TABLE OF CONTENTS
Part No.	Item No.				Page
I.	1.	Business			1
			General		1
			Members		1
			Distribution Systems		2
			Power Supply Systems		3
			Service Organizations and Associate Systems		3
			Telecommunications Systems		3
		Loan Programs			4
			Interest Rates on Loans		5
			CFC Loan Programs		5
			RTFC Loan Programs		6
			NCSC Loan Programs		6
			RUS Guaranteed Loans for Rural Electric Systems		7
			Conversion of Loans		7
			Prepayment of Loans		7
			Loan Security		7
		Guarantee Programs			8
			Guarantees of Long-Term Tax-Exempt Bonds		8
			Guarantees of Lease Transactions		8
			Guarantees of Tax Benefit Transfers		9
			Letters of Credit		9
			Other Guarantees		9
		Disaster Recovery			10
		Tax Status			10
		Investment Policy			10
		Employees			10
		CFC Lending Competition			10
		Member Regulation and Competition			11
		The RUS Program			13
	2.	Properties			14
	3.	Legal Proceedings			14
	4.	Submission of Matters to a Vote of Security Holders			14
II.	5.	Market for the Registrant's Common Equity and Related Stockholder Matters			15
	6.	Selected Financial Data			15
	7.	Management's Discussion and Analysis of Financial Condition and Results of Operations			16
				Risk Factors	16
				Overview	18
				Critical Accounting Policies	19
				Margin Analysis	23
				Liquidity and Capital Resources	31
				Asset/Liability Management	44
				Financial and Industry Outlook	49
				Non-GAAP Financial Measures	52
	7A.	Quantitative and Qualitative Disclosures About Market Risk			56
	8.	Financial Statements and Supplementary Data			56
	9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			56
	9A.	Controls and Procedures			56
III.	10.	Directors and Executive Officers of the Registrant			57
	11.	Executive Compensation			61
	12.	Security Ownership of Certain Beneficial Owners and Management			64
	13.	Certain Relationships and Related Transactions			64
	14.	Principal Accountant Fees and Services			64
IV.	15.	Exhibits and Financial Statement Schedules			65
		Signatures			67

~~Part~~PART I


Item 1.	Business.


General
National Rural Utilities Cooperative Finance Corporation ("CFC" or "the Company") 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 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 consider lending up to 100% of the loan requirements for those members electing not to borrow from RUS consistent with CFC's credit limitation policies. 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~~with credit enhancements in the form of ~~pollution control facilities~~letters of credit and ~~other properties constructed or acquired by its members,~~guarantees of debt ~~in connection with certain leases and various other transactions.~~obligations. CFC is exempt from payment of federal income taxes under the provisions of Section 501(c)(4) of the Internal Revenue ~~Code section 501(c)(4).~~Code. CFC is a not-for-profit member-owned finance cooperative, thus its objective is not to maximize its net margins, but to offer its members the lowest cost financial products and services consistent with sound financial management. CFC's internet address is ~~www.nrucfc.org,~~www.nrucfc.coop, where under "Investors," you can find copies of this annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, all of which CFC makes available as soon as reasonably practicable after the report is filed with the Securities and Exchange Commission. ~~Other than as set forth herein, information~~Information posted on CFC's website is not incorporated by reference into this Form 10-K.

Rural Telephone Finance Cooperative ("RTFC") ~~was incorporated as~~is a private cooperative association incorporated in the ~~state~~District of ~~South Dakota in September 1987~~Columbia and was created for the ~~purpose~~purposes of providing ~~and/or~~and arranging financing for its rural telecommunications members and their affiliates. ~~CFC is the sole source of funding for RTFC and manages the affairs of RTFC through a long-term management agreement. RTFC is a class E member of CFC.~~Effective June 1, 2003, RTFC's results of operations and financial condition have been ~~combined~~consolidated with those of CFC in the accompanying financial ~~statements (see Note 1(b)~~statements. CFC is the sole lender and provides management services to ~~the combined financial statements).~~RTFC through a long-term management agreement. Under a guarantee agreement, CFC has agreed to reimburse RTFC for loan losses. RTFC is headquartered with CFC in Herndon, ~~VA.~~Virginia. RTFC is a taxable entity and takes tax deductions for allocations of net margins as allowed by law under Subchapter T of the Internal Revenue Code. RTFC pays income tax based on its net margins, excluding net margins allocated to its members.

Except as indicated, financial information presented herein includes the consolidated results of CFC and certain entities created and controlled by CFC to hold foreclosed assets, presented with RTFC on a combined basis. CFC established limited liability corporations and partnerships to hold foreclosed assets. CFC has full ownership and control of all such companies and thus consolidates their financial results.

National Cooperative Services Corporation ("NCSC") was incorporated in 1981 in the District of Columbia as a private cooperative association. NCSC provides ~~lease financing related to its members and general~~ financing to the for-profit orand non-profit entities that are owned, operated or controlled by, or provide substantial benefit to, members of CFC. NCSC also markets, through its sponsoring cooperative members, a consumer loan program for home improvements and an affinity credit card program. Both programs are currently funded by third parties. CFC is the sole source of funding for NCSC either through direct loans or through guarantees of NCSC debt. NCSC's membership consists of CFC and ~~electric~~distribution systems that are members of CFC or are eligible for such membership. Effective June 1, 2003, NCSC's results of operations and financial condition have been consolidated with those of CFC in the accompanying financial statements. CFC is the primary source of funding and provides management services to NCSC ~~is a class C member of CFC. As of May 31, 2003, NCSC had 332 members in 43 states and the District of Columbia. NCSC operates under~~through a management agreement ~~with CFC. It~~which is automatically renewable on an annual basis unless terminated by either party. Under a guarantee agreement effective June 1, 2003, CFC has agreed to reimburse NCSC for losses on loans, excluding the consumer loan program. NCSC is headquartered with CFC in Herndon, ~~VA and~~Virginia. NCSC is a taxable corporation. ~~As of June 1, 2003, CFC intends to consolidate financial results with NCSC. See Note 1(r)~~NCSC pays income tax annually based on its net margins for the period.

Unless stated otherwise, references to the ~~combined financial statements for further explanation.~~Company relate to the consolidation of CFC, RTFC, NCSC and certain entities controlled by CFC and created to hold foreclosed assets.

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 consumer and commercial customers of the electric cooperatives are also the customers of the telecommunications organizations, as the service territories of the electric and telecommunications members overlap in many of the rural areas of the United States.

*Members* ~~Members~~
~~CFC had 1,042 electric members~~The Company's consolidated membership was 1,546 as of May 31, ~~2003,~~2005 including ~~898~~899 utility members, ~~most~~the majority of which are consumer-owned electric cooperatives, 71508 telecommunications members, 70 service members and ~~73 associate members. The utility members included 826 distribution systems and 72 generation and transmission ("power supply") systems operating~~69 associates in 49 states, the District of Columbia and ~~one~~three U.S. ~~territory.~~ territories. The utility members included 828 distribution systems and 71 generation and transmission ("power supply") systems. Memberships between CFC, RTFC and NCSC have been eliminated in consolidation.

CFC currently has ~~five~~four classes of electric 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; and


1


*	Class D - national associations of ~~cooperatives; and~~cooperatives.
*
~~Class E - associate~~In addition to its members, -CFC has 69 associates that are 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~~Associates are not entitled to vote at any meeting of the members and are not eligible to be represented on CFC's board of directors. All references to members within this document include members and associates.

1

~~RTFC had 513 telecommunications members as of May 31, 2003.~~ Membership in RTFC is limited to commercial (for-profit) or cooperative (not-for-profit) telecommunications systems that receive or are eligible to receive loans or other assistance from RUS, ~~which~~and that are engaged (or plan to be engaged) in providing telecommunication services to ultimate ~~users and affiliates of such corporations.~~

users.

Membership in NCSC is limited to CFC and organizations that are class A members of CFC or are eligible to be class A members of CFC.

In many cases, the residential and commercial customers of CFC's electric members are also the customers of RTFC's telecommunications members, as the service territories of the electric and telecommunications members overlap in many of the rural areas of the United States.

Set forth below is a table showing by state or U.S. territory the total number of CFC, RTFC and ~~RTFC~~NCSC members, the percentage of total loans and the percentage of total loans and guarantees outstanding at May 31, ~~2003.~~

2005.

Number

Loan and

Number

Loan and

Loan

Guarantee

Loan

Guarantee

State/Territory

Number
Loan and
Number
Loan and
of
Loan
Guarantee
of
Loan
Guarantee
Members
%
%
Members
%
%
Alabama
30
1.51%
1.48%
Missouri
64
3.17%
3.48%

Alaska
29
1.60%
1.47%
Montana
39
1.12%
1.02%

American Samoa
1
0.01%
0.01%
Nebraska
40
0.07%
0.06%

Arizona
23
0.77%
0.92%
Nevada
6
0.47%
0.42%

Arkansas
29
2.67%
2.57%
New Hampshire
6
1.05%
1.10%
California
11
0.12%
0.11%
New Jersey
1
0.10%
0.09%
Colorado
40
4.91%
4.75%
New Mexico
25
0.21%
0.19%

Connecticut
2
1.03%
0.94%
New York
13
0.08%
0.08%
Delaware
2
0.08%
0.07%
North Carolina
45
4.76%
4.81%

District of Columbia
5
1.53%
4.16%
North Dakota
35
0.39%
0.35%

Florida
20
2.44%
2.82%
Ohio
42
1.95%
1.78%

Georgia
69
7.90%
7.20%
Oklahoma
51
2.45%
2.31%
Guam
1
0.00%
0.00%
Oregon
40
1.46%
1.45%
Hawaii
1
0.00%
0.00%
Pennsylvania
26
0.94%
0.97%
Idaho
17
0.87%
0.79%
South Carolina
38
2.75%
2.51%

Illinois
52
3.15%
2.90%
South Dakota
48
0.80%
0.73%

Indiana
52
1.68%
2.04%
Tennessee
29
0.54%
0.49%

Iowa
121
5.73%
5.28%
Texas
112
17.76%
16.88%

Kansas
50
1.56%
1.57%
Utah
11
2.93%
3.01%

Kentucky
33
1.48%
2.02%
Vermont
8
0.33%
0.30%

Louisiana
18
1.46%
1.33%
Virgin Islands
1
3.20%
2.91%

Maine
6
0.21%
0.19%
Virginia
28
1.24%
1.15%

Maryland
2
0.53%
0.48%
Washington
18
0.45%
0.41%

Massachusetts
2
0.00%
0.00%
West Virginia
5
0.02%
0.02%

Michigan
26
1.42%
1.30%
Wisconsin
63
1.56%
1.43%

Minnesota
78
4.38%
4.47%
Wyoming
15
0.73%
0.72%
Mississippi
26
2.43%
2.46%
Total
1,555
100.00%
100.00%

Members

State/Territory

Members

Alabama

1.91%

Missouri

3.50%

3.81%

Alaska

1.74%

1.66%

Montana

0.87%

0.82%

American Samoa

0.02%

0.01%

Nebraska

0.08%

Arizona

0.87%

1.05%

Nevada

0.75%

0.70%

Arkansas

2.93%

2.86%

New Hampshire

0.94%

California

0.11%

0.10%

New Jersey

0.10%

Colorado

4.60%

4.62%

New Mexico

0.18%

0.17%

Connecticut

1.05%

0.99%

New York

0.10%

Delaware

0.10%

North Carolina

5.40%

5.59%

District of Columbia

0.14%

0.28%

North Dakota

0.43%

0.41%

Florida

3.36%

3.70%

Ohio

2.19%

2.07%

Georgia

8.30%

7.82%

Oklahoma

2.60%

2.47%

Guam

Oregon

1.66%

1.68%

Hawaii

0.04%

Pennsylvania

1.40%

1.43%

Idaho

0.90%

0.85%

South Carolina

2.77%

2.61%

Illinois

2.86%

2.70%

South Dakota

0.91%

0.86%

Indiana

1.97%

2.33%

Tennessee

0.66%

0.63%

Iowa

119

2.59%

2.47%

Texas

113

15.31%

15.14%

Kansas

2.84%

2.86%

Utah

2.89%

2.92%

Kentucky

2.40%

2.92%

Vermont

0.46%

0.44%

Louisiana

1.78%

1.70%

Virgin Islands

2.53%

2.38%

Maine

0.07%

0.06%

Virginia

1.15%

1.10%

Maryland

0.89%

0.84%

Washington

0.52%

0.49%

Massachusetts

West Virginia

0.04%

Michigan

1.59%

1.51%

Wisconsin

1.79%

1.69%

Minnesota

4.72%

4.88%

Wyoming

0.74%

Mississippi

2.25%

2.33%

Total

1,546

100.00%

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 purchase contracts with their power supply systems, which are owned and controlled by the member distribution 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 distribution system'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 lease obligations 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 may review 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).

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 60 operating power supply systems financed in whole or in part by RUS or CFC at December 31, ~~2001 (the most recent year for which data is available),~~2004, 59 were cooperatives owned directly or indirectly by groups of distribution systems and one was government owned. Of this number, 34 had generating capacity of at least 100 megawatts, 7 had less than 100 megawatts of generating capacity and 1018 had no generating capacity. The systems with no generating capacity generally operated transmission lines to supply certain distribution systems. Certain other power supply systems have been formed but do not yet own generating or transmission facilities.

At December 31, 2001, the 54 power supply systems that provide reports to CFC owned interests in 141 generating plants representing generating capacity of approximately 32,036 megawatts, or approximately 5.28% of the nation's estimated electric generating capacity, and served 570 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, 2001, steam plants accounted for 83.6% (including nuclear capacity representing approximately 1.5% of such total generating capacity), internal combustion plants accounted for 13.7% and hydroelectric plants accounted for 1.3%.

Service Organizations and Associate ~~Member~~ Systems

Service organizations include the National Rural Electric Cooperative Association ("NRECA"), statewide and regional cooperative ~~associations, and NCSC.~~associations. NRECA represents cooperatives nationally. The statewide cooperative associations represent the cooperatives within a state.

~~Associate members~~Associates 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 primarily provide local exchange and access telecommunications services to rural areas.

Independent rural telecommunications companies provide service throughout ~~America's~~many of the rural ~~areas.~~areas of the United States. These companies, which number approximately 1,300, are called independent because they are not affiliated with the regional ~~bell~~Bell operating companies ("RBOCs"). Included in the total are approximately 250 not-for-profit cooperative telecommunications companies. The majority of these independent rural telecommunications companies are family-owned or privately-held commercial companies. However, ~~approximately 20~~24 of these commercial companies are publicly traded or issue bonds ~~in the marketplace.~~publicly.

Rural telecommunications companies (including all local exchange carriers ("LECs") other than RBOCs, Cincinnati Bell and Sprint) comprise a relatively small sector (less than 15%) of a local exchange telecommunications industry that ~~provide~~provides service to ~~nearly 175~~over 170 million access lines. These rural companies range in size from fewer than 100 customers to more than 1,000,000. Rural telecommunications companies' annual operating revenues range from less than $100,000 to over $2 billion. In addition to basic local exchange and access telecommunications service, most independents offer other communications services including wireless telephone, cable television and internet access. Most rural telecommunications companies' networks incorporate digital switching, fiber optics and other advanced technologies.

Loan Programs


Set forth below is a table showing loans outstanding to borrowers at May 31, 2005, 2004 and 2003 and the weighted average interest rates thereon and loans committed but unadvanced to borrowers at May 31, 2005.

			Loans outstanding and weighted average interest rates												Unadvanced
			thereon at May 31,												Commitments at
(Dollar amounts in thousands)			2005				2004				2003					May 31, 2005 (1)
Total by loan type:
	Long-term fixed rate loans		$	12,724,758		5.52%	$	13,639,947		5.69%	$	12,219,710		6.12%		$	-
	Long-term variable rate loans			4,961,397		4.47%		5,448,223		2.81%		5,806,230		3.65%			5,537,121
	Loans guaranteed by RUS			258,493		5.16%		263,392		4.60%		266,857		4.71%			8,491
	lntermediate-term loans			10,328		5.91%		55,405		2.85%		84,010		4.04%			25,714
	Line of credit loans			1,017,092		4.75%		1,081,556		2.26%		1,107,534		3.98%			6,122,693
Total loans				18,972,068		5.19%		20,488,523		4.72%		19,484,341		5.23%			11,694,019
Less: allowance for loan losses				(589,749	)			(573,939	)			(511,463	)				-
Net loans			$	18,382,319			$	19,914,584				18,972,878				$	11,694,019

Total by segment:
CFC:
		Distribution	$	12,728,866		5.05%	$	12,536,255		4.29%	$	11,410,592		4.69%		$	8,821,217
		Power supply		2,640,787		5.72%		2,684,652		4.94%		2,701,094		5.03%			2,059,350
		Statewide and associate		135,513		5.58%		134,677		3.56%		430,015		4.32%			124,539
		CFC total		15,505,166		5.17%		15,355,584		4.40%		14,541,701		4.74%			11,005,106
RTFC				2,992,192		5.21%		4,643,008		5.83%		4,942,640		6.68%			518,514
NCSC				474,710		5.96%		489,931		4.40%		-		-			170,399
		Total	$	18,972,068		5.19%	$	20,488,523		4.72%	$	19,484,341		5.23%		$	11,694,019
_______________________
(1) Unadvanced commitments include loans for which loan contracts have been approved and executed, but funds have not been advanced. Additional information may be required to assure that all conditions for advance of funds have been fully met and that there has been no material change in the member's condition as represented in the supporting documents. Since commitments may expire without being fully drawn upon and a significant amount of the commitments are for standby liquidity purposes, the total unadvanced loan commitments do not necessarily represent future cash requirements. Collateral and security requirements for advances on commitments are identical to those on initial loan approval. As the interest rate on unadvanced commitments is not set, long-term unadvanced commitments have been classified in this chart as variable rate unadvanced commitments. However, once the loan contracts are executed and funds are advanced, the commitments could be at either a fixed or a variable rate.

The following table summarizes non-performing and restructured loans outstanding by loan program and by segment at May 31:

				Loans outstanding and weighted average interest rates
(Dollar amounts in thousands)				thereon at May 31,
Non-performing loans:			2005				2004				2003
RTFC:
		Long-term fixed rate loans	$	213,092		-	$	-		-	$	-		-
		Long-term variable rate loans		353,480		-		159,328		-		-		-
		Line of credit loans		49,777		-		181,110		-		-		-
		Total RTFC loans		616,349		-		340,438		-		-		-
NCSC:
		Long-term fixed rate loans		277		-		789		-		-		-
		Total non-performing loans	$	616,626		-	$	341,227		-	$	-		-

Restructured loans:
CFC:
		Long-term variable rate loans	$	593,584		-	$	617,808		-	$	629,406		-
RTFC:
		Long-term fixed rate loans		7,342		6.65%		-		-		-		-
		Total restructured loans	$	600,926		0.08%	$	617,808		-	$	629,406		-

4

Set forth below is a table showing loans outstanding to borrowers at May 31, 2003, 2002 and 2001 and the weighted average interest rates thereon and loans committed but unadvanced to borrowers at May 31, 2003.

Loans outstanding and weighted average interest rates
Unadvanced
(Dollar amounts in thousands)
thereon at May 31,
Commitments at
Long-term fixed rate secured loans (C):
2003 (A)
2002
2001
May 31, 2003 (B)
Electric systems
$
9,484,490
5.64%
$
7,848,861
6.32%
$
6,088,076
6.85%
$
-
Telecommunication systems
2,735,220
7.77%
2,694,945
7.90%
2,453,158
8.17%
-
Total long-term fixed rate secured loans
12,219,710
6.12%
10,543,806
6.72%
8,541,234
7.23%
-
Long-term variable rate secured loans (D):
Electric systems
3,211,434
3.36%
4,127,019
4.21%
5,096,467
7.05%
5,650,836
Telecommunication systems
1,965,390
5.30%
2,138,174
5.71%
2,481,257
7.69%
291,724
Total long-term variable rate secured loans
5,176,824
4.09%
6,265,193
4.72%
7,577,724
7.26%
5,942,560
Loans guaranteed by RUS:
Electric systems
266,857
4.71%
242,574
4.75%
182,134
6.31%
30,388
Intermediate-term secured loans:
Electric systems
14,525
3.63%
31,133
5.48%
55,325
7.08%
28,522
Intermediate-term unsecured loans:
Electric systems
50,843
3.65%
177,154
5.19%
276,785
7.24%
72,559
Telecommunication systems
18,642
5.45%
7,298
5.75%
13,836
7.50%
4,827
Total intermediate-term unsecured loans
69,485
4.13%
184,452
5.21%
290,621
7.25%
77,386
Line of credit loans (E):
Electric systems
884,146
3.57%
1,002,459
4.57%
1,193,795
7.35%
5,233,146
Telecommunication systems
223,388
5.60%
226,113
6.32%
377,148
8.12%
377,409
Total line of credit loans
1,107,534
3.98%
1,228,572
4.89%
1,570,943
7.53%
5,610,555
Nonperforming loans:
Electric systems
-
-
1,002,782
-
812
-
-
Telecommunication systems
-
-
8,546
-
-
-
-
Total nonperforming loans
-
-
1,011,328
-
812
-
-
Restructured loans (F):
Electric systems
629,406
-
540,051
6.92%
1,465,157
2.63%
-
Total loans
19,484,341
5.23%
20,047,109
5.61%
19,683,950
6.91%
11,689,411
Less: Allowance for loan losses (G):
(565,058
)
(506,742
)
(331,997
)
-
Net loans
$
18,919,283
$
19,540,367
$
19,351,953
$
11,689,411
Total by member class:
Distribution
$
11,410,592
$
11,866,442
$
11,444,999
$
8,527,266
Power supply
2,701,094
2,624,039
2,308,384
2,321,125
Statewide and associate
430,015
481,552
605,168
167,059
Telecommunication systems
4,942,640
5,075,076
5,325,399
673,961
Total
$
19,484,341
$
20,047,109
$
19,683,950
$
11,689,411

~~________________________________________~~
~~(A)~~	The interest rates in effect at August 1, 2003 on loans to electric members were 5.35% for long-term loans with a seven-year fixed rate term, 2.80% on variable rate long-term loans and 3.05% on intermediate-term loans and lines of credit. The rates in effect at August 1, 2003 on loans to telecommunication systems were 6.20% for long-term loans with a seven-year fixed rate term, 4.65% on long-term variable rate loans, 4.90% on intermediate-term loans and lines of credit.
~~(B)~~	Unadvanced commitments include loans approved by CFC for which loan contracts have been approved and executed, but funds have not been advanced. Since commitments may expire without being fully drawn upon, the total amounts reported as commitments do not necessarily represent future cash requirements. Collateral and security requirements for advances on commitments are identical to those on initial loan approval. As the interest rate on unadvanced commitments is not set, long-term unadvanced commitments have been classified in this chart as variable rate unadvanced commitments. However, once the loan contracts are executed and funds are advanced, the commitments could be at either a fixed or a variable rate.
~~(C)~~	Generally, under the terms of long-term fixed rate loans, members may select a fixed rate for periods that range from one to 35 years. Upon expiration of the interest rate term, the borrower may select another fixed rate term of one to 35 years (but not beyond maturity of the loan) or a variable rate. The borrower may also repay to CFC the principal then outstanding together with interest due thereon and other sums, if required. Includes $522 million and $395 million of unsecured loans at May 31, 2003 and 2002, respectively.
~~(D)~~	~~Includes $328 million and $266 million of unsecured loans and $396 million and $498 million of unsecured unadvanced commitments at May 31, 2003 and 2002, respectively.~~
~~(E)~~	~~Includes $331 million and $387 million of secured loans and $306 million and $251 million of secured unadvanced commitments at May 31, 2003 and 2002, respectively.~~
~~(F)~~	~~The rate on restructured loans represents the rate at which CFC was accruing interest on loans classified as restructured at May 31, 2003, 2002 and 2001.~~
~~(G)~~	CFC includes its guarantee exposures and loan exposures in the calculations of the loan loss allowance. Under the terms of the guarantee agreements, if CFC is required to advance funds, such amount becomes a loan receivable from the member whose obligation CFC guaranteed.

Total loans outstanding, by state or U.S. territory, are summarized below:

(Dollar amounts in thousands)		May 31,							May 31,
State/Territory		2005	2004		2003		State/Territory		2005		2004		2003
Alabama	$	362,305	$	373,978	$	293,524		Montana	$	164,715	$	179,570	$	218,378
Alaska		330,827		370,528		312,080		Nebraska		15,635		14,975		13,421
American Samoa		2,765		1,859		2,850		Nevada		141,571		147,868		90,817
Arizona		165,664		201,548		149,310		New Hampshire		178,740		188,960		204,835
Arkansas		555,055		552,971		520,305		New Jersey		19,438		19,576		19,415
California		20,894		28,270		23,497		New Mexico		34,223		37,476		40,061
Colorado		873,413		929,822		957,814		New York		19,621		20,270		16,640
Connecticut		200,000		200,100		200,000		North Carolina		1,024,134		988,101		927,217
Delaware		19,809		21,093		14,812		North Dakota		81,977		85,749		75,435
District of Columbia		25,526		22,522		298,272		Ohio		415,227		407,850		380,468
Florida		636,792		612,222		475,802		Oklahoma		492,462		482,824		476,736
Georgia		1,573,770		1,555,763		1,538,946		Oregon		314,137		310,736		285,024
Hawaii		7,834		41,120		-		Pennsylvania		265,930		284,644		182,996
Idaho		170,820		175,827		168,971		South Carolina		525,285		576,822		536,437
Illinois		543,196		589,870		613,838		South Dakota		173,074		180,518		156,218
Indiana		373,185		354,512		326,827		Tennessee		125,688		117,857		104,722
Iowa		492,095		1,090,224		1,117,138		Texas		2,904,185		3,545,604		3,461,097
Kansas		539,392		542,033		303,378		Utah		547,288		558,692		571,703
Kentucky		454,976		445,341		289,375		Vermont		87,595		84,510		63,604
Louisiana		337,741		323,035		283,669		Virgin Islands		479,196		552,674		623,037
Maine		12,954		39,159		40,047		Virginia		218,801		311,534		241,157
Maryland		169,581		152,872		102,886		Washington		99,562		93,258		87,893
Massachussetts		-		100		-		West Virginia		8,171		5,797		3,959
Michigan		301,822		286,345		277,150		Wisconsin		339,207		334,039		303,562
Minnesota		895,976		952,984		853,159		Wyoming		139,618		148,814		142,981
Mississippi		426,895		313,904		474,288		Total	$	18,972,068	$	20,488,523	$	19,484,341
Missouri		663,301		631,803		618,590

(Dollar amounts in thousands)
May 31,
May 31,
State/Territory
2003
2002
2001
State/Territory
2003
2002
2001
Alabama
$
293,524
$
263,670
$
364,974 Montana
$
218,378
$
218,497
$
220,234
Alaska
312,080
295,386
293,070 Nebraska
13,421
12,363
12,785
American Samoa
2,850
-
- Nevada
90,817
93,399
94,958
Arizona
149,310
133,465
101,770 New Hampshire
204,835
229,569
243,973
Arkansas
520,305
517,218
531,224 New Jersey
19,415
9,293
8,724
California
23,497
18,042
86,783 New Mexico
40,061
38,519
38,063
Colorado
957,814
793,398
599,602 New York
16,640
16,885
19,808
Connecticut
200,000
201,896
44,421 North Carolina
927,217
963,335
972,887
Delaware
14,812
20,881
46,599 North Dakota
75,435
52,640
63,693
District of Columbia
298,272
335,410
432,122 Ohio
380,468
387,433
379,991
Florida
475,802
473,582
465,348 Oklahoma
476,736
521,388
460,758
Georgia
1,538,946
1,683,474
1,646,326 Oregon
285,024
279,818
262,721
Hawaii
-
233
812 Pennsylvania
182,996
159,157
150,203
Idaho
168,971
157,721
135,287 South Carolina
536,437
537,722
526,647
Illinois
613,838
683,718
607,305 South Dakota
156,218
162,881
165,015
Indiana
326,827
270,907
224,272 Tennessee
104,722
108,150
105,773
Iowa
1,117,138
1,167,938
1,201,570 Texas
3,461,097
4,081,770
3,859,623
Kansas
303,378
289,806
300,987 Utah
571,703
583,888
616,372
Kentucky
289,375
226,679
223,338 Vermont
63,604
40,851
42,019
Louisiana
283,669
261,570
247,395 Virgin Islands
623,037
615,599
587,849
Maine
40,047
43,780
43,568 Virginia
241,157
264,272
269,579
Maryland
102,886
130,094
132,746 Washington
87,893
87,190
91,436
Massachussetts
-
-
50 West Virginia
3,959
2,160
1,699
Michigan
277,150
298,981
306,469 Wisconsin
303,562
300,464
304,913
Minnesota
853,159
856,013
1,099,548 Wyoming
142,981
154,959
147,124
Mississippi
474,288
373,537
283,406 Total
$
19,484,341
$
20,047,109
$
19,683,950
Missouri
618,590
627,508
618,111

Interest Rates on Loans

CFC's goal as a not-for-profit cooperatively-owned finance company is to set 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 primarily based on ~~the~~its cost of funding, ~~plus provisions for~~as well as 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 business type, performance, volume and whether they borrow exclusively from CFC. See Note 2 to the consolidated and combined financial statements for the weighted average interest rates earned on all loans outstanding during the fiscal years ended May 31, ~~2003, 2002~~2005, 2004 and ~~2001.~~2003.

~~Electric~~CFC Loan Programs

Long-Term Loans

Long-term loans are generally for terms of up to 35 years. These loans finance electric plant and equipment which typically have a useful life equal to or in excess of the loan maturity. A borrower can select a fixed interest rate for periods of one to 35 years or a 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 tranches. The borrower then has the option of selecting a fixed or variable interest rate for each tranche.

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 and an annual compliance ~~certificate.~~certificate and be in compliance with all other terms of the loan agreement. 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. 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, ~~2003, 3.89%~~2005, 6% of the dollar amount of long-term loans approved was to borrowers that did not meet the minimum lending criteria.

Line of Credit Loans

Line of credit loans ~~may be~~are generally advanced only at a variable interest rate. The line of credit variable interest rate is set on the first business day of each month. The principal amount of line of credit loans with maturities of greater than one year generally must be paid down to a zero outstanding principal balance for five consecutive days during each ~~year.~~12-month period.

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

~~Telecommunications~~RTFC Loan Programs

The ~~following table summarizes CFC's telecommunications~~RTFC loan portfolio ~~as of May 31, 2003, 2002 and 2001:~~

(Dollar amounts in thousands)
2003
2002
2001
Rural local exchange carriers
$
3,825,877
77%
$
3,811,897
75%
$
3,846,625
72%
Wireless providers
334,638
7%
357,292
7%
478,664
9%
Long distance carriers
324,066
7%
373,809
8%
422,247
8%
Fiber optic network providers
190,768
4%
211,245
4%
216,734
4%
Cable television providers
184,824
4%
194,806
4%
212,348
4%
Competitive local exchange carriers
64,492
1%
105,307
2%
105,310
2%
Other
17,975
-
20,720
-
43,471
1%
Total
$
4,942,640
100%
$
5,075,076
100%
$
5,325,399
100%

~~CFC's telecommunications loan portfolio~~ is ~~heavily~~ concentrated in the rural local exchange carrier ("RLEC") segment of the telecommunications market. The two principal barriers to entry for potential competitors are the low population density of the RLEC service territories and the high quality of service ~~the~~ customers receive from the incumbent RLECs. These services are generally delivered over networks that include fiber optic cable and digital switching.

The businesses to which the remaining ~~telecommunications~~RTFC loans have been made are generally supporting the operations of the RLECs and are owned, operated or controlled by RLECs. Many such loans are supported by payment guarantees from the sponsoring ~~RLECs, particularly loans to personal communications service providers and competitive LECs.~~RLECs.

Long-Term Loans

~~CFC~~RTFC 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, cable television systems and other 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~~Long-term fixed rates for telecommunications loans are set 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 tranches. The borrower then has the option of selecting a fixed or variable interest rate for each tranche.

To borrow from ~~CFC,~~RTFC, 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,~~RTFC, a cable television system, fiber optic network or wireless 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 require performance at levels deemed sufficient to repay the ~~CFC~~RTFC obligations under the approved terms.

Intermediate-Term Loans and Line of Credit Loans

~~CFC~~RTFC 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~~RTFC 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 principal 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 to assist borrowers with liquidity and cash management.

Interim financing line of credit loans are also made available to ~~CFC telecommunications~~RTFC members that have ana loan application pending with RUS and/or Rural Telephone Bank ("RTB") ~~loan application pending~~, an instrumentality of the United States government that provides supplemental financing to RUS borrowers and is managed by RUS, and have received approval from RUS or RTB to obtain interim financing. These loans are for terms up to 24 months and the borrower must repay the ~~CFC~~RTFC loan with advances from the RUS/RTB long-term loans.

NCSC Loan Programs

NCSC makes long-term and short-term loans to organizations affiliated with its members. Loans may be secured or unsecured. The loans to the affiliated organizations may have a guarantee of repayment to NCSC from the CFC class A cooperative with which it is affiliated.

Lease and General Loan Program

NCSC provides financing for the purchase, by a third party, of a member's assets in a sale/leaseback transaction. Collateral for these loans consists of a mortgage on the leased asset, generally a utility plant and/or related equipment. Repayment of principal and interest is funded using lease income collected by the purchaser.

Associate Member Loan Program

NCSC provides financing to for-profit affiliated corporations of cooperatives for economic and community development purposes. Collateral for these loans consists of a first mortgage lien on the assets of the associate member and/or project. These loans are also generally guaranteed by the sponsoring cooperative.

EC Program

Prior to January 2001, NCSC provided consumer loan financing through the EC Home Improvement ("ECHI") program. NCSC lent to consumers who use contractors enrolled in the program by sponsoring electric cooperatives. ECHI loans financed the services provided by contractors to consumers who may or may not be members of the sponsoring electric cooperative. ECHI loans are unsecured. Effective January 5, 2001, NCSC ceased originating ECHI loans. All ECHI loans made after January 5, 2001 have been funded by third party banks.

RUS Guaranteed Loans for Rural Electric Systems

The level of authority for RUS electric program loan guarantees for the fiscal year ending September 30, ~~2003~~2005 is ~~$2.7 billion. The expected level~~$2.0 billion for RUS guarantees of loans made by the Federal Financing Bank ("FFB"), and $100 million for RUS guarantees of private loans, including loans made by CFC. For the fiscal year ~~2004 is $2.1 billion.~~ending on September 30, 2006, the House of Representatives has provided for the same levels as for the current fiscal year, however, the Senate Appropriations Committee has provided for a higher level of $2.7 billion for RUS guarantees of FFB loans and $100 million for RUS guarantees of private loans. Differences between the House and Senate are resolved during the appropriations process. 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 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. RUS guarantees the principal and interest payments on the notes evidencing such loans. ~~The guarantees are uncontestable except for fraud or misrepresentation which the holder had actual knowledge of at the time it became a holder.~~ At May 31, ~~2003,~~2005, CFC had ~~$224~~$218 million of loans outstanding under this program. In addition, at May 31, ~~2003,~~2005, CFC was holding certificates totaling ~~$43~~$40 million representing interests in trusts holding RUS guaranteed loans.

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~~is 25 ~~to 50~~ basis points of the outstanding loan amount plus a ~~make whole~~make-whole premium, if applicable, per current loan policies.

Prepayment of Loans

Borrowers may prepay long-term loans at any time, subject to the payment of a prepayment fee of 33 to 50 basis points and a make-whole premium, if applicable. Line of credit loans may be ~~prepaid~~repaid at any time without a ~~premium.~~premium, provided the loan has a variable interest rate.

Loan Security

Except when providing lines of credit and intermediate-term loans, the Company typically lends to its members on a senior secured basis. Long-term loans are typically secured on a parity with other secured lenders (primarily RUS), if any, by all assets and revenues of the borrower with exceptions typical in utility mortgages. Short-term loans are generally unsecured lines of credit.

The following tables summarize the Company's secured and unsecured loans outstanding by loan program and by segment.

(Dollar amounts in thousands)		At May 31, 2005					At May 31, 2004
Total by loan program:		Secured	%	Unsecured	%		Secured	%	Unsecured	%
	Long-term fixed rate loans	$ 12,293,054	97%	$ 431,704		3%	$ 13,290,756	97%	$ 349,191	3%
	Long-term variable rate loans	4,701,660	95%	259,737		5%	5,191,421	95%	256,802	5%
	Loans guaranteed by RUS	258,493	100%	-		-	263,392	100%	-	-
	lntermediate-term loans	1,235	12%	9,093		88%	5,015	9%	50,390	91%
	Line of credit loans	201,466	20%	815,626		80%	299,250	28%	782,306	72%
	Total loans	$ 17,455,908	92%	$ 1,516,160		8%	$ 19,049,834	93%	$ 1,438,689	7%


7

(Dollar amounts in thousands)		At May 31, 2005					At May 31, 2004
Total by Segment:		Secured	%	Unsecured	%		Secured	%	Unsecured	%
	CFC	$14,316,925	92%	$1,188,241		8%	$14,202,369	92%	$1,153,215	8%
	RTFC	2,747,845	92%	244,347		8%	4,384,412	94%	258,596	6%
	NCSC	391,138	82%	83,572		18%	463,053	95%	26,878	5%
	Total loans	$17,455,908	92%	$1,516,160		8%	$19,049,834	93%	$1,438,689	7%

Guarantee Programs

~~CFC~~The Company uses the same credit policies and monitoring procedures in providing guarantees as it does for loans and commitments.

The following chart provides a breakout of guarantees outstanding by type.


	May 31,						May 31,
(Dollar amounts in thousands)	2003		2002		2001		2005		2004		2003
Long-term tax-exempt bonds	$	899,420	$	940,990	$	979,725	$	738,385	$	780,940	$	899,420
Debt portions of leveraged lease transactions		34,105		41,064		103,794		12,285		14,838		34,105
Indemnifications of tax benefit transfers		184,605		208,637		232,930		141,996		159,745		184,605
Letters of credit		314,114		310,926		370,592		196,597		307,518		314,114
Other guarantees		471,312		554,768		530,517		68,489		68,258		471,312
Total	$	1,903,556	$	2,056,385	$	2,217,559	$	1,157,752	$	1,331,299	$	1,903,556

Guarantees of Long-Term Tax-Exempt Bonds

~~CFC~~The Company has guaranteed debt issued in connection with the construction or acquisition by ~~CFC~~its 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,~~the Company, may include short- and long-term obligations.

In the event of a default by a system for ~~nonpayment~~non-payment of debt service, ~~CFC~~the Company 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~~the Company performs under its guarantee. The system is required to repay, on demand, any amount advanced by ~~CFC~~the Company pursuant to its guarantee. This repayment obligation is secured by a common mortgage with RUS on all the system's assets, but ~~CFC~~the Company 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~~the Company for any guarantee payments

will be treated as a long-term loan. The system is required to pay to ~~CFC~~the Company 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 the debt bears interest at a variable rate and ~~CFC~~the Company has committed to purchase debt so tendered if it cannot otherwise be remarketed. If ~~CFC~~the Company held the securities, the cooperative would pay interest to ~~CFC~~the Company at its intermediate-term loan rate. Since the inception of the program in the mid-1980s, all bonds have been successfully remarketed and thus, ~~CFC~~the Company has not been required to purchase any bonds.

Guarantees of Lease Transactions

~~CFC has a program~~The Company guarantees members' rent obligations to third parties. Included in the Company's guarantees of ~~lending to or guaranteeing~~lease transactions for the year ended May 31, 2005 and 2004 were CFC's guarantees of 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. Effective June 1, 2003, the guarantees of NCSC ~~is obligated to pay administrative and/or guarantee fees to CFC~~debt were eliminated 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.~~consolidation.

Guarantees of Tax Benefit Transfers

~~CFC~~The Company 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~~the Company 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~~The Company 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~~the Company within one year from the date of the draw, with interest accruing from such date at ~~CFC's~~the Company's line of credit variable rate of interest.

Other Guarantees

~~CFC~~The Company 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~~the Company's general and administrative expenses, a provision for losses and a reasonable margin. Included in other guarantees at May 31, 2003 ~~2002 and 2001~~ was $284 million ~~$334 million and $318 million, respectively,~~ of commercial paper issued by NCSC. Effective June 1, 2003, the guarantee of NCSC commercial paper was eliminated in consolidation.

Members' interest expense for the ~~year~~years ended May 31, 2005, 2004 and 2003 on debt obligations guaranteed by ~~CFC~~the Company was approximately $16 million, $13 million and $28 ~~million.~~million, respectively.

The following chart summarizes total guarantees ~~outstanding~~ by ~~member class~~type and segment at May 31, ~~2003, 2002~~2005, 2004 and ~~2001.~~2003.

Guarantees by Member Class
(Dollar amounts in thousands)
2003
2002
2001
Electric systems:
Distribution
$
77,725
4%
$
66,670
3%
$
153,982
7%
Power supply
1,220,795
64%
1,304,367
64%
1,377,755
62%
Statewide and associate
600,036
32%
680,011
33%
685,822
31%
Subtotal electric systems
1,898,556
100%
2,051,048
100%
2,217,559
100%
Telecommunication systems
5,000
-
5,337
-
-
-
Total
$
1,903,556
100%
$
2,056,385
100%
$
2,217,559
100%


(Dollar amounts in thousands)	Guarantees by Member Class
CFC:	2005	2004	2003
Distribution	$

41,842

60,672

77,725

Power supply

1,066,373

92%

1,130,379

85%

1,220,795

64%

Statewide and associate

41,642

111,195

600,036

32%

CFC Total

1,149,857

99%

1,302,246

98%

1,898,556

100%

RTFC

5,000

NCSC

7,895

29,053

Total

1,157,752

100%

1,331,299

100%

1,903,556

100%

Total guarantees outstanding by state and territory are summarized as follows:

May 31,
May 31,
(Dollar amounts in thousands)
2003
2002
2001
2003
2002
2001
Alabama
$
22,795
$
25,945
$
31,053
Missouri
$
126,198
$
138,755
$
150,372
Alaska
3,320
3,240
3,240
New Hampshire
31,500
27,500
31,200
Arizona
47,250
47,425
53,577
North Carolina
100,950
100,265
99,400
Arkansas
29,703
35,688
41,485
North Dakota
-
338
-
Colorado
57,273
58,007
58,716
Ohio
1,000
-
65,000
District of Columbia
590,941
674,435
681,873
Oklahoma
16,760
23,154
31,447
Florida
128,264
137,944
147,057
Oregon
25,810
24,628
14,580
Idaho
850
850
850
Pennsylvania
24,229
23,428
11,772
Illinois
7,093
7,719
15,049
Tennessee
295
300
-
Indiana
109,047
121,264
118,205
Texas
149,217
145,935
147,696
Iowa
12,572
14,290
9,942
Utah
71,749
78,315
114,404
Kansas
33,100
34,300
42,500
Virginia
4,215
4,207
3,950
Kentucky
142,785
149,405
155,240
Wisconsin
1,439
1,475
1,511
Michigan
196
691
585
Wyoming
10,005
10,195
10,380
Minnesota
103,696
111,863
119,745
Total
$
1,903,556
$
2,056,385
$
2,217,559
Mississippi
51,304
54,824
56,730

	May 31,							May 31,
(Dollar amounts in thousands)	2005		2004		2003			2005		2004		2003
Alabama	$	22,450	$	22,630	$	22,795	Missouri	$	104,218	$	113,186	$	126,198
Alaska		3,320		3,320		3,320	New Hampshire		10,500		17,500		31,500
Arizona		45,869		46,865		47,250	New Mexico		1,000		1,000		-
Arkansas		19,776		23,537		29,703	North Carolina		100,854		100,350		100,950
Colorado		55,744		56,518		57,273	North Dakota		-		20,000		-
District of Columbia		30,248		100,000		590,941	Ohio		1,000		-		1,000
Florida		108,385		116,447		128,264	Oklahoma		4,930		11,221		16,760
Idaho		-		850		850	Oregon		24,880		23,520		25,810
Illinois		633		6,218		7,093	Pennsylvania		21,021		21,900		24,229
Indiana		95,900		107,997		109,047	Tennessee		295		295		295
Iowa		5,708		4,885		12,572	Texas		143,682		147,347		149,217
Kansas		35,632		37,200		33,100	Utah		41,126		48,204		71,749
Kentucky		132,115		135,555		142,785	Vermont		1,250		750		-
Louisiana		4,728		4,728		-	Virginia		3,603		4,065		4,215
Michigan		1,207		1,148		196	Wisconsin		274		1,403		1,439
Minnesota		86,372		95,556		103,696	Wyoming		9,595		9,805		10,005
Mississippi		41,437		47,299		51,304	Total	$	1,157,752	$	1,331,299	$	1,903,556

9

Disaster Recovery

CFC has had in place a disaster recovery and business continuity plan since May 2001. The plan includes a duplication of CFC's information systems at an off-site facility and a comprehensive business recovery plan. CFC's production data is replicated in real time to the recovery site. The plan also includes steps for each of CFC's operating groups to conduct business with a view to minimizing disruption for customers. Recovery exercises are conducted twice annually with different teams to expand recovery experience among the staff. CFC contracts with an external vendor for the facilities to house the backup systems as well as office space and related office equipment. ~~CFC is currently studying the costs and benefits of creating its own facility to house the backup system versus contracting with a vendor.~~

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 in its exemption filing. RTFC is a taxable entity under Subchapter T of the Internal Revenue Code. As long as RTFC continues to qualify under Subchapter T of the Internal Revenue Code, it is allowed a deduction from taxable income for the amount of net margin allocated to its members. RTFC pays income tax based on its net margins, excluding net margins allocated to its members. NCSC is a taxable corporation. NCSC pays income tax annually based on its net margins for the period.

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.

Employees

At May 31, ~~2003,~~2005, CFC had ~~222~~219 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. At May 31, 2003, CFC was operating a telecommunications company it had received in a bankruptcy settlement. This company had a total of 177 additional employees consisting of senior management, marketing and sales support, engineers, technicians, IT support and customer service. The company is not unionized and it believes its relationship 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. Competitors include a government sponsored entity whose status as such gives it the ability to offer lower variable and short-term fixed interest rates in select situations.

According to ~~annual~~December 31, 2003 financial data filed with CFC, the ~~808~~812 reporting electric cooperative distribution and 5156 reporting power supply systems had a total of ~~$44~~$42 billion in long-term debt outstanding at December 31, ~~2002.~~2003. RUS is the dominant lender to the electric cooperative industry with ~~$25~~$24 billion or ~~62%~~56% of the total outstanding debt for the ~~859~~868 systems reporting ~~2002~~2003 results to CFC. At December 31, ~~2002,~~2003, CFC had a total of ~~$14~~$15 billion of long-term exposure to its ~~reporting~~ distribution and power supply member systems, including ~~$13~~$14 billion of long-term loans and $1 billion of guarantees. CFC's ~~$14~~$15 billion long-term exposure represented ~~36%~~37% of the total long-term debt to these electric systems. The remaining $1$3 billion or 2%7% was borrowed from other sources. ~~(Competition data is based on December~~(December 31, ~~2002~~2004 financial data filed with CFC by its ~~members)~~borrowers was not available at the time of this filing, therefore competition data is based on December 31, 2003 financial data). At December 31, 2004, CFC had a total of $16 billion of long-term exposure to its distribution and power supply member systems, including $15 billion of long-term loans and $1 billion of guarantees.

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. During fiscal year ~~2003,~~2005, CFC was selected as the lender for ~~62%~~78% of the total supplemental lending ~~requirement (not including amounts lent by FFB).~~requirement. The amount of funding ~~proposed~~approved for RUS electric program direct lending and loan guarantees for fiscal year ~~2004 is $2.0 billion. The amount approved~~2005 was $3.3 billion, of which $2.1 billion was for ~~the prior year~~loan guarantees and $1.2 billion was ~~$1.3 billion. The amount proposed~~ for ~~RUS guaranteed loans for~~direct loans. For fiscal year ~~2004~~2006 the House of Representatives has provided for $3.3 billion, of which $2.1 billion is ~~$2.1 billion.~~for loan guarantees and $1.2 billion is for direct loans, however, the Senate Appropriations Committee has provided for a higher total of $4.0 billion, of which $2.8 billion is for loan guarantees and $1.2 billion is for direct loans. Differences

between the House and Senate are resolved during the appropriations process. 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. CFC and other lenders also compete to fund projects in anticipation of long-term funding from RUS. Under the hardship program, RUS lends 100% of the ~~amount.~~permanent financing required. Under the guarantee program, RUS will guarantee the repayment of all principal and interest by the ~~cooperative.~~cooperative for 100% of the permanent financing required.

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. During the year ended May 31, ~~2003,~~2005, CFC was selected as lender for ~~over 95%~~100% of the total amount lent to distribution systems for the repayment of their RUS ~~debt.~~debt for borrowers in which CFC previously participated as a lender. As of May 31, ~~2003, 233~~2005, 240 borrowers had either fully prepaid or partially prepaid their RUS notes under these provisions. In total, CFC has lent $3.3 billion to distribution systems for the purpose of prepaying their RUS debt, representing 94% of the total note ~~buyouts.~~prepayments.

The competitive market for providing credit to the rural telecommunications industry is difficult to quantify, since many rural telecommunications companies are not RUS borrowers. At December 31, ~~2002,~~2004, RUS had a total of approximately $3.6 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 ~~$818~~approximately $769 million outstanding to telecommunications borrowers at December 31, ~~2002. CFC~~2004. A proposal to liquidate the RTB has been approved by the RTB board of directors. RTFC 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~~RTFC's competition includes ~~regional~~commercial banks, ~~a government sponsored enterprise~~CoBank, ACB ("CoBank") and insurance companies. At December 31, ~~2002, CFC~~2004, RTFC had a total of ~~$4.8~~$3.4 billion in long-term loans outstanding to telecommunications borrowers. At December 31, ~~2002, CFC is aware of~~2004, to RTFC's knowledge, only CoBank ~~ACB ("CoBank")~~ (which at December 31, ~~2002~~2004 had a telecom portfolio of approximately ~~$3.1~~$2.1 billion), ashad a ~~lender with a~~rural telecommunications loan portfolio of similar size to ~~CFC's~~RTFC's and RUS/RTB's.

Member Regulation and Competition

Electric Systems

In 1992 Congress passed the Energy Policy Act effectively providing competition in the generation sector of the wholesale electric power industry. Subsequently 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 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 provides transmission service in interstate commerce, or provides sales for resale in interstate commerce.

The trend toward retail electric competition has appreciably slowed. The electric utility industry has settled into a "hybrid" model in which there are significant differences in the regulatory approaches followed in different states and regions. At May 31, ~~2003, 17~~2004 (the latest information available), 16 states were active in the process of moving toward customer choice. In these states, customer choice was either currently available to all or some customers or will ~~soon~~ be available. Those states are ~~Arizona,~~ Connecticut, Delaware, Illinois, Maine, Maryland, Massachusetts, Michigan, New Hampshire, New Jersey, New York, Ohio, Oregon, Pennsylvania, Rhode Island, Texas and Virginia. Of the remaining states, 27 states were not actively pursuing restructuring, five states have delayed the restructuring process or the implementation of customer choice, and ~~one state has~~two states (Arizona and California) have suspended customer choice.

In the 1716 states ~~that were active in~~where customer choice is or will be available, CFC had a total of ~~244~~224 electric members ~~(183~~(171 distribution, 2220 power supply and ~~39 associate)~~33 associates) and ~~$4,731~~$4,874 million of loans to electric systems ~~in these states.~~at May 31, 2005. In New York, where CFC has five electric members and $9$14 million of loans to electric systems, cooperatives are not required to file competition plans with the state utility commission. In Michigan, where CFC has 14 electric members and $274 million in loans, the starting date for customer choice has been delayed. The Company continues to believe that the distribution systems, which comprise the majority of ~~CFC's~~its membership and loan exposure, will not be materially impacted by ~~a move to~~ customer choice. ~~The experience to date has been that,~~In general, even in those states where customers have a choice of alternative energy suppliers, very few customers have switched from the traditional supplier.

In addition, in five of the 1716 states ~~actively operating under~~where customer choice ~~laws,~~is or will be available, co-ops ~~have a choice~~may decide whether to "opt in" to competition or retain a monopoly position with respect to energy sales. Those states are Illinois, New Jersey, Ohio, Oregon and Texas. As of May 31, ~~2003,~~2005, CFC had loans outstanding in the amount of ~~$3,682~~$3,834 million in those states. Furthermore, even if customers choose to purchase energy from an alternative supplier, the distribution systems own the lines to the customer and it would not be feasible for a competitor to build a second line to serve the same customers in almost all situations. Therefore, the distribution systems will still be charging a fee or access tariff for the service of delivering power regardless of who supplies the power.

The impact on power supply systems cannot be determined until final rules have been approved in each state with regard to stranded cost recovery.

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 to them and the timing of competition for cooperatives. One such factor will be the level of fees that systems will be allowed to charge other utilities for use of their transmission and distribution system. Other issues that may further delay competition include, but are not limited to, the following:

*	ability of cooperatives to "opt out" of the provisions of the customer choice laws in some states;
*	utilities in many states may still be regulated regarding rates on non-competitive services, such as distribution;
*	many states will still regulate the securities issued by utilities, including cooperatives;
*	FERC regulation of rates as well as terms and conditions of transmission service;
*	reconciling the differences between state laws, such that out-of-state utilities can compete with in-state utilities; and
*	the fact that few competitors have much interest in serving residential or rural customers.


In addition to customer choice laws, some state agencies regulate electric cooperatives with regard to rates and borrowing. There are 1716 states that regulate the rates electric systems charge; of these states, ~~three~~two states have partial oversight authority over the cooperatives' rates, but not the specific authority to set rates, and ~~seven~~nine 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 both the issuance of short-term and long-term debt. FERC also has jurisdiction to regulate rates, terms and conditions of service and securities by electric systems within its jurisdiction, which presently includes some cooperatives.

With the enactment of the Energy Policy Act of 2005 in August 2005, the definition of a public utility has been modified to exclude RUS financed cooperatives and non-RUS financed cooperatives provided that the non-RUS cooperatives have total sales less than four million Mwh. The Energy Policy Act of 2005 effectively provides a statutory exemption from FERC regulation for essentially all distribution cooperatives.

Telecommunications Systems

~~CFC~~RTFC 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. Some member telecommunications systems have affiliated companies that are not regulated.

The Telecommunications Act of 1996 (the "Telecom Act") created a framework for competition and deregulation in the local telecommunications market. The Telecom Act had four basic goals: competition, universal service, deregulation and fostering advanced telecommunications and information technologies. The Telecom Act ~~seeks~~sought to achieve competition by requiring all carriers to interconnect with all others and by requiring LECs to provide competitors with ~~total service resale, number portability, dialing parity,~~ access to ~~rights-of-way, reciprocal compensation, co-location, and unbundled access.~~elements of their networks. Congress included provisions in the Telecom Act granting RLECs an exemption from the above ~~requirements.~~unbundled network element requirements, absent a determination that it would be in the public interest.

~~In cities, telecommunications~~Telecommunications competition is ~~occurring. Despite~~a fact. A recent FCC report on competition stated that as of June 2004, competitive local exchange carriers ("CLECs") provided service to 32 million lines - 17.8% of the ~~shakeout in~~nation's 180.1 million end-user switched access lines. Wireless carriers are providing service to 167.3 million mobile telephone service subscriptions - more than the ~~competitive~~148.1 million incumbent LEC ~~segment, facility and non-facility based competitors exist~~("ILEC") switched access lines. Non facilities-based CLECs took advantage of pro-competitive FCC rules that ~~are focused primarily on~~allowed CLECs to obtain all elements of the ~~large~~ILECs' networks necessary to conduct business user market. The RBOCs were motivated to cooperate with competitors in order to win approval to enter the long distance market in their service territories. Now, the RBOCs have gained authority to provide long distance service in all of their local markets and are less inclined to cooperate with competitors. AT&T and MCI are usingat very favorable rates. This is known as the unbundled network element platform ~~to compete with the RBOCs for residential customers, offering packages~~(or UNE-P) and consisted of a combination of an unbundled loop, unbundled local circuit switching and ~~long distance service.~~shared transport.

~~Rural markets have been~~A March 2004 court order forced the ~~last~~FCC to ~~see broad~~revisit its rules on UNE-P. In a decision favorable to the regional Bell companies, in December 2004 the FCC ruled that ILECs no longer had any obligation to provide CLECs with mass market local circuit switching and gave CLECs 12 months to transition existing customers off of unbundled local circuit switching. This ruling caused the UNE-P CLEC business model to collapse and created extreme hardship for many such CLECs. Over 50% of total CLEC lines as of June 2004 were provided through UNE-P. AT&T and MCI subsequently exited the residential CLEC market.

RLECs generally were not subject to UNE-P based ~~local telecommunications service competition.~~competition, since RLECs enjoyed an exemption contained in the Telecom Act. Rural telecommunications companies ~~that border metropolitan areas~~ are experiencing competition, ~~for their largest business customers. Increasingly,~~however. A survey of small rural telecommunications ~~providers are entering~~companies found that 77% face at least one competitor in their markets. For the most part, local exchange competition has benefited RLECs by enabling them to enter nearby towns and cities as competitive LECs, leveraging their existing ~~infrastructure.~~infrastructure and reputation for providing quality, modern telecommunications service.

In addition to competition, the Telecom Act also mandated a ~~new~~ universal telecommunications service support mechanism and required that it be: (1) sufficient to ensure that rural customers receive reasonably comparable rates and services when compared to urban customers; and (2) portable, that is available to all eligible providers. 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. Rules adopted by the FCC in 2000 have provided adequate levels of universal service support. This has been essential for RLECs, as other ~~Commission~~FCC rulings have reduced access charges which are a key ~~RLEC~~ revenue source. Numerous wireless carriers have entered rural markets as competitors to the ~~LEC.~~RLECs. By obtaining competitive eligible telecommunications carrier ~~("CETC")~~ status from state regulators (as provided for in the Telecom Act), these wireless carriers are able to receive universal service funds ("USF") based on the incumbent LEC's costs. This has led to great concern for the sustainability of the fund. USF's current funding base of interstate telecommunications revenues is shrinking as long distance minutes-of-use go down due to wireless, email and ~~email~~voice over internet protocol substitution. Uncontrolled growth of the fund ~~would make~~is making the rate assessed on all participants in the nationwide network unsustainably high. The fourth quarter 2004 rate was 8.9%. The FCC has proposed a second quarter 2005 assessment rate ~~unacceptably high.~~of 11.1%. All industry segments agree that changes need to be made regarding eligibility to receive and the funding mechanism for USF. However, they are not all ~~agreed~~in agreement on what those changes should be. The FCC has a proceeding open to review USF, and Congress is likely to undertake a rewrite of the Telecom Act in the near future.

The FCC also has a proceeding open on intercarrier compensation - the most important components of which are access fees LECs charge to interexchange carriers that originate or terminate long distance traffic on LEC networks. While the large LECs (most of which now own long distance companies) would like to see these fees transition to zero, RLECs depend heavily on access charges and are active participants in the FCC proceeding.

While uncertainty exists regarding USF and access, CFC does not anticipate that any potential revenue losses resulting from these changes will result in material losses on loans outstanding to rural telecommunications companies.

Most RLECs are expanding their service offerings to customers. Without cable as a competitor in most rural areas, RLECs are ~~rolling out~~introducing digital video, high-speed data, and local and long distance voice service. Where they can leverage their infrastructure, they are competing with RBOCs and cable companies in neighboring towns. RLECs have generally been very successful competitors in these situations.

Deregulation ~~thus far~~ has not had much effect on ~~LECs.~~LECs thus far. The FCC has promulgated a series of rules to implement the Telecom Act, and eliminated very few existing regulatory requirements. States continue to regulate RLECs extensively. A revised or totally rewritten Telecom Act would kick off a whole new round of regulatory proceedings.

Another aspect of the Telecom Act dealt with advanced telecommunications and information technologies. In the late 1990s there was the concern that there was a growing "digital divide" between various groups and areas within the country. Legislators sought to provide broadband connectivity to all Americans through programs which 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. Congress also created an RUS broadband loan program in 2002 and authorized ~~$1.4 billion~~$600 million in fiscal year ~~2003~~2005 lending authority. ItFor fiscal year 2006, the Administration is ~~anticipated that RUS will play a significant role in financing infrastructure to help provide rural Americans with access to these services.~~ proposing an additional $300 million.

Given the increased availability of government financing for rural broadband, it is unlikely that CFC or any other supplemental lender will be participating in this financing to any significant degree.

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 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. For fiscal year ~~2003,~~2005, RUS (including RTB) has ~~$495~~$695 million in lending authority for rural telephone systems and an additional ~~$2,583~~$596 million for other telecommunications programs, including distance learning ~~broadband~~ and ~~local-to-local television.~~broadband.

The RE Act provides for RUS to make insured loans and to provide other forms of financial assistance to borrowers. RUS ~~also provides financing at the Treasury rate. RUS~~ is authorized to make direct loans, at below market rates, to systems ~~which are eligible to borrow from it. RUS currently prices~~that qualify for the ~~majority of its insured loans to distribution systems based~~hardship program (5% interest rate) or the municipal rate program (based on a municipal government obligation ~~index and prices hardship loans at a rate of 5%~~index). RUS is also authorized to guarantee loans that ~~have been~~are 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). RUS also provides financing at the Treasury rate. For telecommunications borrowers, RUS also provides financing through the RTB. ~~The RTB is an instrumentality of the United States providing financing at rates reflecting its cost of capital and is managed by RUS.~~ The RUS exercises financial and technical supervision over borrowers' operations. Its loans and guarantees are generally secured by a mortgage on substantially all of the system's property and revenues.

For the fiscal year ending September 30, ~~2004, both~~2006, the House ~~and Senate Appropriations Committees have~~of Representatives has approved a total of $3.3 billion of RUS electric loan and guarantee levels as follows: municipal rate loans of ~~$1 billion,~~$100 million, hardship loans of ~~$240~~$100 million, treasury rate loans of ~~$750 million,~~$1 billion and loan guarantees of $2.1 billion. The Senate Appropriations Committee has approved a total of $4.0 billion for RUS electric loan and guarantee levels; all of this increase above the $3.3 billion provided by the House was for loan guarantees which the Senate bill sets at $2.8 billion. Fiscal year 2006 electric program levels set by the Senate bill for the municipal rate, treasury rate and hardship programs were the same as approved by the House. Differences between the House and Senate bills will be resolved as part of the appropriations process. Electric funding levels for fiscal year ~~2003~~2005 were as follows: municipal rate loans of $100 million, hardship loans of ~~$121~~$120 million, treasury rate loans of ~~$1.1~~$1 billion, and loan guarantees of ~~$2.7~~$2.1 billion.

~~Member Financial Data~~

~~Electric Systems~~

Distribution and power supply systems with long-term loans outstanding are required to submit to CFC annual financial information on Form 7 and Form 12 or FERC Form 1, respectively. The information presented on the Form 7, Form 12 and FERC Form 1 is more detailed information than is typically available in the audited financial statements. The following pages contain composite statements of revenues, expenses and patronage capital for the years ended December 31, 2002, 2001, 2000, 1999 and 1998 and the composite combined balance sheets at December 31, 2002, 2001, 2000, 1999 and 1998, based on the Form 7's, Form 12's and FERC Form 1's received from its members. As of August 18, 2003, CFC had received financial information from 808 distribution systems and 51 power supply systems.

While CFC had 826 distribution system members at May 31, 2003, 16 distribution systems were not required to report financial results on Form 7 because they did not have an outstanding balance of long-term loans at December 31, 2002 and two distribution systems did not file financial results on Form 7 with CFC.

Only 51 of the 72 total power supply systems reported December 31, 2002 financial results on Form 12 or FERC Form 1 to CFC. A total of 16 power supply systems did not report financial results because they did not have an outstanding balance of long-term loans at December 31, 2002. Two power supply systems merged with another and filed combined financial results on Form 12 or FERC Form 1. In addition, three power supply systems did not file financial results on Form 12 or FERC Form 1 with CFC.

~~Telecommunications Systems~~

On the following pages are tables providing composite statements of revenues and expenses from the telecommunications systems that were borrowers of CFC during the five years ended December 31, 2002. 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 August 18, 2003, CFC had received audited financial statements from 201 telecommunications systems.

Only 229 of the 513 telecommunications system members at May 31, 2003 had long-term loans outstanding and therefore were required to submit audited financial statements to CFC at December 31, 2002. A total of five telecommunications system members have not yet filed audited financial statements with CFC, 21 telecommunications system members submitted consolidated audited financial statements and one system was excluded due to the size of the system resulting in a significant weighting of the composite results, even though its loans from CFC represented only 4% of the total telecommunications portfolio. In addition, one system, representing less than 2% of the total telecommunications portfolio, was excluded due to its Chapter 11 bankruptcy filing. The borrower is current on all debt service payments due to CFC. CFC expects the borrower's financial statements to change significantly upon its emergence from bankruptcy.

NOTE: The financial information submitted to CFC is subject to year-end audit adjustments by reporting borrowers and does not, with minor exceptions, take into account current data for certain systems that are not active CFC borrowers. CFC takes no responsibility for the accuracy or completeness of the member data. CFC's independent auditors have not examined any 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.

~~NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION~~

~~COMPOSITE STATEMENTS OF REVENUES, EXPENSES AND PATRONAGE CAPITAL~~

~~AS REPORTED TO CFC BY MEMBER DISTRIBUTION SYSTEMS~~

~~The following are unaudited figures that are based~~

~~upon Form 7 submitted to~~

~~CFC by Member Distribution Systems~~

Years ended December 31,
(Dollar amounts in thousands)
2002
2001
2000
1999
1998
Operating revenues and patronage capital
$
22,856,370
$
21,627,713
$
20,419,019
$
18,805,359
$
18,284,021

Operating deductions:
      Cost of power (1)
14,153,297
13,550,239
12,925,630
11,828,572
11,580,829
      Distribution expense (operations)
992,617
899,310
856,378
792,249
728,565
      Distribution expense (maintenance)
1,249,463
1,183,558
1,106,780
1,024,734
985,571
      Administrative and general expense (2)
2,266,334
2,144,824
1,972,220
1,864,344
1,735,074
      Depreciation and amortization expense
1,600,544
1,487,657
1,387,923
1,290,354
1,203,438
      Taxes
269,587
252,592
241,219
230,238
241,010

          Total
20,531,842
19,518,180
18,490,150
17,030,491
16,474,487

Utility operating margin
2,324,528
2,109,533
1,928,869
1,774,868
1,809,534
Non-operating margin
295,588
104,442
211,957
179,940
173,446
Power supply capital credits (3)
321,548
326,215
272,007
259,099
297,451

          Total
2,941,664
2,540,190
2,412,833
2,213,907
2,280,431

Interest on long-term debt (4)
1,151,978
1,194,016
1,150,231
1,024,369
980,863
Other deductions
74,769
74,854
84,049
50,523
49,628

          Total
1,226,747
1,268,870
1,234,280
1,074,892
1,030,491

Net margin and patronage capital
$
1,714,917
$
1,271,320
$
1,178,553
$
1,139,015
$
1,249,940

TIER (5)
2.48
2.05
2.01
2.11
2.35
DSC (6)
2.16
1.94
2.08
2.15
2.32
MDSC (7)
1.98
1.88
1.99
2.03
2.25
Number of systems included
808
811
812
811
820

~~(1)~~	~~Includes cost of purchased power, power production and transmission expense.~~
~~(2)~~	~~Includes sales expenses, consumer accounts and customer service and informational expense as well as other administrative and general expenses.~~
~~(3)~~	Represents net margin of power supply systems and other associated organizations allocated to their member distribution systems and added in determining net margin and patronage capital of distribution systems under RUS accounting practices. Cash distributions of this credit have rarely been made by the power supply systems and such other organizations to their members.
~~(4)~~	Interest on long-term debt is net of interest charged to construction. CFC believes that amounts incurred by distribution systems for interest charged to construction and allowance for funds used during construction are immaterial relative to their total interest on long-term debt and net margin and patronage capital.
~~(5)~~	The ratio of (x) interest on long-term debt (in each year including all interest charged to construction) and net margin and patronage capital to (y) interest on long-term debt (in each year including all interest charged to construction).
~~(6)~~	The ratio of (x) net margin and patronage capital plus interest on long-term debt (including all interest charged to construction) plus depreciation and amortization to (y) long-term debt service obligations.
~~(7)~~	The ratio of (x) operating margin and patronage capital plus interest on long-term debt (including all interest charged to construction) plus depreciation and amortization expense plus non-operating margin, interest plus cash received in respect of generation and transmission and other capital credits to (y) long-term~~debt service obligations.~~

~~NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION~~

~~COMPOSITE COMBINED BALANCE SHEETS~~

~~AS REPORTED TO CFC BY MEMBER DISTRIBUTION SYSTEMS~~

~~The following are unaudited figures that are based~~

~~upon Form 7 submitted to~~

~~CFC by Member Distribution Systems~~

At December 31,
(Dollar amounts in thousands)
2002
2001
2000
1999
1998
Assets and other debits:
   Utility plant:
      Utility plant in service
$
51,732,230
$
48,895,933
$
45,985,367
$
43,023,535
$
40,387,723
      Construction work in progress
1,350,707
1,442,108
1,438,002
1,262,537
1,129,147
      Total utility plant
53,082,937
50,338,041
47,423,369
44,286,072
41,516,870
   Less: Accumulated provision for
                    depreciation and amortization
14,841,818
14,044,637
13,083,103
12,225,421
11,409,118
      Net utility plant
38,241,119
36,293,404
34,340,266
32,060,651
30,107,752
   Investment in associated organizations (1)
4,442,660
4,225,723
4,002,393
3,790,623
3,665,208
   Current and accrued assets
5,360,318
5,038,616
5,651,652
4,520,592
4,526,663
   Other property and investments
1,240,403
1,076,731
1,019,348
703,585
644,353
   Deferred debits
593,995
613,117
626,903
599,511
530,606
      Total assets and other debits
$
49,878,495
$
47,247,591
$
45,640,562
$
41,674,962
$
39,474,582

Liabilities and other credits:
   Net worth:
      Memberships
$
114,001
$
111,266
$
140,663
$
119,175
$
112,391
      Patronage capital and other equities (2)
20,459,062
19,642,036
18,538,088
17,542,625
16,710,886
      Total net worth
20,573,063
19,753,302
18,678,751
17,661,800
16,823,277
   Long-term debt (3)
23,345,933
21,943,560
21,326,555
19,308,152
18,343,340
   Current and accrued liabilities
4,440,751
4,095,900
4,280,010
433,687
3,098,525
   Deferred credits
974,414
952,642
892,001
3,429,173
884,595
   Miscellaneous operating services
544,334
502,187
463,245
842,150
324,845
      Total liabilities and other credits
$
49,878,495
$
47,247,591
$
45,640,562
$
41,674,962
$
39,474,582

Equity percentage (4)
41.2%
41.8%
40.9%
42.5%
42.6%
Number of systems included
808
811
812
811
820

~~(1)~~	~~Includes investments in service organizations, power supply capital credits and investments in CFC.~~
~~(2)~~	~~Includes non-refundable donations or contributions in cash, services or property from states, municipalities, other government agencies, individuals and others for construction purposes.~~
~~(3)~~	~~Principally debt to RUS and CFC. Includes $10,501,697, $9,794,118, $9,717,546, $8,342,631, and $7,481,368 for the years ended December 31, 2002, 2001, 2000, 1999, and 1998, respectively, due to CFC.~~
~~(4)~~	~~Determined by dividing total net worth by total assets and other debits.~~

~~NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION~~

~~COMPOSITE STATEMENTS OF REVENUES, EXPENSES AND PATRONAGE CAPITAL~~

~~AS REPORTED TO CFC BY MEMBER POWER SUPPLY SYSTEMS~~

~~The following are unaudited figures that are based~~

~~upon Form 12 or FERC Form 1 submitted to~~

~~CFC by Member Power Supply Systems~~

Years ended December 31,
(Dollar amounts in thousands)
2002
2001
2000
1999
1998
Operating revenues and patronage capital
$
11,555,059
$
11,941,467
$
11,431,737
$
10,758,413
$
10,901,138
Operating deductions:
   Cost of power (1)
8,673,728
9,188,992
8,609,376
7,945,476
7,979,542
   Distribution expense (operations)
22,848
22,319
21,375
23,634
17,499
   Distribution expense (maintenance)
15,733
15,907
14,333
14,908
12,524
   Administrative and general expense (2)
461,984
439,032
433,616
414,362
406,441
   Depreciation and amortization expense
977,930
917,165
936,059
904,826
914,270
   Taxes (3)
21,493
26,877
82,297
68,681
69,095

      Total
10,173,716
10,610,292
10,097,056
9,371,887
9,399,371

Utility operating margin
1,381,343
1,331,175
1,334,681
1,386,526
1,501,767
Non-operating margin
224,104
249,256
303,513
258,186
577,842
Power supply capital credits (4)
39,653
44,506
49,077
44,180
56,646

      Total
1,645,100
1,624,937
1,687,271
1,688,892
2,136,255

Interest on long-term debt (5)
1,174,279
1,186,371
1,195,644
1,227,548
1,221,512
Other deductions
118,386
117,937
144,850
185,621
184,868

      Total
1,292,665
1,304,308
1,340,494
1,413,169
1,406,380

Net margin and patronage capital
$
352,435
$
320,629
$
346,777
$
275,723
$
729,875

TIER (6)
1.29
1.25
1.28
1.22
1.60
DSC (7)
0.97
0.99
1.16
1.15
1.45
Number of systems included
51
53
51
54
58

~~(1)~~	~~Includes cost of purchased power, power production and transmission expense.~~
~~(2)~~	~~Includes sales expenses and consumer accounts expense and consumer service and informational expense as well as other administrative and general expenses.~~
~~(3)~~	The significant decrease in 2001 was due to a $63 million deferred income tax credit caused by the change of one system's allocation of patronage capital from a historical book basis to a tax basis method.
~~(4)~~	Certain power supply systems purchase wholesale power from other power supply systems of which they are members. Power supply capital credits represent net margin of power supply systems allocated to member power supply systems on the books of the selling power supply systems. This item has been added in determining net margin and patronage capital of the purchasing power supply systems under RUS accounting practices. Cash distributions of this credit have rarely been made by the selling power supply systems to their members. This item also includes net margin of associated organizations allocated to power supply members and added in determining net margin and patronage capital of the member systems under RUS accounting practices.
~~(5)~~	Interest on long-term debt is net of interest charged to construction. Allowance for funds used during construction has been included in non-operating margin. According to unpublished information interest charged to construction and allowance for funds used during construction for CFC power supply members in the years 1998-2002 were as follows:

Allowance for Funds Used During
Interest Charged to Construction
Construction
Total
2002
$25,479
$15,009
$40,488
2001
39,140
21,851
60,991
2000
20,245
24,736
44,981
1999
10,073
13,604
23,677
1998
9,947
13,133
23,080

~~(6)~~

The ratio of (x) interest on long-term debt (in each year including all interest charged to construction) and net margin and patronage capital to (y) interest on long-term debt (in each year including all interest charged at that time to construction). The TIER calculation for 1999 and 1998 includes the operating results of five systems, which failed to make debt service payments or are operating under a debt restructure agreement. The TIER calculation for 2000 and 2001 includes the operating results of one system and four systems, respectively, that did not borrow from CFC at that time. The TIER calculation for 2002 includes the operating results of 11 systems that do not currently borrow from CFC. Without these systems, the composite TIER would have been 1.29, 1.22, 1.29, 1.24 and 1.27 for the years ended December 31, 2002, 2001, 2000, 1999 and 1998, respectively.

~~(7)~~

The ratio of (x) net margin and patronage capital plus interest on long-term debt (including all interest charged to construction) plus depreciation and amortization to (y) long-term debt service obligations (including all interest charged to construction). The DSC calculation for 1999 and 1998 includes the operating results of five systems which failed to make debt service payments or are operating under a debt restructure agreement. The DSC calculation for 2000 and 2001 includes the operating results of one system and four systems, respectively, that did not borrow from CFC at that time. The DSC calculation for 2002 includes the operating results of 11 systems that do not currently borrow from CFC. Without these systems, the composite DSC would have been 1.14, 0.98, 1.19, 1.23 and 1.28 for the years ended December 31, 2002, 2001, 2000, 1999 and 1998, respectively.

~~NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION~~

~~COMPOSITE COMBINED BALANCE SHEETS~~

~~AS REPORTED TO CFC BY MEMBER POWER SUPPLY SYSTEMS~~

~~The following are unaudited figures that are based~~

~~upon Form 12 or FERC Form 1 submitted to~~

~~CFC by Member Power Supply Systems~~

At December 31,
(Dollar amounts in thousands)
2002
2001
2000
1999
1998
Assets and other debits:
   Utility plant:
      Utility plant in service
$
35,116,374
$
32,687,748
$
31,970,487
$
31,140,658
$
31,141,532
      Construction work in progress
1,962,399
1,813,833
1,571,954
1,151,859
1,041,760
          Total utility plant
37,078,773
34,501,581
33,542,441
32,292,517
32,183,292

      Less: Accumulated provision for
                 depreciation and amortization
15,929,240
14,208,592
13,867,937
13,230,060
13,059,537

          Net utility plant
21,149,533
20,292,989
19,674,504
19,062,457
19,123,755
      Investments in associated
           organizations (1)
1,379,768
1,313,453
1,360,671
1,173,026
1,132,157
      Current and accrued assets
4,214,557
4,120,224
4,067,827
3,904,535
3,740,302
      Other property and investments
1,639,204
1,722,999
1,540,147
1,511,145
1,691,932
      Deferred debits
2,102,269
2,113,357
3,027,612
3,251,458
3,400,876

          Total assets and other debits
$
30,485,331
$
29,563,022
$
29,670,761
$
28,902,621
$
29,089,022

Liabilities and other credits:
   Net worth:
      Memberships
$
49,133
$
49,129
$
49,106
$
49,131
$
263
      Patronage capital and other equities (2)
3,942,442
3,575,050
3,498,360
3,175,374
(52,606
)
          Total net worth
3,991,575
3,624,179
3,547,466
3,224,505
(52,343
)
   Long-term debt (3)
20,159,824
19,935,286
19,051,276
19,591,883
23,389,067
   Current and accrued liabilities
3,070,276
2,878,459
3,186,042
2,328,504
1,877,320
   Deferred credits
1,556,459
1,509,021
1,565,294
1,338,343
1,296,308
   Miscellaneous operating reserves
1,707,197
1,616,077
2,320,683
2,419,386
2,578,670

          Total liabilities and other credits
$
30,485,331
$
29,563,022
$
29,670,761
$
28,902,621
$
29,089,022
Number of systems included
51
53
51
54
58

~~(1)~~	~~Includes investments in service organizations, power supply capital credits and investments in CFC.~~
~~(2)~~	~~The large increase in 1999 was due to the elimination of Cajun Electric Power Cooperative, which was liquidated after filing for bankruptcy. CFC had no credit exposure to Cajun.~~
~~(3)~~	Principally debt to RUS or debt guaranteed by RUS and loaned by FFB and includes $1,979,107, $2,048,767, $1,905,614, $1,761,847 and $1,652,943 as of December 31, 2002, 2001, 2000, 1999 and 1998, respectively, due to CFC.

