporating digital switching, fiber optics and other advanced technologies.

Loan Programs

CFC offers long-term loans with maturities of up to 35 years, intermediate-term loans with maturities of up to five years, and line of credit loans. Long-term and intermediate-term loans are available at fixed or variable interest rates and line of credit loans are available only at a variable interest rate. Long-term loans are generally secured by a first mortgage lien on all assets and revenues of the borrower. Intermediate-term loans may be secured or unsecured and line of credit loans are generally unsecured. On line of credit loans with a maturity of more than one year, the outstanding balance is generally required to be paid down to zero for five consecutive days during each year. CFC makes loans to borrowers on a concurrent basis with RUS (generally 70% RUS/30% CFC) and will also make 100% loans to borrowers electing not to borrow from RUS.

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Members with long-term loans outstanding are required to provide annual audited financial statements to CFC. Borrowers also must make various representations in an officer’s certificate and maintain certain levels of financial performance as prescribed under each loan program.

Set forth below is a table showing loans outstanding to borrowers as of May 31, 2001, 2000 and 1999 and the weighted average interest rates thereon and loans committed but unadvanced to borrowers at May 31, 2001.

Interest Rates on Loans
CFC’s goal as a not-for-profit cooperatively-owned finance company is to set its rates at levels that will provide its members with the lowest cost financing while maintaining sound financial results as required to obtain high credit ratings on its debt instruments. CFC sets its interest rates based on the cost of funding plus provisions for general and administrative expenses, the loan loss allowance and a reasonable net margin. Various discounts, which reduce the stated interest rates, are available to borrowers meeting certain criteria related to performance, volume and whether they borrow exclusively from CFC.

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Set forth below are the weighted average interest rates earned on all loans outstanding during the fiscal years ended May 31:

		2001				2000				1999
Long-term fixed rate			6.78	%			6.66	%			6.69	%
Long-term variable rate			7.60	%			6.59	%			6.20	%
Telecommunication organizations (1)			8.31	%			7.45	%			6.88	%
Refinancing loans guaranteed by RUS			6.61	%			6.29	%			5.87	%
Intermediate-term			7.99	%			6.92	%			6.98	%
Short-term			8.01	%			7.01	%			6.26	%
Associate members			7.86	%			6.85	%			6.47	%
Nonperforming			0.00	%			0.00	%			0.00	%
Restructured			4.33	%			3.90	%			1.73	%
All loans			7.36	%			6.74	%			6.51	%

Electric Loan Programs

Long-Term Loans
Long-term loans are generally for terms of up to 35 years. A borrower can select a fixed interest rate for periods of one to 35 years or the variable rate. Upon the expiration of the selected fixed interest rate term, the borrower must select the variable rate or select another fixed rate term for a period that does not exceed the remaining loan maturity. CFC sets long-term fixed rates daily and the long-term variable rate is set on the first business day of each month. The fixed rate on a loan is determined on the day the loan is advanced based on the rate term selected. A borrower may divide its loan into various traunches. The borrower then has the option of selecting a fixed or variable interest rate for each traunch.

To be eligible for long-term loan advances, distribution systems must maintain an average modified debt service coverage ratio (“MDSC”), as defined in the loan agreement, of 1.35 or greater. The distribution systems must also be in good standing with CFC and their states of incorporation, supply evidence of proper corporate authority and deliver to CFC annual audited financial statements. Generally, the minimum eligibility requirements for power supply systems are an average times interest earned ratio (“TIER”) and MDSC, as described in the loan agreement, of 1.0 or greater. Loans to power supply systems are considered on a case-by-case basis depending on the amount of the loan, the intended use of funds, the financial condition of the borrower and any guarantees that may be provided by a third party, including RUS and the member distribution systems. CFC has in the past and may in the future make long-term loans to distribution and power supply systems that do not meet the minimum lending criteria. During the five years ended May 31, 2001, 2.1% of the dollar amount of long-term loans approved was to borrowers that did not meet the minimum lending criteria. In addition, during the five years ended May 31, 2001, CFC approved loans totaling $624 million for discounted RUS note buyouts by three power supply systems. In these transactions, CFC obtained guarantees from the member distribution systems totaling $323 million.

Intermediate-Term Loans and Line of Credit Loans
Intermediate-term loans are generally for terms of one year to five years. Intermediate-term loans can be advanced at a fixed interest rate or at a variable interest rate. Line of credit loans may be advanced only at a variable interest rate. The intermediate-term and line of credit variable interest rate is set on the first business day of each month. Line of credit loans with maturities of greater than one year generally must be paid down to a zero outstanding balance for five consecutive days during each year.

To be eligible for an intermediate-term loan or line of credit loan, distribution and power supply borrowers must be in good standing with CFC and demonstrate their ability to repay the loan.

Power Vision Program
Under this program, an eligible borrower is pre-approved for long-term secured financing, in an aggregate amount that can be drawn down in increments as requested by the borrower over a five-year period. All necessary approvals, administrative procedures and loan documentation are obtained or put into place at the time the credit facility is established, and the borrower has significant flexibility in determining the size and maturity of each loan requested under the facility. CFC does not charge its members a commitment fee on amounts approved under the power vision program. A borrower must meet loan eligibility criteria at the time of any advance under the power vision program. In addition, a borrower must assure CFC that there has been no material adverse change since loan approval.

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Telecommunications Loan Programs

Long-Term Loans
CFC makes long-term loans to rural telecommunications companies and their affiliates for the acquisition of and the construction or upgrade of wireline telecommunications systems, wireless telecommunications systems, fiber optic networks and cable television systems as well as other legitimate corporate purposes. Long-term loans are generally for periods of up to 15 years. Loans may be advanced at a fixed or variable interest rate. Fixed rates are generally available for periods from one year to 15 years. Upon the expiration of the selected fixed interest rate term, the borrower must select another fixed rate term for a period that does not exceed the remaining loan maturity or select the variable rate. CFC sets long-term fixed rates for telecommunications loans daily and the long-term variable rate is set on the first business day of each month. The fixed rate on a loan is determined on the day the loan is advanced or converted to a fixed rate based on the term selected. A borrower may divide its loan into various traunches. The borrower then has the option of selecting a fixed or variable interest rate for each such traunch.

