NRU Q4 2017 10-Q

NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/ (NRU) SEC Quarterly Report (10-Q) for Q1 2018

NRU 2018 10-K
NRU Q4 2017 10-Q NRU 2018 10-K




UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

__________________________

FORM 10-Q

__________________________


QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended February 28, 2018

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to


Commission File Number: 1-7102

__________________________

NATIONAL RURAL UTILITIES

COOPERATIVE FINANCE CORPORATION

(Exact name of registrant as specified in its charter)

__________________________

District of Columbia

52-0891669

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

20701 Cooperative Way, Dulles, Virginia, 20166

(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (703) 467-1800

__________________________

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes ☒  No ☐


Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes No ☐


Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer☒ Smaller reporting company☐ Emerging growth company ☐

(Do not check if a smaller reporting company)

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transaction period for complying with any new or revised financial accounting standards provided pursuant to Section13(a) of the Exchange Act. ☐


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ☐     No





TABLE OF CONTENTS

Page

PART I - FINANCIAL INFORMATION

1

Item 1.

Financial Statements

44

Condensed Consolidated Statements of Operations

45

Condensed Consolidated Statements of Comprehensive Income

46

Condensed Consolidated Balance Sheets

47

Condensed Consolidated Statements of Changes in Equity

48

Condensed Consolidated Statements of Cash Flows

49

Notes to Condensed Consolidated Financial Statements

50

Note 1 - Summary of Significant Accounting Policies

50

Note 2 - Variable Interest Entities

54

Note  3 - Investment Securities

55

Note 4 - Loans and Commitments

58

Note 5 - Short-Term Borrowings

67

Note  6 - Long-Term Debt

69

Note  7 - Subordinated Deferrable Debt

70

Note 8 - Derivative Instruments and Hedging Activities

71

Note  9 - Equity

74

Note 10 - Guarantees

77

Note 11 - Fair Value Measurement

78

Note 12 - Business Segments

81

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A")

1

Forward-Looking Statements

1

Introduction

1

Summary of Selected Financial Data

2

Executive Summary

4

Critical Accounting Policies and Estimates

6

Accounting Changes and Other Developments

7

Consolidated Results of Operations

7

Consolidated Balance Sheet Analysis

16

Off-Balance Sheet Arrangements

23

Risk Management

26

Credit Risk

26

Liquidity Risk

33

Market Risk

40

Non-GAAP Financial Measures

41

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

86

Item 4.

Controls and Procedures

86

PART II-OTHER INFORMATION

86

Item 1.

Legal Proceedings

86

Item 1A.

Risk Factors

86

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

86

Item 3.

Defaults Upon Senior Securities

86

Item 4.

Mine Safety Disclosures

86

Item 5.

Other Information

86

Item 6.

Exhibits

87

SIGNATURES

88


i




INDEX OF MD&A TABLES

Table

 Description

Page

-

MD&A Tables:

1

Summary of Selected Financial Data

2


2

Average Balances, Interest Income/Interest Expense and Average Yield/Cost

8


3

Rate/Volume Analysis of Changes in Interest Income/Interest Expense

11


4

Non-Interest Income

13


5

Derivative Average Notional Amounts and Average Interest Rates

13


6

Derivative Gains (Losses)

15


7

Non-Interest Expense

16


8

Loans Outstanding by Type and Member Class

17


9

Historical Retention Rate and Repricing Selection

18


10

Total Debt Outstanding

19


11

Member Investments

20


12

Collateral Pledged

21


13

Unencumbered Loans

22


14

Guarantees Outstanding

23


15

Maturities of Guarantee Obligations

24


16

Unadvanced Loan Commitments

24


17

Notional Maturities of Unadvanced Loan Commitments

25


18

Maturities of Notional Amount of Unconditional Committed Lines of Credit

26


19

Loan Portfolio Security Profile

27


20

Credit Exposure to 20 Largest Borrowers

29


21

TDR Loans

30


22

Net Charge-Offs (Recoveries)

30


23

Allowance for Loan Losses

31


24

Rating Triggers for Derivatives

32


25

Liquidity Reserve

33


26

Committed Bank Revolving Line of Credit Agreements

34


27

Short-Term Borrowings

36


28

Issuances and Maturities of Long-Term and Subordinated Debt

37


29

Principal Maturity of Long-Term and Subordinated Debt

37


30

Projected Sources and Uses of Liquidity

38


31

Credit Ratings

39


32

Interest Rate Gap Analysis

41


33

Adjusted Financial Measures - Income Statement

42


34

TIER and Adjusted TIER

42


35

Adjusted Financial Measures - Balance Sheet

43


36

Debt-to-Equity Ratio

43



ii




PART I-FINANCIAL INFORMATION


Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A " )

FORWARD-LOOKING STATEMENTS


This Quarterly Report on Form 10-Q contains certain statements that are considered "forward-looking statements" within the Securities Act of 1933, as amended, and the Exchange Act of 1934, as amended. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identified by our use of words such as "intend," "plan," "may," "should," "will," "project," "estimate," "anticipate," "believe," "expect," "continue," "potential," "opportunity" and similar expressions, whether in the negative or affirmative. All statements about future expectations or projections, including statements about loan volume, the appropriateness of the allowance for loan losses, operating income and expenses, debt-to-equity ratio, borrower financial performance, impaired loans, and sources and uses of liquidity, are forward-looking statements. Although we believe that the expectations reflected in our forward-looking statements are based on reasonable assumptions, actual results and performance may differ materially from our forward-looking statements due to several factors. Factors that could cause future results to vary from our forward-looking statements include, but are not limited to, general economic conditions, legislative changes including those that could affect our tax status, governmental monetary and fiscal policies, demand for our loan products, lending competition, changes in the quality or composition of our loan portfolio, changes in our ability to access external financing, changes in the credit ratings on our debt, valuation of collateral supporting impaired loans, charges associated with our operation or disposition of foreclosed assets, regulatory and economic conditions in the rural electric industry, nonperformance of counterparties to our derivative agreements, the costs and effects of legal or governmental proceedings involving us or our members and the factors listed and described under "Item 1A. Risk Factors" of our Annual Report on Form 10-K for the fiscal year ended May 31, 2017 (" 2017 Form 10-K"). Except as required by law, we undertake no obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date on which the statement is made.

INTRODUCTION


National Rural Utilities Cooperative Finance Corporation ("CFC") is a member-owned cooperative association incorporated under the laws of the District of Columbia in April 1969. CFC's principal purpose is to provide its members with financing to supplement the loan programs of the Rural Utilities Service ("RUS") of the United States Department of Agriculture ("USDA"). CFC makes loans to its rural electric members so they can 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. As a cooperative, CFC is owned by and exclusively serves its membership, which consists of not-for-profit entities or subsidiaries or affiliates of not-for-profit entities. CFC is exempt from federal income taxes under Section 501(c)(4) of the Internal Revenue Code. As a member-owned cooperative, CFC's objective is not to maximize profit, but rather to offer its members cost-based financial products and services. CFC funds its activities primarily through a combination of public and private issuances of debt securities, member investments and retained equity. As a Section 501(c)(4) tax-exempt, member-owned cooperative, we cannot issue equity securities.


Our financial statements include the consolidated accounts of CFC, National Cooperative Services Corporation ("NCSC"), Rural Telephone Finance Cooperative ("RTFC") and subsidiaries created and controlled by CFC to hold foreclosed assets resulting from defaulted loans or bankruptcy. NCSC is a taxable member-owned cooperative that may provide financing to members of CFC, government or quasi-government entities which own electric utility systems that meet the Rural Electrification Act definition of "rural" and for-profit and nonprofit entities that are owned, operated or controlled by, or provide significant benefits to certain members of CFC. RTFC is a taxable Subchapter T cooperative association that provides financing for its rural telecommunications members and their affiliates. CFC did not have any entities that held foreclosed assets as of February 28, 2018 or May 31, 2017 . See "Item 1. Business-Overview" of our 2017 Form 10-K for additional information on the business activities of each of these entities. Unless stated otherwise, references to "we," "our" or "us" relate to CFC and its consolidated entities. All references to members within this document include members, associates and affiliates of CFC and its consolidated entities.



1



Management monitors a variety of key indicators to evaluate our business performance. The following MD&A is intended to provide the reader with an understanding of our results of operations, financial condition and liquidity by discussing the drivers of changes from period to period and the key measures used by management to evaluate performance, such as net interest income, net interest yield, loan growth, debt-to-equity ratio, growth and credit quality metrics. The MD&A is provided as a supplement to, and should be read in conjunction with our unaudited condensed consolidated financial statements and related notes in this Report, our audited consolidated financial statements and related notes in our 2017 Form 10-K and additional information contained in our 2017 Form 10-K, including the risk factors discussed under "Part I-Item 1A. Risk Factors," as well as any risk factors identified under "Part II-Item 1A. Risk Factors" in this Report.

SUMMARY OF SELECTED FINANCIAL DATA


Table 1 provides a summary of consolidated selected financial data for the three and nine months ended February 28, 2018 and 2017 , and as of February 28, 2018 and May 31, 2017 . In addition to financial measures determined in accordance with generally accepted accounting principles in the United States ("GAAP"), management also evaluates performance based on certain non-GAAP measures and metrics, which we refer to as "adjusted" measures. Certain financial covenant provisions in our credit agreements are also based on non-GAAP financial measures. Our key non-GAAP financial measures are adjusted net income, adjusted net interest income, adjusted interest expense, adjusted net interest yield, adjusted times interest earned ratio ("adjusted TIER") and adjusted debt-to-equity ratio. The most comparable GAAP measures are net income, net interest income, interest expense, net interest yield, TIER and debt-to-equity ratio, respectively. The primary adjustments we make to calculate these non-GAAP measures consist of (i) adjusting interest expense and net interest income to include the impact of net periodic derivative cash settlements; (ii) adjusting net income, senior debt and total equity to exclude the non-cash impact of the accounting for derivative financial instruments; (iii) adjusting senior debt to exclude the amount that funds CFC member loans guaranteed by RUS, subordinated deferrable debt and members' subordinated certificates; and (iv) adjusting total equity to include subordinated deferrable debt and members' subordinated certificates and exclude cumulative derivative forward value gains and losses and accumulated other comprehensive income. We believe our non-GAAP adjusted measures, which are not a substitute for GAAP and may not be consistent with similarly titled non-GAAP measures used by other companies, provide meaningful information and are useful to investors because management evaluates performance based on these metrics, and certain financial covenants in our committed bank revolving line of credit agreements and debt indentures are based on adjusted measures. See "Non-GAAP Financial Measures" for a detailed reconciliation of these adjusted measures to the most comparable GAAP measures.


Table 1 : Summary of Selected Financial Data

Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

Change

2018

2017

Change

Statement of operations

Interest income

$

271,468


$

259,920


   4%

$

803,206


$

773,911


   4%

Interest expense

(198,071

)

(186,740

)

6

(585,972

)

(551,474

)

6

Net interest income

73,397


73,180


-

217,234


222,437


(2)

Fee and other income

3,935


5,810


(32)

13,422


15,437


(13)

Total net revenue

77,332


78,990


(2)

230,656


237,874


(3)

Provision for loan losses

(1,105

)

(2,065

)

(46)

(503

)

(4,731

)

(89)

Derivative gains (1)

168,048


42,455


296

247,443


194,822


27

Results of operations of foreclosed assets

-


(29

)

**

(34

)

(1,690

)

(98)

Operating expenses (2)

(22,212

)

(20,710

)

7

(65,762

)

(62,201

)

6

Other non-interest expense

(402

)

(294

)

37

(1,542

)

(1,254

)

23

Income before income taxes

221,661


98,347


125

410,258


362,820


13

Income tax expense

(632

)

(385

)

64

(1,491

)

(1,815

)

(18)

Net income

$

221,029


$

97,962


126

$

408,767


$

361,005


13


2



Three Months Ended February 28,

Nine Months Ended February 28,

2018

2017

Change

2018


2017

Change

Adjusted operational financial measures

Adjusted interest expense (3)

$

(216,995

)

$

(206,094

)

   5%

$

(644,753

)

$

(615,805

)

   5%

Adjusted net interest income (3)

54,473


53,826


1

158,453


158,106


-

Adjusted net income (3)

34,057


36,153


(6)

102,543


101,852


1

Selected ratios

Fixed-charge coverage ratio/TIER (4)

2.12


1.52


60 bps

1.70


1.65


5 bps

Adjusted TIER (3)

1.16


1.18


(2)

1.16


1.17


(1)

Net interest yield (5)

1.16

%

1.19

 %

(3)

1.15

%

1.22

%

(7)

Adjusted net interest yield (3)(6)

0.86


0.87


(1)

0.84


0.86


(2)

Net charge-off rate (7)

-


-


-

-


0.01


(1)

February 28, 2018

May 31, 2017

Change

Balance sheet

Cash and cash equivalents

$

250,697


$

166,615


     50%

Investment securities

337,900


92,554


265

Loans to members (8)

25,342,922


24,367,044


  4

Allowance for loan losses

(37,879

)

(37,376

)

  1

Loans to members, net

25,305,043


24,329,668


  4

Total assets

26,476,407


25,205,692


  5

Short-term borrowings

3,493,736


3,342,900


  5

Long-term debt

18,813,136


17,955,594


  5

Subordinated deferrable debt

742,375


742,274


-

Members' subordinated certificates

1,379,693


1,419,025


  (3)

Total debt outstanding

24,428,940


23,459,793


  4

Total liabilities

25,017,303


24,106,887


  4

Total equity

1,459,104


1,098,805


  33

Guarantees (9)

679,968


889,617


  (24)

Selected ratios period end


Allowance coverage ratio (10)

0.15

%

0.15

%

-

Debt-to-equity ratio (11)

17.15


21.94


(479)

Adjusted debt-to-equity ratio (3)

6.21


5.95


  26

____________________________

** Change is not meaningful.

(1) Consists of derivative cash settlements and derivative forward value gains (losses). Derivative cash settlement amounts represent net periodic contractual interest accruals related to derivatives not designated for hedge accounting. Derivative forward value gains (losses) represent changes in fair value during the period, excluding net periodic contractual interest accruals, related to derivatives not designated for hedge accounting and expense amounts reclassified into income related to the cumulative transition loss recorded in accumulated other comprehensive income as of June 1, 2001, as a result of the adoption of the derivative accounting guidance that required derivatives to be reported at fair value on the balance sheet.

(2) Consists of salaries and employee benefits and the other general and administrative expenses components of non-interest expense, each of which are presented separately on our consolidated statements of operations.

(3) See "Non-GAAP Financial Measures" for details on the calculation of these non-GAAP adjusted measures and the reconciliation to the most comparable GAAP measures.

(4) Calculated based on net income (loss) plus interest expense for the period divided by interest expense for the period. The fixed-charge coverage ratios and TIER were the same during each period presented because we did not have any capitalized interest during these periods.

(5) Calculated based on annualized net interest income for the period divided by average interest-earning assets for the period.

(6) Calculated based on annualized adjusted net interest income for the period divided by average interest-earning assets for the period.


3



(7) Calculated based on annualized net charge-offs (recoveries) for the period divided by average total outstanding loans for the period.

(8) Consists of the outstanding principal balance of member loans plus unamortized deferred loan origination costs, which totaled $11 million as of both February 28, 2018 and May 31, 2017 .

(9) Reflects the total amount of member obligations for which CFC has guaranteed payment to a third party as of the end of each period. This amount represents our maximum exposure to loss, which significantly exceeds the guarantee liability recorded on our consolidated balance sheets. See "Note 10-Guarantees" for additional information.

(10) Calculated based on the allowance for loan losses at period end divided by total outstanding loans at period end.

(11) Calculated based on total liabilities at period end divided by total equity at period end.

EXECUTIVE SUMMARY


Our primary objective as a member-owned cooperative lender is to provide cost-based financial products to our rural electric members while maintaining a sound financial position required for investment-grade credit ratings on our debt instruments. Our objective is not to maximize net income; therefore, the rates we charge our member-borrowers reflect our adjusted interest expense plus a spread to cover our operating expenses, a provision for loan losses and earnings sufficient to achieve interest coverage to meet our financial objectives. Our goal is to earn an annual minimum adjusted TIER of 1.10 and to maintain an adjusted debt-to-equity ratio at approximately or below 6.00-to-1.


We are subject to period-to-period volatility in our reported GAAP results due to changes in market conditions and differences in the way our financial assets and liabilities are accounted for under GAAP. Our financial assets and liabilities expose us to interest-rate risk. We use derivatives, primarily interest rate swaps, as part of our strategy in managing this risk. Our derivatives are intended to economically hedge and manage the interest-rate sensitivity mismatch between our financial assets and liabilities. We are required under GAAP to carry derivatives at fair value on our consolidated balance sheet; however, the financial assets and liabilities for which we use derivatives to economically hedge are carried at amortized cost. Changes in interest rates and spreads result in periodic fluctuations in the fair value of our derivatives, which may cause volatility in our earnings because we do not apply hedge accounting. As a result, the mark-to-market changes in our derivatives are recorded in earnings. Based on the composition of our derivatives, we generally record derivative losses in earnings when interest rates decline and derivative gains when interest rates rise. This earnings volatility generally is not indicative of the underlying economics of our business, as the derivative forward fair value gains or losses recorded each period may or may not be realized over time, depending on the terms of our derivative instruments and future changes in market conditions that impact actual derivative cash settlement amounts. As such, management uses our adjusted non- GAAP results, which include realized net periodic derivative settlements but exclude the impact of unrealized derivative forward fair value gains and losses, to evaluate our operating performance. Because derivative forward fair value gains and losses do not impact our cash flows, liquidity or ability to service our debt costs, our financial debt covenants are also based on our non-GAAP adjusted results.


Financial Performance


Reported Results


We reported net income of $221 million and a TIER of 2.12 for the quarter ended February 28, 2018 ("current quarter"), compared with net income of $98 million and a TIER of 1.52 for the same prior-year quarter. We reported net income of $409 million and a TIER of 1.70 for the nine months ended February 28, 2018 , compared with net income of $361 million and a TIER of 1.65 for the same prior-year period. Our debt-to-equity ratio decreased to 17.15 -to-1 as of February 28, 2018 , from 21.94 -to-1 as of May 31, 2017 , primarily due to an increase in equity resulting from our reported net income of $409 million for the nine months ended February 28, 2018 , which was partially offset by patronage capital retirement of $45 million in September 2017.


The variance of $123 million between our reported net income of $221 million in the current quarter and net income of $98 million for the same prior-year quarter was driven primarily by mark-to-market changes in the fair value of our derivatives. We recognized derivative gains of $168 million in the current quarter, compared with derivative gains of $42 million in the same prior-year quarter, both of which were attributable to a net increase in the fair value of our pay-fixed swaps as interest rates increased across the swap yield curve during each period. The increase in interest rates, however, was more pronounced during the current quarter, which resulted in the significantly higher derivative gains relative to the same prior-year quarter. Although net interest income of $73 million for the current quarter was relatively unchanged from the same


4



prior-year quarter, net interest yield decreased 3 basis points to 1.16% , largely due to an overall increase in our average cost of funds attributable to the increase in short-term interest rates, which resulted in a higher average cost for our short-term and variable-rate borrowings.


The variance of $48 million between our reported net income of $409 million for the nine months ended February 28, 2018 and our net income of $361 million for the same prior-year period was also driven primarily by mark-to-market changes in the fair value of our derivatives. We recognized derivative gains of $247 million for the nine months ended February 28, 2018 , compared with derivative gains of $195 million for the same prior-year period, both due to an increase in interest rates across the swap yield curve. The increase in interest rates, however, was more pronounced during the current nine-month period, with the 10-year and 30-year swap rates increasing by 74 basis points and 53 basis points, respectively, compared with increases of 64 basis points and 44 basis points, respectively, in the same prior year period. We experienced a decrease in net interest income of $5 million due to compression in the net interest yield and an increase in operating expenses of $4 million , which were partially offset by a decrease in the provision for loan losses of $4 million . Our net interest yield was 1.15% for the nine months ended February 28, 2018 , a decrease of 7 basis points from the same prior-year period. The decrease was primarily due to an overall increase in our average cost of funds resulting from the higher average cost of our short-term and variable-rate borrowings.


Adjusted Non-GAAP Results


Our adjusted net income totaled $34 million and our adjusted TIER was 1.16 for the current quarter, compared with adjusted net income of $36 million and adjusted TIER of 1.18 for the same prior-year quarter. Our adjusted net income totaled $103 million and our adjusted TIER was 1.16 for the nine months ended February 28, 2018 , compared with adjusted net income of $102 million and adjusted TIER of 1.17 for the same prior-year period. Our adjusted debt-to-equity ratio increased to 6.21 -to-1 as of February 28, 2018 , from 5.95 -to-1 as of May 31, 2017 , largely due to an increase in debt outstanding to fund loan growth.


Our adjusted net interest income for the current quarter and nine months ended February 28, 2018 remained relatively unchanged from the same prior-year periods, as the compression in the adjusted net interest yield resulting from an increase in our overall average cost of funds was offset by the increase in average interest-earning assets. In addition, the decrease in fee income and the increase in operating expenses were offset by the decrease in the provision for loan losses. Our adjusted net interest yield was 0.86% and 0.84% for the current quarter and the nine months ended February 28, 2018 , respectively, reflecting a decrease of 1 basis point and 2 basis points, respectively, from the same prior-year periods due to the overall increase in our average cost of funds driven by the higher average cost of our short-term and variable-rate borrowings resulting from the increase in short-term interest rates.


Lending Activity


Loans to members totaled $25,343 million as of February 28, 2018 , an increase of $976 million , or 4% , from May 31, 2017 . The increase was primarily due to an increase in CFC distribution loans of $862 million , an increase in NCSC loans of $187 million and an increase in RTFC loans of $9 million , which were partially offset by a decrease in CFC power supply loans of $82 million .


Long-term loan advances totaled $1,864 million during the nine months ended February 28, 2018 , with approximately 64% of those advances for capital expenditures by members and 25% for the refinancing of loans made by other lenders. CFC had long-term fixed-rate loans totaling $783 million that were scheduled to reprice during the nine months ended February 28, 2018 . Of this total, $646 million repriced to a new long-term fixed rate, $135 million repriced to a long-term variable rate and $2 million were repaid in full.


Financing Activity


Our outstanding debt volume generally increases and decreases in response to member loan demand. As total outstanding loans increased during the nine months ended February 28, 2018 , our debt volume also increased. Total debt outstanding was $24,429 million as of February 28, 2018 , an increase of $969 million , or 4% , from May 31, 2017 . The increase was primarily attributable to a net increase in dealer medium-term notes of $694 million , a net increase in the Federal Agricultural Mortgage Corporation ("Farmer Mac") notes payable of $292 million , a net increase in member commercial


5



paper, select notes and daily liquidity fund notes of $49 million and a net increase in dealer commercial paper outstanding of $55 million . These increases were partially offset by a net decrease in notes payable to the Federal Financing Bank under the Guaranteed Underwriter Program of the USDA ("Guaranteed Underwriter Program") of $114 million .


We provide additional information on our financing activities below under "Consolidated Balance Sheet Analysis-Debt" and "Liquidity Risk."


Outlook for the Next 12 Months


We currently expect that our net interest income, net interest yield, adjusted net interest income and adjusted net interest yield will increase over the next 12 months as a result of a projected decrease in our average cost of funds and an increase in average outstanding loans. We have scheduled maturities of higher-cost debt over the next 12 months, including $1,830 million in collateral trust bonds with a weighted average coupon rate of 6.98% . We expect that we will be able to replace this higher-cost debt with lower-cost funding, which will reduce our aggregate weighted average cost of funds. We expect the amount of long-term loan advances to exceed anticipated loan repayments over the next 12 months, resulting in an increase in average outstanding loans.


Long-term debt scheduled to mature over the next 12 months totaled $2,862 million as of February 28, 2018 . We believe we have sufficient liquidity from the combination of existing cash, member loan repayments, committed bank revolving lines of credit and our ability to issue debt in the capital markets, to our members and in private placements, to meet the demand for member loan advances and to satisfy our obligations to repay long-term debt maturing over the next 12 months. As of February 28, 2018 , we had access to liquidity reserves totaling $7,254 million , which consisted of (i) $251 million in cash and cash equivalents, (ii) up to $1,225 million available under committed loan facilities under the Guaranteed Underwriter Program, (iii) up to $3,083 million available under committed bank revolving line of credit agreements, (iv) up to $300 million available under a committed revolving note purchase agreement with Farmer Mac, and (v) up to $2,395 million available under a revolving note purchase agreement with Farmer Mac, subject to market conditions.


We believe we can continue to roll over outstanding member short-term debt of $2,439 million as of February 28, 2018 , based on our expectation that our members will continue to reinvest their excess cash in our commercial paper, daily liquidity fund, select notes and medium-term notes. Although we expect to continue accessing the dealer commercial paper market to help meet our liquidity needs, we intend to manage our short-term wholesale funding risk by maintaining outstanding dealer commercial paper at an amount below $1,250 million for the foreseeable future. We expect to continue to be in compliance with the covenants under our committed bank revolving line of credit agreements, which will allow us to mitigate our roll-over risk as we can draw on these facilities to repay dealer or member commercial paper that cannot be

rolled over.


While we are not subject to bank regulatory capital rules, we generally aim to maintain an adjusted debt-to-equity ratio at approximately or below 6.00-to-1. Our adjusted debt-to-equity ratio was 6.21 as of February 28, 2018 , above our targeted threshold due to the increase in debt outstanding to fund loan growth. Due to anticipated asset growth, we expect our adjusted debt-to-equity ratio to be above 6.00-to-1 over the next 12 months.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES


The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates and assumptions that affect the amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management's judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a discussion of our significant accounting policies under "Note 1-Summary of Significant Accounting Policies" in our 2017 Form 10-K.