~~NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION~~

~~COMPOSITE STATEMENTS OF REVENUES AND EXPENSES~~

~~AS REPORTED TO CFC BY TELECOMMUNICATIONS SYSTEMS~~

~~The following are unaudited figures that are based~~

~~upon financial statements submitted to~~

~~CFC by Member Telecommunications Systems~~

Years ended December 31,
(Dollar amounts in thousands)
2002 (4) (5)
2001 (4)
2000 (3)
1999 (3)
1998
Operating revenues
$
4,765,679
$
4,503,614
$
4,879,808
$
3,908,496
$
2,535,461
Operating expenses (1)
3,364,102
3,030,570
3,509,779
3,003,530
1,846,215
Net income before interest,
depreciation and taxes
1,401,577
1,473,044
1,370,029
904,966
689,246
Interest on long-term debt
477,587
568,829
430,825
221,103
140,436
Net income before depreciation and taxes
923,990
904,215
939,204
683,863
548,810
Depreciation and amortization expenses
719,204
797,665
675,757
410,805
279,277
Net income before taxes
204,786
106,550
263,447
273,058
269,533
Taxes
93,797
91,420
140,378
89,030
71,326
Net income
$
110,989
$
15,130
$
123,069
$
184,028
$
198,207

DSC (2)
1.43
1.59
1.79
2.30
2.14
Number of systems included
201
208
226
191
169

~~(1)~~	~~Includes sales expenses, consumer accounts and customer service and informational expense as well as other administrative and general expenses.~~
~~(2)~~	Debt service coverage ratio is the ratio of (x) net margin plus interest on long-term debt (including all interest charged to construction) plus depreciation and amortization to (y) long-term debt service obligations. During calendar year 2000, CFC closed two large loans to start-up companies for the purpose of acquiring local exchange properties from GTE (now Verizon). Due to significant expenses related to start-up and the transition of these operations, for the years ending 2002, 2001 and 2000 there were substantial transition related expenses reported by these two companies. These expenses were expected when the transactions were underwritten and are typical of such acquisition companies during their start-up mode. Excluding these two borrowers, the composite DSC was 1.71, 1.80 and 2.06 for the years ended December 31, 2002, 2001 and 2000, respectively.
~~(3)~~	For the years ended December 31, 2000 and 1999, some telecommunications members were acquired by Alltel Corporation, and CFC agreed to accept Alltel Corporation's financial statements rather than those of the acquired operating companies. Given Alltel Corporation's size, it is not included in the composite statistics.
~~(4)~~	During the year ended December 31, 2001, Citizens Communications Company became a telecommunications borrower. The December 31, 2002 and 2001 financial results for Citizens have been excluded from the information above because CFC believes that their inclusion would unduly skew these statistics. Loans to Citizens represent only 4% of the total telecommunications loan portfolio. Citizens' long-term debt has been rated Baa2 by Moody's Investors Service, BBB by Standard & Poor's Corporation and BBB by Fitch Ratings. For calendar year 2002, Citizens reported revenues of $2,669 million and a net loss of $683 million. The net loss was the result of a one-time $1,074 million impairment charge under SFAS 144. Citizens' debt service coverage ratio including and excluding this non-cash charge was 0.57 and 1.70, respectively. Had Citizens been included in the composite data above, the composite debt service coverage ratio would have been 0.99, including the non-cash impairment charge.
~~(5)~~	During the year ended December 31, 2002, two of CFC's large telecommunications borrowers recorded impairments to goodwill as a result of new accounting standards. These non-cash charges, which total $140.3 million are reflected in the 2002 composite DSC calculation. Exclusion of these charges would result in a composite DSC of 1.59. In addition, one of CFC's telecommunications borrowers, representing less than 2% of all telecommunications loans outstanding, has been excluded from the 2002 composite figures due to its Chapter 11 bankruptcy filing. CFC is being kept current on its loans to this borrower throughout the bankruptcy and expects to recover all principal and the contract yield on its loans to this borrower, all of which are senior secured. CFC expects the borrowers' financial statements to change significantly upon its emergence from bankruptcy.

~~NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION~~

~~COMPOSITE COMBINED BALANCE SHEETS~~

~~AS REPORTED TO CFC BY TELECOMMUNICATIONS SYSTEMS~~

~~The following are unaudited figures that are based~~

~~upon financial statements submitted to~~

~~CFC by Member Telecommunications Systems~~

At December 31,
(Dollar amounts in thousands)
2002 (4) (5)
2001 (4)
2000 (3)
1999 (3)
1998
Assets and other debits:
     Cash and cash equivalents
$
655,500
$
653,628
$
639,882
$
646,409
$
401,507
     Current assets
970,994
909,931
1,372,186
1,029,905
590,248
     Plant, property and equipment
5,024,619
5,572,227
5,674,846
3,998,038
2,699,798
     Other non-current assets
4,331,119
4,728,130
4,957,209
2,505,597
1,456,301
          Total assets
$
10,982,232
$
11,863,916
$
12,644,123
$
8,179,949
$
5,147,854
Liabilities and equity:
     Current liabilities
$
935,367
$
945,181
$
1,225,408
$
898,080
$
586,176
     Affiliate debt
4,266
7,152
1,135
3,804
23,442
     Long-term debt (1)
6,844,587
7,156,808
6,960,293
4,309,996
2,686,987
     Other non-current liabilities
586,628
464,703
741,921
392,982
232,219
     Equity
2,611,384
3,290,072
3,715,366
2,575,087
1,619,030
          Total liabilities and equity
$
10,982,232
$
11,863,916
$
12,644,123
$
8,179,949
$
5,147,854

Equity percentage (2)
24%
28%
29%
32%
32%
Number of systems included
201
208
226
191
169

~~(1)~~	~~Includes current maturities.~~
~~(2)~~	Determined by dividing total net worth by total assets and other debits. During calendar year 2000, CFC closed two large loans to start-up companies for the purpose of acquiring local exchange properties from GTE (now Verizon). Due to significant expenses related to start-up and the transition of these operations, for the years ending 2001 and 2000 there were substantial operating losses reported by these two companies, which had a negative impact on their reported equity. For the years ended December 31, 2002, 2001 and 2000, the equity percentage would have been 27%, 30% and 32%, respectively, if the data for these two borrowers were excluded.
~~(3)~~	For the years ended December 31, 2000 and 1999, some telecommunications members were acquired by Alltel Corporation, and CFC agreed to accept Alltel Corporation's financial statements rather than those of the acquired operating companies. Given Alltel Corporation's size, it is not included in the composite statistics.
~~(4)~~	During the year ended December 31, 2001, Citizens Communications Company became a telecommunications borrower. The December 31, 2002 and 2001 financial results for Citizens have been excluded from the information above because CFC believes that their inclusion would unduly skew these statistics. Loans to Citizens represent only 4% of the telecommunications loan portfolio. Citizens' long-term debt has been rated Baa2 by Moody's Investors Service, BBB by Standard & Poor's Corporation and BBB by Fitch Ratings. At December 31, 2002, Citizens had total assets of $8.1 billion and equity of $1.2 billion. Had Citizens been included in the composite combined balance sheet data above, the composite equity percentage would have been 20%.
~~(5)~~	One of CFC's telecommunications borrowers, representing less than 2% of all telecommunications loans outstanding, has been excluded from the 2002 composite figures due to its Chapter 11 bankruptcy filing. CFC is being kept current on its loans to this borrower throughout the bankruptcy and expects to recover all principal and the contract yield on its loans to this borrower, all of which are senior secured. CFC expects the borrowers' financial statements to change significantly upon its emergence from bankruptcy.


Item 2.	Properties.


CFC owns and operates a headquarters facility in Fairfax County, Virginia. This facility consists of two six-story office buildings and two separate parking garages situated on ten acres of land. CFC also owns an additional two acres of unimproved ~~land.~~land adjacent to its office building.


Item 3.	Legal Proceedings.


None.


Item 4.	Submission of Matters to a Vote of Security Holders.


None.

~~None.~~


2114


PART II

Item 5.

Market for Registrant's Common Equity and Related Stockholder Matters.


Inapplicable.


Item 6.	Selected Financial Data.


The following is a summary of selected financial data for ~~each of~~ the ~~five~~ years ended May ~~31, 2003.~~31:

(Dollar amounts in thousands)
2003
2002
2001
2000
1999
For the year ended May 31:
Operating income
$
1,070,875
$
1,186,533
$
1,388,295
$
1,020,998
$
792,052
Gross margin
140,028
300,695
270,456
159,674
127,943
Operating margin
15,153
63,834
132,766
115,333
76,439
Derivative cash settlements (A)
122,825
34,191
-
-
-
Derivative forward value (A)
757,212
41,878
-
-
-
Foreign currency adjustments (B)
(243,220
)
(61,030
)
-
-
-
Cumulative effect of change in
accounting principle (A)
-
28,383
-
-
-
Net margin
$
651,970
$
107,256
$
132,766
$
115,333
$
76,439
Fixed charge coverage ratio (C)
1.70
1.09
1.12
1.13
1.12
Adjusted fixed charge coverage ratio (C)
1.17
1.12
1.12
1.13
1.12
As of May 31:
Assets
$
20,974,288
$
20,342,935
$
19,998,842
$
17,083,440
$
13,925,252
Long-term debt (D)
16,000,744
14,855,550
11,376,412
10,595,596
6,891,122
Subordinated deferrable debt
650,000
600,000
550,000
400,000
400,000
Members' subordinated certificates
1,708,297
1,691,970
1,581,860
1,340,417
1,239,816
Members' equity (A)
454,376
392,056
393,899
341,217
296,481
Total equity
930,836
328,731
393,899
341,217
296,481
Guarantees
$
1,903,556
$
2,056,385
$
2,217,559
$
1,945,202
$
1,893,197
Leverage ratio (E)
23.58
67.14
55.40
54.77
52.35
Adjusted leverage ratio (E)
6.63
7.18
7.72
8.10
7.10
Debt to equity ratio (E)
21.53
60.88
49.77
49.07
45.97
Adjusted debt to equity ratio (E)
4.96
5.40
6.05
6.46
5.52

(Dollar amounts in thousands)	2005			2004			2003			2002			2001
For the year ended May 31:
Operating income	$	1,026,126		$	1,007,293		$	1,070,875		$	1,186,533		$	1,388,295
Gross margin		104,063			81,641			131,543			300,695			270,456
Derivative cash settlements (1)		63,044			110,087			122,825			34,191			-
Derivative forward value (1)		29,875			(229,132	)		757,212			41,878			-
Foreign currency adjustments (2)		(22,893	)		(65,310	)		(243,220	)		(61,030	)		-
Operating margin (loss)		130,587			(194,584	)		651,970			78,873			132,766
Cumulative effect of change in
accounting principle (1) (3)		-			22,369			-			28,383			-
Net margin (loss)	$	126,529		$	(178,021	)	$	651,970		$	107,256		$	132,766
Fixed charge coverage ratio (TIER) (4)(5)		1.14			-			1.69			1.09			1.12
Adjusted fixed charge coverage ratio
(Adjusted TIER) (6)		1.14			1.12			1.17			1.12			1.12
As of May 31:
Loans to members	$	18,972,068		$	20,488,523		$	19,484,341		$	20,047,109		$	19,683,950
Allowance for loan losses		(589,749	)		(573,939	)		(511,463	)		(478,342	)		(317,197	)
Assets		20,046,088			21,441,238			21,027,883			20,371,335			20,013,642
Long-term debt (7)		13,701,955			16,659,182			16,000,744			14,855,550			11,376,412
Subordinated deferrable debt		685,000			550,000			650,000			600,000			550,000
Members' subordinated certificates		1,490,750			1,665,158			1,708,297			1,691,970			1,581,860
Members' equity (1)		523,583			483,126			454,376			392,056			393,899
Total equity		768,761			695,734			930,836			328,731			393,899
Guarantees	$	1,157,752		$	1,331,299		$	1,903,556		$	2,056,385		$	2,217,559
Leverage ratio (5)		26.56			31.70			23.64			67.23			55.44
Adjusted leverage ratio (6)		6.49			7.07			6.65			7.20			7.73
Debt to equity ratio (5)		25.05			29.79			21.59			60.97			49.81
Adjusted debt to equity ratio (6)		6.07			6.58			5.97			6.43			6.85

_________________
~~(A)~~(1)	Derivative cash settlements represent the net settlements ~~due~~received/paid on interest rate and cross currency exchange agreements that do not qualify for hedge accounting for the years ended May 31, 2005, 2004, 2003 and 2002. In fiscal year 2001 and prior years, this amount had been included in the cost of funds line on the combined statement of operations. The derivative forward value represents the ~~present~~change in fair value ~~of all future net settlements~~ on exchange agreements that do not qualify for hedge accounting, ~~based~~as well as amortization related to the long-term debt valuation allowance and related to the transition adjustment recorded as an other comprehensive loss on ~~the current estimate of future interest rates.~~June 1, 2001. The cumulative effect of change in accounting principle in 2002 represents the forward value of interest rate and cross currency exchange agreements recorded as a transition adjustment upon adoption of SFAS 133. Members' equity represents total equity excluding foreign currency adjustments, derivative forward value, cumulative effect of change in accounting principle in 2002 and accumulated other comprehensive income (see "Non-GAAP Financial Measures" in Management's Discussion and Analysis for further explanation of members' equity and a reconciliation to total equity).
~~(B)~~(2)	Foreign currency adjustments represent the change on foreign denominated debt that is not related to a qualifying hedge under SFAS 133 during the period. The foreign denominated debt is revalued at each reporting date based on the current exchange rate. To the extent that the current exchange rate is different than the exchange rate at the time of issuance, there will be a change in the value of the foreign denominated debt. CFC enters into foreign currency exchange agreements at the time of each foreign denominated debt issuance to lock in the exchange rate for all principal and interest payments required through maturity.
~~(C)~~(3)	The cumulative effect of change in accounting principle in 2004 represents the impact of implementing Financial Accounting Standards Board Interpretation No. 46 (R), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51, effective June 1, 2003.
(4)	The fixed charge coverage ratio is the same calculation as CFC's Times Interest Earned Ratio ("TIER"). For the year ended May 31, 2004, CFC's earnings were insufficient to cover fixed charges by $200 million.
(5)	See "Non-GAAP Financial Measures" in Management's Discussion and Analysis for the ~~adjusted fixed charge coverage ratio is the same calculation as adjusted TIER.~~GAAP calculations of these ratios.
(6)	Adjusted ratios include non-GAAP adjustments that CFC makes to financial measures in assessing its financial performance. See "Non-GAAP Financial Measures" in Management's Discussion and Analysis for further explanation of these calculations and a reconciliation of the ~~adjustments CFC makes to its TIER calculation to exclude the impact of SFAS 133 and foreign currency~~ adjustments.
~~(D)~~(7)	Includes ~~commercial paper~~short-term debt reclassified as long-term debt in the amount of $5,000 million, $4,650 million, $3,951 million, $3,706 million, ~~$4,638 million, $5,493 million~~ and ~~$2,403~~$4,638 million at May 31, 2005, 2004, 2003, 2002, ~~2001, 2000~~ and ~~1999,~~2001, respectively, and excludes $3,591 million, $2,365 million, $2,911 million, $2,883 million, ~~$4,388 million, $3,040 million~~ and ~~$983~~$4,388 million in long-term debt that comes due, matures and/or will be redeemed during fiscal years 2006, 2005, 2004, 2003, ~~2002, 2001~~ and ~~2000,~~2002, respectively (see Note 4 to the consolidated and combined financial statements). Includes the long-term debt valuation allowance of $0 million, $0 million, $(1) million and $2 million and the foreign currency valuation account of ~~$326~~$221 million, $234 million, $176 million, and $(2) million at May 31, 2005, 2004, 2003 and 2002, respectively.
~~(E)~~		~~See "Non-GAAP Financial Measures" for further explanation of these calculations and a reconciliation of the adjustments CFC makes to its leverage and debt to equity ratio calculations.~~


2215

Item 7.

Management's Discussion and Analysis of Financial Condition and Results of ~~Operations~~.Operations.


Unless stated otherwise, references to the Company relate to the consolidation of National Rural Utilities Cooperative Finance Corporation's ("CFC" or "the Company"), Rural Telephone Finance Corporation ("RTFC"), National Cooperative Services Corporation ("NCSC") and certain entities controlled by CFC and created to hold foreclosed assets. The following discussion and analysis is designed to provide a better understanding of the Company's consolidated financial condition and results of operations and as such should be read in conjunction with the consolidated and combined financial statements, including the notes thereto. Effective June 1, 2003, the Company's financial results include the consolidated accounts of CFC, RTFC, NCSC and certain entities controlled by the Company that were created to hold foreclosed assets. CFC's financial results prior to June 1, 2003 were consolidated with certain entities controlled by CFC that were created to hold foreclosed assets and combined with those of RTFC. CFC refers to its financial measures that are not in accordance with generally accepted accounting principles ("GAAP") as "adjusted" throughout this document. See "Non-GAAP Financial Measures" for further explanation.

Risk Factors

This annual report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These statements may be identified by their use of words like "anticipates", "expects", "projects", "believes", "plans", "may", "intend", "should", "could", "will", "estimate", and other expressions that indicate future events and trends. All statements that address expectations or projections about the future, including statements about loan growth, the adequacy of the loan loss ~~analysis,~~allowance, net margin growth, leverage and debt to adjusted equity ratios, and borrower financial performance are forward-looking statements.

Forward-looking statements are based on ~~certain~~management's current views and assumptions ~~and expectations of~~regarding future events and operating performance that are subject to risks and uncertainties. The Company undertakes no obligation to publicly update or revise any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made. Actual future results and trends may differ materially from historical results or those projected in any such forward-looking statements depending on a variety of factors, including but not limited to the following:


*	Liquidity - ~~CFC~~The Company depends on access to the capital markets to refinance its long and short-term debt, fund new loan advances and if necessary, to fulfill its obligations under its guarantees and repurchase agreements. At May 31, ~~2003, CFC~~2005, the Company had ~~$1,986~~$4,361 million of commercial paper, daily liquidity fund and bank bid notes and ~~$2,911~~$3,591 million of medium-term notes, ~~and~~ collateral trust bonds and long-term notes payable scheduled to mature during the next twelve ~~months, excluding $150 million of foreign currency valuation related to medium-term notes.~~months. There iscan be no ~~guarantee~~assurance that ~~CFC~~the Company will be able to access the capital markets in the future. ~~CFC's~~Downgrades to the Company's long-term debt ratings ~~were downgraded by three of the major credit rating agencies in fiscal year 2002 and Moody's Investors Service has CFC's ratings on negative outlook. Further downgrades~~ or other events that may deny or limit ~~CFC's~~the Company's access to the capital markets could negatively impact its operations. ~~CFC~~The Company has no control over certain items that are considered by the credit rating agencies as part of their analysis for ~~CFC,~~the Company, such as the overall outlook for the electric and telecommunications industries.

*	~~Restructured borrowers~~Covenant compliance - ~~Denton County Electric Cooperative, Inc. d/b/~~The Company must maintain compliance with all covenants related to its revolving credit agreements, including the adjusted times interest earned ratio ("TIER"), adjusted leverage and amount of loans pledged in order to have access to the funds available under the revolving lines of credit. See "Non-GAAP Financial Measures" for further explanation and a ~~CoServ Electric ("CoServ") has emerged from bankruptcy and~~reconciliation of adjusted ratios. A restriction on access to the ~~joint plans~~revolving lines of ~~liquidation and reorganization filed by CoServ and CFC are effective. However,~~credit would impair the ~~calculated impairment~~Company's ability to issue short-term debt, as it is required to maintain backup-liquidity to maintain preferred rating levels on ~~the restructured loan would increase if CoServ were not able to perform as required by the joint plans of liquidation and reorganization.~~its short-term debt.

*	Credit concentration - ~~CFC~~The Company lends ~~only~~primarily into the rural electric and telephone industries and is subject to risks associated with those industries. Credit concentration is one of the risk factors considered by the rating agencies in the evaluation of ~~CFC's~~the Company's credit rating. ~~CFC's~~The Company's credit concentration to its ten largest borrowers could increase from the current ~~25%~~18% of total loans and guarantees outstanding, if:
	*	it were to extend additional loans and/or guarantees to the current ten largest borrowers,
	*	its total loans and/or guarantees outstanding were to decrease, with a disproportionately large share of the decrease to borrowers not in the current ten largest, or
	*	it were to advance large new loans ~~in excess of $100 million~~and/or guarantees to one of the next group of borrowers below the ten largest.

*	Loan loss allowance - Computation of the loan loss ~~reserves~~allowance is inherently based on subjective estimates. A loan write-off in excess of specific reserves for impaired borrowers or a large net loan write-off to a borrower that is currently performing would have a negative impact on the adequacy of the loan loss allowance and the net margin for the year due to an increased loan loss provision.

16

*	Adjusted leverage and adjusted debt to equity ratios - ~~If CFC were to experience significant loan growth over the next few years, as it did from fiscal year 1998 through fiscal year 2001, the~~Maintenance of adjusted leverage and ~~adjusted~~ debt to equity ratios ~~would increase. The equity retention policies are tied~~within a reasonable range of the current levels is important in relation to the ~~growth~~Company's ability to access the capital markets. A significant increase in loans as members purchase subordinated certificates with the advance of loans. However, the required subordinated certificate purchase is not sufficient to allow equity retention in the amount required to continue to lower the adjusted leverage ~~and adjusted~~or debt to equity ~~ratios. The increased loan volume would result in an increased gross margin, which~~ratios could ~~result in an increased allocation~~impair the Company's ability to access the ~~members' equity reserve, but not in an amount required~~capital markets and its ability to ~~reduce~~access the ~~adjusted leverage and adjusted debt to equity ratios.~~revolving lines of credit. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of ~~the adjustments to the leverage and debt to equity~~adjusted ratios.

*	Tax exemption - Legislation that removes or imposes new conditions on the federal tax exemption for 501(c)(4) social welfare corporations ~~would~~could have a negative impact on ~~CFC's~~the Company's net margins. ~~CFC's~~The Company's continued exemption depends on ~~CFC~~it conducting its business in accordance with its exemption from the Internal Revenue Service.


23

*	Derivative accounting - The required accounting for derivative financial instruments has caused increased volatility in ~~CFC's~~the Company's reported financial results. In addition, a standard market does not exist for ~~CFC's~~ derivative instruments, therefore the fair value of derivatives reported in ~~CFC's~~the Company's financial statements is based on quotes obtained from ~~CFC's~~ counterparties. The market quotes provided by counterparties do not represent offers to trade at the quoted price.

*	Foreign currency - The required accounting for foreign denominated debt has caused increased volatility in ~~CFC's~~the Company's financial results. ~~CFC~~The Company is required to adjust the value of the foreign denominated debt on its ~~combined~~consolidated balance ~~sheet~~sheets at each reporting date based on the then current foreign exchange rate.

*	Rating triggers - ~~There are rating triggers associated with $11,059 million notional amount of~~The Company has interest rate, cross currency, and cross currency interest rate exchange ~~agreements. The rating triggers are based on CFC's senior unsecured~~agreements that contain a condition that will allow one counterparty to terminate the agreement if the credit rating ~~from Standard & Poor's Corporation and Moody's Investors Service. If~~of the other counterparty drops to a certain level. This condition is commonly called a rating trigger. Under the rating trigger, if the credit rating for either counterparty falls ~~below~~to the level specified in the agreement, the other counterparty may, but is not obligated to, terminate the agreement. If either counterparty terminates the agreement, a net payment may be due from one counterparty to the other based on the fair value of the underlying derivative instrument. The Company's rating triggers are based on its senior unsecured credit rating from Standard & Poor's Corporation and Moody's Investors Service (see chart on page 49). At May 31, 2005, there are rating triggers associated with $10,625 million notional amount of interest rate, cross currency and cross currency interest rate exchange agreements. If ~~CFC's~~the Company's rating from Moody's Investors Service falls to Baa1 or ~~CFC's~~the Company's rating from Standard & Poor's Corporation falls to BBB+, the counterparties may terminate agreements with a total notional amount of ~~$2,183~~$1,125 million. If ~~CFC's~~the Company's rating from Moody's Investors Service falls below Baa1 or ~~CFC's~~the Company's rating from Standard & Poor's Corporation falls below BBB+, the counterparties may terminate the agreements on the remaining total notional amount of ~~$8,876~~$9,500 million. Based on the fair market value of its interest rate, cross currency and cross currency interest rate exchange agreements at May 31, ~~2003, CFC~~2005, the Company may be required to make a payment of up to ~~$70~~$3 million if its senior unsecured ratings declined to Baa1 or BBB+, and up to ~~$168~~$45 million if its senior unsecured ratings declined below Baa1 or BBB+. In calculating the required payments, ~~CFC~~the Company only considered agreements in which it would have been required to make a payment upon termination.

Calculated impairment - ~~CFC~~The Company calculates loan impairments per the requirements of Statement of Financial Accounting Standards ("SFAS") 114, Accounting by Creditors for Impairment of a Loan - an Amendment of SFAS 5 and SFAS 15, ~~and SFAS 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures - an Amendment of SFAS 114.~~as amended. This pronouncement states that the impairment is calculated based on a comparison of the present value of the expected future cash flows discounted at the original interest rate and/or the estimated fair value of the collateral securing the loan to the recorded investment in the loan. The interest rate in the original loan agreements between ~~CFC~~the Company and ~~CoServ is~~its borrowers may be a blend of the ~~CFC~~ long-term fixed rate for various maturity periods, the ~~CFC~~ long-term variable and line of credit interest rate. ~~CFC~~The Company periodically adjusts the long-term variable and line of credit interest rates to reflect the cost of variable rate and short-term debt. Thus, the original contract rate (weighted average of interest rates on all of the original loans to ~~CoServ)~~the borrower), will change as ~~CFC~~the Company adjusts its long-term variable and line of credit interest rates. ~~CFC's long-term variable and line of credit interest rates are currently at historic low levels. CFC's~~The Company's calculated impairment on ~~the~~non-performing and restructured ~~loan to CoServ~~loans will increase as ~~CFC's~~the Company's long-term variable and line of credit interest rates increase. Currently, an increase of 25 basis points to ~~CFC's~~the Company's variable interest rates ~~results~~would result in an increase of ~~$13~~$10 million to the calculated impairment.

The forward-looking statements are based on management's current views and assumptions regarding future events and operating performance. CFC undertakes no obligation to publicly update or revise any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.

*	~~The following discussion and analysis is designed~~Deficiency of fixed charges - For the year ended May 31, 2004, CFC's net loss prior to ~~provide a better understanding~~the cumulative effect of ~~CFC's combined financial condition and results~~change in accounting principle reported on the consolidated statement of operations as required under GAAP totaled $200 million and ~~as such should be read in conjunction with the combined financial statements, including the notes thereto.~~was not sufficient to cover fixed charges.

17

Overview

CFC was formed in 1969 by the rural electric cooperatives to provide them with a source of ~~funds~~financing to supplement the ~~financing provided by~~loan program of the Rural Utilities Service ("RUS"). CFC was organized as a cooperative in which each member (other than ~~associate members)~~associates) receives one vote. Under CFC's bylaws, the board of directors is composed of 2223 individuals, 20 of whom must be either general managers or directors of member ~~utility~~ systems, ~~and 2~~two of whom are designated by the National Rural Electric Cooperative ~~Association.~~Association and one at-large position who must satisfy the requirements of an audit committee financial expert as defined by Section 407 of the Sarbanes-Oxley Act of 2002 and must be elected from the general membership. The at-large position is to be filled at the discretion of the board and currently is not filled. CFC was granted tax-exempt status under Section 501(c)(4) of the Internal Revenue Code.

~~Rural Telephone Finance Cooperative ("RTFC")~~RTFC was incorporated as a private cooperative association in the state of South Dakota in September 1987 and was created for the purpose of providing and/or arranging financing for its rural telecommunications members and their affiliates. In February 2005, RTFC reincorporated in the District of Columbia. Effective June 1, 2003, RTFC's results of operations and financial condition have been consolidated with those of CFC in the accompanying financial statements (see Note 1(b) to the consolidated and combined financial statements). Prior to June 1, 2003, RTFC's results of operations and financial condition were combined with CFC's. CFC is the sole lender to and manages the affairs of RTFC through a long-term management agreement. ~~RTFC's results of operations and financial condition have been combined with those of~~Under a guarantee agreement, CFC ~~in the accompanying financial statements (see Note 1(b)~~has agreed to ~~the combined financial statements).~~reimburse RTFC ~~is a class E member of CFC.~~for loan losses. RTFC is headquartered with CFC in Herndon, ~~VA and~~Virginia. RTFC is a taxable entity and takes tax deductions for allocations of net margins as allowed by law under Subchapter T of the Internal Revenue Code. ~~CFC is not a member of~~ RTFC ~~and does not elect directors~~pays income tax based on its net margins, excluding net margins allocated to ~~the RTFC board. As of~~its members. At May 31, ~~2003,~~2005, CFC had committed to lend RTFC up to $10 billion, of which ~~$5 billion~~$2,980 million was ~~currently~~ outstanding.

NCSC was incorporated in 1981 in the District of Columbia as a private cooperative association. NCSC provides financing to the for-profit or non-profit entities that are owned, operated or controlled by or provide substantial benefit to members of CFC. NCSC also markets, through its cooperative members, a consumer loan program for home improvements and an affinity credit card program. Both programs are currently funded by third parties except for approximately $10 million of the consumer loan program that was funded by NCSC at May 31, 2005. NCSC's membership consists of CFC and distribution systems that are members of CFC or are eligible for such membership. Effective June 1, 2003, NCSC's results of operations and financial condition have been consolidated with those of CFC in the accompanying financial statements. CFC is the primary source of funding to and manages the lending and financial affairs of NCSC through a management agreement which is automatically renewable on an annual basis unless terminated by either party. Under a guarantee agreement effective June 1, 2003, CFC has agreed to reimburse NCSC for losses on loans, excluding the consumer loan program. NCSC is headquartered with CFC in Herndon, Virginia. NCSC is a taxable corporation. NCSC pays income tax annually based on its net margins for the period. At May 31, 2005, CFC had committed to provide a total of $2 billion of credit to NCSC. At May 31, 2005, CFC had provided a total of $532 million of credit to NCSC, $82 million of outstanding loans and $450 million of credit enhancements.

Unless stated otherwise, references to ~~CFC~~the Company relate to the consolidation of CFC, RTFC, NCSC and certain entities ~~created and~~ controlled by CFC and created to hold foreclosed ~~assets, presented with RTFC on a combined basis.~~assets. CFC established limited liability corporations and partnerships to hold foreclosed assets. CFC has full ownership and control of all such companies and thus consolidates their financial ~~results~~

results.

The Company implemented Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 46(R), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51 effective June 1, 2003, which resulted in the consolidation of two variable interest entities, RTFC and NCSC. CFC is the primary beneficiary of RTFC and NCSC as a result of its exposure to absorbing a majority of the expected losses. Neither company was consolidated with CFC prior to June 1, 2003 and the implementation of FIN 46(R) since CFC has no direct financial ownership interest in either company.

On June 1, 2003, as a result of the consolidation of RTFC and NCSC, total assets increased by $353 million, total liabilities increased by $331 million, minority interest - RTFC and NCSC members' equity increased by $20 million and CFC total equity increased by $2 million. As a result of the consolidation, NCSC loans were consolidated with CFC's loans. Additionally, NCSC debt guaranteed by CFC became debt of the consolidated entity, resulting in a reduction to CFC's guarantee liability. CFC recorded a cumulative effect of change in accounting principle gain of $22 million on the consolidated statement of operations for the year ended May 31, 2004, representing a $3 million increase to the loan loss allowance, a $34 million decrease to the guarantee liability and a $9 million loss representing the amount by which cumulative losses of NCSC exceeded NCSC equity.

The Company's primary objective as a cooperative is to provide its members with the lowest possible loan and guarantee rates while maintaining sound financial results required to obtain high credit ratings on its debt instruments. Therefore, ~~CFC~~the Company marks up its funding costs only to the extent necessary to cover its operating expenses, a provision for loan losses and to provide a margin sufficient to preserve interest coverage in light of ~~CFC's~~the Company's financing objectives. To the extent members contribute to CFC's base capital by purchasing subordinated certificates carrying below-market interest rates, CFC can offer proportionally lower interest rates on its loans to members.

CFC obtains its funding from the capital markets and its membership. CFC enters the capital markets, based on the combined strength of its members, to borrow the funds required to fulfill the financing requirements of its members. On a regular basis, CFC obtains debt financing in the capital markets by issuing fixed rate or variable rate secured collateral trust bonds, fixed rate subordinated deferrable debt, ~~and~~ fixed rate or variable rate unsecured medium-term notes, commercial paper and enters into bank bid note agreements. In addition, CFC obtains debt financing from its membership and other qualified investors through the direct sale of its commercial paper, daily liquidity fund and unsecured medium-term notes.

Rural electric cooperatives that join CFC are generally required to purchase membership subordinated certificates from CFC as a condition of membership. In connection with any long-term loan or guarantee made by CFC ~~to or~~ on behalf of one of its members, CFC may require that the member make an additional investment in CFC by purchasing loan or guarantee subordinated certificates. ~~Like the~~The membership subordinated certificates and the loan and guarantee subordinated certificates are unsecured and subordinate to other senior debt of CFC. Membership subordinated certificates typically pay interest at a rate of 5% and have maturities of up to 100 years. Loan and guarantee certificates may or may not earn interest and have maturities tied to the maturity of the related loan or guarantee.

CFC is required by the cooperative laws under which it is incorporated to have a mechanism to allocate its net margin to its members. CFC allocates its net margin before the non-cash effects of SFAS 133 ~~Accounting for Derivative Instruments and Hedging Activities,~~ and foreign currency adjustments ~~except for derivative cash settlements,~~ annually to an education fund, a members' capital reserve and to members based on each member's ~~participation in~~patronage of the loan programs during the year. The membership and loan and guarantee subordinated certificates along with the education fund, members' capital reserve and unretired allocated margins provide CFC's base capitalization.

~~CFC's~~The Company's performance is closely tied to the performance of its member rural electric and telecommunications systems due to the near 100% concentration of its loan and guarantee portfolio in those industries.

~~Change of Auditors in Fiscal Year 2002~~

On April 16, 2002, CFC engaged Ernst & Young LLP to perform the May 31, 2002 year end audit, replacing former auditor Arthur Andersen LLP. On June 15, 2002, Arthur Andersen LLP was convicted of federal obstruction of justice charges arising from the government's investigation of its role as auditors for Enron Corp. Arthur Andersen LLP personnel who were involved with the Enron account had no involvement with the audit of CFC's financial statements for the fiscal year ended May 31, 2001.

Securities and Exchange Commission ("SEC") rules require CFC to include or incorporate by reference three years of audited financial statements in any prospectus filed by the company. Until CFC's audited financial statements for the fiscal year ended May 31, 2004 become available, the SEC's current rules would require CFC to present audited financial statements for fiscal year 2001 audited by Arthur Andersen LLP.

Critical Accounting Policies

Allowance for Loan Losses

At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had a loan loss allowance that totaled ~~$565~~$590 million and ~~$507~~$574 million, representing ~~2.90%~~3.11% and ~~2.53%~~2.80% of total loans ~~outstanding and 2.64% and 2.29% of total loans and guarantees~~ outstanding, respectively. Generally accepted accounting principles require loans receivable to be reported on the ~~combined~~consolidated balance ~~sheet~~sheets at net realizable value. The net realizable value is the total principal amount of loans outstanding less an estimate of the expected losses inherent in the portfolio. ~~CFC~~The Company calculates its loss allowance on a quarterly basis. The loan loss analysis segments the portfolio into three categories: impaired, high risk and general portfolio. There are significant subjective assumptions and estimates used in calculating the amount of the loss allowance required by each of the three categories. Different assumptions and estimates could also be reasonable. Changes in these assumptions and estimates could have a material impact on ~~CFC's~~the Company's financial statements.

Impaired Exposure

~~CFC~~The Company calculates impairment on certain loans in accordance with SFAS 114 and SFAS 118. SFAS 114 states that a loan is impaired when a creditor does not expect to collect all principal and interest due under the original terms of the loan. ~~CFC~~The Company reviews its portfolio to identify impairments on a quarterly basis. Factors considered in determining an impairment include, but are not limited to: the review of ~~borrower~~the borrower's audited financial statements and interim financial statements if available, ~~borrower~~the borrower's payment history, communication with the borrower, economic conditions in ~~borrower~~the borrower's service territory, pending legal action involving the borrower, restructure agreements between the borrower and ~~CFC,~~the Company, and estimates of the value of the borrower's assets that have been pledged as collateral to secure ~~CFC~~the Company's loans. ~~CFC~~The Company calculates the impairment by comparing the future estimated cash flow, discounted at the original loan interest rate, against ~~CFC's~~its current investment in the receivable. If the current investment in the receivable is greater than the net present value of the future payments discounted at the original contractual interest rate, the impairment is equal to that difference. If it is not possible to estimate the future cash flow associated with a loan, then the impairment calculation is based on the value of the collateral pledged as security for the loan. At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had a total of ~~$164~~$404 million and ~~$202~~$233 million reserved specifically against impaired exposure totaling ~~$629~~$1,208 million and ~~$1,631~~$959 million, respectively, representing ~~29.03%~~33% and ~~39.84%~~24% of the total impaired loan exposure. The $404 million and $233 million specific reserves represented 68% and 41% of the total loan loss ~~allowance. The $164 million and $202 million specific reserves represented 26.07% and 12.39% of the total impaired exposure~~allowance at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively. The balance of impaired exposure outstanding decreased at May 31, 2003 due to the reclassification of the Deseret exposure to the general portfolio and to the receipt of assets as part of the CoServ bankruptcy settlement. The calculated impairment at May 31, ~~2003~~2005 was ~~lower~~higher than at May 31, ~~2002 as a result of the Deseret reclassification, the receipt of assets as part of the CoServ bankruptcy settlement and~~2004 due to ~~lower~~the increase in loan exposure classified as impaired and higher interest rates on ~~CFC~~ variable rate loans, offset by payments received on impaired loans. The original contract rate on ~~CFC's~~a portion of the impaired loans at May 31, ~~2003~~2005 will vary with the changes in ~~CFC's~~the Company's variable interest rates. Based on the current balance of impaired loans at May 31, ~~2003,~~2005, a 25 basis point increase or decrease to ~~CFC~~the Company's variable interest rates ~~will~~would result in an increase or decrease, respectively, of approximately ~~$13~~$10 million to the calculated ~~impairment.~~impairment irrespective of a change in the credit fundamentals of the impaired borrower.

In calculating the impairment on a loan, the ~~estimate~~estimates of the expected future cash flow isor collateral value are the key ~~estimate~~estimates made by management. ~~In all cases, the estimate is based on restructure agreements, borrower projected cash flow and past payment history.~~ Changes in the estimated future cash flow or collateral value would impact the amount of the calculated impairment. The change in cash flow required to make the change in the calculated impairment material will be different for each borrower and depend on the period covered, the original contract interest rate and the amount of the loan outstanding. Estimates are not used to determine ~~CFC's~~the Company's investment in the receivables or the discount rate since, in all cases, they are the loan balance outstanding at the reporting date and the original loan interest rate.

High Risk Exposure

Loan ~~and guarantee~~ exposures considered to be high risk represent exposure in which the borrower has had a history of late payments, the borrower's financial results do not satisfy loan financial covenants, the borrower has contacted ~~CFC~~the Company to discuss pending financial difficulties or for some other reason ~~CFC~~the Company believes that ~~without increased monitoring and special action on its part,~~ the borrower's financial results could deteriorate resulting in an elevated potential for loss. ~~CFC's~~The Company's corporate credit committee is responsible for determining which loans should be classified as high risk and the level of reserve required for each borrower. The committee meets ~~once a month and reviews~~at least quarterly to review all loan facilities with an internal risk rating above a certain level. Once it is determined that exposure to a borrower should be classified as high risk, the committee sets the required reserve level based on the facts and circumstances for each borrower, such as the borrower's financial condition, payment history, ~~CFC's~~the Company's estimate of the collateral value, pending litigation, if any, and other factors. This is an objective and subjective exercise in which the committee uses the available information to make its best estimate as to the level of loss allowance required. At any reporting date the reserve required could vary significantly depending on the facts and circumstances, which could include, but are not limited to: changes in collateral value, ifdeterioration in financial condition, the borrower ~~declares~~declaring bankruptcy, payment default on the Company's loans and other factors. The borrowers in the high risk category will generally either move to the impaired category or back to the general portfolio within a period of ~~twelve~~

12 to 24 months. At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had ~~allocated $87~~reserved $12 million and ~~$47~~$109 million ~~of the loan loss allowance~~ against the ~~$871~~$68 million and ~~$945~~$607 million of exposure classified as high risk, representing coverage of ~~9.99% and 4.97%, respectively.~~18% at both dates. The ~~$87~~$12 million and ~~$47~~$109 million ~~allocated to~~reserve for loans in the high risk category represents ~~15.40%~~2% and ~~9.27%~~19%, respectively, of the total loan loss allowance at May 31, ~~2003~~2005 and ~~2002.~~2004.

General Portfolio

In fiscal year 2003, ~~CFC adopted a more objective~~the Company made refinements to the methodology used to determine the required loan loss allowance for the general ~~portfolio as compared to a more subjective methodology used previously. CFC~~portfolio. The refinements include the use of the improved internal risk rating system, historical default data on corporate bonds and the Company specific loss recovery data. The Company uses the following factors to determine the level of the loan loss allowance for the general portfolio category:

*	Internal risk ratings - ~~CFC~~the Company maintains risk ratings for each ofcredit facility outstanding to its borrowers. ~~CFC adopted the risk rating methodology in fiscal year 2002.~~ The ratings are updated at least annually and are based on the following:
	*	General financial condition of the borrower.
	*	~~CFC's~~The Company's internal estimated value of the collateral securing its loans.
	*	~~CFC's~~The Company's internal evaluation of the borrower's management.
	*	~~CFC's~~The Company's internal evaluation of the borrower's competitive position within its service territory.
	*	~~CFC's~~The Company's estimate of potential impact of proposed regulation and litigation.
	*	Other factors specific to individual borrowers or classes of borrowers.
*	Standard corporate default table - The table provides expected default rates based on rating level and the remaining maturity of the bond. ~~CFC~~The Company uses the standard default table for all corporate bonds provided by Standard and Poor's Corporation to assist in estimating its reserve levels.
*	Recovery rates - Estimated recovery rates based on historical experience of loan balance at the time of default compared to the total loss on the loan to date.

~~CFC~~The Company aggregates the loans in the general portfolio by borrower type (distribution, generation, telecommunications, associate and ~~associate~~other member) and by internal risk rating within borrower type. ~~CFC~~The Company correlates its internal risk ratings to the ratings used in the standard default table based on a comparison of ~~CFC's~~its rating on borrowers that have a rating from one or more of the recognized credit rating agencies and based on a standard matching used by banks.

In addition to the general portfolio reserve requirement as calculated above, ~~CFC~~the Company maintains an additional reserve for borrowers with a total exposure in excess of 1.5% of ~~the~~its total ~~CFC exposure.~~loans and guarantees outstanding. The additional reserve is based on the amount of exposure in excess of 1.5% of the ~~CFC~~Company's total exposure and the borrower's internal risk rating. At May 31, ~~2003, CFC~~2005 and 2004, respectively, the Company had a reserve of ~~$31~~$7 million and $19 million based on the additional risk related to large exposures. At May 31, 2002, CFC considered the additional risk related to large exposures in determining the level of the general reserve, however, no specific dollar amount was identified as there was at May 31, 2003.

At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had a total of ~~$17,718~~$17,437 million and ~~$17,307~~$18,660 million of loans, ~~and $1,903 million and $1,977 million of guarantees,~~ respectively, in the general portfolio. This total does not include ~~$267~~$258 million and ~~$243~~$263 million of loans at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively, that have a USU.S. Government guarantee of all principal and interest payments. ~~CFC~~The Company does not maintain a loan loss ~~reserve~~

allowance on loans that are guaranteed by the USU.S. Government. ~~CFC allocated~~The Company reserved a total of ~~$314~~$174 million and $232 million (including the ~~$31~~$7 million and $19 million described above) ~~and $258 million of the loan loss allowance to~~for loans in the general portfolio at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively, representing coverage of ~~1.60%~~1.00% and ~~1.34%~~1.24% of the total ~~exposure.~~loans for the general portfolio.

The methodology used in fiscal year 2002 considered many of the factors listed above, however the process of evaluating those factors was not as formalized as in fiscal year 2003 after the final adoption of the internal risk rating process. Overall, CFC believes the methodology used in fiscal year 2003 to be enhanced and less subjective than the methodology used in fiscal year 2002.

In fiscal years ~~2003, 2002~~2005, 2004 and ~~2001,~~2003, CFC made provisions to the loan loss reserve totaling ~~$68~~$16 million, ~~$199~~$55 million and ~~$105~~$43 million, respectively. The important factors affecting the provision for each year are listed below:

*	Fiscal year 2005 provision of $16 million resulted primarily from the following factors:
	*	Increase to the calculated impairment of $171 million due to an increase of $249 million to impaired loans outstanding because of the deteriorating financial condition and ongoing litigation of one borrower which moved from high risk to impaired and the impact of higher interest rates on variable rate loans in fiscal year 2005 offset by repayments from another borrower.
	*	Decrease of $97 million to the required high risk reserve primarily due to one borrower which moved from high risk to impaired due to ongoing litigation.
	*	A decrease of $58 million to the required general reserve due to a 6% reduction in the weighted average risk rating for all loans in the general portfolio, a decrease of $12 million required for large exposures and a decrease in allowance as a result of a $1,223 million decrease to loans outstanding in the general portfolio.
	*	Net write-offs during fiscal year 2005 were less than $1 million.
*	Fiscal year 2004 provision of $55 million resulted from the following factors:
	*	Increase to the calculated impairment of $69 million due to an increase of $330 million to impaired loans outstanding because of the deteriorating financial condition of one borrower which moved from high risk to impaired in fiscal year 2004 offset by repayments from another borrower and the impact of lower interest rates on variable rate loans.
	*	Increase of $22 million to the required high risk reserve due to legal action involving one high risk borrower and to a refinement in process to set a minimum reserve for high risk borrowers.
	*	A decrease of $28 million to the required general reserve due to a 9% reduction in the weighted average risk rating for all loans in the general portfolio and a decrease of $6 million required for large exposures offset by an increase in allowance as a result of a $942 million increase to loans outstanding in the general portfolio.
	*	Net recoveries of $2 million.
*	Fiscal year 2003 provision of ~~$68~~$43 million resulted from the following factors:
	*	Impaired exposure decreased by ~~$1,002~~$924 million and calculated impairment decreased by $38 million. Calculated impairment was impacted by decreases to CFC variable interest rates and reductions in total impaired exposure.
	*	High risk exposure decreased by $74 million and the CFC corporate credit committee determined, based on facts and circumstances at that time, that a 10% reserve was required on the high risk exposure compared to a 5% reserve in 2002 which results in a net increase of $40 million to the reserve allocated to the high risk category.
	*	General portfolio exposure increased by ~~$337~~$411 million and the ~~new~~refinement of the allowance methodology resulted in an increase to the reserve of ~~$56 million representing 1.60% of total exposure versus 1.34% of total exposure in 2002.~~$31 million.
	*	Net write-offs of $10 million during fiscal year 2003.


27


*	~~Fiscal year 2002 provision of $199 million resulted from the following factors:~~
	*	Impaired exposure increased by $52 million and calculated impairments increased by $47 million. One impaired borrower defaulted on its restructure agreement and declared bankruptcy resulting in a higher calculated impairment as compared to fiscal year 2001.
	*	High risk exposure increased by $405 million. At year end it was estimated that a reserve of 5.00% was required on high risk exposure resulting in an increase of $26 million compared to 3.98% for fiscal year 2001.
	*	General portfolio exposure decreased by $316 million, however the reserve requirement based on the methodology in effect at that time required an increase to the general reserve of $102 million due to the downturn in the electric and telecommunications industries. The amount reserved against general portfolio exposure at May 31, 2002 represented 1.34% of exposure as compared to 0.79% of exposure at May 31, 2001.
	*	~~Net write-offs of $24 million during fiscal year 2002.~~
*	~~Fiscal year 2001 provision of $105 million resulted from the following factors:~~
	*	~~Increase to impaired exposure of $919 million resulting in an increase to the calculated impairment of $70 million.~~
	*	~~High risk exposure increased by $129 million resulting in an increase of $11 million to the required reserve.~~
	*	General portfolio exposure increased by $2,138 million and the required reserve increased by $23 million. At May 31, 2001 the general reserve represented 0.79% of exposure as compared to 0.76% of exposure at May 31, 2000.
	*	~~Net write-offs of $1 million.~~

Senior management reviews and discusses the estimates and assumptions used in the ~~allocation~~calculations of the loan loss allowance tofor impaired loans, high risk loans and loans covered by the general portfolio, including ~~high~~large exposures related to single obligors, on a quarterly basis. Senior management discusses ~~annual~~ estimates with the board of directors and audit committee and reviews all loan loss related disclosures included in ~~CFC's~~the Company's Form 10-Qs and Form 10-Ks filed with the ~~SEC. Under current policy,~~ Securities and Exchange Commission ("SEC").

CFC's ~~board~~corporate credit committee makes recommendations of ~~directors is required~~loans to ~~approve~~be written off to the respective boards of directors. In making its recommendation to write off all or a portion of a loan ~~write-offs.~~balance, CFC's corporate credit committee considers various factors including cash flow analysis and collateral securing the borrower's loans.

Derivative Financial Instruments

In June 1998, the ~~Financial Accounting Standards Board ("FASB")~~FASB issued SFAS 133. SFAS 133, as amended, establishes accounting and reporting standards requiring that derivative instruments (including certain derivative instruments embedded in other contracts) be recorded in the ~~combined~~consolidated balance ~~sheet~~sheets as either an asset or liability measured at fair value. The statement requires that changes in the derivative instrument's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative instrument's gains and losses to offset related results on the hedged item in the consolidated and combined ~~statement~~statements of operations or to be recorded as other comprehensive income, to the extent effective, and requires that a company formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. ~~CFC adopted this statement on June 1, 2001. CFC~~The Company is neither a dealer nor trader in derivative financial instruments. ~~CFC~~The Company uses interest rate, cross currency and cross currency interest rate exchange agreements to manage its interest rate and foreign currency risk.

As a result of applying SFAS 133, ~~CFC~~the Company has recorded derivative assets of ~~$1,160~~$585 million and ~~$193~~$577 million and derivative liabilities of ~~$355~~$78 million and ~~$252 million, and a long-term debt valuation allowance that decreases long-term debt by $1 million and increases long-term debt by $2~~$130 million at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively. ~~Accumulated~~From inception to date, accumulated other comprehensive ~~losses~~income related to derivatives ~~from inception to date were $47~~was $13 million and ~~$73~~$(12) million as of May 31, ~~2003~~2005 and ~~2002,~~2004, respectively.

The impact of derivatives on ~~CFC's~~the Company's consolidated and combined ~~statement~~statements of operations for the years ended May 31, ~~2003~~2005, 2004 and ~~2002~~2003 was a gain of ~~$880~~$85 million, a loss of $128 million and ~~$104~~a gain of $872 million, respectively. The change in the ~~forward~~fair value of derivatives for the years ended May 31, 2005, 2004 and 2003 was a gain of $30 million, a loss of $229 million and ~~2002 were~~a gain of $757 million, respectively, recorded in the Company's derivative forward value. For the years ended May 31, 2005, 2004 and ~~$42 million which included~~2003, the derivative forward value also includes amortization totaling ~~$19~~zero, $1 million and ~~$21~~$(3) million, respectively, related to the long-term debt valuation allowance and $13 million, $17 million and $22 million, respectively, related to the transition adjustment ~~and long-term debt valuation allowance that was~~ recorded ~~when CFC implemented SFAS 133 on June 1, 2001. During the year ended May 31, 2002, CFC recorded a $28 million gain~~ as ~~a cumulative effect of change in accounting principle related to the fair value of derivatives~~an other comprehensive loss on June 1, 2001, the date ~~CFC adopted~~the Company implemented SFAS 133. In addition, ~~$123~~income totaling $55 million, $101 million and ~~$34~~$115 million ~~representing the~~was recorded for net cash settlements received by ~~CFC~~the Company during the years ended May 31, 2005, 2004 and 2003, respectively, of which $63 million, $110 million and ~~2002,~~$123 million, respectively, ~~were recorded in the derivative cash settlements line item. These amounts~~ relate to ~~the~~ interest rate and cross currency interest rate exchange agreements that do not qualify for hedge accounting under SFAS ~~133. These cash settlements~~133 and were recorded in ~~the~~derivative cash settlements. The remaining expense of $8 million, $9 million and $8 million, respectively, relate to interest rate and cross currency interest rate exchange agreements that do qualify for hedge accounting under SFAS 133 and were recorded in cost of ~~funds prior to fiscal year 2002, the year in which SFAS 133 was implemented.~~funds.

~~CFC~~The Company is required to determine the fair value of its derivative instruments. Because there is not an active secondary market for the types of derivative instruments it uses, ~~CFC~~the Company obtains market quotes from its dealer counterparties. The market quotes are based on the ~~calculated net settlement for the period from the last payment date and the~~ expected future cash flow ~~based on~~and estimated yield curves. ~~CFC subtracts~~The Company performs its own analysis to confirm the ~~accrued net settlement amount~~values obtained from the counterparties. The Company records the change in the fair value ~~quote, leaving the estimated forward value~~ of ~~the derivative. CFC records the accrual related to the net settlements in~~ its ~~derivative cash settlements line and records the forward value of the~~ derivatives for each reporting period in the derivative forward value line on the consolidated and combined statements of operations for the majority of its derivatives or in the other comprehensive income account on the ~~combined~~consolidated balance ~~sheet~~sheets for the derivatives that qualify for ~~special~~ hedge accounting. ~~CFC is not making any material estimates in calculating the fair value of its derivatives.~~ The counterparties are estimating future interest rates as part of the quotes they provide to ~~CFC. CFC~~the Company. The Company adjusts all derivatives to fair value on a quarterly basis. The fair value recorded by ~~CFC~~the Company will change as estimates of future interest rates change. ~~CFC~~To estimate the impact of changes to interest rates on the forward value of derivatives, the Company would need to estimate all changes to interest rates through the maturity of its outstanding derivatives. The Company has derivatives in the current portfolio that do not mature until 2031. Due to the volatility in expected future interest rates, the Company does not believe that it is a useful exercise to attempt to estimate future interest rates through the maturity of its derivative portfolio. In addition, the Company excludes the changes to the fair value of derivatives from its internal analysis since they represent the net present value of all future estimated cash settlements. Thus, the Company does not estimate the impact of changes in future interest rates to the fair value of its derivatives. The Company does not believe that volatility in the derivative forward value line on the consolidated and combined ~~statement~~statements of operations is material as it represents an estimated future value and not a cash impact for the current period.

Cash settlements that the Company pays and receives for derivative instruments that do not qualify for hedge accounting are recorded in the cash settlements line in the consolidated and combined statements of operations. A 25 to 50 basis point increase to the 30-day composite commercial paper index, the three-month LIBOR rate and the six-month LIBOR rate would not have a significant impact on the Company's total cash settlements due to the composition of the portfolio at May 31, 2005. The Company's interest rate exchange agreements at May 31, 2005 include $6,643 million notional amount, or 49% of the total interest rate exchange agreements in which the Company pays a fixed interest rate and receives a variable interest rate. For the remaining $7,050 million notional amount, or 51% of the total interest rate exchange agreements at May 31, 2005, the Company pays a variable interest rate and receives a fixed interest rate. As a result, the impact of an increase in interest rates for interest rate exchange agreements in which the Company pays a variable rate would be offset by the impact of the increase in interest rates for interest rate exchange agreements in which the Company receives a variable rate.

The majority of ~~CFC's~~the Company's derivatives do not qualify for ~~special~~ hedge accounting. To qualify for ~~special~~ hedge accounting, there must be a high correlation between the pay leg of the interest rate exchange agreement and the asset being hedged or between the receive leg of the interest rate exchange agreement and the liability being hedged. A large portion of ~~CFC's~~the Company's interest rate exchange agreements use a 30-day composite commercial paper index as the receive leg, which would have to be highly correlated to ~~CFC's~~the Company's own commercial paper rates to qualify for ~~special~~ hedge accounting. ~~CFC~~The Company sells commercial paper to its members as well as to investors in the capital markets. ~~CFC~~The Company sets its commercial paper rates daily based on its cash requirements. The correlation between the ~~CFC~~Company's commercial paper rates and the 30-day composite commercial paper index has not been consistently high enough to qualify for ~~special~~ hedge accounting.

~~CFC~~22

The Company does not plan to adjust its practice of using the 30-day composite commercial paper or a LIBOR index as the receive portion of its interest rate exchange agreements. ~~CFC~~The Company sets the variable interest rates on its loans based on the cost of its short-term debt, which is comprised of long-term debt due within one year and commercial paper. ~~CFC~~The Company believes that it is properly hedging its gross margin on loans by using the 30-day composite commercial paper or LIBOR index, which isare the ~~rate~~rates that isare most closely related to the rates it charges on its own commercial paper. ~~While~~During certain periods, the correlation between the LIBOR rates or the 30-day composite commercial paper rate and the Company's 90-day and 30-day commercial paper rate has been higher than the required 90% to qualify for hedge accounting. However, the correlation is not ~~sufficient to meet~~consistently above the ~~high standards set in SFAS 133, CFC believes that it is effectively managing interest rate risk.~~

~~New Accounting Pronouncements~~

In January 2003, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51 ("FIN 46"). FIN 46 defines a variable interest entity as those that either have insufficient equity at risk to permit the entity to finance its activities without additional subordinated financial support from other parties or, as a group, its equity holders lack one or more characteristics of a controlling financial interest.

FIN 46 requires the consolidation of a variable interest entity by the party that is the primary beneficiary of the variable interest entity. An enterprise is considered a primary beneficiary if it absorbs a majority of the variable interest entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity.

CFC believes it is the primary beneficiary of two variable interest entities, RTFC and NCSC, as a result of its exposure to absorbing a majority of their expected losses. Neither company has been consolidated with CFC under GAAP prior to FIN 46 since CFC has no direct financial ownership interest in either company. However, CFC is the sole lender to and manages the affairs of RTFC and NCSC through long-term management agreements. Under a guarantee agreement with RTFC, CFC maintains a loan loss reserve for RTFC. RTFC's results of operations and financial condition are currently combined with those of CFC.

Effective June 1, 2003, CFC and NCSC entered into a guarantee agreement under which CFC will indemnify NCSC against losses on loans that are directly funded by loans from CFC. Accordingly, NCSC will reduce its loss allowance to a level appropriate for its consumer loan program exposure.

CFC intends to implement FIN 46 effective June 1, 2003 and believes that such implementation will result in the consolidation of National Cooperative Services Corporation ("NCSC'") and RTFC. Through May 31, 2003, the results of RTFC have been combined with CFC's. See Note 1(r) to the combined financial statements for additional information on NCSC.

CFC anticipates that the impact of adopting FIN 46 effective June 1, 2003, based on NCSC and RTFC balances at May 31, 2003, will be the following: an increase in total assets of approximately $361 million, an increase in total liabilities of approximately $365 million, an increase in NCSC and RTFC members' equity (minority interest) of approximately $16 million and a decrease in total equity of approximately $20 million. The impact on net margin for the year ended May 31, 2004 is not expected to be material. At May 31, 2003, CFC is exposed to loss in its relationship with NCSC to the extent of its net investment (loans receivable and guarantees of NCSC debt obligations less NCSC's investment in CFC) totaling approximately $677 million. At May 31, 2003, there is no additional exposure to loss on the relationship with RTFC due to the fact that RTFC financial results are combined with CFC. At May 31, 2003, CFC had a net investment in RTFC totaling $4,368 million.

~~Non-GAAP Financial Measures~~

CFC makes certain adjustments to financial measures in assessing its financial performance that are not in accordance with generally accepted accounting principles ("GAAP"). These non-GAAP adjustments fall primarily into two categories: (1) adjustments to exclude the impact of SFAS 133 and foreign currency adjustments, and (2) adjustments related to the calculation of leverage and debt to equity ratios.

~~Adjustments to Exclude the Impacts of Derivatives and Foreign Currency Adjustments~~

CFC's primary performance measure is the Times Interest Earned Ratio ("TIER"). TIER is calculated by adding the cost of funds to net margin prior to the cumulative effect of change in accounting principle and dividing that total by the cost of funds. The TIER is a measure of CFC's ability to cover interest expense requirements on its debt. CFC adjusts the TIER calculation to add the derivative cash settlements to the cost of funds and to remove the derivative forward value and foreign currency adjustments from net margin. Adding the cash settlements back to the cost of funds also has a corresponding effect on CFC's gross margin and operating margin. CFC makes these adjustments to its TIER calculation for the purpose of covenant compliance on its revolving credit agreements. CFC's goal is to maintain a minimum adjusted TIER of 1.10.

CFC's cost of funding is the primary factor used to set the interest rates on the loans to its members. CFC uses derivatives to manage interest rate and foreign currency exchange risk on its funding of the loan portfolio. The derivative cash settlements represent the amount that CFC receives from or pays to its counterparties based on90% threshold, therefore the interest rate ~~and foreign currency~~ exchange ~~indexes in~~agreements that use the three-month LIBOR rate or 30-day composite commercial paper rate do not qualify for hedge accounting. For the purposes of its ~~derivatives. CFC uses~~own analysis, the ~~adjusted cost of funding to set interest rates on loans to its members and~~Company believes that the ~~cost of funds adjusted~~correlation is sufficiently high to include derivative cash settlements represents its total cost of funding for the period. CFC adjusts its cost of funds to include the derivative cash settlements for the purpose of covenant compliance on its revolving credit agreements. TIER calculated by adding the derivative cash settlements to the cost of funds reflects management's perspective on its operations and thus, CFC believes that it represents a useful financial measure for investors.

The derivative forward value and foreign currency adjustments do not represent cash inflow or outflow to CFC during the current period. The derivative forward value represents a present value estimate of the future cash inflows or outflows that will be recognized as net cash settlements for all periods through the maturity of its derivatives. Foreign currency adjustments represent the change in value of foreign denominated debt resulting from the change in foreign currency exchange rates during the current period. The derivative forward value and foreign currency adjustments do not represent cash inflows or outflows that affect CFC's current ability to cover its debt service obligations. The forward value calculation is based on future interest rate expectations that may change daily creating volatility in the estimated forward value. The change in foreign currency exchange rates adjusts the debt balance to the amount that would be due at the reporting date. At the issuance date, CFC enters into a foreign currency exchange agreement for all foreign denominated debt that effectively fixes the exchange rate for all interest and principal payments. For the purpose of making operating decisions, CFC subtracts the derivative forward value and foreign currency adjustments from its net margin when calculating TIER and for other net margin presentation purposes. The covenants in CFC's revolving creditconsider these agreements also exclude the effects of derivative forward value and foreign currency adjustments. In addition, since the derivative forward value and foreign currency adjustments do not represent current period cashflow, CFC does not allocate such funds to its members and thus excludes the derivative forward value and foreign currency adjustments from net margin when making certain presentations to its members and in calculating the amount of net margins to be allocated to its members. TIER calculated by excluding the derivative forward value and foreign currency adjustments from net margin reflects management's perspective on its operations and thus, CFC believes that it represents a useful financial measure for investors.

The implementation of SFAS 133 and foreign currency adjustments have also impacted CFC's total equity. The derivative forward value and foreign currency adjustments flow through the combined statement of operations as income or expense, increasing or decreasing the total net margin for the period. The total net margin or net loss for the period represents an increase or decrease, respectively, to total equity. As a result of implementing SFAS 133, CFC's total equity includes othereffective economic hedges.

comprehensive income, which represents estimated unrecognized gains and losses on derivatives. The other comprehensive income component of equity does not flow through the combined statement of operations. As stated above, the derivative forward value and foreign currency adjustments do not represent current cash inflow or outflow. The other comprehensive income is also an estimate of future gains and losses and as such does not represent earnings that CFC can use to fund its loan portfolio. Financial measures calculated with members' equity, which is total equity excluding the impact of SFAS 133 and foreign currency adjustments, reflect management's perspective on its operations and thus, CFC believes that it represents a useful measure of CFC's financial condition and total capitalization.

The following chart provides a reconciliation between cost of funds, gross margin, operating margin, and net margin and these financial measures adjusted to exclude the impact of SFAS 133 and foreign currency adjustments for the years ended May 31, 2003 and 2002. No adjustment for SFAS 133 and foreign currency adjustments is necessary for periods prior to CFC's implementation of SFAS 133 in fiscal year 2002.

Year Ended May 31,
(Dollar amounts in thousands)
2003
2002
Cost of funds
$
930,847
$
885,838
Plus: Derivative cash settlements
(122,825
)
(34,191
)
Adjusted cost of funds
$
808,022
$
851,647

Gross margin
$
140,028
$
300,695
Plus: Derivative cash settlements
122,825
34,191
Adjusted gross margin
$
262,853
$
334,886

Operating margin
$
15,153
$
63,834
Plus: Derivative cash settlements
122,825
34,191
Adjusted operating margin
$
137,978
$
98,025

Net margin prior to cumulative
          effect of change in accounting principle
$
651,970
$
78,873
Less: Derivative forward value
(757,212
)
(41,878
)
          Foreign currency adjustments
243,220
61,030
Adjusted net margin
$
137,978
$
98,025

~~TIER using GAAP financial measures is calculated as follows:~~


		~~Cost of funds + net margin prior to cumulative~~
	~~TIER =~~	~~effect of change in accounting principle~~
		~~Cost of funds~~

~~TIER adjusted to exclude the impact of SFAS 133 and foreign currency adjustments is calculated as follows:~~


	~~Adjusted TIER =~~	~~Cost of funds + derivative cash settlements +~~
		~~net margin prior to the cumulative effect of change in accounting~~
		~~principle - derivative forward value - foreign currency adjustments~~
		~~Cost of funds + derivative cash settlements~~

~~The following chart provides the TIER and adjusted TIER for the years ended May 31, 2003 and 2002.~~

Year Ended
May 31,
2003
2002
TIER
1.70
1.09
Adjusted TIER
1.17
1.12

~~Adjustments to the Calculation of Leverage and Debt to Equity~~

CFC calculates the leverage ratio by adding total liabilities to total guarantees and dividing by total equity. CFC calculates the debt to equity ratio by dividing total liabilities by total equity. CFC adjusts these ratios to subtract debt used to fund loans that are guaranteed by RUS, to subtract from total debt and add to total equity, debt with equity characteristics issued to its members and in the capital markets and to exclude the impact of SFAS 133 and foreign currency adjustments from its total liabilities and total equity. CFC also adjusts the debt to equity ratio to add the loan loss allowance to total equity.

CFC is an eligible lender under the RUS loan guarantee program. Loans issued under this program carry the US Government's guarantee of all interest and principal payments. Thus, CFC has little or no risk associated with the collection of principal and interest payments on these loans. Therefore, CFC believes that there is little or no risk related to the repayment of the liabilities used to fund RUS guaranteed loans and subtracts such liabilities from total liabilities for the purpose of calculating its leverage and debt to equity ratios. CFC adjusts its leverage ratio by subtracting liabilities used to fund RUS guaranteed loans from total liabilities for the purpose of covenant compliance on its revolving credit agreements. The leverage and debt to equity ratios adjusted to subtract debt used to fund RUS guaranteed loans from total liabilities reflects management's perspective on its operations and thus, CFC believes that these are useful financial measures for investors.

CFC requires that its members purchase subordinated certificates as a condition of membership and as a condition to obtaining a loan or guarantee. The subordinated certificates are accounted for as debt under GAAP. The subordinated certificates have long-dated maturities and pay no interest or pay interest that is below market and under certain conditions CFC is prohibited from making interest payments to members on the subordinated certificates. CFC adjusts its leverage ratio by subtracting members' subordinated certificates from total liabilities and adding it to total equity for the purpose of covenant compliance on its revolving credit agreements. The leverage and debt to equity ratios adjusted to treat members' subordinated certificates as equity rather than debt reflects management's perspective on its operations and thus, CFC believes that these are useful financial measures for investors.

CFC also sells subordinated deferrable debt in the capital markets with maturities of up to 49 years and the option to defer interest payments. The characteristics of subordination, deferrable interest and long-dated maturity are all equity characteristics. CFC adjusts its leverage ratio by subtracting subordinated deferrable debt from total liabilities and adding it to total equity for the purpose of covenant compliance on its revolving credit agreements. The leverage and debt to equity ratios adjusted to treat subordinated deferrable debt as equity rather than debt reflects management's perspective on its operations and thus, CFC believes that these are useful financial measures for investors.

As a result of implementing SFAS 133, CFC's combined balance sheet includes the fair value of its derivative instruments. As noted above, the amounts recorded are estimates of the future gains and losses that CFC may incur related to its derivatives. The amounts do not represent current cash flows and are not available to fund current operations. CFC adjusts its leverage ratio by excluding the impact of implementing SFAS 133 from liabilities and equity for the purpose of covenant compliance on its revolving credit agreements. The leverage and debt to equity ratios adjusted to exclude the impact of SFAS 133 from liabilities and equity reflects management's perspective on its operations and thus, CFC believes that these are useful financial measures for investors.

As a result of issuing foreign denominated debt and the implementation of SFAS 133 which discontinued the practice of recording the foreign denominated debt and the related currency exchange agreement as one transaction, CFC must adjust the value of such debt reported on the combined balance sheet for changes in foreign currency exchange rates since the date of issuance. At the time of issuance of all foreign denominated debt, CFC enters into a foreign currency exchange agreement to fix the exchange rate on all principal and interest payments through maturity. The adjustments to the value of the debt on the combined balance sheet are reported on the combined statement of operations. The adjusted debt value at the reporting date does not represent the amount that CFC will ultimately pay to retire the debt, unless the current exchange rate is equal to the exchange rate in the related foreign currency exchange agreement or the counterparty fails to honor its obligations under the agreement. CFC adjusts its leverage ratio by excluding the impact of foreign currency valuation adjustments from liabilities and equity for the purpose of covenant compliance on its revolving credit agreements. The leverage and debt to equity ratios adjusted to exclude the impact of foreign currency reflects management's perspective on its operations and thus, CFC believes that these are useful financial measures for investors.

CFC accumulates the loan loss allowance through the provision for loan losses on its combined statement of operations. Thus, the loan loss allowance represents net margins or equity that has been specifically allocated to cover losses in the loan portfolio. Including the loan loss allowance as part of equity in the debt to equity ratio reflects management's perspective on its operations and thus, CFC believes that it is a useful financial measure for investors.

~~The leverage and debt to equity ratios using GAAP financial measures are calculated as follows:~~


	~~Leverage ratio =~~	~~Liabilities + guarantees outstanding~~
		~~Total equity~~

	~~Debt to equity ratio =~~	~~Liabilities~~
		~~Total equity~~

~~The leverage and debt to equity ratios reflecting the adjustments noted above are calculated as follows:~~


		~~Total liabilities - derivative liabilities - foreign currency valuation account -~~
		~~debt used to fund loans guaranteed by RUS - subordinated deferrable debt -~~
	~~Adjusted leverage ratio =~~	~~members' subordinated certificates +guarantees outstanding~~
		~~Total equity - derivative forward value - cumulative effect of change in~~
		~~accounting principle - foreign currency adjustments - accumulated other~~
		~~comprehensive loss + members' subordinated certificates + subordinated~~
		~~deferrable debt~~


		~~Total liabilities - derivative liabilities - foreign currency valuation account -~~
		~~debt used to fund loans guaranteed by RUS - subordinated deferrable debt -~~
	~~Adjusted debt to equity ratio =~~	~~members' subordinated certificates~~
		~~Total equity - derivative forward value - cumulative effect of change in~~
		~~accounting principle - foreign currency adjustments - accumulated other~~
		~~comprehensive loss + members' subordinated certificates + subordinated~~
		~~deferrable debt + loan loss allowance~~

The following charts provide a reconciliation between the liabilities and equity used to calculate the leverage and debt to equity ratios and these financial measures reflecting the adjustments noted above, as well as the ratio calculations for the five years ended May 31, 2003.

Leverage Ratio:
May 31,
(Dollar amounts in thousands)
2003
2002
2001
2000
1999
Total Liabilities
$
20,043,452
$
20,014,204
$
19,604,943
$
16,742,223
$
13,628,771
   Less:

Derivative liabilities (1) (2)
(353,840
)
(254,143
)
-
-
-
Foreign currency valuation account (3)
(325,810
)
2,355
-
-
-
Debt used to fund loans guaranteed by RUS
(266,857
)
(242,574
)
(182,134
)
(89,153
)
(130,940
)
Subordinated deferrable debt
(650,000
)
(600,000
)
(550,000
)
(400,000
)
(400,000
)
Subordinated certificates
(1,708,297
)
(1,691,970
)
(1,581,860
)
(1,340,417
)
(1,239,816
)
Adjusted liabilities
$
16,738,648
$
17,227,872
$
17,290,949
$
14,912,653
$
11,858,015

Total Equity
$
930,836
$
328,731
$
393,899
$
341,217
$
296,481
   Less:
Prior year cumulative derivative forward value and
         foreign currency adjustments (2)(3)
(9,231
)
-
-
-
-
Current period derivative forward value (2)
(757,212
)
(70,261
)
-
-
-
Current period foreign currency adjustments (3)
243,220
61,030
-
-
-
Accumulated other comprehensive loss (2)
46,763
72,556
-
-
-
Members' equity
454,376
392,056
393,899
341,217
296,481
   Plus:
Subordinated certificates
1,708,297
1,691,970
1,581,860
1,340,417
1,239,816
Subordinated deferrable debt
650,000
600,000
550,000
400,000
400,000
Adjusted equity
$
2,812,673
$
2,684,026
$
2,525,759
$
2,081,634
$
1,936,297

Guarantees
$
1,903,556
$
2,056,385
$
2,217,559
$
1,945,202
$
1,893,197

Leverage ratio
23.58
67.14
55.40
54.77
52.35
Adjusted leverage ratio
6.63
7.18
7.72
8.10
7.10

~~(1) Includes the long-term debt valuation allowance of $(941) and $2,340 at May 31, 2003 and 2002, respectively.~~

~~(2) No adjustment for SFAS 133 is necessary for periods prior to CFC's implementation of SFAS 133 in fiscal year 2002.~~

(3) No adjustment for foreign currency is required prior to CFC's implementation of SFAS 133 in fiscal year 2002. Prior to that date, CFC was allowed under SFAS 52, to account for the foreign denominated debt and the related cross currency exchange agreement as one transaction in the cost of funds.

Debt to Equity Ratio:
May 31,
(Dollar amounts in thousands)
2003
2002
2001
2000
1999
Total Liabilities
$
20,043,452
$
20,014,204
$
19,604,943
$
16,742,223
$
13,628,771
   Less:
Derivative liabilities (1) (2)
(353,840
)
(254,143
)
-
-
-
Foreign currency valuation account (3)
(325,810
)
2,355
-
-
-
Debt used to fund loans guaranteed by RUS
(266,857
)
(242,574
)
(182,134
)
(89,153
)
(130,940
)
Subordinated deferrable debt
(650,000
)
(600,000
)
(550,000
)
(400,000
)
(400,000
)
Subordinated certificates
(1,708,297
)
(1,691,970
)
(1,581,860
)
(1,340,417
)
(1,239,816
)
Adjusted liabilities
$
16,738,648
$
17,227,872
$
17,290,949
$
14,912,653
$
11,858,015

Total Equity
$
930,836
$
328,731
$
393,899
$
341,217
$
296,481
   Less:
Prior year cumulative derivative forward value and
         foreign currency adjustments (2)(3)
(9,231)
-
-
-
-
Current period derivative forward value (2)
(757,212
)
(70,261
)
-
-
-
Current period foreign currency adjustments (3)
243,220
61,030
-
-
-
Accumulated other comprehensive loss (2)
46,763
72,556
-
-
-
Members' equity
454,376
392,056
393,899
341,217
296,481
   Plus:
Subordinated certificates
1,708,297
1,691,970
1,581,860
1,340,417
1,239,816
Subordinated deferrable debt
650,000
600,000
550,000
400,000
400,000
Loan loss allowance
565,058
506,742
331,997
228,292
212,203
Adjusted equity
$
3,377,731
$
3,190,768
$
2,857,756
$
2,309,926
$
2,148,500

Debt to equity ratio
21.53
60.88
49.77
49.07
45.97
Adjusted debt to equity ratio
4.96
5.40
6.05
6.46
5.52

~~(1) Includes the long-term debt valuation allowance of $(941) and $2,340 at May 31, 2003 and 2002, respectively.~~

~~(2) No adjustment for SFAS 133 is necessary for periods prior to CFC's implementation of SFAS 133 in fiscal year 2002.~~

Previously, we have described adjustments that CFC makes to its total outstanding debt and total equity. CFC also adjusts its total capitalization to exclude the impact of SFAS 133 and foreign currency adjustments from the total debt and total equity. Total capitalization includes notes payable, long-term debt, subordinated deferrable debt, members' subordinated certificates and total equity. Adjusted total capitalization excludes the derivative long-term debt valuation allowance and the foreign currency valuation account from total liabilities and excludes the impact of SFAS 133 and foreign currency adjustments from total equity. Total capitalization adjusted to exclude the impact of SFAS 133 and foreign currency adjustments reflects management's perspective on its operations and thus, CFC believes that it is a useful financial measure for investors. The following chart provides a reconciliation between total capitalization and adjusted total capitalization at May 31, 2003 and May 31, 2002. No adjustment for SFAS 133 and foreign currency adjustments is necessary for periods prior to CFC's implementation of SFAS 133 in fiscal year 2002.