To borrow from CFC, a wireline telecommunications system generally must be able to demonstrate the ability to achieve and maintain an annual debt service coverage ratio (“DSC”) and an annual TIER of 1.25 and 1.50, respectively. To borrow from CFC, a cable television system, fiber optic network or cellular telecommunications system generally must be able to demonstrate the ability to achieve and maintain an annual DSC of 1.25. Loans made to start-up ventures using emerging technologies are evaluated based on the quality of the business plan and the level and quality of credit support from established companies. Based on the business plan, specific covenants are developed for each transaction which requires performance at levels sufficient to repay the CFC obligations under the approved terms.

Intermediate-Term Loans and Line of Credit Loans
CFC provides intermediate-term equipment financing to telecommunications borrowers for periods up to five years. These loans are provided on an unsecured basis and are used to finance the purchase and installation of central office equipment, support assets and other communications equipment. Intermediate-term equipment financing loans are generally made to operating telecommunications companies with an equity level of at least 25% of total assets and which have achieved a DSC ratio for each of the previous two calendar years of at least 1.75.

CFC also provides line of credit loans to telecommunications systems for periods of up to five years. These line of credit loans are typically in the form of a revolving line of credit, which generally requires the borrower to pay off the balance for five consecutive business days at least once during each 12-month period. These line of credit loans may be provided on a secured or unsecured basis and are designed primarily for cash management. Line of credit loans are available to telecommunications systems generally in amounts not to exceed the greater of 5% of total assets or 25% of equity in excess of 35% of total assets.

Interim financing line of credit loans are also made available to CFC telecommunications members that have an RUS and/or the Rural Telephone Bank (“RTB”) loan application pending and have received approval from RUS to obtain interim financing. These loans are for terms up to 24 months and must be retired with advances from the RUS/RTB long-term loans.

RUS Guaranteed Loans
Congress enacted legislation that allows certain systems to prepay existing borrowings from the Federal Financing Bank (“FFB”) without prepayment penalties or fees. CFC established a program under which it made long-term loans to members for the purpose of prepaying these loans. Each note evidencing such a loan was issued to a trust, which in turn issued certificates evidencing its ownership to CFC. The principal and interest payments on these notes are guaranteed by RUS. Under RUS loan repayment regulations, the note rate may not exceed the rate borne by the system’s prepaid borrowings from the FFB adjusted to reflect savings accrued since prepayment of the note compared with the rate on the prepaid borrowing. The systems are required to pay servicing fees to CFC in connection with these transactions. At May 31, 2001, CFC was holding certificates totaling $45 million. In addition, at May 31, 2001, CFC serviced $143 million of these loans for trusts, the certificates of which have been sold in public offerings.

The level of authority for RUS loan guarantees for the fiscal year ending September 30, 2001, is $1.7 billion. The proposed level for fiscal year 2002 is $2.7 billion. CFC may participate as an eligible lender in the RUS loan guarantee program under the terms and conditions of a master loan guarantee and servicing agreement, dated as of February 16, 1999, between RUS and CFC. Under this agreement, CFC may make long-term secured loans to eligible members for periods of up to 35 years, at fixed or variable rates established by CFC. As long as CFC is in compliance with the terms and conditions of the agreement, RUS will guarantee the principal and interest payments on the notes evidencing such loans. At May 31, 2001, CFC had $137 million of loans outstanding under this program.

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Largest Borrowers
At May 31, 2001, the ten largest borrowers had outstanding loans from CFC totaling $5,128 million, which represented 26% of CFC’s total loans outstanding. At May 31, 2001, outstanding guarantees for these same ten borrowers totaled $562 million, which represented 26% of CFC’s total guarantees outstanding. CFC’s ten largest credit exposures represented 26% and 21% of total exposure at May 31, 2001 and 2000, respectively. On those dates, no member had outstanding loans and guarantees in excess of 4.3% of the aggregate amount of CFC’s outstanding loans and guarantees.

Credit Limitation
Under CFC’s policy, (1) CFC’s total exposure to any borrower is limited to 25% of CFC’s defined net worth, (2) CFC’s unsecured loans to any borrower are limited to 10% of CFC’s defined net worth, and (3) CFC’s guarantees outstanding for the benefit of any member are limited to 10% of CFC’s defined net worth. CFC’s defined net worth is the total of subordinated certificates issued and outstanding, members’ equity and the loan loss allowance. If a borrower submitting a new loan application has a CFC exposure in excess of any one of the three tests, only the CFC board of directors may approve the new loan application. CFC’s board of directors may approve a loan to a borrower with an exposure in excess of one or more of these tests after consideration of other factors, including the amount of the loan, the maturity of the loan, and the value of collateral held by CFC. At May 31, 2001, there were six borrowers with total exposure greater than 25% of CFC’s defined net worth, one of which also had total guarantees outstanding in excess of 10% of CFC’s defined net worth. Only CFC’s board of directors may approve new loans to these borrowers.

Loan Security
CFC typically makes long-term loans to its members on a secured basis. Intermediate-term loans may be secured or unsecured, as determined on a case-by-case basis. Line of credit loans are generally unsecured. At May 31, 2001, a total of $2,072 million of loans were unsecured representing 11% of total loans. CFC’s long-term loans are typically secured pro-rata with other secured lenders (primarily RUS) by all assets and future revenues of the borrower. In addition to the collateral received, CFC also requires that its borrowers set rates designed to achieve certain financial ratios.

In the case of members whose property is subject to the new form of RUS mortgage that has been used since January 1996, no RUS approval of the CFC loan is required if certain objective tests set forth in the mortgage are met. In August 1998, RUS promulgated regulations which provide that no RUS approval is required for a loan made to a member whose property is subject to the pre-1996 form of RUS mortgage, so long as the objective tests set forth in the new form of RUS mortgage are met. In all other cases, RUS approval of the loan is required, even in the case of a 100% CFC loan, in order to accommodate RUS’s mortgage lien so that CFC may share ratably in the security provided by the mortgaged property. CFC and RUS are then mortgagees in common, entitled to the security in proportion to the unpaid principal amounts of their respective loans. Mortgages do not require that the value of the mortgaged property be at least equal to the obligations secured thereby.

