Washington, D.C. 20549

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For the quarterly period ended August 31, 2018

OR

For the transition period from to

Commission File Number: 1-7102

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(Exact name of registrant as specified in its charter)

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

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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 every Interactive Data File required to be submitted 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 such files).    Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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 ☐

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

INDEX OF MD&A TABLES

PART I-FINANCIAL INFORMATION

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 Securities 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, leverage and debt-to-equity ratios, 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, technological changes within the rural electric utility industry, 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" in our Annual Report on Form 10-K for the fiscal year ended May 31, 2018 (" 2018 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.

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 and transmission ("power supply") systems 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 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 hold, and did not have any subsidiaries or other entities that held, foreclosed assets as of August 31, 2018 or May 31, 2018 . See "Item 1. Business-Overview" in our 2018 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.

Our principal operations are currently organized for management reporting purposes into three business segments: CFC, NCSC and RTFC. 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 factors influencing 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, and credit quality metrics. We provide additional information on the financial performance of each of our business segments in "Note 13-Business Segments." The MD&A section 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 2018 Form 10-K and additional information contained in our 2018 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.

Table 1 provides a summary of consolidated selected financial data for the three months ended August 31, 2018 and 2017 , and as of August 31, 2018 and May 31, 2018 . 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

** Calculation of percentage change is not meaningful.

(1) Consists of interest rate swap cash settlements and 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 income.

(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.

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

(8) 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 11-Guarantees" for additional information.

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

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

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 for our interest rate swaps. As a result, the mark-to-market changes in our interest rate swaps are recorded in earnings. Based on the composition of our interest rate swaps, 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 the periodic cash settlement amounts of our interest rate swaps. As such, management uses our adjusted non-GAAP results to evaluate our operating performance. Our adjusted results include realized net periodic interest rate swap settlement amounts but exclude the impact of unrealized forward fair value gains and losses. Our financial debt covenants are also based on our non-GAAP adjusted results, as the forward fair value gains and losses related to our interest rate swaps do not affect our cash flows, liquidity or ability to service our debt.

Financial Performance

Reported Results

We reported net income of $48 million and a TIER of 1.23 for the quarter ended August 31, 2018 ("current quarter"), compared with net income of $9 million and a TIER of 1.05 for the same prior-year quarter. Our debt-to-equity ratio decreased slightly to 16.71 as of August 31, 2018 , from 16.72 as of May 31, 2018 , primarily due to a decline in liabilities as equity remained relatively unchanged. In July 2018, the CFC Board of Directors authorized the allocation of patronage capital of $95 million for fiscal year 2018 and the retirement of 50% of this amount, or $48 million , which was returned to members in August 2018. The increase in equity from our reported net income of $48 million for the current quarter was offset by the retirement of patronage capital.

The variance of $39 million between our reported net income of $48 million for the current quarter and our net income of $9 million for the same prior-year quarter was primarily driven by a favorable shift in the mark-to-market changes in the fair value of our derivatives. We recognized derivative gains of $7 million in the current quarter due to a net increase in the fair value of our pay-fixed swaps resulting from a slight rise in medium- and long-term interest rates. In contrast, we recognized derivative losses of $46 million during the comparable prior-year quarter, mainly due to a modest flattening of the swap curve as interest rates on the shorter end of the curve rose while medium- and long-term interest rates declined slightly. The favorable shift of $53 million in the fair value of our derivatives was offset in part by the recognition of losses of $7 million on the early extinguishment of debt, a decrease in net interest income of $5 million and an increase in operating expenses of $2 million . The decrease in net interest income resulted from compression in the net interest yield, which was partially offset by an increase in average interest-earning assets of $1,068 million , or 4%. Net interest yield declined by 12 basis points to 1.04% , primarily driven by an increase in our overall average cost of funds due to a higher average cost for our short-term and variable-rate borrowings resulting from the rise in short-term interest rates.