(Dollar amounts in thousands)
May 31, 2003
May 31, 2002
Total capitalization
$
20,386,230
$
19,890,220
   Less:
Long-term debt valuation allowance
941
(2,340
)
Foreign currency valuation account
(325,810
)
2,355
Prior year cumulative derivative forward value and
       foreign currency adjustments
(9,231
)
-
Current period derivative forward value (1)
(757,212
)
(70,261
)
Current period foreign currency adjustments
243,220
61,030
Accumulated other comprehensive loss
46,763
72,556
Adjusted total capitalization
$
19,584,901
$
19,953,560


~~(1) Includes $28,383 related to the cumulative effect of change in accounting principle in fiscal year 2002.~~

~~Restatement~~

In the implementation of SFAS 133, CFC properly accounted for its cross currency and cross currency interest rate exchange agreements, but did not adjust its foreign denominated debt for changes in exchange rate from the date of issuance to the reporting date as required under SFAS 52. Prior to the adoption of SFAS 133, CFC was properly accounting for the foreign denominated debt and the related cross currency or cross currency interest rate exchange agreement by recording the debt at an amount that included the impact of the related exchange agreement and by offsetting the interest payments on the

foreign denominated debt with the cash settlements on the exchange agreements in the cost of funds on the combined statement of operations. As a result of implementing SFAS 133, the fair value of all cross currency and cross currency interest rate exchange agreements were reported on the combined balance sheet as an asset or liability with the change in the fair value reported either in the combined statement of operations or in other comprehensive income. The separate reporting of the fair value of the exchange agreement required that the foreign denominated debt also be adjusted to fair value at each reporting date with the change in fair value reported in the combined statement of operations to reflect the change in exchange rate during the period. For the year ended May 31, 2002 and all quarterly reporting periods in fiscal years 2002 and 2003, CFC did not adjust the fair value of the foreign denominated debt on the combined balance sheet to reflect changes in the exchange rate during the period. CFC continued to record the foreign denominated debt on the combined balance sheet based on the exchange rate that was fixed at the time of issuance by the cross currency exchange agreements, which represents the amount that CFC will pay at maturity, unless the counterparty to the cross currency agreements defaults on its obligations. CFC has restated the May 31, 2002 year-end results as more fully described in Note 1(q) and the quarterly results in fiscal years 2002 and 2003 presented in Note 15 to the combined financial statements in this May 31, 2003 report on Form 10-K.

CFC has reviewed its disclosure controls related to the implementation of new accounting statements and is in the process of implementing changes to such controls in order to prevent and detect such items in the future.

Margin Analysis

~~CFC~~The Company uses an interest expense coverage ratio (or TIER) instead of the dollar amount of gross or net margin as its primary performance indicator, since ~~CFC's~~its net margin in dollar terms is subject to fluctuation as interest rates change. Management has established a 1.10 adjusted TIER as its minimum operating objective. TIER is a measure of ~~CFC's~~the Company's ability to cover the interest expense on ~~funding.~~its debt obligations. TIER is calculated by dividing the cost of funds and the net margin prior to the cumulative effect of change in accounting principle by the cost of funds. ~~CFC's~~ TIER for the years ended May 31, 2005 and 2003 ~~2002~~was 1.14 and ~~2001 was 1.70, 1.09 and 1.12,~~1.69, respectively. ~~CFC adjusts~~For the year ended May 31, 2004, the Company reported a net loss prior to the cumulative effect of change in accounting principle of $200 million, thus the TIER calculation results in a value below 1.00.

The Company also calculates an adjusted TIER to exclude the derivative forward value and foreign currency adjustments from net margin, to add back minority interest to net margin and to include the derivative cash settlements in the cost of funds. Adjusted TIER for the years ended May 31, 2005, 2004 and 2003 ~~2002 and 2001~~ was ~~1.17,~~1.14, 1.12 and ~~1.12,~~1.17, respectively. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of the adjustments ~~CFC~~the Company makes in its TIER calculation to exclude the impact of derivatives required by SFAS 133 and ~~foreign currency adjustments.~~SFAS 52.

Fiscal Year ~~2003~~2005 versus ~~2002~~2004 Results

The following chart presents the results for the year ended May 31, ~~2003~~2005 versus May 31, ~~2002.~~2004.

For the year ended May 31,
Increase/
(Dollar amounts in millions)
2003
2002
(Decrease)
Operating income
$
1,071
$
1,187
$
(116
)
Cost of funds
931
886
45
   Gross margin
140
301
(161
)
Expenses:
General and administrative expenses
38
38
-
Provision for loan losses
68
199
(131
)
   Total expenses
106
237
(131
)
Results of operations of foreclosed assets
1
-
1
Impairment loss on foreclosed assets
(20
)
-
(20
)
   Subtotal foreclosed assets
(19
)
-
(19
)
   Operating margin
15
64
(49
)

Derivative cash settlements
123
34
89
Derivative forward value
757
42
715
Foreign currency adjustments
(243
)
(61
)
(182
)
Cumulative effect of change in accounting principle
-
28
(28
)
   Net margin
$
652
$
107
$
545

TIER
1.70
1.09
Adjusted TIER (1)
1.17
1.12

	For the year ended May 31,						Increase/
(Dollar amounts in millions)	2005			2004			(Decrease)
Operating income	$	1,026		$	1,007		$	19
Cost of funds		(922	)		(925	)		3
Gross margin		104			82			22
Operating expenses:
General and administrative expenses		(43	)		(41	)		(2	)
Provision for loan losses		(16	)		(55	)		39
Recovery of guarantee losses		3			1			2
Total operating expenses		(56	)		(95	)		39
Results of operations of foreclosed assets		13			13			-
Impairment loss on foreclosed assets		-			(11	)		11
Total gain on foreclosed assets		13			2			11
Derivative and foreign currency adjustments:
Derivative cash settlements		63			110			(47	)
Derivative forward value		30			(229	)		259
Foreign currency adjustments		(23	)		(65	)		42
Total gain (loss) on derivative and foreign currency adjustments		70			(184	)		254
Operating margin (loss)		131			(195	)		326
Income tax expense		(2	)		(3	)		1
Minority interest - RTFC and NCSC net margin		(2	)		(2	)		-
Cumulative effect of change in accounting principle		-			22			(22	)
Net margin (loss)	$	127		$	(178	)	$	305
TIER (1)		1.14			-
Adjusted TIER (2)		1.14			1.12

(1) For the year ended May 31, 2004, the Company reported a net loss prior to the cumulative effect of change in accounting principle of $200 million, thus the TIER calculation results in a value below 1.00.
~~(1)~~(2) Adjusted to exclude the impact of the derivative forward value, ~~and~~ foreign currency adjustments and minority interest from net margin and to include the derivative cash settlements in the cost of funds. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of these adjustments.

~~Net~~The following table provides a breakout of the change to operating income, cost of funds and gross margin due to changes in loan volume versus changes to interest rates for the ~~year~~years ended May 31, ~~2003 was $652 million, an increase of $545 million or 509% over the $107 million earned the prior year. The net margin increase was primarily due to increases in the derivative cash settlements~~2005 and ~~forward value and a decrease in the provision for loan losses offset by a decrease in foreign currency adjustments and gross margin spread earned on loans.~~2004.

Volume Rate Variance Table (Dollar amounts in millions)

	For the year ended May 31,
	2005			2004			Change due to
	Average Loan Balance	Income / (Cost)	Rate	Average Loan Balance	Income / (Cost)	Rate	Volume (1)	Rate (2)	Total
Operating Income
CFC (3)	$ 15,494	$ 772	4.99%	$14,982	$ 673	4.49%	$ 23	$ 76	$ 99
RTFC	3,863	226	5.84%	4,809	306	6.37%	(60)	(20)	(80)
NCSC	481	28	5.77%	541	28	5.11%	(3)	3	-
Total	$19,838	$ 1,026	5.17%	$20,332	$ 1,007	4.95%	$ (40)	$ 59	$ 19

Cost of funds
CFC	$15,494	$ (682)	(4.41%)	$14,982	$ (607)	(4.06%)	$ (21)	$ (54)	$ (75)
RTFC	3,863	(221)	(5.71%)	4,809	(300)	(6.24%)	59	20	79
NCSC	481	(19)	(3.90%)	541	(18)	(3.26%)	2	(3)	(1)
Total	$19,838	$ (922)	(4.65%)	$20,332	$ (925)	(4.55%)	$ 40	$ (37)	$ 3

Gross Margin
CFC	$15,494	$ 90	0.58%	$14,982	$ 66	0.44%	$ 2	$ 22	$ 24
RTFC	3,863	5	0.14%	4,809	6	0.13%	(1)	-	(1)
NCSC	481	9	1.87%	541	10	1.86%	(1)	-	(1)
Total	$19,838	$ 104	0.52%	$20,332	$ 82	0.40%	$ -	$ 22	$ 22

Derivative Cash Settlements (3)
CFC	$15,103	$ 65	0.43%	$16,616	$ 114	0.68%	$ (10)	$ (38)	$ (48)
NCSC	71	(2)	(3.11%)	83	(4)	(4.38%)	-	1	1
Total	$15,174	$ 63	0.42%	$16,699	$ 110	0.66%	$ (10)	$ (37)	$ (47)

Adjusted Cost of Funds
Total	$19,838	$ (859)	(4.33%)	$20,332	$ (815)	(4.01%)

_____________________
(1)	Variance due to volume is calculated using the following formula: ((current average balance - prior year average balance) x prior year rate).
(2)	Variance due to rate is calculated using the following formula: ((current rate - prior year rate) x current average balance).
(3)	For derivative cash settlements, average loan balance represents the average notional amount of derivative contracts outstanding and the rate represents the net difference between the average rate paid and the average rate received for cash settlements during the period.

Operating Income

During fiscal year 2005, the Company collected $36 million of make-whole fees related to the prepayment of loans and raised variable interest rates by 210 basis points to 235 basis points depending on the loan program, while fixed interest rates remained relatively stable. The ~~$116~~$36 million ~~or 10%~~of fees collected are included as part of the rate variance in the table above. Operating income for fiscal year 2005 excluding the $36 million of make-whole fees was $990 million with an average yield of 4.99% representing a decrease inof $17 million from the prior year. The increase to income as a result of higher variable interest rates is offset by a reduction to operating income ~~for~~as a result of an increase to loans on non-accrual status. For the year ended May 31, ~~2003~~2005, the Company had a reduction to interest income of $51 million due to non-accrual loans, compared to ~~the prior year was due to the decrease in the yield on average loans outstanding caused by lower interest rates. Average loan volume for the year ended May 31, 2003 was $19,846~~a reduction of $23 million an increase of $10 million, or less than 1%, over the average loan volume of $19,836 for the prior year. CFC's calculated average yield on its loan portfolio was 5.40% for the year ended May 31, 2003, a decrease of 0.58% from 5.98% for the prior year.

The $36 million of make-whole fees were recorded at CFC during fiscal year 2005. CFC's operating income for fiscal year 2005 excluding the $36 million of make-whole fees was $736 million with an average yield of 4.76% representing a decrease of $63 million from the prior year. The impact of non-accrual loans at CFC was a decrease in operating income of $27 million for fiscal year 2005, compared to a decrease of $23 million for the prior year. The impact of non-accrual loans on RTFC operating income was a decrease of $24 million for fiscal year 2005, compared to no reduction in the prior year.

Cost of Funds

The total cost of funding for the year ended May 31, ~~2003~~2005 was $922 million compared to $925 million for the prior year. However, there were offsetting changes to the cost of funds due to the increase to interest rates in the markets and to a lower loan volume. The adjusted cost of funds, which includes the derivative cash settlements, for fiscal year 2005 increased ~~$45~~by $44 million ~~or 5%~~ compared to the prior year. ~~CFC's strategy~~See "Non-GAAP Financial Measures" for further explanation of ~~improving liquidity by replacing dealer commercial paper~~the adjustment the Company makes in its financial analysis to include the derivative cash settlements in its cost of funds. The Company recorded

$63 million of derivative cash settlements for fiscal year 2005, which included the receipt of $85 million of settlement payments from its counterparties less $22 million paid to counterparties for the termination of interest rate exchange agreements used as funding for the loans that were prepaid during the year. Adjusted cost of funds for fiscal year 2005 excluding the $22 million of termination fees was $837 million with ~~medium-term notes and collateral trust bonds increased CFC's~~an average cost of funding ~~costs~~of 4.22% representing an increase of $25 million compared to the prior year. The cost of funds for the year ended May 31, ~~2003 compared to the prior year offsetting the impact of decreasing interest rates on short-term funding. CFC's calculated average cost of funding, which~~2005 and 2004 includes ~~the cost of funds less the~~expense totaling $8 million and $9 million, respectively, for net cash settlements ~~divided by the average loan balance, was 4.07% for fiscal year 2003, a decrease from 4.29% for fiscal year 2002.~~related to exchange agreements that qualify as effective hedges.

Gross Margin

The Company's gross margin ~~spread earned on loans~~ for the year ended May 31, ~~2003 was 71 basis points, a decrease~~2005 increased due to the receipt of ~~81 basis points, or 53%, compared~~$36 million of make-whole fees related to ~~152 basis points for~~loan prepayments offset by an increase to the ~~prior year.~~cost of funding in excess of the increase to interest rates on loans to members. The adjusted gross margin, ~~spread earned on loans~~which includes the cash settlements, for the year ended May 31, ~~2003 adjusted to include derivative cash settlements~~2005 was ~~133 basis points, representing~~$167 million, a decrease of ~~36 basis points, or 21%, compared to the gross margin of 169 basis points for~~$25 million from the prior ~~year period.~~year. See ~~the~~ "Non-GAAP Financial Measures" ~~section~~ for further explanation of the adjustment ~~CFC~~the Company makes in its financial analysis to include the derivative cash settlements in its cost of funds, and therefore gross margin. The adjusted gross margin ~~spread earned on loans~~excluding the $14 million of make-whole fees in excess of termination fees for fiscal year ~~2003 decreased due to the increased cost associated with replacing dealer commercial paper with medium-term notes and collateral trust bonds offsetting the impact~~2005 was $153 million, a decrease of ~~decreasing interest rates on the~~$39 million. The adjusted gross margin ~~earned on loans. CFC's goal as~~yield, excluding the $14 million of make-whole fees in excess of termination fees was 0.77%, a ~~not-for-profit, member-owned financial cooperative is to provide financial products to its members at~~decrease of 17 basis points from the lowest rates possible after covering all expenses and maintaining a reasonable net margin. For the year ended May 31, 2003, CFC exceeded its minimum operating objective of a 1.10 adjusted TIER, therefore CFC did not pass the increase in its cost of funding on to its borrowers.prior year.

~~General and Administrative~~Operating Expenses

General and administrative expenses for ~~fiscal~~the year ~~2003~~ended May 31, 2005 were ~~consistent with fiscal~~$43 million compared to $41 million for the year ~~2002. The general~~ended May 31, 2004. General and administrative expenses ~~for fiscal year 2003~~ represented ~~0.19%~~22 basis points of average loan volume for the ~~same~~year ended May 31, 2005, an increase of 2 basis point as compared to 20 basis points for the prior ~~year.~~year period.

~~Provision for Loan Losses~~

~~CFC considers various factors to determine the adequacy of the~~The loan loss ~~allowance in relation to the credit quality~~provision of ~~its loan and guarantee portfolio. During~~$16 million for the year ended May 31, ~~2003, CFC determined that~~2004 represented a ~~total~~decrease of ~~$68~~$39 million ~~was required as an addition to~~from the ~~loan loss allowance based on the credit quality~~provision of ~~CFC's loan and guarantee portfolio compared to $199~~$55 million for the prior ~~year.~~year period. The Company's loan loss provision ~~for the prior year~~of $16 million at May 31, 2005 was ~~higher~~ due to an increase in the ~~default~~calculated impairments of $171 million offset by a decrease of $97 million for high-risk loans and ~~subsequent impairment on~~a reduction of $58 million to the ~~CoServ loan~~allowance for all other loans. The increase to the calculated impairments was due to both an increase in the principal balance of loans classified as impaired and to an increase in ~~loans classified~~the variable interest rates at May 31, 2005 as ~~high risk. The provision~~compared to the ~~reserve~~prior year. The decrease to the allowance for ~~fiscal~~high risk loans was due to one borrower which moved from high risk to impaired due to ongoing litigation. The reduction to the allowance for all other loans was primarily due to a significant reduction in the balance of loans outstanding at May 31, 2005 as compared to the prior year. The $16 million loan loss provision was recorded at CFC during the year ~~2003 represented 0.34%~~ended May 31, 2005. Under an agreement with RTFC and NCSC, CFC will reimburse both companies for loan losses, with the exception of ~~average~~the NCSC consumer loan ~~volume,~~and grant programs. There was no loan loss provision required at NCSC during the year ended May 31, 2005. The NCSC loan loss allowance decreased by approximately $1 million due to a decrease ~~from 1.00% for~~in the ~~prior year.~~principal balance of NCSC consumer loans.

There was a recovery of $3 million from the guarantee liability in the year ended May 31, 2005 compared to $1 million in the year ended May 31, 2004. The recovery of $3 million during the year ended May 31, 2005 was due to a change in the maturity of a guaranteed bond due to a scheduled redemption in fiscal year 2006. At both May 31, 2005 and 2004, substantially all guarantees were issued by CFC.

~~Results of Operations of and Impairment Loss~~Gain on Foreclosed Assets

~~During~~The Company recorded net income of $13 million from the operation of foreclosed assets for the years ended May 31, 2005 and 2004. In addition, the Company recognized an impairment loss of $11 million to reflect the decrease in the fair value of certain foreclosed assets during the year ended May 31, ~~2003, entities controlled by CFC received real estate developer notes receivable, limited partnership interests in certain real estate developments, partnership interests in real estate properties~~2004. The impairment loss recorded during the year ended May 31, 2005 was insignificant. It is not management's intent to hold and telecommunications assets from entities related to CoServ as part of the plan for CoServ to emerge from bankruptcy. Another borrower transferred real estate assets to an entity controlled by CFC in repayment of the loan as part of a settlement. CFC accounts foroperate these assets, onbut to preserve the combined balance sheets as foreclosed assets. CFC is operating certain real estate and telecommunications assets while attempting to sell these assets. The results of operations from foreclosed assets are shown onvalue for sale at the combined statements of operations since the dates of foreclosure. For the year ending May 31, 2003, this amount was income of $1 million. CFC also recorded a $20 million impairment loss for the write down of certain foreclosed assets to their estimated fair value at May 31, 2003.

36appropriate time.

Derivative Cash Settlements

The ~~amounts that CFC pays and receives related~~total cash settlements decreased for fiscal year 2005 as compared to the ~~cross currency~~prior year due to a reduction in the amount of interest rate exchange agreements in place and to a reduction in the net difference between the average rates paid and received. In addition, a total of $22 million of termination fees were paid during fiscal year 2005 to unwind interest rate exchange agreements that ~~do not qualify~~were used as part of the funding for ~~special hedge accounting~~loans that were ~~recorded as~~prepaid during the year. The total cash settlements received in fiscal year 2005, prior to the $22 million of termination fees, was $85 million, which is a reduction of $25 million from the prior year.

Derivative Forward Value

During the year ended May 31, 2005, derivative ~~cash settlements~~forward value increased $259 million compared to the prior year period. The increase in the derivative forward value is due to changes in the estimate of future interest rates over the remaining life of the derivative contracts. The derivative forward value for the years ended May 31, ~~2003~~2005 and ~~2002.~~ 2004 also includes amortization of $13 million and $17 million, respectively, related to the transition adjustment recorded as an other comprehensive loss on June 1, 2001, the date the Company implemented SFAS 133. This adjustment will be amortized into earnings over the remaining life of the related derivative contracts.

The ~~decreasing interest rate environment,~~Company is required to record the fair value of derivatives on its consolidated balance sheets with changes in the fair value of derivatives that do not qualify for hedge accounting recorded in the consolidated and combined statements of operations as a current period gain or loss. This change in fair value is recorded as the derivative forward value on the consolidated and combined statements of operations. The derivative forward value does not represent a current period cash inflow or outflow, but represents the net present value of the estimated future cash settlements, which are based on the estimate of future interest rates over the remaining life of the derivative contract. The expected future interest rates change often, causing significant changes in the recorded fair value of derivatives and volatility in the reported estimated gain or loss on derivatives in the consolidated and combined statements of operations. Recording the forward value of derivatives results in recording only a portion of the impact on the Company's operations due to future changes in interest rates. Under GAAP, the Company is required to recognize changes in the fair value of its derivatives as a result of expected changes in future interest rates, but there are no provisions for recording changes in the fair value of its loans or debt outstanding as a result of expected changes in future interest rates. As a finance company, the Company passes on its cost of funding through interest rates on loans to members. The Company has demonstrated the ability to pass on its cost of funding to its members through its ability to consistently earn an adjusted TIER in excess of the minimum 1.10 target. The Company has earned an adjusted TIER in excess of 1.10 in every year since 1981. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of adjusted ratios.

Foreign Currency Adjustment

There was a decrease in the expense recorded as a foreign currency adjustment of $42 million for the year ended May 31, 2005 as compared to the year ended May 31, 2004 due to the change in currency exchange ~~rates~~rates. Changes in the exchange rate between the U.S. dollar and Euro and the ~~composition~~U.S. dollar and Australian dollar will cause the value of ~~CFC's exchange agreement portfolio during~~foreign denominated debt outstanding to fluctuate. An increase in the ~~twelve months since May 31, 2002 resulted~~value of the Euro or the Australian dollar versus the value of the U.S. dollar results in an increase in the ~~derivative~~recorded U.S. dollar value of foreign denominated debt and therefore a charge to expense on the consolidated and combined statements of operations, while a decrease in exchange rates results in a reduction in the recorded U.S. dollar value of foreign denominated debt and income. The Company has entered into foreign currency exchange agreements to cover all of the cash ~~settlements received~~flows associated with its foreign denominated debt. Changes in the value of ~~$89 million over~~ the ~~prior year.~~foreign currency exchange agreement will be approximately offset by changes in the value of the outstanding foreign denominated debt.

~~Derivative Forward Value~~Operating Margin (Loss)

Operating margin for the year ended May 31, 2005 was $131 million, compared to a loss of $195 million for the prior year period. The significant increase in the operating margin for the year ended May 31, 2005 compared to the prior year period was primarily due to the $259 million increase in the estimated fair value of derivatives. The adjusted operating margin, which excludes derivative forward value and foreign currency adjustments, for the year ended May 31, 2005 was $124 million, compared to $99 million for the prior year period. See "Non-GAAP Financial Measures" for further explanation of the adjustment the Company makes in its financial analysis to exclude the derivative forward value and foreign currency adjustments in its adjusted operating margin. The adjusted operating margin increased due to the $39 million decrease in the provision for loan losses and the $11 million increase in the gain on foreclosed assets offset by the $25 million decrease in adjusted gross margin. The adjusted operating margin for the year ended May 31, 2005 excluding the net gain of $14 million as a result of loan prepayments and swap terminations was $110 million, an increase of $11 million from the prior year period.

Cumulative Effect of Change in Accounting Principle

~~The $715 million increase in the derivative forward value during the year ended May 31, 2003 is due to changes in the fair value quotes~~As a result of the ~~interest rate~~implementation of Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 46(R), Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51, effective June 1, 2003, CFC consolidated the financial results of NCSC and cross currency interest rate exchange agreements estimated at May 31, 2003 as compared to the prior year. In most cases, variable interest rates have not increased as expected and in a decreasing interest rate environment, a rise in the fair value of fixed to variable exchange agreements usually occurs. CFC pays a variable rate and receives a fixed rate on the majority of its exchange agreements. At May 31, 2003, CFC's interest rate and cross currency interest rate exchange agreements include $8,484 million notional amount, or 51% of the total exchange agreements, in which CFC synthetically changed the interest rate on the debt securities from fixed to variable and $6,595 million notional amount, or 40% of the total exchange agreements, in which CFC synthetically changed the interest rate on the debt securities from variable to fixed. CFC pays a variable rate of interest and receives a variable rate of interest on the remaining exchange agreements. These types of exchange agreements have very little impact on the derivative forward value. Related to the adoption of SFAS 133 during the year ended May 31, 2002, CFC booked a $28 million gain asRTFC. The Company recorded a cumulative effect of change in accounting principle gain of $22 million on ~~June 1, 2001.~~the consolidated statement of operations for the year ended May 31, 2004.

~~Foreign Currency Adjustments~~Net Margin (Loss)

~~For~~Net margin for the year ended May 31, ~~2003, CFC recorded~~2005 was $127 million, an increase of $305 million compared to a net loss of ~~$243~~$178 million ~~related to foreign denominated debt that does not receive hedge treatment under SFAS 133. This was an~~for the prior year period. The net margin for the year ended May 31, 2005 and the significant increase from the ~~loss~~prior year period was primarily due to the $259 million increase in the estimated fair value of ~~$61~~derivatives. The adjusted net margin, which excludes the impact of the derivative forward value, foreign currency adjustments and cumulative effect of change in accounting principle and adds back minority interest, was $122 million ~~recorded~~and $96 million for the ~~prior year.~~year ended May 31, 2005 and 2004, respectively. See "Non-GAAP Financial Measures" for further explanation of the adjustments the Company makes in its financial analysis to net margin (loss). The ~~loss recorded is due to changes in~~adjusted net margin for the ~~foreign exchange rate between~~year ended May 31, 2005 excluding the ~~US dollar~~net gain of $14 million as a result of loan prepayments and ~~the Euro. During fiscal year 2003, CFC had outstanding a total 1,350~~swap terminations was $108 million, ~~Euros. At each reporting date, CFC is required to record the dollar equivalent~~an increase of ~~foreign denominated debt on its combined balance sheet with any change~~$12 million from the prior ~~period reported on the combined statement of operations. The increase to the loss recorded in fiscal~~ year 2003 as compared to fiscal year 2002 was due to an increase in the average amount of Euro denominated debt outstanding and an increase in the value of the Euro against the dollar. For foreign denominated debt with related cross currency exchange agreements that qualify for hedge treatment under SFAS 133, the change in the value of the debt reported in the combined statement of operations is fully offset by the reclassification of an equal amount of the change in the fair value of the related hedge from accumulated other comprehensive loss, where the change in the fair value of the hedge was originally reported.period.

Fiscal Year ~~2002~~2004 versus ~~2001~~2003 Results

The following ~~charts detail~~chart details the results for the year ended May 31, ~~2002~~2004 versus May 31, ~~2001.~~2003.

For the year ended May 31,
Increase/
(Dollar amounts in millions)
2002
2001
(Decrease)
Operating income
$
1,187
$
1,388
$
(201
)
Cost of funds
886
1,118
(232
)
   Gross margin
301
270
31
Expenses:
General and administrative expenses
38
32
6
Provision for loan losses
199
105
94
   Total expenses
237
137
100
   Operating margin
64
133
(69
)

Derivative cash settlements
34
-
34
Derivative forward value
42
-
42
Foreign currency adjustments
(61
)
-
(61
)
Cumulative effect of change in accounting principle
28
-
28
   Net margin
$
107
$
133
$
(26
)

TIER
1.09
1.12
Adjusted TIER (1)
1.12
1.12

	For the year ended May 31,						Increase/
(Dollar amounts in millions)	2004			2003			(Decrease)
Operating income	$	1,007		$	1,071		$	(64	)
Cost of funds		(925	)		(940	)		15
Gross margin		82			131			(49	)
Operating expenses:
General and administrative expenses		(41	)		(38	)		(3	)
Provision for loan losses		(55	)		(43	)		(12	)
Recovery of (provision for) guarantee losses		1			(25	)		26
Total operating expenses		(95	)		(106	)		11

Results of operations of foreclosed assets		13			10			3
Impairment gain (loss) on foreclosed assets		(11	)		(20	)		9
Total gain (loss) on foreclosed assets		2			(10	)		12

Derivative cash settlements		110			123			(13	)
Derivative forward value		(229	)		757			(986	)
Foreign currency adjustments		(65	)		(243	)		178
Total (loss) gain on derivative and foreign currency adjustments		(184	)		637			(821	)

Operating (loss) margin		(195	)		652			(847	)
Income tax expense		(3	)		-			(3	)
Minority interest - RTFC and NCSC net margin		(2	)		-			(2	)
Cumulative effect of change in accounting principle		22			-			22
Net (loss) margin	$	(178	)	$	652		$	(830	)

TIER (1)		-			1.69
Adjusted TIER (2)		1.12			1.17


(1) ~~Fiscal~~For the year ~~2002 is adjusted~~ended May 31, 2004, the Company reported a net loss prior to the cumulative effect of change in accounting principle of $200 million, thus the TIER calculation results in a value below 1.00.
(2) Adjusted to exclude the impact of the derivative forward value, ~~and~~ foreign currency adjustments and minority interest from net margin and include the derivative cash settlements in the cost of funds. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of these adjustments.


3727

~~Net~~The following table provides a breakout of the change to operating income, cost of funds and gross margin due to changes in loan volume versus changes to interest rates for the ~~year~~years ended May 31, ~~2002 was $107 million, a decrease of $26 million or 20% compared to the $133 million earned the prior year. Net margin decreased primarily due to an increase in the provision for loan losses~~2004 and ~~expense incurred due to foreign currency adjustments offset by increases due to the adoption of SFAS 133 and the increase in the gross margin spread earned on loans.~~2003.

Volume Rate Variance Table

(Dollar amounts in millions)

	For the years ended May 31,
	2004			2003			Change due to
	Average Loan Balance	Income / (Cost)	Rate	Average Loan Balance	Income / (Cost)	Rate	Volume (1)	Rate (2)	Total
Operating Income
CFC	$ 14,982	$ 673	4.49%	$ 14,876	$ 726	4.88%	$ 5	$ (58)	$ (53)
RTFC	4,809	306	6.37%	4,970	345	6.93%	(11)	(28)	(39)
NCSC	541	28	5.11%	-	-	-	28	-	28
Total	$ 20,332	$ 1,007	4.95%	$ 19,846	$ 1,071	5.40%	$ 22	$ (86)	$ (64)

Cost of Funds
CFC	$ 14,982	$ (607)	(4.06%)	$ 14,876	$ (602)	(4.05%)	$ (4)	$ (1)	$ (5)
RTFC	4,809	(300)	(6.24%)	4,970	(338)	(6.79%)	11	27	38
NCSC	541	(18)	(3.26%)	-	-	-	(18)	-	(18)
Total	$ 20,332	$ (925)	(4.55%)	$ 19,846	$ (940)	(4.74%)	$ (11)	$ 26	$ 15

Gross Margin
CFC	$ 14,982	$ 66	0.44%	$ 14,876	$ 124	0.84%	$ 1	$ (59)	$ (58)
RTFC	4,809	6	0.13%	4,970	7	0.14%	-	(1)	(1)
NCSC	541	10	1.86%	-	-	-	10	-	10
Total	$ 20,332	$ 82	0.40%	$ 19,846	$ 131	0.66%	$ 11	$ (60)	$ (49)

Derivative Cash Settlements (3)
CFC	$16,616	$ 114	0.68%	$14,934	$ 123	0.82%	$ 14	$ (23)	$ (9)
NCSC	83	(4)	(4.38%)	-	-	-	(4)	-	(4)
Total	$ 16,699	$ 110	0.66%	$14,934	$ 123	0.82%	$ 10	$ (23)	$ (13)

Adjusted Cost of Funds
Total	$ 20,332	$ (815)	(4.01%)	$ 19,846	$ (817)	(4.11%)

_____________
(1)	Variance due to volume is calculated using the following formula: ((current average balance - prior year average balance) x prior year rate).
(2)	Variance due to rate is calculated using the following formula: ((current rate - prior year rate) x current average balance).
(3)	For derivative cash settlements, average loan balance represents the average notional amount of derivative contracts outstanding and the rate represents the net difference between the average rate paid and the average rate received for cash settlements during the period.

Operating Income

Operating income for ~~the~~fiscal year ~~ended May 31, 2002 was $1,187 million,~~2004 represented a decrease of ~~$201~~$64 million or 14% compared to the prior year. Operating income decreased due to reductions in interest rates offset by increases in average loan volume. Average loan volume increased by $969 million or 5% to an average loan balance of $19,836 million at May 31, 2002. The average interest rate on the portfolio for the year ended May 31, 2002 was 5.98%, a decrease of 1.38% from the 7.36% for the prior year.

~~Cost of Funds~~

~~The total cost of funding for the year ended May 31, 2002 was $886 million, a decrease of $232 million or 21%~~as compared to the prior year ~~amount of $1,118 million. The cost of funding decreased~~ due to ~~reductions in interest rates~~lower yield on average loans outstanding offset by ~~increases in~~higher average loan ~~volume outstanding and the reclassification~~volume. The average yield on total loans decreased as a result of ~~$34 million representing the amount that CFC pays and receives related~~reductions to the ~~interest rate exchange agreements that do not qualify for special hedge accounting from the cost~~Company's long-term variable and line of funds to a separate line in the combined statement of operations for the year ended May 31, 2002. Prior to the implementation of SFAS 133 on June 1, 2001, this amount was included in the cost of funds. The reduction to the total cost of funding for fiscal year 2002 as compared to fiscal year 2001 was due to the reduction to interest rates in the capital markets offset by an increase in the amount of debt outstanding. CFC's calculated average cost of funding, which includes the cost of funds less the cash settlements divided by the average loan balance, was 4.29% for fiscal year 2002, a decrease from 5.92% for fiscal year 2001.

~~Gross Margin~~

The gross margin earned on loans for fiscal year 2002 was $301 million, an increase of $31 million or 11% over the prior year amount of $270 million. The gross margin earned for fiscal year 2002 including the $34 million of net settlements received on derivatives totaled $335 million. The gross margin of $335 million represents 1.69% of average loan volume for the year, an increase from the 1.44% for the prior year. The reductions in short-term marketcredit interest rates during the year ended May 31, ~~2002 positively affected CFC's~~2004. During the year ended May 31, 2004, the Company reduced its variable interest rates by 65 basis points to 110 basis points, depending on the loan program. The decreases to the Company's interest rates were based on its decision to lower the gross margin yield it was charging its members.

Cost of Funds

The decrease in cost of funds of $15 million for the year ended May 31, 2004 compared to the prior year period was due to a reduction to interest rates in the markets offset by an increase in loan volume as compared to the prior year. Cost of funds for the years ended May 31, 2004 and 2003 includes $9 million and $8 million of expense, respectively, for net cash settlements related to exchange agreements that qualify as effective hedges. The Company's average adjusted cost of funding, which includes derivative cash settlements, for the year ended May 31, 2004 was approximately the same as the prior year. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of these adjustments.

Gross Margin

The gross margin spread earned on loans for the year ended May 31, 2004 decreased ~~faster than~~as a result of the Company's decision to lower interest rates on ~~CFC's loans. Since CFC sets interest~~its loans to members by more than the reduction in the rates atit paid on its debt funding. The adjusted gross margin spread earned on loans for the ~~beginning~~year ended May 31, 2004, which includes derivative cash settlements, was $192 million compared to $254 million for the prior year. See "Non-GAAP Financial Measures" for further explanation of the ~~month~~adjustment the Company makes in its financial analysis to include the derivative cash settlements in its cost of funds, and ~~CFC's rates are not tied to an index, CFC's rate reductions typically lag behind the market. CFC also increased~~therefore gross margin.

By reducing the gross margin ~~spread on~~yield, CFC is effectively giving its ~~loans~~members an immediate return of patronage capital rather than collecting the higher gross margin yield during the year and returning it at year end and in subsequent years. This is consistent with CFC's goal as ~~part of~~a not-for-profit, member-owned, finance cooperative, to provide its members with the ~~plan to increase the amount of equity accumulated and held.~~lowest cost financial services.

~~General and Administrative~~Operating Expenses

General and administrative expenses for ~~fiscal~~the year ~~2002 totaled~~ended May 31, 2004 were $41 million compared to $38 million for the year ended May 31, 2003. General and administrative expenses represented 20 basis points of average loan volume for the year ended May 31, 2004, an increase of one basis point as compared to 19 basis points for the prior year period.

The loan loss provision of $55 million for the year ended May 31, 2004 represented an increase of $12 million from the provision of $43 million for the prior year period. The $55 million provision required for the year ended May 31, 2004 was the result of a $63 million increase to the estimated loan loss allowance at May 31, 2004 versus May 31, 2003, including an increase of $6 million ~~or 19% from~~due to the June 1, 2003 consolidation of NCSC that was recorded as a cumulative change in accounting principle offset by a net recovery of $2 million related to amounts written off in prior ~~year. These expenses~~periods. The $63 million increase to the estimated loan loss allowance for the year ended May 31, 2004 was primarily due to an increase in the amount allocated to impaired loan and high risk exposures. As a result of consolidation, loans outstanding increased due to the ~~write-off~~addition of ~~deferred expenses related~~NCSC loans and the loan loss allowance increased due to the ~~construction~~addition of ~~a third office building and~~ the development of a risk transfer transaction, an increase in legal expenses, salaries, depreciation and amortization and expenses related to CFC's disaster recovery and business resumption plan. During fiscal year 2002, CFC's Board of Directors voted to cancel plans to construct a third building and also determined not to proceed with the risk transfer transaction. The general and administrative expenses for fiscal year 2002 represented 0.19% of averageNCSC loan ~~volume, an increase of 0.02% from the prior year.~~loss allowance.

The Company reported a $1 million recovery in the provision for guarantee losses for the year ended May 31, 2004 representing a decrease of $26 million from the provision of $25 million recorded for the prior year period. The provision of $25 million for the year ended May 31, 2003 was due to a refinement of the process of estimating the guarantee liability to incorporate the improved internal risk rating system, standard corporate bond default tables and the Company's estimated recovery rates. The total guarantee liability at May 31, 2004 has decreased from May 31, 2003 as a result of the consolidation of NCSC. At May 31, 2003, CFC had a total of $476 million of guarantees of NCSC debt obligations. As a result of the June 1, 2003 consolidation of NCSC, the guaranteed debt became debt of the consolidated company, which eliminated the guarantees. At May 31, 2004 and 2003, 97.8% and 99.7%, respectively, of guarantees were from CFC to its electric members.

~~Provision for Loan Losses~~Gain (Loss) on Foreclosed Assets

~~A total provision~~In October and December 2002, the Company received assets as a result of ~~$199~~bankruptcy settlements. The Company records the results of operating these assets as the results of operations of foreclosed assets. The Company recorded net margin of $13 million ~~was added~~from the operation of foreclosed assets for the year ended May 31, 2004 compared to $10 million for the ~~loan~~year ended May 31, 2003. In addition, the Company recognized an impairment loss ~~reserve~~of $11 million to reflect the decrease in the fair value of certain foreclosed assets during the year ended May 31, ~~2002. The $199~~2004 compared to $20 million ~~provision is an increase of $94 million or 90% over the amount added in~~during the prior year. ~~The provision~~It is not management's intent to hold and operate these assets, but to preserve the ~~reserve~~value for ~~fiscal year 2002 represented 1.00%~~sale at the appropriate time. On October 27, 2003, the Company sold the Denton Telecom Partners d/b/a Advantex (telecommunication assets received as part of ~~average loan volume, an increase from 0.56%~~the CoServ bankruptcy settlement) for $31 million in cash. This sale terminates the ~~prior year. The increased loan loss provision was required due to increased specific reserves~~Company's responsibilities for ~~impaired borrowers, high concentration~~all future operations of ~~total exposure to~~ the ~~largest ten borrowers and to market valuations~~telecommunications assets acquired in the ~~telecommunications and electric utility industry.~~bankruptcy settlement with CoServ.

Derivative Cash Settlements

The ~~amounts that CFC pays and receives related~~total cash settlements received in fiscal year 2004 represented a decrease as compared to the ~~interest~~prior year due to a reduction in the net difference between the average rate ~~cross currency~~received and ~~cross currency~~the average rate paid on interest rate exchange agreements, ~~that do not qualify~~offset by an increase in the average notional balance of interest rate exchange agreements outstanding. The Company increased the average amount of exchange agreements outstanding in fiscal year 2004 by approximately 12% as compared to the prior year as part of the funding for ~~special hedge accounting were recorded~~its outstanding loan portfolio.

Derivative Forward Value

During the year ended May 31, 2004, derivative forward value decreased $986 million compared to the prior year period. The decrease in the derivative ~~cash settlements~~forward value is due to changes in the estimate of future interest rates over the remaining life of the derivative contracts. The derivative forward value for the year ended May 31, ~~2002. In fiscal years 2001~~2004 and ~~2000, prior~~2003 also includes amortization of $1 million and $(3) million, respectively, related to the ~~implementation~~long-term debt valuation allowance and $17 million and $22 million, respectively, related to the transition adjustment recorded as an other comprehensive loss on June 1, 2001, the date the Company implemented SFAS 133. These adjustments will be amortized into earnings over the remaining life of ~~SFAS 133,~~ the ~~net settlements for all interest rate, cross currency~~underlying debt and ~~cross currency interest rate exchange agreements were included in the cost of funds.~~related derivative contracts.

38The Company is required to record the fair value of derivatives on its consolidated balance sheets with changes in the fair value of derivatives that do not qualify for hedge accounting recorded in the consolidated and combined statements of operations as a current period gain or loss. This change in fair value is recorded as the derivative forward value on the consolidated and combined

~~Derivative Forward Value and Cumulative Effect~~statements of ~~Change in Accounting Principle~~

~~Related to the adoption of SFAS 133, CFC booked a $28 million gain as a cumulative effect of change in accounting principle on June 1, 2001 and a $42 million gain as a~~operations. The derivative forward value ~~adjustment for subsequent~~does not represent a current period cash inflow or outflow to the Company, but represents the net present value of the estimated future cash settlements, which are based on the estimate of future interest rates over the remaining life of the derivative contract. The expected future interest rates change often, causing significant changes in the recorded fair value of the Company's derivatives and volatility in the reported estimated gain or loss on derivatives in the consolidated and combined statements of operations. Recording the forward value of derivatives results in recording only a portion of the impact on the Company's operations due to future changes in interest rates. Under GAAP, the Company is required to recognize changes in the fair value of its derivatives as a result of expected changes in future interest rates, but there are no provisions for recording changes in the ~~derivatives during~~fair value of its loans as a result of expected changes in future interest rates. As a finance company, the ~~year ended May 31, 2002. Thus,~~Company passes on its cost of funding through interest rates on loans to members. The Company has demonstrated the ~~net impact~~ability to pass on its cost of funding to its members by consistently earning an adjusted TIER in excess of the ~~SFAS 133 adoption on CFC's net margin during this period excluding derivative cash settlements was~~minimum 1.10 target. The Company has earned an ~~increase~~adjusted TIER in excess of ~~$70 million.~~1.10 in every year since 1981. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of adjusted ratios.

Foreign Currency Adjustments

~~For~~The Company's foreign currency adjustment increased $178 million for the year ended May 31, ~~2002, CFC recorded a loss of $61 million related~~2004 as compared to ~~foreign denominated debt that does not qualify for hedge treatment under SFAS 133. The loss recorded is~~the year ended May 31, 2003 due to ~~changes~~the change in currency exchange rates. Changes in the ~~foreign~~ exchange rate between the USU.S. dollar and Euro and the ~~Euro. CFC began fiscal year 2002 with a total of 350 million of Euro denominated debt. That balance increased to 1,350 million Euros at May 31, 2002. At each reporting date, CFC is required to record~~U.S. dollar and Australian dollar will cause the ~~dollar equivalent~~value of the Company's outstanding foreign denominated debt ~~on its combined balance sheet with any change from the prior period reported on the combined statement of operations. At May 31, 2002, a total of 1,000 million Euros was related~~ to hedges that did not qualify for special accounting treatment under SFAS 133, thus the change in the value was recorded on the combined statement of operations. At May 31, 2002, a total of 350 million Euros were related to an effective derivative hedge. For foreign denominated debt with related cross currency exchange agreements that qualify for hedge treatment under SFAS 133, the changefluctuate. An increase in the value of the ~~debt reported in~~Euro or the ~~combined statement of operations is fully offset by~~Australian dollar versus the ~~reclassification of an equal amount of the change in the fair~~ value of the ~~related hedge from accumulated other comprehensive loss, where the change~~U.S. dollar results in an increase in the ~~fair~~recorded U.S. dollar value of ~~the hedge was originally reported. Prior to fiscal year 2002 and the implementation of SFAS 133, CFC was netting all amounts related to the~~ foreign denominated debt and therefore a charge to expense on the ~~related~~consolidated and combined statements of operations, while a decrease in exchange rates results in a reduction in the recorded U.S. dollar value of foreign denominated debt and income. The Company has entered into foreign currency exchange agreements to cover all of the cash flows associated with its foreign denominated debt. Changes in the value of the foreign currency exchange agreement will be approximately offset by changes in the ~~cost~~value of ~~funds~~the outstanding foreign denominated debt.

Operating (Loss) Margin

Operating loss for the year ended May 31, 2004 was $195 million, compared to operating margin of $652 million for the prior year period. The adjusted operating margin, which excludes derivative forward value and foreign currency adjustments, for the year ended May 31, 2004 was $99 million, compared to $138 million for the prior year period. See "Non-GAAP Financial Measures" for further explanation of the adjustment the Company makes in its financial analysis to exclude the derivative forward value and foreign currency adjustments in its adjusted operating margin. The adjusted operating margin decreased due to the $62 million decrease in gross margin adjusted for cash settlements, the $3 million increase to general and administrative expenses and the $12 million increase to the provision for loan losses partially offset by the $26 million decrease to the provision for guarantee losses and the $12 million decrease to the results of operations and impairment loss on foreclosed assets.

Cumulative Effect of Change in Accounting Principle

As a result of the implementation of FIN 46(R) on June 1, 2003, the Company consolidated the financial results of NCSC and RTFC. The Company recorded a cumulative effect of change in accounting principle gain of $22 million on the ~~combined~~consolidated statement of ~~operations. This~~operations for the year ended May 31, 2004, representing a $3 million increase to the loan loss allowance, a $34 million decrease to the guarantee liability and a $9 million loss representing the amount by which cumulative losses of NCSC exceeded NCSC equity.

Net (Loss) Margin

Net loss for the year ended May 31, 2004 was $178 million, a decrease of $830 million compared to a net margin of $652 million for the ~~correct~~prior year period. The net loss for the year ended May 31, 2004 and the significant decrease from the prior year period are primarily due to the $986 million decrease in the estimated fair value of derivatives and the $49 million decrease to gross margin partly offset by the $178 million and $22 million increase in foreign currency adjustments and cumulative effect of change in accounting principle, respectively. The adjusted net margin, which excludes the impact of the derivative forward value, foreign currency adjustments, cumulative effect of change in accounting principle and adds back minority interest was $96 million, compared to $138 million for the prior year period. See "Non-GAAP Financial Measures" for further explanation of the adjustments the Company makes in its financial analysis to ~~SFAS 133 and it represented the actual cost to CFC of both transactions.~~net (loss) margin.

Operating Results as a Percentage of Average Loans Outstanding

The following is a summary of ~~CFC's~~the Company's operating results as a percentage of average loans outstanding for the fiscal years ended May 31, ~~2003, 2002~~2005, 2004 and ~~2001.~~2003.

2003
2002
2001
Operating income
5.40
%
5.98
%
7.36
%
Cost of funds
4.69
%
4.46
%
5.92
%
   Gross margin
0.71
%
1.52
%
1.44
%
General and administrative expenses
0.19
%
0.19
%
0.17
%
Provision for loan losses
0.34
%
1.00
%
0.56
%
   Total expenses
0.53
%
1.19
%
0.73
%
Results of operations of foreclosed assets
-
-
-
Impairment loss on foreclosed assets
(0.10
)%
-
-
   Subtotal foreclosed assets
(0.10
)%
-
-
Operating margin
0.08
%
0.33
%
0.71
%
Derivative cash settlements
0.62
%
0.17
%
-
Derivative forward value
3.81
%
0.21
%
-
Foreign currency adjustments
(1.22
)%
(0.31
)%
-
Cumulative effect of change in accounting principle
-
0.14
%
-
Net margin
3.29
%
0.54
%
0.71
%
Adjusted gross margin (1)
1.33
%
1.69
%
N/A
Adjusted operating margin (1)
0.70
%
0.50
%
N/A

	2005			2004			2003
Operating income		5.17	%		4.95	%		5.40	%
Cost of funds		(4.65	)%		(4.55	)%		(4.74	)%
Gross margin		0.52	%		0.40	%		0.66	%
Operating expenses:
General and administrative		(0.22	)%		(0.20	)%		(0.19	)%
Provision for loan losses		(0.08	)%		(0.27	)%		(0.22	)%
Recovery of (provision for) guarantee losses		0.02	%		-			(0.12	)%
Total operating expenses		(0.28	)%		(0.47	)%		(0.53	)%

Results of operations of foreclosed assets		0.07	%		0.06	%		0.05	%
Impairment loss on foreclosed assets		-			(0.05	)%		(0.10	)%
Total gain (loss) on foreclosed assets		0.07	%		0.01	%		(0.05	)%

Derivative cash settlements		0.32	%		0.54	%		0.62	%
Derivative forward value		0.15	%		(1.12	) %		3.81	%
Foreign currency adjustments		(0.12	) %		(0.32	)%		(1.22	)%
Total gain (loss) on derivative and foreign
currency adjustments		0.35	%		(0.90	)%		3.21	%

Operating margin (loss)		0.66	%		(0.96	)%		3.29	%
Income tax expense		(0.01	)%		(0.02	)%		-
Minority interest - RTFC and NCSC net margin		(0.01	)%		(0.01	)%		-
Cumulative effect of change in accounting principle		-			0.11	%		-
Net margin (loss)		0.64	%		(0.88	)%		3.29	%
Adjusted gross margin (1)		0.84	%		0.94	%		1.28	%
Adjusted operating margin (2)		0.63	%		0.48	%		0.70	%

	___________________________
(1) Adjusted to include derivative cash settlements in the cost of funds. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of these adjustments. (2) Adjusted to exclude derivative forward value and foreign currency adjustments from the operating margin (loss). See "Non-GAAP Financial Measures" for further explanation and a reconciliation of these adjustments.

Liquidity and Capital Resources

Assets

At May 31, ~~2003, CFC~~2005, the Company had ~~$20,974~~$20,046 million in total assets, ~~an increase~~a decrease of ~~$631~~$1,395 million, or 3%7%, from the balance of ~~$20,343~~$21,441 million at May 31, ~~2002.~~2004. Net loans outstanding to members totaled ~~$18,919~~$18,382 million at May 31, ~~2003,~~2005, a decrease of ~~$621~~$1,533 million compared to a total of ~~$19,540~~$19,915 million at May 31, ~~2002.~~2004. Net loans represented ~~90%~~92% and ~~96%~~93% of total assets at May 31, ~~2003~~2005 and ~~May 31, 2002,~~2004, respectively. The remaining assets, ~~$2,055~~$1,664 million and ~~$803~~$1,526 million at May 31, ~~2003~~2005 and ~~May 31, 2002,~~2004, respectively, consisted of other assets to support ~~CFC's~~the Company's operations, primarily cash and cash equivalents, derivative assets and foreclosed assets. Included in assets at May 31, ~~2003~~2005 and ~~May 31, 2002~~2004 is ~~$1,160~~$585 million and ~~$193~~$577 million, respectively, of derivative ~~assets representing the fair market value of its derivatives. Derivative assets increased by $967 million due to the decreasing interest rate environment.~~assets. Foreclosed assets of ~~$336~~$141 million and $248 million at May 31, ~~2003~~2005 and 2004, respectively, relate to assets received from borrowers as part of a bankruptcy ~~settlement. Unless~~and/or loan settlements. Foreclosed assets decreased by $107 million due to principal payments on the real estate note portfolio. Other than excess cash is invested overnight, ~~CFC~~the Company does not generally use funds to invest in debt or equity securities.

Loans to Members

Net loan balances decreased by ~~$621~~$1,533 million, or 3%8%, from May 31, ~~2002~~2004 to May 31, ~~2003.~~2005. Gross loans decreased by ~~a total of $563~~$1,517 million, and the allowance for loan losses increased by ~~$58~~$16 million, compared to the prior ~~year.~~year end. As a percentage of the portfolio, long-term loans represented 95% and 94% ~~at May 31, 2003~~ (including secured long-term loans classified as restructured and ~~nonperforming), compared to 93%~~non-performing) at May 31, ~~2002.~~2005 and 2004, respectively. The remaining 6%5% and 7%6% at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively, consisted of secured and unsecured intermediate-term and line of credit loans.

Long-term fixed rate loans represented ~~68% and 60%~~72% of the total long-term loans at May 31, ~~2003~~2005 and ~~2002, respectively.~~2004. Loans converting from a variable rate to a fixed rate for the year ended May 31, ~~2003~~2005 totaled ~~$1,747~~$690 million, a decrease from the ~~$2,179~~$1,916 million that converted during the year ended May 31, ~~2002.~~2004. Offsetting the conversions to the fixed rate were ~~$533~~$700 million and ~~$363~~$1,218 million of loans that converted from ~~the~~a fixed rate to ~~the~~a variable rate for the years ended May 31, ~~2003~~2005 and ~~2002,~~2004, respectively. This resulted in a net conversion of ~~$1,214~~$10 million from a fixed rate to a variable rate for the year ended May 31, 2005 compared to a net conversion of $698 million from a variable rate to a fixed rate for the year ended May 31, ~~2003 compared to a net conversion of $1,816 million for the year ended May 31, 2002.~~2004. Approximately ~~64%~~68% or ~~$12,426~~$12,936 million of total loans carried a fixed rate of interest at May 31, ~~2003~~2005 compared to ~~56%~~68% or $13,840 million at May 31, ~~2002.~~2004. All other loans, including ~~$5,867~~$6,036 million and ~~$7,320~~$6,649 million in ~~long-term~~ loans at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively, are subject to interest rate adjustment monthly or semi-monthly.

The decrease in total ~~gross~~ loans outstanding at May 31, ~~2003~~2005 as compared to May 31, 2004 was due primarily ~~due~~ to aprepayments of RTFC loans. The $1,517 million decrease in loans includes decreases of $391 million related to the repayment of nonperforming loans with cash received by CFC and foreclosed assets received by entities controlled by CFC as part of loan settlements, predominantly with CoServ. Additionally, intermediate-term loans decreased $132 million and short-term loans decreased $121 million offset by increases of $57$1,792 million in long-term loans, $45 million in intermediate-term loans, $17 million in restructured loans and ~~$24~~$5 million in RUS guaranteed loans offset by an increase of $275 million in non-performing loans and $67 million in short-term loans. ~~During fiscal year 2003, long-term electric advances totaled $1,306~~RTFC and NCSC loans outstanding decreased $1,651 million and ~~telephone advances totaled $192~~$15 million, respectively, offset by the increase in CFC loans outstanding of $149 million. The ~~electric long-term advances included $36~~increase to CFC loans includes increases of $192 million ~~for the purpose~~to distribution systems and $1 million to service members and associates offset by a decrease of ~~repaying RUS loans, $1,231~~$44 million ~~under the 100% and~~to power ~~vision programs, $11 million under the RUS concurrent loan program and $28 million under the RUS guaranteed loan program.~~supply systems.

Loan and Guarantee Portfolio Assessment

Portfolio Diversity

~~CFC~~The Company provides credit products (loans, financial guarantees and letters of credit) to its members. The ~~combined~~Company's memberships include rural electric distribution systems, rural electric power supply systems, telecommunication systems, statewide rural electric and telecommunication ~~associations~~organizations and ~~associate organizations.~~associated affiliates.

The following chart summarizes loans and guarantees outstanding by ~~member class~~segment at May 31, ~~2003, 2002~~2005, 2004 and ~~2001.~~2003.

(Dollar amounts in millions)
Loans and Guarantees by Member Class

2003
2002
2001
Electric systems:
Distribution
$
11,488
54%
$
11,933
54%
$
11,599
53%
Power supply
3,922
18%
3,928
18%
3,686
17%
Statewide and associate
1,030
5%
1,162
5%
1,291
6%
Subtotal electric systems
16,440
77%
17,023
77%
16,576
76%
Telecommunication systems
4,948
23%
5,080
23%
5,326
24%
Total
$
21,388
100%
$
22,103
100%
$
21,902
100%

	Loans and Guarantees by Member Class
(Dollar amounts in millions)	2005			2004			2003
CFC:
Distribution	$	12,771	64%	$	12,597	58%	$	11,488	54%
Power supply		3,707	18%		3,815	18%		3,922	18%
Statewide and associate		177	1%		246	1%		1,030	5%
CFC Total		16,655	83%		16,658	77%		16,440	77%
RTFC		2,992	15%		4,643	21%		4,948	23%
NCSC		483	2%		519	2%		-	-
Total	$	20,130	100%	$	21,820	100%	$	21,388	100%

~~CFC's~~The following table summarizes the RTFC segment loans and guarantees outstanding as of May 31, 2005, 2004 and 2003.

(Dollar amounts in millions)	2005			2004			2003
Rural local exchange carriers	$	2,358	79%	$	3,615	78%	$	3,831	77%
Wireless providers		211	7%		267	6%		335	7%
Cable television providers		169	6%		176	4%		185	4%
Long distance carriers		135	5%		340	7%		324	7%
Fiber optic network providers		67	2%		168	4%		191	4%
Competitive local exchange carriers		45	1%		62	1%		64	1%
Other		7	-		15	-		18	-
Total	$	2,992	100%	$	4,643	100%	$	4,948	100%

The Company's members are widely dispersed throughout the United States and its territories, including 49 states, the District of Columbia, American Samoa, Guam and the U.S. Virgin Islands. At May 31, 2005, 2004 and 2003, ~~2002~~loans and ~~2001, no~~guarantees outstanding to members in any one state or territory ~~had over~~did not exceed 16%, 17%~~, 20%~~ and ~~19%~~17%, respectively, of total loans and guarantees outstanding.

Credit Concentration

The Company's loan portfolio is widely dispersed throughout the United States and its territories, including 49 states, the District of Columbia, American Samoa and the U.S. Virgin Islands. At May 31, 2005 and 2004, loans outstanding to borrowers in any state or territory did not exceed 16% of total loans outstanding. In addition to the geographic diversity of the portfolio, ~~CFC~~the Company limits its exposure to any one borrower. At May 31, ~~2003,~~2005 and 2004, the total exposure outstanding to any one borrower or controlled group did not exceed ~~3.4%~~3.0% of total loans and guarantees ~~outstanding compared to 4.6% at May 31, 2002.~~outstanding. At May 31, 2003, CFC had $4,768 million in loans outstanding and $610 million in guarantees outstanding to its ten largest borrowers compared to $5,192 million in loans and $701 million in guarantees for the prior year. The amounts outstanding to2005, the ten largest borrowers ~~at May 31, 2003 represented 24% of total loans outstanding~~included four distribution systems, three power supply systems and 32% of total guarantees outstanding compared to 26% of total loans outstanding and 34% of total guarantees outstanding for the prior year. Total credit exposure to the ten largest borrowers was $5,378 million and $5,893 million and represented 25% and 27%, respectively, of total credit exposure at May 31, 2003 and 2002, respectively.three telecommunications systems. At May 31, ~~2003 and 2002,~~2004, the ten largest borrowers included two distribution systems, ~~two~~three power supply systems ~~one service organization~~ and five telecommunications systems. At May 31, 2005 and 2004, the Company had the following amounts outstanding to its ten largest borrowers:

(Dollar amounts in millions)		2005	% of Total		2004	% of Total
Loans	$	3,412	18%	$	4,415	22%
Guarantees		227	20%		240	18%
Total credit exposure	$	3,639	18%	$	4,655	21%

32

Credit Limitation

~~In July 2002, CFC's Board~~CFC, RTFC and NCSC each have policies that limit the amount of ~~Directors approved a new~~ credit ~~limitation policy. The new policy sets the limit on CFC's total exposure and unsecured exposure~~that can be extended to ~~the~~borrowers. All three policies establish an amount of credit that may be extended to each borrower based on ~~CFC's assessment~~the Company's internal risk rating system. The level of ~~its~~credit that may be extended is the same at CFC and RTFC. The amount of credit for each level of risk ~~profile.~~rating in the NCSC policy is significantly lower due to the difference in the size of NCSC's balance sheet versus the balance sheets of CFC and RTFC and the types of businesses to which NCSC lends. The ~~new policy limits are more restrictive than the prior policy. The Board~~board of ~~Directors~~directors must approve new loan requests from a borrower with a total exposure or unsecured exposure in excess of the limits in the policy.

~~Total exposure, as defined by the policy, includes the following:~~
*	~~loans outstanding, excluding loans guaranteed by RUS,~~
*	~~CFC guarantees of~~For the ~~borrower's obligations,~~
*	~~unadvanced loan commitments, and~~
*	~~borrower guarantees to CFC of another member's debt.~~

~~During the period from the adoption of the policy to~~year ended May 31, ~~2003, CFC's Board~~2005, the board of ~~Directors~~directors approved new loan and guarantee facilities totaling ~~approximately $1 billion~~$1,321 million to 1621 borrowers that had a total or unsecured exposure in excess of the limits set forth in the credit limitation policy. ~~Loans~~CFC approved new loan facilities totaling ~~$640~~$1,074 million to ten borrowers, RTFC approved new loan facilities totaling $157 million to three borrowers and NCSC approved new loan facilities totaling $90 million to eight borrowers in excess of the established credit limits. Of the $1,321 million in loans approved during the year ended May 31, 2005, $321 million were refinancings or renewals of existing ~~loans. Loans approved for three of these borrowers totaling $235~~loans and $611 million were bridge loans that must be paid off once the ~~borrowers obtain~~borrower obtains long-term financing from RUS.

The Company's credit limitation policy sets the limit on the total exposure and unsecured exposure to the borrower based on an assessment of the borrower's risk profile.

Total exposure, as defined by the policy, includes the following:

*	loans outstanding, excluding loans guaranteed by RUS,
*	the Company's guarantees of the borrower's obligations,
*	unadvanced loan commitments, and
*	borrower guarantees to the Company of another borrower's debt.

Security Provisions

Except when providing lines of credit and intermediate-term loans, ~~CFC~~the Company typically lends to its members on a senior secured basis. At May 31, 2003, a total of $1,696 million of loans were unsecured representing 9% of total loans. Approximately $233 million or 14% of the unsecured loans represent obligations of distribution borrowers for the initial phase(s) of RUS note buyouts. Upon completion of a borrower's buyout from RUS, CFC receives first lien security on all assets and revenues. The unsecured loans would represent 8% of total loans if these partial note buyout obligations were excluded. CFC's long-termLong-term loans are typically secured on a parity with other secured lenders (primarily RUS), if any, by all assets and revenues of the borrower with exceptions typical in utility mortgages. Short-term loans are generally unsecured lines of credit. ~~At May 31, 2003, a total of $94 million of guarantee reimbursement obligations were unsecured, representing 5% of total guarantees.~~ Guarantee reimbursement obligations are typically secured on a parity with other secured creditors by all assets and revenues of the borrower or by the underlying financed asset. ~~At May 31, 2003, CFC had a total of $1,790 million of~~In addition to the collateral received, borrowers are also required to set rates designed to achieve certain financial ratios. The Company's unsecured loans and guarantees ~~representing 8% of total loans and guarantees. At~~outstanding at May 31, ~~2002, CFC had a total of $1,801 million of unsecured loans~~2005 and ~~guarantees, representing 8% of total loans and guarantees.~~2004 are summarized below.

		2005	% of Total		2004	% of Total
Loans	$	1,516	8%	$	1,439	7%
Guarantees		98	8%		122	9%
Total credit exposure	$	1,614	8%	$	1,561	7%

Portfolio Quality

A total of 64% of the Company's total outstanding credit exposure at May 31, 2005 was to distribution systems. The distribution systems own the power lines and substations that are required to deliver electricity to consumers, both residential customers and business enterprises. Due to the significant capital investment, it is very unlikely that a competing electric company would build the infrastructure required to deliver power to the customers of CFC's distribution system members. In states where CFC's distribution systems may be required to provide access to their lines for other electric companies to deliver electricity, the distribution system will still be allowed to recover the cost of maintaining its system through the rates charged for use of the system by other power companies.

A total of 18% of the Company's total outstanding credit exposure at May 31, 2005 was to power supply systems. Most CFC power supply borrowers sell the majority of their power under all-requirements power contracts to their member distribution systems. These contracts allow, subject to regulatory requirements and competitive constraints, for the recovery of all costs at the power supply level. Due to the contractual connection between the power supply and distribution systems, total combined system equity (power supply equity plus the equity at its affiliated distribution systems) has typically been maintained at the distribution level.

As with CFC, to the extent distribution systems can fund their assets with retained members' equity (i.e., unretired capital credits), overall funding costs for plant and equipment are reduced. Distribution systems can, in turn, pass these savings on to their member/consumers in the form of lower utility rates.

The effectiveness of the all-requirements power contract is dependent on the individual systems' right and ability (legal as well as economic) to establish rates to cover all costs. The boards of directors of most of CFC's power supply and distribution members have the authority to establish ~~binding~~ rates for their consumer members subject to state and federal regulations, as applicable. Some states regulate rate setting and can therefore override the system's internal rate-setting procedures.

~~For financial information on CFC's members, see pages 15 to 20.~~33

A total of 12% of the Company's total outstanding credit exposure at May 31, 2005 was to rural local exchange carriers. Even with widespread competition in the telecommunications industry, there is very little competition in the territory served by the Company's rural local exchange borrowers. The customers in these areas are primarily residential and small businesses, which have not been the focus of competition among exchange carriers.

~~Nonperforming and Restructured~~Non-performing Loans
~~CFC classifies a~~A borrower is classified as ~~nonperforming~~non-performing when any one of the following criteria are met:

*	principal or interest payments on any loan to the borrower are past due 90 days or more,
*	as a result of court proceedings, repayment on the original terms is not anticipated, or
*	for some other reason, management does not expect the timely repayment of principal and interest.


41

Once a borrower is classified as ~~nonperforming,~~non-performing, interest on its loans is generally recognized on a cash basis. When a loan is placed on non-accrual status, CFC typically reverses all accrued and unpaid interest back to the date of the last payment. Alternatively, ~~CFC~~the Company may choose to apply all cash received to the reduction of principal, thereby foregoing interest income recognition. At May 31, ~~2003, CFC~~2005 and 2004, the Company had nonon-performing loans outstanding in the amount of $617 million and $341 million, respectively. All loans classified as nonperforming. At May 31, 2002, CFC had $1,011 million of loans classified as nonperforming. Of the nonperforming loans at May 31, 2002, $1,003 million was to CoServ. During the years ended May 31, 2003 and 2002, all loans classified as nonperformingnon-performing were on a non-accrual status with respect to the recognition of interest income.

At May 31, ~~2003~~2005, non-performing loans included $479 million to Innovative Communication Corporation ("ICC"). ICC is a diversified telecommunications company and ~~2002, CFC had a~~RTFC borrower headquartered in St. Croix, USVI. Through its subsidiaries, ICC provides wireline local telephone service, long-distance telephone services, cable television service and/or wireless telephone service. A total of ~~$628~~$553 million ~~and $1,003 million, respectively, in loans outstanding to CoServ. At May 31, 2002, all~~of loans to ~~CoServ~~ICC were classified as nonperforming as CoServ was in default under its loan agreements with CFC. Upon CoServ's emergence from bankruptcy on December 13, 2002, CFC reclassified the outstanding loan to CoServ from nonperforming to restructured and in the near term will maintain the restructured CoServ loan on non-accrual status. Total loans to CoServperforming at May 31, ~~2003 and 2002 represented 2.9% and 4.5%, respectively, of CFC's total loans and guarantees outstanding.~~2004.

InOn June ~~2002, CoServ~~1, 2004, RTFC filed a lawsuit in the United States District Court for the Eastern District of Virginia against ICC for failure to comply with the terms of its loan agreement with RTFC, under which RTFC is demanding the full repayment of ICC's total outstanding debt, including all principal, interest and ~~CFC~~fees. ICC has answered the complaint, denied that it is in default of the loan agreement, and asserted a counterclaim seeking the reformation of the loan agreement to conform to a 1989 settlement agreement among the Virgin Islands Public Services Commission, ICC's predecessor, and RTFC, in a manner that ICC contended would relieve it of some of the defaults alleged in the amended complaint. By an order dated October 19, 2004, the Court granted ICC's motion to transfer the loan default and guarantee actions to the District of the Virgin Islands.

ICC had been making the regular monthly debt service payments to RTFC in accordance with a stipulation agreement between the companies under which ICC may make the payments and RTFC may accept the payments without prejudice to either party's rights, defenses or claims in the pending litigation. However, ICC did not make the January 31, 2005 debt service payment and did not make the required payment for a secured line of credit that matured on March 20, 2005. As a result of the payment defaults, RTFC classified all loans to ICC as non-performing and placed all loans on non-accrual status as of February 1, 2005. On March 31, 2005, ICC made a partial payment toward its outstanding loan balance with RTFC.

RTFC is the primary secured lender to ICC. RTFC's collateral for the loans includes (i) a series of mortgages, security agreements, financing statements, pledges and guaranties creating liens in favor of RTFC on substantially all of the assets and voting stock of ICC, (ii) a direct pledge of 100% of the voting stock of ICC's USVI local exchange carrier subsidiary, Virgin Islands Telephone Corporation d/b/a Innovative Telephone ("Vitelco"), (iii) secured guaranties, mortgages and direct and indirect stock pledges encumbering the assets and ownership interests in substantially all of ICC's other operating subsidiaries, and (iv) a personal guaranty of the loans from ICC's indirect majority shareholder and chairman.

Based on its analysis, the Company believes that it is adequately reserved for its exposure to ICC at May 31, 2005.

Non-performing loans at May 31, 2005 and 2004 include a total of $135 million and $340 million, respectively, to VarTec Telecom, Inc. ("VarTec"). The loan balance at May 31, 2004 was reduced during fiscal year 2005 by $119 million in payments, $34 million for offsets of allocated but unretired patronage capital and subordinated capital certificates and $52 million in asset sales. On May 31, 2004, loans to VarTec were reclassified to non-performing and put on non-accrual status as of June 1, 2004 resulting in the application of all payments received against principal.

VarTec is a telecommunications company and RTFC borrower located in Dallas, Texas. RTFC is VarTec's principal senior secured creditor. VarTec and its U.S.-based affiliates filed ~~joint plans~~voluntary petitions under Chapter 11 of ~~liquidation~~the United States Bankruptcy Code on November 1, 2004 in Dallas, Texas. VarTec is continuing operations pending completion of sales of its remaining operating assets.

RTFC on a daily basis for ~~each~~application first to the DIP financing and then to other RTFC secured debt. As of ~~CoServ's three business segments: real estate lending, telecommunications~~January 12, 2005, the bankruptcy court approved the financing on a final basis and ~~electric distribution cooperative.~~reserved claims against RTFC and challenges to RTFC's liens until a later date. The ~~real estate plan became effective~~deadline for filing such claims was July 6, 2005. On June 10, 2005, the Official Committee of Unsecured Creditors (the "UCC") initiated an adversary proceeding in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. No other party had filed such a claim by expiration of the deadline. The adversary proceeding asserts the following claims: (i) that RTFC may have engaged in wrongful activities prior to the filing of the bankruptcy proceeding (e.g., RTFC had "control" over VarTec's affairs, RTFC exerted "financial leverage" over VarTec and is liable for VarTec's "deepening insolvency"); (ii) that RTFC's claims against VarTec should be equitably subordinated to the claims of other creditors because of the alleged wrongful activities; and (iii) that certain payments made by VarTec to RTFC and certain liens granted to RTFC are avoidable as preferences or fraudulent transfers or should otherwise be avoided and re-distributed for the benefit of VarTec's bankruptcy estates. The adversary proceeding identifies payments made by VarTec to RTFC of approximately $141 million, but does not specify damages sought. On August 5, 2005, RTFC filed an answer and a motion to dismiss the deepening insolvency claim.

On December 17, 2004, VarTec sold its European operations, and on ~~October 11, 2002. On that date, CoServ transferred~~March 21, 2005, the ~~real estate developer notes receivable, limited partnership interests in~~court approved the sale of certain real estate ~~developments~~in Addison, Texas, and ~~partnership interests~~miscellaneous personal property. On May 5, 2005, VarTec sold its Canadian operations. On July 29, 2005, the court approved a sale of VarTec's remaining operating assets (the "Domestic Assets Sale"). In August 2005, RTFC received $32 million representing partial payment of proceeds from the Domestic Assets Sale. Final closing of the Domestic Assets Sale is subject to government approvals; in the real estate properties to entities controlled by CFC. The loan balance to CoServ was reduced by the fair value of the real estate assets received totaling $325 million and $27 million in cash. On December 13, 2002, CoServ emerged from bankruptcy and the electric plan and telecom plan became effective. On that date, CoServ transferred the telecommunications assets to entities controlled by CFC. The loan balance to CoServ was reduced by $39 million, the fair value of the telecommunications assets received less estimated costs to sell. CFC is accounting for the real estate and telecommunications assets received as foreclosed assets. CoServinterim VarTec will continue to operate ~~as an electric distribution utility~~its business.

As part of the court order approving the DIP financing, VarTec was allowed to continue to make interest payments on the secured RTFC debt and to make principal payments during periods in which no amount was outstanding under the DIP financing. However pursuant to the terms of the Domestic Assets Sale, pending final closing of such sale, such payments will cease. Under the terms of the Domestic Assets Sale, the asset purchaser has reimbursed RTFC for the current amount outstanding under the DIP facility. In addition, the asset purchaser will be required to ~~make quarterly payments~~provide RTFC with funding for all future advances under the DIP facility. RTFC does not anticipate advancing any additional funds under the existing DIP facility. RTFC may have to ~~CFC over the next 35 years. Under the electric plan, CFC may be obligated~~put in place and advance additional funds under an administrative DIP facility to ~~provide up to $200 million of senior secured capital expenditure loans to CoServ over the next 10 years. If CoServ requests capital expenditure loans from CFC, the loans will~~ be approved ~~with~~by the ~~same standard terms~~bankruptcy court.

The court has also ordered that ~~are offered~~all net proceeds of such sales, including the Domestic Assets Sale, be provisionally applied to ~~all electric distribution members.~~RTFC's secured long-term debt. The application is subject to third parties' rights, if any, superior to RTFC's rights and liens, and to further court order to require the return of such funds for use as cash collateral under the Bankruptcy Code.

Based on its analysis, the Company believes that it is adequately reserved against its exposure to VarTec at May 31, 2005.

Restructured Loans

Loans classified as restructured are loans for which agreements have been executed that changed the original terms of the loan, generally a change to the originally scheduled cash flows. ~~At May 31, 2003~~The Company will make a determination on each restructured loan with regard to the accrual of interest income on the loan. The initial decision is based on the terms of the restructure agreement and ~~2002,~~the anticipated performance of the borrower over the term of the agreement. The Company will periodically review the decision to accrue or not to accrue interest income on restructured loans ~~totaled $629 million~~based on the borrower's past performance and ~~$540 million, respectively. Of the restructured loans at May 31, 2003, $628 million was to CoServ, as discussed above. Of the restructured loans at May 31, 2002, $534 million was to Deseret.~~current financial condition.

~~In February 2003, CFC reclassified the $536~~At May 31, 2005 and 2004, restructured loans totaled $601 million and $618 million, respectively, $594 million and $618 million, respectively, of which related to loans ~~then~~ outstanding to ~~Deseret from restructured~~Denton County Electric Cooperative, Inc. d/b/a CoServ Electric ("CoServ"). All CoServ loans have been on non-accrual status since January 1, 2001. Total loans to ~~performing based on Desert's performance to~~CoServ at May 31, 2005 and 2004 represented 2.9% and 2.8% of the Company's total loans and guarantees outstanding, respectively.

To date, ~~and expected future performance~~CoServ has made all required payments under the ~~restructure~~restructured loan. Under the agreement, ~~signed in October 1996. As of May 31, 2003, a total of $529 million of loans were outstanding to Deseret under the restructure agreement signed in October 1996. Under this agreement, Deseret is~~CoServ will be required to make quarterly payments to CFC through ~~2025. In~~2037. Under the agreement, CFC may be obligated to provide up to $200 million of senior secured capital expenditure loans to CoServ for electric distribution infrastructure through 2012. If CoServ requests capital expenditure loans from CFC, these loans will be provided at the standard terms offered to all borrowers and will require debt service payments in addition ~~on an annual basis, CFC receives 80% of~~to the ~~excess cash generated by Deseret during the calendar year (excess cash is calculated based on a formula in the restructure agreement). Deseret has made all minimum~~quarterly payments ~~as required and has made excess cash payments~~that CoServ will make to CFC totaling $134 million or approximately $22 million per year. From January 1, 2001 to February 28, 2003, CFC accrued interest on the Deseret restructured loan at a rate of 7%. On February 28, 2003, when CFC reclassified Deseret's restructured loan to performing, CFC reduced the accrual rate to 5%. CFC keeps 75% of excess cash payments it receives from Deseret to apply against accrued interest and reduce the principal balance. The remaining 25% is applied against the loans made to Deseret member distribution systems to finance their purchase of a participation in the CFC loan to Deseret until paid in full. Once a participation loan has been repaid, CFC retains that portion of the excess payment to apply against the Deseret loan. CFC received excess cash flow totaling $10 million from Deseret during fiscal year 2003.under its restructure agreement. As of May 31, ~~2003, CFC~~2005, no amounts have been advanced to CoServ under this loan facility. Under the terms of the restructure agreement, CoServ has ~~no net write-off on its loans~~the option to ~~Deseret. If CFC had known that Deseret was going to generate excess cash flow~~prepay the restructured loan for $415 million plus an interest payment true up after December 13, 2007 and ~~make payments to CFC as it has done since 1996, CFC would not have accounted~~ for ~~the Deseret restructuring as a troubled debt restructuring.~~$405 million plus an interest payment true up after December 13, 2008.

Loan Impairment

On a quarterly basis, ~~CFC~~the Company reviews all ~~nonperforming~~non-performing and restructured borrowers, as well as some additional borrowers, to determine if the loans to the borrower are impaired and/or to update the impairment calculation. ~~CFC~~The Company calculates an impairment for a borrower based on the expected future cash flow or the fair value of any collateral held by ~~CFC~~the Company as

security for ~~loan(s)~~loans to the borrower. In some cases, to estimate future cash flow, ~~CFC is required to make~~ certain assumptions are required regarding, but not limited to, the following:

*	~~changes to~~ interest rates,
*	court rulings,

*	changes in collateral values,
*	changes in economic conditions in the area in which the cooperative operates, and
*	changes to the industry in which the cooperative operates.