Events of default under the long-term mortgages include default in the payment of the mortgage notes, default (continuing after grace periods in some cases) in the performance of the covenants in the loan agreements or the mortgages and events of bankruptcy and insolvency. Under common mortgages securing long-term CFC loans to distribution system members, RUS has the sole right to exercise remedies on behalf of all holders of mortgage notes for 30 days after default. If RUS does not act within 30 days or if RUS is not legally entitled to act on behalf of all noteholders, CFC may exercise remedies. Under common mortgages securing long-term CFC loans to, or guarantee reimbursement obligations of, power supply members, RUS retains substantial control over the exercise of mortgage remedies. RUS holds the loan security on loans for which it has provided a guarantee.

Security for long-term loans made to RUS telecommunications borrowers generally consists of a first mortgage lien on the assets and revenues of the system on a pari passu basis with RUS. Security for long-term loans made to non-RUS telecommunications borrowers is typically a first mortgage lien on all assets and revenues of the borrower and generally a loan will not exceed 80% of the estimated value of the collateral. At May 31, 2001, a total of $167 million or 3% of CFC’s telecommunications loans outstanding was unsecured. These unsecured loans are primarily lines of credit made to RUS borrowers.

At May 31, 2001, CFC had a total of $371 million of unsecured guarantees, representing 17% of total guarantees. When considered together, CFC’s unsecured credit at May 31, 2001, totaled $2,443 million, representing 11% of total loans and guarantees outstanding.

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Conversion of Loans
A borrower may convert a long-term loan from a variable interest rate to a fixed interest rate at any time without a fee. A borrower may convert a fixed rate to another fixed rate or a variable rate at any time, subject to a fee in most instances. Intermediate-term loans and line of credit loans do not offer conversion options. The fee on the conversion of a fixed interest rate to a variable interest rate ranges from 25 to 50 basis points of the outstanding loan amount plus an amount to cover the funding loss on the remainder of the current fixed rate pricing term.

Prepayment of Loans
Borrowers may prepay long-term loans at any time, subject to the payment of a prepayment premium of 33 to 50 basis points and a make-whole premium, if applicable. Line of credit loans may be prepaid at any time without a premium.

Pledging of Loans
CFC pledges long-term secured distribution member loans as collateral to secure its collateral trust bonds. CFC must maintain collateral on deposit with the trustee in a principal amount at least equal to the principal balance of collateral trust bonds outstanding. At May 31, 2001 and 2000, CFC had $5,612 million and $3,484 million, respectively, of collateral on deposit securing $4,739 million and $3,351 million, respectively, of collateral trust bonds outstanding. CFC may withdraw collateral at any time, provided that the principal balance of notes and cash and eligible securities on deposit after withdrawal is greater than the principal amount of bonds outstanding.

Guarantee Programs

Substantially all guarantees have been provided on behalf of power supply members. Set forth below is a table showing CFC’s guarantees:

Guarantees of Long-Term Tax-Exempt Bonds
CFC has guaranteed debt issued in connection with the construction or acquisition by CFC members of pollution control, solid waste disposal, industrial development and electric distribution facilities. Governmental authorities issue such debt and the interest thereon is exempt from Federal taxation. The proceeds of the offering are made available to the member system, which in turn is obligated to pay the governmental authority amounts sufficient to service the debt. The debt, which is guaranteed by CFC, may include short- and long-term obligations.

In the event of a default by a system for nonpayment of debt service, CFC is obligated to pay, after available debt service reserve funds have been exhausted, scheduled debt service under its guarantee. The bond issue may not be accelerated so long as CFC performs under its guarantee. The system is required to repay, on demand, any amount advanced by CFC pursuant to its guarantee. This repayment obligation is secured by a common mortgage with RUS on all the system’s assets, but CFC may not exercise remedies thereunder for up to two years following default. However, if the debt is accelerated because of a determination that the interest thereon is not tax-exempt, the system’s obligation to reimburse CFC for any guarantee payments will be treated as a long-term loan. The system is required to pay to CFC initial and/or on-going guarantee fees in connection with these transactions.

Certain guaranteed long-term debt bears interest at variable rates which are adjusted at intervals of one to 270 days, weekly, each five weeks or semi-annually to a level expected to permit their resale or auction at par. At the option of the member on whose behalf it is issued, and provided funding sources are available, rates on such debt may be fixed until maturity. Holders have the right to tender the debt for purchase at par at the time rates are reset when it bears interest at a variable rate and CFC has committed to purchase debt so tendered if it cannot otherwise be remarketed. If CFC held the securities, the cooperative would pay interest to CFC at its intermediate-term loan rate.

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Guarantees of Lease Transactions
CFC has a program of lending to or guaranteeing debt issued by NCSC in connection with leveraged lease transactions. In such transactions, NCSC lends money to an industrial or financial company (a “lessor”) for the purchase of a power plant (or an undivided interest therein) or utility equipment which is then leased to a CFC member (the “lessee”) under a lease requiring the lessee to pay amounts sufficient to permit the lessor to service the loan. The loans are made on a non-recourse basis to the lessor but are secured by the property leased and the owner’s rights as lessor. NCSC borrows the funds it lends either directly from CFC or from another creditor with a CFC guarantee. NCSC is obligated to pay administrative and/or guarantee fees to CFC in connection with these transactions. The lessee in each transaction reimburses such fees to NCSC. CFC may also guarantee the rent obligation of its members to a third party.

Guarantees of Tax Benefit Transfers
CFC has also guaranteed members’ obligations to indemnify against loss of tax benefits in certain tax benefit transfers that occurred in 1981 and 1982. A member’s obligation to reimburse CFC for any guarantee payments would be treated as a long-term loan, secured on a pari passu basis with RUS by a first lien on substantially all the member’s property to the extent of any cash received by the member at the outset of the transaction. The remainder would be treated as an intermediate-term loan secured by a subordinated mortgage on substantially all of the member’s property. Due to changes in Federal tax law, no guarantees of this nature have occurred since 1982.

