Item 1. Business.
General
National Rural Utilities Cooperative 		Finance Corporation ("CFC" or "the Company") is a private, 		not-for-profit cooperative association incorporated 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 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 its members with credit enhancements in 		the form of letters of credit and guarantees of debt obligations. CFC is 		exempt from payment of 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. CFC's 		internet address is www.nrucfc.coop, where under "Investors," copies can 		be found of this annual report on Form 10-K, quarterly reports on Form 		10-Q and current reports on Form 8-K, and amendments thereto, all of 		which CFC makes available as soon as reasonably practicable after the 		report is filed with the Securities and Exchange Commission. Information 		posted on CFC's website is not incorporated by reference into this Form 		10-K.
Rural Telephone Finance Cooperative 		("RTFC") was incorporated as a private cooperative association in the 		state of South Dakota in September 1987. In February 2005, RTFC 		reincorporated as a not-for-profit cooperative association in the 		District of Columbia. The principal purpose of RTFC is to provide and 		arrange financing for its rural telecommunications members and their 		affiliates. RTFC's results of operations and financial condition are 		consolidated with those of CFC in the accompanying financial statements. 		CFC is the sole lender to and manages the lending and financial affairs 		of RTFC through a long-term management agreement. Under a guarantee 		agreement, RTFC pays CFC a fee in exchange for which CFC reimburses RTFC 		for loan losses. RTFC is headquartered with CFC in Herndon, Virginia. 		RTFC is a taxable cooperative that pays income tax based on its net 		margins, excluding net margins allocated to its members, as allowed by 		law under Subchapter T of the Internal Revenue Code.
National Cooperative Services Corporation 		("NCSC") was incorporated in 1981 in the District of Columbia as a 		private cooperative association. The principal purpose of NCSC is to 		provide financing to the for-profit and 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. NCSC's results 		of operations and financial condition are 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, 		NCSC pays CFC a fee in exchange for which CFC reimburses NCSC for loan 		losses, excluding losses in the consumer loan program. NCSC is 		headquartered with CFC in Herndon, Virginia. NCSC is a taxable 		corporation that pays income tax annually based on its net margins for 		the period.
Unless stated otherwise, references to 		the Company relate to the consolidation of CFC, RTFC, NCSC and certain 		entities controlled by CFC and created to hold foreclosed assets.
Members
The Company's consolidated membership was 		1,547 as of May 31, 2006 including 898 utility members, the majority of 		which are consumer-owned electric cooperatives, 514 telecommunications 		members, 67 service members and 68 associates in 49 states, the District 		of Columbia and two U.S. territories. The utility members included 829 		distribution systems and 69 generation and transmission ("power supply") 		systems. Memberships between CFC, RTFC and NCSC have been eliminated in 		consolidation.
CFC currently has 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
* Class D - national associations of 		cooperatives.
In addition to its members, CFC has 68 		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. 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.
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, and that are engaged (or plan to be engaged) in 			providing telecommunication services to ultimate 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 NCSC members, the 			percentage of total loans and the percentage of total loans and 			guarantees outstanding at May 31, 2006.
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. 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, 2004 (the latest information 			available), 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 18 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.
Service Organizations and Associate Systems
Service organizations include the National Rural 			Electric Cooperative Association ("NRECA"), statewide and regional 			cooperative associations. NRECA represents cooperatives nationally.
Associates include organizations that are owned, 			controlled or operated by 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 many of the rural areas of the United 			States. These companies, which number approximately 1,300, are 			called independent because they are not affiliated with Verizon, 			AT&T or Qwest. Included in the 1,300 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. Approximately 			20 of these commercial companies are publicly traded or issue bonds 			publicly.
Rural telecommunications companies (including all 			local exchange carriers ("LECs") other than Verizon, AT&T, Qwest, 			Cincinnati Bell and Embarq (formerly Sprint's local exchange 			properties)) comprise a relatively small sector (less than 15%) of a 			local exchange telecommunications industry that provides service to 			over 178 million access lines. These rural companies range in size 			from fewer than 100 customers to more than one million. Rural 			telecommunications companies' annual operating revenues range from 			less than $100,000 to well 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, internet protocol telephony and other 			advanced technologies.
Loan Programs
Set forth below is a table showing loans 			outstanding to borrowers and the weighted average interest rates 			thereon and loans 			committed but unadvanced to borrowers by loan program and by 			segment at May 31:
Total loans outstanding by state or U.S. 			territory based on the location of the system's headquarters are 			summarized below at May 31:
The Company's loan portfolio is widely dispersed 			throughout the United States and its territories, including 48 			states, the District of Columbia, American Samoa and the U.S. Virgin 			Islands. At May 31, 2006, 2005 and 2004, loans outstanding to 			borrowers located in any one state or territory did not exceed 16%, 			16% and 18%, respectively, of total loans outstanding.
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 its cost of funding, as well as general and 			administrative expenses, the loan loss provision 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 financial 			statements for the weighted average interest rates earned on all 			loans outstanding during the fiscal years ended May 31, 2006, 2005 			and 2004.
CFC Loan Programs
Long-Term Loans
Long-term loans are generally for terms of up to 			35 years and can be either amortizing or bullet loans with serial 			payment structures. 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 or repriced 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 generally 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, deliver to CFC annual 			audited financial statements and an annual compliance 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, 2006, 4% 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 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 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.
Interim financing line of credit loans are also 			made available to CFC members that have a loan application pending 			with RUS and have received approval from RUS to obtain interim 			financing. CFC anticipates that advances under these interim 			facilities will be repaid with advances from RUS long-term loans.
RTFC Loan Programs
The RTFC loan portfolio is concentrated in the 			core rural local exchange carrier ("RLEC") segment of the 			telecommunications market. RLECs are characterized by the low 			population density of their service territories. Services are 			generally delivered over networks that include fiber optic cable and 			digital switching. There is generally a significant barrier to 			competitive entry.
The businesses to which the remaining 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.
Long-Term Loans
RTFC makes long-term loans to rural 			telecommunications companies and their affiliates for the 			acquisition, 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. 			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 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 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 RTFC obligations under the approved terms.
Intermediate-Term Loans and Line of Credit 			Loans
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.
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 RTFC members that have a loan application pending 			with RUS and have received approval from RUS to obtain interim 			financing. These loans are for terms up to 24 months and the 			borrower must repay the RTFC loan with advances from the RUS 			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 member cooperative with 			which it is affiliated.
Lease and General Loan Program
NCSC provided financing for the purchase of 			utility plant and/or related equipment, in some cases by a third 			party in a sale/leaseback transaction. Collateral for these loans 			consists of a mortgage on the leased asset, utility plant and/or 			related equipment. NCSC no longer provides this type of financing.
Associate Member Loan Program
NCSC provides financing to for-profit or 			not-for-profit affiliated entities of member 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.
RUS Guaranteed Loans for Rural Electric 			Systems
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. At May 31, 2006, CFC 			had $223 million of loans outstanding under this program. In 			addition, at May 31, 2006, CFC was holding certificates totaling $38 			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. The 			fee on the conversion of a fixed interest rate to a variable 			interest rate is 25 basis points of the outstanding loan amount plus 			a 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 			repaid at any time without a 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.
Guarantee Programs
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 at May 31:
Guarantees of Long-Term 			Tax-Exempt Bonds
The Company has guaranteed debt issued in 			connection with the construction or acquisition by 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 the Company, may include short- and long-term 			obligations.
In the event of a default by a system 			for non-payment of debt service, 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 the Company performs under its guarantee. 			The system is required to repay, on demand, any amount advanced by 			the Company pursuant to its guarantee. This repayment obligation is 			secured by a common mortgage with RUS on all the system's assets, 			but 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 the Company for any guarantee 			payments will be treated as a long-term loan. The system is required 			to pay to 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 the Company has committed to purchase debt so 			tendered if it cannot otherwise be remarketed. If the Company held 			the securities, the cooperative would pay interest to 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, the Company has not been required to purchase any bonds.
Guarantees of Lease 			Transactions
Included in the Company's guarantees 			of lease transactions at May 31, 2005 and 2004 were CFC's guarantees 			of member's rent obligations to third parties. All obligations for 			this type of guarantee were released during the year ended May 31, 			2006.
Guarantees of Tax Benefit 			Transfers
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 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 been put in place 			since 1982. The maturities for this type of guarantee run through 			2015.
Letters of Credit
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 the Company within one year from the date of the 			draw, with interest accruing from such date at the Company's line of 			credit variable rate of interest.
Other Guarantees
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 the 			Company's general and administrative expenses, a provision for 			losses and a reasonable margin.
Members' interest expense for the 			years ended May 31, 2006, 2005 and 2004 on debt obligations 			guaranteed by the Company was approximately $20 million, $16 million 			and $13 million, respectively.
The following chart summarizes total 			guarantees by segment at May 31:
Total guarantees outstanding, by state and 			territory based on the location of the system's headquarters, are 			summarized as follows at May 31:
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 CFC owned backup 			systems as well as office space and related office equipment.
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 revoked 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 			cooperative 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 margin 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 highly-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, 2006, CFC had 210 employees, including 			financial and legal personnel, management specialists, credit 			analysts, accountants and support staff. CFC believes that its 			relations with its employees are good.
CFC Lending Competition
CFC competes with other lenders on price, the 			variety of financing options offered and additional services 			provided to its member/owners. CFC is primarily in competition with 			other banks for the business of its members. The primary bank 			competitor is CoBank, ACB ("CoBank"), a government sponsored entity 			and member of the Farm Credit System whose status as such gives it 			the ability to offer lower interest rates in select situations. 			However, there are some members that are large enough to obtain a 			credit rating and access the capital markets for funding. In these 			cases, CFC is competing with the pricing and funding options the 			member is able to obtain in the capital markets. CFC attempts to 			minimize the impact of competition by offering a variety of loan 			options and complimentary services and by leveraging the thirty-five 			year working relationship that it has with the majority of the 			members.
RUS is generally the members' first financing 			option as it is able to offer members interest rates that are 			generally lower than the rates CFC and the other banks are able to 			offer. Therefore, CFC and other banks compete for bridge loans in 			anticipation of long-term funding from RUS, the portion of a loan 			that RUS is not able to provide, loans to members that can not 			borrow from RUS and loans to members that have elected not to borrow 			from RUS.
According to December 31, 2004 financial data 			filed with CFC, the 810 reporting electric cooperative distribution 			and 59 reporting power supply systems had a total of $48 billion in 			long-term debt outstanding at December 31, 2004. RUS is the dominant 			lender to the electric cooperative industry with $27 billion or 56% 			of the total outstanding debt for the 869 systems reporting 2004 			results to CFC. 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. CFC's $16 billion long-term exposure represented 33% of 			the total long-term debt to these electric systems. The remaining $5 			billion or 11% was borrowed from other sources. (December 31, 2005 			financial data filed with CFC by its borrowers was not available at 			the time of this filing, therefore competition data is based on 			December 31, 2004 financial data). At December 31, 2005, 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.
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, 2005, RUS had a total of approximately $3.6 billion 			outstanding to telecommunications borrowers. The Rural Telephone 			Bank ("RTB") has been liquidated. This dissolution of the RTB 			resulted in the federal government retiring at par value 			approximately $1.5 billion in RTB stock held by rural 			telecommunication providers and transferring the RTB loan portfolio 			to RUS. RTFC is not in direct competition with RUS, but rather 			competes with other lenders for supplemental lending and for the 			full lending requirement of the rural telecommunications companies 			that have decided not to borrow from RUS or for projects not 			eligible for RUS financing. RTFC's competition includes commercial 			banks, CoBank and insurance companies. At December 31, 2005, RTFC 			had a total of $2.1 billion in long-term loans outstanding to 			telecommunications borrowers.
Member Regulation and Competition
Electric Systems
The trend toward retail electric competition has 			faltered. 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, 2004 			(the latest comprehensive information available), 16 states were in 			the process of moving toward customer choice. In these states, 			customer choice was either available to all or some customers or 			would soon be available. Those states were Connecticut, Delaware, 			Illinois, Maine, Maryland, Massachusetts, Michigan, New Hampshire, 			New Jersey, New York, Ohio, Oregon, Pennsylvania, Rhode Island, 			Texas and Virginia. However, several of these states are currently 			reconsidering their move toward customer choice. Of the remaining 			states, 27 states were not actively pursuing restructuring, five 			states had delayed the restructuring process or the implementation 			of customer choice, and two states (Arizona and California) had 			suspended customer choice.
In the 16 states where customer choice was or 			would be available, the Company had a total of 222 electric members 			(170 distribution, 20 power supply and 32 associates) and $5,062 			million of loans to electric systems at May 31, 2006. In New York, 			where the Company has five electric members and $13 million of loans 			to electric systems, cooperatives are not required to file 			competition plans with the state utility commission. In Michigan, 			where the Company has 14 electric members and $264 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 its membership and loan exposure, will not be 			materially impacted by customer choice. 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 16 states where 			customer choice was or would be available, co-ops 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, 2006, CFC had loans 			outstanding in the amount of $3,838 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 of customer choice on power supply 			systems cannot be determined until final rules have been approved in 			each state and on the federal level.
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 16 states that regulate the rates 			electric systems charge; of these states, two states have partial 			oversight authority over the cooperatives' rates, but not the 			specific authority to set rates. 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 			only a few 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 cooperatives currently financed 			by RUS 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
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. To achieve competition, the Act required all carriers 			to interconnect with all others and LECs to provide competitors 			with access to elements of their networks. Congress included 			provisions in the Telecom Act granting RLECs an exemption from the 			above unbundled network element requirements, absent a determination 			that it would be in the public interest.
Competition continues to be a significant factor 			in the telecommunications industry. An April 2006 FCC report on 			competition states that as of June 2005, competitive local exchange 			carriers ("CLECs") provided service to 34 million access lines - 			19.1% of the nation's 178 million end-user switched access lines. 			Wireless carriers are providing service to 191 million mobile 			telephone service subscriptions - more than incumbent LEC ("ILECs") 			and CLECs combined. Non facilities-based CLECs took advantage of 			pro-competitive FCC rules that allowed CLECs to obtain all elements 			of the ILECs' networks necessary to conduct business at favorable 			rates. This is known as the unbundled network element platform 			("UNE-P") and consisted of a combination of an unbundled loop, 			unbundled local circuit switching and shared transport.
A March 2004 court order forced the FCC to 			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. Combined with the failure of the 			stand-alone long distance provider business model, AT&T and MCI 			sought merger partners. AT&T was merged into SBC and is now known as 			AT&T. MCI merged into Verizon.
RLECs generally were not subject to UNE-P based 			competition, since RLECs enjoyed an exemption contained in the 			Telecom Act. Rural telecommunications companies are experiencing 			competition, however. A survey of small rural telecommunications 			companies found that nearly all 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 and 			reputation for providing quality, modern telecommunications service.
In addition to competition, the Telecom Act also 			mandated a 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 FCC rulings have reduced access charges which are a 			key revenue source. Numerous wireless carriers have entered rural 			markets as competitors to the RLECs. By obtaining competitive 			eligible telecommunications carrier 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 voice over 			internet protocol substitution. Uncontrolled growth of the fund is 			making the rate assessed on all participants in the nationwide 			network unsustainably high. The second quarter 2006 assessment rate 			is 10.9%. 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 in agreement on what those changes should 			be. The FCC has a proceeding open to review USF, and Congress is 			addressing it in several bills as part of its rewrite of the Telecom 			Act, which is now under way.
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. RLECs 			have come together with a unified proposal that would preserve some 			access fees and are promoting it with the FCC.
While uncertainty exists regarding USF and 			access, the Company 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 introducing digital video, high-speed data, and local and 			long distance voice service. Where they can leverage their 			infrastructure, they are competing with Verizon, Qwest, AT&T, Embarq 			and cable companies in neighboring towns. RLECs have generally been 			very successful competitors in these situations.
Deregulation has not had much effect on 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 start 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 			$500 million in fiscal year 2006 lending authority. For fiscal year 			2007, the Administration is proposing an additional $356 million.
Given the increased availability of government 			financing for rural broadband, it is unlikely that the Company 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 2006, RUS has $690 			million in lending authority for rural telephone systems and an 			additional $558 million for other telecommunications programs, 			including distance learning and broadband.
The RE Act provides for RUS to make insured loans 			and to provide other forms of financial assistance to borrowers. RUS 			is authorized to make direct loans, at below market rates, to 			systems that qualify for the hardship program (5% interest rate) or 			the municipal rate program (based on a municipal government 			obligation index). RUS is also authorized to guarantee loans that 			are used mainly to provide financing for construction of power 			supply projects. Guaranteed loans bear interest at a rate agreed 			upon by the borrower and the lender (which generally has been the 			Federal Financing Bank ("FFB")). RUS also provides financing at the 			Treasury rate. 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, 2007, 			the House of Representatives has approved a total of $4.2 billion of 			RUS electric loan and guarantee levels as follows: municipal rate 			loans of $100 million, hardship loans of $100 million, treasury rate 			loans of $1 billion and loan guarantees of $3 billion. The Senate 			Appropriations Committee has approved a total of $6.3 billion for 			RUS electric loan and guarantee levels; all of this increase above 			the $4.2 billion provided by the House was for loan guarantees which 			the Senate bill sets at $5.1 billion. Fiscal year 2007 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 which ultimately 			results in an Appropriations Act. Electric funding levels for fiscal 			year 2006 were as follows: municipal rate loans of $100 million, 			hardship loans of $100 million, treasury rate loans of $1 billion, 			and loan guarantees of $2.7 billion.
Item 1A.
Item 1A. Risk Factors
The Company's financial condition and 			results of operations are subject to various risks inherent in its 			business. The material risks and uncertainties that management 			believes affect CFC are described below. The risks and uncertainties 			described below are not the only ones facing CFC. Additional risks 			and uncertainties that management is not aware of, or that it 			currently deems immaterial, may also impair business operations. If 			any of the events or circumstances described in the following risks 			actually occur, our business, financial condition or results of 			operations could suffer. You should consider all of the following 			risks together with all of the other information in this Annual 			Report on Form 10-K.
The Company's ability to maintain 			and grow our business depends on access to external financing.
The Company depends on access to the 			capital markets to refinance its long-term and short-term debt, fund new 			loan advances and if necessary, to fulfill its obligations under its 			guarantee and repurchase agreements. At May 31, 2006, the Company 			had $3,355 million of commercial paper, daily liquidity fund and 			bank bid notes and $1,989 million of medium-term notes, collateral 			trust bonds, subordinated deferrable debt and long-term notes 			payable scheduled to mature during the next twelve months. There can 			be no assurance that the Company will be able to access the markets 			in the future at all or on terms that are acceptable to the Company. 			Downgrades to the Company's long-term debt ratings and/or commercial 			paper ratings or other events that may deny or limit the Company's 			access to the capital markets could negatively impact its 			operations. The Company has no control over certain items that are 			considered by the credit rating agencies as part of their analysis 			for the Company, such as the overall outlook for the electric and 			telecommunications industries.
Fluctuating interest rates could 			adversely affect our income, margin and cash flow.
The Company is exposed to interest 			rate risk in its core lending and borrowing activities. If the 			Company does not set interest rates on its loans at a level to cover 			its cost of funding, there would be an adverse affect on gross 			margin and net margin.
The Company provides its members with 			many options on its loans with regard to interest rates, the term 			for which the selected interest rate is in effect and the ability to 			prepay the loan. As a result there is a possibility of significant 			changes in the composition of the loan portfolio. If the Company is 			not able to adjust its outstanding debt portfolio to match the 			changes in the loan portfolio, there could be an adverse impact on 			gross margin and net margin.
In addition, the Company's calculated 			impairment on non-performing and restructured loans will increase as 			the Company's long-term variable and line of credit interest rates 			increase. Currently, an increase of 25 basis points to the Company's 			variable interest rates would result in an increase of $8 million to 			the calculated impairment.
Competition from other lenders 			could impair the Company's financial results.
The majority of the Company's members 			are eligible to borrow from RUS. The rates offered by RUS are 			generally lower than the rates that the Company and other lenders 			can offer. Thus the members' first financing option generally is to 			borrow funds under the RUS program. The RUS funding level is 			determined by the U.S. Congress each year. Increases to the amount 			of RUS funding could limit the amount of loan growth experienced by 			the Company.
The Company competes with other 			lenders for the portion of the loan commitment that RUS will not 			lend, for the loans to members that can not borrow from RUS or for 			loans to members that have elected not to borrow from RUS. If other 			lenders are more successful than the Company in the competition for 			this loan volume, it could have an adverse impact on the Company's 			financial results.
We may not recover the value of 			amounts that we lend.
CFC's allowance for loan losses is 			established through a provision charged to expense that represents 			management's best estimate of probable losses that have been 			incurred within the existing portfolio for loans. The level of the 			allowance reflects management's continuing evaluation of: industry 			concentrations; specific credit risks; loan loss experience; current 			loan portfolio quality; present economic, political and regulatory 			conditions and unidentified losses and risks inherent in the current 			loan portfolio. The determination of the appropriate level of the 			allowance for loan losses inherently involves a high degree of 			subjectivity and requires CFC to make significant estimates of 			current credit risks and future trends, all of which may undergo 			material changes. Changes in economic conditions affecting 			borrowers, new information regarding existing loans, identification 			of additional problem loans and other factors, both within and 			outside of CFC's control, may require an increase in the allowance 			for loan losses. In addition, if charge-offs in future periods 			exceed the allowance for loan losses, CFC will need additional 			provisions to increase the allowance for loan losses. Any increases 			in the allowance for loan losses will result in a decrease in net 			margin, and may have a material adverse effect on CFC's financial 			results and credit ratings.