As events related to the borrower take place and economic conditions and ~~CFC's~~the Company's assumptions change, the impairment calculations will change. ~~CFC adjusts the amount of its~~The loan loss allowance specifically reserved to cover the calculated impairments is adjusted on a quarterly basis based on the most current information available. At May 31, ~~2003~~2005 and ~~2002,~~2004, CFC had impaired loans totaling $1,208 million and $959 million, respectively. At May 31, 2005 and 2004, CFC had specifically reserved a total of ~~$164~~$404 million and ~~$202~~$233 million, respectively, to cover impaired loans.

~~Based on its analysis, CFC believes that it is adequately reserved against loss on its restructured and nonperforming loans.~~

~~NONPERFORMING AND RESTRUCTURED LOANS~~

As of May 31,
(Dollar amounts in millions)
2003
2002
2001
Nonperforming loans
$
-
$
1,011
$
1
Percent of loans and guarantees outstanding
0.00%
4.57%
0.00%

Restructured loans
$
629
$
540
$
1,465
Percent of loans and guarantees outstanding
2.94%
2.44%
6.69%

Total nonperforming and restructured loans
$
629
$
1,551
$
1,466
Percent of loans and guarantees outstanding
2.94%
7.02%
6.69%

NON-PERFORMING AND RESTRUCTURED LOANS

(Dollar amounts in millions)	As of May 31,
	2005		2004		2003
Non-performing loans	$	617	$	341	$	-
Percent of loans outstanding		3.25%		1.66%		0.00%
Percent of loans and guarantees outstanding		3.06%		1.57%		0.00%

Restructured loans	$	601	$	618	$	629
Percent of loans outstanding		3.17%		3.02%		3.23%
Percent of loans and guarantees outstanding		2.99%		2.83%		2.94%

Total non-performing and restructured loans	$	1,218	$	959	$	629
Percent of loans outstanding		6.42%		4.68%		3.23%
Percent of loans and guarantees outstanding		6.05%		4.40%		2.94%

Allowance for Loan Losses

~~CFC~~The Company maintains an allowance for probable loan losses, which is periodically reviewed by management for adequacy. In performing this assessment, management considers various factors including an analysis of the financial strength of ~~CFC's~~ borrowers, delinquencies, loan charge-off history, underlying collateral, and the effect of economic and industry conditions on its borrowers.

~~During~~The corporate credit committee makes recommendations to the ~~year ended May 31, 2003, CFC wrote~~boards of directors regarding write-offs of loan balances. In making its recommendation to write off all or a ~~total~~portion of ~~$11 million in loans to 5 borrowers~~a loan balance, the corporate credit committee considers various factors including cash flow analysis and ~~recovered $1 million of amounts previously written off. During~~ the ~~year ended May 31, 2002, CFC wrote off a total of $34 million in loans to four borrowers and recovered a total of $10 million of amounts previously written off.~~

collateral securing the borrower's loans. Since inception in 1969, CFC has recorded ~~charge-offs~~write-offs totaling ~~$145~~$147 million and recoveries totaling ~~$29~~$32 million for a net loan loss amount of ~~$116~~$115 million. In the past five fiscal years, CFC has recorded ~~charge-offs~~write-offs totaling ~~$110~~$50 million and recoveries totaling ~~$24~~$15 million for a net loan loss of ~~$86~~$35 million.

Management believes that the allowance for loan losses is adequate to cover estimated probable portfolio losses. The following chart presents a summary of the allowance for loan losses at May 31, ~~2003, 2002~~2005, 2004 and ~~2001.~~2003.

(Dollar amounts in millions)	2005				2004				2003
Beginning balance	$	574			$	511			$	478
Provision for loan losses		16				55				43
Change in allowance due to consolidation (1)		-				6				-
Net recoveries (write-offs)		-				2				(10	)
Ending balance	$	590			$	574			$	511

Loan loss allowance by segment:
CFC	$	589			$	572			$	511
NCSC		1				2				-
Total	$	590			$	574			$	511

As a percentage of total loans outstanding	3.11		%		2.80		%		2.62		%
As a percentage of total non-performing loans outstanding	95.62		%		168.33		%		-
As a percentage of total restructured loans outstanding	98.17		%	92.88			%	81.24			%
_________________________________________

(1) Represents the impact of consolidating NCSC including the increase to CFC's loan loss allowance recorded as a cumulative effect of change in accounting principle and the balance of NCSC's loan loss allowance on June 1, 2003.

(Dollar amounts in millions)
2003
2002
2001
Beginning balance
$
507
$
332
$
228
Provision for loan losses
68
199
105
Charge-offs, net
(10
)
(24
)
(1
)
Ending balance
$
565
$
507
$
332

As a percentage of total loans outstanding
2.90%
2.53%
1.69%
As a percentage of total loans and guarantees outstanding
2.64%
2.29%
1.52%
As a percentage of total nonperforming and restructured loans outstanding
89.78%
32.69%
22.65%

CFC has agreed to indemnify RTFC and NCSC for loan losses, with the exception of the NCSC consumer loans that are covered by the NCSC loan loss allowance. Therefore, there is no loan loss allowance required at RTFC and only a small loan loss allowance is required at NCSC to cover the exposure to consumer loans.

~~CFC made~~There was an increase of $16 million to the ~~large~~balance of the Company's loan loss allowance at May 31, 2005 compared to May 31, 2004. The increase to CFC's loan loss allowance at May 31, 2005 as compared to the prior year was due to an increase in the calculated impairments of $171 million offset by a decrease of $97 million for high-risk loans and a reduction of $58 million to the allowance for all other loans. The increase to the ~~reserve~~calculated impairments was due to both an increase in ~~fiscal year 2002 to provide for larger specific reserves on~~the principal balance of loans classified as impaired ~~loans~~ and to ~~reflect its concentration of credit~~an increase in the ~~ten largest borrowers and~~variable interest rates at May 31, 2005 as compared to the ~~market valuation~~prior year. The decrease to the allowance for high-risk loans was due to a decrease in the principal balance of ~~utility and telecommunications assets.~~loans classified as high risk. The reduction to the allowance for all other loans was due to a significant reduction in the balance of loans outstanding at May 31, 2005 as compared to the prior year.

The balance of NCSC's loan loss allowance at May 31, 2005 represented a decrease of $1 million compared to May 31, 2004 due to a decrease in the principal balance of NCSC consumer loans.

Liabilities, Minority Interest and Equity

Liabilities, minority interest and equity totaled $20,046 million at May 31, 2005, a decrease of $1,395 million or 7% from the balance of $21,441 million at May 31, 2004. CFC obtains funding in the capital markets through the issuance of commercial paper, medium-term notes, collateral trust bonds and subordinated deferrable debt which make up a large portion of the liabilities on the ~~combined~~consolidated balance ~~sheet. The increase to total~~sheets.

Liabilities

Total liabilities ~~and equity~~ at May 31, ~~2003~~2005, were $19,259 million, a decrease of $1,465 million from $20,724 million at May 31, 2004. The decrease to liabilities was due to ~~a $1,145 million increase~~decreases in long-term debt ~~a $602~~of $2,957 million, ~~increase to equity, a $103~~subordinated certificates of $174 million, ~~increase in~~ derivative liabilities ~~a $50~~of $51 million, ~~increase~~accrued interest payable of $18 million, deferred income of $13 million and guarantee liability of $3 million offset by increases of $1,612 million in short-term debt, $135 million in subordinated deferrable debt ~~a $16~~and $4 million ~~increase~~ in ~~member's subordinated certificates and a $33 million increase in accrued interest payable and~~ other ~~liabilities offset by a $1,318 million decrease in notes payable outstanding. The $602 million increase to equity was due to~~liabilities.

Short-Term Debt and Long-Term Debt

The following chart provides a breakout of debt outstanding.

(Dollar amounts in millions)	May 31, 2005			May 31, 2004			Increase/(Decrease)
Short-term debt:
Commercial paper (1)	$	4,261		$	3,525		$	736
Bank bid notes		100			100			-
Long-term debt with remaining maturities less than one year		3,551			2,365			1,186
Foreign currency valuation account		40			-			40
Short-term debt reclassified as long-term (2)		(5,000	)		(4,650	)		(350	)
Total short-term debt		2,952			1,340			1,612
Long-term debt:
Collateral trust bonds		2,946			5,392			(2,446	)
Long-term notes payable		91			107			(16	)
Medium-term notes		5,444			6,276			(832	)
Foreign currency valuation account		221			234			(13	)
Short-term debt reclassified as long-term (2)		5,000			4,650			350
Total long-term debt		13,702			16,659			(2,957	)
Subordinated deferrable debt		685			550			135
Members' subordinated certificates		1,491			1,665			(174	)
Total debt outstanding	$	18,830		$	20,214		$	(1,384	)

Percentage of fixed rate debt (3)		67%			70%
Percentage of variable rate debt (4)		33%			30%
Percentage of long-term debt		84%			93%
Percentage of short-term debt		16%			7%

____________________
43(1) Includes $271 million and $223 million related to the daily liquidity fund at May 31, 2005 and 2004, respectively.
(2) Reclassification of short-term debt to long-term debt is based on the Company's ability to borrow under its revolving credit agreements and refinance short-term debt on a long-term basis, subject to the conditions therein.
(3) Includes variable rate debt that has been swapped to a fixed rate less any fixed rate debt that has been swapped to a variable rate.
(4) The rate on commercial paper notes does not change once the note has been issued. However, the rates on new commercial paper notes change daily and commercial paper notes generally have maturities of less than 90 days. Therefore, commercial paper notes are considered to be variable rate debt. Also includes fixed rate debt that has been swapped to a variable rate less any variable rate debt that has been swapped to a fixed rate.

37

an increase of $540 million related to the change in the fair value of CFC's derivative instruments and foreign currency adjustments and an increase of $137 million to adjusted net margin (see the "Non-GAAP Financial Measures" section for further explanation of the adjustments CFC makes to net margin) offset by a decrease of $75 million for the retirement of patronage capital.

Total debt outstanding at May 31, ~~2003 was $19,455~~2005 decreased by $1,384 million ~~a decrease of $106 million~~as compared to ~~the~~ May 31, ~~2002 balance~~2004 due to the significant reduction to loans outstanding. The short-term debt increased $1,612 million from May 31, 2004 to May 31, 2005 due to increases of ~~$19,561 million.~~

$736 million in commercial paper and daily liquidity fund balances, $1,186 million in long-term debt due within one year and $40 million in the foreign currency valuation account offset by the $350 million increase in the amount of short-term debt supported by revolving credit agreements and reclassified as long-term. The decrease to long-term debt of $2,957 million is primarily due to the prepayment of RTFC loans. Subordinated deferrable debt increased $135 million due to the issuance of 5.95% subordinated notes in February 2005. The decrease to subordinated certificates was due to the offset of subordinated certificates against loans outstanding for two borrowers and to certificates applied as part of the prepayment of loans.

~~Notes Payable~~

Short-Term Debt

~~Notes payable, which~~Short-term debt consists of commercial paper, daily liquidity fund, bank bid notes and long-term debt due within one year, totaled $1,096 million, a decrease of $1,318 million from the prior year. The decrease was primarily due to the $1,316 million decrease in commercial paper and the $245 million increase in the amount of short-term debt supported by revolving credit agreements and reclassified as long-term offset by a $150 million increase to the foreign currency valuation account, a $66 million increase to the daily liquidity fund and a $28 million increase in long-term debt maturing within one year. The foreign currency valuation account reflects the adjustment to ~~CFC's~~the foreign denominated medium-term notes based on current foreign currency exchange rates. At May 31, ~~2003, CFC's~~2005, short-term debt consisted of ~~$820~~$2,873 million in dealer commercial paper, ~~$930~~$989 million in commercial paper issued to ~~CFC's~~the Company's members, ~~$26~~$128 million in commercial paper issued to certain nonmembers, $100 million in bank bid notes, ~~$111~~$271 million in the daily liquidity fund ~~$2,911~~and $3,591 million in collateral trust bonds, ~~and~~ medium-term notes and long-term notes payable that mature within one ~~year and $150 million foreign currency valuation account. CFC~~year. The Company reclassifies a portion of its short-term debt as long-term, based on the ability (subject to certain conditions) and intent, if necessary, to borrow under its revolving credit agreements. ~~CFC~~The Company reclassified ~~$3,951~~$5,000 million and ~~$3,706~~$4,650 million of short-term debt as long-term at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively.

Other information with regard to ~~notes payable due within one year~~short-term debt at May 31, is as follows:

(Dollar amounts in thousands)
2003
2002
2001
Weighted average maturity of notes outstanding at year-end:
   Notes payable (1)
18 days
24 days
28 days
   Long-term debt maturing within one year
195 days
163 days
185 days
     Total
123 days
89 days
93 days
Average amount outstanding during the year (2):
   Notes payable (1)
$
2,971,540
$
4,933,166
$
8,595,668
   Long-term debt maturing within one year
2,707,410
3,742,451
3,090,812
     Total
5,678,950
8,675,617
11,686,480
Maximum amount outstanding at any month-end during the year (2):
   Notes payable (1)
3,681,822
6,943,445
10,169,473
   Long-term debt maturing within one year
3,453,567
4,364,230
4,388,504

(Dollar amounts in thousands)		2005		2004		2003
Weighted average maturity outstanding at year-end: (1)
Short-term debt (2)		22 days		20 days		18 days
Long-term debt maturing within one year		294 days		162 days		195 days
Total		145 days		76 days		123 days
Average amount outstanding during the year (1):
Short-term debt (2)	$	4,355,579	$	3,173,167	$	2,971,540
Long-term debt maturing within one year		1,834,883		2,913,723		2,744,803
Total		6,190,462		6,086,890		5,716,343
Maximum amount outstanding at any month-end during the year (1):
Short-term debt (2)		4,816,367		3,758,428		3,681,822
Long-term debt maturing within one year		3,591,374		3,427,560		3,453,048

(1) Prior to reclassification of short-term debt supported by the revolving credit agreements to long-term debt.

(2) Includes the daily liquidity fund and bank bid notes and does not include long-term debt due in less than one year.

~~(2) Prior to reclassification to long-term debt and the foreign currency valuation account.~~

Commercial Paper

At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had ~~$1,776~~$3,990 million and ~~$3,092~~$3,302 million, respectively, outstanding in commercial paper with a weighted average maturity of 1923 days and ~~25 days.~~21 days, respectively. Commercial paper notes are issued with maturities up to 270 days and are senior unsecured obligations of ~~CFC.~~the Company. Commercial paper sold directly by ~~CFC~~the Company and outstanding to ~~CFC's~~its members and others totaled ~~$956~~$1,117 million and ~~$930~~$1,003 million at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively. Commercial paper sold through dealers totaled ~~$820~~$2,873 million and ~~$2,162~~$2,299 million at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively. ~~CFC~~Included in this amount, the Company has a program to issue commercial paper in Europe ~~but had no amounts~~with $818 million and $217 million outstanding at May 31, ~~2003, compared to $85 million at May 31, 2002.~~2005 and 2004, respectively. The commercial paper sold in Europe may be denominated in foreign currencies. AtMay 31, ~~2003~~2005 and ~~2002,~~2004, there were no amounts outstanding denominated in foreign currencies. CFC also issues extendable commercial notes with a stated maturity of 90 days, and CFC has the option to extend the maturity to 390 days. At May 31, 2003, there were no extendable commercial paper notes outstanding, compared to $105 million at May 31, 2002. The ~~decrease~~increase to the total amount of commercial paper outstanding at May 31, ~~2003,~~2005, as compared to the prior year, was due to an increase in the ~~decrease~~amount of backup liquidity available under the Company's revolving credit agreements and to an increase in the balance of short-term loans ~~outstanding and the increase~~outstanding. The Company intends to ~~long-term debt outstanding. In fiscal year 2003, CFC limited~~limit its issuance of dealer commercial paper and bank bid notes to 15% or less of total debt outstanding in order to reduce the dependency on its ability to continually roll over a large balance of commercial paper funding. However at May 31, 2005, dealer commercial paper and bank bid notes totaled 16% of total debt outstanding compared to 12% at May 31, 2004.

Bank Bid Notes

~~CFC~~The Company obtains funds from various banking institutions under bank bid note arrangements, similar to bank lines of credit. The notes are issued for terms up to three months and are unsecured obligations of ~~CFC.~~the Company. At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had $100 million outstanding in bank bid notes and these notes had a weighted average maturity of 1724 days and 20 days, respectively.

Daily Liquidity Fund

~~CFC's~~The daily liquidity fund, consisting of funds invested by ~~CFC's~~the Company's members, totaled ~~$111~~$271 million as of May 31, ~~2003~~2005 compared to ~~$45~~$223 million at May 31, ~~2002.~~2004. These funds are available on demand by the member investor, not subject to stated maturity dates, and the notes are unsecured obligations of CFC.

Long-Term Debt

During fiscal year ~~2003,~~2005, long-term debt outstanding ~~increased~~decreased by ~~$1,145~~$2,957 million compared to the prior year-end. The ~~increase~~decrease in long-term debt outstanding was due primarily to ~~increases~~the prepayment of ~~$1,199 million in collateral trust bonds,~~loans offset by an increase of ~~$245~~$350 million to the amount of short-term debt supported by the revolving credit agreements and reclassified as long-term debt, offset by decreases of $296 million to medium-term notes and $3 million to the long-term debt valuation allowance. CFC issued more long-term debt during fiscal year 2003 to reduce the amount of commercial paper funding that had to be continually rolled over.debt.

Collateral Trust Bonds

At May 31, ~~2003, CFC~~2005, the Company had ~~$6,293~~$5,394 million in ~~fixed rate~~ collateral trust bonds outstanding. Collateral trust bonds are issued for terms of two years to 30 years. Under its collateral trust bond indentures, CFC must pledge as collateral cash, permitted investments or eligible mortgage notes from its distribution system borrowers, ~~evidencing loans~~in an amount at least equal ~~in principal amount~~ to the outstanding principal amount of collateral trust bonds. At May 31, ~~2003,~~2005, CFC had pledged ~~$6,664~~$7,293 million in mortgage notes, ~~$224~~$218 million of RUS guaranteed loans qualifying as permitted investments and $2 million in cash. During fiscal year 2003, CFC issued a total of $1,500 million in collateral trust bonds. On February 7, 2003, CFC issued $400 million of floating rate bonds due 2005, $600 million of 3% collateral trust bonds due 2006 and $500 million of 3.875% collateral trust bonds due 2008. Virtually all collateral trust bonds were offered to investors in underwritten public offerings. A total of ~~$300~~$2,448 million of collateral trust bonds are scheduled to mature during fiscal year ~~2004~~2006 and are reported as ~~notes payable due within one year.~~short-term debt.

Medium-Term Notes

At May 31, ~~2003, CFC~~2005, the Company had ~~$8,819~~$6,792 million outstanding in medium-term notes. Medium-term notes are senior unsecured obligations of ~~CFC~~the Company and are issued for terms of nine months to 30 years. Medium-term notes outstanding to ~~CFC's~~the Company's members totaled ~~$296~~$275 million at May 31, ~~2003.~~2005. The remaining ~~$8,523~~$6,517 million were sold through dealers to ~~investors including $1,637~~investors. A total of $1,127 million ~~in the European markets.~~ of medium-term notes are scheduled to mature during fiscal year 2006.

At May 31, ~~2003,~~2005 and 2004, the Company had a total of ~~1,350~~$1,366 million and $1,339 million, respectively, of ~~Euro~~foreign denominated medium-term ~~notes were issued.~~notes. As a result of issuing debt in foreign currencies, the Company must adjust the value of the debt reported on the consolidated balance sheets for changes in foreign currency exchange rates since the date of issuance. To the extent that the current exchange rate is different than the exchange rate at the time of issuance, there will be a change in the value of the foreign denominated debt. The adjustment to the value of the debt for the current period is reported on the consolidated and combined statements of operations as foreign currency adjustments. At the time ~~the Euro~~of issuance of all foreign denominated debt, ~~was issued, CFC also entered~~the Company enters into a cross currency ~~and~~or cross currency interest rate exchange agreements to fix the exchange rate on all principal and interest payments ~~due~~ through maturity. At May 31, ~~2003, CFC's~~2005 and 2004, respectively, the reported amount of foreign ~~currency~~denominated debt includes a valuation ~~account was $326~~adjustment of $261 million and $234 million due to ~~adjust~~changes in the value of the Euro ~~denominated medium-term~~and Australian dollar versus the U.S. dollar since the time the debt was issued.

Long-Term Notes Payable

At May 31, 2005 and 2004, respectively, the Company had $107 million and $116 million in long-term notes ~~for~~payable. Long-term notes payable represents unsecured obligations issued by NCSC to provide funding to its members. Payments are due on the ~~change in exchange rates~~long-term notes payable from ~~the date the Euro denominated medium-term notes were issued to the reporting date. A~~2006 through 2022, with a total of ~~$2,611~~$16 million ~~of medium-term notes are scheduled to mature during~~due in fiscal year 2004, excluding $150 million of foreign currency valuation related to these medium-term notes. On August 29, 2002, CFC issued $1,250 million of 5.75% global unsecured notes due 2009 denominated in U.S. dollars to investors in the United States, Europe and Asia. The proceeds from these notes were used to repay commercial paper obligations maturing in September 2002 in line with CFC's goal to reduce reliance on dealer commercial paper.2006.

Subordinated Deferrable Debt

At May 31, ~~2003, CFC~~2005 and 2004, the Company had ~~$650~~$685 million and $550 million, respectively, outstanding in subordinated deferrable debt. Subordinated deferrable debt represents quarterly income capital securities and subordinated notes that are unsecured obligations of ~~CFC,~~the Company, subordinate and junior in right of payment to senior debt and the debt obligations guaranteed by ~~CFC,~~the Company, but senior to subordinated certificates. Subordinated deferrable debt has been issued for periods of up to 49 years. ~~CFC~~The Company has the right at any time and from time to time during the term of the subordinated deferrable debt to suspend interest payments for a period not exceeding 20 consecutive quarters. ~~CFC~~The Company has the right to call the subordinated deferrable debt any time after five years, at par. To date, ~~CFC~~the Company has not exercised its option to suspend interest payments. ~~On March 28, 2003,~~In February 2005, CFC ~~effected the early redemption~~issued $135 million of the 7.65% quarterly income capital securities totaling $75 million issued in September 1997. CFC redeemed these securities at par, and recorded $2 million in cost of funds for the unamortized issuance costs. Subordinated deferrable debt increased due to the $125 million issuance of 6.75%5.95% subordinated notes due ~~2043 issued in February 2003.~~2045.

Members' Subordinated Certificates

~~Subordinated~~Members' subordinated certificates include both membership subordinated certificates and loan and guarantee subordinated certificates, all of which are subordinate to other CFC debt. As a condition of becoming a CFC member, CFC generally requires the purchase of membership subordinated certificates. At May 31, ~~2003~~2005 and ~~2002,~~2004, membership subordinated certificates totaled ~~$644~~$663 million and ~~$641~~$650 million, respectively. These certificates generally mature in 100 years from issuance and pay interest at 5% per annum. At May 31, ~~2003,~~2005, loan and guarantee subordinated certificates totaled ~~$1,064~~$828 million and carried a weighted average interest rate of ~~1.47%~~1.66% compared to ~~$1,051~~$1,015 million with a weighted average interest rate of ~~1.40%~~1.29% at May 31, ~~2002.~~2004. Loan subordinated certificates ~~increased~~decreased by ~~$21~~$195 million and guarantee subordinated certificates ~~decreased~~increased by $7$8 million from May 31, ~~2002~~2004 to May 31, ~~2003.~~2005. The loan and guarantee subordinated certificates are long-term instruments, which may amortize at a rate equivalent to

that of the loan or guarantee to which they relate. ~~On a combined basis,~~The decrease to the loan and guarantee subordinated certificates ~~carried~~of $187 million for the year ended May 31, 2005 is primarily due to offsets totaling $91 million applied to RTFC loans to certain impaired and high risk borrowers, $137 million applied toward loan prepayments and maturities and amortization of certificates of $27 million offset by the purchase of $68 million of new certificates. At May 31, 2005, members' subordinated certificates carry a weighted average interest rate of ~~2.76%~~3.07% compared to a rate of ~~2.73%~~2.69% for the prior year. ~~Loan~~Members may be required to purchase loan and guarantee subordinated certificates ~~may be required to be purchased~~ in conjunction with the receipt of a loan or credit enhancement based on ~~the member's~~their leverage ratio (total debt and credit enhancements from CFC divided by total equity investments in CFC). Members that have a leverage ratio with CFC in excess of a level in the policy are required to purchase additional subordinated certificates as a condition to receiving a long-term loan or credit enhancement. CFC paid a total of $46 million and $47 million, respectively, in interest to holders of subordinated certificates ~~during~~in fiscal ~~year~~years 2005 and 2004.

Minority Interest

Minority interest on the consolidated balance sheets at May 31, 2005 and 2004 was $19 million and $21 million, respectively. The minority interest reported at May 31, 2005 and 2004 represents RTFC and NCSC members' equity, to which CFC's members have no claim. In consolidation, the amount of the subsidiary equity to which the parent company's members have no claim is shown as minority interest. CFC does not own any interest in RTFC and NCSC, but is required to consolidate under FIN 46(R) as it is the primary beneficiary of a variable interest in RTFC and NCSC. RTFC and NCSC are members of CFC. RTFC and NCSC are considered variable interest entities because they are very thinly capitalized, dependent on CFC for all funding and operated by CFC under a management agreement. CFC is considered the primary beneficiary of the variable interests in RTFC and NCSC due to a guarantee agreement, under which it is responsible for absorbing the majority of RTFC and NCSC expected losses. On June 1, 2003, ~~compared to~~the date the Company implemented FIN 46 (R), a total of ~~$44~~$20 million of RTFC equity was reclassified from the combined equity at May 31, 2003 and added to minority interest.

During the year ended May 31, 2005, the balance of minority interest was impacted by the offset of $1 million of unretired RTFC patronage capital allocations against outstanding loan balances to certain impaired and high risk borrowers and the retirement of $3 million of patronage capital to RTFC members in January 2005, offset by $2 million of minority interest net margin for the ~~prior year.~~year ended May 31, 2005.

Equity

~~Under current policy, CFC returns 70%~~The following chart provides a breakout of the ~~allocated margins~~equity balances.

(Dollar amounts in millions)	May 31, 2005			May 31, 2004			Increase/(Decrease)
Membership fees	$	1		$	1		$	-
Education fund		1			1			-
Members' capital reserve		164			131			33
Allocated net margin		357			352			5
Unallocated margin (1)		-			(2	)		2
Total members' equity		523			483			40
Prior year cumulative derivative forward
value and foreign currency adjustments		225			523			(298	)
Current period derivative forward value (2)		31			(233	)		264
Current period foreign currency adjustments		(23	)		(65	)		42
Total retained equity		756			708			48
Accumulated other comprehensive income (loss)		13			(12	)		25
Total equity	$	769		$	696		$	73

(1) The May 31, 2004 balance includes NCSC equity which is included in consolidated equity rather than minority interest since it was in a deficit equity position at that time and therefore represented a charge to CFC.

(2) Represents the ~~next~~derivative forward value gain (loss) recorded by CFC for the period.

Applicants are required to pay a one-time fee to become a member. The fee varies from two hundred dollars to one thousand dollars depending on the membership class. CFC is required by the District of Columbia cooperative law to have a methodology to allocate its net margin to its members. CFC maintains the current year net margin as unallocated through the end of its fiscal ~~year, with the remaining 30% to be held and then retired at a future date (currently 15 years), as permitted by~~year. At that time, CFC's ~~contractual obligations and to the extent that the~~ board of directors allocates its net margin to its members in the form of patronage capital and to board approved reserves. Currently, CFC has two such board approved reserves, the education fund and the members' capital reserve. CFC adjusts the net margin it allocates to its ~~discretion~~members and board approved reserves to exclude the non-cash impacts of SFAS 133 and 52. CFC allocates a small portion, less than 1%, of adjusted net margin annually to the education fund as required by cooperative law. Funds from the education fund are disbursed annually to the statewide cooperative organizations to fund the teaching of cooperative principles in the service territories of the cooperatives in each state. The board of directors determines the amount of adjusted net margin that is allocated to the members' capital reserve, if any. The members' capital reserve represents margins that are held by CFC to increase equity retention. The margins held in the members' capital reserve have not been specifically allocated to any member, but may be allocated to individual members in the future as patronage capital if

authorized by CFC's board of directors. All remaining adjusted net margin is allocated to CFC's members in the form of patronage capital. CFC bases the amount of adjusted net margin allocated to each member on the members' patronage of the CFC lending programs in the year that the ~~financial condition of CFC will not be impaired~~adjusted net margin was earned. There is no impact on CFC's total equity as a ~~result. During~~result of allocating the ~~next six years,~~annual adjusted net margin to members in the form of patronage capital or to board approved reserves. CFC ~~plans~~annually retires a portion of the patronage capital allocated to ~~retire~~members in prior years. CFC's total equity is reduced by the ~~unretired allocations representing allocated margins for fiscal years 1991, 1992~~amount of patronage capital retired to its members and 1993, all of which had been allocated under a previous retirement policy. The unretired allocations do not earn interest and are junior to all debt instruments, including subordinated certificates. On September 3, 2002, CFC's Board of Directors authorized the retirement of $74 million of allocated margins, which included $18 million to RTFC. On January 16, 2003, RTFC retired $19 million of allocated margins which represented 70% of its fiscal year 2002 margin, including the allocationby amounts disbursed from ~~CFC.~~board approved reserves.

At May 31, ~~2003,~~2005, equity totaled $769 million, an increase of $73 million from May 31, 2004. During the year ended May 31, 2005, CFC had $454 million in retained equity excluding the derivative forward value and foreign currency adjustments, which included $1 million of membership fees, $2 million for the education fund, $90 million of members' capital reserve and $361 million of allocated but unretired allocations to members, compared toretired a total of ~~$352~~$78 million ~~for~~of patronage capital which was offset by net margin of $127 million and a reduction to the ~~prior year.~~other comprehensive loss related to derivatives of $25 million.

Contractual Obligations

The following table summarizes ~~CFC's~~the contractual obligations at May 31, ~~2003~~2005 and the related principal amortization and maturities by fiscal ~~year:~~year.

Principal Amortization and Maturities
(Dollar amounts in millions)
Outstanding
Remaining
Instrument
Balance
2004
2005
2006
2007
2008
Years
Notes payable (1)
$
4,898
$
4,898
$
-
$
-
$
-
$
-
$
-
Long-term debt (2)
11,875
-
2,292
2,939
1,094
814
4,736
Subordinated deferrable debt
650
-
-
-
-
-
650
Members' subordinated certificates (3)
1,061
13
9
45
17
4
973
Total contractual obligations
$
18,484
$
4,911
$
2,301
$
2,984
$
1,111
$
818
$
6,359

			Principal Amortization and Maturities
(Dollar amounts in millions)	Outstanding												Remaining
Instrument	Balance		2006		2007		2008		2009		2010		Years
Short-term debt (1)	$	7,952	$	7,952	$	-	$	-	$	-	$	-	$	-
Long-term debt (2)		8,702		-		1,644		1,101		493		1,473		3,991
Subordinated deferrable debt (3)		685		-		-		-		-		-		685
Members' subordinated certificates (4)		1,109		12		26		4		20		4		1,043
Total contractual obligations	$	18,448	$	7,964	$	1,670	$	1,105	$	513	$	1,477	$	5,719

(1) Includes commercial paper, bank bid notes, daily liquidity fund and long-term debt due in less than one year prior to reclassification of ~~$3,951~~$5,000 million to long-term ~~debt and excludes $150 million for the foreign currency valuation account.~~debt.

(2) Excludes ~~$3,951~~$5,000 million reclassification from ~~notes payable, $176 million for the foreign currency valuation account and $(1) million for the long-term debt valuation allowance.~~short-term debt.

(3) Subordinated deferrable debt is listed at the earliest call date for each issue.

(4) Excludes loan subordinated certificates totaling ~~$647~~$382 million that amortize annually based on the outstanding balance of the related loan. There are many items that impact the amortization of a loan, such as loan conversions, loan repricing at the end of an interest rate term, prepayments, ~~etc;~~etc, thus ~~CFC is unable to maintain~~ an amortization schedule cannot be maintained for these certificates. Over the past three years, annual amortization on these certificates has averaged ~~$27~~$30 million. In fiscal year ~~2003,~~2005, amortization represented 5%7% of amortizing loan subordinated certificates outstanding.


Off-Balance Sheet Obligations
Guarantees
The following chart provides a breakout of guarantees outstanding by type and by segment.
						Increase/
(Dollar amounts in millions)	May 31, 2005		May 31, 2004			(Decrease)
Long-term tax-exempt bonds	$	738	$	781	$		(43	)
Debt portions of leveraged lease transactions		12		15			(3	)
Indemnifications of tax benefit transfers		142		160			(18	)
Letters of credit		197		307			(110	)
Other guarantees		69		68			1
�� Total	$	1,158	$	1,331	$		(173	)

CFC

1,150

1,302

(152

)

NCSC

(21

) Total

1,158

1,331

(173

)

~~Off-Balance Sheet Obligations~~

~~Guarantees~~

~~The following chart provides a breakout of guarantees outstanding by type.~~

Increase/
(Dollar amounts in thousands)
May 31, 2003
May 31, 2002
(Decrease)
Long-term tax-exempt bonds
$
900
$
941
$
(41
)
Debt portions of leveraged lease transactions
34
41
(7
)
Indemnifications of tax benefit transfers
185
208
(23
)
Letters of credit
314
311
3
Other guarantees
471
555
(84
)
Total
$
1,904
$
2,056
$
(152
)

The decrease in total guarantees outstanding at May 31, ~~2003~~2005 compared to ~~the prior year~~May 31, 2004 was due primarily to ~~decreases~~a reduction in the amount of ~~NCSC commercial paper guaranteed by CFC~~letters of credit and to normal amortization on long term tax-exempt bonds and tax benefit transfers.

At May 31, 2005 and 2004, the Company had recorded a guarantee liability totaling $16 million and $19 million, respectively, which represents the contingent and non-contingent exposure related to guarantees of members' debt obligations. The ~~following table summarizes CFC's off-balance sheet obligations~~contingent guarantee liability at May 31, ~~2003~~2005 and 2004 totaled $16 million and $19 million, respectively, based on management's estimate of the Company's exposure to losses within the guarantee portfolio. At May 31, 2005 and 2004, 99% and 98% of guarantees, respectively, were related to CFC and the remaining amounts were related ~~principal amortization~~to NCSC. The Company uses factors such as internal borrower risk rating, remaining maturity period, corporate bond default probabilities and ~~maturities by fiscal year:~~estimated recovery rates in estimating its contingent exposure. The remaining balance of the total guarantee liability of less than $1 million at May 31, 2005 and 2004 relates to the Company's non-contingent obligation to stand ready to perform over the term of its guarantees that it has entered into since January 1, 2003. The non-contingent obligation is estimated based on guarantee fees received for guarantees issued. The fees are deferred and amortized on the straight-line method into operating income over the term of the guarantees. The Company has recorded a non-contingent obligation for all new guarantees since January 1, 2003 in accordance with FIN 45, Guarantor's Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees

(Dollar amounts in millions)
Principal Amortization and Maturities
Outstanding
Remaining
Instrument
Balance
2004
2005
2006
2007
2008
Years
Guarantees (1)
$
1,904
$
286
$
107
$
255
$
199
$
193
$
864

of Indebtedness of Others (an interpretation of SFAS 5, 57, and 107 and rescission of FIN 34). The Company received and deferred fees of $0.6 million, $0.8 million and $0.5 million for the year ended May 31, 2005 and 2004 and for the period from January 1, 2003 to May 31, 2003, respectively, related to new guarantees issued during the periods.

The following table summarizes the off-balance sheet obligations at May 31, 2005 and the related principal amortization and maturities by fiscal year.

(Dollar amounts in millions)			Principal Amortization and Maturities
	Outstanding												Remaining
Instrument	Balance		2006		2007		2008		2009		2010		Years
Guarantees (1)	$	1,158	$	243	$	111	$	84	$	87	$	74	$	559
(1) On a total of $692 million of tax-exempt bonds, CFC has unconditionally agreed to purchase bonds tendered or called for redemption at any time if the remarketing agents have not sold such bonds to other purchasers.

(1) On a total of $829 million of tax-exempt bonds, CFC has unconditionally agreed to purchase bonds tendered in connection with periodic interest rate resets or called for redemption if the remarketing agents have not sold such bonds to other purchasers.

Contingent Off-Balance Sheet Commitments

Unadvanced Commitments

~~CFC experienced~~At May 31, 2005, the Company had unadvanced commitments totaling $11,694 million, a decrease of ~~$324~~$117 million ~~in gross unadvanced loan commitments~~compared to ~~a total~~the balance of ~~$11,689~~$11,577 million at May 31, ~~2003.~~2004. Unadvanced commitments include loans ~~approved by CFC~~ for which loan contracts have been approved and executed, but funds have not been advanced. The majority of the short-term unadvanced commitments provide backup liquidity to ~~CFC~~the Company's borrowers; therefore, ~~CFC~~it does not anticipate funding most ~~such~~of these commitments. Approximately ~~48%~~52% and 49% of the outstanding commitments at May 31, ~~2003~~2005 and 2004, respectively, were for short-term or line of credit ~~loans compared~~loans. Substantially all above mentioned credit commitments contain material adverse change clauses, thus for a borrower to 44% for the prior year. Approximately 33% of the unadvanced commitments at May 31, 2003 were approved under the Power Vision Program and will expire if not advanced within 60 months of approval unless the draw period is extended by CFC, compared to 37% for the prior year. Under the Power Vision Program, CFC pre-approved senior secured loans to certain of its electric distribution members provided that they maintain appropriate financial ratios. To qualify for the advance of funds, ~~under all commitments, a borrower~~the Company must ~~assure CFC~~be satisfied that there has been no material ~~adverse~~ change ~~in its financial condition~~ since the loan was approved.

Unadvanced commitments do not represent off-balance sheet liabilities ~~of CFC~~ and have not been included in the chart summarizing off-balance sheet obligations above. ~~CFC~~The Company has no obligation to advance amounts to a borrower that does not meet the minimum conditions as determined by CFC's credit underwriting policy in effect at the time the loan was approved. If there has been a material adverse change in the borrower's financial condition, ~~CFC~~the Company is not required to advance funds. Therefore, ~~CFC classifies~~ unadvanced commitments are classified as contingent liabilities. Amounts advanced under these commitments would be classified as performing loans since the members are required to be in good financial condition to be eligible to receive the advance of funds.

Ratio Analysis

Leverage Ratio

The leverage ratio is calculated by dividing total liabilities and guarantees outstanding by total equity. Based on this formula, the leverage ratio at May 31, ~~2003~~2005 was ~~23.58,~~26.56, a decrease from ~~67.14~~31.70 at May 31, ~~2002.~~2004. The decrease in the leverage ratio is due to a decrease of $1,465 million to total liabilities, a decrease of $173 million in guarantees and an increase of ~~$602~~$73 million in total equity, as discussed above under the Liabilities, Minority Interest and ~~a decrease~~Equity section and the Off-Balance Sheet Obligations section of $152 million in guarantees, offset by an increase of $29 million to total liabilities. The increase to equity was primarily due to an increase of $540 million in the fair value of CFC's derivative instruments"Liquidity and foreign currency adjustments and $137 million in the current year net margin prior to derivative forward value and foreign currency adjustments offset by the retirement of $75 million of prior years' allocated net margins.Capital Resources". For the purpose of covenant compliance on its revolving credit agreements and for internal management purposes, ~~CFC adjusts~~ the leverage ratio calculation is adjusted to exclude derivative liabilities, debt used to fund RUS guaranteed loans, the foreign currency valuation account, ~~to use~~subordinated deferrable debt and subordinated certificates from liabilities, uses members' equity rather than

total equity and ~~to include~~adds subordinated deferrable debt, ~~and~~ subordinated certificates asand minority interest to arrive at adjusted equity. At May 31, ~~2003~~2005 and ~~2002,~~2004, the adjusted leverage ratio ~~reflecting these adjustments~~ was ~~6.63~~6.49 and ~~7.18,~~7.07, respectively. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of the adjustments ~~CFC~~the Company makes in its leverage ratio calculation. The decrease in the adjusted leverage ratio is due to a decrease in adjusted liabilities of ~~$489~~$1,397 million and a decrease of ~~$152~~$173 million in ~~guarantees and an increase in adjusted equity of $129 million.~~guarantees. The decrease in adjusted liabilities is due ~~primarily~~ to ~~a decrease~~decreases in subordinated certificates of ~~$501~~$174 million, inderivative liabilities of $51 million, debt ~~required~~used to fund ~~the outstanding loan balance, excluding the adjustment for debt denominated in a foreign currency. The increase in equity is due primarily to the adjusted net margin~~loans guaranteed by RUS of ~~$137~~$5 million offset by ~~the patronage capital retirement of $75 million and the~~ increases toin subordinated deferrable debt of ~~$50~~$135 million and ~~subordinated certificates~~the foreign currency valuation account of ~~$16~~$27 million. ~~CFC~~The balance of adjusted equity was approximately the same at May 31, 2005 and 2004. The Company will retain the flexibility to further amend its policies to retain members' investments in ~~CFC~~the Company consistent with contractual obligations and maintaining acceptable financial ratios. In addition to the adjustments made to the leverage ratio in the "Non-GAAP Financial Measures" section, guarantees to member systems that have an investment grade rating from Moody's Investors Service and Standard & Poor's Corporation are excluded from the calculation of the leverage ratio under the terms of the revolving credit agreement.

Debt to Equity Ratio

The debt to equity ratio is calculated by dividing total liabilities outstanding by total equity. The debt to equity ratio, based on this formula, at May 31, ~~2003~~2005 was ~~21.53,~~25.05, a decrease from ~~60.88~~29.79 at May 31, ~~2002.~~2004. The decrease in the debt to equity ratio was due to ~~the~~decreases of $1,465 million in total liabilities and an increase of ~~$602 million in equity and decrease of $29~~$73 million to ~~total liabilities~~equity, as ~~noted above. Consistent with~~discussed above and under the ~~covenant requirements on its revolving credit agreements~~Liabilities, Minority Interest and ~~for~~Equity section of "Liquidity and Capital Resources". For internal management purposes, ~~CFC adjusts~~ the debt to equity ratio calculation is adjusted to exclude ~~the~~ derivative liabilities, debt used to fund RUS guaranteed loans, the foreign currency valuation

account, ~~to use~~subordinated deferrable debt and subordinated certificates from liabilities, uses members' equity rather than total equity and ~~to include~~adds subordinated deferrable debt, subordinated certificates and ~~the loan loss allowance as~~minority interest to arrive at adjusted equity. At May 31, ~~2003~~2005 and ~~2002,~~2004, the adjusted debt to equity ratio ~~reflecting these adjustments~~ was ~~4.96~~6.07 and ~~5.40,~~6.58, respectively. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of the adjustments ~~CFC makes in its~~made to the debt to equity ratio calculation. The decrease in the adjusted debt to equity ratio is due to a decrease in adjusted liabilities of ~~$489 million and an increase in adjusted equity of $187~~$1,397 million. In addition to the changes to total liabilities and equity described above in the leverage ratio, CFC includes the loan loss allowance as equity in the adjusted debt to equity ratio. The balance of the loan loss allowance increased by $58 million due to a provision for loan loss of $68 million and net write-offs of $10 million during the year. CFC will retain the flexibility to further amend its policies to retain members' investments in CFC consistent with contractual obligations and maintaining acceptable financial ratios.

~~CFC's~~The Company's management is committed to maintaining the adjusted leverage and adjusted debt to equity ratios within a range required for a strong credit rating. ~~CFC's policy regarding the purchase of loan subordinated certificates requires members with a~~ CFC debt to equity ratio in excess of the limit in the policy to purchase a non-amortizing/non-interest bearing subordinated certificate in the amount of 2% of the loan for distribution systems, 7% of the loan for power supply systems and 10% of the loan for all other systems. For non-standard credit facilities, the borrower is required to purchase interest bearing certificates in amounts determined appropriate by CFC based on the circumstances of the transaction. CFC also created a members' capital reserve, in which a portion of the adjusted net margin is held annually rather than allocated back to the members. CFC ~~can allocate~~and RTFC currently have policies that may require the ~~members' capital reserve back~~purchase of subordinated certificates as a condition to ~~its members if it chooses. CFC's~~receiving a loan or guarantee. The Company's management will continue to monitor the adjusted leverage and adjusted debt to equity ratios. If required, additional policy changes will be made to maintain the adjusted ratios within an acceptable range.

Revolving Credit Agreements

~~At May 31, 2003 and 2002, CFC had three~~The following is a summary of the Company's revolving credit agreements totaling $3,806 million and $4,562 million, respectively, which were 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 a three-year agreement in effect at May 31, 2003 and 2002, CFC may borrow $1,028 million. This agreement terminates on August 8, 2004. There were two 364-day agreements totaling $2,778 million and $3,534 million at May 31, 2003 and 2002, respectively. The $3,534 million of 364-day agreements in place at May 31, 2002 were scheduled to expire on August 7, 2002 and were replaced on July 1, 2002 with two 364-day agreements totaling $2,678 million and expiring on June 30, 2003. Under one 364-day agreement, the amount CFC could borrow decreased from $3,084 million at May 31, 2002 to $2,378 million. Under the second 364-day agreement, the amount CFC could borrow decreased from $450 million at May 31, 2002 to $300 million. On March 6, 2003, this agreement was amended and increased the amount of credit available under the agreement from $300 million to $400 million.31:

(Dollar amount in millions)		2005		2004	Termination Date	Facility fee per annum (1)
Three-year agreement	$	1,740	$	1,740	March 30, 2007	0.10 of 1%
Five-year agreement		1,975		-	March 23, 2010	0.09 of 1%
364-day agreement (2)		1,285		-	March 22, 2006	0.07 of 1%
364-day agreement (2)		-		1,740	March 29, 2005	0.085 of 1%
364-day agreement (2)		-		1,170	March 29, 2005	0.085 of 1%
	$	5,000	$	4,650

~~The agreements~~(1)

Facility fee determined by CFC's senior unsecured credit ratings based on the pricing schedules put in place at ~~May 31, 2003 were replaced on June 30, 2003 with two 364-day agreements totaling $2,923 million expiring on June 28, 2004. Under one 364-day agreement,~~ the ~~amount that CFC could borrow increased from $2,378 million at May 31, 2003 to $2,523 million. There was no change to the amount~~initiation of the ~~second 364-day agreement for $400 million. Both 364-day~~related agreement.

(2)

Any amount outstanding under these agreements ~~have a revolving credit period that terminates on June 28, 2004 during which CFC can borrow, and such borrowings~~ may be converted to a one-year term loan at the end of the revolving credit ~~period.~~periods. For the agreement in place at May 31, 2005, if converted to a term loan, the fee on the outstanding principal amount of the term loan is 0.125 of 1% per annum.

48Up-front fees of between 0.03 and 0.13 of 1% were paid to the banks based on their commitment level in each of the agreements in place at May 31, 2005, totaling in aggregate $3 million, which will be amortized as expense over the life of the agreements. Each agreement contains a provision under which if borrowings exceed 50% of total commitments, a utilization fee of 0.10 of 1% must be paid on the outstanding balance. The utilization fee is 0.10 of 1% for the 364-day and five-year agreements and 0.15 of 1% for the three-year agreement outstanding at May 31, 2005.

~~The~~As of May 31, 2005 and 2004, the Company was in compliance with all covenants and conditions under its revolving credit agreements ~~require CFC to achieve an average fixed charge coverage ratio over the six most recent fiscal quarters of~~in place at ~~least 1.025~~that time and ~~prohibit the retirement of patronage capital unless CFC has achieved a fixed charge coverage ratio of at least 1.05 for the preceding fiscal year.~~ there were no borrowings outstanding under such agreements.

For the purpose of the revolving credit agreements, net margin, senior debt and total equity are adjusted to exclude the non-cash adjustments related to SFAS 133 and ~~pursuant to amendments dated August 13, 2003, SFAS 52, Foreign Currency Translation, are excluded from the covenant calculations. The fixed charge coverage ratio is calculated by adding~~52. Adjusted TIER represents the cost of funds adjusted to include the derivative cash settlements, toplus minority interest net margin, ~~adjusted~~plus net margin prior to ~~exclude the derivative forward value, foreign currency adjustments and~~ the cumulative effect of change in accounting principle and dividing that total by the cost of funds adjusted to include the derivative cash settlements. This is the same calculation as CFC's adjusted TIER. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of the adjustments CFC makes to its TIER calculation to exclude the impact of SFAS 133 and foreign currency adjustments. The revolving credit agreements prohibit CFC from incurring seniorSenior debt ~~in an amount in excess of ten times~~represents the sum of ~~members' equity,~~subordinated deferrable debt, members' subordinated certificates, minority interest and ~~subordinated deferrable debt.~~total equity. 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; and~~Service.

The following represents the Company's required financial ratios at or for the year ended May 31:

	Requirement	2005	2004

Minimum average adjusted TIER over the six most recent fiscal quarters	1.025	1.08	1.15

Minimum adjusted TIER at fiscal year end (1)	1.05	1.14	1.12

Maximum senior debt	10.00	6.30	6.87

(1)	The Company must meet this requirement in order to retire patronage capital.

43

The revolving credit agreements do not contain a material adverse change clause or ratings triggers that limit the banks' obligations to fund under the terms of the ~~agreements.~~agreements, but CFC must be in compliance with their other requirements, including financial ratios, in order to draw down on the facilities.

Asset/Liability Management

A key element of ~~CFC's~~the Company's funding operations is the monitoring and management of interest rate and liquidity risk. This process involves controlling asset and liability volumes, repricing terms and maturity schedules to stabilize gross operating margin and retain liquidity. Throughout the asset/liability management discussion, the term repricing refers to the resetting of interest rates for a loan and does not represent the maturity of a loan. Therefore, loans that reprice do not represent amounts that will be available to service debt or fund ~~CFC's~~the Company's operations.

Matched Funding Policy

~~CFC~~The Company measures the matching of funds to assets by comparing the amount of fixed rate assets repricing or amortizing to the total fixed rate debt maturing over the remaining maturity of the fixed rate loan portfolio. It is ~~CFC's policy~~the Company's funding objective to manage the ~~match~~matched funding of asset and liability repricing terms within a range of 3% of total assets excluding derivative assets. At May 31, ~~2003, CFC~~2005, the Company had ~~$12,426~~$12,730 million of fixed rate assets amortizing or repricing, funded by ~~$10,090~~$10,488 million of fixed rate liabilities maturing during the next 30 years and ~~$2,076~~$1,673 million of members' equity and members' subordinated certificates, a portion of which does not have a scheduled maturity. The difference ~~$260~~of $569 million, or ~~1.31%~~2.84% of total assets and 2.92% of total assets excluding derivative assets, represents the fixed rate assets maturing during the next 30 years in excess of the fixed rate debt and equity, which are funded with variable rate debt. ~~CFC funds variable~~Fixed rate loans are funded with fixed rate collateral trust bonds, medium-term notes, subordinated deferrable debt, members' subordinated certificates and members' equity. With the exception of members' subordinated certificates, which are generally issued at rates below the Company's long-term cost of funding and with extended maturities, and commercial paper, the Company's liabilities have average maturities that closely match the repricing terms (but not the maturities) of its fixed interest rate loans. The Company also uses commercial paper supported by interest rate exchange agreements to fund its portfolio of fixed rate loans. Variable rate assets which reprice monthly are funded with short-term liabilities, primarily commercial paper, collateral trust bonds and medium-term notes issued with a fixed rate and swapped to a variable rate, medium-term notes issued at a variable rate, subordinated certificates, members' equity and bank bid notes. CFC funds fixed rate loans with fixed rate collateral trust bonds, medium-term notes, subordinated deferrable debt, members' subordinated certificates and members' equity. With the exception of members' subordinated certificates, which are generally issued at rates below CFC's long-term cost of funding and with extended maturities, and commercial paper, CFC's liabilities have average maturities that closely match the repricing terms (but not the maturities) of CFC's fixed interest rate loans. CFC also uses commercial paper supported by interest rate exchange agreements to fund its portfolio of fixed rate loans.

Certain of ~~CFC's~~the Company's collateral trust bonds, subordinated deferrable debt and medium-term notes were issued with early redemption provisions. To the extent borrowers are allowed to convert their fixed rate loans to a variable interest rate and to the extent it is beneficial, ~~CFC~~the Company takes advantage of these early redemption ~~privileges.~~provisions. However, because conversions and prepayments can take place at different intervals from early redemptions, ~~CFC~~the Company charges conversion fees designed to compensate for any additional interest rate risk ~~assumed by CFC.~~it assumes.

~~CFC~~The Company makes use of an interest rate gap analysis in the funding of its long-term fixed rate loan portfolio. The analysis compares the scheduled fixed rate loan amortizations and repricings against the scheduled fixed rate debt and members' subordinated certificate amortizations to determine the fixed rate funding gap for each individual year and for the portfolio as a whole. There are no scheduled maturities for the members' equity, primarily unretired patronage capital allocations. The non-amortizing members' subordinated certificates either mature at the time of the related loan or guarantee or 100 years from issuance (50 years in the case of a small portion of certificates). Accordingly, it is assumed in the funding analysis that non-amortizing members' subordinated certificates and members' equity are first used to "fill" any fixed rate funding gaps. The remaining gap represents the amount of excess fixed rate funding due in that year or the amount of fixed rate assets that are assumed to be funded by short-term variable rate debt, primarily commercial paper. The interest rate associated with the assets and debt maturing or members' equity and members' certificates is used to calculate an adjusted TIER for each year and for the portfolio as a whole. The schedule allows ~~CFC~~the Company to analyze the impact on the overall adjusted TIER of issuing a certain amount of debt at a fixed rate for various maturities, prior to issuance of the debt. See "Non-GAAP Financial Measures" for further explanation and reconciliation of the adjustments to TIER.

The following chart shows the scheduled amortization and ~~maturity~~repricing of fixed rate assets and liabilities outstanding at May 31, ~~2003.~~2005.

INTEREST RATE GAP ANALYSIS

(Fixed Rate Assets/Liabilities)

As of May 31, ~~2003~~2005

Over 1
Over 3
Over 5
Over 10
year but
years but
years but
years but
1 year
3 years
5 years
10 years
20 years
Over 20
(Dollar amounts in millions)
or less
or less
or less
or less
or less
years
Total
Assets:
   Amortization and repricing
$
2,797
$
3,486
$
1,394
$
2,522
$
1,824
$
403
$
12,426
     Total assets
$
2,797
$
3,486
$
1,394
$
2,522
$
1,824
$
403
$
12,426

Liabilities and members' equity:
   Long-term debt
$
2,590
$
3,681
$
1,030
$
1,682
$
416
$
691
$
10,090
   Subordinated certificates
67
91
87
507
626
134
1,512
   Members' equity (1)
-
-
-
204
360
-
564
     Total liabilities and members' equity
$
2,657
$
3,772
$
1,117
$
2,393
$
1,402
$
825
$
12,166

Gap (2)
$
(140
)
$
286
$
(277
)
$
(129
)
$
(422
)
$
422
$
(260
)
Cumulative gap
$
(140
)
$
146
$
(131
)
$
(260
)
$
(682
)
$
(260
)
Cumulative gap as a % of total assets (3)
(0.71
)%
0.74
%
(0.66
)%
(1.31
)%
(3.44
)%
(1.31
)%

				Over 1			Over 3			Over 5			Over 10
				year but			years but			years but			years but
	1 year			3 years			5 years			10 years			20 years			Over 20
(Dollar amounts in millions)	or less			or less			or less			or less			or less			years			Total
Assets:
Amortization and repricing	$	1,683		$	3,083		$	2,258		$	3,134		$	1,953		$	619		$	12,730
Total assets	$	1,683		$	3,083		$	2,258		$	3,134		$	1,953		$	619		$	12,730

Liabilities and members' equity:
Long-term debt	$	1,249		$	2,653		$	2,250		$	3,132		$	489		$	715		$	10,488
Subordinated certificates		47			74			60			83			919			74			1,257
Members' equity (1)		13			26			27			91			259			-			416
Total liabilities and members' equity	$	1,309		$	2,753		$	2,337		$	3,306		$	1,667		$	789		$	12,161

Gap (2)	$	374		$	330		$	(79	)	$	(172	)	$	286		$	(170	)	$	569
Cumulative gap	$	374		$	704		$	625		$	453		$	739		$	569
Cumulative gap as a % of total assets		1.87	%		3.51	%		3.12	%		2.26	%		3.69	%		2.84	%
Cumulative gap as a % of adjusted total assets (3)		1.92	%		3.62	%		3.21	%		2.33	%		3.80	%		2.92	%
_____________________

(1)	Includes the portion of the loan loss allowance and subordinated deferrable debt allocated to fund fixed rate assets. See "Non-GAAP Financial Measures" for further explanation of why CFC uses members' equity in its analysis of the funding of its loan portfolio.
(2)	~~Liabilities~~Assets less liabilities and members' ~~equity less assets.~~equity.
(3)	~~Total~~Adjusted total assets represents total assets in the ~~combined~~consolidated balance ~~sheet~~sheets less derivative assets.


Derivative and Financial Instruments
All financial instruments to which the Company was a party at May 31, 2005 were entered into or contracted for purposes other than trading. The following table provides the significant balances and contract terms related to the financial instruments at May 31, 2005.

(Dollar amounts in millions)							Principal Amortization and Maturities
		Outstanding																					Remaining
	Instrument	Balance			Fair Value		2006			2007			2008			2009			2010				Years
Investments		$	2		$	2	$	2		$	-		$	-		$	-		$	-		$	-
Average rate			2.96	%				2.96	%		-			-			-			-			-
Long-term fixed rate loans (1)			12,715			12,034		628			618			653			614			602			9,600
Average rate			5.57	%				5.25	%		5.32	%		5.36	%		5.50	%		5.56	%		5.63	%
Long-term variable rate loans (2)			4,022			4,022		304			238			229			229			205			2,817
Average rate (3)			5.52	%				-			-			-			-			-			-
Intermediate-term loans (4)			10			10		10			-			-			-			-			-
Average rate			5.91	%				5.91	%		-			-			-			-			-
Line of credit loans (5)			967			967		967			-			-			-			-			-
Average rate (3)			4.99	%				4.99	%		-			-			-			-			-
RUS Guaranteed FFB Refinance			40			40		2			2			2			2			2			30
Average rate (3)			3.46	%				-			-			-			-			-			-
Non-performing loans (6)			617			392		-			-			-			-			-			617
Average rate			-					-			-			-			-			-			-
Restructured loans (7)			601			581		8			8			10			13			14			548
Average rate			0.08	%				-			-			-			-			-			-
Liabilities and equity:
Short-term debt (8)			7,952			7,978		7,952			-			-			-			-			-
Average rate			3.84	%				3.84	%		-			-			-			-			-
Medium-term notes (9)			5,665			6,319		-			1,528			86			253			1,258			2,540
Average rate			6.51	%				-			5.73	%		3.99	%		5.61	%		5.76	%		7.52	%
Collateral trust bonds (9)			2,946			3,015		-			100			998			225			200			1,423
Average rate			5.05	%				-			7.30	%		4.45	%		5.75	%		5.70	%		5.11	%
Long-term notes payable			91			106		-			16			16			16			16			27
Average rate			4.94	%				-			3.36	%		3.41	%		3.35	%		3.11	%		8.80	%
Subordinated deferrable debt			685			689		-			-			-			-			-			685
Average rate			6.86	%				-			-			-			-			-			6.86	%
Subordinated certificates (10)			1,109			N/A		12			26			4			20			4			1,043
Average rate			4.17	%				4.51	%		4.32	%		3.90	%		2.69	%		3.30	%		4.19	%

45

_____________________________
50

~~Derivative and Financial Instruments~~

All the financial instruments to which CFC was a party at May 31, 2003 were entered into or contracted for purposes other than trading. The following table provides the significant balances and contract terms related to the financial instruments at May 31, 2003.

(Dollar amounts in millions)
Principal Amortization and Maturities
Outstanding
Remaining
Instrument
Balance
Fair Value
2004
2005
2006
2007
2008
Years
Investments
$
2
$
2
$
2
$
-
$
-
$
-
$
-
$
-
   Average rate
1.15%
-
-
-
-
-
-
Long-term fixed rate loans (1)
12,426
12,307
745
614
492
491
543
9,541
   Average rate
5.86%
6.43%
5.35%
5.97%
6.10%
6.21%
5.81%
Long-term variable rate loans (2)
5,195
5,195
379
319
375
286
230
3,606
   Average rate (3)
4.09%
-
-
-
-
-
-
Intermediate-term loans (4)
84
84
38
44
2
-
-
-
   Average rate
4.05%
4.52%
3.62%
4.23%
-
-
-
Line of credit loans (5)
1,108
1,108
1,108
-
-
-
-
-
   Average rate (3)
3.98%
3.98%
-
-
-
-
-
RUS Guaranteed FFB Refinance
43
43
1
1
2
2
2
35
   Average rate (3)
-
-
-
-
-
-
-
Nonperforming loans
-
-
-
-
-
-
-
-
   Average rate (3)
-
-
-
-
-
-
-
Restructured loans (6)
629
387
25
24
24
24
25
507
   Average rate
-
-
-
-
-
-
-
Liabilities and equity:
   Notes payable (7)
4,898
4,900
4,898
-
-
-
-
-
Average rate
2.04%
2.04%
-
-
-
-
-
   Medium-term notes (8)
5,882
6,740
-
393
493
995
16
3,985
Average rate
6.29%
-
2.40%
4.37%
6.33%
6.35%
6.90%
   Collateral trust bonds (8)
5,993
6,441
-
1,899
2,445
100
798
751
Average rate
5.17%
-
4.68%
5.28%
7.30%
4.75%
6.24%
   Subordinated deferrable debt
650
686
-
-
-
-
-
650
Average rate
7.32%
-
-
-
-
-
7.32%
   Subordinated certificates (9)
1,061
N/A
13
9
45
17
4
973
Average rate
4.46%
5.41%
3.52%
5.31%
5.23%
4.63%
4.41%

(1)	The principal amount of fixed rate loans is the total of scheduled principal amortizations ~~and scheduled repricings.~~without consideration for loans that reprice. Includes ~~$206~~$211 million of loans guaranteed by RUS.
(2)	Long-term variable rate loans include ~~$18~~$7 million of loans guaranteed by RUS.
(3)	Variable rates are set the first day of each month.
(4)	There is no scheduled amortization for intermediate-term variable rate loans.
(5)	The principal amount of line of credit loans are generally required to be paid down for a period of five consecutive days each year. These loans do not have a principal amortization schedule.
(6)	~~Amortization based on scheduled repayments. Assumes an~~The Company's non-performing loans are currently under litigation, therefore amortization schedule and interest accrual rate ~~of 0%~~cannot be estimated for ~~CoServ and ECO.~~future periods.
(7)	~~Notes payable~~Amortization based on expected repayment schedule. Interest accrual rate cannot be estimated for future periods.
(8)	Short-term debt includes commercial paper, bank bid notes and long-term debt due in less than one year prior to reclassification of ~~$3,951~~$5,000 million to long-term ~~debt and excludes $150 million for the foreign currency valuation account.~~debt.
~~(8)~~(9)	Prior to reclassification of ~~$3,951~~$5,000 million from ~~notes payable and excludes $(1) million for the long-term debt valuation allowance and $176 million for the foreign currency valuation account.~~short-term debt.
~~(9)~~(10)	Fair value has not been included as it is impracticable to develop a discount rate that measures fair value (see Note 1213 to the consolidated and combined financial statements). Excludes loan subordinated certificates totaling ~~$647~~$382 million that amortize annually based on the outstanding balance of the related loan, therefore there is no scheduled amortization. Over the past three years, annual amortization on these certificates has averaged ~~$27~~$30 million. In fiscal year ~~2003,~~2005, amortization represented 5%7% of amortizing loan subordinated certificates outstanding.


The following table provides the notional amount, average rate paid, average rate received and maturity dates for the interest rate exchange agreements to which the Company was a party at May 31, 2005.

(Dollar amounts in millions)		Notional					Notional Amortization and Maturities
		Principal															Remaining
	Instruments	Amount			Fair Value		2006		2007		2008		2009		2010		Years
Interest rate exchange agreements		$	13,693		$	208	$	2,900	$	1,915	$	884	$	839	$	1,853	$	5,302
Average rate paid			4.225	%
Average rate received			4.848	%

The following table provides the notional amount in U.S. dollars, average exchange rate and maturity dates for the cross currency and cross currency interest rate exchange agreements to which the Company was a party at May 31, 2005.

(Dollar amounts in millions)			Notional				Notional Amortization and Maturities
			Principal															Remaining
	Instruments		Amount			Fair Value		2006		2007		2008		2009		2010		Years
Cross currency and cross currency
interest rate exchange agreements		$	1,106		$	298	$	390	$	716	$	-	$	-	$	-	$	-
Average exchange rate - Euro			1.032
Average exchange rate - Australian dollar			1.506

~~The following table provides~~At May 31, 2005 and 2004, the Company was a party to interest rate exchange agreements with a total notional amount ~~average~~of $13,693 million and $15,485 million, respectively. The Company uses interest rate ~~paid, average~~exchange agreements as part of its overall interest rate ~~received and maturity dates for~~matching strategy. Interest rate exchange agreements are used when they provide the Company a lower cost of funding or minimize interest rate risk. The Company will enter into interest rate exchange agreements only with highly rated financial institutions. CFC was using interest rate exchange agreements to ~~which CFC was a party at~~synthetically change the interest rate on $6,643 million as of May 31, ~~2003.~~2005 and $7,435 million as of May 31, 2004 of debt used to fund long-term fixed rate loans from a variable rate to a fixed rate. Interest rate exchange agreements were used to synthetically change the interest rates from fixed to variable on $7,050 million and $8,050 million, respectively, of collateral trust bonds and medium-term notes as of May 31, 2005 and 2004. The Company has not invested in derivative financial instruments for trading purposes in the past and does not anticipate doing so in the future.

(Dollar amounts in millions)
Notional
Notional Amortization and Maturities
Principal
Remaining
Instruments
Amount
Fair Value
2004
2005
2006
2007
2008
Years
Interest rate exchange agreements
$
15,345
$
450
$
2,177
$
2,942
$
3,198
$
1,160
$
682
$5,186
Average rate paid
3.28%
Average rate received
3.86%

~~The following table provides~~As of May 31, 2005 and 2004, the ~~notional amount in U.S. dollars, average exchange rate and maturity dates for the~~Company was a party to cross currency and cross currency interest rate exchange agreements with a total notional amount of $1,106 million related to ~~which CFC was~~medium-term notes denominated in foreign currencies. Cross currency and cross currency interest rate exchange agreements with a ~~party~~total notional amount of $824 million at May 31, ~~2003.~~2005 and 2004 in which CFC receives Euros and pays U.S. dollars, and $282 million at May 31, 2005 and 2004 in which CFC receives Australian dollars and pays U.S. dollars, are used to synthetically change the foreign denominated debt to U.S. dollar denominated debt. In addition, cross currency interest rate exchange agreements totaling $716 million at May 31, 2005 and 2004 synthetically change the interest rate from the fixed rate on the foreign denominated debt to variable rate U.S. denominated debt or from a variable rate on the foreign denominated debt to a U.S. denominated variable rate.

The Company enters into an exchange agreement to sell the amount of foreign currency received from the investor for U.S. dollars on the issuance date and to buy the amount of foreign currency required to repay the investor principal and interest due through or on the maturity date. By locking in the exchange rates at the time of issuance, the Company has eliminated the possibility of any currency gain or loss (except in the case of the Company or a counterparty default or unwind of the transaction) which might otherwise have been produced by the foreign currency borrowing.

(Dollar amounts in millions)
Notional
Notional Amortization and Maturities
Principal
Remaining
Instruments
Amount
Fair Value
2004
2005
2006
2007
2008
Years
Cross currency and cross currency
interest rate exchange agreements
$
1,262
$
356
$
439
$
-
$
390
$
433
$
-
$
-
Average exchange rate - Euro
1.069

Market Risk

~~CFC's~~The Company's primary market risks are interest rate risk and liquidity risk. ~~CFC~~The Company is also exposed to counterparty risk as a result of entering into interest rate, cross currency and cross currency interest rate exchange agreements.

The interest rate risk exposure is related to the funding of the fixed rate loan portfolio. ~~CFC~~The Company does not match fund the majority of its fixed rate loans with a specific debt issuance at the time the loan is advanced. ~~CFC~~The Company aggregates fixed rate loans until the volume reaches a level that will allow an economically efficient issuance of debt. ~~CFC~~The Company uses fixed rate collateral trust bonds, medium-term notes, subordinated deferrable debt, members' subordinated certificates, members' equity and variable rate debt to fund fixed rate loans. ~~CFC~~The Company allows borrowers flexibility in the selection of the period for which a fixed interest rate will be in effect. Long-term loans typically have a 15 to 35 year maturity. Borrowers may select fixed interest rates for periods of one year through the life of the loan. To mitigate interest rate risk in the funding of fixed rate loans, ~~CFC~~the Company performs a monthly gap analysis, a comparison of fixed rate assets repricing or maturing by year to fixed rate liabilities and members' equity maturing by year (see chart on page ~~50)~~45). The analysis ~~will indicate~~indicates the total amount of fixed rate loans maturing by year and in aggregate that are assumed to be funded by variable rate debt. ~~CFC's~~The Company's funding objective is to limit the total amount of fixed rate loans that are funded by variable rate debt to 3% or less of total assets, excluding derivative assets. At May 31, ~~2003~~2005 and ~~2002,~~2004, fixed rate loans funded with variable rate debt represented ~~1.31%~~2.84% and ~~0.43%~~1.18% of total assets, respectively, and 2.92% and 1.22% of total assets excluding derivative assets, respectively. At May 31, ~~2003, CFC~~2005, the Company had ~~$260~~$569 million of excess fixed rate assets compared to fixed rate liabilities and members' equity. The interest rate risk is deemed minimal on variable rate loans, since the loans may be priced semi-monthly based on the cost of the debt used to fund the loans. ~~CFC~~The Company uses variable rate debt, members' subordinated certificates and members' equity to fund variable rate loans. At May 31, ~~2003~~2005 and ~~2002, 36% and 44%, respectively,~~2004, 32% of loans carried variable interest rates.

~~CFC~~The Company faces liquidity risk in the funding of its loan portfolio. ~~CFC~~The Company offers long-term loans with maturities of up to 35 years and line of credit loans that are required to be paid down annually. On long-term loans, ~~CFC~~the Company offers a variety of interest rate options including the ability to fix the interest rate for terms of 1one year through maturity. At May 31, ~~2003, CFC~~2005, the Company has a total of ~~$2,911~~$3,591 million of long-term debt maturing ~~prior to May 31, 2004, excluding $150 million of foreign currency valuation related to medium-term notes. CFC~~during the next twelve months. The Company funds the loan portfolio with a variety of debt instruments and its members' equity. ~~CFC~~The Company typically does not match fund each of its loans with a debt instrument of similar final maturity. Debt instruments such as subordinated certificates have maturities that vary from the term of the associated loan or guarantee to 100 years and subordinated deferrable debt has been issued with maturities of up to 49 years. ~~CFC~~The Company may issue collateral trust bonds and medium-term notes for periods of up to 30 years, but typically issues such debt instruments with maturities of 2, 3, 5, 7 and 10 years. Debt instruments such as commercial paper and bank bid notes typically have maturities of 90 days or less. Therefore, ~~CFC~~the Company is at risk if it is not able to issue new debt instruments to replace debt that matures prior to the maturity of the loans for which they are used as funding. Factors that mitigate liquidity risk include ~~CFC~~the Company maintenance of back-up liquidity through revolving credit agreements with domestic and foreign banks and a large volume of scheduled principal repayments received on an annual basis. At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had a total of ~~$3,806~~$5,000 million and ~~$4,562~~$4,650 million in revolving credit agreements and bank lines of credit. ~~On June 30, 2003, this~~In addition, the Company limits the amount ~~increased~~of dealer commercial paper and bank bid notes used in the funding of loans. The Company's objective is to maintain the amount of dealer commercial paper and bank bid notes used to 15% or less of total debt outstanding. At May 31, 2005 and 2004, there was a total of ~~$3,951 million.~~$2,973 million and $2,399 million, respectively, of dealer commercial paper and bank bid notes outstanding, representing 16% and 12%, respectively, of the Company's total debt outstanding.

To facilitate entry into the debt markets, ~~CFC~~the Company maintains high credit ratings on all of its debt issuances from three credit rating agencies (see chart on page ~~54)~~49). ~~CFC~~The Company also maintains shelf registrations with the SEC for its collateral trust bonds, medium-term notes and subordinated deferrable debt. At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had effective shelf registrations totaling ~~$1,375 million and $2,875~~$2,075 million related to collateral trust bonds, ~~$3,143~~$4,244 million and ~~$5,299~~$4,534 million related to medium-term notes and ~~$150~~$165 million and ~~$75~~$300 million related to subordinated deferrable debt, respectively. All of the registrations allow for issuance of the related debt at both variable and fixed interest rates. ~~CFC~~The Company also has commercial paper and medium-term note issuance programs in ~~Europe.~~Europe and Australia. At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had ~~zero~~$818 million and ~~$85~~$217 million of commercial paper, respectively, and ~~$1,637~~$1,045 million and ~~$1,705~~$1,035 million, respectively, of medium-term notes outstanding under the European program and $321 million and $304 million, respectively, of medium-term notes outstanding ~~to European and Asia Pacific investors.~~under the Australian program. At May 31, ~~2003, CFC~~2005, the Company had total internal issuance authority totaling $1,000 million and $4,000 million related to commercial paper and ~~$4,000~~medium-term notes in the European market, respectively, and $2,000 million related to medium-term notes ~~under these programs.~~in the Australian market.

~~CFC~~The Company is exposed to counterparty risk related to the performance of the parties with which it has entered into interest rate, cross currency and cross currency interest rate exchange agreements. To mitigate this risk, ~~CFC~~the Company only enters into these agreements with financial institutions with investment grade ratings. At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company was a party to interest rate exchange agreements with notional amounts totaling ~~$15,345~~$13,693 million and ~~$12,667~~$15,485 million, respectively, and cross currency and cross currency interest rate exchange agreements with notional amounts totaling ~~$1,262 million and $1,408 million, respectively.~~$1,106 million. To date, ~~CFC~~the

Company has not experienced a failure of a counterparty to perform as required under any of these agreements. At May 31, ~~2003, CFC's~~2005, the Company's interest rate, cross currency and cross currency interest rate exchange agreement counterparties had credit ratings ranging from ~~BBB+~~AAA to ~~AAA~~BBB as assigned by Standard & Poor's Corporation.

~~CFC~~The Company currently uses ~~three~~two types of interest rate exchange agreements: (1) ~~CFC~~the Company pays a fixed rate and receives a variable rate and (2) ~~CFC pays a variable rate and receives a different variable rate and (3) CFC~~the Company pays a variable rate and receives a fixed rate. The following chart provides a breakout of the interest rate exchange agreements at May 31, ~~2003~~2005 by type of agreement.

(Dollar amounts in millions)
Notional Amount
Average Rate Paid
Average Rate Received
Pay fixed / receive variable
$
6,595
4.343%
1.253%
Pay variable / receive variable
700
1.341%
1.320%
Pay variable / receive fixed
8,050
2.572%
6.209%
Total
$
15,345
3.277%
3.856%

(Dollar amounts in millions)	Notional Amount		Average Rate Paid		Average Rate Received
Pay fixed / receive variable	$	6,643		3.906%		3.282%
Pay variable / receive fixed		7,050		4.526%		6.323%
Total	$	13,693		4.225%		4.848%

Foreign Currency Risk

~~CFC~~The Company may issue commercial paper, medium-term notes or bonds denominated in foreign currencies. For any such obligation issued, ~~CFC~~the Company expects to enter into a cross currency or cross currency interest rate exchange agreement with a highly-rated counterparty. At May 31, ~~2003, CFC~~2005, the Company had a total of ~~$1,262~~$824 million and $282 million of medium-term notes denominated in Euros and Australian dollars, respectively, for which cross currency and cross currency interest rate exchange agreements were in place obligating ~~CFC~~the Company to pay interest and principal in U.S. dollars based on an exchange rate fixed at the date of issuance. At May 31, ~~2002, this amount was $1,262~~2004, CFC had $824 million and ~~$146~~$282 million of medium-term notes denominated in Euros and ~~Yen, respectively. CFC's~~Australian dollars. The Company's foreign currency valuation account, which represents the change in the foreign exchange rate from the date of issuance to the reporting date, increased the debt balance by ~~$326~~$261 million and ~~decreased the debt balance by $2~~$234 million at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively. The change in the value of the foreign denominated debt ~~was offset by~~is reported in the consolidated and combined statements of operations as foreign currency adjustments. The change in the fair value of cross currency exchange agreements that qualify for hedge accounting is initially recorded to accumulated other comprehensive income and then reclassified to foreign currency adjustments. The change in the fair value of the foreign denominated debt and the change in the fair value of the related cross currency and cross currency interest rate exchange agreements are approximately the same amount and offsetting in the consolidated and combined statements of operations. The change in the fair value of the cross currency and ~~cross currency~~ interest rate exchange ~~agreements.~~agreements that do not qualify for hedge accounting is recorded to the derivative forward value line.

Rating Triggers

~~There are rating triggers associated with $11,059 million notional amount of~~The Company has interest rate, cross currency, and cross currency interest rate exchange ~~agreements. The rating triggers are based on CFC's senior unsecured~~agreements that contain a condition that will allow one counterparty to terminate the agreement if the credit rating ~~from Standard & Poor's Corporation and Moody's Investors Service (medium-term note ratings from chart below). If~~of the other counterparty drops to a certain level. This condition is commonly called a rating trigger. Under the rating trigger, if the credit rating for either counterparty falls ~~below~~to the level specified in the agreement, the other counterparty may, but is not obligated to, terminate the agreement. If either counterparty terminates the agreement, a net payment may be due from one counterparty to the other based on the fair value of the underlying derivative instrument. Rating triggers are not separate financial instruments and are not separate derivatives under SFAS 133. The Company's rating triggers are based on its senior unsecured credit rating from Standard & Poor's Corporation and Moody's Investors Service. At May 31, 2005, there are rating triggers associated with $10,625 million notional amount of interest rate, cross currency and cross currency interest rate exchange agreements. If ~~CFC's~~the Company's rating from Moody's Investors Service falls to Baa1 or ~~CFC's~~the Company's rating from Standard & Poor's Corporation falls to BBB+, the counterparties may terminate agreements with a total notional amount of ~~$2,183~~$1,125 million. If ~~CFC's~~the Company's rating from Moody's Investors Service falls below Baa1 or ~~CFC's~~the Company's rating from Standard & Poor's Corporation falls below BBB+, the counterparties may terminate the agreements on the remaining total notional amount of ~~$8,876~~$9,500 million.