Letters of Credit
CFC issues irrevocable letters of credit to support members’ obligations to energy marketers, other third parties and to the Rural Business and Cooperative Development Service. Letters of credit are generally issued on an unsecured basis and with such issuance fees as may be determined from time to time. Each letter of credit issued by CFC is supported by a reimbursement agreement with the member on whose behalf the letter of credit was issued. In the event a beneficiary draws on a letter of credit, the agreement generally requires the member to reimburse CFC within one year from the date of the draw, with interest accruing from such date at CFC’s variable rate of interest. The agreement also requires the member to pay, as applicable, any late payment charges and all costs of collection, including reasonable attorneys’ fees.

Other Guarantees
CFC may provide other guarantees as requested by its members. Such guarantees may be made on a secured or unsecured basis with guarantee fees set to cover CFC’s cost of capital, general and administrative expenses, a provision for losses and maintenance of a reasonable margin.

CFC Financing Factors

CFC funds its loan programs through retained margins for the current year, allocated but unretired patronage capital (members’ equity investments), members’ subordinated certificate investments and issuance of debt to members and in the capital markets. The following table details the funds outstanding, percentage of total capitalization and the average interest rate on funds outstanding at May 31, 2001, 2000 and 1999.

Members’ Subordinated Certificates

As a Condition of Membership
Generally, members are required to purchase membership subordinated certificates as a condition of membership. The amount of certificates required to be purchased is determined by applying a formula to the member’s operations for a period of time, generally 15 years. The membership subordinated certificates generally mature in 100 years from

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issuance and pay interest at a rate of 5%. At May 31, 2001, CFC had a total of $642 million in membership subordinated certificates outstanding. A small portion of these certificates matures 50 years from issuance and pays interest at a rate of 3%. Issuance of these certificates has not been significant in recent years. At May 31, 2001, the weighted average maturity of these certificates is approximately 75 years.

As a Condition of Borrowing
Distribution system members may be required to purchase, on long-term loans, a loan subordinated certificate for 2% of the loan amount. Power supply system members may be required to purchase a loan subordinated certificate for 7% of the loan amount. These certificates do not pay interest, do not amortize and have the same maturity as the related long-term loan. A small portion of these certificates mature at the same time as the loan and pay interest at a rate of 3%. The requirement to purchase such a certificate is determined by the member’s leverage ratio with CFC and the type of loan selected. In large transactions or for other reasons, CFC may increase the loan subordinated certificate purchase requirement to 12.5% of the loan amount. Certificates issued in these transactions may pay interest and/or may amortize. Telecommunications systems and associate members are required to purchase, on long-term loans, loan subordinated certificates for up to 10% of each loan advance. These certificates do not pay interest, but amortize annually based on the outstanding loan balance. At May 31, 2001, CFC had a total of $748 million of loan subordinated certificates outstanding.

As a Condition of Receiving a Guarantee
Members may be required to purchase a guarantee subordinated certificate of up to 12.5% of the principal amount of the guarantee. The guarantee subordinated certificate matures at the same time as the guarantee. The certificates pay interest at a rate determined in each transaction. At May 31, 2001, CFC had a total of $192 million of guarantee subordinated certificates outstanding.

Century Certificates
The century certificate is a voluntary investment by members, not a required purchase as with membership, loan and guarantee certificates. The century certificates may be issued with maturities of up to 100 years. The certificates are redeemable by the members after 44, 59, 69, 79 and 89 years. Interest is paid on the certificates semi-annually. The interest rate may be fixed or variable. The rates offered are higher than the fixed or variable rates on other securities of similar maturity offered by CFC to its members. CFC has the right to defer interest payments for up to ten semi-annual interest payment periods, or five years. Century certificate investments are subordinate in repayment rights to all other debt except quarterly income capital securities, and senior to members’ subordinated certificates. CFC began to offer the certificates for sale during the first quarter of fiscal year 2001. No century certificates have been sold as of May 31, 2001.

Members’ Equity
CFC is required by the District of Columbia cooperative law to have a methodology to allocate its net margin to its members. CFC allocates its entire net margin annually to an education fund, to a members’ capital reserve and to members based on the members’ patronage of CFC during the year. Under that law, CFC is required to maintain an education fund to further the teaching of cooperative principals. CFC allocates a small portion of its annual net margin to the education fund. In fiscal year 2000, CFC established a members’ capital reserve in which a portion of the annual net margin may be allocated and held by CFC as equity. CFC established the members’ capital reserve to increase equity retention. The net margin allocated to members is retained by CFC and used to fund operations until retired. Currently, CFC retires 70% of the prior year’s margin allocated to members during the current fiscal year and holds the remaining 30% for a period of 15 years. The board of directors must authorize all retirements with consideration being given to CFC’s financial condition. CFC allocates and retires margins to its affiliated organization, RTFC, which in turn allocates its net margin, including the CFC allocation, to its members under similar policies. At May 31, 2001, CFC had a total of $362 million of allocated but unretired margins and $29 million of margins in the members’ capital reserve, which along with $1 million of education fund reserve and $2 million of membership fees comprise the total of members’ equity.

Debt Issuance

Debt Issued in the Capital Markets
CFC issues long- and short-term debt in the domestic and foreign capital markets. CFC issues long-term secured collateral trust bonds for periods of two years to 30 years, unsecured medium-term notes for periods of nine months to 30 years, unsecured quarterly income capital securities for periods of up to 49 years and unsecured commercial paper for periods of one to 270 days and extendable commercial notes with maturities up to 390 days. CFC also enters into bank bid note arrangements with banks. CFC’s collateral trust bonds, medium-term notes, quarterly income capital securities and commercial paper all carry investment grade ratings from three rating agencies (see table in the Management Discussion and Analysis section, page 39).

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Debt Issued to Members
CFC sells unsecured commercial paper and medium-term notes to its members. Commercial paper is sold for periods of up to 270 days and medium-term notes are sold for periods of nine months to 30 years. CFC sets rates for both securities daily. In addition, members may invest in the daily liquidity program, which can be withdrawn by the members on demand.