The Company has been and may in the 			future be in litigation with borrowers related to enforcement or 			collection actions pursuant to loan documents. In such cases, the 			borrower or others may assert counterclaims against the Company or 			initiate actions against the Company related to the loan documents. 			Unfavorable rulings in these cases which result in loan losses that 			exceed the related allowance could have a material adverse effect on 			our financial results and credit ratings.
Our ability to access the capital 			markets depends on our ability to maintain adjusted leverage and 			debt to equity ratios within a reasonable range of the current 			levels.
Maintenance of adjusted leverage and 			debt to equity ratios within a reasonable range of the current 			levels is important in relation to the Company's ability to access 			the capital markets. A significant increase in the adjusted leverage 			or debt to equity ratios could impair the Company's ability to 			access the capital markets, its ability to access the Company's 			revolving lines of credit and its ability to maintain preferred 			credit ratings. See "Non-GAAP Financial Measures" for further 			explanation and a reconciliation of adjusted ratios.
A decline in our credit rating 			could trigger payments under our derivative agreements.
If the Company's credit rating falls 			to the level specified in certain of its derivative agreements, the 			other counterparty may terminate the agreement. If the 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. Based on the fair market value of its 			interest rate, cross currency and cross currency interest rate 			exchange agreements subject to rating triggers at May 31, 2006, the 			Company may be required to make a payment of up to $2 million if its 			senior unsecured ratings declined to Baa1 or BBB+, and up to $71 			million if its senior unsecured ratings 			declined below Baa1 or BBB+. In calculating the required payments, 			the Company only considered agreements in which it would have been 			required to make a payment upon termination. In the event the 			Company is required to make a payment as a result of a rating 			trigger, it could have a material adverse impact on its financial 			results.
Our ability to comply with 			covenants related to our revolving credit agreements and debt 			indentures may affect our ability to obtain financing and maintain 			preferred rating levels on our debt.
The Company must maintain compliance 			with all covenants related to its revolving credit agreements, 			including the adjusted 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 reconciliation of adjusted ratios. A 			restriction on access to the revolving lines of credit would impair 			the Company's ability to issue short-term debt, as it is required to 			maintain backup-liquidity to maintain preferred rating levels on its 			short-term debt.
If the Company does not maintain 			compliance with covenants on its collateral trust bond, medium-term 			note and subordinated deferrable debt indentures, the holders of 			such debt could declare an event of default and accelerate the 			repayment of the full amount of the outstanding debt principal prior 			to the stated maturity of such debt. Additionally, the Company could 			not issue new debt under such indentures. Such an event would 			require the Company to obtain new funding to repay the accelerated 			debt as a result of the covenant default and could have a material 			adverse impact on its financial results and credit ratings.
Our concentration of loans to 			borrowers within rural electric and telephone industries could 			impair our revenues if either or both of those industries were to 			experience economic difficulties.
Credit concentration is one of the 			risk factors considered by the rating agencies in the evaluation of 			the Company's credit rating. Substantially all of the Company's 			credit exposure is to the rural electric and 			telephone industries and is subject to risks associated with 			those industries.
The Company's credit concentration to 			its ten largest borrowers could increase from the current 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 			and/or guarantees to one of the borrowers below the ten largest.
We could jeopardize our federal 			tax exemption if we fail to conduct our business in accordance with 			our exemption from the Internal Revenue Service.
Legislation that removes or imposes 			new conditions on the federal tax exemption for 501(c)(4) social 			welfare organizations could have a negative impact on the Company's 			net margins. CFC's continued exemption depends on it conducting its 			business in accordance with its 501(c)(4) status.
Item 1B.
Item 1B. Unresolved Staff Comments
There are no material unresolved 			written comments that were received from the Securities and Exchange 			Commission's staff 180 days or more before the end of the Company's 			fiscal year related to the Company's periodic or current reports 			filed under the Securities and Exchange Act of 1934.
Item 2.
Item 2. Properties.
CFC leases office space that serves as 		its headquarters in Fairfax County, Virginia. CFC owned its headquarters 		facility until October 2005, when it sold the facility to an affiliate 		of Prentiss Properties Acquisition Partners, L.P. The headquarters 		facility sold by CFC consists of two six-story buildings and adjacent 		parking garages situated on ten acres of land and two acres of 		unimproved land adjacent to the office buildings. CFC has entered into a 		three-year lease with the new building owner for approximately one-third 		of the facility's office space. CFC has the option to extend the lease 		for two additional one-year terms.
Item 3.
Item 3. Legal Proceedings.
None.
Item 4.
Item 4. Submission of Matters to a Vote of 		Security Holders.
None.
PART II
Item 5.
Item 5. Market for Registrant's Common Equity 		and Related Stockholder Matters.
Inapplicable.
Item 6.
Item 6. Selected Financial Data.
The following is a summary of selected financial data for the 			years ended May 31:
Item 7.
Item 7. Management's Discussion and Analysis 		of Financial Condition and Results of Operations.
Unless stated otherwise, references to 		the Company relate to the consolidation of National Rural Utilities 		Cooperative Finance Corporation ("CFC" or "the Company"), Rural 		Telephone Finance Cooperative ("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 financial statements, including the 		notes thereto. 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.
Executive Summary
In this report, the Company will provide 		analysis on its results of operations, financial condition, liquidity 		and market risk. The Company will also provide analysis of trends and 		significant transactions completed in the period covered by the report.
CFC was formed in 1969 by the rural 		electric cooperatives to provide them with a source of financing to 		supplement the loan programs of the Rural Utilities Service ("RUS"). CFC 		was organized as a cooperative in which each member (other than 		associates) is entitled to one vote. Under CFC's bylaws, the board of 		directors is composed of 23 individuals, 20 of whom must be either 		general managers or directors of member systems, two of whom are 		designated by the National Rural Electric Cooperative 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 a trustee, director, manager, 		Chief Executive Officer or Chief Financial Officer of a member. If the 		board of directors determines to fill the at-large seat, the candidates 		are nominated by the board of directors and the at-large director is 		elected by the membership. CFC was granted tax-exempt status under 		Section 501(c)(4) of the Internal Revenue Code.
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 as a not-for-profit cooperative 		association in the District of Columbia. NCSC was incorporated in 1981 		in the District of Columbia as a private cooperative association.
Business Overview
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 attain high credit 		ratings on its debt instruments. As a not-for profit, membership owned 		financial institution, the Company's goal is not to maximize its profit 		on loans to members, but rather to find a balance between charging its 		members the lowest possible rates on loans and maintaining the financial 		performance required to access the capital markets on behalf of its 		members. Thus, 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 the Company's financing objectives.
At May 31, 2006, the Company's consolidated 		membership was 1,547, including 898 utility members, the majority of 		which are consumer-owned electric cooperatives, 514 telecommunications 		members, 67 service members and 68 associates in 49 states, the District 		of Columbia and two U.S. territories. The utility members included 829 		distribution systems and 69 generation and transmission ("power supply") 		systems.
The Company makes long-term loans with maturities of 		up to 35 years to its members. The Company offers both variable and 		fixed rate options for various terms within the loan maturity and/or 		through the maturity of the loan. The Company also offers line of credit 		loans for periods of generally up to 5 years. The Company's long-term 		loans are typically secured by a mortgage on all assets and future 		revenues of the members. In cases where the member is also a borrower of 		RUS, the mortgage will be jointly held by the Company and RUS. The line 		of credit loans are typically unsecured. The Company will also guarantee 		the obligations of its members to third parties and will provide 		liquidity support to its members in the form of letters of credit.
CFC obtains its funding from the capital markets, 		private placement of debt 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, 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 private 		funding sources through the issuance of fixed rate notes. CFC also 		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 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. The membership 		subordinated certificates and the loan and guarantee subordinated 		certificates are unsecured and subordinate to other senior debt of CFC.
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 		Statement of Financial Accounting Standards ("SFAS") 133, Accounting for 		Derivative Instruments and Hedging Activities, as amended and SFAS 52, 		Foreign Currency Translation annually to an education fund, a members' 		capital reserve and to members based on each member's patronage of the 		loan programs during the year. RTFC annually allocates its net margin to 		its members based on each member's patronage of the loan programs during 		the year. NCSC does not allocate its net margin to its members.
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.
Financial Overview
			Results of Operations
The Company uses a times interest earned ratio 		("TIER") instead of the dollar amount of gross or net margin as its 		primary performance indicator, since its net margin in dollar terms is 		subject to fluctuation as interest rates change. TIER is a measure of 		the Company's ability to cover the interest expense on its debt 		obligations. TIER is calculated by dividing the sum of cost of funds and 		the net margin prior to the cumulative effect of change in accounting 		principle by the cost of funds.
For the year ended May 31, 2006, the Company reported 		a net margin of $96 million and TIER of 1.10, compared to a net margin 		of $123 million and TIER of 1.13 for the prior year. For the year ended 		May 31, 2006, the Company reported an adjusted net margin of $97 million 		and adjusted TIER of 1.11, compared to an adjusted net margin of $122 		million and adjusted TIER of 1.14 for the prior year. See "Non-GAAP 		Financial Measures" for more information on the adjustments the Company 		makes to its financial results for the purposes of its own analysis and 		covenant compliance.
During the year ended May 31, 2006, the Company's 		earnings were significantly impacted by the level of loans on 		non-accrual status, the required loan loss provision and the sale of the 		headquarters facility. Holding loans on non-accrual status resulted in a 		reduction of $79 million to reported interest income for the year ended 		May 31, 2006. A loan loss provision of $23 million was required during 		the year ended May 31, 2006 to cover an increase in the calculated 		impairment on loans. The Company recognized a gain of $43 million from 		the sale of its headquarters facility during the year ended May 31, 		2006.
In fiscal year 2007, the Company expects a reduction 		to the amount of loans on non-accrual status due to the anticipated 		resolution of certain problem loans. The reduction to the amount of 		loans on non-accrual status should result in an increase to the adjusted 		gross margin yield during fiscal year 2007. It is anticipated that the 		increases to the federal funds interest rate are nearing an end. Changes 		to the Company's variable interest rates should mirror changes to the 		federal funds rate. The calculated impairment on the Company's loans 		increases or decreases with the increases and decreases to the Company's 		variable interest rates. At May 31, 2006, an increase or decrease of 25 		basis points to the Company's variable interest rates results in an 		increase or decrease of approximately $8 million to the calculated 		impairment on loans.
Financial Condition
During the year ended May 31, 2006, the Company's 		total loans outstanding decreased by $611 million. The decrease relates 		primarily to prepayments of RTFC telecommunication loans. RTFC loans 		outstanding decreased by $830 million and NCSC loans outstanding 		decreased by $71 million, while CFC loans increased by $290 million.
The Company expects that the balance of the loan 		portfolio will remain relatively stable during fiscal year 2007. Loans 		from the Federal Financing Bank ("FFB"), a division of the U.S. Treasury 		Department, with an RUS guarantee, represent a lower cost option for 		rural electric utilities compared to 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 choose not to return to the government loan program, from 		distribution system borrowers that 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. The Company anticipates that the RTFC loan balance will 		continue to decline due to long-term loan amortization and lower levels 		of capital expenditure requirements and asset acquisitions in the rural 		telecommunications marketplace.
During the year ended May 31, 2006, short-term debt 		decreased by $2,608 million and long-term debt increased by $1,940 		million. Short-term debt decreased due to the maturity of collateral 		trust bonds and because CFC further reduced its reliance on the dealer 		commercial paper markets as a result of borrower loan repayments. In 		addition, the Company accessed two new private funding sources during 		the year ended May 31, 2006, notes to Federal Agricultural Mortgage 		Corporation ("Farmer Mac") and the FFB loan facilities with bond 		guarantee agreements with RUS as part of the funding mechanism for the 		Rural Economic Development Loan and Grant ("REDLG") program. Long-term 		debt increased due to these new private funding sources and the issuance 		of collateral trust bonds in May 2006 to refinance the bonds that 		matured during the year.
At May 31, 2006, the Company reported total equity of 		$788 million, an increase of $19 million from $769 million reported at 		May 31, 2005. 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. As a result, it is 		difficult to predict the future changes in 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.
Liquidity
At May 31, 2006, the Company had $3,355 million of 		commercial paper, daily liquidity fund and bank bid notes and $1,989 		million of medium-term notes, collateral trust bonds, subordinated 		deferrable debt and long-term notes payable scheduled to mature during 		the next twelve months. Members held commercial paper (including the 		daily liquidity fund) totaling $1,451 million or approximately 45% of 		the total commercial paper outstanding at May 31, 2006. Commercial paper 		issued through dealers and bank bid notes totaled $1,758 million and 		represented 10% of total debt outstanding at May 31, 2006. 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 2007. 		During the next twelve months, the Company plans to refinance the $1,989 		million of medium-term notes, collateral trust bonds, subordinated 		deferrable debt and long-term notes payable and fund new loan growth by 		issuing a combination of commercial paper, medium-term notes, collateral 		trust bonds and other debt.
CFC uses internally generated member loan repayments, 		capital market debt issuance, private debt issuance, member investments, 		and net margins to fund its operations. In addition, the Company 		maintains both short-term and long-term bank lines in the form of 		revolving credit agreements with its bank group. Members pay a small 		membership fee and are typically required to purchase subordinated 		certificates as a condition to receiving a long-term loan advance and as 		a condition of membership. CFC has a need for funding to make loan 		advances to its members, to make interest payments on its public and 		private debt and to make payments of principal on its maturing debt. To 		facilitate open access to the capital markets, CFC is a regular issuer 		of debt in the capital markets, maintains strong credit ratings and has 		active shelf registrations on file with the Securities and Exchange 		Commission ("SEC") for each of its public debt instruments. CFC also has 		access to foreign debt markets with Euro medium-term note and commercial 		paper programs and an Australian medium-term note program.
During the year ended May 31, 2006, the Company drew 		down a total of $2 billion of funding as part of the REDLG program. 		As part of 		this program, the Company can borrow amounts from the FFB with a 		guarantee of repayment by the RUS. As a result of the RUS guarantee, 		these funds represent a lower cost compared to the Company's other forms 		of debt securities. At May 31, 2006, the Company had RUS approval to 		borrow an additional $500 million under the REDLG program and the 		Company anticipates borrowing this amount prior to the expiration of the 		commitment in July 2009.
Recent Events
On April 26, 2006, RTFC reached a settlement of loan 		litigation with Innovative Communication Corporation ("ICC"), its local 		exchange carrier subsidiary Virgin Islands Telephone Corporation d/b/a 		Innovative Telephone ("Vitelco"), Innovative Communication Company LLC, 		a Delaware limited liability company ("ICC-LLC)" and parent of Emerging 		Communication, Inc., a Delaware corporation and immediate parent of ICC 		("Emcom"), their directors and Jeffrey Prosser ("Prosser"), 		individually. Under the settlement, RTFC obtained entry of judgments in 		the District Court for the District of the Virgin Islands against ICC 		for approximately $525 million and Prosser for approximately $100 		million. RTFC also obtained dismissals with prejudice of all 		counterclaims, affirmative defenses and other lawsuits alleging wrongful 		acts by RTFC, certain of its officers, and CFC. Various parties also 		reached agreement for ICC to satisfy the RTFC judgments in the third 		quarter of calendar year 2006, subject to certain terms and conditions. 		In the event that does not occur, RTFC intends to pursue collection of 		the judgments.
On July 31, 2006, ICC-LLC, and Emcom each filed a 		voluntary petition under Chapter 11 of the United States Bankruptcy Code 		in the United States District Court for the Virgin Islands, Division of 		St. Thomas and St. John, Bankruptcy Division, and Prosser, individually, 		filed a voluntary petition under Chapter 11 of the United States 		Bankruptcy Code in the United States Bankruptcy Court for the District 		of Virgin Islands. Each of the debtors is obligated to RTFC, for certain 		obligations of ICC, including court judgments, to RTFC.
In June 2006, the Company received $40 million as 		part of the court approved sale of the remaining operating assets of 		VarTec, Telecom, Inc. ("VarTec").
See further discussion of ICC and VarTec under the 		Non-performing Loans section of "Financial Condition."
Additionally, in June 2006, the Company redeemed the 		7.625% subordinated deferrable debt securities due 2050 totaling $150 		million. The Company redeemed these securities at par and recorded a 		charge of $5 million in cost of funds for the unamortized issuance 		costs.
Critical Accounting Estimates
Allowance for Loan Losses
At May 31, 2006 and 2005, the Company had a loan loss 		allowance that totaled $611 million and $590 million, representing 3.33% 		and 3.11% of total loans outstanding, respectively. Generally accepted 		accounting principles require loans receivable to be reported on the 		consolidated balance sheets at net realizable value. The net realizable 		value is the total principal amount of loans outstanding less an 		estimate of the probable losses inherent in the portfolio. The Company 		calculates its loss allowance on a quarterly basis. The loan loss 		allowance is calculated by segmenting the portfolio into three 		categories of loans: 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 the Company's financial statements.
Impaired Exposure
The Company calculates impairment on certain loans in 		accordance with SFAS 114, Accounting by Creditors for Impairment of a 		Loan - an Amendment of SFAS 5 and SFAS 15, as amended. 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. The 		Company reviews its portfolio to identify impairments at least on a 		quarterly basis. Factors considered in determining an impairment 		include, but are not limited to: the review of the borrower's audited 		financial statements and interim financial statements if available, the 		borrower's payment history, communication with the borrower, economic 		conditions in the borrower's service territory, pending legal action 		involving the borrower, restructure agreements between the borrower and 		the Company, and estimates of the value of the borrower's assets that 		have been pledged as collateral to secure the Company's loans. The 		Company calculates the impairment by comparing the future estimated cash 		flow, discounted at the original loan interest rate, against 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, 2006 and 2005, the Company had a total of $447 million and 		$404 million reserved specifically against impaired exposure totaling 		$1,201 million and $1,208 million, respectively, representing 37% and 		33% of the total impaired loan exposure. The $447 million and $404 		million specific reserves represented 73% and 68% of the total loan loss 		allowance at May 31, 2006 and 2005, respectively. The calculated 		impairment at May 31, 2006 was higher than at May 31, 2005 due to higher 		interest rates on variable rate loans, offset by payments received on 		impaired loans. The original contract rate on a portion of the impaired 		loans at May 31, 2006 will vary with the changes in the Company's 		variable interest rates. Based on the current balance of impaired loans 		at May 31, 2006, a 25 basis point increase or decrease to the Company's 		variable interest rates would result in an increase or decrease, 		respectively, of approximately $8 million to the calculated impairment 		irrespective of a change in the credit fundamentals of the impaired 		borrower.
In calculating the impairment on a loan, the 		estimates of the expected future cash flow or collateral value are the 		key estimates made by management. 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 		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 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 the Company to discuss pending financial 		difficulties or for some other reason the Company believes that the 		borrower's financial results could deteriorate resulting in an elevated 		potential for loss. 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 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, 		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, deterioration in financial condition, the 		borrower 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 12 to 24 months. At May 31, 2006 and 2005, 		the Company had reserved $2 million and $12 million against the $12 		million and $68 million of exposure classified as high risk, 		representing coverage of 17% and 18%, respectively. The $2 million and 		$12 million reserve for loans in the high risk category represents less 		than 1% and 2%, respectively, of the total loan loss allowance at May 		31, 2006 and 2005.
General Portfolio
The Company's methodology used to determine the 		required loan loss allowance for the general portfolio includes the use 		of an internal risk rating system, historical default data on corporate 		bonds and Company specific loss recovery data. The Company uses the 		following factors, in no particular order, to determine the level of the 		loan loss allowance for the general portfolio category:
* Internal risk ratings - the 		Company maintains risk ratings for each credit facility outstanding to 		its borrowers. The ratings are updated at least annually and are based 		on the following:
* General financial condition of the 		borrower.
* The Company's internal estimated value of 		the collateral securing its loans.
* The Company's internal evaluation of the 		borrower's management.
* The Company's internal evaluation of the 		borrower's competitive position within its service territory.
* 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. The Company uses the standard 		default table for all corporate bonds published 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.
The Company aggregates the loans in the general 		portfolio by borrower type (distribution, generation, 		telecommunications, associate and other member) and by internal risk 		rating within borrower type. The Company correlates its internal risk 		ratings to the ratings used in the standard default table based on a 		comparison of 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, the Company maintains an additional 		reserve for borrowers with a total exposure in excess of 1.5% of its 		total loans and guarantees outstanding. The additional reserve is based 		on the amount of exposure in excess of 1.5% of the Company's total 		exposure and the borrower's internal risk rating. At May 31, 2006 and 		2005, respectively, the Company had a reserve of $3 million and $7 		million based on the additional risk related to large exposures.
At May 31, 2006 and 2005, the Company had a total of 		$16,886 million and $17,437 million of loans, respectively, in the 		general portfolio. This total does not include $261 million and $258 		million of loans at May 31, 2006 and 2005, respectively, that have a 		U.S. Government guarantee of all principal and interest payments. The 		Company does not maintain a loan loss allowance on loans that are 		guaranteed by the U.S. Government. The Company reserved a total of $162 		million and $174 million (including the $3 million and $7 million 		described above) for loans in the general portfolio at May 31, 2006 and 		2005, respectively, representing coverage of 0.96% and 1.00% of the 		total loans for the general portfolio.
In fiscal years 2006, 2005 and 2004, CFC made 		provisions to the loan loss reserve totaling $23 million, $16 million 		and $55 million, respectively.
Senior management reviews the estimates and 		assumptions used in the calculations of the loan loss allowance for 		impaired loans, high risk loans and loans covered by the general 		portfolio, including large exposures related to single obligors, on a 		quarterly basis. Senior management discusses estimates with the board of 		directors and audit committee and reviews all loan loss related 		disclosures included in the Company's Form 10-Qs and Form 10-Ks filed 		with the SEC.
Management makes recommendations regarding loans to 		be written off to the CFC board of directors. In making its 		recommendation to write off all or a portion of a loan balance, 		management considers various factors including cash flow analysis and 		collateral securing the borrower's loans.