Adjusted Non-GAAP Results

Our adjusted net income totaled $28 million and our adjusted TIER was 1.13 for the current quarter, compared with adjusted net income of $35 million and adjusted TIER of 1.16 for the same prior-year quarter. Our adjusted debt-to-equity ratio increased to 6.21 as of August 31, 2018 , from 6.18 as of May 31, 2018 , primarily attributable to a decrease in adjusted equity due to the patronage capital retirement of $48 million , which more than offset our adjusted net income of $28 million .

The decrease in adjusted net income of  $7 million in the current quarter from the comparable prior-year quarter was primarily driven by losses on the early extinguishment of debt of $7 million and an increase in operating expenses of $2 million , offset in part by an increase in adjusted net interest income of  $2 million . The increase in adjusted net interest income was attributable to the increase in average interest-earning assets $1,068 million and a slight increase in the adjusted interest yield of  1  basis point to  0.85% .

Lending Activity and Credit Performance

Loans to members totaled $25,183 million as of August 31, 2018 , relatively unchanged from May 31, 2018 . CFC distribution loans increased by $87 million , which was offset by decreases in CFC power supply loans, NCSC loans and RTFC loans of $76 million , $6 million and $5 million , respectively.

Long-term loan advances totaled $468 million during the current quarter, with approximately 71% 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 $193 million that were scheduled to reprice during the current quarter. Of this total, $96 million repriced to a new long-term fixed rate; $48 million repriced to a long-term variable rate; and $49 million was repaid in full.

The overall credit quality of our loan portfolio remained high as of August 31, 2018 , as evidenced by our strong credit performance metrics. We had no delinquent or nonperforming loans as of August 31, 2018 , and no loan defaults or charge-offs during the current quarter. Outstanding loans to electric utility organizations represented approximately 99% of total outstanding loan portfolio as of August 31, 2018 , unchanged from May 31, 2018 . We historically have had limited defaults and losses on loans in our electric utility loan portfolio. We generally lend to members on a senior secured basis, which reduces the risk of loss in the event of a borrower default. Of our total loans outstanding, 93% were secured and 7% were unsecured as of both August 31, 2018 and May 31, 2018 .

Financing Activity

We issue debt primarily to fund growth in our loan portfolio. As such, our outstanding debt volume generally increases and decreases in response to member loan demand. Total debt outstanding was $24,589 million as of August 31, 2018 , relatively unchanged from May 31, 2018 , as loans to members also remained flat. Decreases in collateral trust bonds, dealer commercial paper and Federal Agricultural Mortgage Corporation ("Farmer Mac") notes payable of $296 million , $135 million , and $114 million , respectively, were largely offset by increases in dealer medium-term notes of $291 million and in member commercial paper, select notes and daily liquidity fund notes of $238 million . Outstanding dealer commercial paper of $929 million and $1,064 million as of August 31, 2018 and May 31, 2018 , respectively, was below our maximum threshold of $1,250 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, adjusted net interest income, net income, adjusted net income, tier, adjusted tier, net interest yield 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. Long-term debt scheduled to mature over the next 12 months totaled $2,820 million as of August 31, 2018 . Included in this amount is $880 million aggregate principal amount of higher-cost collateral trust bonds with a weighted average coupon rate of 9.60%, scheduled to mature on November 1, 2018. On July 12, 2018, we redeemed $300 million of our 10.375% collateral trust bonds due November 1, 2018, leaving a remaining outstanding principal

amount of $700 million . 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 believe we have sufficient liquidity from the combination of existing cash and cash equivalents, member loan repayments, committed bank revolving lines of credit, committed loan facilities from the Federal Financing Bank guaranteed by RUS under the Guaranteed Underwriter Program ("Guaranteed Underwriter Program"), revolving note purchase agreements with Farmer Mac 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 satisfy our obligations to repay long-term debt maturing over the next 12 months. As of August 31, 2018 , sources of liquidity readily available for access totaled $7,295 million , consisting of (i) $266 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 $3,082 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 $2,422 million available under a revolving note purchase agreement with Farmer Mac, subject to market conditions. On August 17, 2018, we executed a commitment letter for a $750 million loan facility under the Guaranteed Underwriter Program. The amount available for access under the Guaranteed Underwriter Program, based on amounts advanced to us as of August 31, 2018 , will increase to $1,975 million upon closing of the facility.