At May 31, ~~2003, CFC~~2005, the Company 's exchange agreements had a derivative fair value of ~~$116~~$44 million, comprised of ~~$186~~$47 million that would be due to ~~CFC~~the Company and ~~$70~~$3 million that ~~CFC~~the Company would have to pay if all interest rate, cross currency and cross currency interest rate exchange agreements with a rating trigger at the level of BBB+ or Baa1 and above were to be terminated, and a derivative fair value of ~~$405~~$271 million, comprised of ~~$573~~$316 million that would be due to ~~CFC~~the Company and ~~$168~~$45 million that ~~CFC~~the Company would have to pay if all interest rate, cross currency and cross currency interest rate exchange agreements with a rating trigger below the level of BBB+ or Baa1 were to be terminated. See chart on page 49 for CFC's senior unsecured credit ratings as of May 31, 2005.

Credit Ratings

~~CFC's~~

The Company's long- and short-term debt and guarantees are rated by three of the major credit rating agencies, Moody's Investors Service, Standard & Poor's Corporation and Fitch Ratings. The following table presents ~~CFC's~~the Company's credit ratings at May 31, ~~2003~~2005 and ~~2002.~~2004.

Moody's Investors

Standard & Poor's

Service

Corporation

Fitch Ratings

Direct:

Collateral trust bonds

A+

Medium-term notes

Subordinated deferrable debt

BBB+

A-

Commercial paper

P-1

A-1

F-1

Guarantees:

Leveraged lease debt

Pooled bonds

Other bonds

Short-term

P-1

A-1

F-1

The ratings listed above have the meaning as defined by each of the respective rating agencies, are not recommendations to buy, sell or hold securities and are subject to revision or withdrawal at any time by the rating organizations.

As a result of the level of exposure to CoServ and telecommunications systems, as well as the general negative outlook for electric utilities related to energy trading and the problems experienced in California, Moody's Investors Service has CFC's ratings on negative outlook. Fitch Ratings and Standard & Poor's Corporation, ~~revised CFC's~~Moody's Investors Service, and Fitch Ratings have the Company's ratings ~~outlook from negative to~~on stable ~~on October 28, 2002 and July 15, 2003, respectively.~~outlook.

Member Investments

At May 31, ~~2003~~2005 and ~~2002, CFC's members~~2004, members' investments provided ~~17.9%~~17.7% and ~~16.4%~~16.9%, respectively, of ~~adjusted~~ total ~~capitalization~~assets as follows:

MEMBERSHIP INVESTMENTS

(Dollar amounts in millions)	2005			% of Total (1)			2004			% of Total (1)
Commercial paper (2)	$	1,260			30	%	$	1,196			34	%
Medium-term notes		275			4	%		275			4	%
Members' subordinated certificates		1,491			100	%		1,665			100	%
Members' equity (3)		524			100	%		483			100	%
Total	$	3,550					$	3,619
Percentage of total assets		17.7	%					16.9	%
Percentage of total assets less derivative assets (3)		18.2	%					17.3	%
______________________
(1) Represents the percentage of each line item outstanding to CFC members.
(2) Includes the $271 million and $223 million related to the daily liquidity fund at May 31, 2005 and 2004, respectively.
(3) See "Non-GAAP Financial Measures" for further explanation and a reconciliation of the adjustments made to total capitalization and a breakout of members' equity.

~~MEMBERSHIP CONTRIBUTIONS TO TOTAL CAPITALIZATION~~

(Dollar amounts in millions)
2003
% of Total (1)
2002
% of Total (1)
Commercial paper (2)
$
1,041
55
%
$
956
30
%
Medium-term notes
297
3
%
235
3
%
Members' subordinated certificates
1,708
100
%
1,692
100
%
Members' equity (3)
454
100
%
392
100
%
Total
$
3,500
$
3,275
Percentage of total capitalization
17.2
%
16.5
%
Percentage of adjusted total capitalization (3)
17.9
%
16.4
%


~~(1)Represents the percentage of each line item outstanding to CFC members.~~
~~(2)Includes the $111 million and $45 million related to the daily liquidity fund at May 31, 2003 and 2002, respectively.~~
~~(3)See "Non-GAAP Financial Measures" for further explanation and a reconciliation of the adjustments made to total capitalization and a breakout of members' equity~~

The total amount of member investments ~~increased $225~~decreased $69 million at May 31, ~~2003~~2005 compared to May 31, ~~2002~~2004 due to the ~~$85~~$174 million decrease in members' subordinated certificates offset by the $64 million increase in member commercial paper and the ~~$62 million increase in member medium-term notes, the $16~~$41 million increase in members' ~~subordinated certificates and the $62 million increase in members'~~ equity. Total commercial paper decreased during the year ended May 31, 2003 by $1,251 million, while the member commercial paper investments increased by $85 million. The impact of this activity was an increase in the percentage of member investments as compared to total investments. Total capitalization includes notes payable, long-term debt, subordinated deferrable debt, members' subordinated certificates and total equity. Total capitalization at May 31, 2003 was $20,386 million compared to $19,890 million at May 31, 2002. Adjusted total capitalization excludes the derivative long-term debt valuation allowance and the foreign currency valuation account from total liabilities and excludes the impact of SFAS 133 and foreign currency adjustments from total equity. Adjusted total capitalization at May 31, 2003 and 2002, was $19,585 million, a decrease of $369 million compared to the adjusted total capitalization of $19,954 million at May 31, 2002. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of adjustments made to total capitalization. When the loan loss allowance is added to both membership contributions and adjusted total capitalization, the percentages of membership investments to adjusted total capitalization are 20.2% and 18.5% at May 31, 2003 and May 31, 2002, respectively.

Financial and Industry Outlook

Loan Growth

~~During the year ended May 31, 2003, CFC experienced a decrease in gross loans outstanding of $563 million or 3%. It is anticipated~~The Company expects that the balance of the loan portfolio will remain relatively stable ~~during~~or decline slightly in the ~~next few years.~~event that certain telecommunications borrowers make prepayments on their loans. For its fiscal year ending September 30, ~~2004,~~2006, the amount of funding proposed by the House of Representatives for RUS ~~has authority for~~ direct lending ~~of $2.0~~and loan guarantees is $1.2 billion and $2.1 billion, respectively. The Senate Appropriations Committee approved the same amounts proposed by the House of ~~authority~~Representatives except for an additional $700 million for loan guarantees. Loans from the ~~FFB~~Federal Financing Bank ("FFB") with an RUS guarantee represent a lower cost option for rural electric utilities compared to ~~CFC. CFC~~the Company. The Company anticipates that the majority of its electric loan growth will come from distribution system borrowers that have fully prepaid their RUS loans and ~~cannot borrow under~~choose not to return to the ~~insured~~government loan program, ~~from RUS for ten years after the prepayment,~~ from distribution system borrowers that ~~cannot~~do not want to wait the 12 to 24 months it may take RUS to process and fund the loan and from power supply systems. ~~CFC~~The Company anticipates that the ~~telecommunications~~RTFC loan balance will continue to decline ~~slightly~~ due to ~~the slower pace~~long-term loan amortization and lower levels of ~~both infrastructure~~ capital expenditure requirements and asset ~~acquisitions.~~acquisitions in the rural telecommunications marketplace.

Liquidity

At May 31, ~~2003, CFC~~2005, the Company had ~~$1,986~~$4,361 million of commercial paper, daily liquidity fund and bank bid notes and ~~$2,911~~$3,591 million of medium-term notes, ~~and~~ collateral trust bonds and long-term notes payable scheduled to mature during the next twelve ~~months, excluding $150 million of foreign currency valuation. CFC's members~~months. Members held commercial paper (including the daily liquidity fund) totaling ~~$1,041~~$1,260 million or approximately ~~55%~~30% of the total commercial paper outstanding at May 31, ~~2003.~~2005. Commercial paper issued through dealers and bank bid notes represented ~~less than 5%~~16% of ~~CFC's~~ total debt outstanding at May 31, ~~2003. CFC~~2005. The Company intends to maintain the balance of dealer commercial paper and bank bid notes at 15% or less of total debt outstanding during fiscal year ~~2004.~~2006. During the next twelve months, ~~CFC~~the Company plans to refinance the ~~$2,911~~$3,591 million of medium-term notes, ~~and~~ collateral trust bonds ~~maturing~~and long-term notes payable and fund new loan growth ~~with loan repayments from borrowers and~~ by issuing a combination of commercial paper, medium-term notes, ~~and~~ collateral trust ~~bonds.~~bonds and other debt. At May 31, ~~2003, CFC~~2005, the Company had effective registration statements covering ~~$1,375~~$2,075 million of collateral trust bonds, ~~$3,143~~$4,244 million of medium-term notes and ~~$150~~$165 million of subordinated deferrable debt. ~~CFC may increase~~In addition, the ~~use of commercial paper in the funding of loans in fiscal year 2004, although it will plan to maintain the balance within the limit described above. CFC~~Company limits the amount of commercial paper issued to the amount of back-up liquidity provided by its revolving credit agreements so that there is 100% coverage of outstanding commercial paper. ~~In addition, CFC~~The Company has Board authorization to issue up to $1,000 million of commercial paper and $4,000 million of medium-term notes in the European market and ~~2,000~~$2,000 million ~~Australian dollars~~ of medium-term notes in the Australian market. ~~Subsequent~~

In June 2005, CFC entered into a bond purchase agreement with the FFB and a bond guarantee agreement with RUS resulting in a $1 billion loan facility under the Rural Electric Development Loan and Guarantee ("REDLG") program. Under this program, CFC is eligible to borrow up to the amount of the outstanding loans that it has issued concurrent with RUS loans. At May 31, 2005, CFC had a total of $2,681 million outstanding on loans issued concurrently with RUS. Under the program, CFC will pay a fee of 30 basis points per annum to RUS for the guarantee of principal and interest payments to FFB. In July 2005, CFC submitted a second application for an additional $1.5 billion facility. CFC has applied for an advance of $450 million and anticipates the advance to occur by the end of the year, in July 2003, CFC's Board gave staff the authority to increase the effective shelf registrations for medium-term notes, collateral trust bonds and subordinated deferrable debt by $2,000 million, $2,000 million and $500 million, respectively.August 2005.

In July 2005, the Company sold $500 million of 4.656% notes to the Federal Agricultural Mortgage Corporation due in 2008 and secured by the pledge of CFC mortgage notes.

Equity Retention

~~CFC made policy~~At May 31, 2005, the Company reported total equity of $769 million, an increase of $73 million from $696 million reported at May 31, 2004. Under GAAP, the Company's reported equity balance fluctuates based on the impact of future expected changes to interest rates on the fair value of its interest rate exchange agreements and the impact of future expected currency exchange rates on its currency exchange agreements. It is difficult to predict the future changes in ~~fiscal~~the Company's reported GAAP equity, due to the uncertainty of the movement in future interest and currency exchange rates. In its internal analysis and for purposes of covenant compliance under its credit agreements, the Company adjusts equity to exclude the non-cash impacts of SFAS 133 and 52.

The Company believes the adjusted equity balance as reported in the Non-GAAP Financial Measure section of this report will continue to increase. The Company has established a members' capital reserve to which a portion of adjusted net margin may be allocated each year. The balance of the members' capital reserve was $164 million at May 31, 2005. The adjusted equity total typically declines slightly in the first quarter each year ~~2000 that were intended~~due to the retirement of patronage capital to its members. Then over the remaining three quarters of the year the accumulated adjusted net margin for the period is typically sufficient to increase the ~~amount~~adjusted equity to a level greater than the prior year end. The same condition may or may not be true for the GAAP reported equity, which will depend on the impact of ~~equity retained. During fiscal year 2002,~~future expected changes to interest and currency exchange rates on the balance of members' equity and subordinated certificates increased by $108 million. During the year ended May 31, 2003, the balance of members' equity and subordinated certificates increased by $79 million. The decrease in loans outstanding reduced the growth in members' equity during fiscal year 2003. However, the decrease in loans outstanding has also reduced the required provision to CFC's loan loss allowance. During the year ended May 31, 2003, CFC experienced an increase of $619 million to total equity and members' certificates. A total of $540 million of this increase was as a result of a net increase in the forwardfair value of ~~its derivatives~~interest rate and ~~foreign~~ currency ~~adjustments.~~exchange agreements. See "Non-GAAP Financial Measures" for further explanation of the adjustments made to exclude the non-cash impacts of SFAS 133 and 52 and for a reconciliation of the ~~adjustments~~non-GAAP measures to ~~TIER.~~the applicable GAAP measures.

Adjusted Gross Margin

~~The~~It is anticipated that the adjusted gross margin ~~earned on loans,~~spread for fiscal year 2006 will be approximately the same as or slightly lower than the 84 basis points for the year ended May 31, ~~2003 was 1.33%, which represents a decrease from the 1.69% earned for the year ended May 31, 2002.~~2005. The decrease was due to increases in the cost of funding as a result of issuing long-term debt to refinance commercial paper which were not passed on to borrowers. CFC lowered its long-term variable interest rates by 85 basis points and its line of credit interest rates by 100 basis points during fiscal year 2003. CFC was able to lower its interest rates due to the reduction to the rates on short-term funding as a result of reductions made by the Federal Reserve and due to a smaller loan loss provision as compared to the prior year. CFC has lowered its variable interest rates by an additional 55 basis points since May 31, 2003. This level of reduction to interest rates will most likely not occur in the cost of funding, thus the gross margin spread should decrease below the 1.33% for the year ended May 31, 2003. CFC'sCompany's goal as a not-for-profit, member-owned financial cooperative is to provide financial products and services to its members at the lowest rates possible after covering all expenses and maintaining a reasonable net margin. Thus, ~~CFC~~the Company does not try to maximize the adjusted gross margin it earns on its loans to members. ~~As long as CFC meets its operating goal of a 1.12 adjusted TIER, CFC does not intend to pass the increase in its cost of funding on to its borrowers.~~ See "Non-GAAP Financial Measures" for further explanation and a reconciliation of the adjustments to gross margin and TIER.

Adjusted Leverage and Adjusted Debt to Equity Ratios

~~During~~The Company expects the ~~year ended May 31, 2003, CFC's adjusted leverage and adjusted debt to equity~~ ratios ~~decreased. The adjusted leverage ratio decreased from 7.18~~ at May 31, ~~2002~~2006 to ~~6.63~~be slightly lower than at May 31, ~~2003.~~2005 due to an expected decrease in debt outstanding. The Company expects that adjusted ~~debt~~net margins earned during fiscal year 2006 will offset the reduction to members' equity ~~ratio decreased from 5.40 at May 31, 2002~~in the first quarter due to ~~4.96 at May 31, 2003.~~the retirement of previously allocated net margins. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of ~~these adjustments. CFC expects~~ the ~~debt~~adjustments to equity and leverage ratios to increase slightly in the first quarter of fiscal year 2004 due to the retirement of allocated net margins from fiscal years 1991, 1992, 1993 and 2003. CFC expects the ratios at May 31, 2004 to be at the same level or slightly lower than they were at May 31, 2003. CFC expects that net margins earned during fiscal year 2004 will offset the reduction to equity in the first quarter due to the retirement of allocated net margins.

Loan Impairment

When ~~CFC's~~the Company's variable interest rates increase, the calculated loan impairment for certain restructured loans will increase and when ~~CFC's~~the Company's variable interest rates decrease, the calculated impairment will decrease. The calculated impairment under SFAS 114, as amended, represents an opportunity cost, as it is a comparison of the yield that ~~CFC~~the Company would have earned on the original loan versus the expected yield on the restructured loan. ~~CFC~~The Company will have to adjust the specific reserve it holds for impaired loans based on changes to its variable interest rates, which could impact the balance of the loan loss allowance and the ~~combined statement~~consolidated statements of operations through an increased provision for loan losses or as an increase to income through the recapture of amounts previously included in the provision for loan losses. ~~CFC's~~Based on market expectations, it is anticipated that the Company's long-term variable and line of credit interest ~~rates are currently at historic low levels, therefore CFC expects that these~~ rates may increase in the near term resulting in an increase to calculated impairments. As ~~CFC's~~the Company's interest rates increase, its operating income and gross margin will increase giving it the financial flexibility to provide for additions to the loan loss allowance to cover increased loan impairments. At this time, an increase of 25 basis points to ~~CFC's~~the Company's variable interest rates results in an increase of ~~$13~~$10 million to the calculated impairment.

CoServ

CoServ made the required quarterly payments on March 31, 2003 and June 30, 2003. These payments are scheduled to continue for 35 years and should total approximately $975 million. CFC will maintain the CoServ loan on non-accrual status in the near future. CFCThe Company may ~~also~~ be required to provide up to $200 million of additional senior secured capital expenditure loans to CoServ ~~over the next 10 years.~~through December 2012. If CoServ requests capital expenditure loans from ~~CFC,~~the Company, these loans will be provided at the standard terms offered to all borrowers and will require debt service payments in addition to the quarterly payments that CoServ will make to ~~CFC.~~the Company.

Under the terms of the restructure agreement, CoServ has the option to prepay the restructured loan for $415 million plus an interest payment true up anytime on or after December 13, 2007 and for $405 million plus an interest payment true up anytime on or after December 13, 2008. If CoServ were to elect to prepay the restructured loan on December 13, 2007, it would be required to make a payment of $433 million to the Company, representing $415 million for the contractual prepayment plus $18 million of interest. Assuming that the Company continues to receive all required quarterly payments from CoServ and applies all such payments to principal, the estimated loan balance would be $532 million at December 13, 2007. If CoServ were to elect to prepay the restructured loan on December 13, 2008, it would be required to make a payment of $423 million to the Company, representing $405 million for the contractual prepayment plus $18 million of interest. Assuming that the Company continues to receive all required quarterly payments from CoServ and applies all such payments to principal, the estimated loan balance would be $505 million at December 13, 2008.

VarTec and ICC

The Company is currently in litigation related to the collection of amounts due from RTFC borrowers VarTec and ICC. While the Company believes it has valid claims against and is the primary secured creditor to both borrowers, there is always some level of uncertainty associated with litigation. VarTec has entered into agreements to sell substantially all of its operating assets and its remaining assets represent various claims that the estate has against third parties. It is expected that the VarTec loan will remain on non-accrual status with respect to the recognition of interest income while the sale of its domestic assets is finalized. The ICC litigation is expected to last for the next 12 to 18 months. As a result of the recent missed payments, RTFC has placed ICC on non-accrual status as of February 1, 2005. The Company will continue to adjust the loan loss allowance held for both VarTec and ICC based on the most current information available.

Credit Concentration

Total loans and guarantees outstanding to the ten largest borrowers at May 31, 2003 totaled $5,378 million and represented 25% of CFC's total loans and guarantees outstanding, a decrease from $5,893 million representing 27% of total loans and guarantees at May 31, 2002. The ten largest borrowers are all expected to perform according to the terms of their loan agreements during fiscal year 2004. CFC plans to strictly monitor the amount of loans extended to its largest borrowers to manage ~~the~~its credit concentration downward.

Loan Loss Allowance

In fiscal year 2003, CFC wrote off a total of $11 million and had recoveries of $1 million related to prior year write-offs, for a total net write-off of $10 million. This increased the net total write-offs since inception to $116 million. At this time it is difficult to estimate the total amount of loans that will be written off during fiscal year ~~2004. CFC does not anticipate any~~2006. Due to the consolidation with NCSC, there will be write-offs ~~related to its ten largest borrowers during fiscal year 2004. CFC~~and recoveries reported every quarter. There are write-offs and recoveries taken by NCSC each quarter in the consumer loan program. These amounts are relatively insignificant and have historically been less than $1 million per quarter. The Company believes that the current loan loss allowance of ~~$565~~$590 million, which includes specific reserves of ~~$164~~$404 million for impaired borrowers, and the loan loss provision, if any, during fiscal year ~~2004~~2006 will be sufficient to allow the loan loss allowance to be adequate at May 31, ~~2004.~~2006.

Foreclosed Assets

In August 2005, the Company sold real estate assets for $30 million. The Company acquired these real estate assets as part of a bankruptcy settlement in 2002. The real estate assets sold by the Company had been accounted for as foreclosed assets. The Company estimates that its fiscal year 2006 first quarter results of operations of foreclosed assets will include a gain of approximately $2 million from the sale.

~~Credit Ratings~~51

In January 2002, Standard & Poor's Corporation, Moody's Investors Service and Fitch Ratings, downgraded CFC's debt ratings by one tick and placed CFC's long-term ratings on negative outlook. Fitch Ratings and Standard & Poor's Corporation revised CFC's ratings outlook from negative to stable on October 28, 2002 and July 15, 2003, respectively. CFC has taken actions to reduce the level of commercial paper outstanding, increase equity retention, manage the adjusted debt to equity and adjusted leverage ratios and experienced positive performance in its loan portfolio. CFC believes that these actions represent significant progress toward meeting the expectations of the agencies. CFC has meetings scheduled with all three rating agencies in August and September 2003 to review the fiscal year 2003 operating results.

Accounting for Derivatives and Foreign Denominated Debt

On June 1, 2001, CFC implemented SFAS 133. At May 31, 2003, CFC had a derivative asset of $1,160 million, a derivative liability of $355 million and a long-term debt valuation allowance that decreases long-term debt by $1 million. Accumulated other comprehensive losses from inception to date for derivatives were $47 million at May 31, 2003. During the year ended May 31, 2003, CFC was required to recognize income, representing the derivative forward value and amortization related to the transition adjustment and long-term debt valuation allowance, of $757 million. CFC also recognized expense of $243 million for the year ended May 31, 2003 representing the change in foreign currency exchange rates at the reporting date. CFC's total equity increased by $602 million during fiscal year 2003, $540 million of which was due to required SFAS 133 and ~~SFAS~~ 52 ~~entries~~have resulted in and are expected to ~~record the increase~~continue to result in a significant amount of volatility in the ~~forward value~~Company's GAAP financial results. The Company does not anticipate such volatility in its own financial analysis that is adjusted to exclude the non-cash impacts of ~~interest rate, cross currency~~SFAS 133 and ~~cross currency interest rate exchange agreements offset by the change in value at the reporting date of foreign denominated debt. As interest rates~~52. See "Non-GAAP Financial Measures" for further explanation and ~~currency exchange rates in the capital markets increase or decrease, the fair value~~a reconciliation of these derivative instruments will change. As a result of implementing SFAS 133, CFC has experienced and anticipates continued increased volatility in reported net margin, other comprehensive income or loss and the total equity balance. CFC is neither a dealer nor trader of derivatives and intends to hold all derivatives through maturity. The adjustments made to record the forward value of derivatives and the outstanding balance of foreign denominated debt based on current exchange rates on the combined balance sheet do not represent current cash flows, but rather an estimate of the net present value of all future cash settlements on derivatives based on the future expectation of interest rates through maturity of CFC's derivatives and the change in foreign currency exchange rates at the reporting date.adjustments.

The forward-looking statements are based on management's current views and assumptions regarding future events and operating performance. ~~CFC~~The Company undertakes no obligation to publicly update or revise any forward-looking statements to reflect circumstances or events that occur after the date the forward-looking statements are made.

Non-GAAP Financial Measures

The Company makes certain adjustments to financial measures in assessing its financial performance that are not in accordance with GAAP. These non-GAAP adjustments fall primarily into two categories: (1) adjustments related to the calculation of the TIER ratio, and (2) adjustments related to the calculation of leverage and debt to equity ratios. These adjustments reflect management's perspective on the Company's operations, and in several cases adjustments used to measure covenant compliance under its revolving credit agreements, and thus the Company believes these are useful financial measures for investors. The Company refers to its non-GAAP financial measures as "adjusted" throughout this document.

Adjustments to the Calculation of the TIER Ratio

The Company's primary performance measure is TIER. TIER is calculated by adding the cost of funds to net margin prior to the cumulative effect of change in accounting principle and dividing that total by the cost of funds. The TIER is a measure of the Company's ability to cover interest expense requirements on its debt. The Company adjusts the TIER calculation to add the derivative cash settlements to the cost of funds, to add minority interest net margin back to total net margin and to remove the derivative forward value and foreign currency adjustments from total net margin. Adding the cash settlements back to the cost of funds also has a corresponding effect on the Company's adjusted gross margin and adjusted operating margin. The Company makes these adjustments to its TIER calculation for the purpose of covenant compliance on its revolving credit agreements. The revolving credit agreements require the Company to achieve an average adjusted TIER ratio over the six most recent fiscal quarters of at least 1.025 and prohibit the retirement of patronage capital unless the Company has achieved an adjusted TIER ratio of at least 1.05 for the preceding fiscal year. The Company's average adjusted TIER for the past six quarters was 1.08 and the Company's adjusted TIER for the year ended May 31, 2005 was 1.14. CFC's goal is to maintain a minimum adjusted annual TIER of 1.10.

The Company uses derivatives to manage interest rate and foreign currency exchange risk on its funding of the loan portfolio. The derivative cash settlements represent the amount that the Company receives from or pays to its counterparties based on the interest rate indexes in its derivatives that do not qualify for hedge accounting. The Company adjusts the reported cost of funding to include the derivative cash settlements. The Company uses the adjusted cost of funding to set interest rates on loans to its members and believes that the cost of funds adjusted to include derivative cash settlements represents its total cost of funding for the period. For the purpose of computing compliance with its revolving credit agreement covenants, the Company is required to adjust its cost of funds to include the derivative cash settlements. TIER calculated by adding the derivative cash settlements to the cost of funds reflects management's perspective on its operations and thus, the Company believes that it represents a useful financial measure for investors.

The derivative forward value and foreign currency adjustments do not represent cash inflows or outflows to the Company during the current period. The derivative forward value represents a present value estimate of the future cash inflows or outflows that will be recognized as net cash settlements for all periods through the maturity of its derivatives that do not qualify for hedge accounting. Foreign currency adjustments represent the change in value of foreign denominated debt resulting from the change in foreign currency exchange rates during the current period. The derivative forward value and foreign currency adjustments do not represent cash inflows or outflows that affect the Company's current ability to cover its debt service obligations. The forward value calculation is based on future interest rate expectations that may change daily creating volatility in the estimated forward value. The change in foreign currency exchange rates adjusts the debt balance to the amount that would be due at the reporting date. At the issuance date, the Company enters into a foreign currency exchange agreement for all foreign denominated debt that effectively fixes the exchange rate for all interest and principal payments. For the purpose of making operating decisions, the Company subtracts the derivative forward value and foreign currency adjustments from its net margin when calculating TIER and for other net margin presentation purposes. The covenants in the Company's revolving credit agreements also exclude the effects of derivative forward value and foreign currency adjustments. In addition, since the derivative forward value and foreign currency adjustments do not represent current period cash flows, the Company does not allocate such funds to its members and thus excludes the derivative forward value and foreign currency

adjustments from net margin when making certain presentations to its members and in calculating the amount of net margins to be allocated to its members. TIER calculated by excluding the derivative forward value and foreign currency adjustments from net margin reflects management's perspective on its operations and thus, the Company believes that it represents a useful financial measure for investors.

The implementation of SFAS 133 and foreign currency adjustments have also impacted the Company's total equity. The derivative forward value and foreign currency adjustments flow through the consolidated and combined statements of operations as income or expense, increasing or decreasing the total net margin for the period. The total net margin or net loss for the period represents an increase or decrease, respectively, to total equity. As a result of implementing SFAS 133, the Company's total equity includes other comprehensive income, which represents estimated unrecognized gains and losses on derivatives. The other comprehensive income component of equity does not flow through the consolidated and combined statements of operations. As stated above, the derivative forward value and foreign currency adjustments do not represent current cash inflow or outflow. The other comprehensive income is also an estimate of future gains and losses and as such does not represent earnings that the Company can use to fund its loan portfolio. Financial measures calculated with members' equity, which is total equity excluding the impact of SFAS 133 and foreign currency adjustments, reflect management's perspective on its operations and thus, the Company believes that they represent a useful measure of its financial condition.

	Year Ended May 31,
	2005			2004			2003
(Dollar amounts in thousands)
Cost of funds	$	(922,063	)	$	(925,652	)	$	(939,332	)
Adjusted to include: Derivative cash settlements		63,044			110,087			122,825
Adjusted cost of funds	$	(859,019	)	$	(815,565	)	$	(816,507	)


Gross margin	$	104,063		$	81,641		$	131,543
Adjusted to include: Derivative cash settlements		63,044			110,087			122,825
Adjusted gross margin	$	167,107		$	191,728		$	254,368


Operating margin (loss)	$	130,587		$	(194,584	)	$	651,970
Adjusted to exclude: Derivative forward value		(29,875	)		229,132			(757,212	)
Foreign currency adjustments		22,893			65,310			243,220
Adjusted operating margin	$	123,605		$	99,858		$	137,978


Margin (loss) prior to cumulative
effect of change in accounting principle	$	126,529		$	(200,390	)	$	651,970
Adjusted to include: Minority interest net margin		2,540			1,989			-
Adjusted to exclude: Derivative forward value		(29,875	)		229,132			(757,212	)
Foreign currency adjustments		22,893			65,310			243,220
Adjusted net margin	$	122,087		$	96,041		$	137,978

TIER using GAAP financial measures is calculated as follows:

		Cost of funds + net margin prior to cumulative
	TIER =	effect of change in accounting principle
		Cost of funds

57Adjusted TIER is calculated as follows:

	Adjusted TIER =	Adjusted cost of funds + adjusted net margin
		Adjusted cost of funds

The following chart provides the TIER and adjusted TIER for the years ended May 31, 2005, 2004 and 2003.

	Year Ended May 31,
	2005		2004		2003
TIER (1)		1.14		-		1.69
Adjusted TIER		1.14		1.12		1.17

(1) For the year ended May 31, 2004, CFC reported a net loss prior to the cumulative effect of change in accounting principle of $200 million, thus the TIER calculation results in a value below 1.00.

Adjustments to the Calculation of Leverage and Debt to Equity

The Company calculates the leverage ratio by adding total liabilities to total guarantees and dividing by total equity. The Company calculates the debt to equity ratio by dividing total liabilities by total equity. The Company adjusts these ratios to (i) subtract debt used to fund loans that are guaranteed by RUS from total debt, (ii) subtract from total debt, and add to total equity, debt with equity characteristics issued to its members and in the capital markets, (iii) include minority interest as equity and (iv) to exclude the impact of non-cash SFAS 133 and foreign currency adjustments from its total liabilities and total equity. For the purpose of computing compliance with its revolving credit agreement covenants, the Company is required to make these adjustments to its leverage ratio calculation. The revolving credit agreements prohibit the Company from incurring senior debt in an amount in excess of ten times the sum of equity, members' subordinated certificates, minority interest and subordinated deferrable debt, as defined by the agreements. The Company makes these same adjustments to its debt to equity ratio as the only difference between the leverage ratio and the debt to equity ratio is the addition of guarantees to liabilities in the leverage ratio. In addition to the adjustments the Company makes to calculate the adjusted leverage ratio, guarantees to the Company member systems that have an investment grade rating from Moody's Investors Service and Standard & Poor's Corporation are excluded from the calculation of the leverage ratio under the terms of the revolving credit agreement.

The Company is an eligible lender under the RUS loan guarantee program. Loans issued under this program carry the U.S. Government's guarantee of all interest and principal payments. Thus, the Company has little or no risk associated with the collection of principal and interest payments on these loans. Therefore, the Company believes that there is little or no risk related to the repayment of the liabilities used to fund RUS guaranteed loans and subtracts such liabilities from total liabilities for the purpose of calculating its leverage and debt to equity ratios. For the purpose of computing compliance with its revolving credit agreement covenants, the Company is required to adjust its leverage ratio by subtracting liabilities used to fund RUS guaranteed loans from total liabilities. The leverage and debt to equity ratios adjusted to subtract debt used to fund RUS guaranteed loans from total liabilities reflect management's perspective on its operations and thus, the Company believes that these are useful financial measures for investors.

The Company requires that its members purchase subordinated certificates as a condition of membership and as a condition to obtaining a loan or guarantee. The subordinated certificates are accounted for as debt under GAAP. The subordinated certificates have long-dated maturities and pay no interest or pay interest that is below market and under certain conditions the Company is prohibited from making interest payments to members on the subordinated certificates. For the purpose of computing compliance with its revolving credit agreement covenants, the Company is required to adjust its leverage ratio by subtracting members' subordinated certificates from total liabilities and adding members' subordinated certificates to total equity. The leverage and debt to equity ratios adjusted to treat members' subordinated certificates as equity rather than debt reflect management's perspective on its operations and thus, the Company believes that these are useful financial measures for investors.

The Company also sells subordinated deferrable debt in the capital markets with maturities of up to 49 years and the option to defer interest payments. The characteristics of subordination, deferrable interest and long-dated maturity are all equity characteristics. For the purpose of computing compliance with its revolving credit agreement covenants, the Company is required to adjust its leverage ratio by subtracting subordinated deferrable debt from total liabilities and adding it to total

equity. The leverage and debt to equity ratios adjusted to treat subordinated deferrable debt as equity rather than debt reflect management's perspective on its operations and thus, the Company believes that these are useful financial measures for investors.

As a result of implementing SFAS 133, the Company's consolidated balance sheets include the fair value of its derivative instruments. As noted above, the amounts recorded are estimates of the future gains and losses that CFC may incur related to its derivatives. The amounts do not represent current cash flows and are not available to fund current operations. For the purpose of computing compliance with its revolving credit agreement covenants, the Company is required to adjust its leverage ratio by excluding the impact of implementing SFAS 133 from liabilities and equity. The leverage and debt to equity ratios adjusted to exclude the impact of SFAS 133 from liabilities and equity reflect management's perspective on its operations and thus, the Company believes that these are useful financial measures for investors.

As a result of issuing foreign denominated debt and the implementation of SFAS 133 which discontinued the practice of recording the foreign denominated debt and the related currency exchange agreement as one transaction, the Company must adjust the value of such debt reported on the consolidated balance sheets for changes in foreign currency exchange rates since the date of issuance in accordance with SFAS 52. At the time of issuance of all foreign denominated debt, the Company enters into a foreign currency exchange agreement to fix the exchange rate on all principal and interest payments through maturity. The adjustments to the value of the debt on the consolidated balance sheets are reported on the consolidated and combined statements of operations as foreign currency adjustments. The adjusted debt value at the reporting date does not represent the amount that the Company will ultimately pay to retire the debt, unless the current exchange rate is equal to the exchange rate in the related foreign currency exchange agreement or the counterparty fails to honor its obligations under the agreement. For the purpose of computing compliance with its revolving credit agreement covenants, the Company is required to adjust its leverage ratio by excluding the impact of foreign currency valuation adjustments from liabilities and equity. The leverage and debt to equity ratios adjusted to exclude the impact of SFAS 52 reflect management's perspective on its operations and thus, the Company believes that these are useful financial measures for investors.

FIN 46(R) requires the Company to consolidate the results of operations and financial condition of RTFC and NCSC even though the Company has no financial interest or voting control over either company. In consolidation, the amount of the subsidiary equity that is owned or due to investors other than the parent company is shown as minority interest. Prior to consolidation, the RTFC members' equity was combined with the Company's equity and therefore included in total equity. For the purpose of computing compliance with its revolving credit agreement covenants, the Company is required to adjust total equity to include minority interest. The leverage and debt to equity ratio adjusted to treat minority interest as equity reflect management's perspective on its operations and thus, the Company believes that these are useful financial measures for investors.

The following chart provides a reconciliation between the liabilities and equity used to calculate the leverage and debt to equity ratios and these financial measures reflecting the adjustments noted above, as of the five years ended May 31, 2005.

	May 31,
(Dollar amounts in thousands)	2005			2004			2003			2002			2001
Liabilities	$	19,258,675		$	20,724,339		$	20,097,047		$	20,042,604		$	19,619,743
Less:
Derivative liabilities (1)		(78,471	)		(129,915	)		(353,840	)		(254,143	)		-
Foreign currency valuation account (2)		(260,978	)		(233,990	)		(325,810	)		2,355			-
Debt used to fund loans guaranteed by RUS		(258,493	)		(263,392	)		(266,857	)		(242,574	)		(182,134	)
Subordinated deferrable debt		(685,000	)		(550,000	)		(650,000	)		(600,000	)		(550,000	)
Subordinated certificates		(1,490,750	)		(1,665,158	)		(1,708,297	)		(1,691,970	)		(1,581,860	)
Adjusted liabilities	$	16,484,983		$	17,881,884		$	16,792,243		$	17,256,272		$	17,305,749

Total equity	$	768,761		$	695,734		$	930,836		$	328,731		$	393,899
Less:
Prior year cumulative derivative forward value and
foreign currency adjustments (1)(2)		(224,716	)		(523,223	)		(9,231	)		-			-
Current period derivative forward value (1)(3)(4)		(30,781	)		233,197			(757,212	)		(70,261	)		-
Current period foreign currency adjustments (2)		22,893			65,310			243,220			61,030			-
Accumulated other comprehensive (income) loss (1)		(12,574	)		12,108			46,763			72,556			-
Subtotal members' equity		523,583			483,126			454,376			392,056			393,899
Plus:
Subordinated certificates		1,490,750			1,665,158			1,708,297			1,691,970			1,581,860
Subordinated deferrable debt		685,000			550,000			650,000			600,000			550,000
Minority interest (5)		18,652			21,165			-			-			-
Adjusted equity	$	2,717,985		$	2,719,449		$	2,812,673		$	2,684,026		$	2,525,759

Guarantees	$	1,157,752		$	1,331,299		$	1,903,556		$	2,056,385		$	2,217,559

55

______________________

(1) No adjustment for SFAS 133 is necessary for periods prior to CFC's implementation of SFAS 133 in fiscal year 2002.

(2) No adjustment for foreign currency is required prior to CFC's implementation of SFAS 133 in fiscal year 2002. Prior to that date, CFC was allowed under SFAS 52 to account for the foreign denominated debt and the related cross currency exchange agreement as one transaction in the cost of funds.

(3) Represents the derivative forward value gain (loss) recorded by CFC for the period.

(4) At May 31, 2002, amount includes $28,383 related to the cumulative effect of change in accounting principle for the implementation of SFAS 133.

(5) No adjustments required for minority interest prior to the implementation of FIN 46(R) in fiscal year 2004.

The leverage and debt to equity ratios using GAAP financial measures are calculated as follows:

	Leverage ratio =	Liabilities + guarantees outstanding
		Total equity

	Debt to equity ratio =	Liabilities
		Total equity

The adjusted leverage and debt to equity ratios are calculated as follows:

	Adjusted leverage ratio =	Adjusted liabilities + guarantees outstanding
		Adjusted equity

	Adjusted debt to equity ratio =	Adjusted liabilities
		Adjusted equity

The following chart provides the leverage and debt to equity ratios, as well as the adjusted ratios, as of the five years ended May 31, 2005. The adjusted leverage ratio and the adjusted debt to equity ratio are the same calculation except for the addition of guarantees to adjusted liabilities in the adjusted leverage ratio.

	May 31,
		2005	2004	2003	2002	2001
Leverage ratio		26.56	31.70	23.64	67.23	55.44
Adjusted leverage ratio		6.49	7.07	6.65	7.20	7.73

Debt to equity ratio		25.05	29.79	21.59	60.97	49.81
Adjusted debt to equity ratio		6.07	6.58	5.97	6.43	6.85


Item 7A.	Quantitative and Qualitative Disclosures About Market Risk.


See Market Risk discussion on pages 5247 to ~~53.~~49.


Item 8.	Financial Statements and Supplementary Data.


The consolidated and combined financial statements, auditors' ~~report~~reports and ~~combined~~ quarterly financial results are included on pages 7169 through 107 (see Note 1516 to consolidated and combined financial statements for a summary of the quarterly results of CFC's operations).


Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.


On April 16, 2002, CFC dismissed Arthur Andersen LLP and engaged Ernst & Young LLP as its independent public accountants for the fiscal year ended May 31, 2002. The audit committee of CFC's board of directors approved the dismissal of Arthur Andersen LLP.

Arthur Andersen LLP's report on CFC's financial statements for the fiscal year ended May 31, 2001 did not contain an adverse opinion or disclaimer of opinion, nor was it qualified or modified as to uncertainty, audit scope or accounting principles.None

During the fiscal year ended May 31, 2001 and through the date of this annual report, there were no disagreements with Arthur Andersen LLP on any matter of accounting principles or practices, financial statement disclosure or auditing scope or procedure which, if not resolved to Arthur Andersen LLP's satisfaction, would have caused them to make reference to the subject matter of the disagreement in connection with their report on CFC's financial statements for such year and there also were no "reportable events" (as defined in Item 304(a)(1)(v) of Regulation S-K promulgated by the SEC), and CFC did not (nor did anyone on its behalf) consult with Ernst & Young LLP with respect to the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on CFC's financial statements, or any other matters or events set forth in Item 304(a)(2)(i) or (ii) of Regulation S-K.

~~CFC provided Arthur Andersen LLP with a copy of the above disclosures. In a letter dated April 19, 2002, Arthur Andersen LLP confirmed its agreement with such statements.~~


Item 9A.	Controls and Procedures


As of the end of CFC's most recent fiscal year, CFC carried out an evaluation, under the supervision and with the participation of CFC's management, including CFC's Chief Executive Officer and Chief Financial Officer, of the effectiveness of CFC's disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that CFC's disclosure controls and procedures are effective, except as described below.

Upon adoption of SFAS 133 in fiscal year 2002, CFC appropriately recorded on the combined balance sheet cross currency and cross currency interest rate exchange agreements at their fair value with changes in the fair value reported in the combined statement of operations or other comprehensive income as required by SFAS 133. However, CFC did not adjust the value of the foreign denominated debt reported on the combined balance sheet as required by SFAS 52 to reflect the change in the currency exchange rate since the date of issuance. Instead, during fiscal year 2002 and the first three quarters of fiscal year 2003, CFC reported the foreign denominated debt on its combined balance sheet at the currency exchange rate fixed by the cross currency and cross currency interest rate exchange agreements. CFC has restated the combined statement of operations and combined balance sheet for all reporting periods since June 1, 2001 to reflect the adjustment to the current value of the foreign denominated debt outstanding. As a result of the foregoing, and consistent with the recommendations of CFC's external auditors, Ernst & Young LLP, CFC is reviewing its disclosure controls and procedures relating to the adoption of new accounting pronouncements and is in the process of adopting appropriate changes to its disclosure controls and procedures in order to prevent and detect such items in the future.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in the reports filed or submitted by CFC under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports filed or submitted under the Exchange Act is accumulated and communicated toSenior management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the Company's disclosure controls and procedures as ~~appropriate,~~defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 ("the Exchange Act"). At the end of the period covered by this report, based on this evaluation process, the Chief Executive Officer and Chief Financial Officer have concluded that the Company's disclosure controls and procedures are effective. There have been no significant changes in the Company's internal controls or other factors that could significantly affect internal controls subsequent to ~~allow timely decisions regarding required disclosure.~~the date we performed our evaluation.


58
56

~~PART III~~


~~Item 10.~~	~~Directors and Executive Officers of the Registrant~~


~~(a)~~	~~Directors~~

Director
Date present
Name
Age
Since
term expires
Stephen R. Louder (President of CFC)
51
1998
2004
Robert A. Caudle (Vice President of CFC)
58
1999
2005
James P. Duncan (Secretary-Treasurer of CFC)
56
2000
2003
Roger Arthur
56
2003
2006
Roger A. Ball
58
2003
2006
Darlene H. Carpenter
57
2001
2004
Cletus Carter
62
2001
2004
J. Malloy Chandler
56
2002
2005
David J. Cowan
66
2003
2006
Glenn English
62
1994
2004
Steven J. Haaven
52
2003
2006
Craig A. Harting
45
2002
2005
James A. Hudelson
58
1999
2005
Terryl Jacobs
44
2002
2005
Tom Kirby
48
2002
2005
Timothy Reeves
55
1998
2004
Gale Rettkowski
57
2001
2006
Ronald P. Salyer
38
2003
2006
Brian D. Schlagel
53
1998
2004
Charles Wayne Whitaker
53
2003
2006
Bobby W. Williams
66
2001
2004
Eric P. Yould
58
2001
2004


~~(b)~~	~~Executive Officers~~

Held present
Title
Name
Age
office since
President and Director
Stephen R. Louder
51
2003
Vice President and Director
Robert A. Caudle
58
2003
Secretary-Treasurer and Director
James P. Duncan
56
2003
Governor and Chief Executive Officer
Sheldon C. Petersen
50
1995
Senior Vice President of Member Services and General Counsel
John J. List
56
1997
Senior Vice President and Chief Financial Officer
Steven L. Lilly
53
1994
Senior Vice President of Operations
John T. Evans
53
1997
Senior Vice President of Corporate Relations
Richard E. Larochelle
50
1998
Senior Vice President of RTFC
Lawrence Zawalick
45
2000
Senior Vice President of Credit Risk Management
John M. Borak
59
2002

PART III

Item 10.		Directors and Executive Officers of the Registrant

(a)	Directors

				Director	Date present
Name			Age	since	term expires
James P. Duncan (President of CFC)			58	2000	2006
Cletus Carter (Vice President of CFC)			64	2001	2007
Terryl Jacobs (Secretary-Treasurer of CFC)			46	2002	2005
Roger Arthur			58	2003	2006
Roger A. Ball			60	2003	2006
Ronald Bergh			62	2005	2007
Darlene H. Carpenter			59	2001	2007
Glenn English			64	1994	2005
Harold Foley			71	2004	2007
Steven J. Haaven			54	2003	2006
Gary Harrison			44	2005	2006
Craig A. Harting			47	2002	2005
Jim Herron			48	2005	2008
Martin Hillert, Jr.			51	2004	2007
Tom Kirby			50	2002	2005
Reuben McBride			58	2005	2008
Gale Rettkowski			59	2001	2006
Ronald P. Salyer			40	2003	2006
Darryl Schriver			40	2004	2007
Charles Wayne Whitaker			55	2003	2006
Bobby W. Williams			68	2001	2007
Eric P. Yould			60	2001	2007

(b)	Executive Officers
				Held present
Title		Name	Age	office since
President and Director		James P. Duncan	58	2005
Vice President and Director		Cletus Carter	64	2005
Secretary-Treasurer and Director		Terryl Jacobs	46	2005
Governor and Chief Executive Officer		Sheldon C. Petersen	52	1995
Senior Vice President of Member Services and General Counsel		John J. List	58	1997
Senior Vice President and Chief Financial Officer		Steven L. Lilly	55	1994
Senior Vice President of Operations		John T. Evans	55	1997
Senior Vice President of Corporate Relations		Richard E. Larochelle	52	1998
Senior Vice President of RTFC		Lawrence Zawalick	47	2000
Senior Vice President of Credit Risk Management		John M. Borak	60	2002

The President, Vice-President and Secretary-Treasurer are elected annually by the board of directors at its first organizational meeting immediately following CFC's annual membership meeting, each to serve a term of one year; the Governor and Chief Executive Officer serves at the pleasure of the board of directors; and the other Executive Officers serve at the pleasure of the Governor and Chief Executive Officer.

(c)	Identification of Certain Significant Employees.

	Inapplicable.


(d)	Family Relationships.


No family relationship exists between any director or executive officer and any other director or executive officer of the registrant.


(e)	(1) and (2) Business Experience and Directorships.

57

In accordance with Article IV of CFC's Bylaws, each candidate for election to the board of directors must be a trustee, director or manager of a member of CFC.

Mr. Louder has been President and General Manager of Deaf Smith Electric Cooperative, Hereford, TX, since 1992. He is a director and currently serves as Secretary/Treasurer at Golden Spread Electric Cooperative. He is a registered professional engineer in the state of Texas and a member of the Community Christian School Board of Trustees. He is also active in local economic development and the 4-H Club.

Mr. Caudle is a Trustee for the Lea County Electric Cooperative in Lovington, NM. He has been active in the domestic oil and gas industry as a partner in two independent companies, CB Partners of Midland, TX, since 1992 and M & W of Lovington, NM since 1993. Since 1990, Mr. Caudle has also owned a consulting business in Lovington, NM named after him, that specializes in utility title and regulatory issues.

~~Mr.~~ Duncan has been ~~the CEO~~Chief Executive Officer ("CEO") and General Manager of Sumter Electric Cooperative, Inc. in Sumterville, FL since 1990. In addition, Mr. Duncan has been a director of Seminole Electric Cooperative since 1990, and currently serves as ~~Chairman~~chairman of the Rate Committee. He has been a board member of Florida Electric Cooperatives Association since 1990 and served as president. He has been ~~Vice President~~vice president of Sumter County Economic Development Council since January 2000. Mr. Duncan is a member of the RTFC Lender Advisory Council. He has served on the ~~SunTrust-Nature~~SunTrust Bank, Nature Coast Division ~~board~~Board since ~~2001. He serves as Deputy Campaign Chairperson of the United Way of Lake and Sumter Counties~~2001 and is active in numerous other community organizations.

Mr. Carter has served as a director of Tri-County Electric Cooperative in Hooker, OK since 1977. In addition, he has also been director of Oklahoma Association of Electric Cooperatives since 1992 and currently serves on the Government Relations Committee. He is a member of the RTFC Lender Advisory Council and is past president of Tri-County and Oklahoma Association of Electric Cooperatives. Mr. Carter has been owner of High Plains Seed Company since 1983 and co-owner of Triple C Cattle Company in Forgan, OK since 1998.

Ms. Jacobs has served as board secretary of Slope Electric Cooperative, Inc. in New England, ND since June 1999, and has been director of the cooperative since 1996. She is a member of the Resolutions Committee for Midwest Electric Consumers Association where she previously served as vice-chairman. Ms. Jacobs has been an insurance agent since 1986 and has worked for Commercial Insurance Agency, Inc. since 2000.

Mr. Arthur has been a board member of Allamakee-Clayton Electric Cooperative in Postville, IA since 1992 and has served as president since 1993. Mr. Arthur ~~serves as~~is a director and former president of the Iowa Association of Electric Cooperatives and chairs the ~~Government Relations Standing~~Regulatory Affairs Committee. He is ~~also~~a board member and secretary of the Cooperative Development Services of Iowa, Wisconsin and Minnesota and a director of the Fayette County Economic Development and board member and vice president of Ag Vantage FS. In addition, Mr. Arthur is a member of the Iowa Farm Bureau and Iowa Pork Producers Association and Iowa Corn and Soybean Association. For the past thirty years,Commission. Since 1972, Mr. Arthur has been owner and operator of Arthur's Country Place Inc, a ~~farmer; he currently farms 800 acres of corn and soybeans.~~family farm corporation.

Mr. Ball has been a board member of Powell Valley Electric Cooperative in New Tazewell, TN since 1988 and has served as president since 1995. Mr. Ball is a former board member of the Claiborne County Industrial Development Board, Claiborne County Planning Commission, Lions Club and former president of Claiborne County Chamber of Commerce. He iscurrently serves as president of the ~~Private Industry Council and~~ Workforce Investment ~~Board. His former occupations include being a high school teacher and county director~~Board for Service Delivery Area 2 of ~~Vocational Education.~~Tennessee. Since 1976, Mr. Ball ishas been owner/ broker of Ball Realty & Auction, specializing in development and management of commercial property. ~~He is also the operator/manager of a family farm of approximately 500 acres.~~

Mr. Bergh has been director of Golden Valley Electric Association, Inc. in Fairbanks, AK since 1981 and served as president from 1984 to 1992. Mr. Bergh has represented Alaska's cooperative electric utilities on the NRECA Board of Directors since 1990. Prior to becoming NRECA president in May 2005, he served as vice-president from March to May 2005 and secretary-treasurer from 2003 to 2005. Mr. Bergh was the owner/manager of Bergh Inc., a full service elevator contractor, in Fairbanks, AK from 1975 to 2000, and the owner of Alaska Lifts, an elevator repair company in Fairbanks, AK from 2000 to 2003. He has been a director of Denali State Bank, Fairbanks, AK since 1985, and a director of AlasConnect, in Fairbanks, AK since 1999.

Ms. Carpenter ~~was chairman of~~has served on the Rappahannock Electric Cooperative ~~in Fredericksburg, VA,~~Board since 1984 and was board chair from 1997 to 2000. At present, she ~~still~~ holds ~~positions~~position on the Audit Committee and ~~Annual Meeting Committees at~~the By-Laws Committee for Rappahannock Electric Cooperative. ~~In November of 2001, she took a part-time Business Development Officer position at 2~~^nd ~~Bank & Trust in Culpeper, VA.~~ She is also a member of the RTFC Lender Advisory Council and has served on the Safety Committee of the VA, MD, DE Association of Electric Cooperatives ~~and has served on the Safety Committee~~ since 1997. Ms. Carpenter was Vice President of ~~the~~ Wachovia Bank NA in Culpeper, VA from ~~1966~~1999 to 2001. She held a part-time Business Development Officer position at 2nd Bank & Trust in Culpeper, VA from 2001 until 2003 and has been a director of the Culpeper County Chamber of Commerce since 1998 and a member of the CulpeperFest Committee and Small Business Committee. Ms. Carpenter is also a member of the Business & Professional Women's Organization. She was president and committee chairman of the Virginia Bankers Association, Young Bankers Section, from 1980 to 1982, and a former member of the Virginia State Education Assistance Authority Lender Advisory Committee. She was also a former member of variousactive in numerous other community ~~service organizations including March of Dimes, American Heart Association, Piedmont United Way, and 4-H Club.~~organizations.

Mr. Carter has served as a board member of Tri-County Electric Cooperative in Hooker, OK, since 1977. Mr. Carter has also been director of Oklahoma Association of Electric Cooperatives since 1992. He has been president of Oklahoma REAL Enterprises, a not-for-profit educational organization, since 1992. He is a member of the Oklahoma Cattlemen's Association and the Oklahoma Farmers Union. Mr. Carter is owner of High Plains Seed Company and co-owner of Triple C Cattle Company in Forgan, OK.

Mr. Chandler has been Executive Vice President and General Manager of Pioneer Electric Cooperative, Inc. in Greenville, AL, and has served as director of the Alabama Rural Electric Association since February 1971. He was President of the Alabama Electric Cooperative from 1992 to 1994, and currently serves as chairman of the Corporate Planning and Power Supply Committee, a title he has held since March 1988. In addition, Mr. Chandler served as director of Energy Co-Opportunity from 1999 to 2001, and as director and President of National Rural Telecommunications Cooperative from 1996 to 1998. He also served as chairman of South Alabama Public Power Association from 1976 to 1978. Mr. Chandler is Executive Vice President of Butler County Water Authority, Lowndes County Water Authority, South Dallas Water Authority, and West Dallas Water Authority. He has been President of Acme Propane Gas Co., Inc. since 1998, and of Pioneer Services Corporation since 1986.

Mr. Cowan has served as the president of NRECA in Washington, DC, since 2003. Mr. Cowan's rural electric affiliations include serving as past president and current director and secretary of the board of Adams Electric Co-op in Gettysburg, PA; and since 1998, as board president of AUSCO (subsidiary of Adams Electric); and as past chairman of Continental Cooperative Services. He has also served as director of Allegheny Electric Cooperative and Middle Atlantic Cooperative Services since1998. He is a former chairman, vice chairman and director of the Pennsylvania Rural Electric Association. Mr. Cowan joined Gettysburg College in 1965 where he currently is a professor and the dean of Enrollment and Education Services. He is a former executive assistant to the president, chairman of the physics department, and American Council of Education Fellow in Academic Administration.

Mr. English has been ~~Chief Executive Officer~~CEO of NRECA in Washington, DC since March 1994. He served in the United States House of Representatives from 1975 to 1994 where he served on the House Agriculture Committee from 1975 to 1994 and was Chairman of the House Agricultural Subcommittee on Environment, Credit and Rural Development from 1989 to 1994. He has been a director of National Rural Telecommunications Cooperative in Herndon, VA since 1994.

Mr. Foley has served as a director of Brown-Atchison Electric Cooperative Association, Inc. in Horton, KS since 1984. He has been board president of Brown-Atchison Electric Cooperative Association since 1991 and held the position of board vice president in 1990. He was a real estate broker with Jepson & Associates in Valley Falls, KS from 1991 until his retirement in June 2003.

Mr. Haaven has been ~~the General Manager~~president and CEO of Wild Rice Electric Cooperative in Mahnomen, MN since ~~1973.~~1987 and serves on the Minnkota Power Cooperative Manager Advisory Committee. He is also a member of the Karian/Peterson Powerline Contracting Board, the Northern Safety & Security Board and president of Carr's Tree Service board. He previously served as CEO, under a shared Management Agreement, of Wild Rice Electric Cooperative/Red River Valley Cooperative in Halstad, MN from 1998 to 1999. Mr. Haaven is a former member of the Rural Electric Political Action Committee Board at Minnesota Rural Electric Association. Mr. Haaven is general manager of the Advisory Committee at EnPower Services and is involved in the Touchstone Energy Project Green Touch in Minnesota State Parks. He is also member, Karian/Peterson Powerline Contracting Board; member, Northern Safety & Security Board; member, Committee To Establish Minnesota Safety, Inc.; board member, Carr's Tree Service. He previously served as office manager and Engineering Aide of Wild Rice Electric Cooperative, and shared CEO, under Management Agreement, of Wild Rice Electric/Red River Valley.

Mr. Harrison has served as General Manager of Dixie Electric Cooperative in Union Springs, AL since 1997. Mr. Harrison has been vice chairman of the Alabama Rural Electric Association since April 2005. He has served as board member of Alabama Electric Cooperatives since April 1997 and chairman of the Marketing and Industrial Development Committee since May 2002. Since January 2001, Mr. Harrison has served as CEO and president of Cooperative Utility Services, LLC.

Mr. Harting has been ~~the~~ General Manager of Sullivan County REC in Forksville, PA since September 1989. He became a member of the ~~Board~~board of United Utility Supply, Inc., in Louisville, ~~Kentucky~~KY in June 1995 and ~~has~~ served on the Management Advisory Committee of the NRECA sponsored Wood Quality Control Program ~~since~~from March ~~2001.~~2001 to March 2005. Mr. Harting also served as a member of the RTFC Lender Advisory Committee from March 2003 to March 2005. He has been a member of the ~~Board~~board of Partners in Distance Learning in Ashland, PA, since December 1998 and also from 1993 to 1996. ~~He has been a member of the board at the Sullivan County Chamber of Commerce since June 2001.~~ Mr. Harting is a member of the Sullivan County Industrial Development Authority, Northern Tier Regional Planning and Development Commission, and Workforce Investment Board of Towanda, PA. ~~Prior to joining Sullivan County REC, Mr. Harting was the Manager of Engineering Services at Tri-County REC in Mansfield, PA, from January 1980 to September 1989.~~

Mr. Hudelson has been General Manager of Wyrulec Company in Lingle, WY, since 1976. He became Chairman of the Legislative Committee for the Wyoming Rural Electric Association in 1989. He served as president of Goshen County Economic Development Corporation from 1991 to 1994, and has been a member since 1990. He has been the director for the Eastern Wyoming Development Corporation since 1999.

~~Ms. Jacobs~~Mr. Herron has served as ~~Board Secretary~~General Manager of ~~Slope~~Mountain View Electric Association, Inc. in Limon, CO since 1996. Prior to that position, Mr. Herron was General Manager at Farmers' Electric Cooperative ~~Inc.~~ in ~~New England, ND, since June 1999, and has been Director~~Clovis, NM from 1993 to 1996. Mr. Herron currently serves on the Colorado Electric Education Institute. Previously, he served as chair of the ~~cooperative since 1996. She is Vice-Chairman of the resolutions committee for Midwest~~Colorado Rural Electric ~~Consumers~~Managers Association and ~~has held this position since September 1999. Ms. Jacobs has been an insurance agent since 1986 and worked for Commercial Insurance Agency, Inc. since 2000. She is a~~board member of the ~~North Dakota Farmers Union~~New Mexico Rural Electric Association.

Mr. Hillert has been CEO and General Manager of Adams Columbia Electric Cooperative in Friendship, WI since 1996. In addition, he serves as chairman of Badger Energy Service in Oconto Falls, WI, board vice president of Network 2010 in Oxford, WI and as a board member of Badger Unified Cooperative Services in Fall Creek, WI since 2001. Mr. Hillert also serves as treasurer of Wisconsin Cooperative Managers Association and is a ~~past committee~~board member of the ~~North Dakota State Farm Service Agency and Mott/Regent School Consolidation Transition Committee.~~Electric Coalition of Wisconsin.

Mr. Kirby has been a board member of Central Indiana Power in ~~Fortville,~~Greenfield, IN, since ~~1991~~1992 and is a past chairman of that board. He ~~has also been Director~~served as director of the Indiana Statewide Association of RECs, Inc. ~~since June 1999.~~from 1999 to 2004. Mr. Kirby ~~has been~~is the director of Diagnostic Imaging at Hamilton Heart, Inc., a cardiology practice in Noblesville, IN. From April 2003 to April 2004, Mr. Kirby was director of Diagnostic Imaging at Women's Hospital of Indianapolis, ~~Indiana since April 2003.~~IN. Mr. Kirby was Chief Technologist at Digirad Imaging Solutions, Inc. from June 2001 to April 2003. He was employed as a nuclear medicine technologist at Saint John's Health Corporation from ~~1981~~1980 to ~~1994.~~2001. He was also ~~Administrative Director~~administrative director of the cardiology, neurology, and pulmonary medicine departments of Saint John's Health Corporation from 1984 to 1989.

Mr. ~~Reeves~~McBride has been ~~President~~a director of Graham County Electric Cooperative in Pima, AZ since 1991 and ~~General Manager of Southern Illinois Power Cooperative, Marion, IL,~~vice president since 1993. ~~He was Executive Vice President and General Manager~~Mr. McBride is owner/operator of ~~Southern Illinois Electric Cooperative from 1981 to 1990, and Assistant to the Manager of Egyptian Electric Cooperative Association from 1974 to~~Reuben McBride Farms, in Pima, AZ, since 1980. ~~He is the Chairman of Illinois ACRE and a member of Illinois Managers Association and the G&T Managers Association. He also~~Mr. McBride served as ~~President~~board president and chairman of the ~~Union County Hospital Board and~~Executive Committee of the ~~Southern Most Illinois Tourism Board, and~~Arizona Electric Power Co-op., Inc from May 2002 to May 2005. In addition, Mr. McBride is a member of both the ~~board of managers of ACES Power Marketing.~~National and Arizona Action Committees for Rural Electrification.

Mr. Rettkowski has served ~~on the board of directors~~as a director of Inland Power and Light Company in Spokane, WA since March 2000 and was president of the board through March 2003. He has served as ~~Secretary-Treasurer~~secretary-treasurer for Northwest Irrigation Utilities since August 1992. ~~He was also a trustee with Lincoln Electric from 1975 to 1995.~~ Mr. Rettkowski ishas been the ~~President~~president of Citizens for Irrigation for the state of Washington ~~and has held this title~~ since September 1991. He is a former director for Big Bend Golf and Country Club and a former trustee of Graingrowers Warehouse Co-op in Wilbur, WA. Mr. Rettkowski has also been ~~involved with agricultural enterprises at~~president of Rettkowski Brothers, a farming corporation in Wilbur, WA, since ~~April 1973.~~1998.

Mr. Salyer has served as the ~~President/~~president and CEO of Pioneer Rural Electric Cooperative in Piqua, OH since ~~2001. Mr. Salyer~~2001, served as executive vice president from 1999 to 2000 and served as operations manager from 1998 to 1999. In addition, he is a member of the Ohio Rural Electric Cooperatives (OREC) Facilities Attachment Committee, ~~and chairs the Disaster Recovery Task Force. He is~~ a trustee of Buckeye Power, Inc. and ~~also serves as~~ a member of the Power Delivery Agreement Operating ~~Committee. Mr. Salyer is a former executive vice president~~Committee and ~~manager of operations of Pioneer Electric Cooperative. He is a former manager of operations of Dayton Power and Light Company in Miamisburg, OH, and~~Transmission/Issues Task Force. In addition, he ~~was a key accounts manager of Dayton Power and Light Company in Dayton, OH. He~~ is also a director of Rural Electric Supply Cooperative of Ohio.

Mr. ~~Schlagel~~Schriver has been General Manager and CEO of Taylor Electric Cooperative, Inc. in Merkel, TX since 2002. Prior to 2002, he held staff positions at the Texas House of Representatives, Texas Legislative Council and Texas Senate. Mr. Schriver is a member of Mid-Tex Generation and Transmission Cooperative. He serves as a director ~~of Morgan County REA, Fort Morgan, CO, since 1990, serving as President from 1997 to 2001. He has owned~~on the Golden Spread Electric Cooperative Board, the Golden Spread Electric Generating Cooperative Board, the Oklaunion Electric Generating Cooperative

Board, and ~~operated Schlagel Farms, an irrigated agriculture enterprise, since 1971. Mr. Schlagel~~ is ~~also Chairman~~a member of the ~~Board for the Colorado Rural Electric Association, is~~Golden Spread Legislative Committee. Mr. Schriver formerly served as director of ~~Roggen Farmers Elevator Association~~Government Affairs of Brazos Electric Power Cooperative from 1996 to 1998 and ~~a Fellow~~ of ~~the Colorado Agriculture Leadership Program. He also served as President~~Governmental Relations of ~~Strasburg School District 31-J and Vice President of the Southeast Wild Fire Protection District.~~Texas Electric Cooperative from 1998 to 2002.

Mr. Whitaker has served as the president and ~~general manager~~General Manager of Southwest Arkansas Electric Cooperative in Texarkana, ~~TX,~~AR since 1986. ~~Additional electric affiliations for~~In addition, Mr. Whitaker ~~include:~~has been director and former chairman of Arkansas Electric Cooperative Corporation and Arkansas Electric Cooperatives, Inc. since 1986. He ~~was~~is also a former director of the National Information Solutions Cooperative and ~~former Chairman~~served as chairman of the Arkansas Rural Electric Self-Insurance Trust from 1994 to 2002. ~~Mr. Whitaker is a member of the Texarkana Chamber of Commerce and a former chairman of the Legislative Committee.~~

Mr. Williams has ~~been a~~served as board member of Walton Electric Membership Corporation in Monroe, GA, since June 1980 and previously served as chairman of the board. From 1987 to 1991, Mr. Williams also served as director of Georgia Electric Membership ~~Cooperative in Tucker, GA,~~Corporation and ~~South Eastern~~held positions as vice-chairman and chairman of the board. He is a former member of Southeastern Electrification ~~Council since 1986.~~Council. He was a director of Button Gwinett National Bank from 1984 to 1998. ~~He is currently retired.~~Mr. Williams retired in June 1997. His former occupations include ~~being a supervisor at Time DC Freight Lines from 1958 to 1968, and he was also the~~ owner and chairman of the board of a residential and commercial construction and development company from 1968 to 1997.

Mr. Yould has served as the executive director and CEO of the Alaska Rural Electric Cooperative Association in Anchorage, AK since 1997. In addition, he has been the general manager of Alaska 220 Communications, L.L.C. in Anchorage, AK since 1999 and executive vice president of the ARECA Insurance Exchange since 1997. ~~He has been a member of the Anchorage Chamber of Commerce since 1992, Alaska State Chamber of Commerce since 1992, and the Anchorage Convention and Visitors Bureau since 1993.~~ Mr. Yould serves on the board of the Resources Development Council of Alaska and the Renewable Energy Alaska Friends of Kennicott. He is a private airplane pilot. Prior to his working for ARECA, Mr. Yould held various positions including Captain in the U.S. Air Force from 1970 to 1974, vice president with Calista Corporation from 1984 to 1985, vice president with Harza Engineering from 1985 to 1989, Rocky Mountain regional manager with Ebasco Engineering from 1989 to 1995, president and CEO of EMCON Alaska, Inc. from 1996 to 1997, and executive director of the Alaska Power Authority from 1978 to 1983.Program.

Mr. Petersen joined CFC in August 1983 as an area representative. He became the director of Policy Development and Internal Audit in January 1990, director of Credit Analysis in November 1990 and Corporate Secretary on June 1, 1992. He became Assistant to the Governor on May 1, 1993. He became Assistant to the Governor and Acting Administrative Officer on June 1, 1994. He became Governor and CEO on March 1, 1995. Mr. Petersen began his career in the rural electrification program in 1976 as staff assistant for Nishnabotna Rural Electric Cooperative in Harlan, IA. He later served as General Manager of Rock County Electric Cooperative Association in Janesville, WI.

Mr. List joined CFC as a staff attorney in February 1972. He served as Corporate Counsel from June 1980 to 1991. He became Senior Vice President and General Counsel on June 1, 1992, and became Senior Vice President, Member Services and General Counsel on February 1, 1997.

Mr. Lilly joined CFC as a Senior Financial Consultant in October 1983. He became director of Special Finance in June 1985 and director of Corporate Finance in June 1986. He became Treasurer and Principal Finance Officer on June 1, ~~1993. He~~1993, and became Senior Vice President and Chief Financial Officer on January 1, 1994.

Mr. Evans joined CFC as Senior Vice President of Operations in November 1997. He was Senior Vice President and Chief Operating Officer of Suburban Hospital Healthcare System, Bethesda, MD from 1994 to 1997. He was Senior Vice President and Chief Operating Officer for Geisinger Medical Center, Danville, PA from 1991 to 1994.

Mr. Larochelle joined CFC as director of Corporate Relations in May 1996. He became Senior Vice President of Corporate Relations in August 1998. Prior to joining CFC, he was the Legislative director at NRECA where he worked for 12 years. He also worked at the USU.S. Department of Agriculture in the Rural Electrification Administration and the Farmers Home Administration.

Mr. Zawalick joined CFC in 1980. Throughout his career with CFC, Mr. Zawalick has held various positions. In April 1995, he was appointed Vice President of Business Development for CFC and Administrative Coordinator of RTFC. In February 2000, Mr. Zawalick was named CFC's Senior Vice President of RTFC.

Mr. Borak joined CFC in June 2002 as Senior Vice President, Credit Risk Management. Previously, he was with Fleet National Bank, Boston, MA from 1992-2001 where he was a Senior Credit Officer with risk management and loan approval responsibility for several industry banking portfolios including investor owned utilities. Prior assignments at Fleet in Hartford, CT included Manager of Credit Review and Manager of Loan Workout in the Connecticut bank.

(f)	Involvement in Certain Legal Proceedings.



None to the knowledge of ~~CFC.~~the Company.


(g)	Promoters and Control Persons.

Inapplicable.

60

(h)	Code of Ethics
	~~Inapplicable.~~
The Company has adopted a Code of Ethics within the meaning of Item 406(b) of Regulation S-K. This Code of Ethics applies to our principal executive officer, our principal financial officer and principal accounting officer. This Code of Ethics is publicly available on our website at www.nrucfc.coop/aboutcfc/howweoperate.

(i)	Audit Committee Financial Expert

At May 31, 2005, the Company did not have a director that qualified as an audit committee financial expert as defined by Section 407 of the Sarbanes-Oxley Act of 2002 ("SOX"). In February 2004, CFC's membership approved changes to the bylaws that would allow the addition of a 23rd director to the board. Candidates for the new director position must qualify as an audit committee financial expert as defined by Section 407 of SOX, come from within CFC's membership and be elected through the district meeting process. CFC's board does not believe it is critical to seek candidates to fill the new position at this time because of CFC's unique governance structure. Twenty of the current twenty-two directors are elected by the membership and have considerable experience with electric cooperatives because they must be a director, trustee or manager of a member system. In that capacity, they are familiar with the operational and financial issues that electric cooperatives face. The other two directors also have industry expertise because they are elected by the national trade association for the members.


Item 11.	Executive Compensation.

The summary compensation table below sets forth the aggregate remuneration for services in all capacities to ~~CFC,~~the Company, on an accrual basis, for the three years ended May 31, ~~2003, 2002~~2005, 2004 and ~~2001,~~2003, to the named executive officers. The named executive officers include the CEO and the four next most highly compensated executive officers serving at May 31, ~~2003,~~2005, with salary and bonus for fiscal year ~~2003~~2005 in excess of $100,000.

Summary Compensation Table
								Long Term
	Annual Compensation							Compensation
	Year		Salary		Bonus	All Other (1)		LTIP Payouts
Sheldon C. Petersen	2005	$	545,000	$	83,105	$	42,656	$	47,000
Governor and Chief Executive Officer	2004		508,750		113,688		27,674		-
	2003		477,500		105,470		19,038		-

Steven L. Lilly	2005		322,000		46,539		25,225		30,000
Senior Vice President and Chief	2004		312,000		66,300		20,065		-
Financial Officer	2003		300,000		63,282		13,042		-

John J. List	2005		279,000		40,324		22,878		26,000
Senior Vice President of Member	2004		270,400		57,460		12,690		-
Services and General Counsel	2003		260,000		54,844		19,771		-

John T. Evans	2005		279,000		40,324		18,553		26,000
Senior Vice President of Operations	2004		270,400		57,460		14,370		-
	2003		260,000		54,844		17,790		-

Lawrence Zawalick	2005		233,000		33,676		19,775		21,720
Senior Vice President of RTFC	2004		225,680		47,957		14,883		-
__________________	2003		217,000		45,774		16,308		-
(1) Amounts for fiscal years 2005, 2004, and 2003 include $36,356, $20,999 and $13,038 related to leave accruals and $6,300, $6,675, and $6,000 related to the Company contributions to a savings plan for Mr. Petersen; $18,950, $13,915, and $7,500 related to leave accruals and $6,275, $6,150, and $5,542 related to the Company contributions to a savings plan for Mr. Lilly; $16,620, $6,560, and $14,429 related to leave accruals and $6,258, $6,130, and $5,342 related to the Company contributions to a savings plan for Mr. List; $12,295, $8,240, and $11,723 related to leave accruals and $6,258, $6,130, and $6,067 related to the Company contributions to a savings plan for Mr. Evans; $13,533, $8,774, and $11,147 related to leave accruals and $6,242, $6,109, and $5,161 related to the Company contributions to a savings plan for Mr. Zawalick.

61

~~Summary Compensation Table~~

Annual Compensation
All Other
Year
Salary
Bonus
Compensation (1)
Sheldon C. Petersen
2003
$
477,500
$
105,470
$
19,038
   Governor and Chief Executive Officer
2002
440,000
82,617
28,186

2001
400,000
97,422
28,148

Steven L. Lilly
2003
300,000
63,282
13,042
   Senior Vice President and Chief
2002
265,000
46,582
16,283
     Financial Officer
2001
247,800
56,142
19,442

John J. List
2003
260,000
54,844
19,771
   Senior Vice President of Member
2002
229,000
40,254
7,447
     Services and General Counsel
2001
219,000
49,617
15,366

John T. Evans
2003
260,000
54,844
17,790
    Senior Vice President of Operations
2002
236,000
41,484
9,761

2001
224,400
50,841
11,536

Lawrence Zawalick
2003
217,000
45,774
16,308
    Senior Vice President of RTFC
2002
197,000
34,629
14,511

2001
188,500
42,707
17,545

~~(1)~~	Amounts for fiscal years 2003, 2002 and 2001 include $13,038, $24,403 and $24,423 related to leave accruals and $6,000, $3,783 and $3,725 related to CFC contributions to a savings plan for Mr. Petersen; $7,500, $12,740 and $15,725 related to leave accruals and $5,542, $3,543 and $3,717 related to CFC contributions to a savings plan for Mr. Lilly; $14,429, $3,964 and $11,898 related to leave accruals and $5,342, $3,483 and $3,468 related to CFC contributions to a savings plan for Mr. List; $11,723, $7,488 and $7,983 related to leave accruals and $6,067, $2,273 and $3,553 related to CFC contributions to a savings plan for Mr. Evans; $11,147, $10,986 and $13,775 related to leave accruals and $5,161, $3,525 and $3,770 related to CFC contributions to a savings plan for Mr. Zawalick.Short-Term Incentive Plan

~~CFC established a~~CFC's short-term incentive compensation plan ~~for all employees in fiscal year 2000. The plan~~ provides for an incentive ~~payments~~opportunity of between 15% and 25% of salary for all employees based on the achievement of performance targets established at the beginning of the fiscal year. CFC's executives are eligible to receive incentive payments of up to 25% of salary under this plan. The short-term incentive plan for executive officers is based primarily on corporate metrics for customer satisfaction, financial ratios, operating efficiency and ~~innovation. A goal is~~learning and growth. Goals are set by the board of directors in each of the four quadrants at the beginning of the fiscal year. Payouts under the plan are based on the achievement of target and stretch levels of performance within each quadrant. ~~Amounts paid to listed executives under the short-term incentive program are included in the bonus column of the compensation table.~~

~~CFC's board of directors approve the performance targets for the incentive plan annually during the strategic planning and budgeting process.~~ The board of directors will also review the performance achievements for the year and must approve the payout under the incentive plan prior to disbursement. Amounts paid to listed executives under the short-term incentive program are included in the bonus column of the compensation table.

64Long-Term Incentive Plan

CFC's board of directors approved a long-term incentive plan for fiscal year ~~2003~~2005 that is summarized in the chart below. Under the plan, the number of units awarded to each employee is based on annual salary at the start of the plan, the incentive opportunity, and the par value of $100 per unit. Executive officers received units based on the following formula: annual salary on June 1, ~~2002~~2004 multiplied by 25% incentive opportunity divided by 100. The payout will be calculated based on a range of $0 to $150 per unit according to the average level of CFC's long-term secured debt ratings from three rating agencies at May 31, 2007.

The table below contains the long-term incentive units awarded to the CEO and the four next most highly compensated executive officers during the year ended May 31, 2005.

		Period Until
	Number of	Maturation or	Estimated Future Payouts
Name	Units	Payout	Threshold	Target ⁽¹⁾	Maximum
Sheldon C. Petersen	1,338	May 31, 2007	$ -	$80,280	$200,700
Steven L. Lilly	805	May 31, 2007	-	48,300	120,750
John J. List	698	May 31, 2007	-	41,880	104,700
John T. Evans	698	May 31, 2007	-	41,880	104,700
Lawrence Zawalick	583	May 31, 2007	-	34,980	87,450

(1) Represents CFC's current estimate of the payout at May 31, 2007.