Derivative Financial Instruments
In June 1998, the 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 consolidated balance 		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 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. 		The Company is neither a dealer nor trader in derivative financial 		instruments. The Company uses interest rate, cross currency and cross 		currency interest rate exchange agreements to manage its interest rate 		and foreign currency risk.
The majority of the Company's derivatives do not 		qualify for hedge accounting. To qualify for 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 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 the Company's own commercial paper rates 		to qualify for hedge accounting. The Company sells commercial paper to 		its members as well as to investors in the capital markets. The Company 		sets its commercial paper rates daily based on its cash requirements. 		The correlation between the Company's commercial paper rates and the 		30-day composite commercial paper index has not been consistently high 		enough to qualify for hedge accounting.
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. 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. 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 are the rates that are most 		closely related to the rates it pays on its own commercial paper. 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 consistently above 		the 90% threshold, therefore the interest rate exchange 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 own 		analysis, the Company believes that the correlation is sufficiently high 		to consider these agreements effective economic hedges.
As a result of applying SFAS 133, the Company has 		recorded derivative assets of $579 million and $585 million and 		derivative liabilities of $85 million and $78 million at May 31, 2006 		and 2005, respectively. From inception to date, accumulated other 		comprehensive income related to derivatives was $13 million and $16 		million as of May 31, 2006 and 2005, respectively.
The impact of derivatives on the Company's 		consolidated statements of operations for the years ended May 31, 2006, 		2005 and 2004 was a gain of $93 million, a gain of $81 million and loss 		of $128 million, respectively. The change in the fair value of 		derivatives for the years ended May 31, 2006, 2005 and 2004 was a gain 		of $29 million, a gain of $26 million and a loss of $229 million, 		respectively, recorded in the Company's derivative forward value. For 		the year ended May 31, 2004, the derivative forward value also includes 		amortization to expense of $1 million related to the long-term debt 		valuation allowance and for the years ended May 31, 2006, 2005 and 2004, 		it includes $0.4 million, $16 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. In 		addition, income totaling $65 million, $55 million and $101 million was 		recorded for total net cash settlements received by the Company during 		the years ended May 31, 2006, 2005 and 2004, respectively, of which $68 		million, $63 million and $110 million, respectively, relate to interest 		rate and cross currency interest rate exchange agreements that do not 		qualify for hedge accounting under SFAS 133 and were recorded in 		derivative cash settlements. The remaining expense of $3 million, $8 		million and $9 million, respectively, relate to interest rate and cross 		currency interest rate exchange agreements that qualify for hedge 		accounting under SFAS 133 and were recorded in cost of funds.
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, the Company 		obtains market quotes from its dealer counterparties. The market quotes 		are based on the expected future cash flow and estimated yield curves. 		The Company performs its own analysis to confirm the values obtained 		from the counterparties. The Company records the change in the fair 		value of its derivatives for each reporting period in the derivative 		forward value line on the consolidated statements of operations for the 		majority of its derivatives or in the other comprehensive income account 		on the consolidated balance sheets for the derivatives that qualify for 		hedge accounting. The counterparties are estimating future interest 		rates as part of the quotes they provide to the Company. The Company 		adjusts all derivatives to fair value on a quarterly basis. The fair 		value recorded by the Company will change as estimates of future 		interest rates change. 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 2045. 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 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 statements of 		operations. Each 25 basis point increase or decrease to the 30-day 		composite commercial paper index, the three-month LIBOR rate and the 		six-month LIBOR rate would result in a $5 million increase or decrease 		in the Company's total cash settlements due to the composition of the 		portfolio at May 31, 2006. The Company's interest rate exchange 		agreements at May 31, 2006 include $7,350 million notional amount, or 		59% 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 $5,186 million notional amount, or 41% of the total 		interest rate exchange agreements at May 31, 2006, the Company
pays a variable interest rate and receives a fixed 		interest rate. Based on the interest rate exchange agreements in place 		at May 31, 2006, an increase to variable interest rates results in an 		increase to cash settlements due to CFC.
Margin Analysis
Results of Operations
Fiscal Year 2006 versus 2005 Results
The following chart presents the results for the year 		ended May 31, 2006 versus May 31, 2005.
(1) Adjusted to exclude the impact of the 		derivative forward value, foreign currency adjustments and minority 		interest from net margin and to include all derivative cash settlements 		in the cost of funds. See "Non-GAAP Financial Measures" for further 		explanation and a reconciliation of these adjustments.
CFC's gross margin will increase or decrease due to 		changes in loan volume and the rate that it receives on its loans and 		pays on its sources of funding, respectively. CFC's loan volume 		substantially determines its funding needs. The following Volume Rate 		Variance 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. The analysis is consistent with the May 31, 		2006 and 2005 consolidated statements of operations. For comparability 		purposes, average daily loan volume is used as the denominator in 		calculating operating income yield, cost of funds rates and gross margin 		spread.
Management calculates an adjusted gross margin, which 		includes all derivative cash settlements, in its cost of funds. The 		following table also includes a breakout of the change to derivative 		cash settlements due to changes in the average notional amount of its 		derivative portfolio versus changes to the net difference between the 		average rate paid and the average rate received. See "Non-GAAP Financial 		Measures" for further explanation of the adjustment the Company makes in 		its financial analysis to include all derivative cash settlements in its 		cost of funds.
(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.
(4) See "Non-GAAP Financial Measures" for 		further explanation of the adjustment the Company makes in its financial 		analysis to include all derivative cash settlements in its cost of 		funds.
Operating Income
Total operating income reported on the consolidated 		statements of operations and shown in the chart above includes the 		following as a percentage of average loans outstanding:
Total operating income for the year ended May 31, 		2006 represented a decrease of $23 million or 2% from the prior year 		primarily due to the decrease in fee income. There were offsetting 		changes to operating income due to the increase to interest rates in the 		markets and to a lower loan volume. During the year ended May 31, 2006, 		the Company raised variable interest rates by between approximately 180 		basis points and 190 basis points depending on the loan program, while 		fixed interest rates remained relatively stable. The increase to income 		as a result of higher variable interest rates was also offset by a 		reduction to operating income as a result of an increase to loans on 		non-accrual status. For the year ended May 31, 2006, the Company had a 		reduction to interest income of $79 million due to non-accrual loans, 		compared to a reduction of $51 million for the prior year period. The 		decrease in loan volume is due to the prepayment of RTFC loans during 		the year ended May 31, 2006.
Total fee and investment income earned during the 		year ended May 31, 2006 decreased $26 million from the prior year. The 		decrease to fee and investment income for the year ended May 31, 2006 		was due to a reduction of $31 million in prepayment and make-whole fees, 		offset slightly by an increase of $7 million to investment income. 		During the year ended May 31, 2005, there were significant loan 		prepayments that generated a large amount of prepayment and make-whole 		fees. The large loan prepayments that occurred during fiscal year 2005 		do not represent normal business activity and are not anticipated to 		occur in the future. The Company does not have a goal of maintaining an 		investment portfolio as part of the business plan to generate income, 		but rather the Company will invest excess cash on a short-term basis. 		Excess cash investments are typically the result of the Company 		prefunding debt maturities and due to commercial paper and medium-term 		note investments made late in the day by its members.
The $110 million increase in CFC operating income was 		due to the increase in interest rates partly offset by the impact of 		non-accrual loans. CFC operating income decreased $36 million for the 		year ended May 31, 2006 due to holding loans on non-accrual, compared to 		$27 million for the prior year period. The impact of non-accrual loans 		on operating income is included in the rate variance in the chart above. 		The $136 million decrease in RTFC operating income was due to loan 		prepayments and the impact of non-accrual loans. RTFC operating income 		decreased $43 million for the year ended May 31, 2006 due to holding 		loans on non-accrual, compared to $24 million in the prior year period.
Cost of Funds
Total cost of funds reported on the consolidated 		statements of operations and shown in the chart above includes the 		following:
The $36 million increase to the cost of funds for the 		year ended May 31, 2006 was due to the increase to interest rates in the 		markets partly offset by lower loan volume and the $11 million decrease 		to total fees expensed by the Company during the year ended May 31, 2006 		as compared to the prior year.
The adjusted cost of funds, which includes all 		derivative cash settlements for the year ended May 31, 2006 increased by 		$31 million compared to the prior year period due to the increase to 		cost of funds noted above partially offset by lower fees for swap 		terminations. See "Non-GAAP Financial Measures" for further explanation 		of the adjustment the Company makes in its financial analysis to include 		all derivative cash settlements in its cost of funds. Derivative cash 		settlements for the year ended May 31, 2006 includes $67 million 		received for derivative cash settlements from the Company's derivative 		counterparties and $1 million received from counterparties for the 		termination of interest rate exchange agreements used as funding for the 		loans that were prepaid during the period. The derivative cash 		settlements for the year ended May 31, 2005 includes $85 million of 		derivative cash settlements received by CFC offset by $22 million of 		fees paid by CFC for the termination of exchange agreements.
Gross Margin
The change in the line items described above resulted 		in a decrease in gross margin of $59 million for the year ended May 31, 		2006 compared to the prior year period. The adjusted gross margin, which 		includes all derivative cash settlements, for the year ended May 31, 		2006 was $113 million, a decrease of $54 million from the prior year 		period. See "Non-GAAP Financial Measures" for further explanation of the 		adjustment the Company makes in its financial analysis to include all 		derivative cash settlements in its cost of funds, and therefore gross 		margin.
Operating Expenses
General and administrative expenses were $52 million 		for the year ended May 31, 2006 compared to $49 million for the year 		ended May 31, 2005. General and administrative expenses represented 28 		basis points of average loan volume for the year ended May 31, 2006 		compared to 25 basis points for the prior year period.
The $4 million decrease to rental and other income 		for the year ended May 31, 2006 was due to the sale of CFC's 		headquarters facility in October 2005. Subsequent to the sale of the 		building, CFC is not collecting rental income as it is no longer a 		landlord for the facility.
The loan loss provision of $23 million for the year 		ended May 31, 2006 represented an increase of $7 million compared to the 		provision for loan losses of $16 million required for the prior year 		period. The $23 million loan loss provision for the year ended May 31, 		2006 was the result of an increase in the calculated loan impairments 		offset by a decrease in the general reserve as a result of the decrease 		in the balance of loans outstanding at May 31, 2006 compared to the 		prior period end.
There was a recovery of $1 million from the guarantee 		liability in the year ended May 31, 2006 compared to $3 million in the 		prior year period. For the year ended May 31, 2006 and 2005, 		substantially all guarantees were issued by CFC.
Results of Operations of Foreclosed Assets
The Company recorded net income of $16 million and 		$13 million from the operation of foreclosed assets for the year ended 		May 31, 2006 and 2005. The results of operations of foreclosed assets 		for the year ended May 31, 2006 includes a gain of $4 million related to 		the sale of real estate assets in August 2005. At May 31, 2006, the 		remaining balance of foreclosed assets is comprised of notes receivable 		which the Company continues to service.
Derivative Cash Settlements
The increase in cash settlements for the year ended 		May 31, 2006 is primarily due to $1 million of termination fees received 		during the year ended May 31, 2006 compared to $22 million of 		termination fees paid during the year ended May 31, 2005 to unwind 		interest rate exchange agreements that were used as part of the funding 		for loans that were prepaid during the period. CFC is currently 		collecting more on its derivative contracts than it is paying.
Derivative Forward Value
During the year ended May 31, 2006, the derivative 		forward value represented an increase of $3 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 		year ended May 31, 2006 and 2005 also includes amortization of $0.4 		million and $16 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 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 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 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 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 		changes to interest rates, but there are no provisions for recording 		changes in the fair value of its loans or debt outstanding as a result 		of changes to 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 		equal to or in excess of the minimum 1.10 target. The Company has earned 		an adjusted TIER equal to or 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
The Company's foreign currency adjustment for the 		year ended May 31, 2006 did not fluctuate compared to the year ended May 		31, 2005. Changes in the exchange rate between the U.S. dollar and Euro 		and the U.S. dollar and Australian dollar may cause the value
of foreign denominated debt outstanding to fluctuate. An 		increase in the value of the Euro or the Australian dollar versus the 		value of the U.S. dollar results in an increase in the recorded U.S. 		dollar value of foreign denominated debt and therefore a charge to 		expense on the consolidated 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 value of the outstanding foreign denominated debt.
Operating Margin
The change in the line items described above resulted 		in a decrease in operating margin of $64 million for the year ended May 		31, 2006 compared to the prior year period. The adjusted operating 		margin, which excludes derivative forward value and foreign currency 		adjustments, for the year ended May 31, 2006 was $57 million, compared 		to $124 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.
Gain on Sale of Building and Land
On October 18, 2005, CFC sold its headquarters 		facility in Fairfax County, Virginia to an affiliate of Prentiss 		Properties Acquisition Partners, L.P. for $85 million. The assets had a 		net book value of $40 million, thus generating a total gain of $43 		million during the year ended May 31, 2006, net of $2 million in closing 		and other related costs.
Net Margin
The change in the line items described above resulted 		in a decrease in net margin of $27 million for the year ended May 31, 		2006 from the prior year period. The adjusted net margin, which excludes 		the impact of the derivative forward value and foreign currency 		adjustments and adds back minority interest, was $97 million, compared 		to $122 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 net margin. Adjusted net margin excluding 		the $43 million gain on the sale of the building and land for the year 		ended May 31, 2006 was $54 million, a decrease of $68 million from the 		prior year.
Fiscal Year 2005 versus 2004 Results
The following chart presents the results for the year 		ended May 31, 2005 versus May 31, 2004.
(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.
(2) Adjusted to exclude the impact of the 		derivative forward value, foreign currency adjustments and minority 		interest from net margin and to include all derivative cash settlements 		in the cost of funds. See "Non-GAAP Financial Measures" for further 		explanation and a reconciliation of these adjustments.
CFC's gross margin will increase or decrease due to 		changes in loan volume and the rate that it receives on its loans and 		pays on its sources of funding, respectively. CFC's loan volume 		substantially determines its funding needs. The following Volume Rate 		Variance 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. The analysis is consistent with the May 31, 		2005 and 2004 consolidated statements of operations. For comparability 		purposes, average daily loan volume is used as the denominator in 		calculating operating income yield, cost of funds rates and gross margin 		spread.
Management calculates an adjusted gross margin, which 		includes all derivative cash settlements, in its cost of funds. The 		following table also includes a breakout of the change to derivative 		cash settlements due to changes in the average notional amount of its 		derivative portfolio versus changes to the net difference between the 		average rate paid and the average rate received. See "Non-GAAP Financial 		Measures" for further explanation of the adjustment the Company makes in 		its financial analysis to include all derivative cash settlements in its 		cost of funds.
		Operating Income
Total operating income reported on the consolidated 		statements of operations and shown in the chart above includes the 		following:
Total operating income for the year ended May 31, 		2005 represented an increase of $21 million or 2% from the prior year 		primarily due to the increase in fee income. Interest income decreased 		$8 million due to the impact of loans on non-accrual and lower loan 		volume offset by the increase to interest rates in the markets. During 		the year ended May 31, 2005, the Company raised variable interest rates 		by between approximately 210 basis points and 235 basis points depending 		on the loan program, while fixed interest rates remained relatively 		stable. For the year ended May 31, 2005, the Company had a reduction to 		interest income of $51 million due to non-accrual loans, compared to a 		reduction of $23 million for the prior year. The decrease in loan volume 		is due to the prepayment of RTFC loans during the year ended May 31, 		2005.
Total fee and investment income earned during the 		year ended May 31, 2005 increased $29 million from the prior year. The 		increase to fee and investment income for the year ended May 31, 2005 		was primarily due to an increase of $34 million in prepayment and 		make-whole fees. During the year ended May 31, 2005, there were 		significant loan prepayments that generated a large amount of prepayment 		and make-whole fees. The large loan prepayments that occurred during 		fiscal year 2005 do not represent normal business activity and are not 		anticipated to occur in the future.
The $63 million increase in CFC operating income was 		due to the increase in interest rates partly offset by the impact of 		non-accrual loans. 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 operating income is included in the rate variance in the chart 		above. The $42 million decrease in RTFC operating income was due to loan 		prepayments and the impact of rising interest rates partially offset by 		the impact of non-accrual loans. 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 		
Total cost of funds reported on the consolidated 		statements of operations and shown in the chart above includes the 		following:
The total cost of funding for the year ended May 31, 		2005 was consistent with the prior year as the increase to interest 		rates in the markets was offset by lower loan volume and fee expenses. 		The adjusted cost of funds, which includes all derivative cash 		settlements, for fiscal year 2005 increased by $46 million compared to 		the prior year due to the decrease in derivative cash settlements. See 		"Non-GAAP Financial Measures" for further explanation of the adjustment 		the Company makes in its financial analysis to include all derivative 		cash settlements in its cost of funds. The $47 million decrease in 		derivative cash settlements includes $22 million of fees paid to 		counterparties for the termination of interest rate exchange agreements 		used as funding for the loans that were prepaid during the year ended 		May 31, 2005.
Gross Margin
The change in the line items described above resulted 		in an increase in gross margin of $22 million for the year ended May 31, 		2005 compared to the prior year period. The adjusted gross margin, which 		includes all derivative cash settlements, for the year ended May 31, 		2005 was $167 million, a decrease of $25 million from the prior year. 		See "Non-GAAP Financial Measures" for further explanation of the 		adjustment the Company makes in its financial analysis to include all 		derivative cash settlements in its cost of funds, and therefore gross 		margin.
Operating Expenses
General and administrative expenses for the year 		ended May 31, 2005 were $49 million compared to $47 million for the year 		ended May 31, 2004. General and administrative expenses represented 25 		basis points of average loan volume for the year ended May 31, 2005, an 		increase of 2 basis points as compared to 23 basis points for the prior 		year period.
The loan loss provision of $16 million for the year 		ended May 31, 2005 represented a decrease of $39 million from the 		provision of $55 million for the prior year period. The Company's loan 		loss provision of $16 million at May 31, 2005 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 calculated 		impairments was due to both an increase in the principal balance of 		loans classified as impaired and to an increase in the variable interest 		rates at May 31, 2005 as compared to the prior year. The decrease to the 		allowance for 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 ended May 31, 2005. Under an agreement 		with RTFC and NCSC, CFC will reimburse both companies for loan losses, 		with the exception of the NCSC consumer loan 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 in the 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.
Gain on Foreclosed Assets
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, 2004. The impairment loss recorded 		during the year ended May 31, 2005 was insignificant. It is not 		management's intent to hold and operate these assets, but to preserve 		the value for sale at the appropriate time.
Derivative Cash Settlements
The total cash settlements decreased for fiscal year 		2005 as compared to the 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 were used as part 		of the funding for loans that were 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 		forward value increased $255 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, 2005 and 2004 also includes amortization of $16 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 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 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 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 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. Changes in the exchange rate between the U.S. 		dollar and Euro and the U.S. dollar and Australian dollar caused the 		value of foreign denominated debt outstanding to fluctuate. An increase 		in the value of the Euro or the Australian dollar versus the value of 		the U.S. dollar results in an increase in the recorded U.S. dollar value 		of foreign denominated debt and therefore a charge to expense on the 		consolidated 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 value of the outstanding foreign denominated debt.
Operating Margin (Loss)
Operating margin for the year ended May 31, 2005 was 		$127 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 $255 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.
Cumulative Effect of Change in Accounting 		Principle
As a result of the 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 RTFC. The Company 		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.
Net Margin (Loss)
Net margin for the year ended May 31, 2005 was $123 		million, an increase of $301 million compared to a net loss of $178 		million for the prior year period. The net margin for the year ended May 		31, 2005 and the significant increase from the prior year period was 		primarily due to the $255 million increase in the estimated fair value 		of 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 and $96 million for the 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).
Operating Results as a Percentage of Average 		Loans Outstanding
The following is a summary of the Company's operating 		results as a percentage of average loans outstanding for the fiscal 		years ended May 31, 2006, 2005 and 2004.
(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.
Ratio of Earnings to Fixed Charges
The following chart provides the calculation of the 		ratio of earnings to fixed charges for the years ended May 31, 2006, 		2005 and 2004. The ratio of earnings to fixed charges is the same 		calculation as TIER. See the Results of Operations for discussion on 		TIER and adjustments that the Company makes to the TIER calculation. 		
Financial Condition
Loan and Guarantee Portfolio Assessment
Loan Programs
Loans to members bear interest at rates determined 		from time to time by the Company after considering 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, the Company's policy is to set interest rates at 		the lowest levels it considers to be consistent with sound financial 		management.
The following chart summarizes loans by type and by 		segment at May 31:
		______________________________
(1) Includes loans classified as restructured and 		non-performing and RUS guaranteed loans.
(2) Consists of secured and unsecured 		intermediate-term and line of credit loans that are subject to interest 		rate adjustment monthly or semi-monthly.
The Company's loans outstanding have decreased $611 		million or 3% during the year ended May 31, 2006 as a result of loan 		prepayments by RTFC borrowers. Long-term fixed rate loans at May 31, 		2006 and 2005 represented 85% and 72%, respectively, of total long-term 		loans. Loans converting from a variable rate to a fixed rate for the 		year ended May 31, 2006 totaled $1,754 million, which was offset by $77 		million of loans that converted from a fixed rate to a variable rate. 		This resulted in a net conversion of $1,677 million from a variable rate 		to a fixed rate for the year ended May 31, 2006. For the year ended May 		31, 2005, loans converting from a fixed rate to a variable rate totaled 		$700 million, which was offset by $690 million of loans that converted 		from a variable rate to a fixed rate. This resulted in a net conversion 		of $10 million from a fixed rate to a variable rate for the year ended 		May 31, 2005.