We have identified certain accounting policies as critical because they involve significant judgments and assumptions about highly complex and inherently uncertain matters, and the use of reasonably different estimates and assumptions could have a material impact on our results of operations or financial condition. Our most critical accounting policies and estimates involve the determination of the allowance for loan losses and fair value. We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as necessary based on changing conditions. There


6



were no material changes in the key inputs and assumptions used in our critical accounting policies during the nine months ended February 28, 2018 . Management has discussed significant judgments and assumptions in applying our critical accounting policies with the Audit Committee of our board of directors. We provide additional information on our critical accounting policies and estimates under "MD&A-Critical Accounting Policies and Estimates" in our 2017 Form 10-K. See "Item 1A. Risk Factors" in our 2017 Form 10-K for a discussion of the risks associated with management's judgments and estimates in applying our accounting policies and methods.

ACCOUNTING CHANGES AND OTHER DEVELOPMENTS


See "Note 1-Summary of Significant Accounting Policies" for information on accounting standards adopted during the current quarter, as well as recently issued accounting standards not yet required to be adopted and the expected impact of these accounting standards. We also discuss the expected impact of the Tax Cuts and Jobs Act ("The Act"), which the President of the United States signed and enacted into law on December 22, 2017. To the extent we believe the adoption of new accounting standards has had or will have a material impact on our consolidated results of operations, financial condition or liquidity, we discuss the impact in the applicable section(s) of this MD&A.

CONSOLIDATED RESULTS OF OPERATIONS


The section below provides a comparative discussion of our condensed consolidated results of operations between the three months ended February 28, 2018 and 2017 and the nine months ended February 28, 2018 and 2017 . Following this section, we provide a comparative analysis of our condensed consolidated balance sheets as of February 28, 2018 and May 31, 2017 . You should read these sections together with our "Executive Summary-Outlook for the Next 12 Months" where we discuss trends and other factors that we expect will affect our future results of operations.


Net Interest Income


Net interest income represents the difference between the interest income earned on our interest-earning assets, which include loans and investment securities, and the interest expense on our interest-bearing liabilities. Our net interest yield represents the difference between the yield on our interest-earning assets and the cost of our interest-bearing liabilities plus the impact from non-interest bearing funding. We expect net interest income and our net interest yield to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities. We do not fund each individual loan with specific debt. Rather, we attempt to minimize costs and maximize efficiency by funding large aggregated amounts of loans.


Table 2 presents our average balance sheets for the three and nine months ended February 28, 2018 and 2017 , and for each major category of our interest-earning assets and interest-bearing liabilities, the interest income earned or interest expense incurred, and the average yield or cost. Table 2 also presents non-GAAP adjusted interest expense, adjusted net interest income and adjusted net interest yield, which reflect the inclusion of net accrued periodic derivative cash settlements in interest expense. We provide reconciliations of our non-GAAP adjusted measures to the most comparable GAAP measures under "Non-GAAP Financial Measures."



7



Table 2 : Average Balances, Interest Income/Interest Expense and Average Yield/Cost

Three Months Ended February 28,

(Dollars in thousands)

2018

2017

Assets:

Average Balance

Interest Income/Expense

Average Yield/Cost

Average Balance

Interest Income/Expense

Average Yield/Cost

Long-term fixed-rate loans (1)

$

22,706,134


$

250,201


4.47

%

$

22,106,076


$

245,480


4.50

%

Long-term variable-rate loans

972,399


7,020


2.93


811,080


5,047


2.52


Line of credit loans

1,512,664


10,367


2.78


1,162,268


6,538


2.28


TDR loans (2)

12,808


221


7.00


13,381


228


6.91


Other income, net (3)

-


(314

)

-


-


(230

)

-


Total loans

25,204,005


267,495


4.30


24,092,805


257,063


4.33


Cash, time deposits and investment securities

539,728


3,973


2.99


875,438


2,857


1.32


Total interest-earning assets

$

25,743,733


$

271,468


4.28

%

$

24,968,243


$

259,920


4.22

%

Other assets, less allowance for loan losses

853,563


617,010


Total assets

$

26,597,296


$

25,585,253


Liabilities:

Short-term borrowings

$

3,777,158


$

14,593


1.57

%

$

3,673,501


$

7,907


0.87

%

Medium-term notes

3,392,554


28,051


3.35


3,377,615


25,166


3.02


Collateral trust bonds

7,590,459


83,730


4.47


7,256,227


85,582


4.78


Guaranteed Underwriter Program notes payable

4,899,496


34,233


2.83


4,864,585


35,086


2.93


Farmer Mac notes payable

2,507,350


13,316


2.15


2,305,681


8,406


1.48


Other notes payable

32,970


369


4.54


38,445


437


4.61


Subordinated deferrable debt

742,351



9,414


5.14


742,217



9,410


5.14


Subordinated certificates

1,372,508


14,365


4.24


1,430,089


14,746


4.18


Total interest-bearing liabilities

$

24,314,846


$

198,071


3.30

%

$

23,688,360


$

186,740


3.20

%

Other liabilities

954,482


798,848


Total liabilities

25,269,328


24,487,208


Total equity

1,327,968


1,098,045


Total liabilities and equity

$

26,597,296


$

25,585,253


Net interest spread (4)

0.98

%

1.02

%

Impact of non-interest bearing funding (5)

0.18


0.17


Net interest income/net interest yield (6)

$

73,397


1.16

%

$

73,180


1.19

%

Adjusted net interest income/adjusted net interest yield:

Interest income

$

271,468


4.28

%

$

259,920


4.22

%

Interest expense

198,071


3.30


186,740


3.20


Add: Net accrued periodic derivative cash settlements (7)

18,924


0.71


19,354


0.74


Adjusted interest expense/adjusted average cost (8)

$

216,995


3.62

%

$

206,094


3.53

%

Adjusted net interest spread (4)

0.66

%

0.69

%

Impact of non-interest bearing funding

0.20


0.18


Adjusted net interest income/adjusted net interest yield (9)

$

54,473


0.86

%

$

53,826


0.87

%


8



Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

Assets:

Average Balance

Interest Income/Expense

Average Yield/Cost

Average Balance

Interest Income/Expense

Average Yield/Cost

Long-term fixed-rate loans (1)

$

22,510,725


$

748,491


4.45

%

$

21,832,967


$

733,425


4.49

%

Long-term variable-rate loans

900,067


18,980


2.82


763,831


14,561


2.55


Line of credit loans

1,398,346


27,662


2.64


1,083,863


18,057


2.23


TDR loans (2)

12,954


669


6.90


14,717


677


6.15


Other income, net (3)

-


(852

)

-


-


(795

)

-


Total loans

24,822,092


794,950


4.28


23,695,378


765,925


4.32


Cash, time deposits and investment securities

476,532


8,256


2.32


749,508


7,986


1.42


Total interest-earning assets

$

25,298,624


$

803,206


4.24

%

$

24,444,886


$

773,911


4.23

%

Other assets, less allowance for loan losses

645,712


634,590


Total assets

$

25,944,336




$

25,079,476






Liabilities:











Short-term borrowings

$

3,330,949


$

35,248


1.41

%

$

3,209,128


$

18,198


0.76

%

Medium-term notes

3,258,159


80,711


3.31


3,353,107


73,456


2.93


Collateral trust bonds

7,621,435


254,328


4.46


7,255,745


255,582


4.71


Guaranteed Underwriter Program notes payable

4,987,617


105,523


2.83


4,833,701


107,074


2.96


Farmer Mac notes payable

2,503,828


36,753


1.96


2,297,045


22,892


1.33


Other notes payable

34,511


1,150


4.46


40,155


1,353


4.50


Subordinated deferrable debt

742,318


28,247


5.09


742,186


28,247


5.09


Subordinated certificates

1,402,077


44,012


4.20


1,438,578


44,672


4.15


Total interest-bearing liabilities

$

23,880,894


$

585,972


3.28

%

$

23,169,645


$

551,474


3.18

%

Other liabilities

882,937



1,019,306



Total liabilities

24,763,831



24,188,951



Total equity

1,180,505


890,525



Total liabilities and equity

$

25,944,336




$

25,079,476




Net interest spread (4)



0.96

%





1.05

%

Impact of non-interest bearing funding (5)

0.19


0.17


Net interest income/net interest yield (6)

$

217,234


1.15

%

$

222,437


1.22

%

Adjusted net interest income/adjusted net interest yield:



Interest income

$

803,206


4.24

%

$

773,911


4.23

%

Interest expense

585,972


3.28


551,474


3.18


Add: Net accrued periodic derivative cash settlements (7)

58,781


0.73


64,331


0.82


Adjusted interest expense/adjusted average cost (8)

$

644,753


3.61

%



$

615,805


3.55

%

Adjusted net interest spread (4)

0.63

%


0.68

%

Impact of non-interest bearing funding

0.21


0.18


Adjusted net interest income/adjusted net interest yield (9)

$

158,453


0.84

%


$

158,106



0.86

%

____________________________

(1) Interest income on long-term, fixed-rate loans includes loan conversion fees, which are generally deferred and recognized as interest income using the effective interest method.

(2) Troubled debt restructuring ("TDR") loans.

(3) Consists of late payment fees and net amortization of deferred loan fees and loan origination costs.


9



(4) Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing liabilities. Adjusted net interest spread represents the difference between the average yield on total interest-earning assets and the adjusted average cost of total interest-bearing liabilities.

(5) Includes other liabilities and equity.

(6) Net interest yield is calculated based on annualized net interest income for the period divided by total average interest-earning assets for the period.

(7) Represents the impact of net accrued periodic derivative cash settlements during the period, which is added to interest expense to derive non-GAAP adjusted interest expense. The average (benefit)/cost associated with derivatives is calculated based on annualized net accrued periodic derivative cash settlements during the period divided by the average outstanding notional amount of derivatives during the period. The average outstanding notional amount of derivatives was $ 10,841 million and $ 10,610 million for the three months ended February 28, 2018 and 2017, respectively. The average outstanding notional amount of derivatives was $ 10,808 million and $ 10,532 million for the nine months ended February 28, 2018 and 2017 , respectively.

(8) Adjusted interest expense represents interest expense plus net accrued periodic derivative cash settlements during the period. Net accrued periodic derivative cash settlements are reported on our consolidated statements of operations as a component of derivative gains (losses). Adjusted average cost is calculated based on annualized adjusted interest expense for the period divided by total average interest-bearing liabilities during the period.

(9) Adjusted net interest yield is calculated based on annualized adjusted net interest income for the period divided by total average interest-earning assets for the period.

Table 3 displays the change in net interest income between periods and the extent to which the variance is attributable to: (i) changes in the volume of our interest-earning assets and interest-bearing liabilities or (ii) changes in the interest rates of these assets and liabilities. The table also presents the change in adjusted net interest income between periods.


10



Table 3 : Rate/Volume Analysis of Changes in Interest Income/Interest Expense

Three Months Ended February 28,

Nine Months Ended February 28,

2018 versus 2017

2018 versus 2017

Variance due to: (1)

Variance due to: (1)

(Dollars in thousands)

Total

Variance

Volume

Rate

Total

Variance

Volume

Rate

Interest income:

Long-term fixed-rate loans

$

4,721


$

6,663


$

(1,942

)

$

15,066


$

22,768


$

(7,702

)

Long-term variable-rate loans

1,973


1,004


969


4,419


2,597


1,822


Line of credit loans

3,829


1,971


1,858


9,605


5,239


4,366


Restructured loans

(7

)

(10

)

3


(8

)

(81

)

73


Other income, net

(84

)

-


(84

)

(57

)

-


(57

)

Total loans

10,432


9,628


804


29,025


30,523


(1,498

)

Cash, time deposits and investment securities

1,116


(1,096

)

2,212


270


(2,909

)

3,179


Interest income

11,548


8,532


3,016


29,295


27,614


1,681


Interest expense:

Short-term borrowings

6,686


223


6,463


17,050


691


16,359


Medium-term notes

2,885


111


2,774


7,255


(2,080

)

9,335


Collateral trust bonds

(1,852

)

3,942


(5,794

)

(1,254

)

12,881


(14,135

)

Guaranteed Underwriter Program notes payable

(853

)

252


(1,105

)

(1,551

)

3,409


(4,960

)

Farmer Mac notes payable

4,910


735


4,175


13,861


2,061


11,800


Other notes payable

(68

)

(62

)

(6

)

(203

)

(190

)

(13

)

Subordinated deferrable debt

4


2


2


-


5


(5

)

Subordinated certificates

(381

)

(594

)

213


(660

)

(1,133

)

473


Interest expense

11,331


4,609


6,722


34,498


15,644


18,854


Net interest income

$

217


$

3,923


$

(3,706

)

$

(5,203

)

$

11,970


$

(17,173

)

Adjusted net interest income:

Interest income

$

11,548


$

8,532


$

3,016


$

29,295


$

27,614


$

1,681


Interest expense

11,331


4,609


6,722


34,498


15,644


18,854


Net accrued periodic derivative cash settlements (2)

(430

)

422


(852

)

(5,550

)

1,684


(7,234

)

Adjusted interest expense (3)

10,901


5,031


5,870


28,948


17,328


11,620


Adjusted net interest income

$

647


$

3,501


$

(2,854

)

$

347


$

10,286


$

(9,939

)

____________________________

(1) The changes for each category of interest income and interest expense are divided between the portion of change attributable to the variance in volume and the portion of change attributable to the variance in rate for that category. The amount attributable to the combined impact of volume and rate has been allocated to each category based on the proportionate absolute dollar amount of change for that category.

(2) For net accrued periodic derivative cash settlements, the variance due to average volume represents the change in derivative cash settlements resulting from the change in the average notional amount of derivative contracts outstanding. The variance due to average rate represents the change in derivative cash settlements resulting from the net difference between the average rate paid and the average rate received for interest rate swaps during the period.

(3) See "Non-GAAP Financial Measures" for additional information on our adjusted non-GAAP measures.


Net interest income of $73 million for the current quarter was relatively unchanged from the same prior-year quarter, as the decrease in the net interest yield of 3% ( 3 basis points) to 1.16% was offset by an increase in average interest-earning assets of 3% .



11



Net interest income of $217 million for the nine months ended February 28, 2018 decreased by $5 million , or 2% , from the same prior-year period, driven by a decrease in the net interest yield of 6% ( 7 basis points) to 1.15% , which was partially offset by an increase in average interest-earning assets of 3% .

Average Interest-Earning Assets: The increase in average interest-earning assets for the current quarter and nine months ended February 28, 2018 was primarily attributable to growth in average total loans of $1,111 million , or 5% and $1,127 million , or 5% , respectively, over the same prior-year periods, as members obtained advances to fund capital investments and refinanced with us loans made by other lenders.


Net Interest Yield: The decrease in the net interest yield for the current quarter and nine months ended February 28, 2018 was primarily due to an increase in our average cost of funds. Our average cost of funds increased by 10 basis points during both the current quarter and nine months ended February 28, 2018 to 3.30% and 3.28% , respectively, largely due to increases in the cost of our short-term and variable-rate debt resulting from an increase in short-term interest rates. The 3-month London Interbank Offered Rate ("LIBOR") was 2.02% as of February 28, 2018 , an increase of 96 basis points from February 28, 2017, while the federal funds rate ranged from 1.00% to 1.50% as of February 28, 2018 , up 75 basis points from February 28, 2017.


Adjusted net interest income of $54 million for the current quarter increased by $1 million , or 1% , from the same prior-year quarter, driven by an increase in average interest-earning assets of 3% , which was partially offset by a decrease in the adjusted net interest yield of 1% ( 1 basis point) to 0.86% .


Adjusted net interest income of $158 million for the nine months ended February 28, 2018 was relatively unchanged from the same prior-year period, as the increase in average interest-earning assets of 3% was largely offset by a decrease in the adjusted net interest yield of 2% ( 2 basis points) to 0.84% . The decrease in the adjusted net interest yield was primarily attributable to an overall increase in the adjusted average cost of funds of 6 basis points to 3.61% , driven by the higher average cost of our short-term and variable-rate borrowings resulting from the increase in short-term interest rates.


Our adjusted net interest income and adjusted net interest yield include the impact of net accrued periodic derivative cash settlements during the period. We recorded net periodic derivative cash settlement expense of $19 million for both the three months ended February 28, 2018 and 2017, and $59 million and $64 million for the nine months ended February 28, 2018 and 2017 , respectively. See "Non-GAAP Financial Measures" for additional information on our adjusted measures.


Provision for Loan Losses


Our provision for loan losses in each period is primarily driven by the level of allowance that we determine is necessary for probable incurred loan losses inherent in our loan portfolio as of each balance sheet date.


We recorded a provision for loan losses of $1 million for both the three and nine months ended February 28, 2018 , compared with a provision for loan losses of $2 million and $5 million , respectively, for the same prior-year periods. The credit quality and performance statistics of our loan portfolio continued to remain strong. We experienced no charge-offs during the three and nine months ended February 28, 2018 , and we had no loans classified as nonperforming as of the end of the period. In comparison, we recorded a net charge-off of $2 million during the nine months ended February 28, 2017 .


We provide additional information on our allowance for loan losses under "Credit Risk-Allowance for Loan Losses" and "Note 4-Loans and Commitments" of this Report. For additional information on our allowance methodology, see "MD&A-Critical Accounting Policies and Estimates" and "Note 1-Summary of Significant Accounting Policies" in our 2017 Form 10-K.


Non-Interest Income


Non-interest income consists of fee and other income, gains and losses on derivatives not accounted for in hedge accounting relationships and results of operations of foreclosed assets.

Table 4 presents the components of non-interest income recorded in our condensed consolidated results of operations for the three and nine months ended February 28, 2018 and 2017 .


12



Table 4 : Non-Interest Income

Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018


2017

Non-interest income:

Fee and other income

$

3,935


$

5,810


$

13,422


$

15,437


Derivative gains

168,048


42,455


247,443


194,822


Results of operations of foreclosed assets

-


(29

)

(34

)

(1,690

)

Total non-interest income

$

171,983


$

48,236


$

260,831


$

208,569



Non-interest income of  $172 million for the current quarter increased by $124 million from the same prior-year quarter. Non-interest income of $261 million for the nine months ended February 28, 2018 increased by $52 million from the same prior-year period. The significant variances in non-interest income for the three and  nine months ended February 28, 2018  between the same prior-year periods were primarily attributable to changes in net derivative gains recognized in our consolidated statements of operations.


Derivative Gains (Losses)


Our derivative instruments are an integral part of our interest rate risk management strategy. Our principal purpose in using derivatives is to manage our aggregate interest rate risk profile within prescribed risk parameters. The derivative instruments we use primarily include interest rate swaps, which we typically hold to maturity. The primary factors affecting the fair value of our derivatives and derivative gains (losses) recorded in our results of operations include changes in interest rates, the shape of the yield curve and the composition of our derivative portfolio. We generally do not designate our interest rate swaps, which currently account for all of our derivatives, for hedge accounting. Accordingly, changes in the fair value of interest rate swaps are reported in our consolidated statements of operations under derivative gains (losses). We did not have any derivatives designated as accounting hedges as of February 28, 2018 or May 31, 2017 .


We currently use two types of interest rate swap agreements: (i) we pay a fixed rate and receive a variable rate ("pay-fixed swaps") and (ii) we pay a variable rate and receive a fixed rate ("receive-fixed swaps"). The benchmark rate for the substantial majority of the floating rate payments under our swap agreements is LIBOR. Table 5 displays the average notional amount outstanding, by swap agreement type, and the weighted-average interest rate paid and received for derivative cash settlements during the three and nine months ended February 28, 2018 and 2017 . As indicated in Table 5 , our derivative portfolio currently consists of a higher proportion of pay-fixed swaps than receive-fixed swaps. The profile of our derivative portfolio, however, may change as a result of changes in market conditions and actions taken to manage our interest rate risk.


Table 5 : Derivative Average Notional Amounts and Average Interest Rates

Three Months Ended February 28,

2018

2017

(Dollars in thousands)

Average

Notional

Balance

Weighted-

Average

Rate Paid

Weighted-

Average

Rate Received

Average

Notional

Balance

Weighted-

Average

Rate Paid

Weighted-

Average

Rate Received

Pay-fixed swaps

$

7,004,710


2.84

%

1.65

%

$

6,389,187


2.89

%

0.97

%

Receive-fixed swaps

3,836,499


2.18


2.61


4,220,667


1.40


2.68


Total

$

10,841,209


2.60

%

2.00

%

$

10,609,854


2.29

%

1.65

%


13



Nine Months Ended February 28,

2018

2017

(Dollars in thousands)

Average

Notional

Balance

Weighted-

Average

Rate Paid

Weighted-

Average

Rate Received

Average

Notional

Balance

Weighted-

Average

Rate Paid

Weighted-

Average

Rate Received

Pay-fixed swaps

$

7,004,166


2.84

%

1.42

%

$

6,673,175


2.91

%

0.82

%

Receive-fixed swaps

3,803,670


1.98


2.63


3,858,890


1.24


2.75


Total

$

10,807,836


2.53

%

1.85

%

$

10,532,065


2.29

%

1.53

%


The average remaining maturity of our pay-fixed and receive-fixed swaps was 19 years and five years, respectively, as of February 28, 2018 . In comparison, the average remaining maturity of our pay-fixed and receive-fixed swaps was 19 years and four years, respectively, as of February 28, 2017 .


Pay-fixed swaps generally decrease in value as interest rates decline and increase in value as interest rates rise. In contrast, receive-fixed swaps generally increase in value as interest rates decline and decrease in value as interest rates rise. Because our pay-fixed and receive-fixed swaps are referenced to different maturity terms along the swap yield curve, different changes in the swap yield curve- parallel, flattening or steepening-will result in differences in the fair value of our derivatives. The chart below provides comparative swap yield curves as of the end of February 28, 2018 , November 30, 2017, May 31, 2017 , February 28, 2017 and May 31, 2016 .


____________________________

Benchmark rates obtained from Bloomberg.


Table 6 presents the components of net derivative gains (losses) recorded in our condensed consolidated results of operations for the three and nine months ended February 28, 2018 and 2017 . Derivative cash settlements represent the net periodic contractual interest amount for our interest-rate swaps for the reporting period. Derivative forward value gains


14



(losses) represent the change in fair value of our interest rate swaps during the reporting period due to changes in expected future interest rates over the remaining life of our derivative contracts.


Table 6 : Derivative Gains (Losses)

Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018

2017

Derivative gains (losses) attributable to:

Derivative cash settlements

$

(18,924

)

$

(19,354

)

$

(58,781

)

$

(64,331

)

Derivative forward value gains

186,972


61,809


306,224


259,153


Derivative gains

$

168,048


$

42,455


$

247,443


$

194,822



The net derivative gains of $168 million and $247 million for the three and nine months ended February 28, 2018 , respectively, were largely attributable to a net increase in the fair value of our pay-fixed swaps as interest rates increased across the yield curve.


The net derivative gains of $42 million and $195 million for the three and nine months ended February 28, 2017 , respectively, were primarily attributable to a net increase in the fair value of our swaps due to an overall increase in interest rates during the periods.


As depicted above in the chart of comparative yield curves, the general level of market interest rates as of the end of the three and nine months ended February 28, 2018 was higher relative to the general level of market rates as of the end of the comparative prior-year periods, which resulted in the recognition of significantly higher net derivative gain amounts.


See "Note 8-Derivative Instruments and Hedging Activities" for additional information on our derivative instruments.


Results of Operations of Foreclosed Assets


Results of operations of foreclosed assets consists of the operating results of entities controlled by CFC that hold foreclosed assets, impairment charges related to those entities, gains or losses related to the disposition of the entities and potential subsequent charges related to those assets. On July 1, 2016, we completed the sale of Caribbean Asset Holdings, LLC ("CAH"). As a result, we did not carry any foreclosed assets on our consolidated balance sheet as of February 28, 2018 or May 31, 2017 .


We recorded charges related to CAH of less than $1 million for the nine months ended February 28, 2018 . These charges were attributable to legal fees. We recorded charges related to CAH of less than $1 million for the three months ended February 28, 2017 and $2 million for the nine months ended February 28, 2017 , attributable to the combined impact of adjustments recorded at the closing date of the sale of CAH, post-closing purchase price adjustments and certain legal costs incurred pertaining to CAH.


In connection with the sale of CAH, $16 million of the sale proceeds was deposited into escrow to fund potential indemnification claims for a period of 15 months following the closing. Of this amount, $14.5 million was designated to cover general indemnification claims and $1.5 million was designated to cover indemnification of certain tax liens. On September 27, 2017, we received a claim notice from the purchaser of CAH asserting potential indemnification claims against the general escrow amount of $14.5 million . The claims were not substantiated sufficiently to be funded; therefore, the $14.5 million has been released back to us. The $1.5 million designated for tax liens remains in escrow. We continue to be liable for certain indemnifications regardless of whether amounts are held in escrow.


Non-Interest Expense


Non-interest expense consists of salaries and employee benefit expense, general and administrative expenses, losses on early extinguishment of debt and other miscellaneous expenses.



15



Table 7 presents the components of non-interest expense recorded in our condensed consolidated results of operations for the three and nine months ended February 28, 2018 and 2017 .


Table 7 : Non-Interest Expense

Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018

2017

Non-interest expense:

Salaries and employee benefits

$

(13,011

)

$

(11,537

)

$

(36,843

)

$

(34,412

)

Other general and administrative expenses

(9,201

)

(9,173

)

(28,919

)

(27,789

)

Gains on early extinguishment of debt

-


192


-


192


Other non-interest expense

(402

)

(486

)

(1,542

)

(1,446

)

Total non-interest expense

$

(22,614

)

$

(21,004

)

$

(67,304

)

$

(63,455

)


Non-interest expense of  $23 million for the current quarter increased by $2 million , or 8% , from the same prior-year quarter. Non-interest expense of $67 million for the nine months ended February 28, 2018 increased by $4 million , or 6% , from the prior-year period. These increases were primarily attributable to higher expenses related to salaries and employee benefits and other general and administrative operating expenses.


Net Income (Loss) Attributable to Noncontrolling Interests


Net income (loss) attributable to noncontrolling interests represents 100% of the results of operations of NCSC and RTFC, as the members of NCSC and RTFC own or control 100% of the interest in their respective companies. The fluctuations in net income (loss) attributable to noncontrolling interests are primarily due to changes in the fair value of NCSC's derivative instruments recognized in NCSC's earnings.