Interest Rate and Currency Exchange Agreements
CFC enters interest rate and currency exchange agreements when required by certain transactions and to minimize interest rate and currency exchange risk. At May 31, 2001, CFC was a party to $9,037 million of interest rate exchange agreements and $390 million of currency exchange agreements (see Note 5 to the combined financial statements).

Revolving Credit Agreements
As of May 31, 2001, CFC had three revolving credit agreements totaling $7,040 million which are used principally to provide liquidity support for CFC’s outstanding commercial paper, commercial paper issued by NCSC and guaranteed by CFC and the adjustable or floating/fixed rate bonds which CFC has guaranteed and of which CFC is standby purchaser.

Under an agreement executed in November 1996, CFC can borrow $2,403 million until November 26, 2001. J.P. Morgan Securities, Inc. and The Bank of Nova Scotia are Co-Syndication Agents, and The Chase Manhattan Bank was the Administrative Agent for this agreement with 52 banks. Any amounts outstanding under this facility would have been due on November 26, 2001. On August 10, 2000, a 364-day agreement for $4,087 million was executed with 34 banks including The Chase Manhattan Bank as Administrative Agent, Bank of America, N.A. as Syndication Agent, The Bank of Nova Scotia and Bank One, N.A. as Co-Documentation Agents and Chase Securities Inc. and Banc of America Securities LLC as Joint Lead Arrangers. On August 10, 2000, a 364-day agreement for $550 million was also executed with ten banks, including The Bank of Nova Scotia as Arranger and Administrative Agent and Banc One, N.A. as Documentation Agent. Both of the 364-day agreements had a revolving credit period that terminated on August 9, 2001 during which CFC could borrow, and such borrowings have been converted to a one-year term loan at the end of the revolving credit period.

In connection with the five-year facility, CFC paid a per annum facility fee of .090 of 1%. The per annum facility fee for both 364-day agreements was .085 of 1%. There was no commitment fee for the five-year facility; however, up front fees between .010 and .040 of 1% were paid to banks in both 364-day agreements based on their level of commitment. All three agreements provide that, if CFC’s senior secured debt ratings decline below AA- or Aa3 and amounts outstanding exceed 50% of the total commitment, the facility fees may be replaced with a utilization fee of .125 of 1%. Generally, pricing options are the same under all three agreements and will be at one or more rates as defined in the agreements, as selected by CFC.

The five-year facility required CFC, among other things, to maintain members’ equity and members’ subordinated certificates of at least $1,468 million at May 31, 2001 (increased each fiscal year by 90% of net margin not distributed to members). The revolving credit agreements required CFC to achieve an average fixed charge coverage ratio over the six most recent fiscal quarters of at least 1.025 and prohibited the retirement of patronage capital unless CFC achieved a fixed charge coverage ratio of at least 1.05 for the preceding fiscal year. The revolving credit agreements prohibited CFC from incurring senior debt in an amount in excess of ten times the sum of members’ equity, members’ subordinated certificates and quarterly income capital securities. Senior debt includes guarantees; however, it excludes:

•		guarantees for members where the long-term unsecured debt of the member is rated at least BBB+ by Standard & Poor’s Corporation or Baa1 by Moody’s Investors Service;
•		indebtedness incurred to fund RUS guaranteed loans; and
•		the payment of principal and interest by the member on the guaranteed indebtedness if covered by insurance or reinsurance provided by an insurer having an insurance financial strength rating of AAA by Standard & Poor’s Corporation or a financial strength rating of Aaa by Moody’s Investors Service.

Based on the ability to borrow under the facilities, CFC classified $4,637 million and $5,493 million, respectively, of its notes payable outstanding as long-term debt at May 31, 2001 and May 31, 2000. CFC expects to maintain more than $4,637 million of notes payable outstanding during the next twelve months. If necessary, CFC can refinance such notes payable on a long-term basis by borrowing under the 364-day facilities, subject to the conditions therein.

Subsequent to year end, on August 8, 2001, CFC entered into three new revolving credit agreements totaling $4,562 million. Under the three-year agreement, CFC may borrow $1,028 million until August 8, 2004. Under a 364-day agreement, CFC may borrow $3,084 million. These credit agreements were entered into with a syndicate of 23 banks with J.P. Morgan Securities, Inc. and Banc of America Securities LLC as Joint Lead Arrangers, The Chase Manhattan Bank as Administrative Agent, Banc of America Securities LLC as Syndication Agent, and Bank One, N.A., ABN Amro Bank N.V. and The Bank

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of Nova Scotia as Documentation Agents. In addition, CFC entered into a second 364-day agreement for $450 million with a syndicate of eight banks with The Bank of Nova Scotia serving as Lead Arranger and Administrative Agent.

The new agreements provide liquidity support and replace the agreements entered into in November 1996 and August 2000 with substantially the same terms, except as noted in this paragraph. In connection with the three-year facility, CFC will pay a per annum facility fee of 0.1 of 1%. The facility fee for both of the 364-day facilities is .085 of 1%. Up front fees between .050 to .080 of 1% were paid to the banks in each of the agreements based on their commitment level, totaling in aggregate $2.9 million. Each agreement contains a provision under which if borrowings exceed 50% of total commitments and CFC’s senior unsecured debt ratings decline below AA- or Aa3, a utilization fee of .125 of 1% must be paid on the outstanding balance.

Borrowing Costs
Set forth below are the weighted average costs incurred by CFC on its short-term borrowings (commercial paper and bank bid notes) and on its long-term borrowings (collateral trust bonds, medium-term notes, quarterly income capital securities and short-term borrowings supported by revolving credit agreements) for the periods shown.

Tax Status
In 1969, CFC obtained a ruling from the Internal Revenue Service recognizing CFC’s exemption from the payment of Federal income taxes under Section 501(c)(4) of the Internal Revenue Code. Such exempt status could be removed as a result of changes in legislation or in administrative policy or as a result of changes in CFC’s business. CFC believes that its operations have not changed materially from those described to the Internal Revenue Service. RTFC is taxable under Subchapter T of the Internal Revenue Code. As long as RTFC continues to qualify under the Internal Revenue Code, it is allowed a deduction from taxable income for the amount of net margin allocated to its members.