The following chart summarizes loans and guarantees 		outstanding by segment at May 31:
The following table summarizes the RTFC segment loans 		and guarantees outstanding as of May 31:
The Company's members are widely dispersed throughout 		the United States and its territories, including 49 states, the District 		of Columbia and two U.S. territories. At May 31, 2006, 2005 and 2004, 		loans and guarantees outstanding to members in any one state or 		territory did not exceed 16%, 16% and 17%, respectively, of total loans 		and guarantees outstanding.
Credit Concentration
CFC, RTFC and NCSC each have policies that limit the 		amount of credit that can be extended to individual borrowers or 		a controlled group of borrowers. The credit limitation policies set the 		limit on the total exposure and unsecured exposure to the borrower based 		on an assessment of the borrower's risk profile and the Company's 		internal risk rating system. As a member owned cooperative, the Company 		makes best efforts to balance meeting the needs of its member/owners and 		mitigating the risk associated with concentrations of credit exposure. 		The respective boards of directors must approve new credit requests from 		a borrower with a total exposure or unsecured exposure in excess of the 		limits in the policy. Management of credit concentrations may include 		the use of syndicated credit agreements.
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.
At May 31, 2006 and 2005, the total exposure 		outstanding to any one borrower or controlled group did not exceed 3.0% 		of total loans and guarantees outstanding. At May 31, 2006, the ten 		largest borrowers included four distribution systems, five power supply 		systems and one telecommunications system. At May 31, 2005, the ten 		largest borrowers included four distribution systems, three power supply 		systems and three telecommunications systems. The following chart shows 		the exposure to the ten largest borrowers as a percentage of total 		exposure at May 31:
			Security Provisions
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. 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. In addition to the collateral received, 		borrowers are also required to set rates designed to achieve certain 		financial ratios.
The following table summarizes the Company's 		unsecured credit exposure by type and by segment at May 31:
Non-performing Loans
A borrower is classified as 		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.
Once a borrower is classified as non-performing, CFC 		typically places the loan on non-accrual status and reverses all accrued 		and unpaid interest back to the date of the last payment. The Company 		generally applies all cash received during the non-accrual period to the 		reduction of principal, thereby foregoing interest income recognition. 		At May 31, 2006 and 2005, the Company had non-performing loans 		outstanding in the amount of $578 million and $617 million, 		respectively. All loans classified as non-performing were on a 		non-accrual status with respect to the recognition of interest income.
At May 31, 2006 and 2005, non-performing loans 		include $488 million and $475 million, respectively, to ICC. ICC is a 		diversified telecommunications company and RTFC borrower headquartered 		in St. Croix, United States Virgin Islands ("USVI"). Through its 		subsidiaries, ICC provides wire line local telephone service, 		long-distance telephone services, cable television service and/or 		wireless telephone service. All loans to ICC have been on non-accrual 		status since February 1, 2005. ICC has not made debt service payments to 		the Company since June 2005.
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 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 certain of its parent entities, 		including Emcom and ICC-LLC, and (iv) a personal guaranty of the loans 		from ICC's indirect majority shareholder and chairman, Prosser.
Beginning on June 1, 2004, RTFC filed a series of 		lawsuits against ICC, Prosser and others for failure to comply with the 		terms of ICC's loan agreement with RTFC dated August 27, 2001 as amended 		on April 4, 2003 (hereinafter, the "RTFC Lawsuits"). In response to the 		RTFC Lawsuits, ICC, Vitelco and Prosser denied liability and asserted 		claims, by way of counterclaim and by filing its own lawsuits against 		RTFC, CFC and certain of RTFC's officers, seeking various remedies, 		including reformation of the loan agreement, injunctive relief, and 		damages. The remedies were based on various theories including a claim 		that RTFC breached an alleged funding obligation for the settlement of 		litigation brought by Emcom shareholders (the "Greenlight Entities") 		against ICC-LLC, ICC and some of ICC's directors, and a claim that Emcom 		and ICC-LLC were entitled to contribution from RTFC and CFC in 		connection with judgments that the Greenlight Entities had been awarded 		(the "ICC Claims," together with the RTFC Lawsuits, the "Loan 		Litigation"). Venue of the Loan Litigation ultimately was fixed in the 		District Court for the District of the Virgin Islands.
On February 10, 2006, Greenlight filed petitions for 		involuntary bankruptcy against Prosser, Emcom and ICC-LLC in the United 		States Bankruptcy Court for the District of Delaware. RTFC has appeared 		in the proceedings as a party-in-interest in accordance with the 		provisions of the United States Bankruptcy Code. The alleged debtors 		have filed motions seeking change of venue and dismissal of the 		involuntary petitions. In addition, Emcom and ICC-LLC have moved to 		require Greenlight to post a bond to indemnify them for damages in the 		event the involuntary bankruptcy proceedings are dismissed. RTFC has 		filed responses seeking denial of all such motions.
On April 26, 2006, RTFC reached a settlement of the 		Loan Litigation with ICC, Vitelco, ICC-LLC, Emcom, their directors and 		Prosser, individually. Under the settlement, RTFC obtained entry of 		judgments in the District Court for the District of the Virgin Islands 		against ICC for approximately $525 million and Prosser for approximately 		$100 million. RTFC also obtained dismissals with prejudice of all 		counterclaims, affirmative defenses and other lawsuits alleging wrongful 		acts by RTFC, certain of its officers, and CFC. Various parties also 		reached agreement for ICC to satisfy the RTFC judgments in the third 		quarter of calendar year 2006, subject to certain terms and conditions. 		In the event that does not occur, RTFC intends to pursue collection of 		the judgments.
On July 31, 2006, ICC-LLC, and Emcom each filed a 		voluntary petition under Chapter 11 of the United States Bankruptcy Code 		in the United States District Court for the Virgin Islands, Division of 		St. Thomas and St. John, Bankruptcy Division, and Prosser, individually, 		filed a voluntary petition under Chapter 11 of the United States 		Bankruptcy Code in the United States Bankruptcy Court for the District 		of Virgin Islands. Each of the debtors is obligated to RTFC, for certain 		obligations of ICC, including court judgments, to RTFC.
Based on its analysis, the Company believes that it 		is adequately reserved for its exposure to ICC at May 31, 2006.
Non-performing loans at May 31, 2006 and 2005 include 		a total of $90 million and $135 million, respectively, to VarTec. VarTec 		is a telecommunications company and RTFC borrower located in Dallas, 		Texas. RTFC is VarTec's principal senior secured creditor. At May 31, 2006 and 2005, all loans 		to VarTec were on non-accrual status, resulting in the application of 		all payments received against principal.
VarTec filed voluntary petitions under Chapter 11 of 		the United States Bankruptcy Code on November 1, 2004. 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 proceeds from the closing of the Domestic Assets Sale were 		received in June 2006 totaling $40 million. Pursuant to court order, all 		net proceeds of asset sales, including the Domestic Assets Sale, have 		been provisionally applied to RTFC's secured 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. On June 19, 2006, 		the Chapter 11 proceedings were converted to Chapter 7 proceedings and a 		Chapter 7 trustee was appointed for each of the estates.
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. As a result of the conversion of the proceedings to Chapter 7, 		the UCC has been dissolved and the Chapter 7 trustee is now the 		plaintiff in the adversary proceedings. 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 December 16, 2005, the 		Court issued an order dismissing the "deepening insolvency" claim 		against RTFC. Trial, if necessary, on the merits of the remaining claims 		is currently scheduled for March 5, 2007. The trial date is subject to 		change.
On October 14, 2005, the Bankruptcy Court approved an 		administrative DIP facility from RTFC in the amount of $9 million, of 		which $9 million was outstanding as of May 31, 2006. The DIP facility 		was extended on March 17, 2006, but RTFC has no obligation to fund 		beyond those budgeted expenses which accrued prior to June 15, 2006. 		However, RTFC may consider providing the estate with further DIP funding 		to pursue the collection of various claims.
Based on its analysis, the Company believes that it 		is adequately reserved for its exposure to VarTec at May 31, 2006.
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. 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 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 based on the borrower's past 		performance and current financial condition.
At May 31, 2006 and 2005, restructured loans totaled 		$630 million and $601 million, respectively. A total of $569 million and 		$594 million of restructured loans were on non-accrual status with 		respect to the recognition of interest income at May 31, 2006 and 2005, 		respectively.
At May 31, 2006 and 2005, the Company had $569 		million and $594 million, respectively, of loans outstanding to 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 CoServ at May 31, 2006 and 2005 represented 2.9% of the 		Company's total loans and guarantees outstanding.
To date, CoServ has made all required payments under 		the restructured loan. Under the agreement, CoServ will be required to 		make quarterly payments to CFC through 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 to the 		quarterly payments that CoServ will make to CFC under its restructure 		agreement. To date, no amounts have been advanced to CoServ under this 		loan facility. 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 after December 13, 2007 and for $405 million 		plus an interest payment true up 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.
Based on its analysis, the Company believes that it 		is adequately reserved for its exposure to CoServ at May 31, 2006.
Pioneer Electric Cooperative, Inc. ("Pioneer") is an 		electric distribution cooperative located in Greenville, Alabama. 		Pioneer had also invested in a propane gas operation, which it recently 		sold. Pioneer has experienced deterioration in its financial condition 		as a result of losses in the gas operation. At May 31, 2006, CFC had a 		total of $54 million in loans outstanding to Pioneer. Pioneer was 		current with respect to all debt service payments at May 31, 2006. CFC 		is the principal creditor to Pioneer.
On March 9, 2006, CFC and Pioneer agreed on the terms 		of a debt modification that resulted in the loans being classified as 		restructured. Under the amended agreement, CFC extended the maturity of 		the outstanding loans and granted a two-year deferral of principal 		payments. In addition, CFC agreed to make available a line of credit for 		general corporate purposes. The restructured loans are secured by first 		liens on substantially all of the assets and revenues of Pioneer. At 		this time, CFC plans to maintain the loans to Pioneer on accrual status.
Based on its analysis, the Company believes that it 		is adequately reserved for its exposure to Pioneer at May 31, 2006.
Loan Impairment
On a quarterly basis, the Company reviews all 		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. The Company calculates an 		impairment for a borrower based on the expected future cash flow or 		the fair value of any collateral held by the Company as security for 		loans to the borrower. In some cases, to estimate future cash flow, 		certain assumptions are required regarding, but not limited to, the 		following:
Allowance for Loan Losses
The Company maintains an allowance for probable loan 		losses, which is reviewed quarterly by management for adequacy. The 		Company maintains an allowance for loan losses at a level estimated by 		management to provide adequately for probable losses inherent in the 		loan portfolio, which are estimated based upon a review of the loan 		portfolio, past loss experience, specific problem loans, economic 		conditions and other pertinent factors which, in management's judgment, 		deserve current recognition in estimating loan losses.
Management makes recommendations to the board of 		directors of CFC regarding write-offs of loan balances. In making its 		recommendation to write off all or a portion of a loan balance, 		management considers various factors including cash flow analysis and 		the collateral securing the borrower's loans. Since inception in 1969, 		write-offs totaled $150 million and recoveries totaled $33 million for a net loss amount of $117 		million. In the past five fiscal years, write-offs totaled $51 million 		and recoveries totaled $16 million for a net loan loss of $35 million.
Management believes that the allowance for loan 		losses is adequate to cover estimated probable portfolio losses.
Activity in the allowance for loan losses is 		summarized below for the years ended May 31:
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.
The Company's loan loss allowance increased $21 		million from May 31, 2005 to May 31, 2006. Within CFC's loan loss 		allowance at May 31, 2006 as compared to the prior year end, there was 		an increase in the calculated impairments of $43 million offset by a 		decrease of $10 million for high risk loans and $12 million to the 		allowance for all other loans. The increase to the calculated 		impairments was primarily due to an increase in the variable interest 		rates at May 31, 2006 as compared to May 31, 2005. The reduction to the 		allowance for all other loans was due to a decrease in the balance of 		loans outstanding at May 31, 2006 as compared to May 31, 2005.
Liabilities, Minority Interest and Equity
Outstanding Debt
The following chart provides a breakout of debt 		outstanding at May 31:
Other information with regard to short-term debt at 		May 31 is as follows:
(Dollar amounts in thousands)
Weighted average maturity outstanding at 		year-end:
Short-term debt (1)
26 days
22 days
20 days
Long-term debt maturing within one year
203 days
294 days
162 days
Total
92 days
145 days
76 days
Average amount outstanding during the 		year:
Short-term debt (1)
$
3,204,852
$
4,355,579
$
3,173,167
Long-term debt maturing within one year
		3,502,026
		1,834,883
2,913,723
Total
6,706,878
6,190,462
6,086,890
Maximum amount outstanding at any 		month-end during the year:
Short-term debt (1)
4,208,796
4,816,367
3,758,428
Long-term debt maturing within one year
4,031,102
3,591,374
3,427,560
(1) Includes the daily liquidity fund 		and bank bid notes and does not include long-term debt due in less than 		one year.
Total debt outstanding at May 31, 2006 		decreased as compared to May 31, 2005 due primarily to decreases of $611 		million to loans outstanding and $158 million to cash and cash 		equivalents. The decrease to loan volume reduces the amount of debt 		required to fund loans. During the year ended May 31, 2006, CFC used 		cash to pay down short-term debt. Short-term debt decreased due to the 		maturity of $2,449 million of collateral trust bonds during the year 		ended May 31, 2006. In addition, CFC further reduced its reliance on the 		dealer commercial paper markets, reducing the amounts outstanding from 		$2,873 million at prior year-end to $1,658 million at May 31, 2006. The 		reduction to dealer commercial paper is a result of borrower loan 		repayments and the Company's two new private funding sources, $500 		million of notes to Farmer Mac and the advance of $2 billion on FFB loan 		facilities with bond guarantee agreements with RUS as part of the 		funding mechanism for the REDLG program. Long-term debt increased due to 		these new private funding sources and due to the issuance of $1,000 		million in extendible floating rate collateral trust bonds which were 		used to refinance a portion of the collateral trust bonds which matured 		during the year.
In December 2005, CFC repurchased $37 		million of the 5.95% subordinated deferrable debt securities due 2045 		and $12 million of the 6.10% subordinated deferrable debt securities due 		2044. CFC recognized a net gain of $2 million on the early redemption of 		the subordinated deferrable debt securities. The net gain on the 		redemption was comprised of a gain of $3 million as the securities were 		redeemed below their par value, offset by the write-off of $1 million of 		unamortized issurance costs recorded in cost of funds. Subsequent to the 		end of the year on June 15, 2006, the Company redeemed the 7.625% 		subordinated deferrable debt securities due 2050 totaling $150 million. 		The Company redeemed these securities at par and recorded a charge of $5 		million in cost of funds for the unamortized issuance costs.
At May 31, 2006 and 2005, the Company had 		a total of $960 million and $1,366 million, respectively, of foreign 		denominated debt. 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 statements of operations as foreign currency adjustments. 		At the time of issuance of all foreign denominated debt, the Company 		enters into a cross currency or cross currency interest rate exchange 		agreement to fix the exchange rate on all principal and interest 		payments through maturity. At May 31, 2006 and 2005, the reported amount 		of foreign denominated debt includes a valuation adjustment of $245 		million and $261 million, respectively due to changes in the value of 		the Euro and Australian dollar versus the U.S. dollar since the time the 		debt was issued.
The decrease to members' subordinated 		certificates of $63 million for the year ended May 31, 2006 is primarily 		due to $133 million applied toward loan prepayments, amortization and 		maturities and a $13 million reduction to a borrower's unissued 		membership certificates offset by the purchase of $83 million of new 		certificates.
Minority Interest
Minority interest on the consolidated balance sheets 		at May 31, 2006 was $22 million, an increase of $3 million from the 		balance of $19 million at May 31, 2005. During the years ended May 31, 		2006, 2005 and 2004 the balance of minority interest has been adjusted 		by minority interest net margins less the offset of unretired RTFC 		patronage capital against loans outstanding to certain impaired and high 		risk borrowers and the retirement of patronage capital to RTFC members 		in January of each fiscal year.
Equity
The following chart provides a breakout of 		the equity balances at May 31:
(1) Represents the 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. 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 adjusts the net margin it allocates to its 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 adjusted 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 annually retires 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 		amounts disbursed from board approved reserves.
At May 31, 2006, equity totaled $788 million, an 		increase of $19 million from May 31, 2005. During the year ended May 31, 		2006, CFC retired $71 million of patronage capital to its members, 		patronage capital totaling $2 million was applied against the 		outstanding loan balance of an impaired borrower and a reduction to 		accumulated other comprehensive income related to derivatives of $3 		million which was offset by net margin of $96 million.
Contractual Obligations
The following table summarizes the long-term 		contractual obligations at May 31, 2006 and the scheduled reductions by 		fiscal year.
(1) Includes principal payments for 		subordinated deferrable debt to be called in June 2006 and long-term 		debt due in less than one year.
(2) Excludes loan subordinated 		certificates totaling $308 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, thus an 		amortization schedule cannot be maintained for these certificates. Over 		the past three years, annual amortization on these certificates has 		averaged $27 million. In fiscal year 2006, amortization represented 8% 		of amortizing loan subordinated certificates outstanding.
(3) Represents the payment obligation 		related to the Company's three-year lease of office space for its 		headquarters facility.
(4) Represents the interest obligation 		on the Company's debt based on terms and conditions at May 31, 2006.
The decrease in total guarantees outstanding at May 		31, 2006 compared to May 31, 2005 was due primarily to a $92 million 		prepayment and normal amortization on long-term tax-exempt bonds, the 		release of the obligation under the remaining leveraged lease 		transaction and normal amortization on tax benefit transfers offset by 		new letters of credit totaling $49 million to NCSC borrowers.
At May 31, 2006 and 2005, the Company had recorded a 		guarantee liability totaling $17 million and $16 million, respectively, 		which represents the contingent and non-contingent exposure related to 		guarantees of members' debt obligations.
The following table summarizes the off-balance sheet 		obligations at May 31, 2006 and the related principal amortization and 		maturities by fiscal year.
(1) On a total of $572 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.
Contingent Off-Balance Sheet Obligations
Unadvanced Loan Commitments
At May 31, 2006, the Company had unadvanced loan 		commitments totaling $12,780 million, a decrease of $1,086 million 		compared to the balance of $11,694 million at May 31, 2005. Unadvanced 		commitments are loans 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 the 		Company's borrowers; therefore, it does not anticipate funding most of 		these commitments. Approximately 52% of the outstanding commitments at 		May 31, 2006 and 2005 were for short-term or line of credit loans. 		Substantially all above mentioned credit commitments contain material 		adverse change clauses, thus for a borrower to qualify for the advance 		of funds, the Company must be satisfied that there has been no material 		change since the loan was approved.
Unadvanced loan commitments do not represent 		off-balance sheet liabilities and have not been included in the chart 		summarizing off-balance sheet obligations above. 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 or the borrower has 		not satisfied other terms in the agreement, the Company is not required 		to advance funds. Therefore, unadvanced commitments are classified as 		contingent liabilities.
Ratio Analysis
Leverage Ratio
The leverage ratio is calculated by dividing the sum 		of total liabilities and guarantees outstanding by total equity. Based 		on this formula, the leverage ratio at May 31, 2006 was 24.68, a 		decrease from 26.58 at May 31, 2005. The decrease in the leverage ratio 		is due to an increase of $19 million in total equity, a decrease of $903 		million to total liabilities and a decrease of $79 million in guarantees 		as discussed under the Liabilities, Minority Interest and Equity section 		and the Off-Balance Sheet Obligations section of "Financial Condition". 		
For the purpose of covenant compliance on its 		revolving credit agreements and for internal management purposes, the 		leverage ratio calculation is adjusted to exclude derivative 		liabilities, debt used to fund RUS guaranteed loans, the foreign 		currency valuation account, subordinated deferrable debt and 		subordinated certificates from liabilities, uses members' equity rather 		than total equity and adds subordinated deferrable debt, subordinated 		certificates and minority interest to arrive at adjusted equity. At May 		31, 2006 and 2005, the adjusted leverage ratio was 6.38 and 6.50, 		respectively. See "Non-GAAP Financial Measures" for further explanation 		and a reconciliation of the adjustments the Company makes in its 		leverage ratio calculation.
The decrease in the adjusted leverage ratio is due to 		a decrease in adjusted liabilities of $785 million and a decrease of $79 		million in guarantees offset by the decrease of $86 million in adjusted 		equity. The decrease in adjusted liabilities is primarily due to a net 		decrease of $802 million in short-term and long-term debt excluding the 		foreign currency valuation account and subordinated deferrable debt to 		be called in June 2006. The decrease to adjusted equity is primarily due 		to the $71 million retirement of allocated margins and decreases of $49 		million in subordinated deferrable debt and $63 million in members 		subordinated certificates offset by adjusted net margin totaling $97 		million. 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 agreements.
Debt to Equity Ratio
The debt to equity ratio is calculated by dividing 		the sum of total liabilities outstanding by total equity. The debt to 		equity ratio, based on this formula at May 31, 2006 was 23.31 a decrease 		from 25.07 at May 31, 2005. The decrease in the debt to equity ratio is 		due to the increase of $19 million to total equity and the decrease of 		$903 million to total liabilities as discussed under the Liabilities, 		Minority Interest and Equity section of "Financial Condition".
For internal management purposes, the debt to equity 		ratio calculation is adjusted to exclude derivative liabilities, debt 		used to fund RUS guaranteed loans, the foreign currency valuation 		account, subordinated deferrable debt and subordinated certificates from 		liabilities, uses members' equity rather than total equity and adds 		subordinated deferrable debt, subordinated certificates and minority 		interest to arrive at adjusted equity. At May 31, 2006 and 2005, the 		adjusted debt to equity ratio was 5.97 and 6.07, respectively. See 		"Non-GAAP Financial Measures" for further explanation and a 		reconciliation of the adjustments made to the debt to equity ratio 		calculation. The decrease in the adjusted debt to equity ratio is due to 		the decrease of $785 million in adjusted liabilities offset by the 		decrease of $86 million in adjusted equity.