We recorded net income attributable to noncontrolling interests of $2 million and $3 million during the three and nine months ended February 28, 2018 , respectively. In comparison, we recorded net income attributable to noncontrolling interests of less than $1 million and $2 million for the three and nine months ended February 28, 2017 , respectively.

CONSOLIDATED BALANCE SHEET ANALYSIS


Total assets of $26,476 million as of February 28, 2018 increased by $1,271 million , or 5% , from May 31, 2017 , primarily due to growth in our loan portfolio. Total liabilities of $25,017 million as of February 28, 2018 increased by $910 million , or 4% , from May 31, 2017 , largely due to debt issuances to fund loan growth. Total equity increased by $360 million to $1,459 million as of February 28, 2018 , attributable to our reported net income of $409 million for the nine months ended

February 28, 2018 , which was partially offset by patronage capital retirement of $45 million .


Following is a discussion of changes in the major components of our assets and liabilities during the nine months ended February 28, 2018 . Period-end balance sheet amounts may vary from average balance sheet amounts due to liquidity and balance sheet management activities that are intended to manage liquidity requirements for the company and our customers, and our market risk exposure in accordance with our risk appetite.


Loan Portfolio


We offer long-term fixed- and variable-rate loans and line of credit variable-rate loans. The substantial majority of loans in our portfolio represent advances under secured long-term facilities with terms up to 35 years. Borrowers have the option of selecting a fixed or variable interest rate for each advance for periods ranging from one year to the final maturity of the facility. Line of credit loans are typically revolving facilities and are generally unsecured.






16



Loans Outstanding


Table 8 summarizes loans to members, by loan type and by member class, as of February 28, 2018 and May 31, 2017 . As indicated in Table 8 , long-term fixed-rate loans accounted for 90% and 91% of loans to members as of February 28, 2018 and May 31, 2017 , respectively.


Table 8 : Loans Outstanding by Type and Member Class

February 28, 2018

May 31, 2017

Increase/

(Dollars in thousands)

Amount

% of Total

Amount

% of Total

(Decrease)

Loans by type:

Long-term loans:

Fixed-rate

$

22,737,089


90

%

$

22,136,690


91

%

$

600,399


Variable-rate

985,714


4


847,419


3


138,295


Total long-term loans

23,722,803


94


22,984,109


94


738,694


Lines of credit

1,609,032


6


1,372,221


6


236,811


Total loans outstanding

25,331,835


100


24,356,330


100


975,505


Deferred loan origination costs


11,087



-



10,714



-



373


Loans to members


$

25,342,922



100

%


$

24,367,044



100

%


$

975,878


Loans by member class:

CFC:

Distribution

$

19,687,812


78

%

$

18,825,366


77

%

$

862,446


Power supply

4,422,600


18


4,504,791


19


(82,191

)

Statewide and associate

57,144


-


57,830


-


(686

)

CFC total

24,167,556


96


23,387,987


96


779,569


NCSC

800,814


3


613,924


3


186,890


RTFC

363,465


1


354,419


1


9,046


Total loans outstanding

25,331,835


100


24,356,330


100


975,505


Deferred loan origination costs

11,087


-


10,714


-


373


Loans to members

$

25,342,922


100

%

$

24,367,044


100

%

$

975,878



Loans to members totaled $25,343 million as of February 28, 2018 , an increase of $976 million , or 4% , from May 31, 2017 . The increase was primarily due to an increase in CFC distribution loans of $862 million , an increase in NCSC loans of $187 million and an increase in RTFC loans of $9 million , which was partially offset by a decrease in CFC power supply loans of $82 million . Long-term loan advances totaled $1,864 million during the nine months ended February 28, 2018 , with approximately 64% of those advances for capital expenditures by members and 25% for the refinancing of loans made by other lenders.


We provide ad ditional information on our loan product types in "Item 1. Business-Loan Programs " and "Note 4-Loans and Commitments" in our 2017 Form 10-K. See "Debt-Secured Borrowings" below for information on encumbered and unencumbered loans and "Credit Risk Management" for information on the credit risk profile of our loan portfolio.


Loan Retention Rate


Table 9 presents a comparison between the historical retention rate of CFC's long-term fixed-rate loans that repriced in accordance with our standard loan provisions, during the nine months ended February 28, 2018 and loans that repriced during fiscal year 2017, and provides information on the percentage of loans that repriced to either another fixed-rate term or a variable rate. The retention rate is calculated based on the election made by the borrower at the repricing date. The average annual retention rate of CFC's repriced loans has been 97% over the last three fiscal years.



17



Table 9 : Historical Retention Rate and Repricing Selection (1)

Nine Months Ended

Fiscal Year Ended

February 28, 2018

May 31, 2017

(Dollars in thousands)

Amount

% of Total

Amount

% of Total

Loans retained:

Long-term fixed rate selected

$

646,448


83

%

$

824,415


84

%

Long-term variable rate selected

134,761


17


137,835


14


Total loans retained by CFC

781,209


100


962,250


98


Loans repriced and sold by CFC

-


-


1,401


-


Loans repaid

2,067


-


23,675


2


Total

$

783,276


100

%

$

987,326


100

%

____________________________

(1) Does not include NCSC and RTFC loans.


Debt


We utilize both short-term and long-term borrowings as part of our funding strategy and asset/liability interest rate risk management. We seek to maintain diversified funding sources across products, programs and markets to manage funding concentrations and reduce our liquidity or debt roll-over risk. Our funding sources include a variety of secured and unsecured debt securities in a wide range of maturities to our members and affiliates and in the capital markets.


Debt Outstanding


Table 10 displays the composition, by product type, of our outstanding debt as of February 28, 2018 and May 31, 2017 . Table 10 also displays the composition of our debt based on several additional selected attributes.


18



Table 10 : Total Debt Outstanding

(Dollars in thousands)

February 28, 2018

May 31, 2017

Increase/
(Decrease)

Debt product type:

Commercial paper:

Members, at par

$

1,021,016


$

928,158


$

92,858


Dealer, net of discounts

1,055,147


999,691


55,456


Total commercial paper

2,076,163


1,927,849


148,314


Select notes to members

674,319


696,889


(22,570

)

Daily liquidity fund notes to members

506,921


527,990


(21,069

)

Medium-term notes:



Members, at par

647,706


612,951


34,755


Dealer, net of discounts

3,058,178


2,364,671


693,507


Total medium-term notes

3,705,884


2,977,622


728,262


Collateral trust bonds

7,634,863


7,634,048


815


Guaranteed Underwriter Program notes payable

4,871,532


4,985,484


(113,952

)

Farmer Mac notes payable

2,805,376


2,513,389


291,987


Other notes payable

31,814


35,223


(3,409

)

Subordinated deferrable debt

742,375


742,274


101


Members' subordinated certificates:

Membership subordinated certificates

630,391


630,098


293


Loan and guarantee subordinated certificates

528,154


567,830


(39,676

)

Member capital securities

221,148


221,097


51


Total members' subordinated certificates

1,379,693


1,419,025


(39,332

)

Total debt outstanding

$

24,428,940


$

23,459,793



$

969,147


Security type:

Unsecured debt

37

%

35

%

Secured debt

63


65


Total

100

%

100

%

Funding source:

Members

17

%

18

%

Private placement:

Guaranteed Underwriter Program notes payable

20


21


Farmer Mac notes payable

12


11


Total private placement

32


32


Capital markets

51


50


Total

100

%

100

%

Interest rate type:

Fixed-rate debt

74

%

74

%

Variable-rate debt

26


26


Total

100

%

100

%

Interest rate type, including the impact of swaps:

Fixed-rate debt (1)

87

%

87

%

Variable-rate debt (2)

13


13


Total

100

%

100

%

Maturity classification: (3)

Short-term borrowings

14

%

14

%

Long-term and subordinated debt (4)

86


86


Total

100

%

100

%

____________________________


19



(1) Includes variable-rate debt that has been swapped to a fixed rate, net of any fixed-rate debt that has been swapped to a variable rate.

(2) Includes fixed-rate debt that has been swapped to a variable rate, net of any variable-rate debt that has been swapped to a fixed rate. Also includes commercial paper notes, which generally have maturities of less than 90 days. The interest rate on commercial paper notes does not change once the note has been issued; however, the interest rate for new commercial paper issuances changes daily.

(3) Borrowings with an original contractual maturity of one year or less are classified as short-term borrowings. Borrowings with an original contractual maturity of greater than one year are classified as long-term debt.

(4) Consists of long-term debt, subordinated deferrable debt and total members' subordinated debt reported on the condensed consolidated balance sheets. Maturity classification is based on the original contractual maturity as of the date of issuance of the debt.


Our outstanding debt volume generally increases and decreases in response to member loan demand. As outstanding loan balances increased during the nine months ended February 28, 2018 , our debt volume also increased. Total debt outstanding was $24,429 million as of February 28, 2018 , an increase of $969 million , or 4% , from May 31, 2017 . The increase was primarily attributable to a net increase in dealer medium-term notes of $694 million , a net increase in Farmer Mac notes payable of $292 million , a net increase in member commercial paper, select notes and daily liquidity fund notes of $49 million and a net increase in dealer commercial paper outstanding of $55 million . These increases were partially offset by a net decrease in Guaranteed Underwriter Program notes payable of $114 million .


Below is a summary of significant financing activities during the  nine months ended February 28, 2018 .


On November 9, 2017 , we closed a $750 million committed loan facility ("Series M") from the Federal Financing Bank under the Guaranteed Underwriter Program.


On November 20, 2017 , we amended and restated the three-year and five-year committed bank revolving line of credit agreements to extend the maturity dates to November 20, 2020 and November 20, 2022 , respectively, and to terminate certain third-party bank commitments.


On January 16, 2018, we redeemed $325 million of notes payable outstanding, with an effective interest rate of 2.10% and an original maturity of April 15, 2026, under the Guaranteed Underwriter Program.

On February 7, 2018, we issued $700 million aggregate principal amount of 3.40% collateral trust bonds due 2028.


On February 26, 2018, we amended the revolving note purchase agreement with Farmer Mac, dated March 24, 2011. Under the amended agreement, we currently can borrow, subject to market conditions, up to $5,200 million at any time through January 11, 2022.


Member Investments


Debt securities issued to our members represent an important, stable source of funding. Table 11 displays outstanding member debt, by debt product type, as of February 28, 2018 and May 31, 2017 .


Table 11 : Member Investments

February 28, 2018

May 31, 2017

Increase/

(Decrease)

(Dollars in thousands)

Amount

% of Total (1)

Amount

% of Total (1)

Commercial paper

$

1,021,016


49

%

$

928,158


48

%

$

92,858


Select notes

674,319


100


696,889


100


(22,570

)

Daily liquidity fund notes

506,921


100


527,990


100


(21,069

)

Medium-term notes

647,706


17


612,951


20


34,755


Members' subordinated certificates

1,379,693


100


1,419,025


100


(39,332

)

Total outstanding member debt

$

4,229,655


$

4,185,013


$

44,642


Percentage of total debt outstanding

17

%

18

%


____________________________

(1) Represents outstanding debt attributable to members for each debt product type as a percentage of the total outstanding debt for each debt product type.



20



Member investments accounted for 17% and 18% of total debt outstanding as of February 28, 2018 and May 31, 2017 , respectively. Over the last three fiscal years, outstanding member investments have averaged $4,297 million on a quarterly basis.


Short-Term Borrowings


Short-term borrowings consist of borrowings with an original contractual maturity of one year or less and do not include the current portion of long-term debt. Short-term borrowings totaled $3,494 million and accounted for 14% of total debt outstanding as of February 28, 2018 , compared with $3,343 million , or 14% , of total debt outstanding as of May 31, 2017 . See Table 27 : Short-Term Borrowings below under "Liquidity Risk" for detail on the composition of our short-term borrowings.


Long-Term and Subordinated Debt


Long-term debt, defined as debt with an original contractual maturity term of greater than one year, primarily consists of medium-term notes, collateral trust bonds, notes payable under the Guaranteed Underwriter Program and notes payable under our note purchase agreement with Farmer Mac. Subordinated debt consists of subordinated deferrable debt and members' subordinated certificates. Our subordinated deferrable debt and members' subordinated certificates have original contractual maturity terms of greater than one year.


Long-term and subordinated debt totaled $20,935 million and accounted for 86% of total debt outstanding as of February 28, 2018 , compared with $20,117 million , or 86% , of total debt outstanding as of May 31, 2017 . As discussed above, the increase in total debt outstanding, including long-term and subordinated debt, was primarily due to the issuance of debt to fund the growth in our loan and investments portfolios. See Table 28 : Issuances and Repayments of Long-Term and Subordinated Debt below under "Liquidity Risk" for a summary of long-term subordinated debt issuances and repayments during the nine months ended February 28, 2018 .


Collateral Pledged


We are required to pledge loans or other collateral in borrowing transactions under our collateral trust bond indentures, note purchase agreements with Farmer Mac and bond agreements under the Guaranteed Underwriter Program. We are required to maintain pledged collateral equal to at least 100% of the face amount of outstanding borrowings. However, we typically maintain pledged collateral in excess of the required percentage to ensure that required collateral levels are maintained and to facilitate the timely execution of debt issuances by reducing or eliminating the lead time to pledge additional collateral. Under the provisions of our committed bank revolving line of credit agreements, the excess collateral that we are allowed to pledge cannot exceed 150% of the outstanding borrowings under our collateral trust bond indentures, Farmer Mac note purchase agreements or the Guaranteed Underwriter Program. In certain cases, provided that all conditions of eligibility under the different programs are satisfied, we may withdraw excess pledged collateral or transfer collateral from one borrowing program to another to facilitate a new debt issuance.


Table 12 displays the collateral coverage ratios as of February 28, 2018 and May 31, 2017 for the debt agreements noted above that require us to pledge collateral.


Table 12 : Collateral Pledged

Requirement/Limit

Debt Indenture

Minimum

Committed Bank Revolving Line of Credit Agreements

Maximum

Actual (1)

Debt Agreement

February 28, 2018

May 31, 2017

Collateral trust bonds 1994 indenture

100

%

150

%

113

%

117

%

Collateral trust bonds 2007 indenture

100


150


112


115


Guaranteed Underwriter Program notes payable

100


150


120


117


Farmer Mac notes payable

100


150


120


117


Clean Renewable Energy Bonds Series 2009A

100


150


115


113



21



____________________________

(1) Calculated based on the amount of collateral pledged divided by the face amount of outstanding secured debt.


Of our total debt outstanding of $24,429 million as of February 28, 2018 , $15,323 million , or 63% , was secured by pledged loans totaling $18,061 million . In comparison, of our total debt outstanding of $23,460 million as of May 31, 2017 , $15,146 million , or 65% , was secured by pledged loans totaling $17,941 million . Total debt outstanding on our condensed consolidated balance sheet is presented net of unamortized discounts and issuance costs. However, our collateral pledging requirements are based on the face amount of secured outstanding debt, which does not take into consideration the impact of net unamortized discounts and issuance costs.


Table 13 displays the unpaid principal balance of loans pledged for secured debt, the excess collateral pledged and unencumbered loans as of February 28, 2018 and May 31, 2017 .


Table 13 : Unencumbered Loans

(Dollars in thousands)

February 28, 2018

May 31, 2017

Total loans outstanding (1)

$

25,331,835


$

24,356,330


Less: Loans required to be pledged for secured debt (2)

(15,606,414

)

(15,435,062

)

 Loans pledged in excess of requirement (2)(3)

(2,454,694

)

(2,505,804

)

 Total pledged loans

(18,061,108

)

(17,940,866

)

Unencumbered loans

$

7,270,727


$

6,415,464


Unencumbered loans as a percentage of total loans

29

%

26

%

____________________________

(1) Reflects unpaid principal balance. Excludes unamortized deferred loan origination costs of $11 million as of both February 28, 2018 and May 31, 2017 .

(2) Reflects unpaid principal balance of pledged loans.

(3) Excludes cash collateral pledged to secure debt. If there is an event of default under most of our indentures, we can only withdraw the excess collateral if we substitute cash or permitted investments of equal value.


As displayed above in Table 13 , we had excess loans pledged as collateral totaling $2,455 million and $2,506 million as of February 28, 2018 and May 31, 2017 , respectively. We typically pledge loans in excess of the required amount for the following reasons: (i) our distribution and power supply loans are typically amortizing loans that require scheduled principal payments over the life of the loan, whereas the debt securities issued under secured indentures and agreements typically have bullet maturities; (ii) distribution and power supply borrowers have the option to prepay their loans; and (iii) individual loans may become ineligible for various reasons, some of which may be temporary.


We provide additional information on our borrowings, including the maturity profile, below in "Liquidity Risk." Refer to "Note 4-Loans and Commitments-Pledging of Loans" for additional information related to pledged collateral. Also refer to "Note 6-Short-Term Borrowings," "Note 7-Long-Term Debt," "Note 8-Subordinated Deferrable Debt" and "Note 9-Members' Subordinated Certificates" in our 2017 Form 10-K for a more detailed description of each of our debt product types.


Equity


Total equity increased by $360 million to $1,459 million as of February 28, 2018 . The increase was primarily attributable to our net income of $409 million for the nine months ended February 28, 2018 , which was partially offset by patronage capital retirement of $45 million in September 2017.


In July 2017, the CFC Board of Directors authorized the allocation of fiscal year 2017 adjusted net income as follows: $90 million to members in the form of patronage capital; $43 million to members' capital reserve; and $1 million to the Cooperative Educational Fund. The amount of patronage capital allocated each year by CFC's Board of Directors is based on adjusted non-GAAP net income, which excludes the impact of derivative forward value gains (losses). See "Non-GAAP Financial Measures" for information on adjusted net income.


In July 2017, the CFC Board of Directors authorized the retirement of patronage capital totaling $45 million , which represented 50% of the fiscal year 2017 allocation of patronage capital of $90 million . We returned the $45 million to


22



members in cash in September 2017. The remaining portion of the allocated amount will be retained by CFC for 25 years under guidelines adopted by the CFC Board of Directors in June 2009.


The CFC Board of Directors is required to make annual allocations of adjusted net income, if any. CFC has made annual retirements of allocated net earnings in 38 of the last 39 fiscal years; however, future retirements of allocated amounts are determined based on CFC's financial condition. The CFC Board of Directors has the authority to change the current practice for allocating and retiring net earnings at any time, subject to applicable laws. See "Item 1. Business-Allocation and Retirement of Patronage Capital" of our 2017 Form 10-K for additional information.

OFF-BALANCE SHEET ARRANGEMENTS


In the ordinary course of business, we engage in financial transactions that are not presented on our condensed consolidated balance sheets, or may be recorded on our condensed consolidated balance sheets in amounts that are different from the full contract or notional amount of the transaction. Our off-balance sheet arrangements consist primarily of guarantees of member obligations and unadvanced loan commitments intended to meet the financial needs of our members.


Guarantees


We provide guarantees for certain contractual obligations of our members to assist them in obtaining various forms of financing. Table 14 displays the notional amount of our outstanding guarantee obligations, by guarantee type and by company, as of February 28, 2018 and May 31, 2017 .


Table 14 : Guarantees Outstanding

(Dollars in thousands)

February 28, 2018

May 31, 2017

Increase/
(Decrease)

Guarantee type:

Long-term tax-exempt bonds

$

317,960


$

468,145


$

(150,185

)

Letters of credit

248,124


307,321


(59,197

)

Other guarantees

113,884


114,151


(267

)

Total

$

679,968


$

889,617


$

(209,649

)

Company:


CFC

$

663,235


$

874,920


$

(211,685

)

NCSC

15,159


13,123


2,036


RTFC

1,574


1,574


-


Total

$

679,968


$

889,617


$

(209,649

)


Of the total notional amount of our outstanding guarantee obligations of $680 million and $890 million as of February 28, 2018 and May 31, 2017 , respectively, 53% and 67%, respectively, were secured by a mortgage lien on substantially all of the assets and future revenue of the borrowers. We recorded a guarantee liability of $8 million and $15 million as of February 28, 2018 and May 31, 2017 , respectively, related to the contingent and noncontingent exposures for guarantee and liquidity obligations associated with our members' debt.


We were the liquidity provider as well as guarantor for long-term variable-rate, tax-exempt bonds issued for our member cooperatives totaling $251 million as of February 28, 2018 . This amount is included above in Table 14 as a component of the long-term tax-exempt bonds totaling $318 million as of February 28, 2018 . As liquidity provider on these tax-exempt bonds, we may be required to purchase bonds that are tendered or put by investors. Investors provide notice to the remarketing agent that they will tender or put a certain amount of bonds at the next interest rate reset date. If the remarketing agent is unable to sell such bonds to other investors by the next interest rate reset date, we have unconditionally agreed to purchase such bonds. We were not required to perform as liquidity provider pursuant to these obligations during the nine months ended February 28, 2018 or the prior fiscal year.



23



We had outstanding letters of credit for the benefit of our members totaling $248 million as of February 28, 2018 , which are related to obligations for which we may be required to advance funds based on various trigger events specified in the letters of credit agreements. If we are required to advance funds, the member is obligated to repay the advance amount, and accrued interest, to us.


In addition to the letters of credit presented in Table 14 , we had master letter of credit facilities in place as of February 28, 2018 , under which we may be required to issue up to an additional $66 million in letters of credit to third parties for the benefit of our members. All of our master letter of credit facilities as of February 28, 2018 were subject to material adverse change clauses at the time of issuance. Prior to issuing a letter of credit under these facilities, we confirm that there has been no material adverse change in the business or condition, financial or otherwise, of the borrower since the time the loan was approved and that the borrower is currently in compliance with the letter of credit terms and conditions.


Table 15 presents the maturities for each of the next five fiscal years and thereafter of the notional amount of our outstanding guarantee obligations as of February 28, 2018 .


Table 15 : Maturities of Guarantee Obligations

 Outstanding
Amount

Maturities of Guaranteed Obligations

(Dollars in thousands)

2018

2019

2020

2021

2022

Thereafter

Guarantees

$

679,968


$

128,126


$

153,908


$

52,090


$

122,136


$

27,854


$

195,854



We provide additional information about our guarantee obligations in "Note 10-Guarantees."


Unadvanced Loan Commitments


Unadvanced loan commitments represent approved and executed loan contracts for which funds have not been advanced to borrowers. Our line of credit commitments include both contracts that are subject to material adverse change clauses and contracts that are not subject to material adverse change clauses, while our long-term loan commitments are typically subject to material adverse change clauses.


Table 16 displays the amount of unadvanced loan commitments, which consist of line of credit and long-term loan commitments, as of February 28, 2018 and May 31, 2017 .


Table 16 : Unadvanced Loan Commitments

February 28, 2018

May 31, 2017

Increase/

(Dollars in thousands)

Amount

% of Total

Amount

% of Total

(Decrease)

Line of credit commitments:

Conditional (1)

$

4,658,370


38

%

$

5,170,393


41

%

$

(512,023

)

Unconditional (2)

2,776,918


23


2,602,262


21


174,656


Total line of credit unadvanced commitments

7,435,288



61


7,772,655


62


(337,367

)

Total long-term loan unadvanced commitments (1)

4,715,976



39


4,802,319


38


(86,343

)

Total unadvanced loan commitments

$

12,151,264



100

%

$

12,574,974


100

%

$

(423,710

)

____________________________

(1) Represents amount related to facilities that are subject to material adverse change clauses.

(2) Represents amount related to facilities that are not subject to material adverse change clauses.


Table 17 presents the amount of unadvanced loan commitments, by loan type, as of February 28, 2018 and the maturities of the commitment amounts for each of the next five fiscal years and thereafter.



24



Table 17 : Notional Maturities of Unadvanced Loan Commitments

Available

Balance

Notional Maturities of Unadvanced Loan Commitments

(Dollars in thousands)

2018

2019

2020

2021

2022

Thereafter

Line of credit loans

$

7,435,288


$

226,587


$

4,057,079


$

782,079


$

995,502


$

707,497


$

666,544


Long-term loans

4,715,976


71,913


924,921


585,953


637,024


1,742,934


753,231


Total

$

12,151,264


$

298,500


$

4,982,000


$

1,368,032


$

1,632,526


$

2,450,431


$

1,419,775



Unadvanced line of credit commitments accounted for 61% of total unadvanced loan commitments as of February 28, 2018 , while unadvanced long-term loan commitments accounted for 39% of total unadvanced loan commitments. Unadvanced line of credit commitments are typically revolving facilities for periods not to exceed five years. Unadvanced line of credit commitments generally serve as supplemental back-up liquidity to our borrowers. Historically, borrowers have not drawn the full commitment amount for line of credit facilities, and we have experienced a very low utilization rate on line of credit loan facilities regardless of whether or not we are obligated to fund the facility where a material adverse change exists. Our unadvanced long-term loan commitments have a five-year draw period under which a borrower may advance funds prior to the expiration of the commitment. We expect that the majority of the long-term unadvanced loan commitments of $4,716 million will be advanced prior to the expiration of the commitment.


Because we historically have experienced a very low utilization rate on line of credit loan facilities, which account for the majority of our total unadvanced loan commitments, we believe the unadvanced loan commitment total of $12,151 million as of February 28, 2018 is not necessarily representative of our future funding cash requirements.


Unadvanced Loan Commitments-Conditional


The substantial majority of our line of credit commitments and all our unadvanced long-term loan commitments include material adverse change clauses. Unadvanced loan commitments subject to material adverse change clauses totaled $9,374 million and $9,973 million as of February 28, 2018 and May 31, 2017 , respectively, and accounted for 77% and 79% of the combined total of unadvanced line of credit and long-term loan commitments as of February 28, 2018 and May 31, 2017 , respectively. Prior to making advances on these facilities, we confirm that there has been no material adverse change in the borrower's business or condition, financial or otherwise, since the time the loan was approved and confirm that the borrower is currently in compliance with loan terms and conditions. In some cases, the borrower's access to the full amount of the facility is further constrained by use of proceeds restrictions, imposition of borrower-specific restrictions, or by additional conditions that must be met prior to advancing funds. Since we generally do not charge a fee for the borrower to have an unadvanced amount on a loan facility that is subject to a material adverse change clause, our borrowers tend to request amounts in excess of their immediate estimated loan requirements.