Investment Policy
Surplus funds are invested pursuant to policies adopted by CFC’s board of directors. Under present policy, surplus funds may be invested in direct obligations of or guaranteed by the United States or agencies thereof or other highly liquid investment grade paper. Current investments include high-rated securities such as commercial paper, obligations of foreign governments, Eurodollar deposits, bankers’ acceptances, bank letters of credit, certificates of deposit or working capital acceptances. The policy also permits investments in certain types of repurchase agreements with highly rated financial institutions, whereby the assets consist of eligible securities of a type listed above set aside in a segregated account. CFC typically has two types of funds available for investment:

•		the debt service reserve funds held by the trustee under the indenture signed in 1972, under which CFC formerly issued collateral trust bonds, used to make bond interest and sinking fund payments; and
•		member loan payments and commercial paper investments in excess of daily cash funding requirements.

Debt service reserve funds are invested with maturities scheduled to coincide with interest and sinking fund payment dates.

Employees
At May 31, 2001, CFC had 207 employees, including engineering, financial and legal personnel, management specialists, credit analysts, accountants and support staff. CFC believes that its relations with its employees are good.

CFC Lending Competition
CFC competes with other lenders on price and the variety of options and additional services offered as well as its overall approach to and relationship with its member/owners.

According to annual financial statements filed with CFC, its electric cooperative distribution and power supply member systems had a total of $40.4 billion in long-term debt outstanding at December 31, 2000. RUS is the dominant lender to the electric cooperative industry with $19.2 billion or 47% of the total outstanding debt. RUS currently prices the majority of its insured loans to distribution systems based on a municipal government obligation index, prices hardship loans at a rate of 5% and provides guarantees of loans to its electrical cooperatives by others, principally the FFB. Under the insured loan program, RUS typically does not lend the full amount of debt requested by the cooperative, requiring the cooperative to seek supplemental lending from private capital sources. The amount of funding proposed for the insured loan program

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for fiscal year 2002 is $1.4 billion. The amount approved for the prior year was $917 million. The amount proposed for RUS guaranteed loans for fiscal year 2002 is $2.7 billion. CFC and other lenders are not in competition with RUS, but rather compete for the supplemental lending requirement, as well as for the full lending requirement for those cooperatives that have decided not to borrow from RUS. Under the hardship program, RUS lends 100% of the amount. Under the guarantee program, RUS will guarantee the repayment of all principal and interest by the cooperative. At December 31, 2000, CFC had a total of $13.5 billion of long-term exposure to distribution and power supply member systems, $11.6 billion of long-term loans and $1.9 billion of guarantees outstanding. CFC’s $13.5 billion long-term exposure represented 34% of the total long-term debt to these electric systems. The remaining $7.7 billion or 19% was borrowed from other sources. During fiscal year 2001, CFC was selected as the lender for 69% of the total supplemental lending requirement (not including amounts lent by FFB). During this same period, CFC was selected as lender for 88% of the total lent to distribution systems for the repayment of their RUS debt. In total, CFC has lent $3.2 billion to distribution systems for the purpose of prepaying their RUS debt. The total lent by CFC represents 93% of the total note buyouts, excluding amounts lent by FFB.

The competitive market for providing credit to the rural telecommunications industry is difficult to quantify, since many rural telecommunications companies are not RUS borrowers and do not report financial results to RUS. At December 31, 2000, RUS had a total of $3.3 billion outstanding to telecommunications borrowers. The RTB, an instrumentality of the United States that provides supplemental financing to RUS borrowers and is managed by RUS, had a total of $1.1 billion outstanding to telecommunications borrowers. CFC is not in direct competition with RUS or RTB, but rather competes with other lenders for additional supplemental lending and for the full lending requirement of the rural telecommunications companies that have decided not to borrow from RUS or RTB or for projects not eligible for RUS or RTB financing. CFC’s competition includes regional banks, a government sponsored enterprise and insurance companies. At December 31, 2000, CFC had a total of $4.9 billion in long-term loans outstanding to telecommunications borrowers. At December 31, 2000, CFC is aware of only CoBank (which at December 31, 2000 had a telecom portfolio of $2.6 billion) as a lender with a telecommunications loan portfolio of similar size to CFC’s and RUS/RTB’s.

Member Regulation and Competition

Electric Systems
In 1992 Congress passed the Energy Policy Act effectively requiring competition in the generation sector of the wholesale electric power industry. In 1996, FERC issued orders 888 and 889. Order 888 provides for competitive wholesale power sales by requiring jurisdictional public utilities that own, control or operate transmission facilities to file non-discriminatory open access transmission tariffs that provide others with transmission service comparable to the service they provide themselves. The reciprocity provision associated with order 888 also provides comparable access to transmission facilities of non-jurisdictional utilities (including RUS borrowers and municipal and other publicly owned electric utilities) that use jurisdictional utilities’ transmission systems. The order further provides for the recovery of stranded costs from departing wholesale customers with agreements dated prior to July 11, 1994. After that date, stranded costs must be agreed upon in the service agreement. Order 889 provides for a real-time electronic information system referred to as the Open Access Same-Time Information System. It also establishes standards of conduct to ensure that transmission owners and their affiliates do not have an unfair competitive advantage by using transmission to sell power.

Section 211 of the Federal Power Act as amended by the Energy Policy Act of 1992 classifies any cooperative with significant transmission assets as a “transmitting utility” for purposes of this section. Under the provisions of this Act, FERC has the authority to order such cooperatives to provide open access for unaffiliated entities. This provision also authorizes FERC to require investor-owned and other utilities to provide the same open access transmission for the benefit of cooperatives. Electric cooperatives have strongly supported section 211 for this reason. Under sections 205 and 206 of the Federal Power Act, a cooperative that pays off its RUS debt may be treated as a jurisdictional public utility subject to FERC regulation if it is a “transmitting utility”. FERC is proceeding under the legal theory that, under these sections, it can order jurisdictional public utilities to provide open access.