Credit Ratings
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 the Company's credit ratings at 		May 31, 2006.
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.
Standard & Poor's Corporation, Moody's 		Investors Service, and Fitch Ratings have the Company's ratings on 		stable outlook.
Liquidity and Capital Resources
The following section will discuss the Company's 		sources and uses of liquidity. The Company's primary sources of 		liquidity include capital market debt issuance, private debt issuance, 		member loan principal repayments, member loan interest payments, a 		revolving bank line facility and member investments. The Company's 		primary uses of liquidity include loan advances, interest payments on 		debt, principal repayments on debt and patronage capital retirements. 		The Company feels that its sources of liquidity are adequate to cover 		the uses of liquidity.
Sources of Liquidity
Capital Market Debt Issuance
At May 31, 2006, the Company had effective 		registration statements covering $1,075 million of collateral trust 		bonds, $3,948 million of medium-term notes and $165 million of 		subordinated deferrable debt. The Company has Board authorization to 		issue up to $1 billion of commercial paper and $4 billion of medium-term 		notes in the European market of which $1 billion and $3.6 billion, 		respectively, was remaining at May 31, 2006. The Company has Board 		authorization to issue $1.5 billion of medium-term notes in the 		Australian market of which $1.2 billion was remaining at May 31, 2006. 		In addition, the Company has a commercial paper program under which it 		sells commercial paper to investors in the capital markets. The amount 		of commercial paper that can be sold is limited to the amount of backup 		liquidity available under the Company's revolving credit agreement. 		
Private Debt Issuance
The Company has made use of two sources of private 		debt issuance during fiscal year 2006. In July 2005, the Company issued 		$500 million of notes to Farmer Mac due in 2008 and secured such 		issuance with the pledge of loans to distribution systems as collateral. 		The Company is also authorized to borrow up to $2.5 billion under FFB 		loan facilities with bond guarantee agreements with RUS as part of the 		funding mechanism for the REDLG program. At May 31, 2006, the Company 		had a total of $2 billion of funding outstanding as part of the REDLG program, 		with remaining authority to borrow an additional $500 million.
Member Loan Repayments
There has been significant prepayment activity over 		the past two fiscal years in the telecommunications loan programs. It is 		not anticipated that there will be significant loan prepayments over the 		next few years. Amortization of long-term loans in each of the five 		fiscal years following May 31, 2006 and thereafter are as follows: 		
(1) Represents scheduled amortization 		based on current rates without consideration for loans that reprice. 		Excludes non-performing loans for which the scheduled amortization 		cannot be estimated.
Member Loan Interest Payments
During the year ended May 31, 2006, interest income 		on the loan portfolio was $971 million, representing an average yield of 		5.28% as compared to 4.88% and 4.80% for the years ended May 31, 2005 		and 2004, respectively. At May 31, 2006, 80% of the total loans 		outstanding had a fixed rate of interest and 20% of loans outstanding 		had a variable rate of interest. At May 31, 2006, a total of 6% of loans 		outstanding were on a non-accrual basis with respect to the recognition 		of interest income.
Bank Revolving Credit Facility
The following is a summary of the Company's revolving 		credit agreements at May 31:
		(Dollar amounts in millions)
Termination 		
		Date
Facility fee per annum (1)
364-day agreement (2)
$
1,025
$
-
March 21, 2007
0.05 of 1%
Five-year agreement
1,025
-
March 22, 2011
0.06 of 1%
Five-year agreement
1,975
1,975
March 23, 2010
0.09 of 1%
Three-year agreement
-
1,740
March 30, 2007
0.10 of 1%
364-day agreement (2)
-
1,285
March 22, 2006
0.07 of 1%
Total
$
4,025
$
5,000
(1) Facility fee determined by CFC's 		senior unsecured credit ratings based on the pricing schedules put in 		place at the initiation of the related agreement.
(2) Any amount outstanding under these 		agreements may be converted to a one-year term loan at the end of the 		revolving credit periods. If converted to a term loan, the fee on the 		outstanding principal amount of the term loan is 0.10 of 1% per annum.
Up-front fees of between 0.05 and 0.13 of 		1% were paid to the banks based on their commitment level to the 		five-year agreements in place at May 31, 2006, totaling in aggregate $3 		million, which will be amortized on a straight-line basis over the life 		of the agreements. No upfront fees were paid to the banks for their 		commitment to the 364-day facility. Each agreement contains a provision 		under which if borrowings exceed 50% of total commitments, a utilization 		fee must be paid on the outstanding balance. The utilization fees are 		0.05 of 1% for the five-year agreement terminating on March 22, 2011 and 		the 364-day agreement and 0.10 of 1% for the five-year agreement 		terminating on March 23, 2010 outstanding at May 31, 2006.
Effective May 31, 2006 and 2005, the 		Company was in compliance with all covenants and conditions under its 		revolving credit agreements in place at that time and there were no 		borrowings outstanding under such agreements.
For the purpose of calculating the 		required financial covenants contained in its revolving credit 		agreements, the Company adjusts net margin, senior debt and total equity 		to exclude the non-cash adjustments related to SFAS 133 and 52. The 		adjusted times interest earned ratio ("TIER"), as defined by the 		agreements, represents the cost of funds adjusted to include the 		derivative cash settlements, plus minority interest net margin, plus net 		margin prior to the cumulative effect of change in accounting principle 		and dividing that total by the cost of funds adjusted to include the 		derivative cash settlements. In addition to the non-cash adjustments 		related to SFAS 133 and 52, senior debt also excludes RUS guaranteed 		loans, subordinated deferrable debt, members' subordinated certificates 		and minority interest. Total equity is adjusted to include subordinated 		deferrable debt, members' subordinated certificates and minority 		interest. 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.
The following represents the Company's required and 		actual financial ratios under the revolving credit agreements at or for 		the year ended May 31:
(1) The Company must meet this requirement in 		order to retire patronage capital.
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, but CFC must be 		in compliance with their other requirements, including financial ratios, 		in order to draw down on the facilities.
Member Investments
At May 31, 2006 and 2005, members funded 		19.2% and 17.7%, respectively, of total assets as follows:
Uses of Liquidity
Loan Advances
Loan advances would come from new loans approved to 		members and from the unadvanced portion of loans that were approved 		prior to May 31, 2006. At May 31, 2006, the Company had unadvanced loan 		commitments totaling $12,780 million. The Company does not expect to 		advance the full amount of the unadvanced commitments at May 31, 2006. 		Unadvanced
commitments generally expire within five years of the first 		advance on a loan and the majority of short-term unadvanced commitments are used as backup liquidity for member 		operations. Approximately 52% of the outstanding commitments at May 31, 		2006 were for short-term or line of credit loans. The Company 		anticipates that over the next twelve months, loan advances will be 		approximately equal to the scheduled loan repayments.
Interest Expense on Debt
For the year ended May 31, 2006, interest expense on 		debt was $942 million, representing 5.12% of the average loan volume for 		which the debt was used as funding. The interest expense on debt 		represented 4.51% and 4.38% of the average loan volume for which the 		debt was used as funding for the years ended May 31, 2005 and 2004, 		respectively. At May 31, 2006, a total of 83% of outstanding debt had a 		fixed interest rate and 17% of outstanding debt had a variable interest 		rate.
Principal Repayments on Long-term Debt
The principal amount of medium-term notes, collateral 		trust bonds, long-term notes payable, subordinated deferrable debt and 		membership subordinated certificates maturing in each of the five fiscal 		years following May 31, 2006 and thereafter is as follows:
(1) For the amount scheduled to 		mature in fiscal year 2007, $1,989 million has been presented as 		long-term debt due in one year under short-term debt and $19 million is 		presented in membership subordinated certificates.
(2) Excludes loan subordinated 		certificates totaling $308 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, thus an 		amortization schedule cannot be maintained for these certificates. Over 		the past three years, annual amortization on these certificates has 		averaged $27 million. In fiscal year 2006, amortization represented 8% 		of amortizing loan subordinated certificates outstanding.
Patronage Capital Retirements
The Company has made annual retirements of its 		allocated patronage capital in 26 of the last 27 years. In July 2006, 		the CFC board of directors approved the allocation of a total of $102 		million from fiscal year 2006 net margin and the members' capital 		reserve to the CFC members. CFC is scheduled to make a cash payment of 		$84 million to its members as retirement of 70% of the amount allocated 		for fiscal year 2006 and 1/9th of the amount allocated for fiscal years 		1991, 1992 and 1993.
Market Risk
The Company's primary market risks are interest rate 		risk and liquidity risk. 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.
Interest Rate Risk
The interest rate risk exposure is related to the 		funding of the fixed rate loan portfolio. 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. The Company aggregates fixed rate 		loans until the volume reaches a level that will allow an economically 		efficient issuance of debt. 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. 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 15 to 35 year maturities. 		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, 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 46). The interest rate risk is deemed minimal on variable 		rate loans, since the loans may be repriced either monthly or 		semi-monthly to reflect the cost of the debt used to fund the loans. At 		May 31, 2006 and 2005, 20% and 32%, respectively, of loans carried 		variable interest rates.
Matched Funding Policy
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 the Company's funding objective to 		manage the matched funding of asset and liability repricing terms within 		a range of 3% of total assets excluding derivative assets. At May 31, 		2006, the Company had $14,557 million of fixed rate assets amortizing or 		repricing, funded by $12,751 million of fixed rate liabilities maturing 		during the next 30 years and $2,002 million of members' equity and 		members' subordinated certificates, a portion of which does not have a 		scheduled maturity. The difference of $196 million, or 1.02% of
total assets and 1.05% of total assets excluding 		derivative assets, represents the fixed rate debt and equity in excess 		of the fixed rate assets maturing during the next 30 years. Fixed 		rate loans are funded with fixed rate collateral trust bonds, 		medium-term notes, long-term notes payable, 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, long-term notes payable 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.
Certain of 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, the Company takes advantage of these early 		redemption provisions. However, because conversions and prepayments can 		take place at different intervals from early redemptions, the Company 		charges conversion fees designed to compensate for any additional 		interest rate risk it assumes.
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 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 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 a reconciliation of the adjustments to TIER.
The following chart shows the scheduled amortization 		and repricing of fixed rate assets and liabilities outstanding at May 		31, 2006.
INTEREST RATE GAP ANALYSIS
(Fixed Rate Assets/Liabilities)
As of May 31, 2006
(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)
Assets less liabilities and 		members' equity.
(3)
Adjusted total assets 		represents total assets in the consolidated balance sheets less 		derivative assets.
Use of Derivatives
At May 31, 2006 and 2005, the Company was 		a party to interest rate exchange agreements with a total notional 		amount of $12,536 million and $13,693 million, respectively. The Company 		uses interest rate exchange agreements as part of 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 will enter into interest rate exchange agreements only with 		highly rated financial
institutions. CFC was using interest rate exchange 		agreements to synthetically change the interest rate from a variable 		rate to a fixed rate on $7,350 million as of May 		31, 2006 and $6,643 million as of May 31, 2005 of debt used to fund 		long-term fixed rate loans. Interest rate exchange agreements were used 		to synthetically change the interest rates from fixed to variable on 		$5,186 million and $7,050 million of long-term debt as of May 31, 2006 		and 2005, respectively. The Company has not invested in derivative 		financial instruments for trading purposes in the past and does not 		anticipate doing so in the future.
As of May 31, 2006 and 2005, the Company 		was a party to cross currency and cross currency interest rate exchange 		agreements with a total notional amount of $716 million and $1,106 		million, respectively, related to medium-term notes denominated in 		foreign currencies. Cross currency and cross currency interest rate 		exchange agreements with a total notional amount of $434 million and 		$824 million, respectively, at May 31, 2006 and 2005 in which the 		Company receives Euros and pays U.S. dollars, and $282 million at May 		31, 2006 and 2005 in which the Company 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, $716 		million of the cross currency interest rate exchange agreements at May 		31, 2006 and 2005 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.
Liquidity Risk
The Company faces liquidity risk in the 		funding of its loan portfolio. The Company offers long-term loans with 		maturities of up to 35 years and line of credit loans that are generally 		required to be paid down annually. On long-term loans, the Company 		offers a variety of interest rate options including the ability to fix 		the interest rate for terms of one year through maturity. At May 31, 		2006, the Company has a total of $1,989 million of long-term debt 		maturing during the next twelve months. The Company funds the loan 		portfolio with a variety of debt instruments and its members' equity. 		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. 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, 		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 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, 		2006 and 2005, the Company had a total of $4.025 billion and $5 billion 		in revolving credit agreements and bank lines of credit. In addition, 		the Company limits the amount 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, 2006 and 2005, 		there was a total of $1,758 million and $2,973 million, respectively, of 		dealer commercial paper and bank bid notes outstanding, representing 10% 		and 16%, respectively, of the Company's total debt outstanding.
Counterparty Risk
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, the Company only enters into 		these agreements with financial institutions with investment grade 		ratings. At May 31, 2006 and 2005, the Company was a party to interest 		rate exchange agreements with notional amounts totaling $12,536 million 		and $13,693 million and cross currency and cross currency interest rate 		exchange agreements with notional amounts totaling $716 million and 		$1,106 million, respectively. To date, the Company has not experienced a 		failure of a counterparty to perform as required under any of these 		agreements. At the time counterparties are selected to participate in 		the Company's exchange agreements, the counterparty must be a 		participant in one of its revolving credit agreements. At May 31, 2006, 		the Company's interest rate, cross currency and cross currency interest 		rate exchange agreement counterparties had credit ratings ranging from 		AAA to A- as assigned by Standard & Poor's Corporation.
The Company currently uses two types of 		interest rate exchange agreements: (1) the Company pays a fixed rate and 		receives a variable rate and (2) 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, 2006 by type of agreement.
Foreign Currency Risk
The Company may issue commercial paper, 		medium-term notes or bonds denominated in foreign currencies. For any 		such obligation issued, the Company expects to enter into a cross 		currency or cross currency interest rate exchange agreement with a 		highly-rated counterparty. At May 31, 2006, the Company had a total of 		$434 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 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, 2005, CFC had 		$824 million and $282 million of medium-term notes denominated in Euros 		and Australian dollars, respectively. 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 $245 million and $261 million at May 31, 2006 and 2005, 		respectively. The change in the value of the foreign denominated debt is 		reported in the consolidated 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 		statements of operations. The change in the fair value of the cross 		currency and interest rate exchange agreements that do not qualify for 		hedge accounting is recorded to the derivative forward value line. 		
Rating Triggers
The Company has certain 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. At May 31, 2006, there 		are rating triggers associated with $10,005 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 $1,097 million. If the Company's rating from Moody's 		Investors Service falls below Baa1 or 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 $8,908 million.
At May 31, 2006, the Company 's exchange 		agreements subject to rating triggers had a derivative fair value of $45 		million, comprised of $47 million that would be due to the Company and 		$2 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 $322 million, comprised of 		$393 million that would be due to the Company and $71 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. See chart on page 42 		for CFC's senior unsecured credit ratings as of May 31, 2006.
For additional information of risks 		related to the Company's business, see Item 1A "Risk Factors".
(1) The principal 		amount of fixed rate loans is the total of scheduled principal 		amortizations without consideration for loans that reprice. Includes 		$216 million of loans guaranteed by RUS.
(2) Long-term 		variable rate loans include $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) The Company's 		non-performing loans are currently under litigation, therefore 		amortization schedule and interest accrual rate cannot be estimated for 		future periods.
(7) 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.
(9) Fair value has 		not been included as it is impracticable to develop a discount rate that 		measures fair value (see Note 13 to the consolidated financial 		statements). Excludes loan subordinated certificates totaling $308 		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 million. In fiscal year 2006, amortization represented 8% of 		amortizing loan subordinated certificates outstanding.
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 and the 		Company's adjusted TIER for the year ended May 31, 2006 was 1.11. 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 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 related 		to derivatives that qualify for hedge accounting does not flow through 		the consolidated 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.
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, 2006, 2005 and 		2004.
TIER using GAAP financial measures is calculated as 		follows:
The following chart provides the TIER and adjusted 		TIER for the years ended May 31, 2006, 2005 and 2004.
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 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, 2006.
The adjusted leverage and debt to equity ratios are 		calculated as follows:
Adjusted leverage ratio =
Adjusted liabilities + 		guarantees outstanding
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, 2006. 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.
Item 7A.
Item 7A. Quantitative and 		Qualitative Disclosures About Market Risk.
See Market Risk discussion on 		pages 45 to 50.
Item 8.
Item 8. Financial Statements and 		Supplementary Data.
The consolidated financial 		statements, auditors' reports and quarterly financial results are 		included on pages 68 through 107 (see Note 17 to consolidated financial 		statements for a summary of the quarterly results of CFC's operations).
Item 9.
Item 9. Changes in and 		Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures
Evaluation of 		Disclosure Controls and Procedures
Senior management, including 		the Chief Executive Officer and Chief Financial Officer, evaluated the 		effectiveness of the Company's disclosure controls and procedures as 		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 were no changes in the 		Company's internal control over financial reporting that occurred during 		our last fiscal quarter that have materially affected, or are reasonably 		likely to materially affect, our internal control over financial 		reporting.
Management's Report on 		Internal Control Over Financial Reporting
The management of National 		Rural Utilities Cooperative Finance Corporation ("CFC") is responsible 		for establishing and maintaining adequate internal control over 		financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under 		the Securities Exchange Act of 1934. CFC's internal control system over 		financial reporting is designed under the supervision of management, 		including the Chief Executive Officer and Chief Financial Officer, to 		provide reasonable assurance regarding the reliability of financial 		reporting and the preparation of financial statements for external 		purposes in accordance with generally accepted accounting principles. 		CFC's internal control over financial reporting includes those policies 		and procedures that:
(i) pertain to the 		maintenance of records that, in reasonable detail, accurately and fairly 		reflect the transactions and dispositions of the assets of the company; 		
(ii) provide 		reasonable assurance that transactions are recorded as necessary to 		permit preparation of financial statements in accordance with 		U.S. generally accepted accounting principles, and that receipts and 		expenditures of the company are being made only in accordance with 		authorizations of management and directors of the company; and
(iii) provide 		reasonable assurance regarding prevention or timely detection of 		unauthorized acquisition, use or disposition of the company's assets 		that could have a material effect on the financial statements.
Any system of internal 		control, no matter how well designed, has inherent limitations, 		including but not limited to the possibility that a control can be 		circumvented or overridden and misstatements due to error or fraud may 		occur and not be detected. Also, because of changes in conditions, 		internal control effectiveness may vary over time. Therefore, even those 		systems determined to be effective can provide only reasonable assurance 		with respect to financial statement preparation and presentation.
CFC's management assessed the 		effectiveness of CFC's internal control over financial reporting as of 		May 31, 2006. In making this assessment, management used the criteria 		set forth by the Committee of Sponsoring Organizations of the Treadway 		Commission ("COSO") in Internal Control-Integrated Framework. Based on 		management's assessment and those criteria, management believes that CFC 		maintained effective internal control over financial reporting as of May 		31, 2006.
CFC's independent registered 		public accounting firm, Deloitte & Touche, LLP has issued an audit 		report on management's assessment and the effectiveness of CFC's 		internal control over financial reporting. This report appears on 		page 68.
Item 9B.
Item 9B. Other Information
None.
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.
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 with the 		exception of the at-large position for the audit committee financial 		expert who may also be a Chief Financial Officer of a member of CFC.
Mr. Carter has served as a 		director of Tri-County Electric Cooperative in Hooker, OK since 1977. In 		addition, he has also been a director of the 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 the owner of High Plains Seeds 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 a director of the cooperative since 1996. 		She is a former member of the Resolutions Committee for Midwest Electric 		Consumers Association where she previously served as vice-chairperson. Ms. 		Jacobs is a member of the RTFC Lender Advisory Council. 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 is a director 		and former president of the Iowa Association of Electric Cooperatives 		and chairs the Regulatory Affairs Committee. He is a board member and 		secretary of the Cooperative Development Services of Iowa, Wisconsin and 		Minnesota and a director of the Fayette County Economic Development 		Commission. Mr. Arthur is a member of the RTFC Lender Advisory Council. 		Since 1972, Mr. Arthur has been owner and operator of Arthur's Country 		Place Inc, a 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 serves as vice 		chairman of the Claiborne County Industrial Development Board and is a 		member of the Claiborne County Planning Commission. He currently serves 		as president of the Workforce Investment Board for Service Delivery Area 		2 of Tennessee. Since 1976, Mr. Ball has been owner/ broker of Ball 		Realty & Auction, specializing in development and management of 		commercial property.
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 National Rural Electric 		Cooperative Association ("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 2004. 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. 		Mr. Bergh retired in 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 has served on 		the Rappahannock Electric Cooperative Board since 1984 and was board 		chair from 1997 to 2000. At present, she holds position on the Audit 		Committee and the By-Laws Committee for Rappahannock Electric 		Cooperative. She has served on the Safety Committee of the VA, MD, DE 		Association of Electric Cooperatives since 1997. Starting in 1966, Ms. 		Carpenter was employed at what is currently known as Wachovia Bank NA in 		Culpeper, VA and served as vice president from 1999 to 2001 when she 		retired.
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 is a former alternate trustee 		representative to Kansas Electric Power Cooperative, Inc. (KEPCo) and 		former vice president of the KEPCo Services, Inc., Board of Directors. 		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 president 		and Chief Executive Officer ("CEO") of Wild Rice Electric Cooperative in 		Mahnomen, MN since 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 is a member of the RTFC 		Lender Advisory Council. He previously served as CEO, under a shared 		management agreement, of Wild Rice Electric Cooperative/Red River Valley 		Cooperative in Halstad, MN. Mr. Haaven is a former member of the Rural 		Electric Political Action Committee Board at Minnesota Rural Electric 		Association.