Unadvanced Loan Commitments-Unconditional


Unadvanced loan commitments not subject to material adverse change clauses at the time of each advance consisted of unadvanced committed lines of credit totaling $2,777 million and $2,602 million as of February 28, 2018 and May 31, 2017 , respectively. For contracts not subject to a material adverse change clause, we are generally required to advance amounts on the committed facilities as long as the borrower is in compliance with the terms and conditions of the facility.


Syndicated loan facilities, where the pricing is set at a spread over LIBOR as agreed upon by all of the participating banks based on market conditions at the time of syndication, accounted for 85% of unconditional line of credit commitments as of February 28, 2018 . The remaining 15% represented unconditional committed line of credit loans which under any new advance would be made at rates determined by us based on our cost, and we have the option to pass on to the borrower any cost increase related to the advance.


Table 18 presents the maturities for each of the next five fiscal years and thereafter of the notional amount of unconditional committed lines of credit not subject to a material adverse change clause as of February 28, 2018 .



25



Table 18 : Maturities of Notional Amount of Unconditional Committed Lines of Credit

Available

Balance

Notional Maturities of Unconditional Committed Lines of Credit

(Dollars in thousands)

2018

2019

2020

2021

2022

Thereafter

Committed lines of credit

$

2,776,918


$

130,000


$

306,122


$

515,691


$

645,083


$

487,908


$

692,114



See "MD&A-Off-Balance Sheet Arrangements" in our 2017 Form 10-K for additional information on our off-balance sheet arrangements.

RISK MANAGEMENT


Overview


We face a variety of risks that can significantly affect our financial performance, liquidity, reputation and ability to meet the expectations of our members, investors and other stakeholders. As a financial services company, the major categories of risk exposures inherent in our business activities include credit risk, liquidity risk, market risk and operational risk. These risk categories are summarized below.


Credit risk is the risk that a borrower or other counterparty will be unable to meet its obligations in accordance with agreed-upon terms.


Liquidity risk is the risk that we will be unable to fund our operations and meet our contractual obligations or that we will be unable to fund new loans to borrowers at a reasonable cost and tenor in a timely manner.


Market risk is the risk that changes in market variables, such as movements in interest rates, may adversely affect the match between the timing of the contractual maturities, re-pricing and prepayments of our financial assets and the related financial liabilities funding those assets.


Operational risk is the risk of loss resulting from inadequate or failed internal controls, processes, systems, human error or external events. Operational risk also includes compliance risk, fiduciary risk, reputational risk and litigation risk.


Effective risk management is critical to our overall operations and in achieving our primary objective of providing cost-based financial products to our rural electric members while maintaining the sound financial results required for investment-grade credit ratings on our debt instruments. Accordingly, we have a risk management framework that is intended to govern the principal risks we face in conducting our business and the aggregate amount of risk we are willing to accept, referred to as risk appetite, in the context of CFC's mission and strategic objectives and initiatives. We provide information on our risk management framework in our 2017 Form 10-K under "Item 7. MD&A-Risk Management-Risk Management Framework."

CREDIT RISK


Our loan portfolio, which represents the largest component of assets on our balance sheet, and guarantees account for the substantial majority of our credit risk exposure. We also engage in certain non-lending activities that may give rise to credit and counterparty settlement risk, including the purchase of investment securities and entering into derivative transactions to manage our interest rate risk. Our primary credit exposure is to rural electric cooperatives that provide essential electric services to end-users, the majority of which are residential customers. We also have a limited portfolio of loans to not-for-profit and for-profit telecommunication companies.


Credit Risk Management


We manage portfolio and borrower credit risk consistent with credit policies established by the CFC Board of Directors and through credit underwriting, approval and monitoring processes and practices adopted by management. Our board- established credit policies include guidelines regarding the types of credit products we offer, limits on credit we extend to


26



individual borrowers, approval authorities delegated to management, and use of syndications and loan sales. We maintain an internal risk rating system in which we assign a rating to each borrower and credit facility. We review and update the risk ratings at least annually. Assigned risk ratings inform our credit approval, borrower monitoring and portfolio review processes. Our Corporate Credit Committee approves individual credit actions within its own authority and together with our Credit Risk Management group, establishes standards for credit underwriting, oversees credits deemed to be higher risk, reviews assigned risk ratings for accuracy, and monitors the overall credit quality and performance statistics of our loan portfolio and guarantees.


Loan and Guarantee Portfolio Credit Risk


Below we provide information on the credit risk profile of our loan portfolio and guarantees, including security provisions, loan concentration, credit performance and our allowance for loan losses.


Security Provisions


Except when providing line of credit loans, we generally lend to our members on a senior secured basis. Long-term loans are generally secured on parity with other secured lenders (primarily RUS), if any, by all assets and revenue of the borrower with exceptions typical in utility mortgages. Line of credit loans are generally unsecured. In addition to the collateral pledged to secure our loans, distribution and power supply borrowers also are required to set rates charged to customers to achieve certain specified financial ratios.


Table 19 presents, by loan type and by company, the amount and percentage of secured and unsecured loans in our loan portfolio as of February 28, 2018 and May 31, 2017 . Of our total loans outstanding, 91% were secured and 9% were unsecured as of February 28, 2018 . Of our total loans outstanding, 92% were secured and 8% were unsecured as of

May 31, 2017 .


Table 19 : Loan Portfolio Security Profile (1)

February 28, 2018

(Dollars in thousands)

Secured

% of Total

Unsecured

% of Total

Total

Loan type:

Long-term loans:

Long-term fixed-rate loans

$

22,162,866


97

%

$

574,223


3

%

$

22,737,089


Long-term variable-rate loans

941,772


96


43,942


4


985,714


Total long-term loans

23,104,638


97


618,165


3


23,722,803


Line of credit loans

68,267


4


1,540,765


96


1,609,032


Total loans outstanding

$

23,172,905


91


$

2,158,930


9


$

25,331,835


Company:

CFC

$

22,183,116


92

%

$

1,984,440


8

%

$

24,167,556


NCSC

641,526


80


159,288


20


800,814


RTFC

348,263


96


15,202


4


363,465


Total loans outstanding

$

23,172,905


91


$

2,158,930


9


$

25,331,835




27



May 31, 2017

(Dollars in thousands)

Secured

% of Total

Unsecured

% of Total

Total

Loan type:

Long-term loans:

Long-term fixed-rate loans

$

21,503,871


97

%

$

632,819


3

%

$

22,136,690


Long-term variable-rate loans

795,326


94


52,093


6


847,419


Total long-term loans

22,299,197


97


684,912


3


22,984,109


Line of credit loans

54,258


4


1,317,963


96


1,372,221


Total loans outstanding

$

22,353,455


92


$

2,002,875


8


$

24,356,330


Company:

CFC

$

21,591,723


92

%

$

1,796,264


8

%

$

23,387,987


NCSC

424,636


69


189,288


31


613,924


RTFC

337,096


95


17,323


5


354,419


Total loans outstanding

$

22,353,455


92


$

2,002,875


8


$

24,356,330


____________________________

(1) Excludes deferred loan origination costs of $11 million as of both February 28, 2018 and May 31, 2017 .


As part of our strategy in managing our credit risk exposure, we entered into a long-term standby purchase commitment agreement with Farmer Mac on August 31, 2015, as amended on May 31, 2016. Under this agreement, we may designate certain loans to be covered under the commitment, as approved by Farmer Mac, and in the event any such loan later goes into payment default for at least 90 days, upon request by us, Farmer Mac must purchase such loan at par value. The outstanding principal balance of loans covered under this agreement totaled $777 million as of February 28, 2018 , compared with $843 million as of May 31, 2017 . No loans have been put to Farmer Mac for purchase pursuant to this agreement. In addition, RUS guaranteed long-term loans totaling $163 million and $167 million as of February 28, 2018 and

May 31, 2017 , respectively.


Credit Concentration


As a tax-exempt, member-owned finance cooperative, CFC's principal focus is to provide funding to its rural electric utility cooperative members to assist them in acquiring, constructing and operating electric distribution, transmission and related facilities. We serve electric and telecommunications members throughout the United States and its territories, including 49 states, the District of Columbia, American Samoa and Guam. Our consolidated membership totaled 1,447 members and 217 associates as of February 28, 2018 . Texas had the largest concentration of outstanding loans to borrowers in any one state, with approximately 15% of total loans outstanding as of both February 28, 2018 and May 31, 2017 . Outstanding loans to electric utility organizations represented approximately 99% of the total outstanding loan portfolio as of February 28, 2018 , unchanged from May 31, 2017 . As a result of lending primarily to our members, we have a loan portfolio with single-industry and single-obligor concentration risk. Despite our credit concentration risks, we historically have experienced limited defaults and very low credit losses in our electric loan portfolio.


Single-Obligor Concentration


Table 20 displays the outstanding exposure of the 20 largest borrowers, by exposure type and by company, as of February 28, 2018 and May 31, 2017 . The 20 largest borrowers consisted of 10 distribution systems, 9 power supply systems and 1 NCSC associate member as of both February 28, 2018 and May 31, 2017 . The largest total outstanding exposure to a single borrower or controlled group represented approximately 2% of total loans and guarantees outstanding as of both February 28, 2018 and May 31, 2017 .



28



Table 20 : Credit Exposure to 20 Largest Borrowers

February 28, 2018

May 31, 2017

Change

(Dollars in thousands)

Amount

% of Total

Amount

% of Total

By exposure type:

Loans

$

5,906,771


23

 %

$

5,749,885


23

 %

$

156,886


Guarantees

145,770


-


354,619


1


(208,849

)

Total exposure to 20 largest borrowers

6,052,541


23


6,104,504


24


(51,963

)

Less: Loans covered under Farmer Mac standby purchase commitment

(386,185

)

(1

)

(351,699

)

(1

)

(34,486

)

Net exposure to 20 largest borrowers

$

5,666,356


22

 %

$

5,752,805


23

 %

$

(86,449

)

By company:

CFC

$

5,793,218


22

 %

$

5,899,709


23

 %

$

(106,491

)

NCSC

259,323


1


204,795


1


54,528


Total exposure to 20 largest borrowers

6,052,541


23


6,104,504


24


(51,963

)

Less: Loans covered under Farmer Mac standby purchase commitment

(386,185

)

(1

)

(351,699

)

(1

)

(34,486

)

Net exposure to 20 largest borrowers

$

5,666,356


22

 %

$

5,752,805


23

 %

$

(86,449

)


Credit Performance


As part of our credit risk management process, we monitor and evaluate each borrower and loan in our loan portfolio and assign numeric internal risk ratings based on quantitative and qualitative assessments. Our ratings are intended to align with the federal banking regulatory credit risk rating classification definitions of pass, special mention, substandard and doubtful. The special mention, substandard, and doubtful categories are intended to comply with the definition of criticized loans by the banking regulatory authorities. Internal risk ratings and payment status trends are indicators, among others, of the level of credit risk in our loan portfolio.


The overall credit risk of our loan portfolio remained low, as evidenced by our strong asset quality metrics, including senior secured positions on most of our loans and low levels of criticized exposure, nonaccrual loans and charge-offs. As displayed in Table 19 above, 91% and 92% of our total outstanding loans were secured as of February 28, 2018 and May 31, 2017 , respectively. As displayed in "Note 4-Loans and Commitments," 0.4% and 0.5% of the loans in our portfolio were classified as criticized as of February 28, 2018 and May 31, 2017 , respectively. Below we provide information on certain additional credit quality indicators, including modified loans that are considered to be troubled debt restructurings ("TDRs"), nonperforming loans and net charge-offs.


Troubled Debt Restructurings


We actively monitor problem loans and, from time to time, attempt to work with borrowers to manage such exposures through loan workouts or modifications that better align with the borrower's current ability to pay. A loan restructuring or modification of terms is accounted for as a TDR if, for economic or legal reasons related to the borrower's financial difficulties, a concession is granted to the borrower that we would not otherwise consider. TDR loans generally are initially placed on nonaccrual status, although in many cases such loans were already on nonaccrual status prior to modification. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed against earnings. These loans may be returned to performing status and the accrual of interest resumed if the borrower performs under the modified terms for an extended period of time, and we expect the borrower to continue to perform in accordance with the modified terms. In certain limited circumstances in which a TDR loan is current at the modification date, the loan may remain on accrual status at the time of modification.


Table 21 presents the carrying value of loans modified as TDRs in prior periods as of February 28, 2018 and May 31, 2017 . These loans were considered individually impaired as of the end of each period presented.



29



Table 21 : TDR Loans

February 28, 2018

May 31, 2017

(Dollars in thousands)

Carrying Amount

% of Total Loans Outstanding

Carrying Amount

% of Total Loans Outstanding

TDR loans:

CFC

$

6,507


0.03

%

$

6,581


0.02

%

RTFC

6,216


0.02


6,592


0.03


Total TDR loans

$

12,723


0.05

%

$

13,173


0.05

%

Performance status of TDR loans:

Performing TDR loans

$

12,723


0.05

%

$

13,173


0.05

%

As indicated in Table 21 , we did not have any TDR loans classified as nonperforming as of February 28, 2018 or

May 31, 2017 . TDR loans as of February 28, 2018 and May 31, 2017 were performing in accordance with the terms of their respective restructured loan agreement and on accrual status as of the respective reported dates.


Nonperforming Loans


In addition to TDR loans that may be classified as nonperforming, we also may have nonperforming loans that have not been modified as a TDR loan. We classify such loans as nonperforming at the earlier of the date when we determine: (i) interest or principal payments on the loan is past due 90 days or more; (ii) as a result of court proceedings, the collection of interest or principal payments based on the original contractual terms is not expected; or (iii) the full and timely collection of interest or principal is otherwise uncertain. Once a loan is classified as nonperforming, we generally place the loan on nonaccrual status. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed against earnings. We had no loans classified as nonperforming as of February 28, 2018 or May 31, 2017 . In addition, we did not have any past due loans as of either February 28, 2018 or May 31, 2017 .


We provide additional information on the credit quality of our loan portfolio in "Note 4-Loans and Commitments."


Net Charge-Offs


Table 22 presents charge-offs, net of recoveries, and the net charge-off rate for the three and nine months ended

February 28, 2018 and 2017 .


Table 22 : Net Charge-Offs (Recoveries)

Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018


2017

Charge-offs:

RTFC

$

-


$

-


$

-


$

2,119


Recoveries:

CFC

-


(53

)

-


(159

)

Net charge-offs (recoveries)

$

-


$

(53

)

$

-


$

1,960


Average total loans outstanding

$

25,204,005


$

24,092,805


$

24,822,092


$

23,695,378


Net charge-off rate (1)

-

%

-

 %

-

%

0.01

%

____________________________

(1) Calculated based on annualized net charge-offs (recoveries) for the period divided by average total outstanding loans for the period.



30



As displayed in Table 22 , we experienced no charge-offs during the nine months ended February 28, 2018 . Charge-offs totaled $2 million during the nine months ended February 28, 2017 , all of which were related to telecommunications loans in the RTFC portfolio. Our average annual net charge-off rate has been less than 0.01% over the last three fiscal years.


Allowance for Loan Losses

The allowance for loan losses represents management's estimate of probable losses inherent in our loan portfolio as of each balance sheet date. We determine the allowance based on borrower risk ratings, historical loss experience, specific problem loans, economic conditions and other pertinent factors that, in management's judgment, may affect the risk of loss in our loan portfolio.


Table 23 summarizes changes in the allowance for loan losses for the three and nine months ended February 28, 2018 and 2017 , and provides a comparison of the allowance by company as of February 28, 2018 and May 31, 2017 .


Table 23 : Allowance for Loan Losses

Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018

2017

Beginning balance

$

36,774


$

33,911


$

37,376


$

33,258


Provision for loan losses

1,105


2,065


503


4,731


Net recoveries (charge-offs)

-


53


-


(1,960

)

Ending balance

$

37,879


$

36,029


$

37,879


$

36,029


February 28, 2018

May 31, 2017

Allowance for loan losses by company:

CFC

$

29,305


$

29,499


NCSC

3,848


2,910


RTFC

4,726


4,967


Total

$

37,879


$

37,376


Allowance coverage ratios:

Loans to members

$

25,342,922


$

24,367,044


Percentage of loans to members

0.15

%

0.15

%


The allowance for loan losses of $38 million as of February 28, 2018 increased by less than $1 million from fiscal year end May 31, 2017 , while the allowance coverage ratio remained unchanged at 0.15% . The credit quality and performance statistics of our loan portfolio remained strong. We had no loans classified as nonperforming as of February 28, 2018 or May 31, 2017 . We experienced no charge-offs during the nine months ended February 28, 2018 . In comparison, we recorded a net charge-off of $2 million during the nine months ended February 28, 2017 . Loans designated as individually impaired totaled $13 million as of both February 28, 2018 and May 31, 2017 , and the specific allowance related to those loans totaled $1 million and $2 million , respectively.


For additional information on our methodology for determining the allowance for loan losses and the judgment and assumptions involved, see "MD&A-Critical Accounting Policies and Estimates-Allowance for Loan Losses" and "Note 1-Summary of Significant Accounting Policies" in our 2017 Form 10-K. See "Note 4-Loans and Commitments" of this Report for additional information on the credit quality of our loan portfolio and the allowance for loan losses.



31



Counterparty Credit Risk


We are exposed to counterparty risk related to the performance of the parties with which we entered into financial transactions, primarily for derivative instruments, cash, time deposits and investment securities that we have with various financial institutions. To mitigate this risk, we only enter into these transactions with financial institutions with investment-grade ratings. Our cash and time deposits with financial institutions generally have an original maturity of less than one year.


We manage our derivative counterparty credit risk by requiring that derivative counterparties participate in one of our committed bank revolving line of credit agreements, monitoring the overall credit worthiness of each counterparty, using counterparty specific credit risk limits, executing master netting arrangements and diversifying our derivative transactions among multiple counterparties. Our derivative counterparties had credit ratings ranging from Aa3 to Baa2 by Moody's Investors Service ("Moody's") and from AA- to A- by S&P Global Ratings ("S&P") as of February 28, 2018 . Our largest counterparty exposure, based on the outstanding notional amount, represented approximately 22% and 23% of the total outstanding notional amount of derivatives as of February 28, 2018 and May 31, 2017 , respectively.


Credit Risk-Related Contingent Features


Our derivative contracts typically contain mutual early termination provisions, generally in the form of a credit rating trigger. Under the mutual credit rating trigger provisions, either counterparty may, but is not obligated to, terminate and settle the agreement if the credit rating of the other counterparty falls to a level specified in the agreement. If a derivative contract is terminated, the amount to be received or paid by us would be equal to the mark-to-market value, as defined in the agreement, as of the termination date.


Our senior unsecured credit ratings from Moody's and S&P were A2 and A, respectively, as of February 28, 2018 . Both Moody's and S&P had our ratings on stable outlook as of February 28, 2018 . Table 24 displays the notional amounts of our derivative contracts with rating triggers as of February 28, 2018 , and the payments that would be required if the contracts were terminated as of that date because of a downgrade of our unsecured credit ratings or the counterparty's unsecured credit ratings below A3/A-, below Baa1/BBB+ to or below Baa2/BBB, below Baa3/BBB- or to or below Ba2/BB+ by Moody's or S&P, respectively. In calculating the payment amounts that would be required upon termination of the derivative contracts, we assumed that the amounts for each counterparty would be netted in accordance with the provisions of the counterparty's master netting agreements. The net payment amounts are based on the fair value of the underlying derivative instrument, excluding the credit risk valuation adjustment, plus any unpaid accrued interest amounts.


Table 24 : Rating Triggers for Derivatives

(Dollars in thousands)

Notional

 Amount

Payable Due From CFC

Receivable Due to CFC

Net (Payable)/Receivable

Impact of rating downgrade trigger:

Falls below A3/A- (1)

$

54,890


$

(10,007

)

$

-


$

(10,007

)

Falls below Baa1/BBB+

7,237,155


(61,923

)

40,825


(21,098

)

Falls to or below Baa2/BBB (2)

503,125


-


5,191


5,191


Falls below Baa3/BBB-

258,923


(12,974

)

-


(12,974

)

Total

$

8,054,093


$

(84,904

)

$

46,016


$

(38,888

)

____________________________

(1) Rating trigger for CFC falls below A3/A-, while rating trigger for counterparty falls below Baa1/BBB+ by Moody's or S&P, respectively.

(2) Rating trigger for CFC falls to or below Baa2/BBB, while rating trigger for counterparty falls to or below Ba2/BB+ by Moody's or S&P, respectively.


The aggregate fair value amount, including the credit risk valuation adjustment, of all interest rate swaps with rating triggers that were in a net liability position was $85 million as of February 28, 2018 . There were no counterparties that fell below the rating trigger levels in our interest swap contracts as of February 28, 2018 . If a counterparty has a credit rating that falls below the rating trigger level specified in the interest swap contract, we have the option to terminate all derivatives with the counterparty. However, we generally do not terminate such agreements early because our interest rate swaps are critical to our matched funding strategy.


32



See "Item 1A. Risk Factors" in our 2017 Form 10-K for additional information about credit risk related to our business.

LIQUIDITY RISK


We consider liquidity to be the ability to access funding or convert assets to cash quickly and efficiently, or to rollover or issue new debt, both under normal operating conditions and under periods of market stress, at a reasonable cost to ensure that we can meet borrower loan requests and other short-term cash obligations.


Liquidity Risk Management


Our liquidity risk management framework is designed to meet our liquidity objectives of providing a reliable source of funding to members, meet maturing debt and other obligations, issue new debt and fund our operations on a cost-effective basis under normal operating conditions as well as under CFC-specific and/or market stress conditions. We engage in various activities to manage liquidity risk and achieve our liquidity objectives. Our Asset Liability Committee establishes guidelines that are intended to ensure that we maintain sufficient, diversified sources of liquidity to cover potential funding requirements as well as unanticipated contingencies. Our Treasury group develops strategies to manage our targeted liquidity position, projects our funding needs under various scenarios, including adverse circumstances, and monitors our liquidity position on an ongoing basis.


Liquidity Reserve


As part of our strategy in meeting our liquidity objectives, we seek to maintain access to liquidity in the form of both on-balance sheet and off-balance sheet funding sources that are readily accessible for immediate liquidity needs. Table 25 below presents the components of our liquidity reserve and a comparison of the amounts available as of February 28, 2018 and May 31, 2017 .


Table 25 : Liquidity Reserve

February 28, 2018

May 31, 2017

(Dollars in millions)

Total

Accessed

Available

Total

Accessed

Available

Cash and cash equivalents

$

251


$

-


$

251


$

167


$

-


$

167


Committed bank revolving line of credit agreements-unsecured (1)

3,085


2


3,083


3,165


1


3,164


Guaranteed Underwriter Program committed facilities-secured (2)

6,548


5,323


1,225


5,798


5,073


725


Farmer Mac revolving note purchase agreement, dated March 24, 2011-secured (3)

5,200


2,805


2,395


4,500


2,513


1,987


Farmer Mac revolving note purchase agreement, dated July 31, 2015-secured

300


-


300


300


-


300


Total

$

15,384


$

8,130


$

7,254


$

13,930


$

7,587


$

6,343


____________________________

(1) The accessed amount of $2 million and $1 million as of February 28, 2018 and May 31, 2017 , respectively, relates to letters of credit issued pursuant

to the line of credit agreement.

(2) The committed facilities under the Guaranteed Underwriting Program are not revolving.

(3) Availability subject to market conditions.


Borrowing Capacity


In addition to cash, our liquidity reserve includes access to funds under committed revolving line of credit agreements with banks, committed loan facilities under the Guaranteed Underwriter Program and our revolving note purchase agreements with Farmer Mac. Following is a discussion of our borrowing capacity and key terms and conditions under each of these facilities.



33



Committed Bank Revolving Line of Credit Agreements-Unsecured


Our committed bank revolving lines of credit may be used for general corporate purposes; however, we generally rely on them as a backup source of liquidity for our member and dealer commercial paper. We had $3,085 million of commitments under committed bank revolving line of credit agreements as of February 28, 2018 . Under our current committed bank revolving line of credit agreements, we have the ability to request up to $300 million of letters of credit, which would result in a reduction in the remaining available amount under the facilities.


On November 20, 2017 , we amended and restated the three-year and five-year committed bank revolving line of credit agreements to extend the maturity dates to November 20, 2020 and November 20, 2022 , respectively, and to terminate certain third-party bank commitments totaling $40 million under the three-year agreement and $40 million under the five- year agreement. As a result, the total commitment amount from third-parties under the three-year facility and the five-year facility is $1,493 million and $1,592 million , respectively, resulting in a combined total commitment amount under the two facilities of $3,085 million .


Table 26 presents the total commitment, the net amount available for use and the outstanding letters of credit under our committed bank revolving line of credit agreements as of February 28, 2018 . We did not have any outstanding borrowings under our bank revolving line of credit agreements as of February 28, 2018 .


Table 26 : Committed Bank Revolving Line of Credit Agreements

February 28, 2018

(Dollars in millions)

Total Commitment

Letters of Credit Outstanding

Net Available for Advance

Maturity

Annual Facility Fee (1)

3-year agreement

$

1,493


$

-


$

1,493


November 20, 2020

7.5 bps

5-year agreement

1,592


2


1,590


November 20, 2022

10 bps

Total

$

3,085


$

2


$

3,083


____________________________

(1) Facility fee based on CFC's senior unsecured credit ratings in accordance with the established pricing schedules at the inception of the related agreement.


Our committed bank revolving line of credit agreements do not contain a material adverse change clause or rating triggers that would limit the banks' obligations to provide funding under the terms of the agreements; however, we must be in compliance with the covenants to draw on the facilities. We have been and expect to continue to be in compliance with the covenants under our committed bank revolving line of credit agreements. As such, we could draw on these facilities to repay dealer or member commercial paper that cannot be rolled over. See "Debt Covenants and Financial Ratios" below for additional information, including the specific financial ratio requirements under our committed bank revolving line of credit agreements.


Guaranteed Underwriter Program Committed Facilities-Secured


Under the Guaranteed Underwriter Program we can borrow from the Federal Financing Bank and use the proceeds to refinance existing indebtedness. As part of the program, we pay fees, based on outstanding borrowings, that support the USDA Rural Economic Development Loan and Grant program. The borrowings under this program are guaranteed by RUS.