Currently, 14 states are operating under customer choice laws. In 13 of these states (Arizona, California, Connecticut, Delaware, Maine, Maryland, Massachusetts, New Hampshire, New Jersey, New York, Ohio, Pennsylvania and West Virginia), CFC has a total of 64 distribution system members and five power supply system members. In California, cooperatives are not required to offer customer choice and all three of CFC’s distribution members located in the state have opted not to allow customer choice. In New York, cooperatives are not required to file competition plans with the State Public Utility Commission. CFC currently does not have any members in Rhode Island. In an additional ten states, laws have been passed and open access is scheduled to be in effect at various phase-in levels by 2004. In these states, power supply systems with rates that are above market may be at risk of losing customer loads. The distribution systems in these states will continue to deliver power to the ultimate customer, regardless of who is supplying the power, the CFC member power supply system or

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some other power generator. For this and the other reasons mentioned below, CFC’s distribution system members are not believed to be at significant risk due to the move to open customer access to power supply systems.

While customer choice laws have been passed in the above states, there are many factors that may delay or influence the choices that customers have available and the timing of true competition. One of the biggest factors will be the issue of stranded cost recovery. Stranded costs are the portion of the investment in generation and/or other facilities which in a competitive environment would be above market price and therefore not otherwise recoverable by the utility. The amount of stranded costs a system is allowed to recover, the timing of the recovery and the method of recovery will all affect the level of competition in a state. The level of fees that systems will be allowed to charge other utilities for use of their transmission and distribution system may also impact the level of residential competition. Other issues that may delay competition include the following:

•		cooperatives are allowed to “opt out” of the provisions of the customer choice laws in some states;
•		utilities in many states will still be regulated regarding rates on non-competitive services, such as distribution;
•		many states will still regulate the borrowing by utilities;
•		FERC regulation of transmission;
•		reconciling the differences in various state laws, so that out-of-state utilities can compete with in-state utilities; and
•		the fact that few competitors have targeted residential or rural customers.

The pace of states passing customer choice laws has slowed. As of June 1, 2001, there were 26 states that had neither customer choice laws nor comprehensive restructuring orders by the state public utility commissions. The time required to pass such laws as well as the issues described above could significantly delay nationwide retail competition. The U.S. Congress has not passed legislation mandating retail customer choice and the passage of such legislation is not anticipated in this Congress. In addition, because of significant price spikes and supply issues in California, implementation of customer choice is being delayed even in some states that have already enacted customer choice legislation.

In addition to customer choice laws, some state agencies regulate electric cooperatives with regard to rates and borrowing. There are 23 states that regulate the rates electric systems charge; of these states, three states have partial oversight authority over the cooperatives’ rates, but not the specific authority to set rates, and seven states allow cooperatives the right to opt in or out of state regulation. There are 19 states that regulate electric systems regarding the issuance of long-term debt and there are two states that regulate the issuance of short-term debt. FERC also has jurisdiction to regulate rates of and refinancing by electric systems within its jurisdiction that are not borrowers of RUS, but which are otherwise jurisdictional.

The 1990 amendments to the Clean Air Act of 1970 required utilities and others to reduce emissions. The amendments contain a range of compliance options and a phase-in period, which will help mitigate the immediate costs of implementation. Many of CFC’s member systems already comply with the provisions of the amendments. Compliance plans for member systems with units affected in Phase I primarily involved fuel switching to low-sulfur coal. The trading of emission allowances may also be an economical alternative to operating or equipment modifications for Phase II (2000). Some member systems originally believed to be adversely affected by the amendments have developed strategies designed to minimize the amendments’ impact. At this time, it is not anticipated that the amendments will have a material adverse impact on the quality of CFC’s loan portfolio.

Telecommunications Systems
CFC member telecommunications systems are regulated at the state and federal levels. Most state regulatory bodies regulate local service rates, intrastate access rates and telecommunications company borrowing. The Federal Communications Commission (“FCC”) regulates interstate access rates and the issuance of licenses required to operate certain types of telecom operations.

The Telecommunications Act of 1996 (the “Telecom Act”) created a framework for competition and deregulation in the local telecommunications market. The Telecom Act has four basic goals: competition, universal service, deregulation and advanced telecommunications and information technologies. The Telecom Act seeks to achieve competition by requiring all carriers to interconnect with all others, local exchange carriers to provide total service resale, number portability, dialing parity, access to rights-of-way, reciprocal compensation, co-location, and unbundled access. Congress included provisions in the Telecom Act granting rural local exchange carriers (“LECs”) an exemption from the above requirements.

In America’s cities, telecommunications competition is occurring. Despite the shakeout in the competitive local exchange carrier segment, facility and non-facility based competitors are focused primarily on the large business user market. Few of these competitors have targeted residential customers. The Regional Bell Operating Companies are motivated to

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cooperate with competitors in order to win approval to enter the long distance market in their service territories. For example, Verizon has won FCC approval to provide long distance service in New York and Massachusetts and SBC Communications, Inc. has received approval in Texas, Oklahoma and Kansas.

Rural markets, with their preponderance of residential subscribers, are the last to see wide-scale local telecommunications service competition. Rural telecommunications companies that border metropolitan areas are experiencing competition for their largest business customers. These rural telecommunications providers generally are not waiting for competition to arrive, but are using the period before they come under competitive pressure to enter small towns and smaller cities as competitive local exchange carriers. They are able to leverage their infrastructure, organization skills, financial strength and local presence to compete with larger, incumbent providers that are not focused on these small markets.

In addition to competition, the Telecom Act also mandated a new universal telecommunications service support mechanism and required that it be sufficient to ensure that rural customers receive reasonably comparable rates and services when compared to urban customers. Congress stated its intent that implicit subsidies presently contained in the access charges local telecommunications companies levy on long distance carriers be eliminated and be made explicit in the new universal service support mechanism. The FCC recently issued new rules for determining rural high-cost universal service support for the next five years. The rules, among other things, base support on actual 2000 cost levels, allow for growth of the universal service fund, and freeze the national average cost of a telco subscriber loop (the benchmark for determining eligibility for support) at $240. CFC believes that adoption of these rules will benefit rural LECs.