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 a board member of Alabama 		Electric Cooperatives since April 1997. Since January 2001, Mr. Harrison 		has served as CEO and president of Cooperative Utility Services, LLC.
Mr. Harting has been General 		Manager of Sullivan County Rural Electric Cooperative in Forksville, PA 		since September 1989. He has been a member of the board of United 		Utility Supply, Inc., in Louisville, KY since June 1995. 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.
Mr. Herron has served as 		General Manager of Mountain View Electric Association, Inc. in Limon, CO 		since 1996. Prior to that position, Mr. Herron was General Manager at 		Farmers' Electric Cooperative in Clovis, NM from 1993 to 1996. Mr. 		Herron currently serves on the Colorado Electric Education Institute. 		Previously, he served as chair of the Colorado Rural Electric Managers 		Association and as board member of the 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 Services 		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 board member of the Electric 		Coalition of Wisconsin. Mr. Hillert serves as chairman of Adams County 		Economic Development and is a member of Advisory Board of Directors for 		the University of Wisconsin Center for Cooperatives.
Mr. Kirby has been a board 		member of Central Indiana Power in Greenfield, IN, since 1991 and is a 		past chairman of that board. He served as director of the Indiana 		Statewide Association of RECs, Inc. from 1999 to 2004. Mr. Kirby has 		been director of Diagnostic Imaging at Hamilton Heart, Inc., a 		cardiology practice in Noblesville, IN since April 2004. From April 2003 		to April 2004, Mr. Kirby was director of Diagnostic Imaging at Women's 		Hospital of Indianapolis, 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 1980 to 2001.
Mr. Kopacz has been the 		General Manager of Midstate Electric Cooperative, Inc. in LaPine, Oregon 		since 1990. He is currently a board director of Northwest Requirement 		Utilities, Northwest Irrigation Utilities and Economic Development for 		Central Oregon. He is also a former board president of Economic 		Development for Central Oregon. He is a former director of Ruralite 		Services, a northwest electric cooperative publication; and former 		president of the Oregon Rural Electric Cooperative Association.
Mr. McBride has been a 		director of Graham County Electric Cooperative in Pima, AZ since 1991 		and vice president since 1993. Mr. McBride is owner/operator of Reuben 		McBride Farms, in Pima, AZ, since 1980. Mr. McBride currently serves on 		the board of Arizona Electric Power Co-op., Inc and served as board 		president and chairman of the Executive Committee from May 2002 to May 		2005. In addition, Mr. McBride is a member of both the National and 		Arizona Action Committees for Rural Electrification.
Mr. Rettkowski has served 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 for Northwest Irrigation Utilities since August 		1992. Mr. Rettkowski has been the president of Citizens for Irrigation 		for the state of Washington since September 1991. He is a former trustee 		of Lincoln Electric and Graingrowers Warehouse Co-op. Mr. Rettkowski has 		also been president of Rettkowski Brothers, a farming corporation in 		Wilbur, WA, since 1998.
Mr. Salyer has served as the 		president and CEO of Pioneer Rural Electric Cooperative in Piqua, OH 		since 2001 and served as executive vice president from 1999 to 2000. In 		addition, he is a member of the Ohio Rural Electric Cooperatives (OREC) 		Facilities Attachment Committee, chairman of the OREC Communications 		Systems Task Force and a trustee of Buckeye Power, Inc. In addition, he 		is also a director of Rural Electric Supply Cooperative of Ohio. He is a 		member of the RTFC Lender Advisory Council.
Mr. 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. He serves 		as a director on the Golden Spread Electric Cooperative Board, the 		Golden Spread Electric Generating Cooperative Board, the Oklaunion 		Electric Generating Cooperative Board, the Yoakum Electric Generating 		Cooperative Board, the Mid-Tex Cooperative Board and the Texas 		Agricultural Cooperative Council. Mr. Schriver is a Group 4 member of 		the Governmental Relations Committee of Texas Electric Cooperatives. Mr. 		Schriver formerly served as director of Government Affairs of Brazos 		Electric Power Cooperative from 1996 to 1998 and of Governmental 		Relations of Texas Electric Cooperative from 1998 to 2002. He is a 		member of the RTFC Lender Advisory Council.
Mr. Wasson has been the 		president and CEO of Laurens Electric Cooperative in Laurens, South 		Carolina since 1973. He has served on the board of directors of New 		Horizon Electric Cooperative since 1997 and has served as chairman since 		2005. Mr. Wasson has been a board member of the South Carolina Electric 		Cooperative Association since 1975 and served as chairman from December 		1983 to December 1985. He also serves as a director of The Palmetto 		Bank.
Mr. Whitaker has served as 		the president and General Manager of Southwest Arkansas Electric 		Cooperative in Texarkana, AR since 1986. In addition, Mr. Whitaker has 		been director and former chairman of Arkansas Electric Cooperative 		Corporation and Arkansas Electric Cooperative, Inc. since 1986. He is 		also a former director of the National Information Solutions Cooperative 		and served as chairman of the Arkansas Rural Electric Self-Insurance 		Trust from 1994 to 2002.
Mr. Williams has 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 Corporation and held positions as vice-chairman and chairman 		of the board. He is a former member of Southeastern Electrification 		Council. He was a former chairman of Button Gwinett National Bank from 		1984 to 1998. Mr. Williams retired in June 1997. His former occupations 		include owner and chairman of the board of a residential and commercial 		construction and development company from 1968 to 1997.
Mr. Wolfe has been the 		president and CEO of Mid-Carolina Electric Cooperative, Inc. in 		Lexington, South Carolina since 1975. He has also represented South 		Carolina's electric cooperatives on the NRECA Board of Directors since 		1999 and currently serves as the vice president. Prior to his election 		to vice president, Mr. Wolfe served as secretary-treasurer of the NRECA 		board. Mr. Wolfe serves as a director of The Electric Cooperatives of 		South Carolina, Inc., and of Central Electric Power Cooperative where he 		has served as chairman of various statewide committees.
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, 		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 U.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 the 		Company.
(h) Code of Ethics
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/ourCoreBeliefs.htm.
(i) Audit Committee
Our Audit Committee currently 		consists of twelve directors: Mr. Schriver (Chairperson), Mr. McBride 		(Vice-Chairperson), Mr. Carter, Ms. Carpenter, Mr. Harting, Mr. Wasson, 		Mr. Harrison, Mr. Salyer, Mr. Arthur, Ms. Jacobs, Mr. Foley and Mr. 		Whitaker. The members of the Audit Committee are "independent" as that 		term is defined in the listing standards of the NYSE and the rules of 		the Securities Exchange Act. The Audit Committee reviews the Company's 		financial statements and the disclosure under Management's Discussion 		and Analysis in our Annual Report on Form 10-K. The committee meets with 		our independent registered public accounting firm, internal auditors, 		Chief Executive Officer and financial management executives to review 		the scope and results of audits and recommendations made by those 		persons with respect to internal and external accounting controls and 		specific accounting and financial reporting issues and to assess 		corporate risk. The Board has adopted a written charter for the Audit 		Committee.
At May 31, 2006, 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 twenty-third 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 has identified candidates to run for this at-large 		position in the membership elections to be held in the fall of 2006. CFC 		had not filled the position previously because of its 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.
In connection with annual performance reviews, on 		June 1, 2006, National Rural Utilities Cooperative Finance Corporation 		increased the compensation of Steven Lilly, Senior Vice President and 		Chief Financial Officer; John List, Senior Vice President of Member 		Services and General Counsel; John Evans, Senior Vice President of 		Operations; and Lawrence Zawalick, Senior Vice President of RTFC.
As a result of the increase, Mr. Lilly, Mr. List and 		Mr. Evans will each receive a salary of $364,000 for fiscal year 2007 		and Mr. Zawalick will receive a salary of $265,500 for fiscal year 2007.
Short-Term Incentive Plan
CFC's short-term incentive compensation plan provides 		for an incentive 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 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. 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.
Long-Term Incentive Plan
CFC's board of directors approved a long-term 		incentive plan for fiscal year 2006 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, 		2005 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, 2008.
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, 2006.
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, 2006, 		that began on June 1, 2006 with a payout scheduled for May 31, 2009. The 		long-term incentive plan for fiscal year 2005, with terms similar to the 		one approved for fiscal year 2006, began on June 1, 2004 and has a 		payout scheduled for May 31, 2007.
Defined Benefit or Actuarial Plan Disclosure
NRECA administers the Retirement Security 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 plan. As of May 31, 2006, 		the number of years of service credited and the compensation covered 		under the plan, respectively, for the officers listed above was as 		follows: Sheldon C. Petersen-22 years 9 months, $502,000; John J. 		List-34 years 3 months, $277,680; Steven L. Lilly-22 years 7 months, 		$309,800; Lawrence Zawalick-26 years, $225,536; and John T. Evans-8 		years 6 months, $279,080.
The following chart represents the potential benefits 		paid out under the Retirement Security Plan and the Pension Restoration 		Plan discussed below.
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. Under the plan, the amount that 		NRECA invoices CFC for the Retirement Security Plan will continue to be 		based on the full base 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 has paid such additional benefits to the covered 		employee through two components of the Pension Restoration Plan, a 		Severance Pay Plan and a Deferred Compensation Plan. Under the Severance 		Pay Plan, the employee was paid an amount equal to the lost pension 		benefits but not exceeding twice the employee's annual compensation for 		the prior year. The benefit was paid within 24 months of termination of 		employment. To the extent that the Severance Pay Plan could not pay all 		of the lost pension benefits, the remainder was paid under a Deferred 		Compensation Plan in a lump sum or in installments of up to 60 months.
The Severance Pay Plan component of the Pension 		Restoration Plan has been eliminated effective January 1, 2005. Any 		benefit earned prior to December 31, 2004 will be held for the employee 		and will be paid out as outlined above. Benefits earned as of January 1, 		2005, however, will be paid solely under the Deferred Compensation 		component of the Pension Restoration Plan, which carries a substantial 		risk of forfeiture.
As of December 31, 2005, the NRECA 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 receive a fixed sum of $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 meeting attended.
Employment Contracts and Termination of 		Employment and Change-In-Control Arrangements
Pursuant to an employment agreement effective as of 		March 1, 2004, CFC has agreed to employ Mr. Petersen as Chief Executive 		Officer through February 28, 2009 (with automatic one-year extensions 		unless either party objects) at no less than his base salary at the 		time, currently $632,500 per annum, plus such 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 July 22, 2004, RTFC has agreed to employ Mr. Petersen for a 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. 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 option, may request that the deferred 		component of his compensation package be directed into alternative 		investment
vehicles that 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 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 60.
Compensation Committee Interlocks and Insider 		Participation
During the year ended May 31, 2006, there were no 		compensation committee interlocks or insider participation related to 		executive compensation.
Item 12.
Item 12. Security Ownership of 		Certain Beneficial Owners and Management.
Inapplicable.
Item 13.
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 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. CFC has adopted a policy 		whereby any transaction involving a potential conflict of interest 		between a director and CFC is approved only by the disinterested 		directors.
1. Consolidated financial 		statements Page
Report of Independent 		Registered Public Accounting Firm on Internal Control Over Financial
		 Reporting
Reports of Independent 		Registered Public Accounting Firms
Consolidated Balance Sheets
Consolidated Statements of 		Operations
Consolidated Statements of 		Changes in Equity
Consolidated Statements of 		Cash Flows
Notes to Consolidated 		Financial Statements
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.
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 25th day of August 2006.
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.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING 		FIRM
To the Board of Directors and Members of
National Rural Utilities Cooperative Finance 		Corporation
Herndon, Virginia
We have audited management's assessment, included in 		the accompanying Management's Report on Internal Control Over 		Financial Reporting, that National Rural Utilities Cooperative 		Finance Corporation and subsidiaries (the "Company") maintained 		effective internal control over financial reporting as of May 31, 2006, 		based on criteria established in Internal Control-Integrated 		Framework issued by the Committee of Sponsoring Organizations of the 		Treadway Commission. The Company's management is responsible for 		maintaining effective internal control over financial reporting and for 		its assessment of the effectiveness of internal control over financial 		reporting. Our responsibility is to express an opinion on management's 		assessment and an opinion on the effectiveness of the Company's internal 		control over financial reporting 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 effective internal control 		over financial reporting was maintained in all material respects. Our 		audit included obtaining an understanding of internal control over 		financial reporting, evaluating management's assessment, testing and 		evaluating the design and operating effectiveness of internal control, 		and performing such other procedures as we considered necessary in the 		circumstances. We believe that our audit provides a reasonable basis for 		our opinions.
A company's internal control over financial reporting 		is a process designed by, or under the supervision of, the company's 		principal executive and principal financial officers, or persons 		performing similar functions, and effected by the company's board of 		directors, management, and other personnel to provide reasonable 		assurance regarding the reliability of financial reporting and the 		preparation of financial statements for external purposes in accordance 		with generally accepted accounting principles. A company's internal 		control over financial reporting includes those policies and procedures 		that (1) pertain to the maintenance of records that, in reasonable 		detail, accurately and fairly reflect the transactions and dispositions 		of the assets of the company; (2) provide reasonable assurance that 		transactions are recorded as necessary to permit preparation of 		financial statements in accordance with generally accepted accounting 		principles, and that receipts and expenditures of the company are being 		made only in accordance with authorizations of management and directors 		of the company; and (3) provide reasonable assurance regarding 		prevention or timely detection of unauthorized acquisition, use, or 		disposition of the company's assets that could have a material effect on 		the financial statements.
Because of the inherent limitations of internal 		control over financial reporting, including the possibility of collusion 		or improper management override of controls, material misstatements due 		to error or fraud may not be prevented or detected on a timely basis. 		Also, projections of any evaluation of the effectiveness of the internal 		control over financial reporting to future periods are subject to the 		risk that the controls may become inadequate because of changes in 		conditions, or that the degree of compliance with the policies or 		procedures may deteriorate.
In our opinion, management's assessment that the 		Company maintained effective internal control over financial reporting 		as of May 31, 2006, is fairly stated, in all material respects, based on 		the criteria established in Internal Control-Integrated Framework 		issued by the Committee of Sponsoring Organizations of the Treadway 		Commission. Also in our opinion, the Company maintained, in all material 		respects, effective internal control over financial reporting as of May 		31, 2006, based on the criteria established in Internal 		Control-Integrated Framework issued by the Committee of Sponsoring 		Organizations of the Treadway Commission.
We have also audited, in accordance with the 		standards of the Public Company Accounting Oversight Board (United 		States), the consolidated financial statements as of and for the year 		ended May 31, 2006 of the Company and our report dated August 25, 2006 		expressed an unqualified opinion on those financial statements. 		
/s/DELOITTE & TOUCHE LLP
McLean, Virginia
August 25, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING 		FIRM
To the Board of Directors and Members of
National Rural Utilities Cooperative Finance 		Corporation
Herndon, Virginia
We have audited the accompanying consolidated balance 		sheets of National Rural Utilities Cooperative Finance Corporation and 		subsidiaries (the "Company") as of May 31, 2006 and 2005, and the 		related consolidated statements of operations, changes in equity, and 		cash flows for each of the years 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 audits.
We conducted our audits 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. 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, such consolidated financial 		statements present fairly, in all material respects, the financial 		position of National Rural Utilities Cooperative Finance Corporation and 		subsidiaries as of May 31, 2006 and 2005, and the results of their 		operations and their cash flows for each of the years then ended, in 		conformity with accounting principles generally accepted in the United 		States of America.
We have also audited, in accordance with the 		standards of the Public Company Accounting Oversight Board (United 		States), the effectiveness of the Company's internal control over 		financial reporting as of May 31, 2006, based on the criteria 		established in Internal Control - Integrated Framework issued by 		the Committee of Sponsoring Organizations of the Treadway Commission and 		our report dated August 25, 2006 expressed an unqualified opinion on 		management's assessment of the effectiveness of the Company's internal 		control over financial reporting and an unqualified opinion on the 		effectiveness of the Company's internal control over financial 		reporting.
/s/ DELOITTE & TOUCHE LLP
McLean, Virginia
August 25, 2006
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING 		FIRM
TO THE BOARD OF DIRECTORS AND MEMBERS OF NATIONAL 		RURAL
UTILITIES COOPERATIVE FINANCE CORPORATION
We have audited the accompanying consolidated 		statements of operations, changes in equity, and cash flows of National 		Rural Utilities Cooperative Finance Corporation ("the Company") for the 		year ended May 31, 2004. 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. We were not engaged to perform an audit 		of the Company's 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 Company's 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 audit provides a reasonable basis for 		our opinion.
In our opinion, the financial statements referred to 		above present fairly, in all material respects, the consolidated results 		of operations and cash flows of National Rural Utilities Cooperative 		Finance Corporation for the year ended May 31, 2004, in conformity with 		U.S. generally accepted accounting principles.
/s/ Ernst & Young LLP
McLean, Virginia
July 28, 2004
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
CONSOLIDATED BALANCE SHEETS
May 31, 2006 and 2005
(in thousands)
A S S E T S
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
CONSOLIDATED BALANCE SHEETS
May 31, 2006 and 2005
(in thousands)
L I A B I L I T I E S A N D E Q U I T Y
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands)
For the Years Ended May 31, 2006, 2005 and 2004
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(in thousands)
For the Years Ended May 31, 2006, 2005 and 2004 		
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the Years Ended May 31, 2006, 2005 and 2004
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
For the Years Ended May 31, 2006, 2005 and 2004
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) General Information and 		Accounting Policies
(a) General Information
National Rural Utilities Cooperative 		Finance Corporation ("CFC" or "the Company") is a private, 		not-for-profit cooperative association incorporated 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 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 its members with credit enhancements in 		the form of letters of credit and guarantees of debt obligations. CFC is 		exempt from payment of 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. In February 2005, RTFC 		reincorporated as a not-for-profit cooperative association in the 		District of Columbia. The principal purpose of RTFC is to provide and 		arrange financing for its rural telecommunications members and their 		affiliates. RTFC's results of operations and financial condition are 		consolidated with those of CFC in the accompanying financial statements. 		RTFC is headquartered with CFC in Herndon, Virginia. RTFC is a taxable 		cooperative that pays income tax based on its net margins, excluding net 		margins allocated to its members, as allowed by law under Subchapter T 		of the Internal Revenue Code.
National Cooperative Services Corporation 		("NCSC") was incorporated in 1981 in the District of Columbia as a 		private cooperative association. The principal purpose of NCSC is to 		provide 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. NCSC's results 		of operations and financial condition are consolidated with those of CFC 		in the accompanying financial statements. NCSC is headquartered with CFC 		in Herndon, Virginia. NCSC is a taxable corporation that pays income tax 		annually based on its net margins for the period.
The Company's consolidated membership was 		1,547 as of May 31, 2006 including 898 utility members, the majority of 		which are consumer-owned electric cooperatives, 514 telecommunications 		members, 67 service members and 68 associates in 49 states, the District 		of Columbia and two U.S. territories. The utility members included 829 		distribution systems and 69 generation and transmission ("power supply") 		systems. Memberships between CFC, RTFC and NCSC have been eliminated in 		consolidation.
(b) Principles of Consolidation
The accompanying financial statements 		include the consolidated accounts of CFC, RTFC and NCSC and certain 		entities controlled by CFC created to hold foreclosed assets, after 		elimination of all material intercompany accounts and transactions. 		Financial Accounting Standards Board ("FASB") Interpretation No. ("FIN") 		46(R), Consolidation of Variable Interest Entities, an interpretation of 		Accounting Research Bulletin No. 51, requires CFC to consolidate 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.
CFC is the sole lender to and manages the lending and 		financial affairs of RTFC through a long-term management agreement. 		Under a guarantee agreement, RTFC pays CFC a fee in exchange for which 		CFC reimburses RTFC for loan losses. 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 member 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, NCSC 		pays CFC a fee in exchange for which CFC reimburses NCSC for loan 		losses, excluding losses in the consumer loan program. CFC does not 		control the election of directors to the NCSC board. NCSC is a service 		organization member of CFC.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
RTFC 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, 2006, CFC had guaranteed $228 million of 		NCSC debt with third parties. These guarantees are not included in Note 		12 at May 31, 2006 as the debt that CFC had guaranteed is reported as 		debt of the Company. At May 31, 2006, CFC had no guarantees of RTFC debt 		to third party creditors. All CFC loans to RTFC and NCSC are secured by 		all assets and revenues of RTFC and NCSC. At May 31, 2006, RTFC had 		total assets of $2,372 million including loans outstanding to members of 		$2,162 million and NCSC had total assets of $444 million including loans 		outstanding of $404 million. At May 31, 2006, CFC had committed to lend 		RTFC up to $10 billion, of which $2,146 million was outstanding. At May 		31, 2006, CFC had committed to provide credit to NCSC of up to $1 		billion. At May 31, 2006, CFC had provided a total of $430 million of 		credit to NCSC, representing $202 million of outstanding loans and $228 		million of credit enhancements.
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. CFC presents these companies in one line on the consolidated 		balance sheets and the consolidated statements of operations.
On June 1, 2003, as a result of the consolidation of 		RTFC and NCSC, 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 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.
Unless stated otherwise, references to 		the Company relate to the consolidation of CFC, RTFC, NCSC and certain 		entities controlled by CFC and created to hold foreclosed 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.
(d) Allowance for Loan Losses
The Company maintains an allowance for 		loan losses at a level estimated by management to provide adequately for 		probable losses inherent in the loan portfolio, which are estimated 		based upon a review of the loan portfolio, past loss experience, 		specific problem loans, economic conditions and other pertinent factors 		which, in management's judgment, deserve current recognition in 		estimating loan losses. On a quarterly basis, the Company prepares an 		analysis of the adequacy of the loan loss allowance and makes 		adjustments to the allowance as necessary. The allowance is based on 		estimates and, accordingly, actual loan losses may differ from the 		allowance amount.