On November 9, 2017 , we closed on a $750 million committed loan facility ("Series M") from the Federal Financing Bank under the Guaranteed Underwriter Program. Pursuant to this facility, we may borrow any time before July 15, 2022. Each advance is subject to quarterly amortization and a final maturity not longer than 20 years from the advance date. The closing of this committed loan facility increased the amount available for access under the Guaranteed Underwriter Program to $1,225 million as of February 28, 2018 . Of this amount, $100 million is available for advance through January 15, 2019, $375 million is available for advance through October 15, 2019 and $750 million is available through July 15, 2022.


We are required to pledge eligible distribution system or power supply system loans as collateral in an amount at least equal to the total outstanding borrowings under the Guaranteed Underwriter Program. See "Consolidated Balance Sheet Analysis-Debt-Collateral Pledged" and "Note 4-Loans and Commitments" for additional information on pledged collateral.


34



Farmer Mac Revolving Note Purchase Agreements-Secured


As indicated in Table 25 , we have two revolving note purchase agreements with Farmer Mac, which together allow us to borrow up to $5,500 million from Farmer Mac. On February 26, 2018, we amended our first revolving note purchase agreement with Farmer Mac, dated March 24, 2011. Under the amended agreement we can borrow, subject to market conditions, up to $5,200 million at any time through January 11, 2022, and such date shall automatically extend on each anniversary date of the closing for an additional year, unless prior to any such anniversary date, Farmer Mac provides us with a notice that the draw period will not be extended beyond the remaining term. This revolving note purchase agreement allows us to borrow, repay and re-borrow funds at any time through maturity, as market conditions permit, provided that the outstanding principal amount at any time does not exceed the total available under the agreement. Each borrowing under the note purchase agreement is evidenced by a pricing agreement setting forth the interest rate, maturity date and other related terms as we may negotiate with Farmer Mac at the time of each such borrowing. We may select a fixed rate or variable rate at the time of each advance with a maturity as determined in the applicable pricing agreement. We had outstanding secured notes payable totaling $2,805 million and $2,513 million as of February 28, 2018 and May 31, 2017 , respectively, under the Farmer Mac revolving note purchase agreement of $5,200 million . The available borrowing amount totaled $2,395 million as of February 28, 2018 .


Under the terms of the second revolving note purchase agreement with Farmer Mac dated July 31, 2015, we can borrow up to $300 million at any time through July 31, 2018 at a fixed spread over LIBOR. This agreement also allows us to borrow, repay and re-borrow funds at any time through maturity, provided that the outstanding principal amount at any time does not exceed the total available under the agreement. We had no outstanding notes payable under this agreement as of

February 28, 2018 and May 31, 2017 .


Pursuant to both Farmer Mac revolving note purchase agreements, we are required to pledge eligible distribution system or power supply system loans as collateral in an amount at least equal to the total principal amount of notes outstanding. See "Consolidated Balance Sheet Analysis-Debt-Collateral Pledged" and "Note 4-Loans and Commitments" for additional information on pledged collateral.


Short-Term Borrowings


We rely on short-term borrowings, which we refer to as our short-term funding portfolio, as a source to meet our daily, near-term funding needs. Our short-term funding portfolio consists of commercial paper, which we offer to members and dealers, select notes and daily liquidity fund notes offered to members, and bank-bid notes and medium-term notes offered to members and dealers. Table 27 displays the composition of our short-term borrowings as of February 28, 2018 and

May 31, 2017 .



35



Table 27 : Short-Term Borrowings

February 28, 2018

May 31, 2017

(Dollars in thousands)

Amount

 Outstanding

% of Total Debt Outstanding

Amount
Outstanding

% of Total Debt Outstanding

Short-term borrowings:

Commercial paper:

Commercial paper to dealers, net of discounts

$

1,055,147


4

%

$

999,691


4

%

Commercial paper to members, at par

1,021,016


4


928,158


4


Total commercial paper

2,076,163


8


1,927,849


8


Select notes to members

674,319


3


696,889


3


Daily liquidity fund notes to members

506,921


2


527,990


2


Medium-term notes to members

236,333


1


190,172


1


Total short-term borrowings

$

3,493,736


14

%

$

3,342,900


14

%

February 28, 2018

May 31, 2017

Amount

 Outstanding

% of Total Short-Term Borrowings

Amount
Outstanding

% of Total Short-Term Borrowings

Funding source:

Members

$

2,438,589


70

%

$

2,343,209


70

%

Capital markets

1,055,147


30


999,691


30


Total short-term borrowings

$

3,493,736


100

%

$

3,342,900


100

%


Our short-term borrowings totaled $3,494 million and accounted for 14% of total debt outstanding as of February 28, 2018 , compared with $3,343 million , or 14% , of total debt outstanding as of May 31, 2017 . Member borrowings accounted for 70% of our total short-term borrowings as of both February 28, 2018 and May 31, 2017 . Of the total outstanding commercial paper, $1,055 million and $1,000 million was issued to dealers as of February 28, 2018 and May 31, 2017 , respectively. Our intent is to manage our short-term wholesale funding risk by maintaining outstanding dealer commercial paper at an amount below $1,250 million for the foreseeable future.


Long-Term and Subordinated Debt


Long-term and subordinated debt represents the most significant component of our funding. The issuance of long-term debt allows us to reduce our reliance on short-term borrowings and manage our refinancing and interest rate risk, due in part to the multi-year contractual maturity structure of long-term debt. In addition to access to private debt facilities, we also issue debt in the public capital markets. Under the SEC rules, we are classified as a "well-known seasoned issuer." In November 2017, we filed a new shelf registration statement for our senior and subordinated debt securities under which we can register an unlimited amount of senior and subordinated debt securities, including medium-term notes, member capital securities and subordinated deferrable debt, until November 2020. Notwithstanding the foregoing, we have contractual limitations with respect to the amount of senior indebtedness we may incur. See "MD&A-Liquidity Risk" of our 2017 Form 10-K for additional information on our shelf registration statements with the SEC.


As discussed in " Consolidated Balance Sheet Analysis-Debt, " l ong-term and subordinated debt totaled $20,935 million and accounted for 86% of total debt outstanding as of February 28, 2018 , compared with $20,117 million , or 86% , of total debt outstanding as of May 31, 2017 . The increase in total debt outstanding, including long-term and subordinated debt, was primarily due to the issuance of debt to fund loan portfolio growth. Table 28 summarizes long-term and subordinated debt issuances and repayments during the nine months ended February 28, 2018 .



36



Table 28 : Issuances and Repayments of Long-Term and Subordinated Debt (1)

Nine Months Ended February 28, 2018

(Dollars in thousands)

Issuances

Repayments (1)

Increase/Decrease

Long-term and subordinated debt activity: (2)

Collateral trust bonds

$

700,000


$

705,000


$

(5,000

)

Guaranteed Underwriter Program notes payable

250,000


363,978


(113,978

)

Farmer Mac notes payable

325,000


33,013


291,987


Medium-term notes sold to members

183,169


194,575


(11,406

)

Medium-term notes sold to dealers

706,166


11,343


694,823


Other notes payable

-


3,565


(3,565

)

Members' subordinated certificates

4,802


44,134


(39,332

)

Total

$

2,169,137


$

1,355,608


$

813,529


____________________________

(1) Repayments include principal maturities, scheduled amortizations payments, repurchases and redemptions,.

(2) Amounts exclude unamortized debt issuance costs and discounts.


Table 29 summarizes the scheduled amortization of the principal amount of long-term debt, subordinated deferrable debt and members' subordinated certificates as of February 28, 2018 .


Table 29 : Principal Maturity of Long-Term and Subordinated Debt

(Dollars in thousands)

Amount

     Maturing (1)

% of Total

Fiscal year ending:

May 31, 2018

$

289,956


1

%

May 31, 2019

2,717,712


13


May 31, 2020

1,469,165


7


May 31, 2021

1,640,398


8


May 31, 2022

1,590,796


8


Thereafter

13,226,651


63


Total

$

20,934,678


100

%

____________________________

(1) Excludes $0.5 million in subscribed and unissued member subordinated certificates for which a payment has been received. Member loan subordinated certificates totaling $274 million amortize annually based on the unpaid principal balance of the related loan.


We provide additional information on our financing activities above under "Consolidated Balance Sheet Analysis-Debt."


Investment Portfolio


In addition to our primary sources of liquidity discussed above, we have an investment portfolio, composed of time deposits, available-for-sale investment securities and held-to-maturity investment securities, which totaled $339 million and $319 million as of February 28, 2018 and May 31, 2017 , respectively. We intend for our investment portfolio to remain adequately liquid to serve as a contingent supplemental source of liquidity for unanticipated liquidity needs.


During the second quarter of fiscal year 2018, we commenced the purchase of additional investment securities, consisting primarily of certificates of deposit, commercial paper, corporate debt securities, commercial mortgage-backed securities, and other asset-backed securities. Pursuant to our investment policy guidelines, all fixed-income securities, at the time of purchase, must be rated at least investment grade and on stable outlook based on external credit ratings from at least two of the leading global credit rating agencies, when available, or the corresponding equivalent, when not available. Securities rated investment grade, that is those rated Baa3 or higher by Moody's or BBB- or higher by S&P, are generally considered by the rating agencies to be of lower credit risk than non-investment grade securities. We have the positive intent and ability


37



to hold these securities to maturity. As such, we have classified them as held to maturity on our condensed consolidated balance sheet.


Our investment portfolio is unencumbered and structured so that securities have active secondary or resale markets under normal market conditions. The objective of the portfolio is to achieve returns commensurate with the level of risk assumed subject to CFC's investment policy guidelines and liquidity requirements.


We provide additional information on available-for-sale and held-to-maturity investment securities held in our our investment portfolio in "Note 3-Investment Securities."


Projected Near-Term Sources and Uses of Liquidity


As discussed above, our primary sources of liquidity include cash flows from operations, our short-term funding portfolio, our liquidity reserve and the issuance of long-term and subordinated debt, as well as loan principal and interest payments. Our primary uses of liquidity include loan advances to members, principal and interest payments on borrowings, periodic settlement payments related to derivative contracts, costs related to the disposition of foreclosed assets and operating expenses.


Table 30 below displays our projected sources and uses of cash, by quarter, over the next six quarters through the quarter ending August 31, 2019 . Our projected liquidity position reflects our current plan to expand our investment portfolio. Our assumptions also include the following: (i) the estimated issuance of long-term debt, including collateral trust bonds and private placement of term debt, is based on maintaining a matched funding position within our loan portfolio with our bank revolving lines of credit serving as a backup liquidity facility for commercial paper and on maintaining outstanding dealer commercial paper at an amount below $1,250 million; (ii) long-term loan scheduled amortization payments represent the scheduled long-term loan payments for loans outstanding as of February 28, 2018 , and our current estimate of long-term loan prepayments, which the amount and timing of are subject to change; (iii) other loan repayments and other loan advances primarily relate to line of credit repayments and advances; (iv) long-term debt maturities reflect scheduled maturities of outstanding term debt for the periods presented; and (v) long-term loan advances reflect our current estimate of member demand for loans, the amount and timing of which are subject to change.


Table 30 : Projected Sources and Uses of Liquidity (1)

Projected Sources of Liquidity

Projected Uses of Liquidity

(Dollars in millions)

Long-Term Debt Issuance

Anticipated Long-Term
Loan Repayments
(2)

Other Loan Repayments (3)

Total Projected
Sources of
Liquidity

Long-Term Debt Maturities (4)

Long-Term
 Loan Advances

Other Loan Advances (5)

Total Projected
Uses of
Liquidity

Other Sources/ (Uses) of Liquidity (6)

4Q FY 2018

$

365


$

300


$

220


$

885


$

336


$

405


$

-


$

741


$

(244

)

1Q FY 2019

150


316


52


518


166


480


-


646


135


2Q FY 2019

1,875


327


-


2,202


1,601


528


13


2,142


(66

)

3Q FY 2019

1,175


306


-


1,481


760


549


-


1,309


(172

)

4Q FY 2019

510


282


-


792


407


354


-


761


(32

)

1Q FY 2020

295


309


-


604


167


405


-


572


(30

)

Total

$

4,370


$

1,840


$

272


$

6,482


$

3,437


$

2,721


$

13


$

6,171


$

(409

)

____________________________

(1) The dates presented represent the end of each quarterly period through the quarter ending August 31, 2019 .

(2) Anticipated long-term loan repayments include scheduled long-term loan amortizations, anticipated cash repayments at repricing date and sales.

(3) Other loan repayments include anticipated short-term loan repayments.

(4) Long-term debt maturities also includes medium-term notes with an original maturity of one year or less and expected early redemptions of debt.

(5) Other loan advances include anticipated short-term loan advances.

(6) Includes net increase or decrease to dealer commercial paper, and purchases and maturity of investments.


As displayed in Table 30 , we currently project long-term advances of $1,962 million over the next 12 months, which we anticipate will exceed anticipated loan repayments over the same period of $1,249 million by approximately $713 million . The estimates presented above are developed at a particular point in time based on our expected future business growth and


38



funding. Our actual results and future estimates may vary, perhaps significantly, from the current projections, as a result of changes in market conditions, management actions or other factors.


Credit Ratings


Our funding and liquidity, borrowing capacity, ability to access capital markets and other sources of funds and the cost of these funds are partially dependent on our credit ratings. Rating agencies base their ratings on numerous factors, including liquidity, capital adequacy, industry position, member support, management, asset quality, quality of earnings and the probability of systemic support. Significant changes in these factors could result in different ratings. Table 31 displays our credit ratings as of February 28, 2018 , which were unchanged as of the date of the filing of this Report.


Table 31 : Credit Ratings

February 28, 2018

Moody's

S&P

Fitch

Long-term issuer credit rating (1)

A2

A

A

Senior secured debt (2)

A1

A

  A+

Senior unsecured debt (3)

A2

A

A

Subordinated debt

A3

BBB+

BBB+

Commercial paper

P-1

A-1

F1

Outlook

Stable

Stable

Stable

___________________________

(1) Based on our senior unsecured debt rating.

(2) Applies to our collateral trust bonds.

(3) Applies to our medium-term notes.


During the second quarter of fiscal year 2018, Moody's and S&P affirmed our ratings and outlook. In order to access the commercial paper markets at attractive rates, we believe we need to maintain our current commercial paper credit ratings of P-1 by Moody's, A-1 by S&P and F1 by Fitch. In addition, the notes payable to the Federal Financing Bank and guaranteed by RUS under the Guaranteed Underwriter Program contain a provision that if during any portion of the fiscal year, our senior secured credit ratings do not have at least two of the following ratings: (i) A3 or higher from Moody's, (ii) A- or higher from S&P, (iii) A- or higher from Fitch or (iv) an equivalent rating from a successor rating agency to any of the above rating agencies, we may not make cash patronage capital distributions in excess of 5% of total patronage capital. See "Credit Risk-Counterparty Credit Risk-Credit Risk-Related Contingent Features" above for information on credit rating provisions related to our derivative contracts.


Financial Ratios


Our debt-to-equity ratio decreased to 17.15 -to-1 as of February 28, 2018 , from 21.94 -to-1 as of May 31, 2017 , primarily due to an increase in equity resulting from our reported net income of $409 million for the nine months ended February 28, 2018 , which was partially offset by patronage capital retirement of $45 million in September 2017.


Our adjusted debt-to-equity ratio increased to 6.21 -to-1 as of February 28, 2018 , from 5.95 -to-1 as of May 31, 2017 , largely due to an increase in debt outstanding to fund loan growth. We provide a reconciliation of our adjusted debt-to-equity ratio to the most comparable GAAP measure and an explanation of the adjustments below in "Non-GAAP Financial Measures."


Debt Covenants


As part of our short-term and long-term borrowing arrangements, we are subject to various financial and operational covenants. If we fail to maintain specified financial ratios, such failure could constitute a default by CFC of certain debt covenants under our committed bank revolving line of credit agreements and senior debt indentures. We were in compliance with all covenants and conditions under our committed bank revolving line of credit agreements and senior debt indentures as of February 28, 2018 .



39



As discussed above in "Summary of Selected Financial Data," the financial covenants set forth in our committed bank revolving line of credit agreements and senior debt indentures are based on adjusted financial measures, including adjusted TIER. We provide a reconciliation of adjusted TIER and other non-GAAP measures disclosed in this Report to the most comparable GAAP measures and an explanation of the adjustments below in "Non-GAAP Financial Measures."

MARKET RISK


Interest rate risk represents our primary market risk. Interest rate risk is the risk arising from movements in interest rates that may result in differences between the timing of contractual maturities, re-pricing characteristics and prepayments on our assets and their related liabilities.


Interest Rate Risk Management


Our interest rate risk exposure is primarily related to the funding of the fixed-rate loan portfolio. Our Asset Liability Committee provides oversight over maintaining our interest rate position within a prescribed policy range using approved strategies. The Asset Liability Committee reviews a complete interest rate risk analysis, reviews proposed modifications, if any, to our interest rate risk management strategy and considers adopting strategy changes. Our Asset Liability Committee monitors interest rate risk and meets quarterly to review and discuss information such as national economic forecasts, federal funds and interest rate forecasts, interest rate gap analysis, our liquidity position, loan and debt maturities, short-term and long-term funding needs, anticipated loan demands, credit concentration risk, derivative counterparty exposure and financial forecasts. The Asset Liability Committee also discusses the composition of fixed-rate versus variable-rate lending, new funding opportunities, changes to the nature and mix of assets and liabilities for structural mismatches, and interest rate swap transactions.


Matched Funding Objective


Our funding objective is to manage the matched funding of asset and liability repricing terms within a range of adjusted total assets (calculated by excluding derivative assets from total assets) deemed appropriate by the Asset Liability Committee based on the current environment and extended outlook for interest rates. We refer to the difference between fixed-rate loans scheduled for amortization or repricing and the fixed-rate liabilities and equity funding those loans as our interest rate gap. Our primary strategies for managing our interest rate risk include the use of derivatives and limiting the amount of fixed-rate assets that can be funded by variable-rate debt to a specified percentage of adjusted total assets based on market conditions.


We provide our members with many options on loans with regard to interest rates, the term for which the selected interest rate is in effect and the ability to convert or prepay the loan. Long-term loans generally have maturities of up to 35 years. Borrowers may select fixed interest rates for periods of one year through the life of the loan. We do not match fund the majority of our fixed-rate loans with a specific debt issuance at the time the loans are advanced. We fund the amount of fixed-rate assets that exceed fixed-rate debt and members' equity with short-term debt, primarily commercial paper.


Interest Rate Gap Analysis


To monitor and mitigate interest rate risk in the funding of fixed-rate loans, we perform a monthly interest rate gap analysis that provides a comparison between fixed-rate assets repricing or maturing by year and fixed-rate liabilities and members' equity maturing by year.


We maintain an unmatched position on our fixed-rate assets within a targeted range of adjusted total assets. The limited unmatched position is intended to provide flexibility to ensure that we are able to match the current maturing portion of long-term fixed rate loans based on maturity date and the opportunity in the current low interest rate environment to increase the gross yield on our fixed rate assets without taking what we would consider to be excessive risk.


Table 32 displays the scheduled amortization and repricing of fixed-rate assets and liabilities outstanding as of February 28, 2018 . We exclude variable-rate loans from our interest rate gap analysis as we do not consider the interest rate risk on these loans to be significant because they are subject to repricing at least monthly. Loans with variable interest rates accounted for 10% and 9% of our total loan portfolio as of February 28, 2018 and May 31, 2017 , respectively. Fixed-rate liabilities include


40



debt issued at a fixed rate as well as variable-rate debt swapped to a fixed rate using interest rate swaps. Fixed-rate debt swapped to a variable rate using interest rate swaps is excluded from the analysis since it is used to match fund the variable-rate loan pool. With the exception of members' subordinated certificates, which are generally issued with extended maturities, and commercial paper, our liabilities have average maturities that closely match the repricing terms (but not the maturities) of our fixed-rate loans.


Table 32 : Interest Rate Gap Analysis

(Dollars in millions)

Prior to 5/31/18

Two Years 6/1/18 to 5/31/20

Two Years 6/1/20 to
5/31/22

Five Years 6/1/22 to
5/31/27

10 Years 6/1/27 to 5/31/37

6/1/37 and Thereafter

Total

Asset amortization and repricing

$

442


$

3,543


$

3,002


$

5,758


$

6,905


$

3,305


$

22,955


Liabilities and members' equity:


Long-term debt (1)

$

212


$

3,830


$

2,575


$

5,401


$

5,543


$

1,622


$

19,183


Subordinated certificates

5


53


48


974


156


579


1,815


Members' equity (2)

-


23


24


105


293


906


1,351


Total liabilities and members' equity (3)

$

217


$

3,906


$

2,647


$

6,480


$

5,992


$

3,107


$

22,349


Gap (4)

$

225


$

(363

)

$

355


$

(722

)

$

913


$

198


$

606


Cumulative gap

225


(138

)

217


(505

)

408


606


Cumulative gap as a % of total assets

0.85

%

(0.52

)%

0.82

%

(1.91

)%

1.54

%

2.29

%

Cumulative gap as a % of adjusted total assets (5)

0.86


(0.53

)

0.83


(1.93

)

1.56


2.31


____________________________

(1) Includes long-term fixed-rate debt and net fixed-rate swaps.

(2) Includes the portion of the allowance for loan losses and subordinated deferrable debt allocated to fund fixed-rate assets and excludes noncash adjustments from the accounting for derivative financial instruments.

(3) Debt is presented based on call date.

(4) Calculated based on the amount of assets amortizing and repricing less total liabilities and members' equity.

(5) Adjusted total assets represents total assets reported in our condensed consolidated balance sheets less derivative assets.


The difference, or interest rate gap, of $606 million between the fixed-rate loans scheduled for amortization or repricing of $22,955 million and the fixed-rate liabilities and equity funding the loans of $22,349 million presented in Table 32 reflects the amount of fixed-rate assets that are funded with short-term and variable-rate debt as of February 28, 2018 . The gap of $606 million represented 2.29% of total assets and 2.31% of adjusted total assets (total assets excluding derivative assets) as of February 28, 2018 . As discussed above, we manage this gap within a prescribed range because funding long-term, fixed-rate loans with short-term and variable-rate debt may expose us to higher interest rate and liquidity risk.

NON-GAAP FINANCIAL MEASURES


In addition to financial measures determined in accordance with GAAP, management evaluates performance based on certain non-GAAP measures, which we refer to as "adjusted" measures. We provide a discussion of each of these non-GAAP measures in our 2017 Form 10-K under "Item 7. MD&A-Non-GAAP Measures." Below we provide a reconciliation of our adjusted measures to the most comparable GAAP measures in this section. We believe our non-GAAP adjusted metrics, which are not a substitute for GAAP and may not be consistent with similarly titled non-GAAP measures used by other companies, provide meaningful information and are useful to investors because management uses these metrics to compare operating results across financial reporting periods, for internal budgeting and forecasting purposes, for compensation decisions and for short- and long-term strategic planning decisions. In addition, certain of the financial covenants in our committed bank revolving line of credit agreements and debt indentures are based on our adjusted measures.



41



Statements of Operations Non-GAAP Adjustments


Table 33 provides a reconciliation of adjusted interest expense, adjusted net interest income and adjusted net income to the comparable GAAP measures three and nine months ended February 28, 2018 and 2017 . The adjusted amounts are used in the calculation of our adjusted net interest yield and adjusted TIER.


Table 33 : Adjusted Financial Measures - Income Statement

Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018

2017

Interest expense

$

(198,071

)

$

(186,740

)

$

(585,972

)

$

(551,474

)

Include: Derivative cash settlements

(18,924

)

(19,354

)

(58,781

)

(64,331

)

Adjusted interest expense

$

(216,995

)

$

(206,094

)

$

(644,753

)

$

(615,805

)

Net interest income

$

73,397


$

73,180


$

217,234


$

222,437


Include: Derivative cash settlements

(18,924

)

(19,354

)

(58,781

)

(64,331

)

Adjusted net interest income

$

54,473


$

53,826


$

158,453


$

158,106


Net income

$

221,029


$

97,962


$

408,767


$

361,005


Exclude: Derivative forward value gains

186,972


61,809


306,224


259,153


Adjusted net income

$

34,057


$

36,153


$

102,543


$

101,852



We consider the cost of derivatives to be an inherent cost of funding and hedging our loan portfolio and, therefore, economically similar to the interest expense that we recognize on debt issued for funding. We therefore include derivative cash settlements in our adjusted interest expense and exclude the unrealized forward value of derivatives from our adjusted net income.


TIER and Adjusted TIER


Table 34 presents our TIER and adjusted TIER for the three and nine months ended February 28, 2018 and 2017 .



Table 34 : TIER and Adjusted TIER

Three Months Ended February 28,

Nine Months Ended February 28,

2018

2017

2018

2017

TIER (1)

2.12


1.52


1.70


1.65


Adjusted TIER (2)

1.16


1.18


1.16


1.17


____________________________

(1) TIER is calculated based on net income plus interest expense for the period divided by interest expense for the period.

(2) Adjusted TIER is calculated based on adjusted net income plus adjusted interest expense for the period divided by adjusted interest expense for the period.

Debt-to-Equity and Adjusted Debt-to-Equity


Table 35 provides a reconciliation between the liabilities and equity used to calculate the debt-to-equity and the adjusted debt-to-equity ratios as of February 28, 2018 and May 31, 2017 . As indicated in the table below, subordinated debt is treated in the same manner as equity in calculating our adjusted-debt-to-equity ratio.