At the time of this filing, CFC's average long-term secured credit rating was A+/stable, which would generate a payout of $40 per unit under the long-term incentive plan.

The board of directors has approved a new long-term incentive plan, with terms similar to the one in effect at May 31, ~~2003,~~2005, that ~~will begin~~began on June 1, 2005 with a payout scheduled for May 31, 2008. The long-term incentive plan for fiscal year 2004, with terms similar to the one approved for fiscal year 2005, began on June 1, 2003 ~~with~~and has a payout scheduled for May 31, 2006.

Period Until
Estimated Future Payouts
Number of
Maturation
Name
Units
or Payout
Threshold
Target (1)
Maximum
Sheldon C. Petersen
1,175
May 31, 2005
$ -
$70,500
$176,250
Steven L. Lilly
750
May 31, 2005
-
45,000
112,500
John J. List
650
May 31, 2005
-
39,000
97,500
John T. Evans
650
May 31, 2005
-
39,000
97,500
Lawrence Zawalick
543
May 31, 2005
-
32,550
81,375

~~(1) Represents CFC's current estimate of the payout at May 31, 2005.~~

The following table summarizes the payout per unit based on the average level of CFC's long-term secured debt ratings from three rating agencies at May 31, 2005. At the time of this filing, CFC's average credit rating was A+/negative.

Outlook
negative
stable
positive
negative
stable
positive
NA
Composite rating
A+
A+
A+
AA-
AA-
AA-
AA & above
Payout
$0
$40
$60
$80
$100
$120
$150

Defined Benefit or Actuarial Plan Disclosure

NRECA maintains the Retirement ~~and~~ Security ~~Program~~Pension Plan entitling CFC employees to receive annually, under a 50% joint and surviving spouse annuity, 1.90% of the average of their five highest base salaries during their last ten years of employment, multiplied by the number of years of participation in the ~~program.~~plan. As of May 31, ~~2003,~~2005, the number of years of service credited and the compensation covered under the ~~program,~~plan, respectively, for the officers listed above was as follows: Sheldon C. ~~Petersen-19~~Petersen-21 years 9 months, ~~$393,000;~~$465,000; John J. ~~List-31~~List-33 years 3 months, ~~$223,440;~~$251,480; Steven L. ~~Lilly-19~~Lilly-21 years 7 months, ~~$252,980;~~$289,360; Lawrence ~~Zawalick-23~~Zawalick-25 years, ~~$195,625;~~$212,236; and John T. ~~Evans-5~~Evans-7 years 6 months, ~~$227,960.~~$253,960.

The following chart represents the potential benefits paid out under the Retirement ~~and~~ Security ~~Program~~Pension Plan and the Pension Restoration Plan discussed below.


		Pension Plan Table								Pension Plan Table
		Years of Service								Years of Service
		5	10	15	20	25	30	35		5	10	15	20	25	30	35
Average base salary	Average base salary								Average base salary
$175,000		$16,625	$33,250	$ 49,875	$ 66,500	$ 83,125	$ 99,750	$116,375
200,000		19,000	38,000	57,000	76,000	95,000	114,000	133,000		19,000	38,000	57,000	76,000	95,000	114,000	133,000
225,000		21,375	42,750	64,125	85,500	106,875	128,250	149,625		21,375	42,750	64,125	85,500	106,875	128,250	149,625
250,000		23,750	47,500	71,250	95,000	118,750	142,500	166,250		23,750	47,500	71,250	95,000	118,750	142,500	166,250
275,000		26,125	52,250	78,375	104,500	130,625	156,750	182,875		26,125	52,250	78,375	104,500	130,625	156,750	182,875
300,000		28,500	57,000	85,500	114,000	142,500	171,000	199,250		28,500	57,000	85,500	114,000	142,500	171,000	199,500
325,000		30,875	61,750	92,625	123,500	154,375	185,250	216,125		30,875	61,750	92,625	123,500	154,375	185,250	216,125
350,000		33,250	66,500	99,750	133,000	166,250	199,500	232,750		33,250	66,500	99,750	133,000	166,250	199,500	232,750
375,000		35,625	71,250	106,875	142,500	178,125	213,750	249,375		35,625	71,250	106,875	142,500	178,125	213,750	249,375
400,000		38,000	76,000	114,000	152,000	190,000	228,000	266,000		38,000	76,000	114,000	152,000	190,000	228,000	266,000
425,000										40,375	80,750	121,125	161,500	201,875	242,250	282,625
450,000										42,750	85,500	128,250	171,000	213,750	256,500	299,250
475,000										45,125	90,250	135,375	180,500	225,625	270,750	315,875

The Economic Growth and Tax Relief Reconciliation Act of 2001 sets a limit on the compensation to be used in the calculation of pension benefits. In order to restore potential lost benefits, CFC has adopted a Pension Restoration Plan that is administered by NRECA. Under the plan, the amount that NRECA invoices CFC will continue to be based on the full compensation paid to each employee. Upon the retirement of a covered employee, NRECA will calculate the retirement and

security benefit to be paid with consideration of the compensation limits and will pay the maximum benefit thereunder. NRECA will also calculate the retirement and security benefit that would have been available without consideration of the compensation limits and CFC will pay the difference. NRECA will then give CFC a credit against future retirement and security contribution liabilities in the amount paid by CFC to the covered employee.

CFC will pay such additional benefits to the covered employee through two components of the Pension Restoration Plan, a Severance Pay Plan and a Deferred ~~Pay Restoration~~Compensation Plan. Under the Severance Pay Plan, the employee is paid an amount equal to the lost pension benefits but not to exceed twice the employee's annual compensation for the prior year. The benefit must be paid within 24 months of termination of employment. To the extent that the Severance Pay Plan cannot pay all of the lost pension benefits, the remainder will be paid under a Deferred Compensation Plan, which will be paid out in a lump sum or in installments of up to 60 months.

As of December 31, ~~2002,~~2004, the NRECA ~~retirement and security program~~Retirement Security Pension Plan meets the ERISA standards for a funded plan and CFC was current with regard to its obligations to NRECA, the plan provider.

Compensation of Directors

Directors ~~are reimbursed for travel and lodging expenses and~~ receive a ~~daily fee~~fixed sum of ~~$530 related to their attendance at all~~$32,000 per year plus reimbursement of travel expenses, which is prorated for any portion of the year served. The annual fixed sum is paid in installments following the conclusion of each board ~~of directors functions and a fee of $150 for conference call meetings.~~meeting attended.

Employment Contracts and Termination of Employment and Change-In-Control Arrangements

Pursuant to an employment agreement effective as of March 1, ~~2001,~~2004, CFC has agreed to employ Mr. Petersen as Chief Executive Officer through February ~~29, 2004~~28, 2009 (with automatic one-year extensions unless either party objects) at no less than ~~$500,000~~$575,000 per annum plus such ~~bonus~~incentive payments (if any) as may be awarded him. Certain payments have been agreed to in the event of Mr. Petersen's termination other than for cause; for example, Mr. Petersen leaving for good reason, disability or termination of his employment due to death.

Pursuant to a separate employment agreement effective as of ~~March 1, 1996,~~July 22, 2004, RTFC has agreed to employ Mr. Petersen for a ~~term~~period coterminous to the CFC agreement that is automatically extended at each March 1, after 2009, for an additional year unless RTFC or Mr. Petersen does not wish to extend or further extend the term of employment. As compensation, RTFC must credit $30,000 to a deferred compensation account on January 1 of each year of the ~~term $30,000.~~term. Interest will be credited to the account on December 31 of each such year at a rate equal to CFC's 20-year medium-term note rate on that date. The board of directors has approved that Mr. Petersen, at his ~~discretion,~~option, may ~~direct~~request that the deferred component of his compensation package be directed into alternative investment vehicles that ~~would~~could offer the opportunity to earn a return that is greater than the CFC 20-year MTN rate. Mr. Petersen has not yet chosen to exercise that option. If Mr. Petersen's employment is terminated by RTFC other than for cause, or by Mr. Petersen for ~~good~~any reason, or by his death or disability, the account will be deemed continued for the remainder of the term of employment (but in no

event less than six months nor more than a year), interest will be credited on a proportional basis for the calendar year during which the continuation ends and the balance in the account will be paid to Mr. Petersen or his beneficiaries in a lump sum. The compensation described in this contract has not been included in the Summary Compensation Table for executive officers on page 61.

Compensation Committee Interlocks and Insider Participation

During the year ended May 31, ~~2003,~~2005, there were no compensation committee interlocks or insider participation related to executive compensation.


Item 12.	Security Ownership of Certain Beneficial Owners and Management.


Inapplicable.


Item 13.	Certain Relationships and Related Transactions.

Loans and guarantees were made to member systems of which officers or directors of CFC are members, employees or directors in the ordinary course of CFC's business on the same terms, including interest rates and collateral, as those prevailing at the time for comparable ~~transaction~~transactions with other members and did not involve more than normal risk of uncollectibility or present other unfavorable features. It is anticipated that, consistent with its loan and guarantee policies in effect from time to time, additional loans and guarantees will be made by CFC to member systems and trade and service organizations of which officers or directors of CFC are members, employees, officers or directors. In light of its cooperative nature, pursuant to which CFC was established for the very purpose of extending financing to its members (from whose ranks its directors must be drawn), CFC is of the view that no purpose would be served by including detailed information with respect to specific loans and guarantees to members with which any of its directors are affiliated.


66

~~PART IV~~


Item 14.	Principal Accountant Fees and Services.

The following table summarizes the aggregate professional fees for the audit of the financial statements for the years ended May 31, 2005 and 2004 and fees for other services during that period by Deloitte & Touche, LLP and Ernst & Young, LLP, respectively.

(Dollar amounts in thousands)			2005		2004
Audit fees (1)		$	546,228	$	720,125
Audit-related fees (2)			15,481		142,815
Tax fees (3)			12,704		15,000
Non-audit, non-tax fees (4)			6,750		-
Total		$	581,163	$	877,940
__	________________
(1)	Audit fees in 2005 and 2004 consist of fees for the audit of the consolidated financial statements of CFC, including RTFC and NCSC in accordance with FIN 46(R), totaling $395,290 and $478,500, respectively, as well as the preparation of the stand-alone financial statements for RTFC and NCSC totaling $90,938 and $137,500, respectively. Additionally, audit fees in 2005 and 2004 include comfort letter fees. Audit fees in 2004 also include fees for consent letters and consultation related to documents filed with the Securities and Exchange Commission.
(2)	Audit-related fees in 2005 and 2004 consist of consultation on financial reporting and the implementation of new accounting standards. Audit-related fees in 2004 also include audit-related presentations at rating agency meetings.
(3)	Tax fees consist of assistance with matters related to tax compliance and consulting.
(4)	Non-audit fees relate to the audit of a trust serviced by CFC.

CFC's Audit Committee (the "Committee") is solely responsible for the nomination, approval, compensation, evaluation and discharge of the independent public accountants. The independent public accountants report directly to the Committee and the Committee is responsible for the resolution of disagreements between management and the independent public accountants. Consistent with Securities and Exchange Commission requirements, the Committee has adopted a policy to pre-approve all audit and permissible non-audit services provided by the independent public accountants. Under the policy, the Committee's pre-approval for permissible non-audit services is not required if all such services 1) do not aggregate to more than five percent of total revenue paid to the independent public accountants in the fiscal year when services are provided, 2) were not recognized as non-audit services at the time of the engagement and 3) are promptly brought to the attention of the Committee and approved by the Committee prior to the completion of the audit. CFC's independent public accountants for the current fiscal year have been appointed by the Committee.

64

PART IV

Item 15. Exhibits and Financial Statement ~~Schedules, and Reports on Form 8-K.~~Schedules.


	(a)			Documents filed as a part of this report.


1.	~~Combined~~Consolidated financial statements	~~Page~~	Page
	Reports of Independent ~~Auditors~~Registered Public Accounting Firms	71	69
	~~Combined~~Consolidated Balance Sheets	74	72
	Consolidated and Combined Statements of Operations	76	74
	Consolidated and Combined Statements of Changes in Equity	77	75
	Consolidated and Combined Statements of Cash Flows	78	76
	Notes to Consolidated and Combined Financial Statements	79	78


2.	Financial statement schedules


All schedules are omitted because they are not required, are inapplicable or the information is included in the financial statements or notes thereto.


3.	Exhibits

	3.1	-	Articles of Incorporation. Incorporated by reference to Exhibit 3.1 to Registration Statement No. 2-46018, filed October 12, 1972.
	3.2	-	~~Amendments to~~Amended Bylaws as approved by CFC's board of directors and members on March ~~21, 2000, and a copy of the Bylaws as amended.~~1, 2005. Incorporated by reference to Exhibit ~~3.4~~3.2 to CFC's Form ~~10-K~~10-Q filed on ~~August 29, 2000.~~ April 14, 2005.
	4.1	-	Form of Capital Term Certificate. Incorporated by reference to Exhibit 4.3 to Registration Statement No. 2-46018 filed October 12, 1972.
	4.2	-	Indenture dated as of February 15, 1994, between the Registrant and U.S. Bank National Association, successor trustee. Incorporated by reference to Exhibit 4.3 from the report on Form 8-K filed by CFC on June 14, 1994.
	4.3	-	Revolving Credit Agreement dated as of ~~August 8, 2001~~March 30, 2004 for ~~$1,028,125,000~~$1,650,000,000 maturing on ~~August 8, 2004.~~March 30, 2007. Incorporated by reference to Exhibit ~~5.1~~4.3 to CFC's Form ~~8-K~~10-Q filed ~~August 28, 2001.~~ on April 14, 2004.
	4.4	-	~~Amendment and Waiver No. 2 dated August 13, 2003 to the Revolving Credit Agreement for $1,028,125,000 maturing on August 8, 2004.~~
	~~4.5~~	-	Revolving Credit Agreement dated as of ~~June 30, 2003~~March 23, 2005 for ~~$2,522,500,000~~$1,975,000,000 maturing on ~~June 28, 2004.~~ March 23, 2010. Incorporated by reference to Exhibit 4.4 to CFC's Form 10-Q filed on April 14, 2005.
	~~4.6~~ 4.5	-	~~Amendment and Waiver No. 1 dated August 13, 2003 to the Revolving Credit Agreement for $2,522,500,000 maturing on June 28, 2004.~~
	~~4.7~~	-	Revolving Credit Agreement dated as of ~~June 30, 2003~~March 23, 2005 for ~~$400,000,000~~$1,285,000,000 maturing on ~~June 28, 2004.~~ March 22, 2006. Incorporated by reference to Exhibit 4.5 to CFC's Form 10-Q filed on April 14, 2005.
	~~4.8~~ 4.6	-	Amendment ~~and Waiver~~ No. 1 ~~dated August 13, 2003~~ to the three-year Revolving Credit Agreement ~~for $400,000,000 maturing on June 28,~~dated as of July 20, 2005 amending the agreement dated as of March 30, 2004.
	~~4.9~~ 4.7	-	Amendment No. 1 to the 364-day Revolving Credit Agreement dated as of July 20, 2005 amending the agreement dated as of March 23, 2005.
	4.8	-	Amendment No. 1 to the five-year Revolving Credit Agreement dated as of July 20, 2005 amending the agreement dated as of March 23, 2005.
	4.9	-	Indenture between CFC and Mellon Bank, N.A., as Trustee. Incorporated by reference to Exhibit 4.6 to Registration Statement on Form S-3 filed on October 15, 1996 (Registration No. 33-64231).
	4.10	-	Indenture between CFC and Chemical Bank, as Trustee. Incorporated by reference to Exhibit 4.7 to Amendment No. 1 to Registration Statement on Form S-3 filed on December 15, 1987 (Registration No. 33-34927).
	4.11	-	First Supplemental Indenture between CFC and Chemical Bank, as Trustee. Incorporated by reference to Exhibit 4.8 to Registration Statement on Form S-3 filed on October 1, 1990 (Registration No. 33-58445).
	4.12	-	Bond Purchase Agreement between the Registrant, Federal Financing Bank and Rural Utilities Services dated as of June 14, 2005 for up to $1,000,000,000.
	4.13	-	Series A Bond Guarantee Agreement between the Registrant and the Rural Utilities Service dated as of June 14, 2005 for up to $1,000,000,000.
	4.14	-	Pledge Agreement dated as of June 14, 2005, between the Registrant, the Rural Utilities Service and U.S. Bank Trust National Association.
	4.15	-	Series A Future Advance Bond from the Registrant to the Federal Financing Bank dated as of June 14, 2005 for up to $1,000,000,000 maturing on July 15, 2028.
	4.16	-	Note Purchase Agreement dated as of July 28, 2005 for $500,000,000 between the Registrant and Federal Agricultural Mortgage Corporation.
	4.17	-	Pledge Agreement dated as of July 28, 2005, between the Registrant, Federal Agricultural Mortgage Corporation and U.S. Bank Trust National Association.

65

	4.18	-	Registration Rights Agreement dated as of July 28, 2005 between the Registrant and Federal Agricultural Mortgage Corporation.
	4.19	-	4.656% Senior Notes due 2008 dated as of July 29, 2005 from the Registrant to Federal Agricultural Mortgage Corporation.
		-	Registrant agrees to furnish to the Commission a copy of all other instruments defining the rights of holders of its long-term debt upon request.


	Management Contracts and Compensatory Plans and Arrangements.

10.1	-	Plan Document for ~~CFC deferred compensation program. Incorporated by reference to Exhibit 10 to Registration Statement No. 2-70355, filed December 23, 1980.~~CFC's Deferred Compensation Program amended and restated as of July 1, 2003.
10.2	-	Employment Contract between CFC and Sheldon C. Petersen, dated as of March 1, ~~2001.~~2004. Incorporated by reference to Exhibit 10.2 ~~from the report on~~to CFC's Form 10-K filed ~~by CFC~~ on August ~~29, 2001.~~20, 2004.
10.3	-	Supplemental Benefit Agreement between RTFC and Sheldon C. Petersen, dated as of ~~March 1, 1996.~~July 22, 2004. Incorporated by reference to Exhibit 10.3 to CFC's Form 10-K filed on August ~~27, 1996.~~20, 2004.
12	-	Computations of ratio of ~~margin~~margins to fixed charges.

14.1	-	Ethics Policy for CEO and Senior Financial Officers. Incorporated by reference to Exhibit 14.1 to CFC's Form 10-Q filed on October 14, 2004.
23.1	-	Consent of ~~Ernst &Young~~Deloitte & Touche LLP.
23.2	-	~~Notice regarding consent~~Consent of ~~Arthur Andersen~~Ernst & Young LLP.

31.1	-	Certification of the Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.
31.2	-	Certification of the Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002.
32.1	-	Certification of the Chief Executive Officer required by Section 906 of the Sarbanes-Oxley Act of 2002.
32.2	-	Certification of the Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002.

~~(b)~~

~~Reports on Form 8-K.~~


	~~None.~~


6866

SIGNATURES

~~SIGNATURES~~

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the County of Fairfax, Commonwealth of Virginia, on the ~~28th~~24^th day of August ~~2003.~~2005.


	NATIONAL RURAL UTILITIES COOPERATIVE
	FINANCE CORPORATION

	By:	/s/ SHELDON C. PETERSEN
		Sheldon C. Petersen
		Governor and Chief Executive Officer



Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.


Signature	Title	Date

/s/ SHELDON C. PETERSEN	Governor and Chief Executive Officer
Sheldon C. Petersen

/s/ STEVEN L. LILLY	Senior Vice President and Chief Financial
Steven L. Lilly	Officer

/s/ STEVEN L. SLEPIAN	Vice President and Controller (Principal
Steven L. Slepian	Accounting Officer)

/s/ ~~STEPHEN R. LOUDER~~JAMES P. DUNCAN	President and Director
~~Stephen R. Louder~~James P. Duncan

/s/ ~~ROBERT A. CAUDLE~~CLETUS CARTER	Vice President and Director
~~Robert A. Caudle~~Cletus Carter

/s/ ~~JAMES P. DUNCAN~~TERRYL JACOBS	Secretary-Treasurer and Director
~~James P. Duncan~~Terryl Jacobs
		August 24, 2005
/s/ ROGER ARTHUR	Director
Roger Arthur		~~August 28, 2003~~

/s/ ROGER A. BALL	Director
Roger A. Ball

/s/ RONALD BERGH	Director
Ronald Bergh

/s/ DARLENE H. CARPENTER	Director
Darlene H. Carpenter

	Director
Glenn English

/s/ ~~CLETUS CARTER~~HAROLD FOLEY	Director
~~Cletus Carter~~Harold Foley

/s/ STEVE HAAVEN	Director
Steve Haaven

67

Signature	Title	Date

/s/ ~~J. MALLOY CHANDLER~~GARY HARRISON	Director
~~J. Malloy Chandler~~
Gary Harrison
~~/s/ DAVID J. COWAN~~	~~Director~~
~~David J. Cowan~~

	~~Director~~
~~Glenn English~~

~~/s/ STEVEN J. HAAVEN~~	~~Director~~
~~Steven J. Haaven~~

~~Signature~~	~~Title~~	~~Date~~


/s/ CRAIG A. HARTING	Director
Craig A. Harting

/s/ JIM HERRON	Director
~~Craig A. Harting~~Jim Herron

/s/ ~~JAMES A. HUDELSON~~MARTIN HILLERT, JR.	Director
~~James A. Hudelson~~Martin Hillert, Jr.

~~/s/ TERRYL JACOBS~~	~~Director~~
~~Terryl Jacobs~~

/s/ TOM KIRBY	Director
Tom Kirby

~~/s/ TIMOTHY REEVES~~	~~Director~~
~~Timothy Reeves~~

/s/ REUBEN MCBRIDE	Director	August ~~28, 2003~~24, 2005
Reuben McBride

/s/ GALE RETTKOWSKI	Director
Gale Rettkowski

/s/ RONALD P. SALYER	Director
Ronald P. Salyer

~~/s/ BRIAN D. SCHLAGEL~~	~~Director~~
~~Brian D. Schlagel~~
/s/ DARRYL SCHRIVER	Director
Darryl Schriver

/s/ ~~CHARLES~~ WAYNE WHITAKER	Director
~~Charles~~ Wayne Whitaker

/s/ BOBBY W. WILLIAMS	Director
Bobby W. Williams

/s/ ERIC P. YOULD	Director
Eric P. Yould


70

68

REPORT OF INDEPENDENT ~~AUDITORS~~REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors of

National Rural Utilities Cooperative Finance Corporation

We have audited the accompanying consolidated balance sheet of National Rural Utilities Cooperative Finance Corporation and subsidiaries (the "Company") as of May 31, 2005, and the related consolidated statements of operations, changes in equity, and cash flows for the year then ended. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of National Rural Utilities Cooperative Finance Corporation and subsidiaries at May 31, 2005, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ Deloitte & Touche

McLean, Virginia

August 18, 2005

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

TO THE BOARD OF DIRECTORS AND MEMBERS OF NATIONAL RURAL

~~NATIONAL RURAL~~ UTILITIES COOPERATIVE FINANCE CORPORATION

We have audited the accompanying consolidated balance sheet of National Rural Utilities Cooperative Finance Corporation ("the Consolidated Company") as of May 31, 2004, and the related consolidated statements of operations, changes in equity, and cash flows for the year then ended and the combined ~~balance sheets~~statements of operations, changes in equity and cash flows of National Rural Utilities Cooperative Finance Corporation and Rural Telephone Finance Cooperative ("the Combined Companies") ~~as of~~for the year ended May 31, ~~2003 and 2002, and the related combined statements of operations, changes in equity, and cash flows for the years then ended.~~2003. These financial statements are the responsibility of the Consolidated and Combined Companies' management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with ~~auditing~~the standards ~~generally accepted in~~of the ~~United States.~~Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. We were not engaged to perform an audit of the Consolidated Company's or Combined Companies' internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purposes of expressing an opinion on the effectiveness of the Consolidated Company's or Combined Companies' internal control over financial reporting. Accordingly we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the ~~combined~~consolidated financial position of National Rural Utilities Cooperative Finance Corporation at May 31, ~~2003~~2004, and ~~2002~~the consolidated results of its operations and its cash flows for the year then ended and the combined results of operations and cash flows of National Rural Utilities Cooperative Finance Corporation and Rural Telephone Finance Cooperative ~~and the combined results of their operations and their cash flows~~ for the ~~years then~~year ended May 31, 2003, in conformity with ~~accounting principles~~U.S. generally accepted ~~in the United States.~~accounting principles.

As more fully described in Note 1, under "Restatement," the Companies have restated the 2002 combined financial statements to reflect an adjustment to the current value of foreign currency denominated debt.

~~Also as~~ discussed in Note 1 to the ~~combined~~consolidated financial statements, ~~under "Derivative Financial Instruments", the Companies adopted SFAS 133,~~ ~~Accounting for Derivative Instruments and Hedging Activities~~~~, and SFAS 138,~~ ~~Accounting for Certain Derivative Instruments and Certain Hedging Activities~~, ~~an amendment of SFAS 133~~ ~~and accordingly changed their method of accounting for derivatives and hedging activities effective June 1, 2001.~~

We also audited the adjustments, described in Note 1 to the combined financial statements under "Reclassifications", that were applied to restate the 2001 financial statements. In our opinion, such adjustments are appropriate and have been properly applied.

~~Ernst & Young LLP~~

~~McLean, Virginia~~

~~August 13, 2003~~

This is a copy of the audit report previously issued by Arthur Andersen LLP in connection with CFC's filing on Form 10-K for the year ended May 31, 2001. This audit report has not been reissued by Arthur Andersen LLP in connection with this filing on Form 10-K. See Exhibit 23.2 for further discussion.

~~REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS~~

~~TO THE BOARD OF DIRECTORS~~

~~NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION:~~

~~We have audited the accompanying combined balance sheets of~~ National Rural Utilities Cooperative Finance Corporation ~~(a not-for-profit corporation under the District~~consolidates Rural Telephone Finance Cooperative and National Cooperative Services Corporation as a result of ~~Columbia Cooperative Association Act) and other related entities ("the Companies") as discussed in Note~~adopting FASB Interpretation No. 46(R) (revised December 2003), Consolidation of Variable Interest Entities, effective June 1, as of May 31, 2001 and 2000, and the related combined statements of income, expenses and net margin, changes in members' equity and cash flows for each of the three years in the period ended May 31, 2001. These financial statements are the responsibility of the Companies' management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the combined financial position of National Rural Utilities Cooperative Finance Corporation and other related entities as of May 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended May 31, 2001 in conformity with accounting principles generally accepted in the United States.

~~ARTHUR ANDERSEN LLP~~

~~Vienna, Virginia~~

~~July 5, 2001~~

~~(This page intentionally left blank.)~~2003.

/s/ Ernst & Young LLP


73

McLean, Virginia
July 28, 2004


70

(This page intentionally left blank)

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

~~COMBINED~~CONSOLIDATED BALANCE SHEETS

May 31, ~~2003~~2005 and ~~2002~~2004

(Dollar ~~Amounts~~amounts in ~~Thousands)~~thousands)

A S S E T S

2003
2002

Cash and cash equivalents
$
138,872
$
218,384

Loans to members
19,484,341
20,047,109
Less: allowance for loan losses
(565,058)
(506,742)
Loans to members, net
18,919,283
19,540,367

Receivables
213,419
187,157

Fixed assets, net
44,754
46,089

Debt service reserve funds
85,793
86,198

Foreclosed assets
335,576
-

Derivative assets
1,160,244
192,598

Other assets
76,347
72,142

$
20,974,288
$
20,342,935

		2005			2004
Cash and cash equivalents	$	418,514		$	140,307
Loans to members		18,972,068			20,488,523
Less: Allowance for loan losses		(589,749	)		(573,939	)
Loans to members, net		18,382,319			19,914,584

Receivables

299,350

348,206

Fixed assets, net

42,496

42,688

Debt service reserve funds

93,182

84,236

Bond issuance costs, net

56,492

61,324

Foreclosed assets

140,950

247,660

Derivative assets

584,863

577,493

Other assets

27,922

24,740

20,046,088

21,441,238

See accompanying notes.

~~See accompanying notes.~~

7472

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

~~COMBINED~~CONSOLIDATED BALANCE SHEETS

May 31, ~~2003~~2005 and ~~2002~~2004

(Dollar ~~Amounts~~amounts in ~~Thousands)~~thousands)

L I A B I L I T I E S A N D E Q U I T Y

2003
2002

Notes payable, due within one year
$
1,096,353
$
2,413,969

Accrued interest payable
184,204
177,178

Long-term debt
16,000,744
14,855,550

Other liabilities
49,073
23,734

Derivative liabilities
354,781
251,803

Subordinated deferrable debt
650,000
600,000

Members' subordinated certificates:
    Membership subordinated certificates
643,772
641,390
    Loan and guarantee subordinated certificates
1,064,525
1,050,580
          Total members' subordinated certificates
1,708,297
1,691,970

Equity:
    Retained equity
977,599
401,287
    Accumulated other comprehensive loss
(46,763
)
(72,556
)
          Total equity
930,836
328,731

          Total members' subordinated certificates and equity
2,639,133
2,020,701
$
20,974,288
$
20,342,935

~~See accompanying notes.~~



		2005		2004

Short-term debt	$	2,952,579	$	1,340,039
Accrued interest payable		256,011		273,965
Long-term debt		13,701,955		16,659,182
Deferred income		51,219		63,865
Guarantee liability		16,094		19,184
Other liabilities		26,596		23,031
Derivative liabilities		78,471		129,915
Subordinated deferrable debt		685,000		550,000
Members' subordinated certificates:
Membership subordinated certificates		663,067		649,909
Loan and guarantee subordinated certificates		827,683		1,015,249
Total members' subordinated certificates		1,490,750		1,665,158
Minority interest - RTFC and NCSC members' equity		18,652		21,165
Equity:
Retained equity		756,187	��	707,842
Accumulated other comprehensive income (loss)		12,574		(12,108	)
Total equity		768,761		695,734
	$	20,046,088	$	21,441,238

See accompanying notes.

73

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

CONSOLIDATED AND COMBINED STATEMENTS OF OPERATIONS

(Dollar amounts in thousands)

For the Years Ended May 31, ~~2003, 2002~~2005, 2004 and ~~2001~~2003

		2005			2004			2003
Operating income	$	1,026,126		$	1,007,293		$	1,070,875
Cost of funds		(922,063	)		(925,652	)		(939,332	)
Gross margin		104,063			81,641			131,543
Expenses:
General and administrative		(43,231	)		(40,392	)		(38,169	)
Provision for loan losses		(16,402	)		(54,921	)		(43,071	)
Recovery of (provision for) guarantee losses		3,107			851			(25,195	)
Total expenses		(56,526	)		(94,462	)		(106,435	)
Results of operations of foreclosed assets		13,079			13,469			9,734
Impairment loss on foreclosed assets		(55	)		(10,877	)		(19,689	)
Total gain (loss) on foreclosed assets		13,024			2,592			(9,955	)
Derivative and foreign currency adjustments:
Derivative cash settlements		63,044			110,087			122,825
Derivative forward value		29,875			(229,132	)		757,212
Foreign currency adjustments		(22,893	)		(65,310	)		(243,220	)
Total gain (loss) on derivative and foreign currency adjustments		70,026			(184,355	)		636,817
Operating margin (loss)		130,587			(194,584	)		651,970
Income tax expense		(1,518	)		(3,817	)		-
Margin (loss) prior to minority interest and cumulative
effect of change in accounting principle		129,069			(198,401	)		651,970
Minority interest - RTFC and NCSC net margin		(2,540	)		(1,989	)		-
Margin (loss) prior to cumulative effect of change in
accounting principle		126,529			(200,390	)		651,970
Cumulative effect of change in accounting principle		-			22,369			-
Net margin (loss)	$	126,529		$	(178,021	)	$	651,970

See accompanying notes.

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

CONSOLIDATED AND COMBINED STATEMENTS OF CHANGES IN EQUITY

(Dollar Amounts in Thousands)

For the Years Ended May 31, 2005, 2004 and 2003

																					Patronage Capital
																					Allocated
				Accumulated
				Other			Subtotal												Member's			General
				Comprehensive			Retained			Membership			Unallocated			Education			Capital			Reserve
	Total			Income (Loss)			Equity			Fee			Margin			Fund			Reserve			Fund			Other
Balance as of May 31, 2002	$	328,731		$	(72,556	)	$	401,287		$	1,510		$	30,356		$	1,007		$	16,329		$	498		$	351,587
Patronage capital retirement		(74,622	)		-			(74,622	)		-			-			-			-			-			(74,622	)
Operating margin		651,970			-			651,970			-			513,992			997			52,318			-			84,663
Accumulated other
comprehensive income		25,793			25,793			-			-			-			-			-			-			-
Other		(1,036	)		-			(1,036	)		(4	)		(21,125	)		(69	)		21,125			-			(963	)

Balance as of May 31, 2003	$	930,836		$	(46,763	)	$	977,599		$	1,506		$	523,223		$	1,935		$	89,772		$	498		$	360,665
Patronage capital retirement		(70,576	)		-			(70,576	)		-			-			-			-			-			(70,576	)
Operating loss		(194,584	)		-			(194,584	)		-			(294,807	)		839			33,919			(1	)		65,466
Accumulated other
comprehensive income		34,655			34,655			-			-			-			-			-			-			-
Income tax expense		(3,817	)		-			(3,817	)		-			(3,817	)		-			-			-			-
Minority interest - RTFC and
NCSC net margin		(1,989	)		-			(1,989	)		-			(1,989	)		-			-			-			-
Cumulative effect of change in
accounting principle		22,369			-			22,369			-			-			-			7,605			-			14,764
Reclass to RTFC members' equity		(19,908	)		-			(19,908	)		(512	)		-			(790	)		-			-			(18,606	)
Other		(1,252	)		-			(1,252	)		(1	)		-			(662	)		-			-			(589	)

Balance as of May 31, 2004	$	695,734		$	(12,108	)	$	707,842		$	993		$	222,610		$	1,322		$	131,296		$	497		$	351,124
Patronage capital retirement		(77,755	)		-			(77,755	)		-			-			-			-			-			(77,755	)
Operating margin		130,587			-			130,587			-			14,052			778			32,771			-			82,986
Accumulated other
comprehensive income		24,682			24,682			-			-			-			-			-			-			-
Income tax expense		(1,518	)		-			(1,518	)		-			(1,518	)		-			-			-			-
Minority interest - RTFC and
NCSC net margin		(2,540	)		-			(2,540	)		-			(2,540	)		-			-			-			-
Other		(429	)		-			(429	)		-			-			(900	)		-			-			471
Balance as of May 31, 2005	$	768,761		$	12,574		$	756,187		$	993		$	232,604		$	1,200		$	164,067		$	497		$	356,826

See accompanying notes.

2003
2002
2001
Operating income
$
1,070,875
$
1,186,533
$
1,388,295
Less: cost of funds
930,847
885,838
1,117,839

Gross margin
140,028
300,695
270,456

Expenses:
General and administrative
38,169
37,512
32,486
Provision for loan losses
68,266
199,349
105,204

Total expenses
106,435
236,861
137,690

Results of operations of foreclosed assets
1,249
-
-
Impairment loss on foreclosed assets
(19,689
)
-
-

Subtotal foreclosed assets
(18,440
)
-
-

Operating margin
15,153
63,834
132,766

Derivative and foreign currency adjustments:
Derivative cash settlements
122,825
34,191
-
Derivative forward value
757,212
41,878
-
Foreign currency adjustments
(243,220
)
(61,030
)
-

Total derivative and foreign currency adjustments
636,817
15,039
-

Cumulative effect of change in accounting principle
-
28,383
-

Net margin
$
651,970
$
107,256
$
132,766

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS

(Dollar amounts in thousands)

For the Years Ended May 31, 2005, 2004 and 2003

	2005				2004			2003
CASH FLOWS FROM OPERATING ACTIVITIES:
Net margin (loss)	$	126,529		$	(178,021	)	$	651,970
Add/(deduct):
Amortization of deferred income		(17,597	)		(23,783	)		(7,821	)
Amortization of bond issuance costs and deferred charges		14,255			15,760			13,759
Depreciation		3,559			3,097			4,307
Provision for loan losses		16,402			54,921			43,071
(Recovery of) provision for guarantee losses		(3,107	)		(851	)		25,195
Results of operations of foreclosed assets		(13,079	)		(13,469	)		(9,734	)
Impairment loss on foreclosed assets		55			10,877			19,689
Derivative forward value		(29,875	)		229,132			(757,212	)
Foreign currency adjustments		22,893			65,310			243,220
Cumulative effect of change in accounting principle		-			(22,369	)		-
Changes in operating assets and liabilities:
Receivables		56,568			30,173			3,526
Accrued interest payable		(17,954	)		(3,429	)		7,026
Other		(6,517	)		(29,747	)		5,218

Net cash provided by operating activities		152,132			137,601			242,214

CASH FLOWS FROM INVESTING ACTIVITIES:
Advances made on loans		(6,466,367	)		(4,124,846	)		(4,548,137	)
Principal collected on loans		7,883,988			3,496,813			4,731,561
Net investment in fixed assets		(3,367	)		(1,031	)		(2,972	)
Net cash provided by foreclosed assets		116,134			59,508			23,862
Net proceeds from sale of foreclosed assets		3,600			31,000			-
Cash assumed through consolidation		-			4,564			-

Net cash provided by (used in) investing activities		1,533,988			(533,992	)		204,314

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuances (repayments) of short-term debt, net		736,466			1,355,563			(1,250,848	)
Proceeds from issuance of long-term debt		289,757			2,177,111			3,632,650
Payments for retirement of long-term debt		(2,394,391	)		(2,955,377	)		(2,895,104	)
Proceeds from issuance of subordinated deferrable debt, net		131,246			96,850			121,062
Payments to retire subordinated deferrable debt		-			(200,000	)		(75,000	)
Proceeds from issuance of members' subordinated certificates		97,016			88,539			96,567
Payments for retirement of members' subordinated certificates		(199,844	)		(93,384	)		(80,745	)
Payments for retirement of patronage capital		(51,356	)		(51,890	)		(74,622	)
Payments for retirement of minority interest patronage capital		(16,807	)		(19,586	)		-

Net cash provided by (used in) financing activities		(1,407,913	)		397,826			(526,040	)

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS		278,207			1,435			(79,512	)
BEGINNING CASH AND CASH EQUIVALENTS		140,307			138,872			218,384
ENDING CASH AND CASH EQUIVALENTS	$	418,514		$	140,307		$	138,872

See accompanying notes.

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

CONSOLIDATED AND COMBINED STATEMENTS OF CASH FLOWS

(Dollar amounts in thousands)

For the Years Ended May 31, 2005, 2004 and 2003

		2005		2004			2003
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during year for interest	$	928,975	$	917,156		$	921,317

Non-cash financing and investing activities:
Fair value of foreclosed assets received in collection of loans	$	-	$	-		$	369,393
Subordinated certificates applied against loan balances		84,228		-			-
Patronage capital applied against loan balances		8,486		-			-
Minority interest patronage capital applied against loan balances		5,528		-			-

Consolidation of NCSC and RTFC effective June 1, 2003:
Total assets assumed, net of eliminations	$	-	$	(348,200	)

Total liabilities assumed, net of eliminations

331,100

Total minority interest assumed, net of eliminations

19,908

Cumulative effect of change in accounting principle

22,369

Net reclassification of combined equity to minority interest

(20,613

)

Cash assumed

4,564

See accompanying notes.

7677


NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS ~~OF CHANGES IN EQUITY~~

~~For the Years Ended May 31, 2003, 2002 and 2001~~

~~(Dollar Amounts in Thousands)~~

Patronage Capital
Accumulated
Allocated
Other
Members'
General
Membership
Comprehensive
Unallocated
Education
Capital
Reserve
Total
Fees
Income/(Loss)
Margin
Fund
Reserve
Fund
Other
Balance as of May 31, 2000
$
341,217
$
1,538
$
-
$
6,143
$
927
$
16,329
$
500
$
315,780
Patronage capital
(77,439
)
-
-
-
-
-
-
(77,439
)
Net margin
132,766
-
-
6,821
363
-
(2
)
125,584
Other
(2,645
)
(28
)
-
-
(546
)
-
-
(2,071
)
Balance as of May 31, 2001
393,899
1,510
-
12,964
744
16,329
498
361,854
Cumulative effect of change
in accounting principle
(52,697
)
-
(81,080
)
28,383
-
-
-
-
Patronage capital
(98,323
)
-
-
-
-
-
-
(98,323
)
Operating margin
63,834
-
-
8,114
506
-
-
55,214
Derivative forward value
50,402
-
8,524
41,878
-
-
-
-
Derivative cash settlements
34,191
-
-
-
-
-
-
34,191
Foreign currency adjustments
(61,030
)
-
-
(61,030
)
-
-
-
-
Other
(1,545
)
-
-
47
(243
)
-
-
(1,349
)
Balance as of May 31, 2002
328,731
1,510
(72,556
)
30,356
1,007
16,329
498
351,587
Patronage capital
(74,622
)
-
-
-
-
-
-
(74,622
)
Operating margin
15,153
-
-
-
109
5,746
-
9,298
Derivative forward value
783,005
-
25,793
757,212
-
-
-
-
Derivative cash settlements
122,825
-
-
-
888
46,572
-
75,365
Foreign currency adjustments
(243,220
)
-
-
(243,220
)
-
-
-
-
Other
(1,036
)
(4
)
-
(21,125
)
(69
)
21,125
-
(963
)
Balance as of May 31, 2003
$
930,836
$
1,506
$
(46,763
)
$
523,223
$
1,935
$
89,772
$
498
$
360,665

~~See accompanying notes.~~

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

COMBINED STATEMENTS OF CASH FLOWS

For the Years Ended May 31, 2003, 2002 and 2001

(Dollar Amounts in Thousands)

2003
2002
2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net margin
$
651,970
$
107,256
$
132,766
Add/(deduct):
     Provision for loan losses
68,266
199,349
105,204
     Depreciation
4,307
3,960
2,332
     Amortization of deferred income
(7,821
)
(1,403
)
(761
)
     Derivative forward value
(757,212
)
(41,878
)
-
     Foreign currency adjustments
243,220
61,030
-
     Cumulative effect of change in accounting principle
-
(28,383
)
-
     Amortization of bond issuance costs and deferred charges
13,759
22,753
7,284
     Results of operations of foreclosed assets
(1,249
)
-
-
     Impairment loss on foreclosed assets
19,689
-
-
     Changes in operating assets and liabilities:
        Receivables
3,526
12,676
(32,245
)
        Accrued interest payable
7,026
52,455
7,113
        Other
5,218
(9,927
)
(42,589
)

Net cash provided by operating activities
250,699
377,888
179,104

CASH FLOWS FROM INVESTING ACTIVITIES:
Advances made on loans
(4,548,137
)
(5,513,679
)
(8,782,519
)
Principal collected on loans
4,731,561
5,125,915
5,775,116
Net investment in fixed assets
(2,972
)
(2,712
)
(5,997
)
Net cash provided by foreclosed assets
15,377
-
-

Net cash provided by/(used in) investing activities
195,829
(390,476
)
(3,013,400
)

CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of notes payable, net
(1,250,848
)
(2,956,989
)
(511,045
)
Debt service investments, net
-
21,986
(1,055
)
Proceeds from issuance of long-term debt, net
3,632,650
7,407,547
6,058,736
Payments for retirement of long-term debt
(2,895,104
)
(4,533,840
)
(3,069,479
)
Proceeds from issuance of subordinated deferrable debt
121,062
169,487
150,000
Payments for retirement of subordinated deferrable debt
(75,000
)
(125,000
)
-
Proceeds from issuance of members' subordinated certificates
96,567
167,497
290,501
Retirement of members' subordinated certificates
(80,745
)
(60,481
)
(28,872
)
Payments for retirement of patronage capital
(74,622
)
(99,792
)
(59,961
)

Net cash (used in)/provided by financing activities
(526,040
)
(9,585
)
2,828,825

NET DECREASE IN CASH AND CASH EQUIVALENTS
(79,512
)
(22,173
)
(5,471
)
BEGINNING CASH AND CASH EQUIVALENTS
218,384
240,557
246,028
ENDING CASH AND CASH EQUIVALENTS
$
138,872
$
218,384
$
240,557

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during year for interest
$
921,317
$
815,960
$
1,122,635

NON-CASH INVESTING AND FINANCING ACTIVITIES:
Foreclosed assets in collection of loans
$
369,393
$
-
$
-

   See accompanying notes.


(1)	General Information and Accounting Policies

(a)

General Information


National Rural Utilities Cooperative Finance Corporation ("CFC" or "the Company") 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 source of financing to supplement the loan programs of the Rural Utilities Service ("RUS") of the United States Department of Agriculture. CFC 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 for tax-exempt financings of pollution control facilities and other properties constructed or acquired by~~ its members ~~and,~~with credit enhancements in ~~addition, provides~~the form of letters of credit and guarantees of ~~taxable~~ debt in connection with certain lease and other transactions of its members. CFC had 1,042 electric members as of May 31, 2003 including 898 utility members, the majority of which are consumer-owned cooperatives, 71 service members and 73 associate members. The utility members included 826 distribution systems and 72 generation and transmission ("power supply") systems in 49 states, the District of Columbia and one U.S. territory.obligations. CFC is exempt from payment of ~~Federal~~federal income taxes under the provisions of Section 501(c)(4) of the Internal Revenue Code. CFC is a not-for-profit member-owned finance cooperative, thus its objective is not to maximize its net margins, but to offer its members the lowest cost financial products and services consistent with sound financial management.

Rural Telephone Finance Cooperative ("RTFC") was incorporated as a private cooperative association in the state of South Dakota in September 1987 and was created for the ~~purpose~~purposes of providing ~~and/or~~and arranging financing for its rural telecommunications members and their affiliates. In February 2005, RTFC reincorporated in the District of Columbia. Effective June 1, 2003, RTFC's results of operations and financial condition have been ~~combined~~consolidated with those of CFC in the accompanying financial statements. ~~At May 31, 2003,~~CFC is the sole lender to and manages the affairs of RTFC ~~had 513 telecommunications members in 45 states, the District of Columbia and two U.S. territories.~~through a long-term management agreement. Under a guarantee agreement, CFC has agreed to reimburse RTFC for loan losses. RTFC is headquartered with CFC in Herndon, ~~VA.~~Virginia. RTFC is a taxable entity and takes tax deductions for allocations of net margins as allowed by law under Subchapter T of the Internal Revenue Code. RTFC pays income tax based on its net margins, excluding net margins allocated to its members.

National Cooperative Services Corporation ("NCSC") was incorporated in 1981 in the District of Columbia as a private cooperative association. NCSC provides financing to the for-profit or non-profit entities that are owned, operated or controlled by or provide substantial benefit to members of CFC. NCSC also markets, through its cooperative members, a consumer loan program for home improvements and an affinity credit card program. NCSC's membership consists of CFC and distribution systems that are members of CFC or are eligible for such membership. Effective June 1, 2003, NCSC's results of operations and financial condition have been consolidated with those of CFC in the accompanying financial statements. CFC is the primary source of funding to and manages the lending and financial affairs of NCSC through a management agreement which is automatically renewable on an annual basis unless terminated by either party. Under a guarantee agreement effective June 1, 2003, CFC has agreed to reimburse NCSC for losses on loans, excluding the consumer loan program. NCSC is headquartered with CFC in Herndon, Virginia. NCSC is a taxable corporation. NCSC pays income tax annually based on its net margins for the period.

The Company's consolidated membership was 1,546 as of May 31, 2005 including 899 utility members, the majority of which are consumer-owned electric cooperatives, 508 telecommunications members, 70 service members and 69 associates in 49 states, the District of Columbia and three U.S. territories. The utility members included 828 distribution systems and 71 generation and transmission ("power supply") systems. Memberships between CFC, RTFC and NCSC have been eliminated in consolidation.


	(b)	Principles of Consolidation and Combination


The accompanying financial statements, effective June 1, 2003, include the consolidated accounts of CFC, RTFC and NCSC and certain entities controlled by CFC ~~that were~~ created to hold foreclosed assets, ~~combined with RTFC~~ after elimination of all material intercompany accounts and transactions. Prior to June 1, 2003, RTFC and NCSC were not consolidated with CFC since CFC has no direct financial ownership interest in either company; however RTFC's results of operations and financial condition were combined with those of CFC. As a result of adopting Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 46(R) , Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51, effective June 1, 2003, CFC consolidates the financial results of RTFC and NCSC. CFC is the primary beneficiary of variable interests in RTFC and NCSC due to its exposure to absorbing the majority of expected losses.

FIN 46(R) requires the consolidation of a variable interest entity by the party that is the primary beneficiary of the variable interest entity. An enterprise is considered a primary beneficiary if it absorbs a majority of the variable interest entity's expected losses, receives a majority of the entity's expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Prior to FIN 46(R), entities were generally consolidated by an enterprise when it had a controlling financial interest through ownership of a majority voting interest in the entity.

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

CFC ~~established limited liability corporations~~implemented FIN 46(R) effective June 1, 2003, which resulted in the consolidation of two variable interest entities, RTFC and ~~partnerships~~NCSC. CFC is the primary beneficiary of the variable interest in RTFC and NCSC as a result of its exposure to ~~hold foreclosed assets.~~absorbing a majority of the expected losses. Neither company was consolidated with CFC prior to June 1, 2003 and the implementation of FIN 46(R) since CFC has ~~full~~no direct financial ownership ~~and control of all such companies and thus consolidates their~~interest in either company. RTFC's financial ~~results.~~statements were combined with CFC's prior to June 1, 2003.

CFC is the sole lender to and manages the affairs of RTFC through a long-term management agreement. Under ~~an indemnification~~a guarantee agreement, CFC has agreed to reimburse RTFC for loan losses. ~~As a result, RTFC does not maintain a loan loss allowance. Under the agreement, RTFC pays a fee to CFC based on the amount of loss allowance CFC maintains related to telecommunications exposure.~~ Six members of the CFC board serve as a lender advisory council to the RTFC board. All loans that require RTFC board approval also require the approval of the CFC lender advisory council. CFC is not a member of RTFC and does not elect directors to the RTFC board. RTFC is an associate of CFC.

CFC is the primary source of funding to and manages the lending and financial affairs of NCSC through a management agreement which is automatically renewable on an annual basis unless terminated by either party. NCSC funds its programs either through loans from CFC or commercial paper and long-term notes issued by NCSC and guaranteed by CFC. In connection with these guarantees, NCSC must pay a guarantee fee and purchase from CFC interest-bearing subordinated term certificates in proportion to the related guarantee. Under a guarantee agreement effective June 1, 2003, CFC has agreed to reimburse NCSC for losses on loans, excluding the consumer loan program. CFC does not control the election of directors to the NCSC board. NCSC is a class EC member of CFC.

AsRTFC and NCSC creditors have no recourse against CFC in the event of a default by RTFC and NCSC, unless there is a guarantee agreement under which CFC has guaranteed NCSC and RTFC debt obligations to a third party. At May 31, ~~2003~~2005, CFC had guaranteed $450 million of NCSC debt with third parties. These guarantees are not included in Note 12 at May 31, 2005 as the debt that CFC had guaranteed is reported as debt of the Company. At May 31, 2005, CFC had no guarantees of RTFC debt to third party creditors. All CFC loans to RTFC and ~~2002,~~NCSC are secured by all assets and revenues of RTFC and NCSC. At May 31, 2005, RTFC had total assets of $3,277 million including loans outstanding to members of $2,992 million and NCSC had total assets of $541 million including loans outstanding of $475 million. At May 31, 2005, CFC had committed to lend RTFC up to $10 billion, ~~to fund loans to RTFC's members and their affiliates. As~~ of which $2,980 million was outstanding. At May 31, ~~2003 and 2002, RTFC~~2005, CFC had committed to provide credit to NCSC of up to $2 billion. At May 31, 2005, CFC had provided a total of $532 million of credit to NCSC, representing $82 million of outstanding loans and ~~unadvanced loan commitments totaling $5,617~~$450 million ~~and $5,810 million, respectively. RTFC's net margin is allocated to RTFC borrowers, its patrons.~~of credit enhancements.

79CFC established limited liability corporations and partnerships to hold foreclosed assets. CFC has full ownership and control of all such companies and thus consolidates their financial results. CFC presents these companies in one line on the consolidated balance sheets and the consolidated and combined statements of operations.

~~Summary financial information relating~~

On June 1, 2003, as a result of the consolidation of RTFC and NCSC, total assets increased by $353 million, total liabilities increased by $331 million, minority interest - RTFC and NCSC members' equity increased by $20 million and CFC total equity increased by $2 million. As a result of the consolidation, NCSC loans were consolidated with CFC's loans. Additionally, NCSC debt guaranteed by CFC became debt of the consolidated entity, resulting in a reduction to CFC's guarantee liability. CFC recorded a cumulative effect of change in accounting principle gain of $22 million on the consolidated statement of operations, representing a $3 million increase to the ~~RTFC stand-alone financial statements is presented below:~~

loan loss allowance, a $34 million decrease to the guarantee liability and a $9 million loss representing the amount by which cumulative losses of NCSC exceeded NCSC equity.

(Dollar amounts in thousands)
As of May 31:
2003
2002
Outstanding loans to members and their affiliates
$4,942,640
$5,075,076
Total assets
5,469,305
5,607,281
Notes payable to CFC
4,921,655
5,056,283
Total liabilities
5,380,661
5,527,466
Total equity (1)
88,644
79,815

(Dollar amounts in thousands)
For the years ended May 31:
2003
2002
2001
Operating income
$344,492
$373,765
$419,524
Net margin (1)
27,913
26,816
38,098

~~(1)~~

The transfer of RTFC equity is governed by the South Dakota Cooperative Association Act, which provides that net margin shall be allocated and paid to patrons. However, reserves may be created and credited to patrons in proportion to total patronage. RTFC net margin includes $25.2 million, $23.6 million and $34.2 million representing its allocation of CFC's net margin for fiscal years 2003, 2002 and 2001, respectively.

Unless stated otherwise, references to ~~CFC~~the Company relate to the consolidation of CFC, RTFC, NCSC and certain entities controlled by CFC and created to hold foreclosed ~~assets, and RTFC on a combined basis.~~assets.


	(c)	Cash and Cash Equivalents

CFC includes cash, certificates of deposit and other investments with remaining maturities of less than 90 days as cash and cash equivalents.

79

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


	(d)	Allowance for Loan Losses


CFC maintains an allowance for loan losses at a level management considers to be adequate in relation to the credit quality, tenor, forecasted default, estimated recovery rates and amount of its loan ~~and guarantee~~ portfolio. CFC calculates three components to its loan loss allowance. The first is calculated to cover loan impairments based on the requirements of Statement of Financial Accounting Standard ("SFAS") 114, Accounting by Creditors for Impairment of a Loan - an Amendment of SFAS 5 and SFAS 15, and SFAS 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures - an Amendment of SFAS 114. The second component is calculated to cover loans classified as high risk by CFC's corporate credit committee. The corporate credit committee estimates the amount of reserves required for each borrower classified as high risk based on the individual facts and circumstances at the reporting date. The third component is calculated based on the general portfolio, which contains all other loan exposure. In February 2003, CFC incorporated a refinement of its risk rating system into the process of estimating the amount of the loan loss allowance for the general portfolio. The use of the improved internal risk rating system also allowed CFC to make use of the Standard and ~~guarantee exposure.~~Poor's Corporation corporate bond default tables that provide the probability of default based on borrower credit rating and remaining maturity. CFC believes that the incorporation of the improved internal risk rating system and corporate bond default tables into its estimate of the loan loss allowance results in a better estimate than the more subjective techniques used previously. CFC does not believe that this change had a material impact on its loan loss allowance or loan loss provision. CFC aggregates loan ~~and guarantee~~ exposure by borrower type, and then risk rating within borrower type. CFC then uses corporate default tables and estimated recovery rates to assist in estimating the reserve levels based on CFC's risk rating and loan maturity. In addition, the general portfolio includes a component related to the increased risk associated with large credit exposures within the general portfolio.

CFC's corporate credit committee makes recommendations of loans to be written off to the boards of directors of CFC, RTFC and NCSC. In making its recommendation to write off all or a portion of a loan balance, CFC's corporate credit committee considers various factors including cash flow analysis and collateral securing the borrower's loans.

The allowance is based on estimates and, accordingly, actual loan losses may differ from the allowance amount.

Activity in the allowance account is summarized ~~as follows~~below for the years ended May 31:

(Dollar amounts in thousands)
2003
2002
2001
Balance at beginning of year
$
506,742
$
331,997
$
228,292
Provision for loan losses
68,266
199,349
105,204
Charge-offs
(10,840
)
(34,191
)
(1,499
)
Recoveries
890
9,587
-
Balance at end of year
$
565,058
$
506,742
$
331,997

(Dollar amounts in thousands)		2005			2004			2003
Balance at beginning of year	$	573,939		$	511,463		$	478,342
Provision for loan losses		16,402			54,921			43,071
Change in allowance due to consolidation (1)		-			6,029			-
Write-offs		(1,354	)		(2,639	)		(10,840	)
Recoveries		762			4,165			890
Balance at end of year	$	589,749		$	573,939		$	511,463

(1) ~~A total~~Represents the impact of ~~$47.5 million, $28.4 million and $14.8 million of~~consolidating NCSC including the increase to the loan loss ~~allowances were related to CFC's guarantee exposure at May 31, 2003, 2002~~allowance recorded as a cumulative effect of change in accounting principle and ~~2001, respectively.~~the balance of NCSC's loan loss allowance on June 1, 2003.


80

(e)

~~Nonperforming~~Non-performing Loans


CFC classifies a borrower as ~~nonperforming~~non-performing when any one of the following criteria are met:

*	~~principal or interest payments on any loan to the borrower are past due 90 days or more based on contractual terms,~~
*	~~as a result of court proceedings, repayment on the original terms is not anticipated, or~~
*	principal or interest payments on any loan to the borrower are past due 90 days or more,
*	as a result of court proceedings, repayment on the original terms is not anticipated, or
*	for some other reason, management does not expect the timely repayment of principal and interest.

Once a borrower is classified as ~~nonperforming,~~non-performing, interest on its loans is generally recognized on a cash basis. Alternatively, CFC may choose to apply all cash received to the reduction of principal, thereby foregoing interest income recognition. When a loan is placed on non-accrual status, CFC typically reverses all accrued and unpaid interest back to the date of the last payment. The decision to return a loan to accrual status is determined on a case by case basis.

(f)

Impairment of Loans


CFC calculates impairment of loans receivable by comparing the present value of the estimated future cash flows associated with the loan discounted at the original loan interest rate(s) and/or the estimated fair value of the collateral securing the loan to the recorded investment in the loan in accordance with the provisions of SFAS 114. Loss reserves are specifically allocated based on the calculated impairment.


80

(g)

Fixed Assets


Buildings, furniture and fixtures and related equipment are stated at cost less accumulated depreciation and amortization of ~~$19~~$24 million and ~~$15~~$22 million as of May 31, ~~2003~~2005 and ~~2002,~~2004, respectively. Depreciation expense ($4 million, $4$3 million and $2$4 million in fiscal years ~~2003, 2002~~2005, 2004 and ~~2001,~~2003, respectively) is computed primarily on the straight-line method over estimated useful lives ranging from 2 to 40 years.

(h)

Foreclosed Assets


CFC records foreclosed assets received in satisfaction of loan receivables at fair value or fair value less costs to sell and maintains these assets on the ~~combined~~consolidated balance sheets as foreclosed assets. It is CFC's intent to sell the foreclosed assets, ~~however,~~but the assets do not currently meet conditions to qualify for assets held for sale under SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Accordingly, CFC records depreciation of foreclosed assets. Foreclosed assets are assessed for impairment on a periodic basis. The results of operations from foreclosed assets are shown separately on the consolidated and combined statements of operations.

(i)

Derivative Financial Instruments


CFC is neither a dealer nor a trader in derivative financial instruments. CFC uses interest rate, cross currency and cross currency interest rate exchange agreements to manage its interest rate risk and foreign exchange risk.

In accordance with SFAS 133, Accounting for Derivative Instruments and Hedging Activities, and SFAS 138, Accounting for Certain Derivative Instruments and Certain Hedging Activities, an amendment of SFAS 133, adopted by CFC on June 1, 2001, CFC records derivative instruments on the ~~combined~~consolidated balance ~~sheet~~sheets as either an asset or liability measured at fair value. Changes in the fair value of derivative instruments are recognized in the derivative forward value line ~~item~~ of the consolidated and combined ~~statement~~statements of operations unless specific hedge accounting criteria are met. IfThe change to the fair value is recorded to other comprehensive income if the hedge accounting criteria are ~~met for~~met. In the case of certain foreign currency exchange agreements ~~changes~~that meet hedge accounting criteria, the change in fair value ~~of derivative instruments are used~~is recorded to other comprehensive income and then reclassified to offset the related ~~changes in fair value on the hedged item~~change in the dollar value of foreign denominated debt in the consolidated and combined ~~statement~~statements of operations. CFC formally documents, designates, and assesses the effectiveness of transactions that receive hedge accounting.

Net settlements that CFC pays and receives for derivative instruments that qualified for hedge accounting are recorded in the cost of funds. CFC records net settlements related to derivative instruments that do not qualify for hedge accounting in derivative cash settlements. Prior to the implementation of SFAS 133, the net settlements for all interest rate exchange agreements were included in the cost of funds.

Upon implementation on June 1, 2001, CFC recorded transition adjustments as required by SFAS 133. The impact of such adjustments was a cumulative effect of change in accounting principle gain of $28 million to net margins, an other comprehensive loss of $81 million, the recognition of a $52 million derivative asset and a $197 million derivative liability for the fair value of the derivatives, a long-term debt valuation allowance to reflect a $2 million net increase in the fair value of certain long-term debt on the combined balance sheet and a reduction of debt of $94 million based on the change in exchange rates since the date of issuance on foreign denominated debt. Part of the adjustment recorded in other comprehensive loss totaling $62 million will be amortized into earnings over the remaining life of the ~~debt. The remaining $19 million will adjust with changes in the fair value of derivatives and~~interest rate exchange rates on foreign denominated debt. As the results for fiscal years 2003 and 2002 indicate, CFC expects that the adoption of SFAS 133 will increase the volatility of reported net margins and comprehensive income. The amount of volatility is based on notional amounts, derivative positions and market conditions that exist during the period.agreements.

	(j)	Guarantee liability

CFC guarantees the contractual obligations of its members so that they may obtain various forms of financing. With the exception of letters of credit, the underlying obligations may not be accelerated so long as CFC performs under its guarantee. CFC records a guarantee liability which represents CFC's contingent and non-contingent exposure related to its guarantees of its members' debt obligations. CFC's contingent guarantee liability is based on management's estimate of CFC's exposure to losses within the guarantee portfolio. CFC uses factors such as borrower risk rating, maturity periods, corporate bond default probabilities and historical recovery rates in estimating its contingent exposure. Adjustments to the contingent guarantee liability are recorded in CFC's provision for guarantee losses. CFC has recorded a non-contingent guarantee liability for all new guarantees since January 1, 2003 in accordance with FIN No. 45, Guarantor's Accounting and Disclosure Requirement for Guarantees, Including Indirect Guarantees of Indebtedness of Others (an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34). CFC's non-contingent guarantee liability represents CFC's obligation to stand ready to perform pursuant to the terms of its guarantees that it has entered into since January 1, 2003. CFC's non-contingent obligation is estimated based on guarantee fees charged for guarantees issued, which represents management's estimate of the fair value of its obligation to stand ready to perform. The fees are deferred and amortized using the straight-line method into operating income over the term of the guarantee.

81

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


	(k)	Amortization of Bond Discounts and Bond Issuance Costs

Bond discounts and bond issuance costs are deferred and amortized as interest expense using the effective interest method or a method approximating the effective interest method over the life of each bond issue.

(l)

Membership Fees

Members are charged a one-time membership fee based on member class. CFC distribution system members (class A), power supply system members (class B), and national associations of cooperatives (class D) ~~and associate members (class E)~~ pay a $1,000 membership fee. CFC service organization members (class C) pay a $200 membership fee. CFC associates pay a $1,000 fee. RTFC voting members ~~(class E)~~ pay a $1,000 membership ~~fee and non-voting~~fee. RTFC associates pay a $100 fee. NCSC members ~~(class E)~~ pay a $100 membership fee. Membership fees are accounted for as members' equity.

~~(k)~~(m)

Financial Instruments with Off-Balance Sheet Risk


In the normal course of business, CFC is a party to financial instruments with off-balance sheet risk to meet the financing needs of its member borrowers. These financial instruments include commitments to extend credit, standby letters of credit and guarantees of members' obligations. The expected inherent loss related to CFC's off-balance sheet financial instruments is covered in CFC's ~~loan loss allowance.~~guarantee liability.

~~(l)~~

~~Interest Income~~

~~Interest income is recognized on an accrual basis on all loans, unless specified otherwise in Note 13.~~

~~(m)~~

~~Amortization of Bond Discounts and Bond Issuance Costs~~

Bond discounts and bond issuance costs are deferred (classified in other assets on the combined balance sheet) and amortized as interest expense using the effective interest method over the life of each bond issue.


	(n)	Operating Income

The majority of the Company's operating income relates to interest earned on loans to members that is recognized on an accrual basis, unless specified otherwise in Note 14. Operating income also includes other fees associated with the Company's loan and guarantee transactions. These fees, as well as the related recognition policy, are summarized below:

*	Conversion fees may be charged when converting from one loan interest rate option to another. Conversion fees are deferred and recognized, using the straight-line method, which approximates the interest method, over the remaining term of the original loan interest rate pricing term, except for a small portion of the total fee charged to cover administrative costs related to the conversion which is recognized immediately.
*	Prepayment fees are charged for the early repayment of principal in full and are recognized when collected.
*	Late payment fees are charged on late loan payments and are recognized when collected.
*	Origination fees are charged only on RTFC loan commitments and in most cases are refundable on a prorata basis according to the amount of the loan commitment that is advanced. Such refundable fees are deferred and then recognized in full if the loan is not advanced prior to the expiration of the commitment.
*	Guarantee fees are charged based on the amount, type and term of the guarantee. Guarantee fees are deferred and amortized using the straight-line method, which approximates the interest method, into operating income over the life of the guarantee.

In fiscal year 2005, 2004 and 2003, the Company recognized fees totaling $58 million, $31 million and $15 million, respectively, in operating income including $18 million, $24 million and $8 million of conversion fees, respectively. Fees totaling $8 million, $56 million and $29 million were deferred during the years ended May 31, 2005, 2004 and 2003, respectively. At May 31, 2005 and 2004, the Company had deferred conversion fees totaling $51 million and $64 million, respectively.

The increase in fees recognized during fiscal year 2005 compared to 2004 was due to make-whole fees and exit fees totaling $36 million related to the prepayment of RTFC loans during fiscal year 2005. In fiscal year 2004, the increase in fees compared to fiscal year 2003 was due to more conversion fees recognized during the period.

In addition, loan origination costs on facilities are deferred and amortized using the straight-line method over the life of the facility as a reduction to operating income.

	(o)	Income Tax Expense

CFC does not pay income taxes. RTFC pays income tax on the amount of the net margin that it does not allocate to its members. Currently about 1% of the RTFC net margin is not allocated to its members.

82

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

NCSC pays tax on the full amount of its net margin. The income tax expense recorded in the consolidated statement of operations for the years ended May 31, 2005 and 2004 represents the income tax expense for RTFC and NCSC at the combined federal and state of Virginia income tax rate of approximately 38%. During the year ended May 31, 2005, NCSC used the remainder of its prior year loss carryforwards and is currently paying Virginia state and federal income taxes.

	(p)	Allocation of Net Margin

CFC is required by the District of Columbia cooperative law to have a methodology to allocate its net margin to its members. Annually, CFC's board of directors allocates its net margin, excluding certain non-cash adjustments, to its members in the form of patronage capital and to board approved reserves. Currently CFC has two such board approved reserves, the education fund and the members' capital reserve. CFC allocates a small portion, less than 1%, of net margin annually to the education fund to further the teaching of cooperative principles as required by cooperative law. Funds from the education fund are disbursed annually to the statewide cooperative organizations to fund the teaching of cooperative principles in the service territories of the cooperatives in each state. The board of directors will determine the amount of margin that is allocated to the members' capital reserve, if any. The members' capital reserve represents margins that are held by CFC to increase equity retention. The margins held in the members' capital reserve have not been specifically allocated to any member, but may be allocated to individual members in the future as patronage capital if authorized by CFC's board of directors. All remaining margin is annually allocated to CFC's members in the form of patronage capital. CFC bases the amount of margin allocated to each member on the members' patronage of the CFC lending programs in the year that the margin was earned. There is no impact on CFC's total equity as a result of allocating margins to members in the form of patronage capital or to board approved reserves. CFC's board of directors has annually voted to retire a portion of the patronage capital allocated to members in prior years. CFC's total equity is reduced by the amount of patronage capital retired to its members and by disbursements from the education fund.

(q)

Comprehensive Income


Comprehensive income includes ~~CFC's~~the Company's net margin, as well as other comprehensive ~~income/(loss)~~income related to derivatives. Comprehensive income for the years ended May 31, ~~2003, 2002~~2005, 2004 and ~~2001~~2003 is calculated as follows:

(Dollar amounts in thousands)
2003
2002
2001
Net margin
$
651,970
$
107,256
$
132,766
Other comprehensive income/(loss):
      Unrealized gain/(loss) on derivatives
3,709
(72,556
)
-
      Reclassification adjustment for
                    realized losses on derivatives
22,084
-
-
Comprehensive income
$
677,763
$
34,700
$
132,766

(Dollar amounts in thousands)		2005		2004			2003
Net margin (loss)	$	126,529	$	(178,021	)	$	651,970
Other comprehensive income:
Unrealized gain on derivatives		11,996		18,304			3,709
Reclassification adjustment for
realized losses on derivatives		12,686		16,351			22,084
Comprehensive income (loss)	$	151,211	$	(143,366	)	$	677,763


82

~~(o)~~(r)

Use of Estimates


The preparation of financial statements in conformity with ~~accounting principles~~U.S. generally accepted ~~in the United States~~accounting principles requires management to make estimates and assumptions that affect the assets and liabilities and the revenue and expenses reported in the financial statements, as well as amounts included in the notes thereto, including discussion and disclosure of contingent liabilities. While CFC uses its best estimates and judgments based on the known facts at the date of the financial statements, actual results could differ from these estimates as future events occur.

CFC does not believe it is vulnerable to the risk of a near-term severe impact as a result of any concentrations of its activities.

~~(p)~~(s)

Reclassifications


Certain reclassifications of prior year amounts have been made to conform to the ~~fiscal year 2003 presentation.~~current reporting format.

83

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS 145, Rescission of FASB Statements 4, 44, and 64, Amendment of FASB Statement 13, and Technical Corrections. SFAS 4, Reporting Gains and Losses from Extinguishment of Debt, required that all gains and losses from extinguishment of debt be aggregated and classified as an extraordinary item. As a result of the rescission of SFAS 4, gains and losses from the extinguishment of debt should be classified in accordance with the criteria in Accounting Principles Board ("APB") Opinion 30, Reporting the Results of Operations - Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions. According to APB 30, an event or transaction must be both unusual in nature and infrequent in occurrence in order to be classified as extraordinary. For the year ended May 31, 2001, CFC recorded an extraordinary loss of $0.3 million relating to the early redemption of collateral trust bonds. The redemption was not considered unusual in nature or infrequent in occurrence. CFC early adopted SFAS 145 as of May 31, 2002 and accordingly, the $0.3 million loss noted above was reclassified to the cost of funds in the combined statements of operations and statements of cash flow.

	~~(q)~~	~~Restatement~~

It is CFC's policy to effectively fix the exchange rate through maturity on all foreign denominated debt through a cross currency or cross currency interest rate exchange agreement. Prior to the adoption of SFAS 133, CFC appropriately recorded the debt at the exchange rate fixed through maturity after giving effect to cross currency and cross currency interest rate exchange agreements. Upon adoption of SFAS 133 in fiscal year 2002, the cross currency and cross currency interest rate exchange agreements were appropriately recorded on the combined balance sheet at their fair value with changes in the fair value reported in the combined statement of operations or other comprehensive income. However, CFC did not adjust the value of the foreign denominated debt reported on the combined balance sheet as required under applicable accounting principles to reflect the change in the currency exchange rate since the date of issuance. Instead, during fiscal year 2002 and the first three quarters of fiscal year 2003, the foreign denominated debt was reported on the combined balance sheet at the currency exchange rate fixed by the cross currency and cross currency interest rate exchange agreements. CFC has restated the combined statement of operations, combined balance sheet, combined statement of changes in equity and combined statement of cash flows for all reporting periods since June 1, 2001, to reflect the adjustment to the current value of the foreign denominated debt outstanding as of the applicable reporting date.

~~The following adjustments to the amounts reported on the May 31, 2002 combined balance sheet have been made to the accompanying May 31, 2002 combined balance sheet.~~

Notes Payable,
Other
due within
Long-term
Retained
Comprehensive
(Dollar amounts in thousands)
one year
Debt
Equity
Loss
As reported in May 31, 2002 Form 10-K
$
2,414,488
$
14,857,386
$
462,317
$
(135,941
)
Change in foreign currency valuation (1)
(519
)
(1,836
)
(61,030
)
63,385
As restated
$
2,413,969
$
14,855,550
$
401,287
$
(72,556
)

(1) The restatement to other comprehensive loss represents the reclassification of a portion of the change in the fair value of the exchange agreement that qualifies as an effective hedge under SFAS 133 for foreign denominated debt. Under SFAS 133, an amount equal to the change in the fair value of the foreign denominated debt is reclassified from other comprehensive loss, where the change in the fair value of the related exchange agreement is originally recorded, to the combined statement of operations to fully offset the change in the fair value of the related foreign denominated debt.

~~The following restatement to the amounts reported on the May 31, 2002 combined statement of operations have been made to the accompanying May 31, 2002 combined statement of operations.~~

Total Derivative and
Foreign Currency
Foreign Currency
Comprehensive
(Dollar amounts in thousands)
Adjustments
Adjustments
Net Margin
Income
As reported in May 31, 2002 Form 10-K
$
-
$
76,069
$
168,286
$
32,345
Change in foreign currency valuation
(61,030
)
(61,030
)
(61,030
)
2,355
As restated
$
(61,030
)
$
15,039
$
107,256
$
34,700

The quarterly results for all interim periods in fiscal years 2002 and 2003 have also been restated for the changes in foreign currency exchange rates. See Note 15 Combined Quarterly Financial Results for an explanation of the changes and a reconciliation from the amounts previously filed with the SEC and the restated amounts shown in this May 31, 2003 Form 10-K.

	~~(r)~~	~~New Accounting Pronouncements~~

In January 2003, the FASB issued Interpretation ("FIN") No. 46, Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51. FIN 46 defines a variable interest entity as those that either have insufficient equity at risk to permit the entity to finance its activities without additional subordinated financial support from other parties or, as a group, its equity holders lack one or more characteristics of a controlling financial interest.

CFC believes it is the primary beneficiary of two variable interest entities, RTFC and National Cooperative Services Corporation ("NCSC"), as a result of its exposure to absorbing a majority of their expected losses. Neither company has been consolidated with CFC under GAAP prior to FIN 46 since CFC has no direct financial ownership interest in either company. However, CFC is the sole lender to and manages the affairs of RTFC and NCSC through long-term management agreements. Both RTFC and NCSC are members of CFC. Under a guarantee agreement with RTFC, CFC maintains a loan loss reserve for RTFC. RTFC's results of operations and financial condition are currently combined with those of CFC.

NCSC was incorporated in 1981 in the District of Columbia as a private cooperative association. NCSC provides lease financing related to its members and general financing to for-profit or non-profit entities that are owned, operated or controlled by or provide substantial benefit to members of CFC. NCSC also markets, through its sponsoring cooperative members, a consumer loan program for home improvements and an affinity credit card program. Both programs are currently funded by third parties. NCSC's membership consists of CFC and distribution systems that are members of CFC or are eligible for such membership. As of May 31, 2003, NCSC had 332 members in 43 states and the District of Columbia. NCSC operates under a management agreement with CFC. It is headquartered with CFC in Herndon, VA and is a taxable corporation.

As a service member of CFC, NCSC is entitled to borrow and obtain credit enhancements from CFC under the terms and conditions then in effect for CFC members. NCSC funds its programs either through loans from CFC or commercial paper and long-term notes issued by NCSC and guaranteed by CFC. In connection with these guarantees, NCSC must purchase from CFC interest-bearing subordinated term certificates in proportion to the related guarantee.

CFC intends to implement FIN 46 effective June 1, 2003 and believes that such implementation will result in the consolidation of NCSC and RTFC. Through May 31, 2003, the results of RTFC have been combined with CFC's.

~~In April 2003, FASB issued SFAS 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities~~. The statement amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. SFAS 149 is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. ~~CFC's adoption of SFAS 149 is not expected to have a material impact on CFC's financial position or results of operations.~~

In May 2003, the FASB issued SFAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity. The statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability. The statement is effective at the beginning of the first interim period beginning after June 15, 2003. CFC's adoption of SFAS 150 is not expected to have a material impact on CFC's financial position or results of operations.

(2)	Loans and Commitments

Loans to members bear interest at rates determined from time to time by the ~~board of directors~~Company after considering ~~CFC's~~its cost of funds, operating expenses, provision for loan losses and the maintenance of reasonable margin levels. In keeping with its not-for-profit, cooperative charter, ~~CFC's~~the Company's policy is to set interest rates at the lowest levels it considers to be consistent with sound financial management.