Management makes recommendations of loans 		to be written off to the board of directors of CFC. In making its 		recommendation to write off all or a portion of a loan balance, 		management considers various factors including cash flow analysis and 		collateral securing the borrower's loans.
Activity in the loan loss allowance 		account is summarized below for the years ended May 31:
(in thousands)
Balance at beginning of year
$
589,749
$
573,939
$
511,463
Provision for loan losses
23,240
16,402
54,921
Change due to consolidation (1)
-
-
6,029
Write-offs
(2,197
)
(1,354
)
(2,639
)
Recoveries
4,165
Balance at end of year
$
611,443
$
589,749
$
573,939
(1) Represents the impact of 		consolidating NCSC including the increase to the 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.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
(e) Non-performing Loans
CFC classifies a borrower as 		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.
Once a borrower is classified as 		non-performing, CFC typically places the loan on non-accrual status and 		reverses all accrued and unpaid interest back to the date of the last 		payment. CFC generally applies all cash received during the non-accrual 		period 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, Accounting by Creditors for Impairment of a Loan 		- an Amendment of SFAS 5 and SFAS 15, as amended. Loss reserves are 		specifically allocated based on the calculated impairment.
(g) Fixed Assets
Buildings, furniture and fixtures and 		related equipment are stated at cost less accumulated depreciation and 		amortization of $8 million and $24 million as of May 31, 2006 and 2005, 		respectively. Depreciation expense ($2 million, $4 million and $3 		million in fiscal years 2006, 2005 and 2004, 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 consolidated balance sheets as 		foreclosed assets. It is CFC's intent to sell the foreclosed assets, 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 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 and foreign currency 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, CFC records derivative instruments on the 		consolidated balance 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 of the consolidated 		statements of operations unless specific hedge accounting criteria are 		met. The change to the fair value is recorded to other comprehensive 		income if cash flow hedge accounting criteria are met. In the case of 		certain foreign currency exchange agreements that meet hedge accounting 		criteria, the change in fair value is recorded to other comprehensive 		income and then reclassified to offset the related change in the dollar 		value of foreign denominated debt in the consolidated statements of 		operations. CFC formally documents, designates, and assesses the 		effectiveness of transactions that receive hedge accounting.
Net settlements for derivative instruments that 		qualify for hedge accounting are recorded in 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 cost of funds.
Upon implementation on June 1, 2001, CFC recorded 		transition adjustments as required by SFAS 133. Part of the adjustment 		recorded in other comprehensive loss totaling $62 million will be 		amortized into earnings over the remaining life of the interest rate 		exchange agreements.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
(j) Guarantee Liability
CFC guarantees certain 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 or modified 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.
(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.
(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 		guarantee liability.
(n) Operating Income
Operating income includes the following for the years ended May 31:
(1) Represents interest income on loans 		to members.
(2) Represents interest income on the 		investment of cash.
(3) Conversion fees are deferred and 		recognized using 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.
(4) Make-whole and prepayment fees are 		charged for the early repayment of principal in full and recognized when 		collected.
(5) Commitment 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.
(6) 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 into operating income over 		the life of the guarantee.
(7) Other fees include late payment fees 		charged on late loan payments and recognized when collected and other 		fees associated with syndication of loans that are deferred and 		amortized using the straight-line method. Additionally, other fees 		includes loan origination fees that are deferred and amortized over the 		life of the facility as a reduction to operating income using the 		straight-line method which approximates the interest method.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
Fees totaling $6 million, $8 million and $56 million 		were deferred during the years ended May 31, 2006, 2005 and 2004, 		respectively. At May 31, 2006 and 2005, the Company had deferred 		conversion fees totaling $37 million and $51 million, respectively. 		
(o) Cost of Funds
Cost of funds includes the following for 		the years ended May 31:
(p) Income Tax Expense
CFC does not pay income taxes. RTFC takes 		a deduction for the amount of the net margin that it allocates to its 		members. Currently about 99% of the RTFC net margin is allocated to its 		members.
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, 2006, 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.
(q) 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.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
(r) Comprehensive Income
Comprehensive income includes the 		Company's net margin, as well as other comprehensive income related to 		derivatives. Comprehensive income for the years ended May 31, 2006, 2005 		and 2004 is calculated as follows:
(s) Operating Lease Obligations
On October 18, 2005, the Company entered 		into an agreement to lease 107,228 square feet of office, meeting and 		storage space in two office buildings located in Herndon, Virginia. The 		lease is for three years, terminating on October 17, 2008. The Company 		has the option to extend the lease for two additional one-year periods 		with terms similar to the initial three-year lease. The Company had 		previously owned these two buildings which were sold at the initiation 		of the agreement (see Note 15).
The following represents the future 		minimum lease payments due for the years ended May 31:
Contingent rental payments may be due if 		the building operating expenses exceed the base year amount included in 		the lease agreement. The Company would be required to pay contingent 		rental payments based on the amount of space leased in the building 		divided by total rentable space in the building times the amount that 		operating expenses exceeded the base year amount in the lease agreement. 		To date, the Company has not been required to make contingent rental 		payments.
The Company recognizes rental expense on 		a straight-line basis, which requires taking the total scheduled 		payments and dividing by the number of months in the lease term. During 		the year ended May 31, 2006, the Company recognized rental expense of $2 		million.
(t) Use of Estimates
The preparation of financial statements 		in conformity with U.S. generally accepted 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.
(u) Reclassifications
Certain reclassifications of prior year 		amounts have been made to conform to the current reporting format.
At May 31, 2006, CFC discontinued 		reclassifying amounts from short-term debt to long-term debt based on 		its ability to borrow on a long-term basis under its committed revolving 		credit agreements. In order to conform to the current year presentation, 		the Company reclassified amounts at May 31, 2005 resulting in an 		increase to notes payable and a decrease to long-term debt of $5 		billion. The changes are offsetting and do not result in an adjustment 		to liabilities and total equity on the consolidated balance sheet or to 		the net change in cash and cash equivalents for the year ended May 31, 		2005.
At May 31, 2006, CFC discontinued netting 		amounts related to its interest receivable and interest payable for 		foreign denominated debt and derivative instruments. In order to conform 		to the current year presentation, the Company reclassified amounts at 		May 31, 2005 resulting in an increase to both the accrued interest and 		other receivables and the accrued interest payable recorded on the 		consolidated balance sheet of $14 million. The changes are offsetting and do not 		result in a net change in cash and cash equivalents for the years ended 		May 31, 2005 and 2004.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
(2) Loans and Commitments
Loans to members bear interest at rates 		determined from time to time by the Company after considering 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, the Company's policy is to set 		interest rates at the lowest levels it considers to be consistent with 		sound financial management.
Loans outstanding to members, weighted average 		interest rates thereon and unadvanced commitments by loan type and by 		segment are summarized as follows at May 31:
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
(1) Unadvanced loan commitments are 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.
Loan origination costs are deferred and amortized 		using the straight-line method, which approximates the interest method, 		over the life of the loan as a reduction to operating income. At May 31, 		2006 and 2005, the balance for deferred loan origination costs related 		to loans outstanding totaled $3 million and $2 million, respectively.
Credit Concentration
The Company's loan portfolio is widely dispersed 		throughout the United States and its territories, including 48 states, 		the District of Columbia, American Samoa and the U.S. Virgin Islands. At 		May 31, 2006 and 2005, 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, the Company limits its 		exposure to any one borrower. At May 31, 2006 and 2005, the total 		exposure outstanding to any one borrower or controlled group did not 		exceed 3.0% of total loans and guarantees outstanding. At May 31, 2006, 		the ten largest borrowers included four distribution systems, five power 		supply systems and one telecommunications systems. At May 31, 2005, the 		ten largest borrowers included four distribution systems, three power 		supply systems and three telecommunications systems. The following chart 		shows the exposure to the ten largest borrowers as a percentage of total 		exposure at May 31:
In general, 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 		intermediate-term and short-term loans is the prevailing bank prime rate plus 1% per annum; on RTFC short-term loans, the prevailing bank prime rate plus 11/2% 		per annum; and on NCSC short-term loans, the prevailing bank prime rate 		plus 1% per annum.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
Loan Repricing
Long-term fixed rate loans outstanding at May 31, 		2006, which will be subject to the repricing of their interest rates 		during the next five fiscal years are summarized as follows (due to 		principal repayments, amounts subject to interest rate repricing may be 		lower at the actual time of interest rate repricing):
(1) Represents scheduled amortization 		based on current rates without consideration for loans that reprice. 		Excludes non-performing loans for which the scheduled amortization 		cannot be estimated.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
Concurrent Loans
CFC 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, 2006 and 2005, CFC had $2,563 million and $2,681 million 		outstanding, respectively, of loans issued on a concurrent basis with 		RUS.
Pledging of Loans
As of May 31, 2006 and 2005, distribution system 		mortgage notes related to outstanding long-term loans totaling $5,472 		million and $7,293 million, respectively, and RUS guaranteed loans 		qualifying as permitted investments totaling $223 million and $218 		million, respectively, 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, 2006 and 2005.
As of May 31, 2006, distribution system mortgage 		notes related to outstanding long-term loans totaling $574 million were 		pledged as collateral to secure CFC's notes to Federal Agricultural 		Mortgage Corporation ("Farmer Mac") issued in July 2005 and due in 2008.
In addition to the loans pledged as collateral at May 		31, 2006, CFC had $2,302 million of mortgage notes on deposit with the 		trustee for the $2 billion of notes payable to the Federal 		Financing Bank ("FFB") of the United States Treasury (see Note 5). There 		are certain rating triggers related to the $2 billion of notes payable 		to the FFB that would result in the mortgage notes being pledged as 		collateral rather than held on deposit.
The entire $2 billion of notes payable to the FFB 		contain a rating trigger related to the Company's senior secured credit 		ratings from Standard & Poor's Corporation, Moody's Investors Service and 		Fitch Ratings (see chart on page 42). A rating trigger event exists if 		the Company's senior secured debt does not have at least two of the 		following ratings: (i) A- or higher from Standard & Poor's Corporation, 		(ii) A3 or higher from Moody's Investors Service, (iii) A- or higher 		from Fitch Ratings and (iv) an equivalent rating from a successor rating 		agency to any of the above rating agencies. If the Company's senior 		secured credit ratings fall below the levels listed above, the total 		$2,302 million of mortgage notes would be pledged as collateral rather 		than held on deposit.
A total of $1 billion of notes payable to the FFB has 		a second rating trigger related to the appointment of a financial expert 		to the Company's board of directors. A rating trigger event will exist 		if CFC does not have a financial expert (as defined by Section 407 of 		the Sarbanes-Oxley Act of 2002) appointed to serve on the audit 		committee of its board of directors by thirty days after the CFC March 		2007 annual meeting through the tenor of the bonds or if the financial 		expert position remains vacant for more than 90 consecutive days after 		the initial appointment. If the Company does not satisfy the financial 		expert rating trigger, $1,171 million of mortgage notes would be pledged 		as collateral rather than held on deposit.
RUS Guaranteed Loans
At May 31, 2006 and 2005, CFC had a total of $261 		million and $258 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, 2006 and 		2005, CFC had a total of $38 million and $40 million, respectively, 		under a program in which RUS previously allowed certain qualifying 		cooperatives to repay loans held by the FFB early and allowed the 		transfer of the guarantee to the new lender. At May 31, 2006 and 2005, 		CFC had a total of $223 million and $218 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
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. At May 31, 		2006, the balance of foreclosed assets included real estate developer 		notes receivable and limited partnership interests in certain real 		estate developments. At May 31, 2005, the balance of foreclosed assets 		also included partnership interests in real estate properties. CFC 		operated the real estate properties before selling such properties in 		August 2005 for $30 million resulting in a gain of $4 million included 		in the results of operations of foreclosed assets during the year ended 		May 31, 2006. CFC continues to service the notes receivable.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
The activity for foreclosed assets is summarized 		below for the years ended May 31:
(4) Short-Term Debt and Credit 		Arrangements
The following is a summary of short-term 		debt and the weighted average interest rates thereon at May 31:
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.
Foreign Denominated Short-Term Debt
Included in short-term debt at May 31, 2006 and 2005 		are medium-term notes due within one year that are denominated in a 		foreign currency. At the time of issuance of short-term debt denominated 		in a foreign currency, CFC enters into a cross currency or cross 		currency interest rate exchange agreement to fix the exchange rate on 		all principal and interest payments through maturity. The foreign 		denominated short-term 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 reported value of the foreign denominated short-term 		debt. The adjustment to the reported value of the short-term debt on the 		consolidated balance sheets is also reported on the consolidated 		statements of operations as foreign currency adjustments. As a result of 		entering cross currency and cross currency interest rate exchange 		agreements, the adjusted short-term debt value at the reporting date 		does not represent the amount that CFC will ultimately pay to retire the 		short-term debt, unless the counterparty to the exchange agreement does 		not perform as required under the agreement.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
Revolving Credit Agreements
The following is a summary of the Company's revolving 		credit agreements at May 31:
		(Dollar amounts in thousands)
		Termination Date
Facility fee per 		
		annum (1)
364-day agreement (2)
$
1,025,000
$
-
March 21, 2007
0.05 of 1%
Five-year agreement
1,025,000
-
March 22, 2011
0.06 of 1%
Five-year agreement
1,975,000
1,975,000
March 23, 2010
0.09 of 1%
Three-year agreement
-
1,740,000
March 30, 2007
0.10 of 1%
364-day agreement (2)
-
1,285,000
March 22, 2006
0.07 of 1%
Total
$
4,025,000
$
5,000,000
(1) Facility fee determined by CFC's 		senior unsecured credit ratings based on the pricing schedules put in 		place at the initiation of the related agreement.
(2) Any amount outstanding under these 		agreements may be converted to a one-year term loan at the end of the 		revolving credit periods. If converted to a term loan, the fee on the 		outstanding principal amount of the term loan is 0.10 of 1% per annum.
Up-front fees of between 0.05 and 0.13 of 		1% were paid to the banks based on their commitment level to the 		five-year agreements in place at May 31, 2006, totaling in aggregate $3 		million, which will be amortized on a straight-line basis over the life 		of the agreements. No upfront fees were paid to the banks for their 		commitment to the 364-day facility. Each agreement contains a provision 		under which if borrowings exceed 50% of total commitments, a utilization 		fee must be paid on the outstanding balance. The utilization fees are 		0.05 of 1% for the five-year agreement terminating on March 22, 2011 and 		the 364-day agreement terminating on March 21, 2007 and 0.10 of 1% for the five-year agreement 		terminating on March 23, 2010.
Effective May 31, 2006 and 2005, the 		Company was in compliance with all covenants and conditions under its 		revolving credit agreements in place at that time and there were no 		borrowings outstanding under such agreements.
For the purpose of calculating the 		required financial covenants contained in its revolving credit 		agreements, the Company adjusts net margin, senior debt and total equity 		to exclude the non-cash adjustments related to SFAS 133 and 52. The 		adjusted times interest earned ratio ("TIER"), as defined by the 		agreements, represents the cost of funds adjusted to include the 		derivative cash settlements, plus minority interest net margin, plus net 		margin prior to the cumulative effect of change in accounting principle 		and dividing that total by the cost of funds adjusted to include the 		derivative cash settlements. In addition to the non-cash adjustments 		related to SFAS 133 and 52, senior debt also excludes RUS guaranteed 		loans, subordinated deferrable debt, members' subordinated certificates 		and minority interest. Total equity is adjusted to include subordinated 		deferrable debt, members' subordinated certificates and minority 		interest. 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.
The following represents the Company's 		required and actual financial ratios under the revolving credit 		agreements at or for the year ended May 31:
(1) The Company must meet this requirement in 		order to retire patronage capital.
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, but CFC must be 		in compliance with their other requirements, including financial ratios, 		in order to draw down on the facilities.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
(5) Long-Term Debt
The following is a summary of long-term 		debt and the weighted average interest rates thereon at May 31:
The principal amount of medium-term notes, collateral 		trust bonds and long-term notes payable maturing in each of the five 		fiscal years following May 31, 2006 and thereafter is as follows:
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
Collateral trust bonds are secured by the pledge of 		mortgage notes or eligible securities in an amount at least equal to the 		principal balance of the bonds outstanding. See Note 2 for additional 		information on the collateral pledged to secure the Company's collateral 		trust bonds. Medium-term notes are unsecured obligations of CFC.
Unsecured Notes Payable
During the quarter ended November 30, 2005, CFC 		received advances totaling $500 million and during the quarter ended 		February 28, 2006, CFC received the remaining advances totaling $500 		million of a $1 billion loan facility under a bond purchase agreement 		with the FFB and a bond guarantee agreement with RUS as part of the 		funding mechanism for the Rural Economic Development Loan and Grant 		("REDLG") program. In July 2005, CFC submitted a second application for 		an additional $1.5 billion facility which closed in April 2006. In May 		2006, CFC received an advance of $1 billion on this second facility. As 		part of the REDLG 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, 2006, CFC had a total of $2.6 billion outstanding on loans 		issued concurrently with RUS. As part of the REDLG program, CFC will pay 		a fee of 30 basis points per annum on the total amount borrowed to RUS. 		The $2 billion of unsecured notes payable issued as part of the REDLG 		program require CFC to place on deposit mortgage notes in an amount at 		least equal to the principal balance of the notes outstanding. See Note 		2 for additional information on the mortgage notes held on deposit.
Secured Notes Payable
In July 2005, the Company sold $500 million of 4.656% 		notes to Farmer Mac due in 2008. The $500 million of secured notes 		payable sold to Farmer Mac are secured by the pledge of mortgage notes 		in an amount at least equal to the principal balance of the notes 		outstanding. See Note 2 for additional information on the collateral 		pledged to secure the Company's notes payable.
Foreign Denominated Debt
Included in long-term debt at May 31, 		2005 are medium-term notes that are denominated in a foreign currency. 		At the time of issuance for medium-term notes denominated in a foreign 		currency, CFC enters into a cross currency or cross currency interest 		rate exchange agreement to fix the exchange rate on all principal and 		interest payments through maturity. The foreign denominated long-term 		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 long-term debt. The adjustment to the 		value of the long-term debt on the consolidated balance sheets is also 		reported on the consolidated statements of operations as foreign 		currency adjustments. As a result of entering cross currency and cross 		currency interest rate exchange agreements, the adjusted long-term debt 		value at the reporting date does not represent the amount that CFC will 		ultimately pay to retire the long-term debt, unless the counterparty to 		the exchange agreement does not perform as required under the agreement.
(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:
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
(7) Derivative Financial Instruments
The Company is neither a dealer nor a 		trader in derivative financial instruments. The Company uses interest 		rate, cross currency and cross currency interest rate exchange 		agreements to manage its interest rate risk and foreign currency exchange risk.
Interest Rate Exchange Agreements
Generally, the Company's interest rate 		exchange agreements do not qualify for hedge accounting under SFAS 133. 		The majority of the 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 used as the cost basis 		in setting the 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. The Company's 		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 was a party to the following 		interest rate exchange agreements at May 31:
Consistent with SFAS 133, as amended, the Company 		records derivative instruments on the consolidated balance sheet 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 statement of operations unless 		specific hedge accounting criteria are met. The change to the fair value 		is either recorded to other comprehensive income or the cost of funds, 		depending on whether the interest rate exchange agreement qualifies as 		an effective hedge. Net settlements paid and received for derivative 		instruments that qualify for hedge accounting are recorded in cost of 		funds. Net settlements related to derivative instruments that do not 		qualify for hedge accounting are recorded as derivative cash settlements 		in the consolidated statement of operations. The Company formally 		documents, designates, and assesses the effectiveness of transactions 		that receive hedge accounting.
The Company has classified cash activity associated 		with derivatives as an operating activity in the consolidated statements 		of cash flows.
Interest rate exchange agreements had the following 		impact on the Company for the years ended May 31:
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
Cash settlements includes income of $61 million and 		$65 million during the years ended May 31, 2006 and 2005, respectively, 		related to the periodic amounts that were paid and received related to 		its interest rate exchange agreements. During the years ended May 31, 		2006 and 2005, cash settlements also includes $1 million of fees 		received from and $22 million of fees paid, respectively, to 		counterparties for the Company's termination of agreements. These 		agreements were terminated due to the prepayment of RTFC loans during 		the years ended May 31, 2006 and 2005, respectively, the proceeds of 		which were used to pay down the underlying debt for the terminated 		interest rate exchange agreements. There were no fees received 		from or paid to counterparties for the termination of agreements during 		the year ended May 31, 2004.
For the years ended May 31, 2006 and 2005, the 		derivative forward value also includes amortization of $0.4 million and 		$16 million, respectively, related to the transition adjustment recorded 		as an other comprehensive loss on June 1, 2001, the date the Company 		implemented SFAS 133. The transition adjustment will be amortized into 		earnings over the remaining life of the related interest rate exchange 		agreements. Approximately $(0.8) million is expected to be amortized 		over the next twelve months related to the transition adjustment and 		will continue through April 2029.
Cross Currency and Cross Currency Interest Rate 		Exchange Agreements
At May 31, 2006 and 2005, the Company was a party to 		the following cross currency and cross currency interest rate exchange 		agreements.