42



Table 35 : Adjusted Financial Measures - Balance Sheet

(Dollars in thousands)

February 28, 2018


May 31, 2017

Total liabilities

$

25,017,303


$

24,106,887


Exclude:

Derivative liabilities

282,892


385,337


Debt used to fund loans guaranteed by RUS

162,531


167,395


Subordinated deferrable debt

742,375


742,274


Subordinated certificates

1,379,693


1,419,025


Adjusted total liabilities

$

22,449,812


$

21,392,856


Total equity

$

1,459,104


$

1,098,805


Include:


Subordinated deferrable debt

742,375


742,274


Subordinated certificates

1,379,693


1,419,025


Total subordinated debt and certificates

2,122,068


2,161,299


Exclude:

Prior year-end cumulative derivative forward value losses

(340,976

)

(520,357

)

Current year derivative forward value gains

306,224


179,381


Total cumulative derivative forward value losses

(34,752

)

(340,976

)

Accumulated other comprehensive income (1)

3,159


3,702


Adjusted total equity

$

3,612,765


$

3,597,378


____________________________

(1) Represents the AOCI related to derivatives. See "Note 9-Equity" for a breakout of our AOCI components.


Table 36 displays the calculations of our debt-to-equity and adjusted debt-to-equity ratios as of February 28, 2018 and May 31, 2017 .


Table 36 : Debt-to-Equity Ratio

February 28, 2018

May 31, 2017

Debt-to-equity ratio (1)

17.15


21.94


Adjusted debt-to-equity ratio (2)

6.21


5.95


____________________________

(1) Calculated based on total liabilities as of the end of the period divided by total equity as of the end of the period.

(2) Calculated based on adjusted total liabilities at period end divided by adjusted total equity at period end.


43



Item 1.

Financial Statements


Page

Condensed Consolidated Statements of Operations

45

Condensed Consolidated Statements of Comprehensive Income

46

Condensed Consolidated Balance Sheets

47

Condensed Consolidated Statements of Changes in Equity

48

Condensed Consolidated Statements of Cash Flows

49

Notes to Condensed Consolidated Financial Statements

50

Note 1 - Summary of Significant Accounting Policies

50

Note 2 - Variable Interest Entities

54

Note  3 - Investment Securities

55

Note 4 - Loans and Commitments

58

Note  5 - Short-Term Borrowings

67

Note  6 - Long-Term Debt

69

Note  7 - Subordinated Deferrable Debt

70

Note 8 - Derivative Instruments and Hedging Activities

71

Note 9 - Equity

74

Note 10 - Guarantees

77

Note 11 - Fair Value Measurement

78

Note 12 - Business Segments

81



44


NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

        CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)


Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018


2017

Interest income

$

271,468


$

259,920


$

803,206


$

773,911


Interest expense

(198,071

)

(186,740

)

(585,972

)

(551,474

)

Net interest income

73,397


73,180


217,234


222,437


Provision for loan losses

(1,105

)

(2,065

)

(503

)

(4,731

)

Net interest income after provision for loan losses

72,292


71,115


216,731


217,706


Non-interest income:





Fee and other income

3,935


5,810


13,422


15,437


Derivative gains

168,048


42,455


247,443


194,822


Results of operations of foreclosed assets

-


(29

)

(34

)

(1,690

)

Total non-interest income

171,983


48,236


260,831


208,569


Non-interest expense:





Salaries and employee benefits

(13,011

)

(11,537

)

(36,843

)

(34,412

)

Other general and administrative expenses

(9,201

)

(9,173

)

(28,919

)

(27,789

)

Gains on early extinguishment of debt

-


192


-


192


Other non-interest expense

(402

)

(486

)

(1,542

)

(1,446

)

Total non-interest expense

(22,614

)

(21,004

)

(67,304

)

(63,455

)

Income before income taxes

221,661


98,347


410,258


362,820


Income tax expense

(632

)

(385

)

(1,491

)

(1,815

)

Net income

221,029


97,962


408,767


361,005


Less: Net income attributable to noncontrolling interests

(1,614

)

(404

)

(2,646

)

(2,289

)

Net income attributable to CFC

$

219,415


$

97,558


$

406,121


$

358,716


See accompanying notes to condensed consolidated financial statements.




45









NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

        CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)


Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018

2017

Net income

$

221,029


$

97,962


$

408,767


$

361,005


Other comprehensive income (loss):





Unrealized gains (losses) on available-for-sale investment securities

(1,763

)

3,923


(2,906

)

2,151


Reclassification of losses on foreclosed assets to net income

-


-


-


9,823


Reclassification of derivative gains to net income

(157

)

(195

)

(543

)

(591

)

Defined benefit plan adjustments

128


45


381


133


Other comprehensive income (loss)

(1,792

)

3,773


(3,068

)

11,516


Total comprehensive income

219,237


101,735


405,699


372,521


Less: Total comprehensive income attributable to noncontrolling interests

(1,614

)

(404

)

(2,646

)

(2,289

)

Total comprehensive income attributable to CFC

$

217,623


$

101,331


$

403,053


$

370,232


See accompanying notes to condensed consolidated financial statements.


46






NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

       CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(Dollars in thousands)

February 28, 2018


May 31, 2017

Assets:

Cash and cash equivalents

$

250,697


$

166,615


Restricted cash

6,951


21,806


Time deposits

1,000


226,000


Investment securities:

Available for sale, at fair value

89,648


92,554


Held to maturity, at amortized cost

248,252


-


Total investment securities

337,900


92,554


Loans to members

25,342,922


24,367,044


Less: Allowance for loan losses

(37,879

)

(37,376

)

Loans to members, net

25,305,043


24,329,668


Accrued interest receivable

114,994


111,493


Other receivables

36,371


45,469


Fixed assets, net

113,060


122,260


Derivative assets

252,888


49,481


Other assets

57,503


40,346


Total assets

$

26,476,407


$

25,205,692


Liabilities:



Accrued interest payable

$

198,316


$

137,476


Debt outstanding:

Short-term borrowings

3,493,736


3,342,900


Long-term debt

18,813,136


17,955,594


Subordinated deferrable debt

742,375


742,274


Members' subordinated certificates:



Membership subordinated certificates

630,391


630,098


Loan and guarantee subordinated certificates

528,154


567,830


Member capital securities

221,148


221,097


Total members' subordinated certificates

1,379,693


1,419,025


Total debt outstanding

24,428,940


23,459,793


Deferred income

65,954


73,972


Derivative liabilities

282,892


385,337


Other liabilities

41,201


50,309


Total liabilities

25,017,303


24,106,887


Commitments and contingencies





Equity:

CFC equity:



Retained equity

1,416,975


1,056,778


Accumulated other comprehensive income

10,107


13,175


Total CFC equity

1,427,082


1,069,953


Noncontrolling interests

32,022


28,852


Total equity

1,459,104


1,098,805


Total liabilities and equity

$

26,476,407


$

25,205,692


See accompanying notes to condensed consolidated financial statements.


47






NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

 CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(UNAUDITED)


(Dollars in thousands)

Membership
Fees and
Educational
Fund

Patronage
Capital
Allocated

Members'
Capital
Reserve

Unallocated
Net Income
(Loss)

CFC
Retained
Equity

Accumulated
Other
Comprehensive
Income

Total
CFC
Equity

Non-controlling
Interests

Total
Equity

Balance as of May 31, 2017

$

2,900


$

761,701


$

630,305


$

(338,128

)

$

1,056,778


$

13,175


$

1,069,953


$

28,852


$

1,098,805


Net income

-


-


-


406,121


406,121


-


406,121


2,646


408,767


Other comprehensive loss

-


-


-


-


-


(3,068

)

(3,068

)



(3,068

)

Patronage capital retirement

-


(45,220

)

-


-


(45,220

)

-


(45,220

)

-


(45,220

)

Other

(704

)

-


-


-


(704

)

-


(704

)

524


(180

)

Balance as of February 28, 2018

$

2,196


$

716,481


$

630,305


$

67,993


$

1,416,975


$

10,107


$

1,427,082


$

32,022


$

1,459,104


Balance as of May 31, 2016

$

2,772


$

713,853


$

587,219


$

(513,610

)

$

790,234


$

1,058


$

791,292


$

26,086


$

817,378


Net income

-


-


-


358,716


358,716


-


358,716


2,289


361,005


Other comprehensive income

-


-


-


-


-


11,516


11,516


-


11,516


Patronage capital retirement

-


(42,593

)

-


103


(42,490

)

-


(42,490

)

-


(42,490

)

Other

(643

)

-


-


-


(643

)

-


(643

)

572


(71

)

Balance as of February 28, 2017

$

2,129


$

671,260


$

587,219


$

(154,791

)

$

1,105,817


$

12,574


$

1,118,391


$

28,947


$

1,147,338


See accompanying notes to condensed consolidated financial statements.



48






NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

Cash flows from operating activities:

Net income

$

408,767


$

361,005


Adjustments to reconcile net income to net cash provided by operating activities:

Amortization of deferred loan fees

(8,760

)

(9,159

)

Amortization of debt issuance costs and deferred charges

7,787


7,034


Amortization of discount on long-term debt

7,488


7,072


Amortization of issuance costs for bank revolving bank line of credit

4,043


4,213


Depreciation and amortization of fixed assets

5,967


5,352


Provision for loan losses

503


4,731


Results of operations of foreclosed assets

-


1,690


Derivative forward value gains

(306,224

)

(259,153

)

Changes in operating assets and liabilities:

Accrued interest receivable

(3,501

)

586


Accrued interest payable

60,840


62,378


Deferred income

743


7,839


Other

(5,680

)

(979

)

Net cash provided by operating activities

171,973


192,609


Cash flows from investing activities:

Advances on loans

(6,780,736

)

(6,042,651

)

Principal collections on loans

5,805,231


5,003,038


Net investment in fixed assets

(10,571

)

(14,976

)

Net cash proceeds from sale of foreclosed assets

-


47,065


Proceeds from foreclosed assets

-


4,036


Net proceeds from (investments in) time deposits

225,000


(290,000

)

Purchases of held-to-maturity investments

(249,198

)

-


Proceeds from maturities of held-to-maturity investments

777


-


Change in restricted cash

14,855


(16,132

)

Net cash used in investing activities

(994,642

)

(1,309,620

)

Cash flows from financing activities:

Proceeds from short-term borrowings, net

131,109


410,447


Proceeds from short-term borrowings with original maturity greater than 90 days

828,625


791,124


Repayments of short term-debt with original maturity greater than 90 days

(808,898

)

(752,340

)

Payments for issuance costs for revolving bank lines of credit

(2,441

)

(2,543

)

Proceeds from issuance of long-term debt, net of issuance costs

2,153,842


1,710,561


Payments for retirement of long-term debt

(1,311,473

)

(943,872

)

Payments for issuance costs for subordinated deferrable debt

-


(68

)

Proceeds from issuance of members' subordinated certificates

4,802


2,743


Payments for retirement of members' subordinated certificates

(44,135

)

(25,946

)

Payments for retirement of patronage capital

(44,667

)

(41,871

)

Repayments of membership fees, net

(13

)

-


Net cash provided by financing activities

906,751


1,148,235


Net increase in cash and cash equivalents

84,082


31,224


Beginning cash and cash equivalents

166,615


204,540


Ending cash and cash equivalents

$

250,697


$

235,764


Supplemental disclosure of cash flow information:

Cash paid for interest

$

513,300


$

470,777


Cash paid for income taxes

252


386


See accompanying notes to condensed consolidated financial statements.


49





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)



NOTE 1-SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES


The Company


National Rural Utilities Cooperative Finance Corporation ("CFC") is a member-owned cooperative association incorporated under the laws of the District of Columbia in April 1969. CFC's principal purpose is to provide its members with financing to supplement the loan programs of the Rural Utilities Service ("RUS") of the United States Department of Agriculture ("USDA"). CFC makes loans to its rural electric members so they can 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. As a cooperative, CFC is owned by and exclusively serves its membership, which consists of not-for-profit entities or subsidiaries or affiliates of not-for-profit entities. CFC is exempt from federal income taxes.


Basis of Presentation and Use of Estimates


The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") and should be read in conjunction with the audited consolidated financial statements, and related notes thereto, included in CFC's Annual Report on Form 10-K for the fiscal year ended May 31, 2017 (" 2017 Form 10-K"). We believe that all necessary adjustments, which consisted only of normal recurring items, have been included in the accompanying financial statements to present fairly the results of the interim periods. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts and related disclosures. While management makes its best judgment, actual amounts or results could differ from these estimates. Our most significant estimates and assumptions involve determining the allowance for loan losses and the fair value of financial assets and liabilities. The results of operations in the interim financial statements is not necessarily indicative of the results that may be expected for other interim periods or for the full fiscal year ending May 31, 2018.


Principles of Consolidation


The accompanying condensed consolidated financial statements include the accounts of CFC, variable interest entities ("VIEs") where CFC is the primary beneficiary and subsidiary entities created and controlled by CFC to hold foreclosed assets. CFC did not have any entities that held foreclosed assets as of February 28, 2018 or May 31, 2017 . All intercompany balances and transactions have been eliminated. National Cooperative Services Corporation ("NCSC") and Rural Telephone Finance Cooperative ("RTFC") are VIEs which are required to be consolidated by CFC. NCSC is a taxable member-owned cooperative that may provide financing to members of CFC, government or quasi-government entities which own electric utility systems that meet the Rural Electrification Act definition of "rural", and for-profit and nonprofit entities that are owned, operated or controlled by, or provide significant benefits to certain members of CFC. RTFC is a taxable Subchapter T cooperative association that provides financing for its rural telecommunications members and their affiliates. Unless stated otherwise, references to "we," "our" or "us" relate to CFC and its consolidated entities.


Restricted Cash


Restricted cash, which totaled $7 million and $22 million as of February 28, 2018 and May 31, 2017 , respectively, consisted primarily of funds held in escrow. On July 1, 2016, CFC completed the sale of Caribbean Asset Holdings, LLC ("CAH"), an entity that held foreclosed assets, to ATN VI Holdings, LLC. In connection with the sale, $16 million of the sale proceeds was deposited into escrow to fund potential indemnification claims for a period of 15 months following the closing. Of this amount, $14.5 million was designated to cover general indemnification claims and $1.5 million was designated to cover indemnification of certain tax liens. On September 27, 2017, we received a claim notice from the purchaser of CAH asserting potential indemnification claims against the general escrow amount of $14.5 million . The claims were not


50





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


substantiated sufficiently to be funded; therefore, the $14.5 million has been released back to us. The $1.5 million designated for tax liens remains in escrow. We continue to be liable for certain indemnifications regardless of whether amounts are held in escrow.


Asset Held for Sale


In 2007, CFC purchased a parcel of land, consisting of approximately 28 acres, located in Loudoun County, Virginia as a potential site to construct a new facility for its headquarters. CFC subsequently identified another site in Loudoun County for its headquarters, purchased the land and built its headquarters facility at this location. On January 26, 2018, we entered into a letter of intent for the sale of the 28 acres in Loudoun County, Virginia that was purchased in 2007. On March 14, 2018, CFC entered into a purchase and sale agreement ("the agreement"), subject to certain terms and conditions, for the sale of this real estate property in excess of its carrying value of $14 million . The agreement includes a specified purchaser due diligence period that expires on April 20, 2018. The property was previously included in fixed assets, net on our condensed consolidated balance sheet. We designated the property as held for sale as of February 28, 2018 and reclassified it from fixed assets, net to other assets on our condensed consolidated balance sheet. Because the estimated fair value of this property, based on the estimated sale proceeds less cost to sell, exceeds the carrying value, we continue to report the property on our condensed consolidated balance sheet at the carrying amount of $14 million . Although we currently believe the disposition of this property is probable within the next 12 months, there can be no assurance that the disposition will be consummated in accordance with the terms of the agreement.


Interest Income


The following table presents interest income, by interest-earning asset category, for the three and nine months ended February 28, 2018 and 2017 .


Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018


2017

Interest income by interest-earning asset type:

Long-term fixed-rate loans (1)

$

250,201


$

245,480


$

748,491


$

733,425


Long-term variable-rate loans

7,020


5,047


18,980


14,561


Line of credit loans

10,367


6,538


27,662


18,057


TDR loans (2)

221


228


669


677


Other income, net (3)

(314

)

(230

)

(852

)

(795

)

Total loans

267,495


257,063


794,950


765,925


Cash, time deposits and investment securities

3,973


2,857


8,256


7,986


Total interest income

$

271,468


$

259,920


$

803,206


$

773,911


____________________________

(1) Includes loan conversion fees, which are generally deferred and recognized as interest income using the effective interest method.

(2) Troubled debt restructuring ("TDR") loans.

(3) Consists of late payment fees and net amortization of deferred loan fees and loan origination costs. Deferred income of $66 million and $74 million as of February 28, 2018 and May 31, 2017 , respectively, consists primarily of deferred loan conversion fees totaling $60 million and $68 million , respectively.


Interest Expense


The following table presents interest expense, by debt product type, for the three and nine months ended February 28, 2018 and 2017 .


51





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018

2017

Interest expense by debt product type: (1)(2)

Short-term borrowings

$

14,593


$

7,907


$

35,248


$

18,198


Medium-term notes

28,051


25,166


80,711


73,456


Collateral trust bonds

83,730


85,582


254,328


255,582


Guaranteed Underwriter Program notes payable

34,233


35,086


105,523


107,074


Farmer Mac notes payable

13,316


8,406


36,753


22,892


Other notes payable

369


437


1,150


1,353


Subordinated deferrable debt

9,414


9,410


28,247


28,247


Subordinated certificates

14,365


14,746


44,012


44,672


Total interest expense

$

198,071


$

186,740


$

585,972


$

551,474


____________________________

(1) Includes amortization of debt discounts and debt issuance costs, which are generally deferred and recognized as interest expense using the effective interest method. Issuance costs related to dealer commercial paper, however, are recognized as interest expense immediately as incurred.

(2) Includes fees related to funding arrangements, such as up-front fees paid to banks participating in our committed bank revolving line of credit agreements. Depending on the nature of the fee, amounts may be deferred and recognized as interest expense ratably over the term of the arrangement or recognized immediately as incurred. 


Recently Issued But Not Yet Adopted Accounting Standards and Tax Reform


Tax Cuts and Jobs Act


On December 22, 2017, the President of the United States signed and enacted into law H.R. 1, the Tax Cuts and Jobs Act ("The Act"), which, except for certain provisions, is effective for tax years beginning on or after January 1, 2018. The Act significantly changes existing U.S. tax law and includes numerous provisions that will affect businesses. One of the primary changes is a reduction in the federal statutory corporate U.S. income tax rate to 21% percent from 35% and other changes that impact business-related exclusions, deductions and credits. CFC is exempt from federal income tax under Section 501(c)(4) of the Internal Revenue Code. NCSC is subject to federal income tax; however, NCSC's annual taxable income and federal income tax is not material to our consolidated results of operations, financial position or liquidity. RTFC is subject to federal income tax; however, the allocation of patronage capital to its members is a deduction that historically has resulted in a significant reduction in its annual taxable income and federal income tax. Therefore, we do not expect The Act to have a material impact on our consolidated results of operations, financial condition or liquidity.


Derivatives and Hedging-Targeted Improvements to Accounting for Hedging Activities


In August 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-12, Derivatives and Hedging-Targeted Improvements to Accounting for Hedging Acti vities, which expands the types of risk management strategies that qualify for hedge accounting treatment to more closely align the results of hedge accounting with the economics of certain risk management activities and simplifies certain hedge documentation and assessment requirement. It also eliminates the concept of separately recording hedge ineffectiveness and expands disclosure requirements. The guidance is effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those years. Early adoption is permitted in any interim period or fiscal year before the effective date. The guidance is effective for us beginning June 1, 2019. Hedge accounting is elective, and we currently do not apply hedge accounting. If we continue to elect not to apply hedge accounting, the adoption of the new guidance will have no impact on our consolidated financial statements.


52





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


Receivables-Nonrefundable Fees and Other Cost


In March 2017, FASB issued ASU 2017-08, Receivables-Nonrefundable Fees and Other Costs, which shortens the amortization period for the premium on certain callable debt securities to the earliest call date rather the maturity date. The guidance is applicable to any individual debt security, purchased at a premium, with an explicit and noncontingent call feature with a fixed price on a preset date. The guidance does not impact the accounting for purchased callable debt securities held at a discount; the discount will continue to amortize to the maturity date. The guidance is effective for public entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. This update is effective for us beginning June 1, 2019. Adoption of the guidance requires modified retrospection transition as of the beginning of the period of adoption through a cumulative-effect adjustment to retained earnings. We do not expect that the adoption of this guidance will have a material impact on our consolidated financial statements.


Statement of Cash Flows-Restricted Cash


In November 2016, FASB issued ASU 2016-18, Statement of Cash Flows-Restricted Cash, which addresses the presentation of restricted cash in the statement of cash flows. The guidance requires that the statement of cash flows explain the change in the beginning-of-period and end-of-period total of cash, cash equivalents and restricted cash balances. We currently explain the change during the period in total of cash and cash equivalents on our consolidated statements of cash flows. The guidance is effective for public entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, and must be applied retrospectively. This update is effective for us beginning June 1, 2018. The adoption of this guidance will change the presentation of restricted cash on our consolidated statement of cash flows, and we will revise amounts previously reported on our consolidated statements of cash flows to conform to this presentation. Adoption of the guidance, however, will have no impact on our consolidated results of operations, financial condition or liquidity.


Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments


In June 2016, the FASB issued ASU 2016-13, Financial Instruments-Credit Losses: Measurement of Credit Losses on Financial Instruments, which replaces the existing incurred loss impairment model and establishes a single allowance framework based on a current expected credit loss model for financial assets carried at amortized cost, including loans and held-to-maturity debt securities. The current expected loss model requires an entity to estimate the credit losses expected over the life of the credit exposure upon initial recognition of that exposure when the financial asset is originated or acquired, which will generally result in earlier recognition of credit losses. The guidance also amends the other-than-temporary model for available-for-sale debt securities by requiring the use of an allowance, rather than directly reducing the carrying value of the security. The new guidance also requires expanded credit quality disclosures. The new standard is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019. Early application will be permitted for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. This update is effective for us beginning June 1, 2020. Upon adoption, we will be required to record a cumulative-effect adjustment to retained earnings. The impact on our consolidated financial statements from the adoption of this new guidance will depend on the composition and risk profile of our loan portfolio as of the date of adoption. We do not expect to early adopt this guidance.


Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities


In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, which amends certain aspects of the recognition, measurement, presentation and disclosure of certain financial instruments, including equity investments and liabilities measured at fair value under the fair value option. The main provisions include a requirement that all investments in equity securities be measured at fair value through earnings, with certain exceptions, and a requirement to present separately in other comprehensive income the portion of the total change in fair value attributable to an entity's own credit risk for financial liabilities where the fair value


53





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


option has been elected. This update will be effective for us beginning June 1, 2018. Upon adoption, we will be required to reclassify the gain (loss) related to our equity investment securities classified as available-for-sale from accumulated other comprehensive income ("AOCI") to retained earnings as a cumulative-effect adjustment and begin recording future changes in fair value through earnings. We had a gain of $9 million recorded in AOCI for our available-for-sale equity investments as of February 28, 2018 . The impact on our consolidated financial statements at adoption will depend on the net unrealized gains (losses) recorded in AOCI for these equity investments as of the date of adoption.


Revenue from Contracts with Customers


In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers , which modifies the guidance used to recognize revenue from contracts with customers for transfers of goods or services and transfers of nonfinancial assets, unless those contracts are within the scope of other guidance. The new guidance is effective for us beginning June 1, 2018. Because the scope of the guidance explicitly excludes net interest income as well as many other revenues for financial assets and liabilities including loans, securities, and derivatives, which account for the substantial majority of our revenues, we do not expect that the adoption of the guidance will have a material impact, if any, on our consolidated financial statements.

NOTE 2-VARIABLE INTEREST ENTITIES


NCSC and RTFC meet the definition of a VIE because they do not have sufficient equity investment at risk to finance their activities without financial support. CFC is the primary source of funding for NCSC and the sole source of funding for RTFC. Under the terms of management agreements, CFC manages the business operations of NCSC and RTFC. CFC also unconditionally guarantees full indemnification for any loan losses of NCSC and RTFC pursuant to guarantee agreements with each company. CFC earns management and guarantee fees from its agreements with NCSC and RTFC.


NCSC and RTFC creditors have no recourse against CFC in the event of a default by NCSC and RTFC, unless there is a guarantee agreement under which CFC has guaranteed NCSC or RTFC debt obligations to a third party. The following table provides information on incremental consolidated assets and liabilities of VIE's included in CFC's condensed consolidated financial statements, after applying intercompany eliminations, as of February 28, 2018 and May 31, 2017 .


(Dollars in thousands)

February 28, 2018

May 31, 2017

Total loans outstanding

$

1,164,279


$

968,343


Other assets

11,558


10,157


Total assets

$

1,175,837


$

978,500


Long-term debt

$

10,000


$

10,000


Other liabilities

33,620


36,899


Total liabilities

$

43,620


$

46,899



The following table provides information on CFC's credit commitments to NCSC and RTFC, and its potential exposure to loss as of February 28, 2018 and May 31, 2017 .



54





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


(Dollars in thousands)

February 28, 2018


May 31, 2017

CFC credit commitments

$

5,500,000


$

5,500,000


Outstanding commitments:

Borrowings payable to CFC (1)

1,129,351


931,686


CFC third-party guarantees

16,733


14,697


Other credit enhancements

17,047


20,963


Total credit enhancements

33,780


35,660


Total outstanding commitments

1,163,131


967,346


CFC available credit commitments

$

4,336,869


$

4,532,654


____________________________

(1) Borrowings payable to CFC are eliminated in consolidation.


CFC loans to NCSC and RTFC are secured by all assets and revenues of NCSC and RTFC. CFC's maximum potential exposure for the credit enhancements totaled $36 million . The maturities for obligations guaranteed by CFC extend through 2031.

NOTE 3-INVESTMENT SECURITIES


We record purchases and sales of securities on a trade-date basis. The accounting and measurement framework for investment securities differs depending on the security classification. We currently classify and account for our investment securities as either available for sale ("AFS") or held to maturity ("HTM") based on our investment strategy and management's assessment of our intent and ability to hold the securities until maturity. Securities that we may sell prior to maturity in response to changes in our investment strategy, liquidity needs, credit risk mitigating considerations, market risk profile or for other reasons are classified as AFS. Securities that we have the positive intent and ability to hold until maturity are classified as HTM.