85

Loans outstanding to members, weighted average interest rates thereon and unadvanced commitments by loan type are summarized as follows at May 31:

2003
2002
Weighted
Weighted
Average
Unadvanced
Average
Unadvanced
Loans
Interest
Commitments
Loans
Interest
Commitments
(Dollar amounts in thousands)
Outstanding
Rates
(A)
Outstanding
Rates
(A)
Long-term fixed rate secured loans (B):
Electric systems
$
9,484,490
5.64%
$
-
$
7,848,861
6.32%
$
-
Telecommunication systems
2,735,220
7.77%
-
2,694,945
7.90%
-
Total long-term fixed rate secured loans
12,219,710
6.12%
-
10,543,806
6.72%
-
Long-term variable rate secured loans (C):
Electric systems
3,211,434
3.35%
5,650,836
4,127,019
4.21%
6,135,109
Telecommunication systems
1,965,390
5.30%
291,724
2,138,174
5.71%
315,047
Total long-term variable rate secured loans
5,176,824
4.09%
5,942,560
6,265,193
4.72%
6,450,156
Loans guaranteed by RUS:
Electric systems
266,857
4.71%
30,388
242,574
4.75%
58,014
Intermediate-term secured loans:
Electric systems
14,525
3.63%
28,522
31,133
5.48%
26,277
Intermediate-term unsecured loans:
Electric systems
50,843
3.65%
72,559
177,154
5.19%
238,013
Telecommunication systems
18,642
5.45%
4,827
7,298
5.75%
5,779
Total intermediate-term unsecured loans
69,485
4.13%
77,386
184,452
5.21%
243,792
Line of credit loans (D):
Electric systems
884,146
3.57%
5,233,146
1,002,459
4.57%
4,821,764
Telecommunication systems
223,388
5.60%
377,409
226,113
6.32%
413,861
Total line of credit loans
1,107,534
3.98%
5,610,555
1,228,572
4.89%
5,235,625
Nonperforming loans:
Electric systems
-
-
-
1,002,782
-
-
Telecommunication systems
-
-
-
8,546
-
-
Total nonperforming loans
-
-
-
1,011,328
-
-
Restructured loans (E):
Electric systems
629,406
-
-
540,051
6.92%
-
Total loans
19,484,341
5.23%
11,689,411
20,047,109
5.61%
12,013,864
Less: Allowance for loan losses (F)
(565,058
)
-
(506,742
)
-
Net loans
$
18,919,283
$
11,689,411
$
19,540,367
$
12,013,864
Total by member class:
Distribution
$
11,410,592
$
8,527,266
$
11,866,442
$
8,647,187
Power supply
2,701,094
2,321,125
2,624,039
2,405,217
Statewide and associate
430,015
167,059
481,552
226,773
Telecommunication systems
4,942,640
673,961
5,075,076
734,687
Total
$
19,484,341
$
11,689,411
$
20,047,109
$
12,013,864

	2005					2004
	Loan outstanding and					Loan outstanding and
	weighted average interest			Unadvanced (1)		weighted average interest			Unadvanced (1)
(Dollar amounts in thousands)	rates thereon			Commitments		rates thereon			Commitments
Total by loan type:
Long-term fixed rate loans	$	12,724,758	5.52%	$	-	$	13,639,947	5.69%	$	-
Long-term variable rate loans		4,961,397	4.47%		5,537,121		5,448,223	2.81%		5,826,228
Loans guaranteed by RUS		258,493	5.16%		8,491		263,392	4.60%		8,491
Intermediate-term loans		10,328	5.91%		25,714		55,405	2.85%		82,419
Line of credit loans		1,017,092	4.75%		6,122,693		1,081,556	2.26%		5,659,400
Total loans		18,972,068	5.19%		11,694,019		20,488,523	4.72%		11,576,538
Less: Allowance for loan losses

(589,749

)

(573,939

)

Net Loans

18,382,319

11,694,019

19,914,584

11,576,538

Total by segment:

CFC:

Distribution

12,728,866

5.05%

8,821,217

12,536,255

4.29%

8,532,978

Power supply

2,640,787

5.72%

2,059,350

2,684,652

4.94%

2,101,439

Statewide and associate

135,513

5.58%

124,539

134,677

3.56%

188,626

CFC Total

15,505,166

5.17%

11,005,106

15,355,584

4.40%

10,823,043

RTFC

2,992,192

5.21%

518,514

4,643,008

5.83%

593,787

NCSC

474,710

5.96%

170,399

489,931

4.40%

159,708

Total

18,972,068

5.19%

11,694,019

20,488,523

4.72%

11,576,538

(1) Unadvanced commitments include loans for which loan contracts have been approved and executed, but funds have not been advanced. Additional information may be required to assure that all conditions for advance of funds have been fully met and that there has been no material change in the member's condition as represented in the supporting documents. Since commitments may expire without being fully drawn upon and a significant amount of the commitments are for standby liquidity purposes, the total unadvanced loan commitments do not necessarily represent future cash requirements. Collateral and security requirements for advances on commitments are identical to those on initial loan approval. As the interest rate on unadvanced commitments is not set, long-term unadvanced commitments have been classified in this chart as variable rate unadvanced commitments. However, once the loan contracts are executed and funds are advanced, the commitments could be at either a fixed or a variable rate.

The following table summarizes non-performing and restructured loans outstanding by loan program and by segment at May 31:

2005

2004

Loan outstanding and

(Dollar amounts in thousands)

weighted average interest

Non-performing loans:

rates thereon

RTFC:

Long-term fixed rate loans

213,092

Long-term variable rate loans

353,480

159,328

Line of credit loans

49,777

181,110

Total RTFC loans

616,349

340,438

NCSC

277

789

Total non-performing loans

616,626

341,227

Restructured loans:

CFC:

Long-term variable rate loans

593,584

617,808

RTFC

Long-term fixed rate loans

7,342

6.65%

Total restructured loans

600,926

0.08%

617,808

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


~~(A)~~	~~Unadvanced commitments include~~At May 31, 2005 and 2004, deferred loan origination costs related to loans approved by CFC for which loan contracts have been approved and executed, but funds have not been advanced. Since commitments may expire without being fully drawn upon, the total amounts reported as commitments do not necessarily represent future cash requirements. Collateral and security requirements for advances on commitments are identical to those on initial loan approval. As the interest rate on unadvanced commitments is not set, long-term unadvanced commitments have been classified in this chart as variable rate unadvanced commitments. However, once the loan contracts are executed and funds are advanced, the commitments could be at either a fixed or a variable rate.
~~(B)~~	Generally, under the terms of long-term fixed rate loans, members may select a fixed rate for periods that range from one to 35 years. Upon expiration of the interest rate term, the borrower may select another fixed rate term of one to 35 years (but not beyond maturity of the loan) or a variable rate. The borrower may also repay to CFC the principal then outstanding ~~together with interest due thereon and other sums, if required. Includes $522~~totaled $2 million and ~~$395~~$1 million, ~~of unsecured loans at May 31, 2003 and 2002,~~ respectively.
~~(C)~~	~~Includes $328 million and $266 million of unsecured loans and $396 million and $498 million of unsecured unadvanced commitments at May 31, 2003 and 2002, respectively.~~
~~(D)~~	~~Includes $331 million and $387 million of secured loans and $306 million and $251 million of secured unadvanced commitments at May 31, 2003 and 2002, respectively.~~
~~(E)~~	~~The rate on restructured loans represents the rate at which CFC was accruing interest on the loans classified as restructured at May 31, 2003 and 2002.~~
~~(F)~~	CFC includes its guarantee exposures and loan exposures in the calculations of the loan loss allowance. Under the terms of the guarantee agreements, if CFC is required to advance funds, such amount becomes a loan receivable from the member whose obligation CFC guaranteed.

Credit Concentration

~~CFC's~~The Company's loan portfolio is widely dispersed throughout the United States and its territories, including 4849 states, the District of Columbia, American Samoa and the U.S. Virgin Islands. At May 31, ~~2003~~2005 and ~~2002, no~~2004, loans outstanding to borrowers in any state or territory ~~had over 18% and 21%, respectively,~~did not exceed 16% of total loans outstanding. In addition to the geographic diversity of the portfolio, ~~CFC~~the Company limits its exposure to any one borrower. At May 31, ~~2003,~~2005 and 2004, the total exposure outstanding to any one borrower or controlled group did not exceed ~~3.4%~~3.0% of total loans and guarantees ~~outstanding compared to 4.6% at May 31, 2002.~~outstanding. At May 31, 2003, CFC had $4,768 million in loans outstanding and $610 million in guarantees outstanding to its ten largest borrowers compared to $5,192 million in loans and $701 million in guarantees for the prior year. The amounts outstanding to2005, the ten largest borrowers ~~at May 31, 2003 represented 24% of total loans outstanding~~included four distribution systems, three power supply systems and 32% of total guarantees outstanding compared to 26% of total loans outstanding and 34% of total guarantees outstanding for the prior year. Total credit exposure to the ten largest borrowers was $5,378 million and $5,893 million and represented 25% and 27% of total credit exposure at May 31, 2003 and 2002, respectively.three telecommunications systems. At May 31, ~~2003 and 2002,~~2004, the ten largest borrowers included two distribution systems, ~~two~~three power supply systems ~~one service organization~~ and five telecommunications systems. At May 31, 2005 and 2004, the Company had the following amounts outstanding to its ten largest borrowers:

(Dollar amounts in millions)		2005	% of Total		2004	% of Total
Loans	$	3,412	18%	$	4,415	22%
Guarantees		227	20%		240	18%
Total credit exposure	$	3,639	18%	$	4,655	21%

Interest Rates

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

For the Years Ended May 31,
2003
2002
2001
Long-term fixed rate
5.92%
6.56%
6.78%
Long-term variable rate
3.64%
5.08%
7.60%
Telecommunication organizations (1)
6.92%
7.13%
8.31%
Refinancing loans guaranteed by RUS
1.91%
3.14%
6.61%
Intermediate-term
4.55%
5.97%
7.99%
Short-term
3.82%
5.49%
8.01%
Associate members
4.32%
5.53%
7.86%
Nonperforming (2)
0.00%
0.00%
0.00%
Restructured
3.88%
3.21%
4.33%
All loans
5.40%
5.98%
7.36%

	For the Years Ended May 31,
	2005	2004	2003
Long-term fixed rate	5.62%	5.85%	6.39%
Long-term variable rate	4.50%	3.48%	4.36%
Loans guaranteed by RUS	4.90%	4.61%	4.62%
Intermediate-term	3.87%	3.33%	4.65%
Line of credit loans	3.97%	3.36%	4.26%
Non-performing	0.00%	0.00%	0.00%
Restructured	0.05%	0.00%	3.88%
Total	5.17%	4.95%	5.40%
Total by segment:
CFC	4.99%	4.49%	4.88%
RTFC	5.84%	6.37%	6.93%
NCSC	5.77%	5.11%	-
Total	5.17%	4.95%	5.40%

~~(1)~~	~~Includes long-term fixed rate, long-term variable rate, intermediate-term and short-term loans.~~
~~(2)~~	~~Interest rate earned by CFC recognized on~~In general, a ~~cash basis.~~

A borrower can select a fixed interest rate on long-term loans for periods of one to 35 years or the variable rate. Upon 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 variable rates monthly. On notification to borrowers, CFC may adjust the variable interest rate semi-monthly. Under CFC's policy, the maximum interest rate which may be charged on short-term loans is the prevailing bank prime rate plus 1% per annum; on intermediate-term loans, the prevailing bank prime rate plus 1% per annum; and on RTFC short-term loans, the prevailing bank prime rate plus 11/2%2% per annum. 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.

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

Loan Repricing

Long-term fixed rate loans outstanding at May 31, ~~2003,~~2005, which will be subject to adjustment of their interest rates during the next five fiscal years are summarized as follows (due to principal repayments, amounts subject to interest rate adjustment may be lower at the actual time of interest rate adjustment):

Weighted Average
(Dollar amounts in thousands)
Interest Rate
Amount Repricing
2004
5.00%
$
2,336,164
2005
5.29%
1,681,776
2006
7.25%
1,384,533
2007
5.63%
563,640
2008
5.79%
316,815
Thereafter
4.60%
1,833,162

	Weighted Average
(Dollar amounts in thousands)	Interest Rate		Amount Repricing

2006		4.35%	$	1,060,001
2007		4.54%		1,095,391
2008		4.91%		828,781
2009		5.22%		831,444
2010		5.36%		590,635
Thereafter		5.98%		2,234,035

During the year ended May 31, ~~2003,~~2005, long-term fixed rate loans totaling ~~$574~~$1,206 million had their interest rates adjusted.

Loan Amortization

On most long-term ~~secured~~ loans, level quarterly payments are required with respect to principal and interest in amounts sufficient to repay the loan principal, generally over a period ending approximately 35 years from the date of the secured promissory note.

Amortization of long-term loans in each of the five fiscal years following May 31, ~~2003~~2005 and thereafter are as follows:

(Dollar amounts in thousands)
Amortization (1)
2004
$
867,417
2005
963,019
2006
897,863
2007
809,362
2008
806,746
Thereafter
13,948,390

(Dollar amounts in thousands)		Amortization (1)

	2006	$	932,482
	2007		857,958
	2008		884,688
	2009		845,392
	2010		808,944
	Thereafter		12,447,409

(1) Represents scheduled amortization based on current rates without consideration for loans that reprice. Excludes restructured and non-performing loans.

Loan Security

~~CFC~~The Company evaluates each borrower's creditworthiness on a case-by-case basis. It is generally ~~CFC's~~the Company's policy to require collateral for long-term loans. Such collateral usually consists of a first mortgage lien on the borrower's total system, including plant and equipment, and a pledge of future revenues. The loan and security documents also contain various provisions with respect to the mortgaging of the borrower's property and debt service coverage ratios, maintenance of adequate insurance coverage as well as certain other restrictive covenants. ~~As of May 31, 2003 and 2002, unsecured loans represented 9% and 8% of total loans, respectively.~~

The following tables summarize the Company's secured and unsecured loans outstanding by loan program and by segment.

(Dollar amounts in thousands)		At May 31, 2005					At May 31, 2004
Total by loan program:		Secured	%	Unsecured	%		Secured	%	Unsecured	%
	Long-term fixed rate loans	$ 12,293,054	97%	$ 431,704		3%	$ 13,290,756	97%	$ 349,191	3%
	Long-term variable rate loans	4,701,660	95%	259,737		5%	5,191,421	95%	256,802	5%
	Loans guaranteed by RUS	258,493	100%	-		-	263,392	100%	-	-
	lntermediate-term loans	1,235	12%	9,093		88%	5,015	9%	50,390	91%
	Line of credit loans	201,466	20%	815,626		80%	299,250	28%	782,306	72%
	Total loans	$ 17,455,908	92%	$ 1,516,160		8%	$ 19,049,834	93%	$ 1,438,689	7%

Total by segment:
	CFC	$14,316,925	92%	$1,188,241	8%	$14,202,369	92%	$1,153,215	8%
	RTFC	2,747,845	92%	244,347	8%	4,384,412	94%	258,596	6%
	NCSC	391,138	82%	83,572	18%	463,053	95%	26,878	5%
	Total loans	$17,455,908	92%	$1,516,160	8%	$19,049,834	93%	$1,438,689	7%

86

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

Concurrent Loans

CFC generally makes loans to borrowers both as the sole lender of the loan commitment and on a concurrent basis with RUS. Under default provisions of common mortgages securing long-term CFC loans to distribution system members that also borrow from RUS, RUS has the sole right to act within 30 days or, if RUS is not legally entitled to act on behalf of all noteholders, CFC may exercise remedies. Under common default provisions of 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. As of May 31, ~~2003~~2005 and ~~2002,~~2004, CFC had ~~$ 2,916~~$2,681 million and ~~$3,073~~$2,802 million outstanding, respectively, onof loans issued on a concurrent basis with RUS.

Pledging of Loans

As of May 31, ~~2003~~2005 and ~~2002,~~2004, distribution system mortgage notes representing approximately ~~$6,664~~$7,293 million and ~~$6,144~~$7,476 million, respectively, related to outstanding long-term loans ~~to members~~ and ~~$224~~$218 million and ~~$0,~~$222 million, respectively, of RUS guaranteed loans qualifying as permitted investments were pledged as collateral to secure CFC's collateral trust bonds under the 1994 indenture. In addition, $2 million of cash was pledged under the 1972 indenture at May 31, ~~2003~~2005 and ~~2002.~~2004.

RUS Guaranteed Loans

At May 31, ~~2003~~2005 and ~~2002,~~2004, CFC had a total of ~~$267~~$258 million and ~~$243~~$263 million, respectively, of loans outstanding on which RUS had guaranteed the repayment of principal and interest. There are two programs under which these loans were advanced. At May 31, ~~2003~~2005 and ~~2002,~~2004, CFC had a total of ~~$43~~$40 million and ~~$44~~$41 million, respectively, under a program in which RUS previously allowed certain qualifying cooperatives to repay loans held by the Federal Financing Bank of the United States Treasury early and allowed the transfer of the guarantee to the new lender. At May 31, ~~2003~~2005 and ~~2002,~~2004, CFC had a total of ~~$224~~$218 million and ~~$199~~$222 million, respectively, under a program in which RUS approved CFC, in February 1999, as a lender under its current loan guarantee program.


(3)	Foreclosed Assets

~~Entities controlled by~~Foreclosed assets received in satisfaction of loan receivables are recorded at the lower of cost or market and identified on the consolidated balance sheets as foreclosed assets. During fiscal year 2003, CFC received assets ~~from entities related to~~with a fair value totaling $369 million primarily comprised of real estate developer notes receivable, limited partnership interests in certain real estate developments and partnership interests in real estate properties, as well as telecommunications assets as part of the bankruptcy settlement with Denton County Electric Cooperative, d/b/a CoServ Electric ("CoServ") ~~as part of the plan for CoServ to emerge from bankruptcy. On October 11, 2002,~~. CFC ~~received all~~operates certain real estate assets and interests in real estate operations previously held by CoServ. On December 13, 2002, CFC received all telecommunications assets held by CoServ. In December 2002, another borrower transferred real estate assets to an entity controlled by CFC in repayment of the loan as part of a settlement.

CFC accounts for these assets on the combined balance sheets as foreclosed assets and recorded these assets at their fair value at the time of transfer.

(Dollar amounts in thousands)
Foreclosed Assets
Original recorded fair value
$
369,393
Results of operations
1,249
Net cash received
(15,377
)
Impairment to fair value write down
(19,689
)
Ending balance of foreclosed assets
$
335,576


~~CFC is operating certain real estate and telecommunications assets and servicing~~services the notes receivable while attempting to sell these assets. CFC operated the telecommunications assets before they were sold on October 27, 2003 for $31 million in cash. This sale terminated CFC's responsibilities for all future operations of the telecom assets acquired in the bankruptcy settlement with CoServ. CFC may make additional advances as required under the terms of the notes receivable or make additional investments in the real estate assets to preserve their fair value. The results of operations from foreclosed assets since the dates of foreclosure are shown on the combined statements of operations. For the year ended May 31, 2003, this amount was income of $1 million. CFC also recorded a $20 million impairment loss for the write down of certain foreclosed assets to their fair value at May 31, 2003. An impairment loss of $10 million was recorded to write down telecommunications assets based on a letter ofIt is CFC's intent to ~~purchase these~~eventually sell the foreclosed assets. ~~An impairment loss of $9 million was recorded~~However, the assets do not currently meet the conditions necessary to qualify as assets held for ~~real estate assets based~~sale under SFAS 144. Accordingly, CFC records depreciation on an estimate of discounted future cash flows. Additionally, CFC recorded an impairment loss of $1 million to increase the allowance for loan losses for notes receivable based on individual risk assessments performed on the loan portfolio.foreclosed assets.

(4)

The activity for foreclosed assets is summarized below for the years ended May 31:

(Dollar amounts in thousands)	2005			2004			2003
Beginning balance	$	247,660		$	335,576		$	-
Recorded fair value		-			-			369,393
Results of operations		13,079			13,469			9,734
Net cash received		(116,134	)		(59,508	)		(23,862	)
Impairment to fair value write down		(55	)		(10,877	)		(19,689	)
Sale of foreclosed assets		(3,600	)		(31,000	)		-
Ending balance of foreclosed assets	$	140,950		$	247,660		$	335,576

Related to the foreclosed assets were funding costs totaling $6 million, $10 million and $8 million for the years ended May 31, 2005, 2004 and 2003 which are reported in the cost of funds in the consolidated and combined statements of operations.

~~Notes Payable and Credit Arrangements~~NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION


~~Notes payable due within one year~~NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


(4)	Short-Term Debt and Credit Arrangements

The following is a summary of short-term debt at May 31, and weighted average interest rates ~~thereon, are summarized~~thereon.

	2005					2004
				Weighted				Weighted
	Amount			Average		Amounts		Average
(Dollar amounts in thousands)	Outstanding			Interest Rate		Outstanding		Interest Rate
Short-term debt:
Commercial paper sold through dealers, net of discounts	$	2,873,167			3.07%	$	2,298,605		1.09%
Commercial paper sold by CFC directly to members, at par		989,250			3.11%		973,383		1.11%
Commercial paper sold by CFC directly to non-members, at par		127,920			3.14%		29,918		1.15%
Total commercial paper		3,990,337			3.09%		3,301,906		1.10%
Daily liquidity fund		270,868			3.10%		222,833		1.10%
Bank bid notes		100,000			3.14%		100,000		1.13%
Total short-term debt		4,361,205			3.09%		3,624,739		1.10%
Long-term debt maturing within one year:
Medium-term notes (1)		1,086,593			3.64%		456,247		2.15%
Foreign currency valuation account (1)		40,425			-		-		-
Secured collateral trust bonds		2,448,530			5.28%		1,899,773		4.57%
Long-term notes payable		15,826			3.27%		9,280		3.42%
Total long-term debt maturing within one year		3,591,374			4.76%		2,365,300		4.10%
Short-term debt supported by revolving credit
agreements, classified as long-term debt (see Note 5)		(5,000,000	)		3.84%		(4,650,000

)

2.28%

Total short-term debt

2,952,579

3.84%

1,340,039

2.28%

_________________________

(1)

At May 31, 2005, medium-term notes includes $390 million related to medium-term notes denominated in Euros. The foreign currency valuation account represents the change in the dollar value of foreign denominated debt due to changes in currency exchange rates from the date the debt was issued to the reporting date as ~~follows:~~required under SFAS 52.

2003
2002
Weighted
Weighted
Amounts
Average
Amounts
Average
(Dollar amounts in thousands)
Outstanding
Interest Rate
Outstanding
Interest Rate
Commercial paper sold through dealers, net of
$
819,672
1.30%
$
2,162,158
1.88%
   discounts of $328 and $2,484, respectively
Commercial paper sold by CFC directly to members, at par
930,274
1.26%
911,212
1.91%
Commercial paper sold by CFC directly to nonmembers, at par
25,605
1.30%
18,642
1.89%
    Total commercial paper
1,775,551
1.28%
3,092,012
1.89%

Daily liquidity fund
110,602
1.22%
44,989
2.00%
Bank bid notes
100,000
1.37%
100,000
1.91%
Long-term debt maturing within one year
2,911,375
2.56%
2,883,112
4.26%
Foreign currency valuation account
149,450
(519
)

Total notes payable due within one year
5,046,978
2.04%
6,119,594
3.00%
Notes payable supported by revolving credit
   agreements, classified as long-term debt (see Note 5)
(3,950,625
)
2.04%
(3,705,625
)
3.00%
Total notes payable due in one year after reclassification to long-term
$
1,096,353
2.04%
$
2,413,969
3.00%

CFC issues commercial paper for periods of one to 270 days. CFC also enters into short-term bank bid note agreements, which are unsecured obligations of CFC and do not require backup bank lines for liquidity purposes. Bank bid note facilities are uncommitted lines of credit for which CFC does not pay a fee. The commitments are generally subject to termination at the discretion of the individual banks.

Revolving Credit Agreements

(Dollar amount in thousands)		2005		2004	Termination Date	Facility fee per annum (1)
Three-year agreement	$	1,740,000	$	1,740,000	March 30, 2007	0.10 of 1%
Five-year agreement		1,975,000		-	March 23, 2010	0.09 of 1%
364-day agreement (2)		1,285,000		-	March 22, 2006	0.07 of 1%
364-day agreement (2)		-		1,740,000	March 29, 2005	0.085 of 1%
364-day agreement (2)		-		1,170,000	March 29, 2005	0.085 of 1%
	$	5,000,000	$	4,650,000

________________
89(1)

Under a three-year agreement in effect at May 31, 2003 and 2002, CFC may borrow $1,028 million. This agreement terminates on August 8, 2004. In connection with this facility, CFC pays a per annum facilityFacility fee ~~of 0.125 of 1% as~~ determined by CFC's senior unsecured credit ratings based on athe pricing ~~schedule~~schedules put in place at the ~~credit~~initiation of the related agreement.

(2)

~~At May 31, 2003 and 2002 there were two 364-day~~Any amount outstanding under these agreements totaling $2,778 million and $3,534 million, respectively. The $3,534 million of 364-day agreements outstanding at May 31, 2002 were scheduled to expire on August 7, 2002 and were replaced on July 1, 2002 with two 364-day agreements totaling $2,678 million and expiring on June 30, 2003. Under one 364-day agreement, the amount CFC could borrow decreased from $3,084 million at May 31, 2002 to $2,378 million. Under the second 364-day agreement, the amount CFC could borrow decreased from $450 million at May 31, 2002 to $300 million. On March 6, 2003, this agreement was amended to increase the amount of credit available under the agreement from $300 million to $400 million.

The agreements in place at May 31, 2003 were replaced on June 30, 2003 with two 364-day agreements totaling $2,923 million. Under one 364-day agreement, the amount that CFC could borrow increased from $2,378 million at May 31, 2003 to $2,523 million. There was no change to the amount of the second 364-day agreement for $400 million. Both 364-day agreements have a revolving credit period that terminates on June 28, 2004 during which CFC can borrow, and such borrowings may be converted to a one-year term loan at the end of the revolving credit ~~period with~~periods. For the agreement in place at May 31, 2005, if converted to a ~~.250 of 1% per annum~~term loan, the fee on the outstanding principal amount of the term ~~loan.~~loan is 0.125 of 1% per annum.

~~The facility fee for the 364-day facilities is .085 of 1% per annum based on the pricing schedules in place at May 31, 2003 and in the agreements currently in effect.~~ Up-front fees of between ~~.075 to .090~~0.03 and 0.13 of 1% were paid to the banks based on their commitment level in each of the agreements ~~based on their commitment level,~~in place at May 31, 2005, totaling in aggregate ~~$2 million and~~ $3 million, ~~for commitments to~~which will be amortized as expense over the ~~agreements in effect at May 31, 2003 and~~life of the ~~current agreements, respectively.~~agreements. Each agreement contains a provision under which if borrowings exceed 50% of total commitments, a utilization fee ~~of .150 of 1%~~ must be paid on the outstanding balance. The utilization fee is 0.10 of 1% for the 364-day and five-year agreements and 0.15 of 1% for the three-year agreement outstanding at May 31, 2005.

For the purpose of the revolving credit agreements, net margin, senior debt and total equity are adjusted to exclude the non-cash

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


adjustments related to SFAS 133 and ~~pursuant to amendments dated August 13, 2003, SFAS 52, Foreign Currency Translation, are excluded from the covenant calculations. The fixed charge coverage~~52. Adjusted times interest earned ratio ~~is calculated by adding~~("TIER") represents the cost of funds adjusted to include the derivative cash settlements, toplus minority interest net margin, ~~adjusted~~plus net margin prior to ~~exclude the derivative forward value, foreign currency adjustments and~~ the cumulative effect of change in accounting principle and dividing that total by the cost of funds adjusted to include the derivative cash settlements. This is the same calculation as CFC's adjusted TIER. See "Non-GAAP Financial Measures" for further explanation and a reconciliation of the adjustments CFC makes to its TIER calculation to exclude the impact of SFAS 133 and foreign currency adjustments. The revolving credit agreements prohibit CFC from incurring seniorSenior debt ~~in an amount in excess of ten times~~represents the sum of ~~members' equity,~~subordinated deferrable debt, members' subordinated certificates, minority interest and ~~subordinated deferrable debt.~~total equity. 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.


*	~~indebtedness incurred to fund RUS guaranteed loans;~~ The following represents the Company's required financial ratios at or for the year ended May 31:
*	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; and

	Requirement	2005	2004

Minimum average adjusted TIER over the six most recent fiscal quarters	1.025	1.08	1.15

Minimum adjusted TIER at fiscal year end (1)	1.05	1.14	1.12

Maximum senior debt	10.00	6.30	6.87
_____________

(1)	The Company must meet this requirement in order to retire patronage capital.

Based on the ability to borrow under the bank line facilities, ~~CFC~~the Company classified ~~$3,951~~$5,000 million and ~~$3,706~~$4,650 million, respectively, of its ~~notes payable~~short-term debt outstanding as long-term debt at May 31, ~~2003~~2005 and ~~May 31, 2002. CFC~~2004. The Company expects to maintain more than ~~$3,951~~$5,000 million of ~~notes payable~~short-term debt outstanding during the next twelve months. If necessary, ~~CFC~~the Company can refinance such ~~notes payable~~short-term debt on a long-term basis by borrowing under the ~~three-year~~ credit ~~agreement totaling $1,028 million and the new 364-day~~ agreements totaling ~~$2,923~~$5,000 million discussed above, subject to the conditions therein.

9089

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


(5)	Long-Term Debt


The following is a summary of long-term debt at May 31 and the weighted average interest rates thereon:

2003
2002
Amounts Weighted Average Amounts Weighted Average
(Dollar amounts in thousands)
Outstanding
Interest Rate
Outstanding
Interest Rate
Notes payable supported by revolving credit agreement:
$
3,950,625
2.04%
$
3,705,625
3.00%
Unsecured medium-term notes:
   Medium-term notes, sold through dealers (1)
5,738,750
6,286,725
   Medium-term notes, sold directly to members (2)
157,935
77,133
   Subtotal
5,896,685
6,363,858
          Less: unamortized discount
(15,185
)
(8,800
)
                  Foreign currency valuation account
176,360
(1,836
)
   Total medium-term notes
6,057,860
6.29%
6,353,222
5.48%

Secured collateral trust bonds:
   5.30%, Bonds, due 2003 (3)
-
100,000
   6.00%, Bonds, due 2004 (3)
-
200,000
   5.25%, Bonds, due 2004
1,000,000
1,000,000
   6.375%, Bonds, due 2004
100,000
100,000
   5.50%, Bonds, due 2005
200,000
200,000
   Floating Rate Bonds, due 2005
400,000
-
   6.125%, Bonds, due 2005
200,000
200,000
   6.65%, Bonds, due 2005
50,000
50,000
   3.00%, Bonds, due 2006
600,000
-
   6.00%, Bonds, due 2006
1,500,000
1,500,000
   6.00%, Bonds, due 2006
300,000
300,000
   7.30%, Bonds, due 2006
100,000
100,000
   6.20%, Bonds, due 2008
300,000
300,000
   3.875%, Bonds, due 2008
500,000
-
   5.75%, Bonds, due 2008
225,000
225,000
   Floating Rate Bonds, Series E-2, due 2010 (4)
2,032
2,037
   5.70%, Bonds, due 2010
200,000
200,000
   7.20%, Bonds, due 2015
50,000
50,000
   6.55%, Bonds, due 2018
175,000
175,000
   7.35%, Bonds, due 2026
100,000
100,000
   Subtotal
6,002,032
4,802,037
          Less: unamortized discount
(8,832
)
(7,674
)
Total collateral trust bonds
5,993,200
5.17%
4,794,363
5.90%
Long-term debt valuation allowance (SFAS 133)
(941)
2,340
Total long-term debt
$
16,000,744
4.82%
$
14,855,550
5.00%

	2005			2004
	Amounts		Weighted Average	Amounts		Weighted Average
(Dollar amounts in thousands)	Outstanding		Interest Rate	Outstanding		Interest Rate
Unsecured medium-term notes:
Medium-term notes, sold through dealers (1)(5)	$	5,387,082		$	6,190,950
Medium-term notes, sold directly to members (2)		68,382			98,918
Subtotal		5,455,464			6,289,868
Unamortized discount

(11,330

)

(13,484

)

Foreign currency valuation account (5)

220,553

233,990

Total unsecured medium-term notes

5,664,687

6.51%

6,510,374

5.94%

Secured collateral trust bonds:

6.65%, Bonds, due 2005 (3)

50,000

3.00%, Bonds, due 2006 (3)

600,000

6.00%, Bonds, due 2006 (3)

1,500,000

6.00%, Bonds, due 2006 (3)

300,000

7.30%, Bonds, due 2006

100,000

3.25%, Bonds, due 2007

200,000

6.20%, Bonds, due 2008

300,000

3.875%, Bonds, due 2008

500,000

5.75%, Bonds, due 2008

225,000

Floating Rate Bonds, Series E-2, due 2010 (4)

2,024

2,025

5.70%, Bonds, due 2010

200,000

4.375% Bonds, due 2010

500,000

4.75% Bonds, due 2014

600,000

7.20%, Bonds, due 2015

50,000

6.55%, Bonds, due 2018

175,000

7.35%, Bonds, due 2026

100,000

Subtotal

2,952,024

5,402,025

Unamortized discount

(5,880

)

(10,168

)

Total secured collateral trust bonds

2,946,144

5.05%

5,391,857

5.15%

Long-term notes payable

91,124

4.94%

106,951

4.12%

Short-term debt supported by revolving credit

agreements, classified as long-term debt (see Note 4)

5,000,000

3.84%

4,650,000

2.28%

Total long-term debt

13,701,955

5.21%

16,659,182

4.66%

________________
(1)	Medium-term notes sold through dealers mature through 2032 as of May 31, ~~2003~~2005 and ~~2002.~~2004. Does not include ~~$2,473~~$921 million and ~~$1,700~~$280 million of medium-term notes sold through dealers that were reclassified as ~~notes payable due within one year~~short-term debt at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively.
(2)	Medium-term notes sold directly to members mature through 2023 ~~and 2010~~ as of May 31, ~~2003~~2005 and ~~2002, respectively.~~2004. Does not include ~~$138~~$206 million and ~~$158~~$176 million of medium-term notes sold to members that were reclassified as ~~notes payable due within one year~~short-term debt at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively.
(3)	Included as ~~notes payable due in one year~~short-term debt at May 31, ~~2003.~~2005.
(4)	Issued under the 1972 indenture. All others issued under the 1994 indenture.
(5)	At May 31, 2005 and 2004, medium-term notes sold through dealers includes $434 million and $824 million, respectively, related to medium-term notes denominated in Euros and $282 million and $282 million, respectively, of medium-term notes denominated in Australian dollars. The foreign currency valuation account represents the change in the dollar value of foreign denominated debt due to changes in currency exchange rates from the date the debt was issued to the reporting date as required under SFAS 52.

The principal amount of medium-term notes, ~~and~~ collateral trust bonds and long-term notes payable maturing in each of the five fiscal years following May 31, ~~2003~~2005 and thereafter is as follows:

	Amount		Weighted Average		Amount		Weighted Average
(Dollar amounts in thousands)	Maturing (2)		Interest Rate		Maturing		Interest Rate
2004 (1)	$	2,911,375		2.56%
2005		2,291,931		4.29%
2006		2,938,472		5.13%
2006 (1)					$	3,591,374		4.76%
2007		1,094,346		6.42%		1,643,951		5.80%
2008		813,730		4.78%		1,100,614		4.40%
2009						493,582		5.60%
2010						1,473,157		5.72%
Thereafter		4,736,221		6.80%		3,990,651		6.67%
Total					$	12,293,329		5.64%

_____________
(1)	The amount scheduled to mature in fiscal year ~~2004~~2006 has been presented as long-term debt due in one year under ~~notes payable.~~short-term debt.
~~(2)~~		Excludes the long-term debt valuation allowance totaling $(1) million and $2 million and the foreign currency valuation account totaling $326 million and $(2) million at May 31, 2003 and 2002, respectively.


9190

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

Under the 1972 indenture for collateral trust bonds, CFC is required to maintain funds in a debt service investment account equivalent to principal and interest payments due on the bonds over the next 12 months. At May 31, ~~2003~~2005 and ~~2002, there was only~~2004, CFC had $2 million invested in bank certificates of deposit and marketable securities representing pledged collateral and used to meet debt service requirements for interest on the one series of bonds outstanding under the 1972 indenture. ~~At May 31, 2003 and 2002, CFC had $2 million of debt service funds invested in bank certificates of deposit and marketable securities.~~

The ~~outstanding~~remaining collateral trust bonds outstanding under the 1994 indenture are secured by the pledge of mortgage notes taken by CFC in connection with long-term secured loans made to ~~those~~ members and RUS guaranteed loans qualifying as permitted investments fulfilling specified criteria as set forth in the indentures. Medium-term notes are unsecured obligations of CFC.

Foreign Denominated Debt

As a result of issuing debt in foreign currencies, CFC must adjust the value of the debt reported on the ~~combined~~consolidated balance ~~sheet~~sheets for changes in foreign currency exchange rates since the date of issuance. At the time of issuance of all foreign denominated debt, CFC enters into a cross currency or cross currency interest rate exchange agreements to fix the exchange rate on all principal and interest payments through maturity. The foreign denominated debt is revalued at each reporting date based on the current exchange rate. To the extent that the current exchange rate is different than the exchange rate at the time of issuance, there will be a change in the value of the foreign denominated debt. The adjustment to the value of the debt on the ~~combined~~consolidated balance ~~sheet~~sheets is also reported on the consolidated and combined ~~statement~~statements of operations as foreign currency adjustments. For foreign denominated debt with related cross currency exchange agreements that qualify for hedge treatment under SFAS 133, the change in the value of the debt reported in the combined statement of operations is fully offset by the reclassification of an equal amount of the change in the fair value of the related hedge from accumulated other comprehensive loss, where the change in the fair value of the hedge was originally reported. As a result of entering cross currency and cross currency interest rate exchange agreements, the adjusted debt value at the reporting date does not represent the amount that CFC will ultimately pay to retire the debt, unless the counterparty to the cross currency or cross currency interest rate exchange agreement does not perform as required under the agreement.

~~(6)~~

~~Derivative Financial Instruments~~

~~Interest Rate Exchange Agreements~~

At May 31, 2003 and 2002, CFC was a party to interest rate exchange agreements totaling notional amounts of $15,345 million and $12,667 million, respectively. CFC uses interest rate exchange agreements as part of its overall interest rate matching strategy. Interest rate exchange agreements are used when they provide CFC a lower cost of funding or minimize interest rate risk. CFC has not invested in derivative financial instruments for trading purposes in the past and does not anticipate doing so in the future. CFC's interest rate exchange agreements at May 31, 2003 have maturity dates ranging from 2003 to 2029.

Generally, CFC's interest rate exchange agreements do not qualify for special hedge accounting under SFAS 133. The majority of CFC's interest rate exchange agreements use a 30-day composite commercial paper index as either the pay or receive leg. The 30-day composite commercial paper index is the best match for the CFC commercial paper that is the underlying debt and is also used as the cost basis in the CFC variable interest rates. However, the correlation between movement in the 30-day composite commercial paper index and movement in CFC's commercial paper rates is not high enough to qualify for special hedge accounting.

In interest rate exchange agreements in which CFC receives a fixed rate, the fixed rate is equal to the rate on the underlying debt, and the rate that CFC pays is tied to the rate earned on the asset funded. In interest rate exchange agreements in which CFC receives a variable rate, the variable rate is tied to the same index as the variable rate CFC pays on the underlying debt and the rate that CFC pays is tied to the rate earned on the asset funded.

At May 31, 2003 and 2002, none of CFC's interest rate exchange agreements qualified for hedge accounting; therefore, all changes in fair value are recorded in the combined statement of operations. The net impact of the interest rate exchange agreements on earnings for the year ended May 31, 2003 and 2002, respectively, was a gain of $454 million and a gain of $16 million, which includes net amortization of $19 million and $21 million related to the long-term debt valuation allowance and the transition adjustment recorded as an other comprehensive loss on June 1, 2001. These adjustments will be amortized into earnings over the remaining life of the agreements. Approximately $17 million is expected to be

~~amortized over the next 12 months. The amortization will continue through April 2029, the final maturity date for interest rate exchange agreements included in the transition adjustment.~~

At May 31, 2003 and 2002, interest rate exchange agreements with a total notional amount of $6,595 million and $4,542 million, respectively, in which CFC pays a fixed rate and receives a variable rate based on a 30-day composite commercial paper index or a LIBOR based rate, were used to synthetically change the rate on debt used to fund long-term fixed rate loans from a variable rate to a fixed rate.

At May 31, 2003 and 2002, interest rate exchange agreements with a total notional amount of $700 million and $1,800 million, respectively, in which CFC pays a variable rate based on a 30-day composite commercial paper index and receives a LIBOR based rate, were used to synthetically change the rate on floating collateral trust bonds and medium-term notes from a variable LIBOR rate to the 30-day commercial paper rate. CFC synthetically changes the rate from a LIBOR based rate to a commercial paper based rate because its long-term variable interest rate is based on the cost of its short-term debt, primarily commercial paper.

At May 31, 2003 and 2002, interest rate exchange agreements with a total notional amount of $8,050 million and $6,325 million, respectively, in which CFC pays a variable rate based on a 30-day composite commercial paper index or a LIBOR based rate and receives a fixed rate, were used to synthetically change the rate on debt from fixed to variable.

No amounts that CFC paid and received related to the interest rate exchange agreements qualified for hedge accounting for the years ended May 31, 2003 and 2002, thus all such amounts were included in CFC's derivative cash settlements. In fiscal year 2001, prior to the implementation of SFAS 133, the net settlements for all interest rate exchange agreements were included in the cost of funds. The estimated forward value of CFC's interest rate exchange agreements is shown on the combined balance sheet due to the adoption of SFAS 133.

Either CFC or the counterparty to an interest rate exchange agreement may terminate the agreement due to specified events, primarily a credit downgrade. If either counterparty terminates the agreement, a payment may be due from one counterparty to the other based on the fair value of the underlying derivative instrument. During the year ended May 31, 2002, CFC paid $4 million of fees to counterparties related to the exiting of an agreement and the buydown of rates on an agreement which were recorded as a derivative forward value. CFC is exposed to counterparty credit risk on interest rate exchange agreements if the counterparty to the interest rate exchange agreement does not perform pursuant to the agreement's terms. CFC only enters into interest rate exchange agreements with financial institutions with investment grade ratings.

~~Cross Currency and Cross Currency Interest Rate Exchange Agreements~~

At May 31, 2003, CFC had medium-term notes outstanding that were denominated in foreign currencies. CFC entered into cross currency and cross currency interest rate exchange agreements related to each foreign denominated issue in order to synthetically change the foreign denominated debt to U.S. dollar denominated debt. At May 31, 2003 and 2002, CFC was a party to cross currency and cross currency interest rate exchange agreements with a total notional amount of $1,262 and $1,408 million, respectively.

*	~~Cross currency interest rate exchange agreements that are not designated as and do not qualify as hedges~~.
	Cross currency interest rate exchange agreements with a total notional amount of $872 million at May 31, 2003 and 2002, in which CFC receives Euros and pays U.S. dollars, and $146 million at May 31, 2002, in which CFC receives Yen and pays U.S. dollars, are used to synthetically change the foreign denominated debt to U.S. dollar denominated debt. In addition, the agreements synthetically change the interest rate from the fixed rate on the foreign denominated debt to variable rate U.S. denominated debt or from a variable rate on the foreign denominated debt to a different variable rate. These cross currency interest rate exchange agreements do not qualify for hedge accounting; therefore, all changes in fair value are recorded in the combined statement of operations. The net impact of these cross currency interest rate exchange agreements on earnings for the years ended May 31, 2003 and 2002 was a gain of $303 million and $58 million, respectively.

*	~~Cross currency exchange agreements that are designated as and qualify as hedges.~~
	At May 31, 2003 and 2002, cross currency exchange agreements with a total notional amount of $390 million in which CFC receives Euros and pays U.S. dollars are designated as and qualify as effective cash flow hedges. Effectiveness is

assessed by comparing the critical terms of the cross currency exchange agreements to the critical terms of the hedged debt. All effective changes in forward value on these cross currency exchange agreements are recorded as other comprehensive income (loss) and reported in the combined statement of changes in equity. Reclassifications are then made from other comprehensive loss to foreign currency adjustments on the combined statement of operations in an amount equal to the change in the fair value of the foreign denominated debt that is related to the effective hedge, which results in the full offset of the change in the fair value of such debt based on the changes in the exchange rate during the period. The net impact was other comprehensive income of $4 million for the year ended May 31, 2003 and other comprehensive loss of $31 million for the year ended May 31, 2002. The other comprehensive loss for the year ended May 31, 2002 excludes $42 million related to the transition adjustment recorded for interest rate and cross currency interest rate exchange agreements that do not qualify as hedges. No amount related to ineffectiveness was recorded in the combined statement of operations for the years ended May 31, 2003 and 2002. These cross currency exchange agreements mature in February 2006.

The following chart provides details of CFC's outstanding cross currency and cross currency interest rate exchange agreements at May 31, 2003 and 2002.

Notional Principal Amount
(Currency amounts in thousands)
U.S. Dollars
Foreign Currency
Exchange
May 31,
May 31,
May 31,
May 31,
Maturity Date
Rate
2003
2002
2003
2002
Aug. 6, 2002
124.30
$
-
$
40,225
(3)
-
5,000,000
YEN (2)
Aug. 13, 2002
124.35
-
40,210
(3)
-
5,000,000
YEN (2)
Aug. 16, 2002
122.90
-
24,410
(3)
-
3,000,000
YEN (2)
Aug. 20, 2002
122.90
-
40,684
(3)
-
5,000,000
YEN (2)
Dec. 10, 2003
1.139
438,850
(3)
438,850
(3)
500,000
EU (1)
500,000
EU (1)
Feb. 24, 2006
0.8969
390,250
390,250
350,000
EU (1)
350,000
EU (1)
Mar. 14, 2007
1.153
433,500
(3)
433,500
(3)
500,000
EU (1)
500,000
EU (1)

~~(1) EU - Euros~~

~~(2) YEN - Japanese Yen~~

(3) These agreements also change the interest rate from a foreign denominated fixed rate to a U.S. dollar denominated variable rate or from a foreign denominated variable rate to a U.S. dollar denominated variable rate.

Generally, CFC does not qualify for special hedge accounting on cross currency interest rate exchange agreements in which the interest rate is moved from fixed to floating or from one floating index to another floating index.

CFC entered into these exchange agreements to sell the amount of foreign currency received from the investor for U.S. dollars on the issuance date and to buy the amount of foreign currency required to repay the investor principal and interest due through or on the maturity date. By fixing the exchange rates at the time of issuance, CFC has eliminated the possibility of any currency gain or loss (except in the case of CFC or a counterparty default or unwind of the transaction), which might otherwise have been produced by the foreign currency borrowing.

On foreign denominated medium-term notes with maturities longer than one year, interest is paid annually and on medium-term notes with maturities of less than one year, interest is paid at maturity. CFC considers the cost of all related cross currency and cross currency interest rate exchange agreements as part of the total cost of debt issuance when deciding on whether to issue debt in the U.S. or foreign capital markets and whether to issue the debt denominated in U.S. dollars or foreign currencies.

Either counterparty to the cross currency and cross currency interest rate exchange agreements may terminate the agreement due to specified events, primarily a credit downgrade. If either counterparty terminates the agreement, a payment may be due from one counterparty to the other based on the fair value of the underlying derivative instrument which would result in a gain or loss. CFC is exposed to counterparty credit risk and foreign currency risk on the cross currency and cross currency interest rate exchange agreements if the counterparty to the agreement does not perform pursuant to the agreement's terms. CFC only enters into cross currency and cross currency interest rate exchange agreements with financial institutions with investment grade ratings.

All amounts that CFC paid and received related to the cross currency and cross currency interest rate exchange agreements that did not qualify for hedge accounting for the years ended May 31, 2003 and 2002 were included in derivative cash settlements. In fiscal years 2001, prior to the implementation of SFAS 133, the net settlements for all cross currency and cross currency interest rate exchange agreements were included in the cost of funds. All amounts that CFC paid and received related to cross currency and cross currency interest rate exchange agreements that did qualify for hedge accounting under SFAS 133 were included in cost of funds. The estimated forward value of CFC's cross currency and cross currency interest rate exchange agreements is shown on the combined balance sheet due to the adoption of SFAS 133.

~~Rating Triggers~~

At May 31, 2003, there are rating triggers associated with $11,059 million notional amount of interest rate, cross currency and cross currency interest rate exchange agreements. The rating triggers are based on CFC's senior unsecured credit rating from Standard & Poor's Corporation and Moody's Investors Service. If the rating for either counterparty falls below the level specified in the agreement, the other counterparty may, but is not obligated to, terminate the agreement. If either counterparty terminates the agreement, a payment may be due from one counterparty to the other based on the fair value of the underlying derivative instrument. If CFC's rating from Moody's Investors Service falls to Baa1 or CFC's rating from Standard & Poor's Corporation falls to BBB+, the counterparties may terminate agreements with a total notional amount of $2,183 million. If CFC's rating from Moody's Investors Service falls below Baa1 or CFC's rating from Standard & Poor's Corporation falls below BBB+, the counterparties may terminate the agreements on the remaining total notional amount of $8,876 million.

At May 31, 2003, CFC had a fair value of $116 million, comprised of $186 million that would be due to CFC and $70 million that CFC would have to pay if all interest rate, cross currency and cross currency interest rate exchange agreements with a rating trigger at the level of BBB+ or Baa1 and above were to be terminated and a fair value of $405 million, comprised of $573 million that would be due to CFC and $168 million that CFC would have to pay if all interest rate, cross currency and cross currency interest rate exchange agreements with a rating trigger below the level of BBB+ or Baa1 were to be terminated.


~~(7)~~(6)	Subordinated Deferrable Debt


Subordinated deferrable debt represents quarterly income capital securities and subordinated notes that are long-term obligations subordinated to CFC's outstanding debt and senior to subordinated certificates held by CFC's members. CFC's subordinated deferrable debt is issued for terms of up to 49 years, pays interest quarterly, may be called at par after five years and allows CFC to defer the payment of interest for up to 20 consecutive quarters. To date, CFC has not exercised its right to defer interest payments. The following table is a summary of subordinated deferrable debt outstanding at May 31:

2003
2002
Weighted
Weighted
Amounts
Average
Amounts
Average
(Dollar amounts in thousands)
Outstanding
Interest Rate
Outstanding
Interest Rate
6.75% due 2043
$
125,000
$
-
7.65% due 2046
-
75,000
7.375% due 2047
200,000
200,000
7.625% due 2050
150,000
150,000
7.40% due 2050
175,000
175,000
Total
$
650,000
7.32%
$
600,000
7.48%

	2005				2004
			Weighted				Weighted
	Amounts		Average		Amounts		Average
(Dollar amounts in thousands)	Outstanding		Interest Rate		Outstanding		Interest Rate
6.75% due 2043	$	125,000			$	125,000
6.10% due 2044		100,000				100,000
5.95% due 2045		135,000				-
7.625% due 2050		150,000				150,000
7.40% due 2050		175,000				175,000
Total	$	685,000		6.86%	$	550,000		7.08%


~~CFC issued $125~~(7)	Derivative Financial Instruments

Interest Rate Exchange Agreements
At May 31, 2005 and 2004, the Company was a party to interest rate exchange agreements with notional amounts totaling $13,693 million and $15,485 million, respectively. The Company uses interest rate exchange agreements as part of ~~6.75% subordinated notes on February 28, 2003. On March 28, 2003, CFC effected~~its overall interest rate matching strategy. Interest rate exchange agreements are used when they provide a lower cost of funding or minimize interest rate risk. The Company has not invested in derivative financial instruments for trading purposes in the ~~early redemption~~past and does not anticipate doing so in the future. The Company's interest rate exchange agreements at May 31, 2005 have maturity dates ranging from 2005 to 2031.

Generally, the Company's interest rate exchange agreements do not qualify for hedge accounting under SFAS 133. The majority of the ~~7.65% quarterly income capital securities totaling $75 million issued in September 1997. CFC redeemed these securities at par,~~Company's interest rate exchange agreements use a 30-day composite commercial paper index as either the pay or receive leg. The 30-day composite commercial paper index is the best match for the commercial paper that is the underlying debt and ~~recorded $2 million~~is also used as the cost basis in the ~~cost~~Company's variable interest rates. However, the correlation between movement in the 30-day composite commercial paper index and movement in the Company's commercial paper rates is not consistently high enough to qualify for hedge accounting.

91

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

In interest rate exchange agreements in which the Company receives a fixed rate, the fixed rate is equal to the rate on the underlying debt, and the rate that the Company pays is tied to the rate earned on the asset funded. In interest rate exchange agreements in which the Company receives a variable rate, the variable rate is tied to the same index as the variable rate the Company pays on the underlying debt and the rate that the Company pays is tied to the rate earned on the asset funded. However, when the Company uses its commercial paper as the underlying debt, the receive leg of ~~funds~~the interest rate exchange agreement is based on the 30-day composite commercial paper index. Commercial paper rates are not indexed to the 30-day composite commercial paper index and the Company does not solely issue its commercial paper with maturities of 30 days. The Company uses the 30-day composite commercial paper index as the pay leg in these interest rate exchange agreements because it is the market index that best correlates with its own commercial paper.

*	Interest rate exchange agreements that are not designated as and do not qualify as hedges.
	During the years ended May 31, 2005, 2004 and 2003, income related to interest rate exchange agreements that did not qualify for hedge accounting totaling $43 million, $82 million and $104 million, respectively, was recorded as derivative cash settlements in the consolidated and combined statements of operations. Cash settlements includes income of $65 million, $82 million and $104 million during the years ended May 31, 2005, 2004 and 2003, respectively, for the ~~unamortized issuance cost during~~periodic amounts that were paid and received related to its interest rate exchange agreements. During the year ended May 31, ~~2003. On December~~2005, cash settlements also includes $22 million of fees paid to counterparties related to the exiting of agreements. These agreements were terminated due to the prepayment of approximately $1.1 billion of loans, the proceeds of which were used to pay down the underlying debt for the terminated interest rate exchange agreements. The impact on earnings for the years ended May 31, 2005, 2004 and 2003 due to the change in fair value of these interest rate exchange agreements was a gain of $7 million, a loss of $274 million and a gain of $454 million, respectively, recorded in CFC's derivative forward value. For the years ended May 31, 2005, 2004 and 2003, the derivative forward value also includes amortization of zero, $1 million and $(3) million, respectively, related to the long-term debt valuation allowance and $13 million, $17 million and $22 million, respectively, related to the transition adjustment recorded as an other comprehensive loss on June 1, 2001, the date CFC ~~redeemed~~implemented SFAS 133. The transition adjustment will be amortized into earnings over the ~~$125~~remaining life of the related interest rate exchange agreements. Approximately $3 million ~~quarterly income capital securities at par,~~is expected to be amortized over the next 12 months related to the transition adjustment and ~~recorded $4~~amortization will continue through April 2029.

	At May 31, 2005 and 2004, interest rate exchange agreements with a total notional amount of $6,443 million and $7,235 million, respectively, in which the Company pays a fixed rate and receives a variable rate based on a 30-day composite commercial paper index or a LIBOR based rate, were used to synthetically change the rate on debt used to fund long-term fixed rate loans from a variable rate to a fixed rate.

	At May 31, 2005 and 2004, interest rate exchange agreements with a total notional amount of $7,050 million and $8,050 million, respectively, in which the Company pays a variable rate based on a 30-day composite commercial paper index or a LIBOR based rate and receives a fixed rate, were used to synthetically change the rate on debt from fixed to variable.

*	Interest rate exchange agreements that are designated as and qualify as hedges.
	At May 31, 2005 and 2004, interest rate exchange agreements with a total notional amount of $200 million in which the Company pays a fixed rate and receives a variable rate based on a LIBOR based rate were used to synthetically change the rate on debt used to fund long-term fixed rate loans from a variable rate to a fixed rate. These agreements are designated as and qualify as effective cash flow hedges. Effectiveness is assessed by comparing the critical terms of the interest rate exchange agreements to the critical terms of the hedged debt. Interest rate exchange agreements that qualify as effective cash flow hedges are deemed to be effective if the payment dates match exactly to the payment dates on the hedged debt throughout the terms of the agreements. All effective changes in forward value on these interest rate exchange agreements are recorded as other comprehensive income and reported in the consolidated and combined statement of changes in equity. The net impact was a loss of less than $1 million, a gain of $2 million and no impact to other comprehensive income for the years ended May 31, 2005, 2004 and 2003, respectively. No amount related to ineffectiveness was recorded in the consolidated and combined statement of operations for the years ended May 31, 2005, 2004 and 2003. For the years ended May 31, 2005, 2004 and 2003, cost of funds includes income of less than $1 million, expense of $1 million and zero, respectively, related to net cash settlements for ~~the unamortized issuance cost.~~interest rate exchange agreements that qualify as effective hedges.

Either the Company or the counterparty to an interest rate exchange agreement may terminate the agreement due to specified events, primarily a credit downgrade. If either counterparty terminates the agreement, a payment may be due from one counterparty to the other based on the fair value of the underlying derivative instrument. The Company is exposed to counterparty credit risk on interest rate exchange agreements if the counterparty to the interest rate exchange agreement does not perform pursuant to the agreement's terms. The Company only enters into interest rate exchange agreements with financial institutions with investment grade ratings.

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

Cross Currency and Cross Currency Interest Rate Exchange Agreements

At May 31, 2005, the Company had medium-term notes outstanding that are denominated in foreign currencies. The Company entered into cross currency and cross currency interest rate exchange agreements related to each foreign denominated issue in order to synthetically change the foreign denominated debt to U.S. dollar denominated debt. At May 31, 2005 and 2004, the Company was a party to cross currency and cross currency interest rate exchange agreements with a total notional amount of $1,106 million.

*	Cross currency interest rate exchange agreements that are not designated as and do not qualify as hedges.
	At May 31, 2005 and 2004, cross currency interest rate exchange agreements with a total notional amount of $434 million in which the Company receives Euros and pays U.S. dollars, and $282 million in which the Company receives Australian dollars and pays U.S. dollars, were used to synthetically change the foreign denominated debt to U.S. dollar denominated debt. In addition, the agreements synthetically change the interest rate from the fixed rate on the foreign denominated debt to variable rate U.S. denominated debt or from a variable rate on the foreign denominated debt to a different variable rate. These cross currency interest rate exchange agreements do not qualify for hedge accounting. Since the agreements synthetically change both the interest rate and the currency exchange rate in one agreement, the criteria to qualify for effectiveness specifies that the change in fair value of the debt when divided by the change in the fair value of the derivative must be within a range of 80% to 125%, which is more difficult to obtain than matching the critical terms. Therefore, all changes in fair value are recorded in the consolidated and combined statements of operations. The impact on earnings for the years ended May 31, 2005, 2004 and 2003 due to the change in fair value of these cross currency interest rate exchange agreements were gains of $23 million, $45 million and $303 million, respectively, recorded in the derivative forward value. The amounts paid and received related to cross currency interest rate exchange agreements that did not qualify for hedge accounting were income of $20 million, $28 million and $19 million, respectively, for the years ended May 31, 2005, 2004 and 2003 and were included in as part of derivative cash settlements.

*	Cross currency exchange agreements that are designated as and qualify as hedges.
	At May 31, 2005 and 2004, cross currency exchange agreements with a total notional amount of $390 million in which the Company receives Euros and pays U.S. dollars are designated as and qualify as effective cash flow hedges. Effectiveness is assessed by comparing the critical terms of the cross currency exchange agreements to the critical terms of the hedged debt. Cross currency exchange agreements that qualify as effective cash flow hedges are deemed to be effective if the payment dates match exactly to the payment dates on the hedged debt throughout the terms of the agreements. All effective changes in forward value on these cross currency exchange agreements are recorded as other comprehensive income (loss) and reported in the consolidated and combined statements of changes in equity. Reclassifications are then made from other comprehensive income (loss) to foreign currency adjustments on the consolidated and combined statements of operations in an amount equal to the change in the dollar value of foreign denominated debt, which results in the full offset of the change in the dollar value of such debt based on the changes in the exchange rate during the period. There were gains of $12 million, $16 million and $4 million to other comprehensive income for the years ended May 31, 2005, 2004 and 2003, respectively. No amount related to ineffectiveness was recorded in the consolidated and combined statements of operations for the years ended May 31, 2005, 2004 and 2003. Cost of funds includes $8 million of expense related to net cash settlements for cross currency exchange agreements that qualify as effective hedges for the years ended May 31, 2005, 2004 and 2003.

The following chart summarizes the cross currency and cross currency interest rate exchange agreements outstanding at May 31, 2005 and 2004.

(Currency amounts in thousands)

Notional Principal Amount

Original

U.S. Dollars (4)

Foreign Currency

Exchange

May 31,

Maturity Date

Rate

2005

2004

2005

2004

February 24, 2006

0.8969

390,250

350,000

EU (1)

350,000

EU (1)

July 7, 2006

1.506

282,200

(3)

282,200

(3)

425,000

AU (2)

425,000

AUD (2)

March 14, 2007

1.153

433,500

(3)

433,500

(3)

500,000

EU (1)

500,000

EU (1)

______________

(1) EU - Euros

(2) AUD - Australian dollars

(4) Amounts in the chart represent the U.S. dollar value at the initiation of the exchange agreement. At May 31, 2005 and 2004, one U. S. dollar was the equivalent of 0.813 and 0.820 Euros, respectively. One U. S. dollar was the equivalent of 1.324 and 1.398 Australian dollars at May 31, 2005 and 2004, respectively.

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

Generally, the Company's cross currency interest rate exchange agreements in which the interest rate is moved from fixed to floating or from one floating index to another floating index do not qualify for hedge accounting.

The Company entered into these exchange agreements to sell the amount of foreign currency received from the investor for U.S. dollars on the issuance date and to buy the amount of foreign currency required to repay the investor principal and interest due through or on the maturity date. By locking in the exchange rates at the time of issuance, the Company has eliminated the possibility of any currency gain or loss (except in the case of the Company or a counterparty default or unwind of the transaction), which might otherwise have been produced by the foreign currency borrowing.

On foreign denominated medium-term notes with maturities longer than one year, interest is paid annually and on medium-term notes with maturities of less than one year, interest is paid at maturity. The Company considers the cost of all related cross currency and cross currency interest rate exchange agreements as part of the total cost of debt issuance when deciding whether to issue debt in the U.S. or foreign capital markets and whether to issue the debt denominated in U.S. dollars or foreign currencies.

Either counterparty to the cross currency and cross currency interest rate exchange agreements may terminate the agreement due to specified events, primarily a credit downgrade. If either counterparty terminates the agreement, a payment may be due from one counterparty to the other based on the fair value of the underlying derivative instrument which would result in a gain or loss. The Company is exposed to counterparty credit risk and foreign currency risk on the cross currency and cross currency interest rate exchange agreements if the counterparty to the agreement does not perform pursuant to the agreement's terms. The Company only enters into cross currency and cross currency interest rate exchange agreements with financial institutions with investment grade ratings.

Rating Triggers

The Company has interest rate, cross currency, and cross currency interest rate exchange agreements that contain a condition that will allow one counterparty to terminate the agreement if the credit rating of the other counterparty drops to a certain level. This condition is commonly called a rating trigger. Under the rating trigger, if the credit rating for either counterparty falls to the level specified in the agreement, the other counterparty may, but is not obligated to, terminate the agreement. If either counterparty terminates the agreement, a net payment may be due from one counterparty to the other based on the fair value of the underlying derivative instrument. Rating triggers are not separate financial instruments and are not separate derivatives under SFAS 133. The Company's rating triggers are based on its senior unsecured credit rating from Standard & Poor's Corporation and Moody's Investors Service (see chart on page 49). At May 31, 2005, there were rating triggers associated with $10,625 million notional amount of interest rate, cross currency and cross currency interest rate exchange agreements. If the Company's rating from Moody's Investors Service falls to Baa1 or the Company's rating from Standard & Poor's Corporation falls to BBB+, the counterparties may terminate agreements with a total notional amount of $1,125 million. If the Company's rating from Moody's Investors Service falls below Baa1 or the Company's rating from Standard & Poor's falls below BBB+, the counterparties may terminate the agreements on the remaining total notional amount of $9,500 million.

At May 31, 2005, the Company's exchange agreements had a derivative fair value of $44 million, comprised of $47 million that would be due to the Company and $3 million that the Company would have to pay if all interest rate, cross currency and cross currency interest rate exchange agreements with a rating trigger at the level of BBB+ or Baa1 and above were to be terminated and a derivative fair value of $271 million, comprised of $316 million that would be due to the Company and $45 million that the Company would have to pay if all interest rate, cross currency and cross currency interest rate exchange agreements with a rating trigger below the level of BBB+ or Baa1 were to be terminated. At May 31, 2005, CFC's senior unsecured debt had ratings of A2 and A from Moody's Investors Service and Standard & Poor's Corporation, respectively.

(8)	Members' Subordinated Certificates


Membership Subordinated Certificates
To join CFC and to establish eligibility to borrow, CFC members (other than ~~associate members~~service organizations and ~~service organizations)~~associates) are required to execute agreements to subscribe to membership subordinated certificates. Such certificates are interest-bearing, unsecured, subordinated debt of CFC. CFC is authorized to issue membership subordinated certificates without limitation as to the total principal amount.

Generally, membership subordinated certificates mature in the years 2020 through 2095 and bear interest at 5% per annum. The maturity dates and interest rates payable on such certificates vary in accordance with applicable CFC policy.

94

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

Loan and Guarantee Subordinated Certificates

Members obtaining long-term loans, certain intermediate-term loans or guarantees ~~from CFC~~ are generally required to purchase additional loan or guarantee subordinated certificates with each such loan or guarantee. These certificates are unsecured, subordinated debt of ~~CFC.~~the Company.

Certificates currently purchased in conjunction with long-term loans are generally ~~noninterest~~non-interest bearing. CFC's policy regarding the purchase of loan subordinated certificates requires members with a CFC debt to equity ratio in excess of the limit in the policy to purchase a non-amortizing/non-interest bearing subordinated certificate in the amount of 2% of the long-term loan for distribution systems and 7% of the long-term loan for power supply ~~systems~~systems. CFC associates and RTFC members are required to purchase loan subordinated certificates of either 5% or 10% of ~~the~~each long-term loan ~~for all other systems.~~advance. For non-standard credit facilities, the borrower is required to purchase interest bearing certificates in amounts determined appropriate by CFC based on the circumstances of the transaction.

The maturity dates and the interest rates payable on guarantee subordinated certificates purchased in conjunction with CFC's guarantee program vary in accordance with applicable CFC policy. Members may be required to purchase ~~noninterest- bearing~~noninterest-bearing debt service reserve subordinated certificates in connection with CFC's guarantee of long-term tax-exempt bonds (see Note ~~11)~~12). CFC pledges proceeds from the sale of such certificates to the debt service reserve fund established in connection with the bond issue and any earnings from the investments of the fund inure solely to the benefit of the members for whom the bonds are issued. These certificates have varying maturities not exceeding the longest maturity of the guaranteed obligation.

Information with respect to members' subordinated certificates at May 31 is as follows:

2003
2002
Weighted
Weighted
Amounts
Average
Amounts
Average
(Dollar amounts in thousands)
Outstanding
Interest Rate
Outstanding
Interest Rate
Number of subscribing members
898
897

Membership subordinated certificates
Certificates maturing 2020 through 2095
$
627,106
$
626,824
Subscribed and unissued
16,666
14,566
Total membership subordinated certificates
643,772
4.90%
641,390
4.91%

Loan and guarantee subordinated certificates
3% certificates maturing through 2040
115,735
115,735
3% to 12% certificates maturing through 2038
208,105
185,389
Noninterest-bearing certificates maturing through 2038
687,370
697,559
Subscribed and unissued
53,315
51,897
Total loan and guarantee subordinated certificates
1,064,525
1.47%
1,050,580
1.40%

Total members' subordinated certificates
$
1,708,297
2.76%
$
1,691,970
2.73%

	2005				2004
			Weighted				Weighted
	Amounts		Average		Amounts		Average
(Dollar amounts in thousands)	Outstanding		Interest Rate		Outstanding		Interest Rate
Number of subscribing members		899				897
Membership subordinated certificates:
Certificates maturing 2020 through 2095	$	628,552			$	628,282
Subscribed and unissued		34,515				21,627
Total membership subordinated certificates		663,067		4.84%		649,909		4.88%
Loan and guarantee subordinated certificates:
3% certificates maturing through 2040		115,735				115,735
2% to 14% certificates maturing through 2040		181,407				177,387
Noninterest-bearing certificates maturing through 2039		473,655				661,651
Subscribed and unissued		56,886				60,476
Total loan and guarantee subordinated certificates		827,683		1.66%		1,015,249		1.29%
Total members' subordinated certificates	$	1,490,750		3.07%	$	1,665,158		2.69%

~~Member~~Membership subordinated certificates generally mature in 100 years from issuance. The weighted average maturity for membership subordinated certificates outstanding at May 31, 2005 and 2004 was 71 years and 72 years, respectively. Loan and guarantee subordinated certificates have the same maturity as the related long-term loan. Some certificates may also amortize annually based on the outstanding loan balance.

(9)	Minority Interest

At May 31, 2005 and 2004, the Company reported minority interests of $19 million and $21 million, respectively, on the consolidated balance sheets. Minority interest represents the interest of other parties in RTFC and NCSC. The members of RTFC and NCSC own or control 100% of the interest in the respective company. CFC implemented FIN 46(R) on June 1, 2003 which required the consolidation of RTFC's and NCSC's results of operation and financial condition even though CFC has no financial interest or voting control over either company.

On June 1, 2003, a total of $20 million of RTFC equity was reclassified from the combined equity at May 31, 2003 and added to minority interest. During the year ended May 31, 2005, the balance of minority interest was impacted by the offset of $1 million of unretired RTFC patronage capital allocations against outstanding loan balances to certain impaired and high risk borrowers and the retirement of $3 million of patronage capital to RTFC members in January 2005, offset by $2 million of minority interest net margin for the year ended May 31, 2005.

95

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


(10)	Equity

CFC is required by the District of Columbia cooperative law to have a methodology to allocate its net margin to its members. CFC maintains the current year net margin as unallocated through the end of its fiscal year. At that time, CFC's board of directors allocates its net margin to its members in the form of patronage capital and to board approved reserves. Currently, CFC has two such board approved reserves, the education fund and the members' capital reserve. CFC allocates a small portion, less than 1%, of net margin annually to the education fund. The allocation to the education fund must be at least 0.25% of net margin as required by CFC's bylaws. Funds from the education fund are disbursed annually to fund cooperative education among employees and directors of cooperatives in the service territories of each state. The board of directors determines the amount of net margin that is allocated to the members' capital reserve, if any. The members' capital reserve represents margins that are held by CFC to increase equity retention. The margins held in the members' capital reserve have not been allocated to any member, but may be allocated to individual members in the future as patronage capital if authorized by CFC's board of directors. All remaining net margin is allocated to CFC's members in the form of patronage capital. CFC bases the amount of net margin allocated to each member on the members' patronage of the CFC lending programs in the year that the net margin was earned. There is no impact on CFC's total equity as a result of allocating margins to members in the form of patronage capital or to board approved reserves. CFC's board of directors has annually voted to retire a portion of the patronage capital allocated to members in prior years. CFC's total equity is reduced by the amount of patronage capital retired to members and by amounts disbursed from board approved reserves. CFC adjusts the net margin it allocates to members and board approved reserves to exclude the non-cash impacts of SFAS 133 and 52.


CFC's ~~Board~~board of ~~Directors~~directors authorized the retirement of ~~$74~~$69 million of allocated margins in ~~September 2002,~~July 2004, representing 70% of the allocated margin for fiscal year ~~2002~~2004 and one-ninth of the allocated margins for fiscal years 1991, 1992 and 1993. This amount was retired in August 2004. Under current policy, the remaining 30% of the fiscal year ~~2002~~2003 allocated margin will be retained by CFC and used to fund operations for 15 years and then may be retired. The retirement of allocated margins for fiscal years 1991, 1992 and 1993 is done as part of the transition to the current retirement cycle adopted in 1994 and will last through fiscal year 2008. After that time and under current policy, retirements will be comprised of the 70% of allocated margins from the prior year as approved by the board of directors and the remaining portion of allocated margins retained by CFC from prior years (50% for 1994 and 30% for all years thereafter). The $69 million retired by CFC in August 2004 included $18 million to RTFC.

The $74 million retired by CFC in September 2002 included $18 million retired to RTFC. RTFC retired $19 million in January 2003 representing 70% of its fiscal year 2002 allocated margin, including the allocated margin it received from CFC. In July ~~2003,~~2005, CFC's board of directors authorized the allocation of the fiscal year 2005 adjusted net margin as follows: $0.8 million to the education fund, $83 million to members in the form of patronage capital and $33 million to the members' capital reserve. In July 2005, CFC's board of directors also authorized the retirement of allocated margins totaling $71 million, representing 70% of the fiscal year ~~2003~~2005 allocated margin and one-ninth of the fiscal years 1991, 1992 and 1993 allocated margins. This amount ~~was retired in August 2003. Management anticipates that 70% of RTFC's allocated margin for fiscal year 2003~~ will be ~~retired in January 2004.~~returned to members at the end of August 2005. Future allocations and retirements of ~~allocated~~ margins will be made annually as determined by CFC's ~~and RTFC's Boards~~board of ~~Directors~~directors with due regard for CFC's ~~and RTFC's~~ financial condition. The ~~Boards~~board of ~~Directors~~directors for CFC ~~and RTFC have~~has the authority to change the policy for allocating ~~margins~~ and retiring ~~allocated~~net margins at any time, subject to applicable cooperative law.

In July 2002, CFC's Board of Directors approved the reclassification of the total retained and unallocated margins of $21 million to the members' capital reserve. CFC's Board of Directors established a members' capital reserve in which a portion of the annual net margin may be allocated and held by CFC to increase equity retention. In July 2003, CFC's board of directors authorized the allocation of $52 million of the net margin for fiscal year 2003 to the members' capital reserve.

At May 31, ~~2003~~2005 and ~~2002,~~2004, the total equity included the following components:

	May 31,						May 31,
(Dollar amounts in thousands)	2003			2002			2005			2004
Membership fees	$	1,506		$	1,510		$	993		$	993
Education fund		1,935			1,007			1,200			1,322
Members' capital reserve		89,772			16,329			164,067			131,296
Allocated net margin		361,163			352,085			357,323			351,621
Unallocated margin(1)		-			21,125			-			(2,106	)
Total members' equity		454,376			392,056			523,583			483,126
Prior year cumulative derivative forward
�� value and foreign currency adjustments ( 1)(2)		9,231			-
Current period derivative forward value (1)(2)		757,212			70,261
value and foreign currency adjustments								224,716			523,223
Current period derivative forward value (2)								30,781			(233,197	)
Current period foreign currency adjustments ~~(1)~~		(243,220	)		(61,030	)		(22,893	)		(65,310	)
Total retained equity		977,599			401,287			756,187			707,842
Accumulated other comprehensive loss (1)		(46,763	)		(72,556	)
Accumulated other comprehensive income (loss)								12,574			(12,108	)
Total equity	$	930,836		$	328,731		$	768,761		$	695,734

(1) ~~Items related~~The May 31, 2004 balance includes NCSC equity which is included in consolidated equity rather than minority interest since it was in a deficit equity position at that time and therefore represented a charge to ~~the adoption of SFAS 133 and adjustments to value debt denominated in foreign currencies at the reporting date.~~CFC.

(2) ~~Includes $28,383 related to~~Represents the ~~cumulative effect of change in accounting principle in fiscal year 2002.~~derivative forward value gain (loss) recorded by CFC for the period.

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


~~(10)~~(11)	Employee Benefits


CFC is a participant in the National Rural Electric Cooperative Association ("NRECA") Retirement ~~and~~ Security ~~Program.~~Pension Plan. This ~~program~~plan is available to all qualified CFC employees. Under the ~~program,~~plan, participating employees are entitled to receive annually, under a 50% joint and surviving spouse annuity, 1.90% of the average of their five highest base salaries during their last ten years of employment, multiplied by the number of years of participation in the ~~program.~~plan. CFC contributed ~~$2.2~~$2.8 million, ~~$1.6~~$2.5 million and ~~$1.4~~$2.2 million to the Retirement ~~and~~ Security ~~Program~~Pension Plan during fiscal years 2005, 2004 and 2003, ~~2002 and 2001.~~respectively. Funding requirements that are billed are charged to general and administrative expenses on a monthly basis. This is a multi-employer plan, available to all member cooperatives of NRECA, and therefore the projected benefit obligation and plan assets are not determined or allocated separately by individual employer.

The Economic Growth and Tax Relief Act of 2001 set a limit of ~~$200,000~~$210,000 for calendar year ~~2003~~2005 on the compensation to be used in the calculation of pension benefits. In order to restore potential lost benefits, CFC has adopted a Pension Restoration Plan administered by NRECA. Under the plan, the amount that NRECA invoices CFC will continue to be based on the full compensation paid to each employee. Upon the retirement of a covered employee, NRECA will calculate the retirement and security benefit to be paid with consideration of the compensation limits and will pay the maximum benefit thereunder. NRECA will also calculate the retirement and security benefit that would have been available without consideration of the compensation limits and CFC will pay the difference. NRECA will then give CFC a credit against future retirement and security contribution liabilities in the amount paid by CFC to the covered employee.

CFC recognizes in current year margin any expected payouts for post-retirement benefits (other than pensions) as a result of current service. Post-retirement benefits include, but are not limited to, health and welfare benefits provided after retirement. While CFC allows retired employees to participate in its medical and life insurance plans, the retirees must do so at their own expense. ~~Any liability which may be incurred by allowing retired employees to remain on CFC's medical and life insurance plans is not material to CFC's financial condition, results of operations or cash flows.~~

CFC offers a 401(k) defined contribution savings program to all employees that have completed a minimum of 1,000 hours of service in either the first 12 consecutive months or first full calendar year of employment. Beginning on January 1, 2003, CFC contributes an amount up to 3% of an employee's salary each year for all employees participating in the program. Prior to that time, CFC's contribution percentage was 2%. During the years ended May 31, ~~2003, 2002~~2005, 2004 and ~~2001,~~2003, CFC contributed ~~$0.4~~$0.5 million, ~~$0.3~~$0.5 million and ~~$0.2~~$0.4 million, respectively, under the program.

~~(11)~~(12)	Guarantees

~~CFC~~The Company guarantees the contractual obligations of its members so that they may obtain various forms of financing. With the exception of letters of credit, the underlying obligations may not be accelerated so long as ~~CFC~~the Company performs under its guarantee. At May 31, 2005 and 2004, the Company had recorded a guarantee liability totaling $16 million and $19 million, respectively, which represents the Company's contingent and non-contingent exposure related to guarantees of members' debt obligations. The ~~following chart summarizes CFC's total guarantees by type and member class~~contingent guarantee liability at May 31, 2005 and 2004 totaled $16 million and $19 million, respectively, based on management's estimate of exposure to losses within the guarantee portfolio. The Company uses factors such as internal borrower risk rating, remaining term of guarantee, corporate bond default probabilities and estimated recovery rates in estimating its contingent exposure. The remaining balance of the total guarantee liability of less than $1 million at May 31, 2005 and 2004 relates to the Company's non-contingent obligation to stand ready to perform over the term of its guarantees that it has entered into since January 1, 2003. The Company's non-contingent obligation is estimated based on guarantee fees received. The fees are deferred and amortized on the straight-line method into operating income over the term of the guarantees. The Company has recorded a non-contingent obligation for all new guarantees since January 1, 2003 in accordance with FIN 45. The Company received and ~~2002.~~deferred fees of $0.6 million, $0.8 million and $0.5 million for the years ended May 31, 2005 and 2004 and for the period from January 1, 2003 to May 31, 2003, respectively, related to new guarantees issued during the periods.

(Dollar amounts in thousands)
2003
2002
Long-term tax exempt bonds (1)
$
899,420
$
940,990
Debt portions of leveraged lease transactions (2)
34,105
41,064
Indemnifications of tax benefit transfers (3)
184,605
208,637
Letters of credit (4)
314,114
310,926
Other guarantees (5)
471,312
554,768
             Total
$
1,903,556
$
2,056,385
Total by member class:
    Distribution
$
77,725
$
66,670
    Power supply
1,220,795
1,304,367
    Statewide and associate
600,036
680,011
    Telecommunications systems
5,000
5,337
                     Total
$
1,903,556
$
2,056,385


97

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


The following chart summarizes total guarantees by type and segment at May 31, 2005 and 2004:

(Dollar amounts in thousands)	2005		2004
Long-term tax exempt bonds (1)	$	738,385	$	780,940
Debt portions of leveraged lease transactions (2)		12,285		14,838
Indemnifications of tax benefit transfers (3)		141,996		159,745
Letters of credit (4)		196,597		307,518
Other guarantees (5)		68,489		68,258
Total	$	1,157,752	$	1,331,299
Total by segment:
CFC:
Distribution	$	41,842	$	60,672
Power supply		1,066,373		1,130,379
Statewide and associate		41,642		111,195
CFC total		1,149,857		1,302,246
NCSC		7,895		29,053
Total	$	1,157,752	$	1,331,299

(1)

The maturities for this type of guarantee run through 2026. 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. CFC has unconditionally guaranteed to the holders or to trustees for the benefit of holders of these bonds the full principal, premium, if any, and interest on each bond when due. In addition, CFC has agreed to make up, at certain times, deficiencies in the debt service reserve funds for certain of these issues of bonds. In the event of default by a system for ~~nonpayment~~non-payment of debt service, CFC is obligated to pay any required amounts under its guarantees, which will prevent the acceleration of the bond issue. The system is required to repay, on demand, any amount advanced by CFC and interest thereon pursuant to the documents evidencing the system's reimbursement obligation.

	Of the amounts shown above, ~~$829~~$692 million and ~~$859~~$725 million as of May 31, ~~2003~~2005 and ~~2002,~~2004, respectively, are adjustable or floating/fixed rate bonds. The floating interest rate on such bonds may be converted to a fixed rate as specified in the indenture for each bond offering. During the variable rate period (including at the time of conversion to a fixed rate), CFC has unconditionally agreed to purchase bonds tendered or called for redemption if the remarketing agents have not previously sold such bonds to other purchasers. CFC's maximum potential exposure includes guaranteed principal and interest related to the bonds. CFC is unable to determine the maximum amount of interest that it could be required to pay related to the floating rate bonds. As of May 31, ~~2003,~~2005, CFC's maximum potential exposure for the ~~$70~~$46 million of fixed rate tax-exempt bonds is ~~$91~~$58 million. Many of these bonds have a call provision that in the event of a default would allow CFC to trigger the call provision. This would limit CFC's exposure to future interest payments on these bonds. CFC's maximum potential exposure is secured by a mortgage lien on all of the system's assets and future revenues. 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.

(2)	The maturities for this type of guarantee run through ~~2024.~~2007. CFC has guaranteed ~~debt issued by CFC~~the rent obligation of its members ~~in connection with leveraged lease transactions. The amounts shown represent loans from the member~~ to a trust for the benefit of an industrial or financial company for the purchase of a power plant or utility equipment that was subsequently leased to a CFC member. These loans were funded as either a direct loan from CFC or a private debt placement guaranteed by CFC.third party. In the event of default by the system for ~~nonpayment~~non-payment of debt service, CFC is obligated to pay any required amounts under its guarantees, which will prevent the acceleration of the debt obligation. The system is required to repay, on demand, any amount advanced by CFC and interest thereon pursuant to the documents evidencing the system's reimbursement obligation. As of May 31, ~~2003,~~2005, CFC's maximum potential exposure for guaranteed principal and interest is ~~$39~~$14 million. This amount is secured by the property leased, the owner's rights as lessor and, in some instances, all assets of the lessee. ~~CFC may also guarantee the rent obligation of its members to a third party.~~

(3)	The maturities for this type of guarantee run through 2015. CFC has unconditionally guaranteed to lessors certain indemnity payments, which may be required to be made by the lessees in connection with tax benefit transfers. In the event of default by a system for ~~nonpayment~~non-payment of indemnity payments, CFC is obligated to pay any required amounts under its guarantees, which will prevent the acceleration of the indemnity payments. The member is required to repay any amount advanced by CFC and interest thereon pursuant to the documents evidencing the system's reimbursement obligation. The amounts shown represent CFC's maximum potential exposure for guaranteed indemnity payments. A member's obligation to reimburse CFC for any guarantee payments would be treated as a long-term loan to the extent of any cash received by the member at the outset of the transaction. This amount is secured by a mortgage lien on all of the system's assets and future revenues. 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 further guarantees of this nature are anticipated.

(4)	The maturities for this type of guarantee run through ~~2013.~~2017. Additionally, letters of credit totaling ~~$14~~$9 million at May 31, 2005 have a term of one year and automatically extend for a period of one year unless ~~CFC~~the Company cancels the agreement within 120 days of maturity (in which case, the beneficiary may draw on the letter of credit). ~~CFC~~The Company issues irrevocable letters of credit to support members' obligations to energy marketers and other third parties and to the Rural Business and Cooperative Development Service with 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~~the Company within one year from the date of the draw.

	Interest would accrue from the date of the draw at ~~CFC's~~the line of credit variable rate of interest in effect on such date. The agreement also requires the member to pay, as applicable, a late payment charge and all costs of collection, including reasonable attorneys' fees. As of May 31, ~~2003, CFC's~~2005, the Company's maximum potential exposure is ~~$314~~$197 million, of which ~~the outstanding balance of $280~~$159 million is secured. Security provisions include a mortgage lien on all of the system's assets, future revenues, and the system's commercial paper invested at ~~CFC.~~the Company. In addition to the letters of credit listed in the table, ~~above,~~ under master letter of credit facilities, ~~CFC~~the Company may be required to issue up to an additional ~~$92~~$212 million in letters of credit to third parties for the benefit of its members at May 31, ~~2003.~~2005. At May 31, ~~2002,~~2004, this amount was ~~$57~~$121 million.

(5)	The maturities for this type of guarantee run through 2025. CFC provides other guarantees as required by its members. In the event of default by a system for ~~nonpayment~~non-payment of the obligation, CFC must pay any required amounts under its guarantees, which will prevent the acceleration of the obligation. Such guarantees may be made on a secured or unsecured basis with guarantee fees set to cover CFC's general and administrative expenses, a provision for losses and a reasonable margin. The member is required to repay any amount advanced by CFC and interest thereon pursuant to the documents evidencing the system's reimbursement obligation. Of CFC's maximum potential exposure for guaranteed principal and interest totaling ~~$506~~$68 million at May 31, ~~2003, $446~~2005, $8 million is secured by a mortgage lien on all of the system's assets and future revenues and the remaining $60 million is unsecured. At May 31, 2003 and 2002, CFC had unconditionally guaranteed commercial paper issued by NCSC in the amount of $284 million and $334 million, respectively. CFC is unable to determine the maximum amount of interest that it could be required to pay on the $284 million of guaranteed commercial paper since the interest rates continuously reset as it matures and is rolled over into new issuances.

98

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

CFC uses the same credit policies and monitoring procedures in providing guarantees as it does for loans and commitments.

The following table details the scheduled reductions of CFC's outstanding guarantees in each of the fiscal years following
May 31, ~~2003:~~2005:

(Dollar amounts in thousands)
Amount
2004
$
286,146
2005
106,660
2006
254,663
2007
198,667
2008
193,206
Thereafter
864,214

(Dollar amounts in thousands)	Amount
2006	$	243,256
2007		110,469
2008		84,403
2009		86,622
2010		74,318
Thereafter		558,684
Total	$	1,157,752

~~On January 1, 2003,~~ CFC ~~adopted FIN 45. Starting January 1, 2003, CFC records a liability for~~charges an annual fee related to the fair value of new or modified guarantees representing CFC's obligation to stand ready to perform over the term of the guarantee. At May 31, 2003, CFC recorded a liability of less than $1 million in other liabilities for $42 million of letters of credit issued since December 31, 2002.

~~The~~ majority of ~~guarantees are charged an annual fee.~~its guarantees. During ~~each of~~ the years ended May 31, ~~2003, 2002~~2005, 2004 and ~~2001,~~2003, CFC earned $2 million, $1 million and $1 million, respectively, in fees related to guarantees.

At May 31, ~~2003,~~2005 and 2004, CFC had a total of ~~$94~~$98 million and $122 million of guarantees, representing 5%8% and 9% of total guarantees, respectively, under which its right of recovery from its members was not secured.

~~(12)~~(13)

Fair Value of Financial Instruments


The following disclosure of the estimated fair value of financial instruments is made in accordance with SFAS 107, Disclosure about Fair Value of Financial Instruments. Whenever possible, the estimated fair value amounts have been determined using quoted market information as of May 31, ~~2003~~2005 and ~~2002, along with other valuation methodologies which are summarized below.~~2004. The estimated fair value information presented is not necessarily indicative of amounts ~~CFC~~the Company could realize currently in a market sale since ~~CFC~~it may be unable to sell such instruments due to contractual restrictions or to the lack of an established market. The estimated market values have not been updated since May 31, ~~2003;~~2005; therefore, current estimates of fair value may differ significantly from the amounts presented. With the exception of redeeming collateral trust bonds and subordinated deferrable debt under early redemption provisions and allowing borrowers to prepay their loans, ~~CFC~~the Company has held and intends to hold all financial instruments to maturity. Below is a summary of significant methodologies used in estimating fair value amounts and a schedule of fair values at May 31, ~~2003~~2005 and ~~2002.~~2004.

Cash and Cash Equivalents

Includes cash and certificates of deposit with remaining maturities of less than 90 days, which are valued at the carrying value.

Loans to Members

Fair values are estimated by discounting the future cash flows using the ~~CFC~~ current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Loans with different risk characteristics, specifically ~~nonperforming~~non-performing and restructured loans, are valued using a discount rate commensurate with the risk involved. Loans with interest rate repricing ~~maturities~~scheduled within 90 days of ~~less than or equal to 90 days~~year end are valued at cost, which approximates fair value. Variable rate loans are valued at cost, which approximates fair value since the Company has the option to reset rates every 30 days.

~~Receivables and debt service reserve funds~~Debt Service Reserve Funds

~~CFC~~The Company considers the carrying value of ~~receivables and~~ debt service reserve funds to be equal to fair value. Interest is billed to members on a quarterly basis and with the exception of non-performing borrowers, payments are typically received on time. In most cases CFC does not accrue interest on non-performing borrowers, thus no amounts due from non-performing borrowers would be included in the receivables balance. Debt service reserve funds represent cash or short-term investments on deposit with the trustee of ~~CFC's~~ collateral trust bonds and thus carrying value is considered to be equal to fair value.

~~Notes Payable~~Short-Term Debt

~~Notes payable~~Short-term debt consist of commercial paper, ~~and~~ bank bid ~~notes.~~notes and other debt due within one year. The fair value of ~~commercial paper and bank bid notes~~short-term debt with maturities greater than 90 days is estimated based on quoted market rates for debt with similar ~~maturities for commercial paper and on bid prices from the various banking institutions for bid notes.~~maturities. The fair value of ~~commercial paper and bank bid notes~~short-term debt with maturities less than or equal to 90 days ~~are valued at~~is carrying value, which is a reasonable estimate of fair value.

Long-Term Debt

Long-term debt consists of collateral trust bonds, medium-term notes and ~~medium-term notes.~~long-term notes payable. The fair value of long-term debt is estimated based on published bid prices or dealer quotes or is estimated using quoted market prices for similar securities when no market quote is available and based on current exchange rates for long-term debt denominated in a foreign currency.

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

Long-term debt with a variable interest rate is valued at cost, which approximates fair value since rates adjust based on a market index every 30 days.

Subordinated Deferrable Debt

The fair value of subordinated deferrable debt is estimated based on published market prices.

~~100~~

Members' Subordinated Certificates

As it is impracticable to develop a discount rate that measures fair value, subordinated certificates have not been valued. Members' subordinated certificates are extended long-term obligations of ~~CFC;~~the Company; many have original maturities of 70 to 100 years. These certificates are issued to ~~CFC's~~the Company's members as a condition of membership or as a condition of obtaining loan funds or guarantees and are non-transferable. As these certificates were not issued primarily for their future payment stream but mainly as a condition of membership and to receiving future loan funds, there is no ready market from which to obtain fair value quotes.

Interest Rate, Cross Currency and Cross Currency Interest Rate Exchange Agreements

~~As a result of adopting SFAS 133 in fiscal year 2002, derivative~~Derivative instruments are recorded in the ~~combined~~consolidated balance ~~sheet~~sheets at fair value. The fair value of the interest rate and cross currency interest rate exchange agreements is estimated taking into account the ~~current~~expected future market rate of interest and the current creditworthiness of the exchange counterparties. The fair value of ~~the cross currency and~~ cross currency interest rate exchange agreements additionally takes into account the expected future currency exchange rate. The fair value of the cross currency exchange agreements is estimated taking into account the expected future currency exchange rate and the current creditworthiness of the exchange counterparties.

Commitments

The fair value is estimated as the carrying value, or zero. Extensions of credit under these commitments, if exercised, would result in loans priced at market rates.

Guarantees

~~CFC charges guarantee fees~~It is impracticable to supply fair value information related to guarantees based on ~~the specifics of each individual transaction. The demand for CFC guarantees has been insignificant in the last few years. In addition,~~market comparisons as there is no other company that provides guarantees to rural electric utility companies from which to obtain market rate information. ~~As a result, it is impracticable to supply~~Additionally, the demand for CFC guarantees has been insignificant in the last few years. The fair value ~~information~~of CFC's guarantees shown below is based on the amount recorded as a guarantee liability which represents CFC's contingent and non-contingent exposure related to its guarantees. CFC's contingent guarantee liability is based on management's estimate of CFC's exposure to losses within the guarantee portfolio. CFC's non-contingent guarantee liability is estimated based on guarantee fees received for guarantees issued since January 1, 2003, which represents management's estimate of the fair value of its obligation to stand ready to perform. CFC charges guarantee fees based on the specifics of each individual transaction.

100

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

Carrying and fair values as of May 31, ~~2003~~2005 and ~~2002~~2004 are presented as follows:

2003
2002
(Dollar amounts in thousands)
Carrying Value
Fair Value
Carrying Value
Fair Value
Assets:
Cash and cash equivalents
$
138,872
$
138,872
$
218,384
$
218,384

Loans to members, net
18,919,283
18,536,825
19,540,367
18,528,841

Liabilities:
Notes payable (1)
5,046,978
5,048,998
6,119,594
6,114,426
Long-term debt (1)
12,050,119
13,356,049
11,149,925
11,319,319
Subordinated deferrable debt
650,000
685,640
600,000
589,899

Derivative Instruments:
Interest rate exchange agreements
449,657
449,657
(23,378
)
(23,378
)
Cross currency interest
          rate exchange agreements
355,806
355,806
(35,827
)
(35,827
)

Off-balance sheet Instruments:
Commitments
-
-
-
-

	2005				2004
(Dollar amounts in thousands)	Carrying Value		Fair Value		Carrying Value		Fair Value
Assets:
Cash and cash equivalents	$	418,514	$	418,514	$	140,307	$	140,307
Loans to members, net		18,382,319		17,681,520		19,914,584		18,285,544
Debt service reserve funds		93,182		93,182		84,236		84,236
Cash flow interest rate exchange
agreements		61,671		61,671		97,579		97,579
Cash flow cross currency interest
rate exchange agreements	��	64,797		64,797		37,985		37,985
Fair value interest rate exchange
agreements		224,992		224,992		220,745		220,745
Fair value cross currency interest
rate exchange agreements		233,403		233,403		221,184		221,184
Liabilities:
Short-term debt (1)		7,952,579		7,977,991		5,990,039		5,983,502
Long-term debt (1)		8,701,955		9,439,911		12,009,182		12,473,238
Guarantee liability (2)		16,094		16,094		19,184		19,184
Cash flow interest rate exchange
agreements		67,154		67,154		117,428		117,428
Fair value interest rate exchange
agreements		11,317		11,317		12,487		12,487
Subordinated deferrable debt		685,000		689,288		550,000		541,765
Off-balance sheet instruments:
Commitments		-		-		-		-

(1) Prior to reclassification of ~~notes payable~~short-term debt supported by the revolving credit agreements to long-term debt.

(2) The carrying value represents CFC's exposure related to its guarantees and therefore will not equal total guarantees shown in Note 12.


~~(13)~~(14)	Contingencies

(a) At May 31, ~~2003, CFC~~2005 and 2004, the Company had ~~no nonperforming~~non-performing loans ~~outstanding. At May 31, 2002, CFC had nonperforming loans~~outstanding in the amount of ~~$1,011~~$617 million ~~outstanding.~~and $341 million, respectively. During fiscal year ~~2003, 2002~~2005, 2004 and ~~2001,~~2003, all loans classified as ~~nonperforming~~non-performing were on a ~~nonaccrual~~non-accrual status with respect to the recognition of interest income. The effect of not accruing interest on ~~nonperforming~~non-performing loans was a decrease in interest income of $24 million, ~~$21~~$0.2 million and ~~$14~~$24 million for the years ended May 31, 2005, 2004 and 2003, ~~2002 and 2001,~~ respectively. ~~CFC reclassified loans outstanding to CoServ from nonperforming to restructured subsequent to CoServ's emergence from bankruptcy on December 13, 2002.~~

~~101~~

At May 31, ~~2003~~2005 and ~~2002, CFC~~2004, the Company had restructured loans in the amount of ~~$629~~$601 million and ~~$540~~$618 million, respectively. At May 31, ~~2003, all~~2005 and 2004, $594 million and $618 million, respectively, of restructured loans were on ~~nonaccrual~~non-accrual status with respect to the recognition of interest income. ~~At May 31, 2002, there were $534 million of restructured loans on accrual status.~~ A total of ~~$28 million, $38~~$0.3 million and ~~$33~~$28 million of interest was accrued on restructured loans ~~classified as restructured~~ during the years ended May 31, 2005 and 2003, ~~2002 and 2001,~~ respectively. No interest income was accrued on restructured loans for the year ended May 31, 2004. The effect of not accruing interest income at the stated rates on restructured loans was a decrease in interest income of $4$27 million, ~~$29~~$23 million and ~~$26~~$4 million for the years ended May 31, 2005, 2004 and 2003, ~~2002 and 2001,~~ respectively.

During fiscal year 2003, loans outstanding to Deseret Generation & Transmission Co-operative ("Deseret") were reclassified from restructured to performing. CFC reclassified loans outstanding to CoServ from nonperforming to restructured subsequent to CoServ's emergence from bankruptcy on December 13, 2002. See Notes 13(c) and 13(d) for further explanation.

(b) ~~CFC~~The Company classified ~~$629~~$1,208 million and ~~$1,553~~$959 million of loans as impaired pursuant to the provisions of SFAS 114, ~~and SFAS 118~~as amended, at May 31, ~~2003~~2005 and ~~2002,~~2004, respectively. ~~CFC~~The Company reserved ~~$164~~$404 million and ~~$202~~$233 million of the loan loss allowance for such impaired loans at May 31, ~~2003~~2005 and ~~May 31, 2002,~~2004, respectively. The amount ofincluded in the loan loss allowance ~~reserved~~ for such loans was based on a comparison of the present value of the expected future cash flow associated with the loan discounted at the original contract interest rate and/or the estimated fair value of the collateral securing the loan to the recorded investment in the loan. Impaired loans may be on accrual or non-accrual status with respect to the recognition of interest income ~~as dictated by~~based on a review of the terms of the restructure agreement and borrower performance. ~~CFC may place certain impaired loans on accrual status with respect to the recognition of~~The Company did not accrue interest income ~~based on a review of the borrower's performance under the restructure agreement. CFC accrued interest income totaling $28 million, $38 million and $33 million~~ on loans classified as impaired during the years ended May 31, ~~2003, 2002~~2005 and ~~2001, respectively.~~2004. The Company accrued interest income totaling $28 million on loans classified as impaired during the year ended May 31, 2003. The average recorded investment in impaired loans for the years ended May 31, 2005, 2004 and 2003 ~~2002 and 2001~~ was ~~$1,176~~$992 million, ~~$1,523~~$626 million and ~~$936~~$1,176 million, respectively.

~~CFC~~101

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


The Company updates impairment calculations on a quarterly basis. Since a borrower's original contract rate ~~typically includes~~may include a variable rate component, calculated impairment ~~will~~could vary with changes to ~~CFC's~~the Company's variable rate, independent of a borrower's underlying economic condition. In addition, the calculated impairment for a borrower will fluctuate based on changes to certain assumptions. Changes to assumptions include, but are not limited to the following:

	*	court rulings,
	*	changes to collateral values, and
	*	changes to expected future cash flows both as to timing and amount.

(c) Deseret is a power supply member of CFC located in Utah. Deseret owns and operates the Bonanza generating plant ("Bonanza") and owns a 25% interest in the Hunter generating plant along with a system of transmission lines. Deseret also owns and operates a coal mine through its Blue Mountain Energy subsidiary. In 1996, Deseret and CFC entered into an Obligations Restructuring Agreement ("ORA") that required Deseret to make quarterly payments to CFC and required CFC to perform under its guarantees of Deseret's debt and lease obligations. In addition, 80% of any excess cash flow, as determined by formula in the ORA, is paid to CFC within 90 days of the close of the calendar year. In connection with the ORA, on October 16, 1996, CFC acquired all of Deseret's indebtedness in the outstanding principal amount of $740 million from RUS for the sum of $239 million. The member systems of Deseret purchased from CFC, for $55 million, a participation interest in the RUS debt. The participation agreement allows the Deseret member distribution systems to put the participations back to CFC unconditionally on December 31, 2019. The balance of the member participation loans was less than $1 million at May 31, 2003.

During fiscal year 2003, CFC reclassified the outstanding loans to Deseret from restructured to performing. Deseret has made all payments required by the ORA, including $134 million of excess cash payments. CFC received quarterly cash flow payments totaling $42 million and in addition received excess cash payments totaling $10 million during the year ended May 31, 2003. Subsequent to the end of the year, on June 30, 2003, CFC received the required $9 million quarterly minimum payment from Deseret. Under the ORA, CFC keeps 75% of excess cash payments and applies the remaining 25% against the balance of the member participation loans. CFC has no net principal loss on its loans to Deseret.

~~102~~

At May 31, ~~2003~~2005 and ~~2002, CFC had the following exposure to Deseret:~~

(Dollar amounts in millions)
2003
2002
Loans outstanding (1)
$
529
$
534
Guarantees outstanding:
    Tax benefit transfers
-
1
    Mine equipment leases
30
36
    Letters of credit
28
29
   Other (2)
13
12
Total guarantees
71
78

Total exposure
$
600
$
612


~~(1)~~	As of May 31, 2003, the loan balance of $529 million to Deseret is comprised of $177 million of cash flow shortfalls related to Deseret's debt service and rental obligations guaranteed by CFC, $266 million related to the redemption of the Bonanza secured lease obligation bonds, $58 million related to the purchase of RUS loans, $18 million related to the original CFC loan to Deseret and $10 million related to the settlement of the foreclosure litigation.
~~(2)~~	~~Other guarantees include a guarantee of certain operational and maintenance expenses.~~

~~(d) At May 31, 2003 and 2002,~~2004, CFC had a total of ~~$628~~$594 million and ~~$1,003~~$618 million, respectively, of loans outstanding to CoServ, a large electric distribution cooperative located in Denton County, Texas, that provides retail electric service to residential and business customers in an area where there has been significant residential and commercial growth in and adjacent to its current service territory over the last few years. CoServ adopted a strategy to provide a broad range of utility and other related services to consumers both in its service territory and the newly developing areas adjacent to its service territory. The non-electric services were provided through its controlled affiliates, which were funded primarily through advances from CoServ, and included natural gas, home-security, cable television and a variety of telecommunications services. CoServ also made substantial loans to and equity investments in residential and commercial real estate development projects. CFC's loans to CoServ were secured by assets and revenues of the electric distribution system, real estate notes receivable, real estate properties and telecommunications assets. There is competition for substantially all services provided in the CoServ service territory.

~~At May 31, 2002, all loans to CoServ were classified as nonperforming as CoServ was in default under its loan agreement with CFC.~~customers. All loans have been on non-accrual status since January 1, 2001. Total loans to CoServ at May 31, ~~2003~~2005 and ~~2002~~2004 represented 2.9% and ~~4.5%~~2.8%, respectively, of ~~CFC's~~the Company's total loans and guarantees outstanding.

On June 17, 2002, CFC and CoServ Realty Holdings, L.P. ("CRH") filed with the United States Bankruptcy Court ("the Court") a joint plan of liquidation of CRH (the "Real Estate Plan"). The Real Estate Plan provided, among other things, that CRH transfer all equity interests, cash, notes and accounts receivable, mortgage notes, properties, licensee rights and other assets of CRH and CRH entities engaged in realty investment and lending to entities controlled by CFC.

On June 24, 2002, CFC and CoServ filed with the Court a joint plan of reorganization of CoServ (the "Electric Plan"). On June 24, 2002, CFC, CoServ, L.L.C. d/b/a CoServ Communications, CoServ Telecom GP, L.L.C., DWB GP, Inc., CoServ Telecom Holdings, L.P., Multitechnology Services, L.P. d/b/a CoServ Broadband Services and Dallas Wireless Broadband, L.P. d/b/a CoServ Broadband (collectively, the "Telecom Debtors") filed with the Court a joint plan of liquidation of the Telecom Debtors (the "Telecom Plan").

On August 29, 2002, the Real Estate Plan was confirmed by the Court. On September 11, 2002, the Electric Plan was confirmed by the Court. On October 11, 2002, the Real Estate Plan became effective. Entities controlled by CFC took possession of $325 million of notes receivable from real estate developers, limited partnership interests in certain real estate developments and partnership interests in certain real estate assets. CFC received approximately $27 million in cash from the lock box that was established to collect all payments on notes receivable from the developers. CFC reduced the outstanding loan balance to CoServ by the cash received and the estimated fair value of the notes receivable and properties.

~~On December 13, 2002,~~Under the terms of a bankruptcy settlement, CFC restructured its loans to CoServ. CoServ emerged from bankruptcy and the Electric Plan and Telecom Plan became effective. On that date, CoServ transferred the telecommunications assets to entities controlled by CFC. The loan balance to CoServ was reduced by $39 million, the estimated fair value of the telecommunications assets received less estimated costs to sell. CFC is ~~accounting for the real estate and telecommunications assets received as foreclosed assets.~~

~~103~~

After the effective date, CFC reclassified the outstanding loan to CoServ as restructured and in the near term will maintain the restructured CoServ loan on non-accrual status. CoServ will continue to operate as an electric distribution utility and is requiredscheduled to make quarterly payments to CFC ~~over~~through December 2037. As part of the ~~35-year agreement. Payments by CoServ to CFC are current as agreed to in the bankruptcy plan. Under the Electric Plan,~~restructuring, CFC may be obligated to provide up to $200 million of senior secured capital expenditure loans to CoServ ~~over the next 10 years.~~for electric distribution infrastructure through December 2012. If CoServ requests capital expenditure loans from CFC, ~~the~~these loans will be ~~approved with~~provided at the ~~same~~ standard terms ~~that are~~ offered to all ~~electric distribution members.~~borrowers and will require debt service payments in addition to the quarterly payments that CoServ is required to make to CFC. As of May 31, 2005, no amounts have been advanced to CoServ under this loan facility. To date, CoServ has made all payments required under the restructure agreement. Under the terms of the restructure agreement, CoServ has the option to prepay the loan for $415 million plus an interest payment true up after December 13, 2007 and for $405 million plus an interest payment true up after December 13, 2008.

CoServ and CFC ~~now~~ have no claims related to any of the legal actions asserted prior to or during the bankruptcy proceedings. CFC's legal claim against CoServ will now be limited to CoServ's performance under the terms of the bankruptcy settlement.

Based on its analysis, the Company believes that it is adequately reserved for its exposure to CoServ at May 31, 2005.

(d) VarTec Telecom, Inc. ("VarTec") is a telecommunications company and RTFC borrower located in Dallas, Texas. VarTec has experienced extensive competition in its primary businesses, resulting in a significant reduction to its cash flow. VarTec and 16 of its U.S.-based affiliates, which are guarantors of VarTec's debt to RTFC, filed voluntary petitions under Chapter 11 of the United States Bankruptcy Code on November 1, 2004 in Dallas, Texas. VarTec is continuing operations pending completion of sales of its remaining operating assets.

RTFC is VarTec's principal senior secured creditor. At May 31, 2005 and 2004, RTFC had a total of $135 million and $340 million, respectively, of loans outstanding to VarTec. The loan balance at May 31, 2004 was reduced during fiscal year 2005 by $119 million in payments, $34 million for offsets of allocated but unretired patronage capital and subordinated capital certificates and $52 million in asset sales. All loans to VarTec are on non-accrual status, resulting in the application of all payments received against principal. RTFC and VarTec entered into an amended and restated credit agreement effective as of October 7, 2004 (the "Amended Credit Agreement"). On October 8, 2004, VarTec repaid $90 million of its loans to RTFC; $70 million of the repayment was applied to long-term loans and $20 million of the repayment was applied to a $70 million revolving credit facility under the Amended Credit Agreement and was available for readvance subject to satisfaction of the terms and conditions therein. During fiscal year 2005, RTFC offset $4 million of allocated but unretired patronage capital and $30 million of subordinated capital certificates against the loan balance.

RTFC agreed to provide VarTec debtor-in-possession ("DIP") financing up to $20 million, plus temporary additional revolving loans of up to $10 million. The financing available under the temporary additional revolving loans has been reduced to zero and cancelled. As part of the agreement, VarTec is required to sweep all cash to RTFC on a daily basis for application first to the DIP financing and then to other RTFC secured debt. As of January 12, 2005, the bankruptcy court approved the financing on a final basis and reserved claims against RTFC and challenges to RTFC's liens until a later date. The deadline for filing such claims was July 6, 2005. On June 10, 2005, the Official Committee of Unsecured Creditors (the "UCC") initiated an adversary proceeding in the United States Bankruptcy Court for the Northern District of Texas, Dallas Division. No other party had filed such a claim by expiration of the deadline. The adversary proceeding asserts the following claims: (i) that RTFC may have engaged in wrongful activities prior to the filing of the bankruptcy proceeding (e.g., RTFC had "control" over VarTec's affairs, RTFC exerted "financial leverage" over VarTec and is liable for VarTec's "deepening insolvency"); (ii) that RTFC's claims against VarTec should be equitably subordinated to the claims of other creditors because of the alleged wrongful activities; and (iii) that certain payments made by VarTec to RTFC and certain liens granted to RTFC are avoidable

102

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

as preferences or fraudulent transfers or should otherwise be avoided and re-distributed for the benefit of VarTec's bankruptcy estates. The adversary proceeding identifies payments made by VarTec to RTFC of approximately $141 million, but does not specify damages sought. On August 5, 2005, RTFC filed an answer and a motion to dismiss the deepening insolvency claim.

On December 17, 2004, VarTec sold its European operations, and on March 21, 2005, the court approved the sale of certain real estate in Addison, Texas, and miscellaneous personal property. On May 5, 2005, VarTec sold its Canadian operations. On July 29, 2005, the court approved a sale of VarTec's remaining operating assets (the "Domestic Assets Sale"). In August 2005, RTFC received $32 million representing partial payment of proceeds from the Domestic Assets Sale. Final closing of the Domestic Assets Sale is subject to government approvals; in the interim VarTec will continue to operate its business.

As part of the court order approving the DIP financing, VarTec was allowed to continue to make interest payments on the secured RTFC debt and to make principal payments during periods in which no amount was outstanding under the DIP financing. However pursuant to the terms of the Domestic Assets Sale, pending final closing of such sale, such payments will cease. Under the terms of the Domestic Assets Sale, the asset purchaser has reimbursed RTFC for the current amount outstanding under the DIP facility. In addition, the asset purchaser will be required to provide RTFC with funding for all future advances under the DIP facility. RTFC does not anticipate advancing any additional funds under the existing DIP facility. RTFC may have to put in place and advance additional funds under an administrative DIP facility to be approved by the bankruptcy court.

The court has also ordered that all net proceeds of such sales, including the Domestic Assets Sale, be provisionally applied to RTFC's secured long-term debt. The application is subject to third parties' rights, if any, superior to RTFC's rights and liens, and to further court order to require the return of such funds for use as cash collateral under the Bankruptcy Code.

Based on its analysis, the Company believes that it is adequately reserved against its exposure to VarTec at May 31, 2005.

(e) Innovative Communication Corporation ("ICC") is a diversified telecommunications company and RTFC borrower headquartered in St. Croix, United States Virgin Islands ("USVI"). In the USVI, through its subsidiary Virgin Islands Telephone Corporation d/b/a Innovative Telephone ("Vitelco"), ICC provides wire line local and long-distance telephone services. Cable television service and/or wireless telephone service is provided to subscribers in the USVI and a number of other islands located in the eastern and southern Caribbean and mainland France. ICC also owns a local newspaper based in St. Thomas, USVI and operates a public access television station that serves the USVI.

As of May 31, 2005 and 2004, RTFC had $475 million and $553 million, respectively, in loans outstanding to ICC. In addition, at May 31, 2005, RTFC had a total of $4 million outstanding to Vitelco. In January 2005, ICC did not make the full regular debt service payment on its loans to RTFC. In March 2005, both ICC and Vitelco did not make the final maturity principal payments on line of credit loans in the amounts of $10 million and $4 million, respectively. RTFC placed all loans to ICC on non-accrual status as of February 1, 2005 and all loans to Vitelco on non-accrual status as of March 20, 2005. On March 23, 2005, RTFC filed a lawsuit in the United States District Court for the Eastern District of Virginia against Vitelco for such default. The matter has been settled, and all amounts due under the line of credit loan to Vitelco were paid by agreement of the parties on terms agreed to by the parties.

RTFC's collateral for the loans includes (i) a series of mortgages, security agreements, financing statements, pledges and guaranties creating liens in favor of RTFC on substantially all of the assets and voting stock of ICC, (ii) a direct pledge of 100% of the voting stock of ICC's USVI local exchange carrier subsidiary, Vitelco, (iii) secured guaranties, mortgages and direct and indirect stock pledges encumbering the assets and ownership interests in substantially all of ICC's other operating subsidiaries, and (iv) a personal guaranty of the loans from ICC's indirect majority shareholder and chairman.

On June 1, 2004, RTFC filed a lawsuit in the United States District Court for the Eastern District of Virginia against ICC for failure to comply with the terms of its loan agreement with RTFC dated August 27, 2001 as amended on April 4, 2003 (hereinafter, the "loan default litigation"). RTFC thereafter amended the complaint to allege additional loan agreement defaults by ICC and to demand the full repayment of ICC's total outstanding debt under the loan agreement, including all principal, interest and fees. ICC answered the amended complaint, denied that it is in default under the loan agreement, and asserted a counterclaim seeking the reformation of the loan agreement to conform to a 1989 settlement agreement among the Virgin Islands Public Services Commission, ICC's predecessor, and RTFC, in a manner that ICC contended would relieve it of some of the defaults alleged in the amended complaint.

In September 2004, RTFC exercised its right to offset amounts allocated to ICC as patronage capital and ICC investments in subordinated capital certificates against the long-term outstanding loan balance. During fiscal year 2005, RTFC offset $10 million of patronage capital that had previously been allocated to ICC, but had not yet been retired. RTFC also offset $54

103

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

million of subordinated capital certificates held by ICC. RTFC borrowers are required to purchase subordinated capital certificates with each long-term loan advance.

On September 22, 2004, RTFC filed a lawsuit in the United States District Court for the Eastern District of Virginia against Jeffrey Prosser in his capacity as a guarantor of the indebtedness of ICC to RTFC. Prosser, in his capacity as guarantor, is jointly and severally liable for all existing, current and future ICC indebtedness. RTFC is seeking to recover from Prosser the full amount of principal, interest and fees due from ICC. Prosser answered the complaint by denying liability and all material allegations therein.

By an order dated October 19, 2004, the Court granted ICC's motion to transfer the loan default and guarantee actions to the District of the Virgin Islands. The Court also granted a motion to allow ICC to add a first supplemental counterclaim for anticipatory breach relating to RTFC's alleged funding obligation for the settlement of a litigation brought by shareholders of ICC's former parent company against ICC and some of its directors in connection with a buyout of those shareholders by ICC in 1998 (the "Greenlight litigation"). RTFC replied to ICC's counterclaim for anticipatory breach by denying all material allegations and liability.

On January 11, 2005, RTFC served a motion for partial summary judgment in the loan default action. In its motion, RTFC seeks partial summary judgment as to ICC's liability for certain events of default alleged in the amended complaint. In addition, RTFC seeks summary judgment dismissing ICC's defense and counterclaim for reformation of the loan agreement, and ICC's counterclaim for anticipatory repudiation in connection with the alleged obligation to fund ICC's settlement of the Greenlight litigation. On March 2, 2005, the Virgin Islands District Court issued an order permitting the parties to take limited written and deposition discovery pertaining to RTFC's partial summary judgment motion. ICC has opposed the motion for summary judgment and cross-moved for summary judgment dismissing the loan default action on the ground that loan is not in default for various reasons, including those set forth in its answer and counterclaims.

ICC has also filed a motion to amend its counterclaims to assert a variety of causes of action alleging that RTFC has not acted in good faith in connection with the lending relationship and with the enforcement by RTFC of its rights under the loan agreements, and seeking contribution against RTFC for any amounts that ICC may be called upon to pay in the Greenlight litigation. On March 2, 2005, the Virgin Islands District Court reserved ruling on ICC's motion to amend its counterclaims. These same counterclaims were also alleged by ICC and its subsidiary Vitelco against RTFC in another action pending in the District of the Virgin Islands in which RTFC has sued the directors of ICC and Vitelco for breach of fiduciary duty. In each case, ICC has not stated the amount of damages it is seeking. RTFC has moved to dismiss these counterclaims in the derivative action and believes that they are meritless. The motion has not yet been scheduled for argument before the Court.

Based on its analysis, ~~CFC~~the Company believes that it is adequately reserved for ~~the estimated probable loss on~~ its ~~loan~~exposure to ~~CoServ.~~

(e) In December 2002, a borrower with an outstanding loan balance of $13 million transferred assets to entities controlled by CFC in repayment of the loan as part of a settlement. The assets had a fair value of $5 million. As a result, CFC took a write-off of $8 million in December 2002, which was fully reserved for in the specific reserve of the loan loss allowance. The assets received as settlement of the loan are being accounted for as foreclosed assets while entities controlled by CFC attempt to arrange a sale.

(f) Energy Co-Opportunity ("ECO") was incorporated in the state of Delaware in 1998. ECO was organized by rural electric cooperatives with the assistance of CFC. CFC is not a member of ECO. ECO sold propane tanks to its members,ICC and through an investment in H Power planned to be involved in the distribution of fuel cells to rural utility systems. ECO members have assisted with the field testing of H Power fuel cells. ECO obtained funds for its operations through payments it received by providing services to H Power pursuant to an agreement between the parties, and from revenues received by providing services to members and other entities.

ECO has been in payment default of its CFC loans. In order to facilitate the receipt of funds from H Power, CFC agreed to defer all principal and interest payments on the loans until December 31, 2003, subject to compliance by ECO with certain conditions. At May 31, 2003 and 2002, all loans to ECO were classified as restructured.

CFC had a total of $32 million in loans to ECO, which were secured by all assets and revenues of ECO and its affiliates, including 4.75 million shares of H Power stock. On November 30, 2001, CFC wrote off $20 million of the loan balance, resulting in a reported balance of $12 million. At May 31, 2002, CFC wrote off an additional $6 million to reduce the loan balance to the value of the collateral.

During the year ended May 31, 2003, H Power merged with Plug Power. As a result of this merger, CFC received a $1 million payment, which was applied against the principal balance of the loan. ECO's 4.75 million shares of H Power stock were exchanged for 788,995 shares of Plug Power stock and were transferred outright to CFC. In May 2003, CFC sold all of the shares of Plug Power stock for approximately $4 million, $3 million of which had been received by CFCVitelco at May 31, 2003. Through proceeds received from the sale of Plug Power stock and the offset of ECO's investments in subordinated certificates and unretired patronage capital allocations, CFC reduced the loan balance by $4 million and wrote off CFC's remaining exposure of $1 million resulting in an outstanding loan balance at May 31, 2003 of $1 million. In June 2003, CFC received the final proceeds of $1 million from the sale of Plug Power stock and reduced ECO's outstanding loan balance to zero. Additionally, ECO announced that it would currently cease all operations and close the cooperative in mid-2004. As a result, in July 2003, CFC and ECO entered into a settlement agreement where CFC received $1.7 million as payment in full and complete satisfaction of all amounts due from ECO. This amount was recorded as a recovery in the allowance for loan losses at that time.2005.

~~(14)~~(15)

Segment Information

In November 2004, management changed the segment presentation to better reflect the reports it is currently using to manage the business. The Company's consolidated and combined financial statements include the financial results of CFC, ~~operates in two business segments - rural electric lending~~RTFC and ~~rural telecommunications lending. The~~NCSC. Full financial ~~information~~statements are produced for ~~these two segments provides a breakout~~each of the ~~combined statement of operations between electric loans~~three companies and ~~telecommunications loans~~are the primary reports that management reviews in evaluating performance. The segment presentation for the year ended May 31, 2005 reflects the ~~full~~operating results of each of the three companies as a separate segment. The three segments presented are CFC, RTFC and NCSC, replacing the prior segments of electric, telecommunications and other. The presentation of the years ended May 31, 2004 and 2003 have been restated on a comparable basis as the year ended May 31, 2005.

As stated elsewhere in the consolidated and combined financial statements, CFC is the sole lender to RTFC and the primary source of funding for NCSC. NCSC also obtains funding from third parties with a CFC guarantee. Thus CFC takes all of the risk related to the funding of the loans to RTFC and NCSC, and in return, CFC earns a gross margin ~~earned~~ on ~~each portfolio. The telecommunications systems' combined statement~~the loans to RTFC and NCSC.

Pursuant to guarantee agreements, CFC has agreed to indemnify RTFC and NCSC for loan losses, with the exception of ~~operations represents~~the NCSC consumer loan program and grant program. Thus CFC maintains the majority of the total ~~earned on telecommunications loans at both the CFC~~consolidated loan loss allowance. A small loan loss allowance is maintained by NCSC to cover its consumer loan and ~~RTFC levels. The electric systems' combined statement of operations is only the amount earned on loans to electric member systems. The~~ grant exposure.

104

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)

income is allocated to either segment based on actual income earned on loans to electric member systems and telecommunications member systems. The cost of funding and derivative cash settlements are allocated based on CFC's current matched funding and risk management policies. Operating expenses, the derivative forward value and foreign currency adjustments are allocated based on total average loan volume. The loan loss provision is allocated based on CFC's loan loss analysis. On the combined balance sheet, the breakout of loans outstanding represents actual loans outstanding to electric member systems and telecommunications member systems. The loan loss allowance is allocated between the two segments based on CFC's loan loss analysis. All other assets except for foreclosed assets are allocated based on the total average loan volume. Using the methodology described above, financial information reported for the telecommunications systems segment will not agree to summary financial information for RTFC as a stand-alone entity.

The following chart contains consolidated and combined ~~statement~~statements of operations ~~information~~ for the years ended May 31, 2005, 2004, and 2003 ~~2002,~~ and ~~2001 and combined~~consolidated balance ~~sheet information~~sheets as of May 31, ~~2003, 2002,~~2005 and ~~2001.~~2004.

For the year ended May 31, 2003
(Dollar amounts in thousands)
Electric Systems
Telecommunications Systems
Total Combined
Combined statement of operations:
Operating income
$
726,384
$
344,491
$
1,070,875
Cost of funds
652,991
277,856
930,847
     Gross margin
73,393
66,635
140,028
Expenses:
General and administrative expenses
28,609
9,560
38,169
Provision for loan losses
30,370
37,896
68,266
    Total expenses
58,979
47,456
106,435
Results of operations of foreclosed assets
1,249
-
1,249
Impairment loss on foreclosed assets
(19,689
)
-
(19,689
)
    Subtotal foreclosed assets
(18,440
)
-
(18,440
)
   Operating (loss)/margin
(4,026
)
19,179
15,153
Derivative cash settlements
86,162
36,663
122,825
Derivative forward value
567,564
189,648
757,212
Foreign currency adjustments
(182,304
)
(60,916
)
(243,220
)
   Net margin
$
467,396
$
184,574
$
651,970
Assets:
Loans outstanding, net
$
14,152,237
$
4,767,046
$
18,919,283
Other assets
1,624,365
430,640
2,055,005
   Total assets
$
15,776,602
$
5,197,686
$
20,974,288

~~105~~

	For the year ended May 31, 2005
(Dollar amounts in thousands)	CFC			RTFC			NCSC			Consolidated
Statement of Operations:
Operating income	$	772,619		$	225,732		$	27,775		$	1,026,126
Cost of funds		(682,828	)		(220,458	)		(18,777	)		(922,063	)
Gross margin		89,791			5,274			8,998			104,063

Operating expenses:
General and administrative expenses		(38,218	)		(2,959	)		(2,054	)		(43,231	)
Provision for loan losses		(16,402	)		-			-			(16,402	)
Recovery of guarantee losses		3,107			-			-			3,107
Total operating expenses		(51,513	)		(2,959	)		(2,054	)		(56,526	)

Results of operations of foreclosed assets		13,079			-			-			13,079
Impairment loss on foreclosed assets		(55	)		-			-			(55	)
Total gain on foreclosed assets		13,024			-			-			13,024

Derivative cash settlements		65,233			-			(2,189	)		63,044
Derivative forward value		30,781			-			(906	)		29,875
Foreign currency adjustments		(22,893	)		-			-			(22,893	)
Total gain (loss) on derivative and foreign
currency adjustments		73,121			-			(3,095	)		70,026
Operating margin		124,423			2,315			3,849			130,587

Income tax expense		-			(57	)		(1,461	)		(1,518	)
Net margin per segment reporting	$	124,423		$	2,258		$	2,388		$	129,069

Reconciliation of net margin:
Net margin per segment reporting										$	129,069
Minority interest- RTFC and NCSC net margin											(2,540	)
Net margin per consolidated statement of operations										$	126,529

Assets:
Loans to members	$	15,505,166		$	2,992,192		$	474,710		$	18,972,068
Less: Allowance for loan losses		(588,365	)		-			(1,384	)		(589,749	)
Loans to members, net		14,916,801			2,992,192			473,326			18,382,319
Other assets		1,329,954			266,040			67,775			1,663,769
Total assets	$	16,246,755		$	3,258,232		$	541,101		$	20,046,088

105

For the year ended May 31, 2002
(Dollar amounts in thousands)
Electric Systems
Telecommunications Systems
Total Combined
Combined statement of operations:
Operating income
$
812,768
$
373,765
$
1,186,533
Cost of funds
628,651
257,187
885,838
   Gross margin
184,117
116,578
300,695
Expenses:
General and administrative expenses
27,593
9,919
37,512
Provision for loan losses
144,349
55,000
199,349
   Total expenses
171,942
64,919
236,861
   Operating margin
12,175
51,659
63,834
Derivative cash settlements
24,264
9,927
34,191
Derivative forward value
30,804
11,074
41,878
Foreign currency adjustments
(44,892
)
(16,138
)
(61,030
)
Cumulative effect of change in accounting principle
20,878
7,505
28,383
   Net margin
$
43,229
$
64,027
$
107,256
Assets:
Loans outstanding, net
$
14,604,091
$
4,936,276
$
19,540,367
Other assets
590,343
212,225
802,568
   Total assets
$
15,194,434
$
5,148,501
$
20,342,935

For the year ended May 31, 2001
(Dollar amounts in thousands)
Electric Systems
Telecommunications Systems
Total Combined
Combined statement of operations:
Operating income
$
968,771
$
419,524
$
1,388,295
Cost of funds
804,384
313,455
1,117,839
   Gross margin
164,387
106,069
270,456
Expenses:
General and administrative expenses
23,790
8,696
32,486
Provision for loan losses
74,404
30,800
105,204
   Total expenses
98,194
39,496
137,690
   Net margin
$
66,193
$
66,573
$
132,766
Loans outstanding, net
$
14,113,354
$
5,238,599
$
19,351,953
Other assets
479,664
175,323
654,987
   Total assets
$
14,593,018
$
5,413,922
$
20,006,940

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONSOLIDATED AND COMBINED FINANCIAL STATEMENTS - (Continued)


	For the year ended May 31, 2004
(Dollar amounts in thousands)	CFC			RTFC			NCSC			Consolidated
Statement of Operations:
Operating income	$	673,078		$	306,579		$	27,636		$	1,007,293
Cost of funds		(607,771	)		(300,281	)		(17,600	)		(925,652	)
Gross margin		65,307			6,298			10,036			81,641

Operating expenses:
General and administrative expenses		(35,096	)		(4,256	)		(1,040	)		(40,392	)
(Provision for) recovery of loan losses		(55,364	)		-			443			(54,921	)
Recovery of guarantee losses		851			-			-			851
Total operating expenses		(89,609	)		(4,256	)		(597	)		(94,462	)

Results of operations of foreclosed assets		13,469			-			-			13,469
Impairment loss on foreclosed assets		(10,877	)		-			-			(10,877	)
Total loss on foreclosed assets		2,592			-			-			2,592

Derivative cash settlements		113,694			-			(3,607	)		110,087
Derivative forward value		(233,198	)		-			4,066			(229,132	)
Foreign currency adjustments		(65,310	)		-			-			(65,310	)
Total (loss) gain on derivative and foreign
currency adjustments		(184,814	)		-			459			(184,355	)
Operating (loss) margin		(206,524	)		2,042			9,898			(194,584	)

Income tax expense		-			(52	)		(3,765	)		(3,817	)
Cumulative effect of change in accounting principle		22,369			-			-			22,369
Net (loss) margin per segment reporting	$	(184,155	)	$	1,990		$	6,133		$	(176,032	)

Reconciliation of net margin:
Net margin per segment reporting										$	(176,032	)
Minority interest- RTFC and NCSC net margin											(1,989	)
Net margin per consolidated statement of operations										$	(178,021	)

Assets:
Loans to members	$	15,355,584		$	4,643,008		$	489,931		$	20,488,523
Less: Allowance for loan losses		(571,739	)		-			(2,200	)		(573,939	)
Loans to members, net		14,783,845			4,643,008			487,731			19,914,584
Other assets		967,986			505,439			53,229			1,526,654
Total assets	$	15,751,831		$	5,148,447		$	540,960		$	21,441,238

106

	For the year ended May 31, 2003
(Dollar amounts in thousands)	CFC			RTFC			Combined
Statement of Operations:
Operating income	$	726,383		$	344,492		$	1,070,875
Cost of funds		(601,730	)		(337,602	)		(939,332	)
Gross margin		124,653			6,890			131,543

Operating expenses:
General and administrative expenses		(34,042	)		(4,127	)		(38,169	)
Provision for loan losses		(43,071	)		-			(43,071	)
Provision for guarantee losses		(25,195	)		-			(25,195	)
Total operating expenses		(102,308	)		(4,127	)		(106,435	)

Results of operations of foreclosed assets		9,734			-			9,734
Impairment loss on foreclosed assets		(19,689	)		-			(19,689	)
Total loss on foreclosed assets		(9,955)			-			(9,955	)

Derivative cash settlements		122,825			-			122,825
Derivative forward value		757,212			-			757,212
Foreign currency adjustments		(243,220	)		-			(243,220	)
Net margin per segment reporting	$	649,207		$	2,763		$	651,970

~~106~~

~~(15)~~(16)

~~Combined~~Selected Quarterly Financial ~~Results~~Data (Unaudited)

Summarized results of operations for the four quarters of fiscal years ~~2003~~2005 and ~~2002~~2004 are as follows:

Fiscal Year 2003
Quarters Ended
August 31
November 30
February 28
(Dollar amounts in thousands)
(restated)
(restated)
(restated)
May 31
Total Year
Operating income
$279,126
$272,034
$260,376
$259,339
$1,070,875
Gross margin
44,935
33,640
30,500
30,953
140,028
Operating margin/(loss)
(1,018
)
(7,653
)
20,539
3,285
15,153
Net margin
213,589
34,867
246,457
157,057
651,970

Fiscal Year 2002
Quarters Ended
August 31
November 30
February 28
May 31
Total Year
(Dollar amounts in thousands)
(restated)
(restated)
(restated)
(restated)
(restated)
Operating income
$327,829
$302,074
$277,816
$278,814
$1,186,533
Gross margin
86,078
82,538
84,000
48,079
300,695
Operating margin
27,622
15,263
17,528
3,421
63,834
Net margin/(loss)
63,698
40,837
9,680
(6,959
)
107,256

	Fiscal Year 2005
	Quarters Ended
(Dollar amounts in thousands)	August 31			November 30		February 28		May 31			Total Year

Operating income		$ 247,125			$ 281,304		$ 251,325		$ 246,372			$1,026,126
Gross margin		18,747			54,501		23,185		7,630			104,063
Operating margin (loss)		90,738			48,872		7,809		(16,832	)		130,587
Net margin (loss)		89,941			46,964		6,450		(16,826	)		126,529

	Fiscal Year 2004
	Quarters Ended
(Dollar amounts in thousands)	August 31			November 30		February 29		May 31			Total Year

Operating income		$ 255,275			$ 256,537		$ 246,874		$ 248,607			$1,007,293
Gross margin		29,900			22,282		21,399		8,060			81,641
Operating (loss) margin		(240,210	)		83,760		96,188		(134,322	)		(194,584	)
Net (loss) margin prior to cumulative effect
of change in accounting principle		(241,912	)		82,221		95,146		(135,845	)		(200,390	)
Net (loss) margin		(219,543	)		82,221		95,146		(135,845	)		(178,021	)


~~At May 31, 2003, CFC made adjustments to~~(17)	Subsequent Events

In August 2005, the ~~quarterly net margin reported~~Company sold real estate assets for $30 million. The Company acquired these real estate assets as part of a bankruptcy settlement in 2002. The real estate assets sold by the Company had been accounted for as foreclosed assets. The Company estimates that its fiscal years 2002 and 2003 to reflect the required accounting related to holding foreign denominated debt which is restated in the above chart (see further discussion in Note 1(q)). CFC was required to restate the balanceyear 2006 first quarter results of ~~the foreign denominated debt on its combined balance sheet to reflect the change in the exchange rate~~operations of foreclosed assets will include a gain of approximately $2 million from the date of issuance to the applicable reporting date. CFC had reported the foreign denominated debt at the original exchange rate due to the fact that CFC had also entered into foreign currency exchange agreements that effectively fixed the exchange rate on all interest and principal payments at the time of issuance on all foreign denominated debt. This results in the restatement to the net margin/(loss) reported at each quarter end for fiscal years 2002 and 2003.sale.


~~The following chart contains a reconciliation~~In July 2005, the Company sold $500 million of 4.656% notes to the ~~amounts previously reported as filed with~~Federal Agricultural Mortgage Corporation due in 2008 and secured by the ~~SEC and the restated amounts as reported in this May 31, 2003 Form 10-K.~~

August 31,
November 30,
February 28,
(Dollar amounts in thousands)
2002
2002
2003
Net margin as reported previously
$
260,813
$
47,460
$
331,160
Foreign currency adjustments
(47,224
)
(12,593
)
(84,703
)
Net margin as reported in this Form 10-K
$
213,589
$
34,867
$
246,457

(Dollar amounts in thousands)
August 31,
November 30,
February 28,
May 31,
2001
2001
2002
2002
Net margin/(loss) as reported previously
$
69,749
$
35,338
$
(7,981
)
$
71,180
Foreign currency adjustments
(6,051
)
5,499
17,661
(78,139
)
Net margin/(loss) as reported in this Form 10-K
$
63,698
$
40,837
$
9,680
$
(6,959
)

pledge of CFC mortgage notes.
107

	Name of each		Name of each
	exchange on		exchange on
Title of each class	which listed	Title of each class	which listed
~~5.30% Collateral Trust Bonds, due 2003~~	~~NYSE~~	~~5.70% Collateral Trust Bonds, due 2010~~	~~NYSE~~
~~6.00% Collateral Trust Bonds, due 2004~~	~~NYSE~~	~~7.20% Collateral Trust Bonds, due 2015~~	~~NYSE~~
~~6.375% Collateral Trust Bonds, due 2004~~	~~NYSE~~	~~6.55% Collateral Trust Bonds, due 2018~~	~~NYSE~~
~~5.50%~~6.65% Collateral Trust Bonds, due 2005	NYSE	7.35% Collateral Trust Bonds, due 2026	NYSE
~~6.125%~~7.30% Collateral Trust Bonds, due ~~2005~~2006	NYSE	6.75% Subordinated Notes, due 2043	NYSE
~~6.65%~~6.20% Collateral Trust Bonds, due ~~2005~~2008	NYSE	~~7.375% Quarterly Income Capital Securities,~~6.10% Subordinated Notes, due ~~2047~~2044	NYSE
~~7.30%~~5.75% Collateral Trust Bonds, due ~~2006~~2008	NYSE	5.95% Subordinated Notes, due 2045	NYSE
5.70% Collateral Trust Bonds, due 2010	NYSE	7.625% Quarterly Income Capital Securities, due 2050	NYSE
~~6.20%~~7.20% Collateral Trust Bonds, due ~~2008~~2015	NYSE	7.40% Quarterly Income Capital Securities, due 2050	NYSE
~~5.75%~~6.55% Collateral Trust Bonds, due ~~2008~~2018	NYSE

TABLE OF CONTENTS
Part No.	Item No.				Page
I.	1.	Business			1
			General		1
			Members		2
			Distribution Systems		3
			Power Supply Systems		3
			Service Organizations and Associate Member Systems		3
			Telecommunications Systems		3
		Loan Programs			4
			Interest Rates on Loans		5
			Electric Loan Programs		5
			Telecommunications Loan Programs		6
			RUS Guaranteed Loans for Rural Electric Systems		7
			Conversion of Loans		7
			Prepayment of Loans		7
		Guarantee Programs			7
			Guarantees of Long-Term Tax-Exempt Bonds		7
			Guarantees of Lease Transactions		8
			Guarantees of Tax Benefit Transfers		8
			Letters of Credit		8
			Other Guarantees		8
		Disaster Recovery			9
		Tax Status			9
		Investment Policy			9
		Employees			9
		CFC Lending Competition			10
		Member Regulation and Competition			10
		The RUS Program			13
		Member Financial Data			13
	2.	Properties			21
	3.	Legal Proceedings			21
	4.	Submission of Matters to a Vote of Security Holders			21
II.	5.	Market for the Registrant's Common Equity and Related Stockholder Matters			22
	6.	Selected Financial Data			22
	7.	Management's Discussion and Analysis of Financial Condition and Results of Operations			23
				Overview	24
				Change of Auditors in Fiscal Year 2002	25
				Critical Accounting Policies	26
				New Accounting Pronouncements	29
				Non-GAAP Financial Measures	30
				Restatement	34
				Margin Analysis	35
				Liquidity and Capital Resources	39
				Asset/Liability Management	49
				Financial and Industry Outlook	55
	7A.	Quantitative and Qualitative Disclosures About Market Risk			58
	8.	Financial Statements and Supplementary Data			58
	9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			58
	9A.	Controls and Procedures			58
III.	10.	Directors and Executive Officers of the Registrant			59
	11.	Executive Compensation			64
	12.	Security Ownership of Certain Beneficial Owners and Management			66
	13.	Certain Relationships and Related Transactions			66
IV.	14.	Exhibits, Financial Statement Schedules, and Reports on Form 8-K			67
		Signatures			69

(Dollar amounts in thousands)		May 31,							May 31,
State/Territory		2003		2002		2001	State/Territory		2003		2002		2001
Alabama	$	293,524	$	263,670	$	364,974	Montana	$	218,378	$	218,497	$	220,234
Alaska		312,080		295,386		293,070	Nebraska		13,421		12,363		12,785
American Samoa		2,850		-		-	Nevada		90,817		93,399		94,958
Arizona		149,310		133,465		101,770	New Hampshire		204,835		229,569		243,973
Arkansas		520,305		517,218		531,224	New Jersey		19,415		9,293		8,724
California		23,497		18,042		86,783	New Mexico		40,061		38,519		38,063
Colorado		957,814		793,398		599,602	New York		16,640		16,885		19,808
Connecticut		200,000		201,896		44,421	North Carolina		927,217		963,335		972,887
Delaware		14,812		20,881		46,599	North Dakota		75,435		52,640		63,693
District of Columbia		298,272		335,410		432,122	Ohio		380,468		387,433		379,991
Florida		475,802		473,582		465,348	Oklahoma		476,736		521,388		460,758
Georgia		1,538,946		1,683,474		1,646,326	Oregon		285,024		279,818		262,721
Hawaii		-		233		812	Pennsylvania		182,996		159,157		150,203
Idaho		168,971		157,721		135,287	South Carolina		536,437		537,722		526,647
Illinois		613,838		683,718		607,305	South Dakota		156,218		162,881		165,015
Indiana		326,827		270,907		224,272	Tennessee		104,722		108,150		105,773
Iowa		1,117,138		1,167,938		1,201,570	Texas		3,461,097		4,081,770		3,859,623
Kansas		303,378		289,806		300,987	Utah		571,703		583,888		616,372
Kentucky		289,375		226,679		223,338	Vermont		63,604		40,851		42,019
Louisiana		283,669		261,570		247,395	Virgin Islands		623,037		615,599		587,849
Maine		40,047		43,780		43,568	Virginia		241,157		264,272		269,579
Maryland		102,886		130,094		132,746	Washington		87,893		87,190		91,436
Massachussetts		-		-		50	West Virginia		3,959		2,160		1,699
Michigan		277,150		298,981		306,469	Wisconsin		303,562		300,464		304,913
Minnesota		853,159		856,013		1,099,548	Wyoming		142,981		154,959		147,124
Mississippi		474,288		373,537		283,406	Total	$	19,484,341	$	20,047,109	$	19,683,950
Missouri		618,590		627,508		618,111

		Years ended December 31,
(Dollar amounts in thousands)		2002		2001		2000		1999		1998

Operating revenues and patronage capital	$	22,856,370	$	21,627,713	$	20,419,019	$	18,805,359	$	18,284,021

Operating deductions:
Cost of power (1)		14,153,297		13,550,239		12,925,630		11,828,572		11,580,829
Distribution expense (operations)		992,617		899,310		856,378		792,249		728,565
Distribution expense (maintenance)		1,249,463		1,183,558		1,106,780		1,024,734		985,571
Administrative and general expense (2)		2,266,334		2,144,824		1,972,220		1,864,344		1,735,074
Depreciation and amortization expense		1,600,544		1,487,657		1,387,923		1,290,354		1,203,438
Taxes		269,587		252,592		241,219		230,238		241,010

Total		20,531,842		19,518,180		18,490,150		17,030,491		16,474,487

Utility operating margin		2,324,528		2,109,533		1,928,869		1,774,868		1,809,534
Non-operating margin		295,588		104,442		211,957		179,940		173,446
Power supply capital credits (3)		321,548		326,215		272,007		259,099		297,451

Total		2,941,664		2,540,190		2,412,833		2,213,907		2,280,431

Interest on long-term debt (4)		1,151,978		1,194,016		1,150,231		1,024,369		980,863
Other deductions		74,769		74,854		84,049		50,523		49,628

Total		1,226,747		1,268,870		1,234,280		1,074,892		1,030,491

Net margin and patronage capital	$	1,714,917	$	1,271,320	$	1,178,553	$	1,139,015	$	1,249,940

TIER (5)		2.48		2.05		2.01		2.11		2.35
DSC (6)		2.16		1.94		2.08		2.15		2.32
MDSC (7)		1.98		1.88		1.99		2.03		2.25
Number of systems included		808		811		812		811		820

	At December 31,
(Dollar amounts in thousands)	2002		2001		2000		1999		1998
Assets and other debits:
Utility plant:
Utility plant in service	$	51,732,230	$	48,895,933	$	45,985,367	$	43,023,535	$	40,387,723
Construction work in progress		1,350,707		1,442,108		1,438,002		1,262,537		1,129,147
Total utility plant		53,082,937		50,338,041		47,423,369		44,286,072		41,516,870
Less: Accumulated provision for
depreciation and amortization		14,841,818		14,044,637		13,083,103		12,225,421		11,409,118
Net utility plant		38,241,119		36,293,404		34,340,266		32,060,651		30,107,752
Investment in associated organizations (1)		4,442,660		4,225,723		4,002,393		3,790,623		3,665,208
Current and accrued assets		5,360,318		5,038,616		5,651,652		4,520,592		4,526,663
Other property and investments		1,240,403		1,076,731		1,019,348		703,585		644,353
Deferred debits		593,995		613,117		626,903		599,511		530,606
Total assets and other debits	$	49,878,495	$	47,247,591	$	45,640,562	$	41,674,962	$	39,474,582

Liabilities and other credits:
Net worth:
Memberships	$	114,001	$	111,266	$	140,663	$	119,175	$	112,391
Patronage capital and other equities (2)		20,459,062		19,642,036		18,538,088		17,542,625		16,710,886
Total net worth		20,573,063		19,753,302		18,678,751		17,661,800		16,823,277
Long-term debt (3)		23,345,933		21,943,560		21,326,555		19,308,152		18,343,340
Current and accrued liabilities		4,440,751		4,095,900		4,280,010		433,687		3,098,525
Deferred credits		974,414		952,642		892,001		3,429,173		884,595
Miscellaneous operating services		544,334		502,187		463,245		842,150		324,845
Total liabilities and other credits	$	49,878,495	$	47,247,591	$	45,640,562	$	41,674,962	$	39,474,582

Equity percentage (4)		41.2%		41.8%		40.9%		42.5%		42.6%
Number of systems included		808		811		812		811		820

		Allowance for Funds Used During
	Interest Charged to Construction	Construction	Total
2002	$25,479	$15,009	$40,488
2001	39,140	21,851	60,991
2000	20,245	24,736	44,981
1999	10,073	13,604	23,677
1998	9,947	13,133	23,080

	Years ended December 31,
(Dollar amounts in thousands)	2002 (4) (5)		2001 (4)		2000 (3)		1999 (3)		1998
Operating revenues	$	4,765,679	$	4,503,614	$	4,879,808	$	3,908,496	$	2,535,461
Operating expenses (1)		3,364,102		3,030,570		3,509,779		3,003,530		1,846,215
Net income before interest,
depreciation and taxes		1,401,577		1,473,044		1,370,029		904,966		689,246
Interest on long-term debt		477,587		568,829		430,825		221,103		140,436
Net income before depreciation and taxes		923,990		904,215		939,204		683,863		548,810
Depreciation and amortization expenses		719,204		797,665		675,757		410,805		279,277
Net income before taxes		204,786		106,550		263,447		273,058		269,533
Taxes		93,797		91,420		140,378		89,030		71,326
Net income	$	110,989	$	15,130	$	123,069	$	184,028	$	198,207

DSC (2)		1.43		1.59		1.79		2.30		2.14
Number of systems included		201		208		226		191		169


Leverage Ratio:	May 31,
(Dollar amounts in thousands)	2003			2002			2001			2000			1999
Total Liabilities	$	20,043,452		$	20,014,204		$	19,604,943		$	16,742,223		$	13,628,771
Less:
Derivative liabilities (1) (2)		(353,840	)		(254,143	)		-			-			-
Foreign currency valuation account (3)		(325,810	)		2,355			-			-			-
Debt used to fund loans guaranteed by RUS		(266,857	)		(242,574	)		(182,134	)		(89,153	)		(130,940	)
Subordinated deferrable debt		(650,000	)		(600,000	)		(550,000	)		(400,000	)		(400,000	)
Subordinated certificates		(1,708,297	)		(1,691,970	)		(1,581,860	)		(1,340,417	)		(1,239,816	)
Adjusted liabilities	$	16,738,648		$	17,227,872		$	17,290,949		$	14,912,653		$	11,858,015

Total Equity	$	930,836		$	328,731		$	393,899		$	341,217		$	296,481
Less:
Prior year cumulative derivative forward value and
foreign currency adjustments (2)(3)		(9,231	)		-			-			-			-
Current period derivative forward value (2)		(757,212	)		(70,261	)		-			-			-
Current period foreign currency adjustments (3)		243,220			61,030			-			-			-
Accumulated other comprehensive loss (2)		46,763			72,556			-			-			-
Members' equity		454,376			392,056			393,899			341,217			296,481
Plus:
Subordinated certificates		1,708,297			1,691,970			1,581,860			1,340,417			1,239,816
Subordinated deferrable debt		650,000			600,000			550,000			400,000			400,000
Adjusted equity	$	2,812,673		$	2,684,026		$	2,525,759		$	2,081,634		$	1,936,297

Guarantees	$	1,903,556		$	2,056,385		$	2,217,559		$	1,945,202		$	1,893,197

Leverage ratio		23.58			67.14			55.40			54.77			52.35
Adjusted leverage ratio		6.63			7.18			7.72			8.10			7.10


Debt to Equity Ratio:	May 31,
(Dollar amounts in thousands)	2003			2002			2001			2000			1999
Total Liabilities	$	20,043,452		$	20,014,204		$	19,604,943		$	16,742,223		$	13,628,771
Less:
Derivative liabilities (1) (2)		(353,840	)		(254,143	)		-			-			-
Foreign currency valuation account (3)		(325,810	)		2,355			-			-			-
Debt used to fund loans guaranteed by RUS		(266,857	)		(242,574	)		(182,134	)		(89,153	)		(130,940	)
Subordinated deferrable debt		(650,000	)		(600,000	)		(550,000	)		(400,000	)		(400,000	)
Subordinated certificates		(1,708,297	)		(1,691,970	)		(1,581,860	)		(1,340,417	)		(1,239,816	)
Adjusted liabilities	$	16,738,648		$	17,227,872		$	17,290,949		$	14,912,653		$	11,858,015

Total Equity	$	930,836		$	328,731		$	393,899		$	341,217		$	296,481
Less:
Prior year cumulative derivative forward value and
foreign currency adjustments (2)(3)		(9,231)			-			-			-			-
Current period derivative forward value (2)		(757,212	)		(70,261	)		-			-			-
Current period foreign currency adjustments (3)		243,220			61,030			-			-			-
Accumulated other comprehensive loss (2)		46,763			72,556			-			-			-
Members' equity		454,376			392,056			393,899			341,217			296,481
Plus:
Subordinated certificates		1,708,297			1,691,970			1,581,860			1,340,417			1,239,816
Subordinated deferrable debt		650,000			600,000			550,000			400,000			400,000
Loan loss allowance		565,058			506,742			331,997			228,292			212,203
Adjusted equity	$	3,377,731		$	3,190,768		$	2,857,756		$	2,309,926		$	2,148,500

Debt to equity ratio		21.53			60.88			49.77			49.07			45.97
Adjusted debt to equity ratio		4.96			5.40			6.05			6.46			5.52


(Dollar amounts in thousands)	May 31, 2003			May 31, 2002
Total capitalization	$	20,386,230		$	19,890,220
Less:
Long-term debt valuation allowance		941			(2,340	)
Foreign currency valuation account		(325,810	)		2,355
Prior year cumulative derivative forward value and
foreign currency adjustments		(9,231	)		-
Current period derivative forward value (1)		(757,212	)		(70,261	)
Current period foreign currency adjustments		243,220			61,030
Accumulated other comprehensive loss		46,763			72,556
Adjusted total capitalization	$	19,584,901		$	19,953,560


	Annual Compensation					All Other
	Year		Salary		Bonus	Compensation (1)
Sheldon C. Petersen	2003	$	477,500	$	105,470	$	19,038
Governor and Chief Executive Officer	2002		440,000		82,617		28,186
	2001		400,000		97,422		28,148

Steven L. Lilly	2003		300,000		63,282		13,042
Senior Vice President and Chief	2002		265,000		46,582		16,283
Financial Officer	2001		247,800		56,142		19,442

John J. List	2003		260,000		54,844		19,771
Senior Vice President of Member	2002		229,000		40,254		7,447
Services and General Counsel	2001		219,000		49,617		15,366

John T. Evans	2003		260,000		54,844		17,790
Senior Vice President of Operations	2002		236,000		41,484		9,761
	2001		224,400		50,841		11,536

Lawrence Zawalick	2003		217,000		45,774		16,308
Senior Vice President of RTFC	2002		197,000		34,629		14,511
	2001		188,500		42,707		17,545

Outlook	negative	stable	positive	negative	stable	positive	NA
Composite rating	A+	A+	A+	AA-	AA-	AA-	AA & above
Payout	$0	$40	$60	$80	$100	$120	$150

		2003			2002

Notes payable, due within one year	$	1,096,353		$	2,413,969

Accrued interest payable		184,204			177,178

Long-term debt		16,000,744			14,855,550

Other liabilities		49,073			23,734

Derivative liabilities		354,781			251,803

Subordinated deferrable debt		650,000			600,000

Members' subordinated certificates:
Membership subordinated certificates		643,772			641,390
Loan and guarantee subordinated certificates		1,064,525			1,050,580
Total members' subordinated certificates		1,708,297			1,691,970

Equity:
Retained equity		977,599			401,287
Accumulated other comprehensive loss		(46,763	)		(72,556	)
Total equity		930,836			328,731

Total members' subordinated certificates and equity		2,639,133			2,020,701

	$	20,974,288		$	20,342,935


NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

COMBINED STATEMENTS OF CASH FLOWS

For the Years Ended May 31, 2003, 2002 and 2001

(Dollar Amounts in Thousands)

	2003				2002			2001
CASH FLOWS FROM OPERATING ACTIVITIES:
Net margin	$	651,970		$	107,256		$	132,766
Add/(deduct):
Provision for loan losses		68,266			199,349			105,204
Depreciation		4,307			3,960			2,332
Amortization of deferred income		(7,821	)		(1,403	)		(761	)
Derivative forward value		(757,212	)		(41,878	)		-
Foreign currency adjustments		243,220			61,030			-
Cumulative effect of change in accounting principle		-			(28,383	)		-
Amortization of bond issuance costs and deferred charges		13,759			22,753			7,284
Results of operations of foreclosed assets		(1,249	)		-			-
Impairment loss on foreclosed assets		19,689			-			-
Changes in operating assets and liabilities:
Receivables		3,526			12,676			(32,245	)
Accrued interest payable		7,026			52,455			7,113
Other		5,218			(9,927	)		(42,589	)

Net cash provided by operating activities		250,699			377,888			179,104

CASH FLOWS FROM INVESTING ACTIVITIES:
Advances made on loans		(4,548,137	)		(5,513,679	)		(8,782,519	)
Principal collected on loans		4,731,561			5,125,915			5,775,116
Net investment in fixed assets		(2,972	)		(2,712	)		(5,997	)
Net cash provided by foreclosed assets		15,377			-			-

Net cash provided by/(used in) investing activities		195,829			(390,476	)		(3,013,400	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Repayments of notes payable, net		(1,250,848	)		(2,956,989	)		(511,045	)
Debt service investments, net		-			21,986			(1,055	)
Proceeds from issuance of long-term debt, net		3,632,650			7,407,547			6,058,736
Payments for retirement of long-term debt		(2,895,104	)		(4,533,840	)		(3,069,479	)
Proceeds from issuance of subordinated deferrable debt		121,062			169,487			150,000
Payments for retirement of subordinated deferrable debt		(75,000	)		(125,000	)		-
Proceeds from issuance of members' subordinated certificates		96,567			167,497			290,501
Retirement of members' subordinated certificates		(80,745	)		(60,481	)		(28,872	)
Payments for retirement of patronage capital		(74,622	)		(99,792	)		(59,961	)

Net cash (used in)/provided by financing activities		(526,040	)		(9,585	)		2,828,825

NET DECREASE IN CASH AND CASH EQUIVALENTS		(79,512	)		(22,173	)		(5,471	)
BEGINNING CASH AND CASH EQUIVALENTS		218,384			240,557			246,028
ENDING CASH AND CASH EQUIVALENTS	$	138,872		$	218,384		$	240,557

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during year for interest	$	921,317		$	815,960		$	1,122,635

NON-CASH INVESTING AND FINANCING ACTIVITIES:
Foreclosed assets in collection of loans	$	369,393		$	-		$	-

See accompanying notes.

(Dollar amounts in thousands)
For the years ended May 31:	2003	2002	2001
Operating income	$344,492	$373,765	$419,524
Net margin (1)	27,913	26,816	38,098


	Notes Payable,									Other
	due within			Long-term			Retained			Comprehensive
(Dollar amounts in thousands)	one year			Debt			Equity			Loss
As reported in May 31, 2002 Form 10-K	$	2,414,488		$	14,857,386		$	462,317		$	(135,941	)
Change in foreign currency valuation (1)		(519	)		(1,836	)		(61,030	)		63,385
As restated	$	2,413,969		$	14,855,550		$	401,287		$	(72,556	)


				Total Derivative and
	Foreign Currency			Foreign Currency						Comprehensive
(Dollar amounts in thousands)	Adjustments			Adjustments			Net Margin			Income
As reported in May 31, 2002 Form 10-K	$	-		$	76,069		$	168,286		$	32,345
Change in foreign currency valuation		(61,030	)		(61,030	)		(61,030	)		2,355
As restated	$	(61,030	)	$	15,039		$	107,256		$	34,700

(3)

(4)

(4)

(8)

(10)(11)