In 1999, the FCC approved a plan put forward by large LECs and interexchange carriers (“IXCs”) that reduced access charges the large LECs charge the IXCs, and authorized alternative mechanisms by which the large LECs can recover a significant portion of lost access revenues. The national telephone trade associations have developed a similar plan (the “MAG plan”) for small rural LECs that includes a solution for the uncertainty that has surrounded universal service funding. The FCC has indicated its intention to address this plan in the near future. CFC does not anticipate that any loss in revenue resulting from this plan (if adopted by the FCC) would result in material losses on loans outstanding to rural telecommunications companies.

Deregulation thus far has not had much effect on LECs. The FCC has promulgated a series of rules to implement the Telecom Act, and eliminated very few existing regulatory requirements.

The final aspect of the Telecom Act dealt with advanced telecommunications and information technologies. The concern that there is a growing “digital divide” between various groups and areas within the country has led to programs to provide funding to connect schools and libraries to the internet. RUS has issued rules liberalizing its lending criteria to facilitate provision of advanced telecommunications and information services in rural areas. It is anticipated that RUS will play a significant role in financing infrastructure to help provide rural Americans with access to these services. Subject to credit review in specific institutions, CFC is prepared to supplement the government’s financing of this effort.

The RUS Program

Since the enactment of the Rural Electrification Act in 1936 (the “RE Act”), RUS has financed the construction of electric generating plants, transmission facilities and distribution systems in order to provide electricity to persons in rural areas. Principally through the organization of systems under the RUS loan program in 48 states and U.S. territories, the percentage of farms and residences in rural areas of the United States receiving central station electric service increased from 11% in 1934 to almost 100% currently. Rural electric systems serve 12% of all consumers of electricity in the United States and its territories and account for approximately 8% of total sales of electricity and own about 5% of energy generation and generating capacity.

In 1949, the RE Act was amended to allow RUS to lend for the purpose of furnishing and improving rural telecommunications service. The RUS telecommunications lending program had 760 reporting borrowers at December 31, 1999. The 760 borrowers operated 4,385 exchanges, providing service to a total of 5.5 million subscribers, including 1.2 million business subscribers and 4.3 million residential customers (RUS will no longer publish telecommunications data).

The RE Act provides for RUS to make insured loans and to provide other forms of financial assistance to borrowers. RUS is authorized to make direct loans, at below market rates, to systems which are eligible to borrow from it. RUS is also authorized to guarantee loans that have been used mainly to provide financing for construction of bulk power supply projects. Guaranteed loans bear interest at a rate agreed upon by the borrower and the lender (which generally has been the FFB). For telecommunications borrowers, RUS also provides financing through RTB. RTB is an instrumentality of the United States providing financing at rates reflecting its cost of capital and is managed by RUS. RUS exercises financial and technical supervision over borrowers’ operations. Its loans and guarantees are generally secured by a mortgage on substantially all of the

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system’s property and revenues.

For fiscal year 2002, the House Agriculture Appropriations Committee has approved RUS electric loan levels as follows: municipal government obligations index loans of $795 million, hardship loans of $121 million, treasury rate loans of $500 million, and loan guarantees of $2.7 billion. The Senate committee has approved the same levels as the House for hardship loans and loan guarantees, and has approved municipal rate loans of $500 million and treasury rate loans of $750 million. Electric funding levels for the fiscal year ending September 30, 2001 were as follows: municipal government obligations index loans of $295 million, hardship loans of $122 million, treasury rate loans of $500 million, and loan guarantees of $1.7 billion. Thus, the fiscal year 2002 levels approved by the House Agricultural Appropriations Committee represent a substantial increase over current year levels.

Legislation enacted in 1992 allows RUS electric borrowers to prepay their loans to RUS at a discount based on the government’s cost of funds at the time of prepayment. If a borrower chooses to prepay its notes, it becomes ineligible for future RUS insured loans for a period of ten years, but remains eligible for RUS loan guarantees. As of May 31, 2001, 228 borrowers had either fully prepaid or partially prepaid their RUS notes under these provisions. These borrowers have $6.9 billion in loans outstanding from CFC.

Member Financial Data

Electric Systems
On the following pages are tables providing composite statements of revenues, expenses and patronage capital from the distribution systems and power supply systems which were members of CFC during the five years ended December 31, 2000, and their respective composite balance sheets at the end of each such year. As of July 31, 2001, CFC had received financial information from 812 distribution systems and 51 power supply systems.

While CFC had 830 distribution system members at May 31, 2001, one system was not required to file due to a merger and 17 systems were not required to report financial results because they did not have outstanding balances of long-term loans at December 31, 2000.

Only 51 of the 70 total power supply systems report financial results to CFC. A total of 15 power supply systems did not report financial results because they did not have an outstanding balance of long-term loans at December 31, 2000. One power supply system merged with another and filed combined financial results. In addition, three power supply systems did not meet the filing deadline.

Telecommunications Systems
On the following pages are tables providing composite statements of revenues and expenses from the telecommunications systems that were members of CFC during the three years ended December 31, 2000. The first year for which CFC has collected such data and their respective composite balance sheet was 1998. Members with long-term loans outstanding are generally required to submit annual data as of December 31 in the form of audited financial statements. As of July 31, 2001, CFC had received audited financial statements from 226 telecommunications systems.

While CFC had 515 telecommunications system members at May 31, 2001, a total of 260 had long-term loans outstanding and were required to submit audited financial statements to CFC at December 31, 2000. A total of 17 telecommunications system members did not meet the filing deadline and 17 telecommunications system members submitted consolidated audited financial statements.

NOTE: CFC’s independent public accountants have not examined statistical information contained in this section, and the number and geographical dispersion of the systems have made impractical an independent investigation by CFC of the statistical information. The information presented is based upon financial statements submitted to CFC, subject to year-end audit adjustments, by reporting borrowers and does not, with minor exceptions, take into account current data for certain systems, primarily those which are not active CFC borrowers.

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The following are unaudited figures that are based
upon financial statements submitted to
CFC by Member Distribution Systems

17

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
COMPOSITE BALANCE SHEETS
AS REPORTED TO CFC BY MEMBER DISTRIBUTION SYSTEMS

The following are unaudited figures that are based
upon financial statements submitted to
CFC by Member Distribution Systems