We report securities classified as AFS on our condensed consolidated balance sheets at fair value with unrealized gains or losses recorded as a component of accumulated other comprehensive income ("AOCI"). We report securities classified as HTM on our condensed consolidated balance sheets at amortized cost. Interest income on fixed-income securities, including amortization of premiums and accretion of discounts, is generally recognized over the contractual life of the securities based on the effective yield method.


We did no t have any securities classified as HTM as of May 31, 2017 . During the second quarter of fiscal year 2018, we commenced the purchase of additional investment securities, consisting primarily of certificates of deposit with maturities greater than 90 days, commercial paper, corporate debt securities, commercial mortgage-backed securities ("MBS") and other asset-backed securities ("ABS"). We have the positive intent and ability to hold these securities to maturity. As such, we have classified them as held to maturity on our condensed consolidated balance sheet.


Pursuant to our investment policy guidelines, all fixed-income securities, at the time of purchase, must be rated at least investment grade and on stable outlook based on external credit ratings from at least two of the leading global credit rating agencies, when available, or the corresponding equivalent, when not available. Securities rated investment grade, that is those rated Baa3 or higher by Moody's Investors Service ("Moody's") or BBB- or higher by S&P Global Ratings ("S&P"), are generally considered by the rating agencies to be of lower credit risk than non-investment grade securities.


Amortized Cost and Fair Value of Investment Securities


The following tables present the amortized cost and fair value our investment securities and the corresponding gross unrealized gains and losses, by classification category and major security type, as of February 28, 2018 and May 31, 2017 .


55





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


February 28, 2018

(Dollars in thousands)

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Fair Value

Available for sale:

Farmer Mac-Series A Non-Cumulative Preferred Stock

$

30,000


$

-


$

(120

)

$

29,880


Farmer Mac-Series B Non-Cumulative Preferred Stock

25,000


1,620


-


26,620


Farmer Mac-Series C Non-Cumulative Preferred Stock

25,000


1,938


-


26,938


Farmer Mac-Class A Common Stock

538


5,672


-


6,210


Total investment securities, available-for-sale

80,538


9,230


(120

)

89,648


Held to maturity:

Certificates of deposit

4,147


-


(10

)

4,137


Commercial paper

7,228


-


(17

)

7,211


Corporate bonds

210,149


45


(3,696

)

206,498


Commercial MBS, non-agency

4,040


-


(6

)

4,034


Other ABS (1)

22,688


-


(195

)

22,493


Total investment securities, held-to-maturity

248,252


45


(3,924

)

244,373


Total investment securities

$

328,790


$

9,275



$

(4,044

)


$

334,021


____________________________

(1) Consists primarily of securities backed by auto lease loans, equipment-backed loans, auto loans and credit card loans.

May 31, 2017

(Dollars in thousands)

Amortized Cost

Gross Unrealized Gains

Gross Unrealized Losses

Fair Value

Available for sale:


Farmer Mac-Series A Non-Cumulative Preferred Stock

$

30,000


$

1,585


$

-


$

31,585


Farmer Mac-Series B Non-Cumulative Preferred Stock

25,000


1,940


-


26,940


Farmer Mac-Series C Non-Cumulative Preferred Stock

25,000


4,150


-


29,150


Farmer Mac-Class A Common Stock

538


4,341


-


4,879


Total investment securities, available-for-sale

$

80,538


$

12,016


$

-


$

92,554



For additional information on the unrealized gains (losses) losses recorded on our available-for-sale investment securities, see "Note 9-Equity-Accumulated Other Comprehensive Income."


Investment Securities in Gross Unrealized Loss Position


An unrealized loss exists when the current fair value of an individual security is less than its amortized cost basis. The following table presents the fair value and gross unrealized losses for investments in a gross loss position, aggregated by security type, and the length of time the securities have been in a continuous unrealized loss position as of February 28, 2018 . The securities are segregated between investments that have been in a continuous unrealized loss position for less than twelve months and twelve months or more based on the point in time that the fair value declined below the amortized cost basis. We did not have any investment securities in a gross unrealized loss position as of May 31, 2017 .



56





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


February 28, 2018

Unrealized Loss Position Less than 12 Months

Unrealized Loss Position 12 Months or Longer

Total

(Dollars in thousands)

Fair Value

Gross Unrealized Losses

Fair Value

Gross Unrealized Losses

Fair Value

Gross Unrealized Losses

Available for sale:

Farmer Mac-Series A Non-Cumulative Preferred Stock

$

29,880


$

(120

)

$

-


$

-


$

29,880


$

(120

)

Held to maturity:

Certificates of deposit

4,137


(10

)

-


-


4,137


(10

)

Commercial paper

7,211


(17

)

-


-


7,211


(17

)

Corporate bonds

190,279


(3,696

)

-


-


190,279


(3,696

)

Commercial MBS, non-agency

4,034


(6

)

-


-


4,034


(6

)

Other asset-backed securities (1)

22,493


(195

)

-


-


22,493


(195

)

Total investment securities, held-to-maturity

228,154


(3,924

)

-


-


228,154


(3,924

)

Total investment securities

$

258,034


$

(4,044

)

$

-


$

-


$

258,034


$

(4,044

)

____________________________

(1) Consists primarily of securities backed by auto lease loans, equipment-backed loans, auto loans and credit card loans.


Other-Than-Temporary Impairment


We conduct periodic reviews of all securities with unrealized losses to evaluate whether the impairment is other than temporary. The number of individual securities in an unrealized loss position was 173 as of February 28, 2018 . We have assessed each security with gross unrealized losses included in the above table for credit impairment. As part of that assessment, we concluded that the unrealized losses are primarily driven by changes in market interest rates rather than by adverse changes in the credit quality of these securities. Based on our assessment, we expect to recover the entire amortized cost basis of these securities, as we do not intend to sell any of the securities and believe that it is more likely than not that we will not be required to sell prior to recovery of the amortized cost basis. Accordingly, we currently consider the impairment of these securities to be temporary.


Contractual Maturity and Yield


The following table presents, by major security type, the remaining contractual maturity based on amortized cost and fair value as of February 28, 2018 of our HTM investment securities. Because borrowers may have the right to call or prepay certain obligations, the expected maturities of our investments may differ from the scheduled contractual maturities presented below. 


57





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


February 28, 2018

(Dollars in thousands)

Due in 1 Year or Less

Due > 1 Year through 5 Years

Due > 5 Years through 10 Years

Due >10 Years

Total

Amortized cost:

Certificates of deposit

$

4,147


$

-


$

-


$

-


$

4,147


Commercial paper

7,228


-


-


-


7,228


Corporate bonds

4,624


200,975


4,550


-


210,149


Commercial MBS, non-agency

-


-


-


4,040


4,040


Other asset-backed securities (1)

-


22,688


-


-


22,688


Total

$

15,999


$

223,663


$

4,550


$

4,040


$

248,252


Fair value:

Certificates of deposit

$

4,137


$

-


$

-


$

-


$

4,137


Commercial paper

7,211


-


-


-


7,211


Corporate bonds

4,593


197,466


4,439


-


206,498


Commercial MBS, non-agency

-


-


-


4,034


4,034


Other ABS (1)

-


22,493


-


-


22,493


Total

$

15,941


$

219,959


$

4,439


$

4,034


$

244,373


Weighted average coupon (2)

1.83

%

2.66

%

3.25

%

2.46

%

2.61

%

____________________________

(1) Consists primarily of securities backed by auto lease loans, equipment-backed loans, auto loans and credit card loans.

(2) Calculated based on the weighted average coupon rate, which excludes the impact of amortization of premium and accretion of discount.


The average contractual maturity and weighted average coupon of our HTM investment securities was three years and 2.61% , respectively, as of February 28, 2018 . The average credit rating of these securities, based on their lowest credit rating by Moody's and S&P was A3 and A-, respectively, as of February 28, 2018 .


Realized Gains and Losses


We have not sold any of our investment securities during the three and nine months ended February 28, 2018 and 2017 , and therefore have not recorded any realized gains or losses.

NOTE 4-LOANS AND COMMITMENTS

Loans, which are classified as held for investment, are carried at the outstanding unpaid principal balance net of unamortized loan origination costs. The following table presents loans outstanding, by loan type and by member class, as of February 28, 2018 and May 31, 2017 .



58





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


February 28, 2018

May 31, 2017

(Dollars in thousands)

Loans

Outstanding

Unadvanced

Commitments (1)

Loans

Outstanding

Unadvanced

Commitments (1)

Loan type:

Long-term loans:

Fixed rate

$

22,737,089


$

-


$

22,136,690


$

-


Variable rate

985,714


4,715,976


847,419


4,802,319


Total long-term loans

23,722,803


4,715,976


22,984,109


4,802,319


Lines of credit

1,609,032


7,435,288


1,372,221


7,772,655


Total loans outstanding

25,331,835


12,151,264


24,356,330


12,574,974


Deferred loan origination costs


11,087



-



10,714



-


Loans to members


$

25,342,922



$

12,151,264



$

24,367,044



$

12,574,974


Member class:

CFC:

Distribution

$

19,687,812


$

7,750,226


$

18,825,366


$

8,295,146


Power supply

4,422,600


3,394,064


4,504,791


3,276,113


Statewide and associate

57,144


126,467


57,830


144,406


Total CFC

24,167,556


11,270,757


23,387,987


11,715,665


NCSC

800,814


581,125


613,924


584,944


RTFC

363,465


299,382


354,419


274,365


Total loans outstanding

25,331,835


12,151,264


24,356,330


12,574,974


Deferred loan origination costs

11,087


-


10,714


-


Loans to members

$

25,342,922


$

12,151,264


$

24,367,044


$

12,574,974


____________________________

(1) The interest rate on unadvanced loan commitments is not set until an advance is made; therefore, all long-term unadvanced loan commitments are reported as variable-rate. However, the borrower may select either a fixed or a variable rate when an advance on a commitment is made.


Unadvanced Loan Commitments


Unadvanced loan commitments represent approved and executed loan contracts for which funds have not been advanced to borrowers. The following table summarizes the available balance under unadvanced loan commitments as of February 28, 2018 and the related maturities by fiscal year and thereafter by loan type:

Available

Balance

Notional Maturities of Unadvanced Loan Commitments

(Dollars in thousands)

2018

2019

2020

2021

2022

Thereafter

Line of credit loans

$

7,435,288



$

226,587



$

4,057,079



$

782,079



$

995,502



$

707,497



$

666,544


Long-term loans

4,715,976



71,913



924,921



585,953



637,024



1,742,934



753,231


Total

$

12,151,264



$

298,500



$

4,982,000



$

1,368,032



$

1,632,526



$

2,450,431



$

1,419,775



Unadvanced line of credit commitments accounted for 61% of total unadvanced loan commitments as of February 28, 2018 , while unadvanced long-term loan commitments accounted for 39% of total unadvanced loan commitments. Unadvanced line of credit commitments are typically revolving facilities for periods not to exceed five years. Unadvanced line of credit


59





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


commitments generally serve as supplemental back-up liquidity to our borrowers. Historically, borrowers have not drawn the full commitment amount for line of credit facilities, and we have experienced a very low utilization rate on line of credit loan facilities regardless of whether or not we are obligated to fund the facility where a material adverse change exists. Our unadvanced long-term loan commitments have a five-year draw period under which a borrower may advance funds prior to the expiration of the commitment. We expect that the majority of the long-term unadvanced loan commitments of $4,716 million will be advanced prior to the expiration of the commitment.


Because we historically have experienced a very low utilization rate on line of credit loan facilities, which account for the majority of our total unadvanced loan commitments, we believe the unadvanced loan commitment total of $12,151 million as of February 28, 2018 is not necessarily representative of our future funding cash requirements.


Unadvanced Loan Commitments-Conditional


The substantial majority of our line of credit commitments and all of our unadvanced long-term loan commitments include material adverse change clauses. Unadvanced loan commitments subject to material adverse change clauses totaled $9,374 million and $9,973 million as of February 28, 2018 and May 31, 2017 , respectively. Prior to making an advance on these facilities, we confirm that there has been no material adverse change in the business or condition, financial or otherwise, of the borrower since the time the loan was approved and confirm that the borrower is currently in compliance with loan terms and conditions. In some cases, the borrower's access to the full amount of the facility is further constrained by the designated purpose, imposition of borrower-specific restrictions or by additional conditions that must be met prior to advancing funds.


Unadvanced Loan Commitments-Unconditional


Unadvanced loan commitments not subject to material adverse change clauses at the time of each advance consisted of unadvanced committed lines of credit totaling $2,777 million and $2,602 million as of February 28, 2018 and May 31, 2017 , respectively. As such, we are required to advance amounts on these committed facilities as long as the borrower is in compliance with the terms and conditions of the facility.


The following table summarizes the available balance under unconditional committed lines of credit, and the related maturities by fiscal year and thereafter, as of February 28, 2018 .

Available

Balance

Notional Maturities of Unconditional Committed Lines of Credit

(Dollars in thousands)

2018

2019

2020

2021

2022

Thereafter

Committed lines of credit

$2,776,918

$130,000

$306,122

$515,691

$645,083

$487,908

$692,114


Loan Sales


We transfer, from time to time, loans to third parties under our direct loan sale program. We sold CFC loans with outstanding balances totaling $118 million and $33 million , at par for cash, during the nine months ended February 28, 2018 and 2017 , respectively. We recorded immaterial losses upon the sale of these loans, attributable to the unamortized deferred loan origination costs associated with the transferred loans.


Pledging of Loans


We are required to pledge eligible mortgage notes in an amount at least equal to the outstanding balance of our secured debt. The following table summarizes our loans outstanding as collateral pledged to secure our collateral trust bonds, Clean Renewable Energy Bonds, notes payable to Farmer Mac and notes payable to the Federal Financing Bank and guaranteed by RUS under the Guaranteed Underwriter Program of the USDA ("Guaranteed Underwriter Program") and the amount of the


60





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


corresponding debt outstanding as of February 28, 2018 and May 31, 2017 . See "Note 5-Short-Term Borrowings" and "Note 6-Long-Term Debt" for information on our borrowings.

(Dollars in thousands)

February 28, 2018

May 31, 2017

Collateral trust bonds:

2007 indenture:

Distribution system mortgage notes

$

8,453,575


$

8,740,572


RUS-guaranteed loans qualifying as permitted investments

142,133


146,373


Total pledged collateral

$

8,595,708


$

8,886,945


Collateral trust bonds outstanding

7,697,711


7,697,711


1994 indenture:

Distribution system mortgage notes

$

249,384


$

263,007


Collateral trust bonds outstanding

220,000


225,000


Farmer Mac:

Distribution and power supply system mortgage notes

$

3,375,180


$

2,942,456


Notes payable outstanding

2,805,376


2,513,389


Clean Renewable Energy Bonds Series 2009A:

Distribution and power supply system mortgage notes

$

13,339


$

14,943


Cash

-


481


Total pledged collateral

$

13,339


$

15,424


Notes payable outstanding

11,556


13,214


Federal Financing Bank:

Distribution and power supply system mortgage notes

$

5,827,497


$

5,833,515


Notes payable outstanding

4,871,771


4,985,748



Credit Concentration


As a tax-exempt, member-owned finance cooperative, CFC's principal focus is to provide funding to its rural electric utility cooperative members to assist them in acquiring, constructing and operating electric distribution, transmission and related facilities. We serve electric and telecommunications members throughout the United States and its territories, including 49 states, the District of Columbia, American Samoa and Guam. Our consolidated membership totaled 1,447 members and 217 associates as of February 28, 2018 . Texas had the largest concentration of outstanding loans to borrowers in any one state, with approximately 15% of total loans outstanding as of both February 28, 2018 and May 31, 2017 . Outstanding loans to electric utility organizations represented approximately 99% of the total outstanding loan portfolio as of February 28, 2018 , unchanged from May 31, 2017 . The remaining outstanding loans in our portfolio were to RTFC members, affiliates and associates in the telecommunications industry. As a result of lending primarily to our members we have a loan portfolio with single-industry and single-obligor concentration risk. Despite our credit concentration risks, we historically have experienced limited defaults and very low credit losses in our electric loan portfolio.


Single-Obligor Concentration


The outstanding exposure to our 20 largest borrowers was 23% and 24% as of February 28, 2018 and May 31, 2017 , respectively. The 20 largest borrowers consisted of 10 distribution systems, 9 power supply systems and 1 NCSC associate


61





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


member as of both February 28, 2018 and May 31, 2017 . The largest total outstanding exposure to a single borrower or controlled group represented approximately 2% of total loans and guarantees outstanding as of both February 28, 2018 and May 31, 2017 .


Credit Quality


We closely monitor loan performance trends to manage and evaluate our credit risk exposure. We seek to provide a balance between meeting the credit needs of our members, while also ensuring the sound credit quality of our loan portfolio. Payment status and internal risk ratings are key indicators, among others, of the level of credit risk in our loan portfolio.


As part of our strategy in managing our credit risk exposure, we entered into a long-term standby purchase commitment agreement with Farmer Mac. Under this agreement, we may designate certain long-term loans to be covered under the commitment, subject to approval by Farmer Mac, and in the event any such loan later goes into payment default for at least 90 days, upon request by us, Farmer Mac must purchase such loan at par value. The aggregate unpaid principal balance of designated and Farmer Mac approved loans was $777 million and $843 million as of February 28, 2018 and May 31, 2017 , respectively. Under the agreement, we are required to pay Farmer Mac a monthly fee based on the unpaid principal balance of loans covered under the purchase commitment. No loans had been put to Farmer Mac for purchase, pursuant to this agreement, as of February 28, 2018 . Also, we had long-term loans totaling $163 million and $167 million as of February 28, 2018 and May 31, 2017 , respectively, that were guaranteed by the Rural Utilities Service ("RUS") of the United States Department of Agriculture.


Payment Status of Loans


The tables below present the payment status of loans outstanding by member class as of February 28, 2018 and May 31, 2017 . As indicated in the table, we did not have any past due loans as of either February 28, 2018 or May 31, 2017 .

February 28, 2018

(Dollars in thousands)

Current

30-89 Days Past Due

90 Days or More

Past Due (1)

Total

Past Due

Total Financing

Receivables

Nonaccrual Loans

CFC:

Distribution

$

19,687,812


$

-


$

-


$

-


$

19,687,812


$

-


Power supply

4,422,600


-


-


-


4,422,600


-


Statewide and associate

57,144


-


-


-


57,144


-


CFC total

24,167,556


-


-


-


24,167,556


-


NCSC

800,814


-


-


-


800,814


-


RTFC

363,465


-


-


-


363,465


-


Total loans outstanding

$

25,331,835


$

-


$

-


$

-


$

25,331,835


$

-


Percentage of total loans

100.00

%

-

%

-

%

-

%

100.00

%

-

%



62





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


May 31, 2017

(Dollars in thousands)

Current

30-89 Days Past Due

90 Days or More

Past Due (1)

Total
Past Due

Total Financing
Receivables

Nonaccrual Loans

CFC:

Distribution

$

18,825,366


$

-


$

-


$

-


$

18,825,366


$

-


Power supply

4,504,791


-


-


-


4,504,791


-


Statewide and associate

57,830


-


-


-


57,830


-


CFC total

23,387,987


-


-


-


23,387,987


-


NCSC

613,924


-


-


-


613,924


-


RTFC

354,419


-


-


-


354,419


-


Total loans outstanding

$

24,356,330


$

-


$

-


$

-


$

24,356,330


$

-


Percentage of total loans

100.00

%

-

%

-

%

-

%

100.00

%

-

%

____________________________

(1) All loans 90 days or more past due are on nonaccrual status.


Troubled Debt Restructured ("TDR") Loans


We did not have any loans modified as TDRs during the nine months ended February 28, 2018 . The following table provides a summary of loans modified as TDRs in prior periods, the performance status of these loans and the unadvanced loan commitments related to the TDR loans, by member class, as of February 28, 2018 and May 31, 2017 .

February 28, 2018

May 31, 2017

(Dollars in thousands)

Loans

Outstanding

% of Total Loans

Unadvanced

Commitments

Loans

Outstanding

% of Total Loans

Unadvanced

Commitments

TDR loans:

Performing TDR loans:

CFC/Distribution

$

6,507


0.03

%

$

-


$

6,581


0.02

%

$

-


RTFC

6,216


0.02


-


6,592


0.03


-


Total performing TDR loans

12,723


0.05


-


13,173


0.05


-


Total TDR loans

$

12,723


0.05

%

$

-


$

13,173


0.05

%

$

-



We did not have any TDR loans classified as nonperforming as of February 28, 2018 or May 31, 2017 . TDR loans classified as performing as of February 28, 2018 and May 31, 2017 were performing in accordance with the terms of their respective restructured loan agreement and on accrual status as of the respective reported dates. One borrower with a TDR loan also had a line of credit facility, restricted for fuel purchases only, totaling $6 million as of both February 28, 2018 and

May 31, 2017 . The outstanding amount under this facility totaled approximately $0.8 million and $0.5 million as of February 28, 2018 and May 31, 2017 , respectively, and was classified as performing as of each respective date.


Nonperforming Loans


In addition to TDR loans that may be classified as nonperforming, we also may have nonperforming loans that have not been modified as a TDR loan. We did not have any loans classified as nonperforming as of February 28, 2018 or

May 31, 2017 .


We had no foregone interest income for loans on nonaccrual status during the three and nine months ended


63





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


February 28, 2018. We had foregone interest income for loans on nonaccrual status totaling $31 thousand during the nine months ended February 28, 2017 .


Impaired Loans


The following table provides information on loans classified as individually impaired loans as of February 28, 2018 and May 31, 2017 .


February 28, 2018

May 31, 2017

(Dollars in thousands)

Recorded

Investment

Related

Allowance

Recorded

Investment

Related

Allowance

With no specific allowance recorded:

CFC

$

6,507


$

-


$

6,581


$

-


With a specific allowance recorded:

RTFC

6,216


1,272


6,592


1,640


Total impaired loans

$

12,723


$

1,272


$

13,173


$

1,640



The following table presents, by company, the average recorded investment for individually impaired loans and the interest income recognized on these loans for the three and nine months ended February 28, 2018 and 2017 .

Three Months Ended February 28,

2018

2017

2018

2017

(Dollars in thousands)

Average Recorded Investment 

Interest Income Recognized 

CFC

$

6,507


$

6,582


$

142


$

144


RTFC

6,299


6,799


79


84


Total impaired loans

$

12,806


$

13,381


$

221


$

228


Nine Months Ended February 28,

2018

2017

2018

2017

(Dollars in thousands)

Average Recorded Investment 

Interest Income Recognized 

CFC

$

6,529


$

6,624


$

428


$

418


RTFC

6,425


8,093


241


259


Total impaired loans

$

12,954


$

14,717


$

669


$

677



Internal Risk Ratings of Loans


We evaluate the credit quality of our loans using an internal risk rating system that employs similar criteria for all member classes. Our internal risk rating system is based on a determination of a borrower's risk of default utilizing both quantitative and qualitative measurements. Each risk rating is reassessed annually following the receipt of the borrower's audited financial statements; however, interim risk rating downgrades or upgrades may occur as a result of significant developments or trends. Our borrower risk ratings fall into the following four categories based on the criteria identified below.


Pass :  Borrowers that are not experiencing difficulty and/or not showing a potential or well-defined credit weakness.

Special Mention :  Borrowers that may be characterized by a potential credit weakness or deteriorating financial condition that is not sufficiently serious to warrant a classification of substandard or doubtful.


64





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


Substandard :  Borrowers that display a well-defined credit weakness that may jeopardize the full collection of principal and interest.

Doubtful :  Borrowers that have a well-defined weakness and the full collection of principal and interest is questionable or improbable.


Loans to borrowers in the pass, special mention and substandard categories are generally included in the collective loan portfolio for purposes of determining the allowance for loan losses. Loans to borrowers in the doubtful category are considered to be individually impaired and therefore reflected in the impaired loan portfolio. The special mention, substandard, and doubtful categories are intended to comply with the definition of criticized loans by the banking regulatory authorities.


The following tables present total loans outstanding, by member class and borrower risk rating category, based on the risk ratings used in the estimation of our allowance for loan losses as of February 28, 2018 and May 31, 2017 .

February 28, 2018

(Dollars in thousands)

Pass

Special Mention

Substandard

Doubtful

Total

CFC:

Distribution

$

19,585,802


$

102,010


$

-


$

-


$

19,687,812


Power supply

4,422,600


-


-


-


4,422,600


Statewide and associate

57,144


-


-


-


57,144


CFC total

24,065,546


102,010


-


-


24,167,556


NCSC

800,814


-


-


-


800,814


RTFC

357,249


-


6,216


-


363,465


Total loans outstanding

$

25,223,609


$

102,010


$

6,216


$

-


$

25,331,835



May 31, 2017

(Dollars in thousands)

Pass

Special Mention

Substandard

Doubtful

Total

CFC:

Distribution

$

18,715,810


$

109,556


$

-


$

-


$

18,825,366


Power supply

4,504,791


-


-


-


4,504,791


Statewide and associate

56,654


1,176


-


-


57,830


CFC total

23,277,255


110,732


-


-


23,387,987


NCSC

612,592


1,332


-


-


613,924


RTFC

346,944


-


7,475


-


354,419


Total loans outstanding

$

24,236,791


$

112,064


$

7,475


$

-


$

24,356,330



Allowance for Loan Losses


We maintain an allowance for loan losses at a level estimated by management to provide for probable losses inherent in the loan portfolio as of each balance sheet date. Our allowance for loan losses consists of an amount for loans collectively evaluated for impairment, referred to as our collective allowance, and an amount for loans designated as individually impaired, referred to as our specific allowance.





65





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


The following tables summarize changes, by company, in the allowance for loan losses as of and for the three and nine months ended February 28, 2018 and 2017 .