The Company entered into the cross currency and cross 		currency interest rate exchange agreements related to the issuance of 		medium-term notes denominated in Euros and Australian dollars. In 		addition to foreign currency exchange, the agreements that do not 		qualify for hedge accounting also synthetically change the interest rate 		from a 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. 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%. Under this 		criteria, the agreements do not qualify for hedge treatment, therefore 		all changes in fair value are recorded in the consolidated statements of 		operations.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 		CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 		(Continued)
Cross currency and cross currency interest rate 		exchange agreements had the following impact on the Company for the 		years ended May 31:
Rating Triggers
The Company has certain interest rate, cross 		currency, and cross currency interest rate exchange agreements that 		contain a provision called a rating trigger. Under a 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 rating triggers contained in certain of 		the Company's derivative contracts are based on its senior unsecured 		credit rating from Standard & Poor's Corporation and Moody's Investors 		Service (see chart on page 42).
At May 31, 2006, the Company has the following 		notional amount and fair values associated with exchange agreements that 		contain rating triggers. For the purpose of the presentation, the 		Company has grouped the rating triggers into two categories, (1) ratings 		from Moody's Investors Service falls to Baa1 or from Standard & Poor's 		Corporation falls to BBB+ and (2) ratings from Moody's Investors Service 		falls below Baa1 or from Standard & Poor's Corporation falls below BBB+.
(in thousands)
		Rating Level:
		Notional Amount
		Required Company Payment
Amount Company Would Collect
		Total
Fall to Baa1/BBB+
$
1,096,874
$
(2,080)
$
47,097
$
45,017
Fall below Baa1/BBB+
8,908,022
(70,924)
393,038
322,114
Total
$
10,004,896
$
(73,004)
$
440,135
$
367,131
(8) Members' Subordinated Certificates
Membership Subordinated Certificates
To join CFC and to establish eligibility 		to borrow, CFC members (other than service organizations and 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.
Loan and Guarantee Subordinated Certificates
Members obtaining long-term loans, certain 			intermediate-term loans or guarantees are generally required to 			purchase additional loan or guarantee subordinated certificates with 			each such loan or guarantee based on the members' CFC debt to equity 			ratio. These certificates are unsecured, subordinated debt of the 			Company.
Certificates currently purchased in conjunction 			with long-term loans are generally 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. CFC associates and RTFC members are 			required to purchase loan subordinated certificates of 10% of each 			long-term loan 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.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
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 non-interest bearing 			debt service reserve subordinated certificates in connection with 			CFC's guarantee of long-term tax-exempt bonds (see Note 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:
Membership subordinated certificates generally 			mature in 100 years from issuance. The weighted average maturity for 			membership subordinated certificates outstanding at May 31, 2006 and 			2005 was 70 years and 71 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.
(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 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
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
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 of directors authorized 			the retirement of $71 million of allocated margins in July 2005, 			representing 70% of the allocated margin for fiscal year 2005 and 			one-ninth of the allocated margins for fiscal years 1991, 1992 and 			1993. This amount was retired in August 2005. Under current policy, 			the remaining 30% of the fiscal year 2005 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).
In July 2006, CFC's board of 			directors authorized the allocation of the fiscal year 2006 adjusted 			net margin as follows: $0.8 million to the education fund and $95 			million to members in the form of patronage capital. The board of 			directors also authorized the allocation of $7 million from the 			members' capital reserve. In July 2006, CFC's board of directors 			authorized the retirement of allocated margins totaling $84 million, 			representing 70% of the fiscal year 2006 allocation and one-ninth of 			the fiscal years 1991, 1992 and 1993 allocated margins. This amount 			will be returned to members in cash at the end of August 2006. 			Future allocations and retirements of margins will be made annually 			as determined by CFC's board of directors with due regard for CFC's 			financial condition. The board of directors for CFC has the 			authority to change the policy for allocating and retiring net 			margins at any time, subject to applicable cooperative law.
At May 31, 2006 and 2005, equity included the 			following components:
(1) Represents the derivative forward 			value gain recorded by CFC for the period.
(11) Employee Benefits
CFC is a participant in the National 			Rural Electric Cooperative Association ("NRECA") Retirement Security 			Plan. This plan is available to all qualified CFC employees. Under 			the 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 plan. CFC contributed $3.0 million, $2.8 million and $2.5 			million to the Retirement Security Plan during fiscal years 2006, 			2005 and 2004, 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 $220,000 for calendar year 2006 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 for the Retirement Security Plan 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
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
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 has paid such additional benefits to the 			covered employee through two components of the Pension Restoration 			Plan, a Severance Pay Plan and a Deferred Compensation Plan. Under 			the Severance Pay Plan, the employee was paid an amount equal to the 			lost pension benefits but not exceeding twice the employee's annual 			compensation for the prior year. The benefit was paid within 24 			months of termination of employment. To the extent that the 			Severance Pay Plan could not pay all of the lost pension benefits, 			the remainder was paid under a Deferred Compensation Plan in a lump 			sum or in installments of up to 60 months.
The Severance Pay Plan component of the Pension 			Restoration Plan has been eliminated effective January 1, 2005. Any 			benefit earned prior to December 31, 2004 will be held for the 			employee and will be paid out as outlined above. Benefits earned as 			of January 1, 2005, however, will be paid solely under the Deferred 			Compensation component of the Pension Restoration Plan, which 			carries a substantial risk of forfeiture.
As of December 31, 2005, the NRECA Retirement 			Security Plan meets the ERISA standards for a funded plan and CFC 			was current with regard to its obligations to NRECA, the plan 			provider.
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.
The Company guarantees certain 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 the Company performs 			under its guarantee. At May 31, 2006 and 2005, the Company had 			recorded a guarantee liability totaling $17 million and $16 million, 			respectively, which represents the contingent and non-contingent 			exposure related to guarantees of members' debt obligations. The 			contingent guarantee liability at May 31, 2006 and 2005 totaled $15 			million and $16 million, respectively, based on management's 			estimate of exposure to losses within the guarantee portfolio. The 			Company uses factors such as internal 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 $2 million and less than 			$1 million, respectively, at May 31, 2006 and 2005 relates to the 			Company's non-contingent obligation to stand ready to perform over 			the term of its guarantees that it has entered into or modified 			since January 1, 2003 in accordance with FIN 45. The 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 			deferred fees of $2 million, $0.6 million and $0.8 million for the 			years ended May 31, 2006, 2005 and 2004, respectively, related to 			new guarantees issued during the periods. Activity in the guarantee 			liability account is summarized below for the years ended May 31:
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
The following chart summarizes total guarantees 			by type and segment at May 31:
(1) The maturities for this 			type of guarantee run through 2026. CFC has guaranteed debt issued 			in connection with the construction or acquisition 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 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, $572 million and $692 million as of May 31, 2006 and 2005, 			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, 2006, CFC's maximum potential exposure for 			the $36 million of fixed rate tax-exempt bonds is $46 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) All obligations for this 			type of guarantee have been released. CFC had guaranteed rent 			obligations to a third party. In the event of default by the system 			for non-payment of debt service, CFC was obligated to pay any 			required amounts under its guarantees to prevent the acceleration of 			the debt obligation. The system was required to repay, on demand, 			any amount advanced by CFC and interest thereon pursuant to the 			documents evidencing the system's reimbursement obligation. Amounts 			were secured by the property leased, the owner's rights as lessor 			and, in some instances, all assets of the lessee.
(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 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 2017. Additionally, letters of credit 			totaling $12 million at May 31, 2006 have a term of one year and 			automatically extend for a period of one year unless the Company 			cancels the agreement within 120 days of maturity (in which case, 			the beneficiary may draw on the letter of credit). 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 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 the Company within one year from the date of the 			draw. Interest would accrue from the date of the draw at 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, 2006, the Company's maximum potential 			exposure is $272 million, of which $201 million is secured. 			Additionally, in the event of default for $26 million of secured 			NCSC letters of credit, NCSC is only liable for 40% of the amount 			guaranteed due to a reimbursement obligation agreement for the 			remaining 60%. Security provisions include a mortgage lien on all of 			the system's assets, future revenues, and the system's commercial 			paper invested at the Company. In addition to the letters of credit 			listed in the table, under master letter of credit facilities, the 			Company may be required to issue up to an additional $217 million in 			letters of credit to third parties for the benefit of its members at 			May 31, 2006. At May 31, 2005, this amount was $212 million.
(5) The maturities for this 			type of guarantee run through 2056. CFC provides other guarantees 			for its members. In the event of default by a system for 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 $75 million at May 31, 2006, $3 			million is secured by a mortgage lien on all of the system's assets 			and future revenues and the remaining $72 million is unsecured. 			
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED 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, 2006:
At May 31, 2006 and 2005, CFC had a total of $144 			million and $98 million of guarantees, representing 13% and 8% of 			total guarantees, respectively, under which its right of recovery 			from its members was not secured.
(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, 2006 and 			2005. The estimated fair value information presented is not 			necessarily indicative of amounts the Company could realize 			currently in a market sale since 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, 2006; 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, 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, 2006 and 2005.
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 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 non-performing and restructured loans, 			are valued using a discount rate commensurate with the risk 			involved. Loans with interest rate repricing scheduled within 90 			days of year end are valued at carrying value, 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.
Debt Service Reserve Funds
The Company considers the carrying 			value of debt service reserve funds to be equal to fair value. Debt 			service reserve funds represent cash or short-term investments on 			deposit with the trustee of collateral trust bonds and thus carrying 			value is considered to be equal to fair value.
Short-Term Debt
Short-term debt consist of commercial 			paper, bank bid notes and other debt due within one year. The fair 			value of short-term debt with maturities greater than 90 days is 			estimated based on quoted market rates for debt with similar 			maturities. The fair value of short-term debt with maturities less 			than or equal to 90 days 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 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 FINANCIAL STATEMENTS - 			(Continued)
Long-term debt with a variable interest rate is 			valued at carrying value, which approximates fair value since rates 			may be adjusted every 30 days.
Subordinated Deferrable Debt
The fair value of subordinated deferrable debt is 			estimated based on published market prices.
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 the Company; many have original maturities of 70 to 			100 years. These certificates are issued to 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
Derivative instruments are recorded in the 			consolidated balance sheets at fair value. The fair value of the 			interest rate and cross currency interest rate exchange agreements 			is estimated taking into account the expected future market rate of 			interest and the current creditworthiness of the exchange 			counterparties. The fair value of 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
It is impracticable to supply fair value 			information related to guarantees based on market comparisons as 			there is no other company that provides guarantees to rural electric 			utility companies from which to obtain market rate information. 			Additionally, the demand for CFC guarantees has been insignificant 			in the last few years. The fair value of CFC's guarantees shown 			is based on the amount recorded as a guarantee liability which 			represents CFC's contingent and non-contingent exposure related to 			its guarantees.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
Carrying and fair values as of May 31, 2006 and 			2005 are presented as follows:
(1) The carrying value represents 			CFC's exposure related to its guarantees and therefore will not 			equal total guarantees shown in Note 12.
The Company had the following loans classified as 			non-performing and restructured at May 31:
(in thousands)
Non-performing loans
$
577,869
$
616,626
Restructured loans
630,354
600,926
Total
$
1,208,223
$
1,217,552
(a) During the year ended May 31, 2006 and 2005, 			all loans classified as non-performing were on a non-accrual status 			with respect to the recognition of interest income. At May 31, 2006 			and 2005, $569 million and $594 million, respectively, of 			restructured loans were on non-accrual status with respect to the 			recognition of interest income. A total of $1 million and $0.3 			million of interest income was accrued on restructured loans during 			the year ended May 31, 2006 and 2005.
Interest income was reduced as follows as a 			result of holding loans on non-accrual status for the years ended 			May 31:
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
(b) The Company classified $1,201 			million and $1,208 million of loans as impaired pursuant to the 			provisions of SFAS 114 at May 31, 2006 and 2005, respectively. The 			Company reserved $447 million and $404 million of the loan loss 			allowance for such impaired loans at May 31, 2006 and 2005, 			respectively. The amount included in the loan loss allowance 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 based on a review of 			the terms of the restructure agreement and borrower performance. The 			Company accrued a total of $1 million of interest income on impaired 			loans for the year ended May 31, 2006. The Company did not accrue 			interest income on loans classified as impaired during the year 			ended May 31, 2005. The average recorded investment in impaired 			loans for the year ended May 31, 2006 and 2005 was $1,162 million 			and $992 million, respectively.
The Company updates impairment 			calculations on a quarterly basis. Since a borrower's original 			contract rate may include a variable rate component, calculated 			impairment could vary with changes to the Company's variable rate, 			independent of a borrower's underlying financial performance or 			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) At May 31, 2006 and 2005, CFC had 			a total of $569 million and $594 million, respectively, of loans 			outstanding to Denton County Electric Cooperative, d/b/a CoServ 			Electric ("CoServ"), a large electric distribution cooperative 			located in Denton County, Texas, that provides retail electric 			service to residential and business customers. All loans have been 			on non-accrual status since January 1, 2001. Total loans to CoServ 			at May 31, 2006 and 2005 represented 2.9%, respectively, of the 			Company's total loans and guarantees outstanding.
Under the terms of a bankruptcy 			settlement, CFC restructured its loans to CoServ. CoServ is 			scheduled to make quarterly payments to CFC through December 2037. 			As part of the restructuring, CFC may be obligated to provide up to 			$200 million of senior secured capital expenditure loans to CoServ 			for electric distribution infrastructure through December 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 to the quarterly payments 			that CoServ is required to make to CFC. As of May 31, 2006, 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 on or after December 13, 2007 and for $405 million 			plus an interest payment true up on or after December 13, 2008.
CoServ and CFC have no claims related 			to any of the legal actions asserted prior to or during the 			bankruptcy proceedings. CFC's legal claim against CoServ is 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, 2006.
(d) VarTec Telecom, Inc. ("VarTec") 			is a telecommunications company and RTFC borrower located in Dallas, 			Texas. RTFC is VarTec's principal senior secured creditor. At May 			31, 2006 and 2005, RTFC had a total of $90 million and $135 million, 			respectively, of loans outstanding to VarTec. At May 31, 2006 and 			2005, all loans to VarTec were on non-accrual status, resulting in 			the application of all payments received against principal.
VarTec and 16 of its U.S.-based 			affiliates, which were 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. 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 proceeds from the closing of the Domestic Assets Sale 			were received in June 2006 totaling $40 million. Pursuant to court 			order, all net proceeds of asset sales, including the Domestic 			Assets Sale, have been provisionally applied to RTFC's secured 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. On June 19, 2006, the Chapter 11 proceedings 			were converted to Chapter 7 proceedings and a Chapter 7 trustee was 			appointed for each of the estates.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
On June 10, 2005, the Official 			Committee of Unsecured Creditors (the "UCC") initiated an adversary 			proceeding against RTFC in the United States Bankruptcy Court for 			the Northern District of Texas, Dallas Division. As a result of the 			conversion of the proceedings to Chapter 7, the UCC has been 			dissolved and the Chapter 7 trustee is now the plaintiff in the 			adversary proceedings. 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 December 16, 2005, the Court issued an order dismissing 			the "deepening insolvency" claim against RTFC. Trial, if necessary, 			on the merits of the remaining claims is currently scheduled for 			March 5, 2007. The trial date is subject to change.
On October 14, 2005, the Bankruptcy 			Court approved an administrative DIP facility from RTFC in the 			amount of $9 million, of which $9 million was outstanding as of May 			31, 2006. The DIP facility was extended on March 17, 2006, but RTFC 			has no obligation to fund beyond those budgeted expenses which 			accrued prior to June 15, 2006. However, RTFC may consider providing 			the estate with further DIP funding to pursue the collection of 			various claims.
Based on its analysis, the Company 			believes that it is adequately reserved for its exposure to VarTec 			at May 31, 2006.
(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, 2006 and 2005, RTFC had 			$488 million and $475 million, respectively, in loans outstanding to 			ICC. All loans to ICC have been on non-accrual status since February 			1, 2005. ICC has not made debt service payments to the Company since 			June 2005.
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, 			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 certain 			of its parent entities, including ICC's immediate parent, Emerging 			Communication, Inc., a Delaware corporation ("Emcom") and Emcom's 			parent, Innovative Communication Company LLC, a Delaware limited 			liability company ("ICC-LLC"), and (iv) a personal guaranty of the 			loans from ICC's indirect majority shareholder and chairman, Jeffrey 			Prosser ("Prosser").
Beginning on June 1, 			2004, RTFC filed a series of lawsuits against ICC, Prosser and 			others for failure to comply with the terms of ICC's loan agreement 			with RTFC dated August 27, 2001 as amended on April 4, 2003 			(hereinafter, the "RTFC Lawsuits"). In response to the RTFC 			Lawsuits, ICC, Vitelco and Prosser denied liability and asserted 			claims, by way of counterclaim and by filing its own lawsuits 			against RTFC, CFC and certain of RTFC's officers, seeking various 			remedies, including reformation of the loan agreement, injunctive 			relief, and damages. The remedies were based on various theories 			including a claim that RTFC breached an alleged funding obligation 			for the settlement of litigation brought by Emcom shareholders (the 			"Greenlight Entities") against ICC-LLC, ICC and some of ICC's 			directors, and a claim that Emcom and ICC-LLC were entitled to 			contribution from RTFC and CFC in connection with judgments that the 			Greenlight Entities had been awarded (the "ICC Claims," together 			with the RTFC Lawsuits, the "Loan Litigation"). Venue of the Loan 			Litigation ultimately was fixed in the District Court for the 			District of the Virgin Islands.
On February 10, 2006, Greenlight 			filed petitions for involuntary bankruptcy against Prosser, Emcom 			and ICC-LLC in the United States Bankruptcy Court for the District 			of Delaware. RTFC has appeared in the proceedings as a 			party-in-interest in accordance with the provisions of the United 			States Bankruptcy Code. The alleged debtors have filed motions 			seeking change of venue and dismissal of the involuntary petitions. 			In addition, Emcom and ICC-LLC have moved to require Greenlight to 			post a bond to indemnify them for damages in the event the 			involuntary bankruptcy proceedings are dismissed. RTFC has filed 			responses seeking denial of all such motions.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
On April 26, 2006, RTFC reached a 			settlement of the Loan Litigation with ICC, Vitelco, ICC-LLC, Emcom, 			their directors and Prosser, individually. Under the settlement, 			RTFC obtained entry of judgments in the District Court for the 			District of the Virgin Islands against ICC for approximately $525 			million and Prosser for approximately $100 million. RTFC also 			obtained dismissals with prejudice of all counterclaims, affirmative 			defenses and other lawsuits alleging wrongful acts by RTFC, certain 			of its officers, and CFC. Various parties also reached agreement for 			ICC to satisfy the RTFC judgments in the third quarter of calendar 			year 2006, subject to certain terms and conditions. In the event 			that does not occur, RTFC intends to pursue collection of the 			judgments.
On July 31, 2006, ICC-LLC, and Emcom 			each filed a voluntary petition under Chapter 11 of the United 			States Bankruptcy Code in the United States District Court for the 			Virgin Islands, Division of St. Thomas and St. John, Bankruptcy 			Division, and Prosser, individually, filed a voluntary petition 			under Chapter 11 of the United States Bankruptcy Code in the United 			States Bankruptcy Court for the District of Virgin Islands. Each of 			the debtors is obligated to RTFC, for certain obligations of ICC, 			including court judgments, to RTFC.
Based on its analysis, the Company 			believes that it is adequately reserved for its exposure to ICC at 			May 31, 2006.
(f) Pioneer Electric Cooperative, 			Inc. ("Pioneer") is an electric distribution cooperative located in 			Greenville, Alabama. Pioneer had also invested in a propane gas 			operation, which it recently sold. Pioneer has experienced 			deterioration in its financial condition as a result of losses in 			the gas operation. At May 31, 2006, CFC had a total of $54 million 			in loans outstanding to Pioneer. Pioneer was current with respect to 			all debt service payments at May 31, 2006. CFC is the principal 			creditor to Pioneer.
On March 9, 2006, CFC and Pioneer 			agreed on the terms of a debt modification that resulted in the 			loans being classified as restructured. Under the amended agreement, 			CFC extended the maturity of the outstanding loans and granted a 			two-year deferral of principal payments. In addition, CFC agreed to 			make available a line of credit for general corporate purposes. The 			restructured loans are secured by first liens on substantially all 			of the assets and revenues of Pioneer. At this time, CFC plans to 			maintain the loans to Pioneer on accrual status.
Based on its analysis, the Company 			believes that it is adequately reserved for its exposure to Pioneer 			at May 31, 2006.
(15) Gain on Sale of Building and Land
On October 18, 2005, CFC sold its 			headquarters facility in Fairfax County, Virginia to an affiliate of 			Prentiss Properties Acquisition Partners, L.P. for $85 million. The 			assets had a net book value of $40 million, thus generating a total 			gain of $43 million during the year ended May 31, 2006, net of $2 			million in closing and other related costs. The headquarters 			facility consists of two six-story buildings and adjacent parking 			garages situated on ten acres of land and two acres of unimproved 			land adjacent to the office buildings. On the sale date, CFC entered 			into a three-year lease with the new building owner for 			approximately one-third of the office space. CFC has the option to 			extend the lease for two additional one-year terms.
The Company's consolidated financial statements 			include the financial results of CFC, RTFC and NCSC. Full financial 			statements are produced for each of the three companies and are the 			primary reports that management reviews in evaluating performance. 			The segment presentation for the years ended May 31, 2006, 2005 and 			2004 reflect the operating results of each of the three companies as 			a separate segment.
As stated elsewhere in the consolidated 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 on 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 			the NCSC consumer loan program. Thus, CFC maintains the majority of 			the total consolidated loan loss allowance. A small loan loss 			allowance is maintained by NCSC to cover its consumer loan exposure.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
The following chart contains consolidated 			statements of operations for the years ended May 31, 2006, 2005, and 			2004 and consolidated balance sheets as of May 31, 2006 and 2005.
NATIONAL RURAL UTILITIES COOPERATIVE FINANCE 			CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 			(Continued)
(17) Selected Quarterly 			Financial Data (Unaudited)
Summarized results of operations for 			the four quarters of fiscal years 2006 and 2005 are as follows: