Defaults Plague Little-Known Big Lender

By Steven Mufson
Washington Post Staff Writer
Monday, April 30, 2007

The National Rural Utilities Cooperative Finance Corp., located in a sleek office building off the Dulles Toll Road, is one of the Washington area's biggest lending businesses. It has a $17.8 billion loan portfolio -- bigger than any bank based in the area -- and a chief executive who pulls down a salary of more than $800,000 a year.

It's also one of the least-known big businesses around. But a nasty legal fight with a borrower and a critical report by a bond analyst have focused attention on the unusual -- and unregulated -- lending institution's struggle over the past five years to keep itself on an even keel despite loan losses, rising interest rates and razor-thin margins.

The CFC occupies what sounds like an obscure business niche: It lends money to cooperatives that generate electricity and deliver it to rural America.

Chief executive Sheldon C. Petersen says it can deliver the "best loans to our members." As a nonprofit (and thus tax-exempt) cooperative, the CFC faces no pressure to produce stock returns or big dividends; any profit belongs to the member-customers. High marks from three rating agencies smooth the way for the CFC to borrow money cheaply on bond markets.

It also has powerful friends in Congress -- made friendlier with the lobbying support of the National Rural Cooperative Association, which has dished out $1.4 million in campaign contributions in each of the past two election cycles. The 2002 Farm Bill gave the CFC permission to borrow at even lower rates from the Federal Financing Bank, an arm of the Treasury Department. So far, the CFC has drawn $2 billion of the $4 billion credit available. The Agriculture Department's Rural Utilities Service guarantees that the money will be repaid.

Yet the CFC has had problems. It reported an operating loss of $40 million in the first nine months of its fiscal year (ended Feb. 28). In the preceding year, the tiny difference between the income from the relatively low interest paid by its members and its average cost of borrowing wasn't enough to cover the firm's administrative overhead.

Meanwhile, the CFC is working its way through some major defaults -- including two on giant loans to borrowers who had diversified into activities far beyond rural electricity, such as golf courses, newspapers and shopping centers. The defaults, plus changes in interest rates and loan structures, have cut the fair market value of the CFC's portfolio by $2.7 billion from book value, according to filings with the Securities and Exchange Commission.

Three months ago, Egan-Jones Ratings downgraded the CFC's bonds to junk status, asserting that it had "inadequate capitalization."

"The only way the co-op has been profitable has been through asset sale gains and some derivative items," said Sean Egan, managing director of Egan-Jones, noting that the CFC had sold its headquarters building in Herndon. "That doesn't give us comfort that they have the cushion you'd ordinarily expect for an investment grade."

Though Egan-Jones is not one of the rating agencies recognized by the SEC, the firm gained renown by lowering its ratings on Enron, WorldCom and Global Crossing before other agencies did. Egan-Jones also boasts that, unlike other ratings agencies, it does not collect fees from the companies it evaluates.

At the moment, Egan's is a lone voice on the CFC. On Feb. 23, Fitch Ratings raised the CFC's outlook to "positive" and affirmed its A rating after concluding that the impact of some of the bad loans would be minimal. Three weeks later, a consortium of 19 banks agreed to extend $2.25 billion in revolving credit to the CFC. In the past two weeks, the CFC has sold $1.12 billion in new bonds at rates substantially lower than expiring notes.

"We're unique," Petersen said early this month. "It doesn't fit into the standard MBA business model, but it works." He said that the fair market value of the loans doesn't matter because the CFC isn't selling them. The CFC sold its building because the Sept. 11, 2001, attacks made Petersen want to move to a more secure location, he said.

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