Three Months Ended February 28, 2018

(Dollars in thousands)

CFC

NCSC

RTFC

Total

Balance as of November 30, 2017

$

28,799


$

3,117


$

4,858


$

36,774


Provision (benefit) for loan losses

506


731


(132

)

1,105


Balance as of February 28, 2018

$

29,305


$

3,848


$

4,726


$

37,879


Three Months Ended February 28, 2017

(Dollars in thousands)

CFC

NCSC

RTFC

Total

Balance as of November 30, 2016

$

25,857


$

3,664


$

4,390


$

33,911


Provision (benefit) for loan losses

2,448


(215

)

(168

)

2,065


Recoveries

53


-


-


53


Balance as of February 28, 2017

$

28,358


$

3,449


$

4,222


$

36,029


Nine Months Ended February 28, 2018

(Dollars in thousands)

CFC

NCSC

RTFC

Total

Balance as of May 31, 2017

$

29,499


$

2,910


$

4,967


$

37,376


Provision (benefit) for loan losses

(194

)

938


(241

)

503


Balance as of February 28, 2018

$

29,305


$

3,848


$

4,726


$

37,879


Nine Months Ended February 28, 2017

(Dollars in thousands)

CFC

NCSC

RTFC

Total

Balance as of May 31, 2016

$

24,559


$

3,134


$

5,565


$

33,258


Provision for loan losses

3,640


315


776


4,731


Charge-offs

-


-


(2,119

)

(2,119

)

Recoveries

159


-


-


159


Net recoveries (charge-offs)

159


-


(2,119

)

(1,960

)

Balance as of February 28, 2017

$

28,358


$

3,449


$

4,222


$

36,029



The tables below present, by company, the components of our allowance for loan losses and the recorded investment of the related loans as of February 28, 2018 and May 31, 2017 .



66





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


February 28, 2018

(Dollars in thousands)

CFC

NCSC

RTFC

Total

Allowance by company:

Collective allowance

$

29,305


$

3,848


$

3,454


$

36,607


Specific allowance

-


-


1,272


1,272


Total allowance for loan losses

$

29,305


$

3,848


$

4,726


$

37,879


Recorded investment in loans:

Collectively evaluated loans

$

24,161,049


$

800,814


$

357,249


$

25,319,112


Individually evaluated loans

6,507


-


6,216


12,723


Total recorded investment in loans

$

24,167,556


$

800,814


$

363,465


$

25,331,835


Total recorded investment in loans, net (1)

$

24,138,251


$

796,966


$

358,739


$

25,293,956



May 31, 2017

(Dollars in thousands)

CFC

NCSC

RTFC

Total

Allowance by company:

Collective allowance

$

29,499


$

2,910


$

3,327


$

35,736


Specific allowance

-


-


1,640


1,640


Total ending balance of the allowance

$

29,499


$

2,910


$

4,967


$

37,376


Recorded investment in loans:

Collectively evaluated loans

$

23,381,406


$

613,924


$

347,827


$

24,343,157


Individually evaluated loans

6,581


-


6,592


13,173


Total recorded investment in loans

$

23,387,987


$

613,924


$

354,419


$

24,356,330


Total recorded investment in loans, net (1)

$

23,358,488


$

611,014


$

349,452


$

24,318,954


____________________________

(1) Excludes unamortized deferred loan origination costs $11 million as of both February 28, 2018 and May 31, 2017 .


Reserve for Unadvanced Commitments


We also maintain a reserve for unadvanced loan commitments at a level estimated by management to provide for probable losses under these commitments as of each balance sheet dated. Unadvanced loan commitments are analyzed and segregated by loan type and risk using our internal risk rating scales. We use these risk classifications, in combination with the probability of commitment usage, and any other pertinent information to estimate a reserve for unadvanced loan commitments, which we record as a liability on our condensed consolidated balance sheets. The reserve for these commitments was less than $1 million as of both February 28, 2018 and May 31, 2017 .

NOTE 5-SHORT-TERM BORROWINGS


Short-term borrowings consist of borrowings with an original contractual maturity of one year or less and do not include the current portion of long-term debt. Our short-term borrowings totaled $3,494 million and accounted for 14% of total debt outstanding as of February 28, 2018 , compared with $3,343 million , or 14% , of total debt outstanding as of May 31, 2017 .



67





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


Committed Bank Revolving Line of Credit Agreements


We had $3,085 million and $3,165 million of commitments under committed bank revolving line of credit agreements as of February 28, 2018 and May 31, 2017 , respectively. Under our current committed bank revolving line of credit agreements, we have the ability to request up to $300 million of letters of credit, which would result in a reduction in the remaining available amount under the facilities.


On November 20, 2017 , we amended and restated the three-year and five-year committed bank revolving line of credit agreements to extend the maturity dates to November 20, 2020 and November 20, 2022 , respectively, and to terminate certain third-party bank commitments totaling $40 million under the three-year agreement and $40 million under the five- year agreement. As a result, the total commitment amount from third-parties under the three-year facility and the five-year facility is $1,493 million and $1,592 million , respectively, resulting in a combined total commitment amount under the two facilities of $3,085 million .


The following table presents the total commitment, the net amount available for use and the outstanding letters of credit under our committed bank revolving line of credit agreements as of February 28, 2018 and May 31, 2017 .

February 28, 2018


May 31, 2017



(Dollars in millions)

Total Commitment


Letters of Credit Outstanding


Net Available for Use


Total Commitment


Letters of Credit Outstanding


Net Available for Use


Maturity


Annual Facility Fee (1)

3-year agreement

$

-


$

-


$

-


$

1,533


$

-


$

1,533


November 19, 2019

7.5 bps

3-year agreement

1,493


-


1,493


-


-


-


November 20, 2020

7.5 bps

Total 3-year agreement

1,493


-


1,493


1,533


-


1,533


5-year agreement

-


-


-


1,632


1


1,631


November 19, 2021

10 bps

5-year agreement

1,592


2


1,590


-


-


-


November 20, 2022

10 bps

Total 5-year agreement

1,592



2



1,590



1,632



1



1,631




Total

$

3,085


$

2


$

3,083


$

3,165


$

1


$

3,164


____________________________

(1) Facility fee determined by CFC's senior unsecured credit ratings based on the pricing schedules put in place at the inception of the related agreement.


We had no borrowings outstanding under our committed bank revolving line of credit agreements as of February 28, 2018 or May 31, 2017 , and we were in compliance with all covenants and conditions under the agreements as of each date.


68





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


NOTE 6-LONG-TERM DEBT


The following table displays long-term debt outstanding, by debt type, as of February 28, 2018 and May 31, 2017 .

(Dollars in thousands)

February 28, 2018

May 31, 2017

Unsecured long-term debt:

Medium-term notes sold through dealers

$

3,081,779


$

2,386,956


Medium-term notes sold to members

411,373


422,779


Subtotal medium-term notes

3,493,152


2,809,735


Unamortized discount

(704

)

(382

)

Debt issuance costs

(22,897

)

(21,903

)

Total unsecured medium-term notes

3,469,551


2,787,450


Unsecured notes payable

20,892


22,799


Unamortized discount

(300

)

(379

)

Debt issuance costs

(74

)

(94

)

Total unsecured notes payable

20,518


22,326


Total unsecured long-term debt

3,490,069


2,809,776


Secured long-term debt:



Collateral trust bonds

7,917,711


7,922,711


Unamortized discount

(252,991

)

(258,329

)

Debt issuance costs

(29,857

)

(30,334

)

Total collateral trust bonds

7,634,863


7,634,048


Guaranteed Underwriter Program notes payable

4,871,771


4,985,748


Debt issuance costs

(239

)

(264

)

Total Guaranteed Underwriter Program notes payable

4,871,532


4,985,484


Farmer Mac notes payable

2,805,376


2,513,389


Other secured notes payable

11,556


13,214


Debt issuance costs

(260

)

(317

)

Total other secured notes payable

11,296


12,897


Total secured notes payable

7,688,204


7,511,770


Total secured long-term debt

15,323,067


15,145,818


Total long-term debt

$

18,813,136


$

17,955,594



Collateral Trust Bonds


On February 7, 2018, we issued $700 million aggregate principal amount of 3.40% collateral trust bonds due 2028.


Secured Notes Payable


We had outstanding secured notes payable totaling $4,872 million and $4,985 million as of February 28, 2018 and May 31, 2017 , respectively, under bond purchase agreements with Federal Financing Bank and a bond guarantee agreement with RUS issued under the Guaranteed Underwriter Program, which provides guarantees to Federal Financing Bank. We pay RUS a fee of 30 basis points per year on the total amount outstanding. On November 9, 2017 , we closed on a $750 million committed loan facility ("Series M") from the Federal Financing Bank under the Guaranteed Underwriter Program. Pursuant to this facility, we may borrow any time before July 15, 2022. Each advance is subject to quarterly amortization and a final maturity not longer than 20 years from the advance date. On January 16, 2018 we redeemed $325 million of notes payable outstanding under the Guaranteed Underwriter Program, with an original maturity of April 15, 2026. During the nine months ended February 28, 2018 , we borrowed $250 million under our committed loan facilities with the Federal Financing Bank. We had up to $1,225 million available for access under the Guaranteed Underwriter Program as of February 28, 2018 .



69





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


We are required to pledge eligible distribution system or power supply system loans as collateral in an amount at least equal to the total principal amount of notes outstanding under the Guaranteed Underwriter Program. See "Note 4-Loans and Commitments" for additional information on the collateral pledged to secure notes payable under this program.


We have two revolving note purchase agreements with Farmer Mac, which together allow us to borrow up to $5,500 million from Farmer Mac. On February 26, 2018, we amended our first revolving note purchase agreement with Farmer Mac, dated March 24, 2011. Under the amended agreement, we currently can borrow, subject to market conditions, up to $5,200 million at any time through January 11, 2022, and such date shall automatically extend on each anniversary date of the closing for an additional year, unless prior to any such anniversary date, Farmer Mac provides us with a notice that the draw period will not be extended beyond the remaining term. This revolving note purchase agreement allows us to borrow, repay and re-borrow funds at any time through maturity, as market conditions permit, provided that the outstanding principal amount at any time does not exceed the total available under the agreement. Each borrowing under the revolving note purchase agreement is evidenced by a pricing agreement setting forth the interest rate, maturity date and other related terms as we may negotiate with Farmer Mac at the time of each such borrowing. We may select a fixed rate or variable rate at the time of each advance with a maturity as determined in the applicable pricing agreement. Under this note purchase agreement with Farmer Mac, we had outstanding secured notes payable totaling $2,805 million and $2,513 million as of February 28, 2018 and May 31, 2017 , respectively. We borrowed $325 million under this note purchase agreement with Farmer Mac during the nine months ended February 28, 2018 .


Under the terms of the second revolving note purchase agreement with Farmer Mac dated July 31, 2015, we can borrow up to $300 million at any time through July 31, 2018 at a fixed spread over LIBOR. This agreement also allows us to borrow, repay and re-borrow funds at any time through maturity, provided that the outstanding principal amount at any time does not exceed the total available under the agreement. We had no notes payable outstanding under this revolving note purchase agreement with Farmer Mac as of February 28, 2018 and May 31, 2017 .


We are required to pledge eligible distribution system or power supply system loans as collateral in an amount at least equal to the total principal amount of notes outstanding under each of our Farmer Mac revolving note purchase agreements. See "Note 4-Loans and Commitments" for additional information on the collateral pledged to secure notes payable under these programs.


We were in compliance with all covenants and conditions under our senior debt indentures as of February 28, 2018 and May 31, 2017 .

NOTE 7-SUBORDINATED DEFERRABLE DEBT


The following table presents subordinated deferrable debt outstanding as of February 28, 2018 and May 31, 2017 .

February 28, 2018

May 31, 2017

(Dollars in thousands)

Amount

Amount

4.75% due 2043 with a call date of April 30, 2023

$

400,000


$

400,000


5.25% due 2046 with a call date of April 20, 2026

350,000


350,000


Debt issuance costs

(7,625

)

(7,726

)

Total subordinated deferrable debt

$

742,375


$

742,274




70





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


NOTE 8-DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES


Use of Derivatives


We are an end user of derivative financial instruments and do not engage in derivative trading. We use derivatives, primarily interest rate swaps and Treasury rate locks, to manage interest rate risk. Derivatives may be privately negotiated contracts, which are often referred to as over-the-counter ("OTC") derivatives, or they may be listed and traded on an exchange. We generally engage in OTC derivative transactions.


Accounting for Derivatives


In accordance with the accounting standards for derivatives and hedging activities, we record derivative instruments at fair value as either a derivative asset or derivative liability on our condensed consolidated balance sheets. We report derivative asset and liability amounts on a gross basis based on individual contracts, which does not take into consideration the effects of master netting agreements or collateral netting. Derivatives in a gain position are reported as derivative assets on our condensed consolidated balance sheets, while derivatives in a loss position are reported as derivative liabilities. Accrued interest related to derivatives is reported on our condensed consolidated balance sheets as a component of either accrued interest and other receivables or accrued interest payable.


If we do not elect hedge accounting treatment, changes in the fair value of derivative instruments, which consist of net accrued periodic derivative cash settlements and derivative forward value amounts, are recognized in our consolidated statements of operations under derivative gains (losses). If we elect hedge accounting treatment for derivatives, we formally document, designate and assess the effectiveness of the hedge relationship. Changes in the fair value of derivatives designated as qualifying fair value hedges are recorded in earnings together with offsetting changes in the fair value of the hedged item and any related ineffectiveness. Changes in the fair value of derivatives designated as qualifying cash flow hedges are recorded as a component of OCI, to the extent that the hedge relationships are effective, and reclassified AOCI to earnings using the effective interest method over the term of the forecasted transaction. Any ineffectiveness in the hedging relationship is recognized as a component of derivative gains (losses) in our consolidated statement of operations.


We generally do not designate interest rate swaps, which currently represent all of our outstanding derivatives, for hedge accounting. Accordingly, changes in the fair value of interest rate swaps are reported in our consolidated statements of operations under derivative gains (losses). Net periodic cash settlements related to interest rate swaps are classified as an operating activity in our consolidated statements of cash flows.


Outstanding Notional Amount of Derivatives


The notional amount provides an indication of the volume of our derivatives activity, but this amount is not recorded on our condensed consolidated balance sheets. The notional amount is used only as the basis on which interest payments are determined and is not the amount exchanged. The following table shows the outstanding notional amounts and the weighted-average rate paid and received for our interest rate swaps, by type, as of February 28, 2018 and May 31, 2017 . The substantial majority of our interest rate swaps use an index based on the London Interbank Offered Rate ("LIBOR") for either the pay or receive leg of the swap agreement.


71





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


February 28, 2018

May 31, 2017

(Dollars in thousands)

Notional

   Amount

Weighted-

Average

Rate Paid

Weighted-

Average

Rate Received

Notional
Amount

Weighted-
Average
Rate Paid

Weighted-
Average
Rate Received

Pay-fixed swaps

$

6,987,403


2.84

%

1.78

%

$

6,807,013


2.85

%

1.16

%

Receive-fixed swaps

3,824,000


2.37


2.50


3,699,000


1.72


2.64


Total interest rate swaps

10,811,403


2.67


2.03


10,506,013


2.46


1.68


Forward pay-fixed swaps

226,256


285,383


Total

$

11,037,659


$

10,791,396



Impact of Derivatives on Condensed Consolidated Balance Sheets


The following table displays the fair value of the derivative assets and derivative liabilities recorded on our condensed consolidated balance sheets and the related outstanding notional amount of our interest rate swaps as of February 28, 2018 and May 31, 2017 .

February 28, 2018

May 31, 2017

(Dollars in thousands)

Fair Value

Notional Balance

Fair Value

Notional Balance

Derivative assets

$

252,888


$

5,168,362


$

49,481


$

3,754,120


Derivative liabilities

(282,892

)

5,869,297


(385,337

)

7,037,276


Total

$

(30,004

)

$

11,037,659


$

(335,856

)

$

10,791,396



All of our master swap agreements include legally enforceable netting provisions that allow for offsetting of all contracts with a given counterparty in the event of default by one of the two parties. However, as indicated above, we report derivative asset and liability amounts on a gross basis by individual contracts. The following table presents the gross fair value of derivative assets and liabilities reported on our condensed consolidated balance sheets as of February 28, 2018 and May 31, 2017 , and provides information on the impact of netting provisions and collateral pledged.


February 28, 2018

Gross Amount

of Recognized

Assets/ Liabilities

Gross Amount

Offset in the

Balance Sheet

Net Amount of Assets/ Liabilities

Presented

in the

Balance Sheet

Gross Amount

Not Offset in the

Balance Sheet

(Dollars in thousands)

Financial

Instruments

Cash

Collateral

Pledged

Net

Amount

Derivative assets:

Interest rate swaps

$

252,888


$

-


$

252,888


$

200,760


$

-


$

52,128


Derivative liabilities:

Interest rate swaps

282,892


-


282,892


200,760


-


82,132




72





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


May 31, 2017

Gross Amount

of Recognized

Assets/ Liabilities

Gross Amount

Offset in the

Balance Sheet

Net Amount of Assets/ Liabilities

Presented

in the

Balance Sheet

Gross Amount

Not Offset in the

Balance Sheet

(Dollars in thousands)

Financial

Instruments

Cash

Collateral

Pledged

Net

Amount

Derivative assets:

Interest rate swaps

$

49,481


$

-


$

49,481


$

49,481


$

-


$

-


Derivative liabilities:

Interest rate swaps

385,337


-


385,337


49,481


-


335,856



Impact of Derivatives on Condensed Consolidated Statements of Operations


Derivative gains (losses) reported in our condensed consolidated statements of operations consist of derivative cash settlements and derivative forward value gains (losses). Derivative cash settlements represent net contractual interest expense accruals on interest rate swaps during the period. The derivative forward value gains (losses) represent the change in fair value of our interest rate swaps during the reporting period due to changes in the estimate of future interest rates over the remaining life of our derivative contracts.


The following table presents the components of the derivative gains (losses) reported in our condensed consolidated statements of operations for our interest rate swaps for the three and nine months ended February 28, 2018 and 2017 .

Three Months Ended February 28,

Nine Months Ended February 28,

(Dollars in thousands)

2018

2017

2018

2017

Derivative cash settlements

$

(18,924

)

$

(19,354

)

$

(58,781

)

$

(64,331

)

Derivative forward value gains

186,972


61,809


306,224


259,153


Derivative gains

$

168,048


$

42,455


$

247,443


$

194,822



Credit-Risk-Related Contingent Features


Our derivative contracts typically contain mutual early termination provisions, generally in the form of a credit rating trigger. Under the mutual credit rating trigger provisions, either counterparty may, but is not obligated to, terminate and settle the agreement if the credit rating of the other counterparty falls to a level specified in the agreement. If a derivative contract is terminated, the amount to be received or paid by us would be equal to the mark-to-market value, as defined in the agreement, as of the termination date.


Our senior unsecured credit ratings from Moody's and S&P were A2 and A, respectively, as of February 28, 2018 . Both Moody's and S&P had our ratings on stable outlook as of February 28, 2018 . The following table displays the notional amounts of our derivative contracts with rating triggers as of February 28, 2018 and the payments that would be required if the contracts were terminated as of that date because of a downgrade of our unsecured credit ratings or the counterparty's unsecured credit ratings below A3/A-, below Baa1/BBB+ to or below Baa2/BBB, below Baa3/BBB- or to or below Ba2/BB+ by Moody's or S&P, respectively. In calculating the payment amounts that would be required upon termination of the derivative contracts, we assumed that the amounts for each counterparty would be netted in accordance with the provisions of the master netting agreements for each counterparty. The net payment amounts are based on the fair value of the underlying derivative instrument, excluding the credit risk valuation adjustment, plus any unpaid accrued interest amounts.


73





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


(Dollars in thousands)

Notional

 Amount

Payable Due From CFC

Receivable

Due to CFC

Net (Payable)/Receivable

Impact of rating downgrade trigger:

Falls below A3/A- (1)


$

54,890



$

(10,007

)


$

-



$

(10,007

)

Falls below Baa1/BBB+

7,237,155



(61,923

)


40,825



(21,098

)

Falls to or below Baa2/BBB (2)

503,125



-



5,191



5,191


Falls below Baa3/BBB-

258,923


(12,974

)

-


(12,974

)

Total

$

8,054,093



$

(84,904

)


$

46,016



$

(38,888

)

____________________________

(1) Rating trigger for CFC falls below A3/A-, while rating trigger for counterparty falls below Baa1/BBB+ by Moody's or S&P, respectively.

(2) Rating trigger for CFC falls to or below Baa2/BBB, while rating trigger for counterparty falls to or below Ba2/BB+ by Moody's or S&P, respectively.


Our largest counterparty exposure, based on the outstanding notional amount, represented approximately 22% and 23% of the total outstanding notional amount of derivatives as of February 28, 2018 and May 31, 2017 , respectively. The aggregate fair value amount, including the credit risk valuation adjustment, of all interest rate swaps with rating triggers that were in a net liability position was $85 million as of February 28, 2018 .

NOTE 9-EQUITY


Total equity increased by $360 million to $1,459 million as of February 28, 2018 . The increase was primarily attributable to our reported net income of $409 million for the nine months ended February 28, 2018 , which was partially offset by patronage capital retirement of $45 million in September 2017. The following table presents the components of equity as of February 28, 2018 and May 31, 2017 .

(Dollars in thousands)

February 28, 2018

May 31, 2017

Membership fees

$

968


$

971


Educational fund

1,228


1,929


Total membership fees and educational fund

2,196


2,900


Patronage capital allocated

716,481


761,701


Members' capital reserve

630,305


630,305


Unallocated net income (loss):

Prior year-end cumulative derivative forward value losses (1)

(332,525

)

(507,904

)

Current year derivative forward value gains (1)

302,308


175,379


Current period-end cumulative derivative forward value losses (1)

(30,217

)

(332,525

)

Other unallocated net income (loss)

98,210


(5,603

)

Unallocated net income (loss)

67,993


(338,128

)

CFC retained equity

1,416,975


1,056,778


Accumulated other comprehensive income

10,107


13,175


Total CFC equity

1,427,082


1,069,953


Noncontrolling interests

32,022


28,852


Total equity

$

1,459,104


$

1,098,805


____________________________

(1) Represents derivative forward value gains (losses) for CFC only, as total CFC equity does not include the noncontrolling interests of the consolidated variable interest entities NCSC and RTFC. See "Note 12-Business Segments" for the separate statements of operations for CFC .


74





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


In July 2017, the CFC Board of Directors authorized the allocation of the fiscal year 2017 adjusted net income as follows: $90 million to members in the form of patronage capital; $43 million to members' capital reserve; and $1 million to the Cooperative Educational Fund. The amount of patronage capital allocated each year by CFC's Board of Directors is based on adjusted net income, which excludes the impact of derivative forward value gains (losses). See "MD&A-Non-GAAP Financial Measures" for information on adjusted net income.


In July 2017, the CFC Board of Directors authorized the retirement of patronage capital totaling $45 million , which represented 50% of the fiscal year 2017 allocation of patronage capital of $90 million . We returned the $45 million to members in cash in September 2017. The remaining portion of the allocated amount will be retained by CFC for 25 years under guidelines adopted by the CFC Board of Directors in June 2009.


The CFC Board of Directors is required to make annual allocations of adjusted net income, if any. CFC has made annual retirements of allocated net earnings in 38 of the last 39 fiscal years; however, future retirements of allocated amounts are determined based on CFC's financial condition. The CFC Board of Directors has the authority to change the current practice for allocating and retiring net earnings at any time, subject to applicable laws. See "Item 1. Business-Allocation and Retirement of Patronage Capital" of our 2017 Form 10-K for additional information.


Accumulated Other Comprehensive Income


The following tables summarize, by component, the activity in AOCI as of and for the three and nine months ended February 28, 2018 and 2017 .

Three Months Ended February 28, 2018

(Dollars in thousands)

Unrealized Gains (Losses)

AFS Securities

Unrealized Gains
Derivatives

Unrealized Losses Foreclosed Assets

Unrealized Losses Defined Benefit Plan

Total

Beginning balance

$

10,873


$

3,316


$

-


$

(2,290

)

$

11,899


Unrealized losses

(1,763

)

-


-


-


(1,763

)

Losses reclassified into earnings

-


-


-


128


128


Gains reclassified into earnings

-


(157

)

-


-


(157

)

Other comprehensive income (loss)

(1,763

)

(157

)

-


128


(1,792

)

Ending balance

$

9,110


$

3,159


$

-


$

(2,162

)

$

10,107


Three Months Ended February 28, 2017

(Dollars in thousands)

Unrealized Gains (Losses)

AFS Securities

Unrealized Gains

Derivatives

Unrealized Losses Foreclosed Assets

Unrealized Losses Defined Benefit Plan

Total

Beginning balance

$

5,630


$

4,091


$

-


$

(920

)

$

8,801


Unrealized gains

3,923


-


-


-


3,923


Losses reclassified into earnings

-


-


-


45


45


Gains reclassified into earnings

-


(195

)

-


-


(195

)

Other comprehensive income (loss)

3,923


(195

)

-


45


3,773


Ending balance

$

9,553


$

3,896


$

-


$

(875

)

$

12,574



75





NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)


Nine Months Ended February 28, 2018

(Dollars in thousands)

Unrealized Gains (Losses)

AFS Securities

Unrealized Gains

Derivatives

Unrealized Losses Foreclosed Assets

Unrealized Losses Defined Benefit Plan

Total

Beginning balance

$

12,016


$

3,702


$

-


$

(2,543

)

$

13,175


Unrealized losses

(2,906

)

-


-


-


(2,906

)

Losses reclassified into earnings

-


-


-


381


381


Gains reclassified into earnings

-


(543

)

-


-


(543

)

Other comprehensive income (loss)

(2,906

)

(543

)

-


381


(3,068

)

Ending balance

$

9,110


$

3,159


$

-


$

(2,162

)

$

10,107


Nine Months Ended February 28, 2017

(Dollars in thousands)

Unrealized Gains (Losses)

AFS Securities

Unrealized Gains

Derivatives

Unrealized Losses Foreclosed Assets

Unrealized Losses Defined Benefit Plan

Total

Beginning balance

$

7,402


$

4,487


$

(9,823

)

$

(1,008

)

$

1,058


Unrealized gains

2,151


-


-


-


2,151


Losses reclassified into earnings

-


-


9,823


133


9,956


Gains reclassified into earnings

-


(591