We believe we can continue to roll over the outstanding member short-term debt of $2,864 million as of August 31, 2018 , based on our expectation that our members will continue to reinvest their excess cash in our commercial paper, daily liquidity fund notes, 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 roll-over risk, as we can draw on these facilities to repay dealer or member commercial paper that cannot be refinanced with similar debt.

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 August 31, 2018 , above our targeted threshold due to the decrease in adjusted equity resulting from the patronage capital retirement of $48 million during the quarter. We expect that our adjusted debt-to-equity ratio will decrease during the remainder of the fiscal year due to an increase in equity from earnings. As a result, we believe our adjusted debt-to equity ratio will decrease closer to our target ratio of 6.00-to-1 over the next 12 months.

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 2018 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 were no material changes in the key inputs and assumptions used in our critical accounting policies during the current quarter. 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 2018 Form 10-K. See "Item 1A. Risk Factors" in our 2018 Form 10-K for a discussion of the risks associated with management's judgments and estimates in applying our accounting policies and methods.

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 the adoption of these accounting standards. 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 also discuss the impact in the applicable section(s) of this MD&A.

The section below provides a comparative discussion of our condensed consolidated results of operations between the three months ended August 31, 2018 and 2017 . Following this section, we provide a comparative analysis of our condensed consolidated balance sheets as of August 31, 2018 and May 31, 2018 . 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 includes 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 proportionately funding large aggregated amounts of loans.

Table 2 presents average balances for the three months ended August 31, 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."

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

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(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.

(4) Net interest spread represents the difference between the average yield on total average interest-earning assets and the average cost of total average interest-bearing liabilities. Adjusted net interest spread represents the difference between the average yield on total average interest-earning assets and the adjusted average cost of total average 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 interest rate swap settlements during the period. This amount 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 interest rate swap settlements during the period divided by the average outstanding notional amount of derivatives during the period. The average outstanding notional amount of interest rate swaps was $ 10,955 million and $ 10,682 million for the three months ended August 31, 2018 and 2017 , respectively.

(8) Adjusted interest expense represents interest expense plus net accrued periodic interest rate swap cash settlements during the period. Net accrued periodic derivative cash settlements are reported on our consolidated statements of income 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. Changes that are not solely due to either volume or rate are allocated to these categories on a pro-rata basis based on the absolute value of the change due to average volume and average rate.

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(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 $68 million for the current quarter decreased by $5 million , or 7% , from the comparable prior-year quarter, driven by a decrease in net interest yield of 10% ( 12 basis points) to 1.04% , which was partially offset by an increase in average interest-earning assets of 4% .

The 3-month London Interbank Offered Rate ("LIBOR") was 2.32% as of August 31, 2018 , an increase of 100 basis points from August 31, 2017 , while the federal funds target rate was 2.00% as of August 31, 2018 , up 75 basis points from August 31, 2017 .

Adjusted net interest income of $55 million for the current quarter increased by $2 million , or 5% , from the comparable prior-year quarter, due to the combined impact of an increase in average interest-earning assets of 4% and a slight increase in the adjusted net interest yield of 1% ( 1 basis point) to 0.85% . The increase in the adjusted net interest yield reflected the combined impact of increases in the average yield on interest-earning assets and the benefit from non-interest bearing funding, which were partially offset by an increase in the adjusted average cost of debt.

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 $13 million and $20 million for the three months ended August 31, 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 benefit for loan losses of less than $1 million for both the current quarter and comparable prior-year quarter. The credit quality and performance statistics of our loan portfolio continued to remain strong. We had no payment defaults, charge-offs, delinquent loans or nonperforming loans in our loan portfolio during the current quarter or the comparable prior-year quarter.

We provide additional information on our allowance for loan losses under "Credit Risk-Allowance for Loan Losses" and "Note 5-Allowance for Loan Losses" 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 2018 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 results of operations for the three months ended August 31, 2018 and 2017 .

Table 4 : Non-Interest Income

The significant variances in non-interest income between periods were primarily attributable to changes in net derivative gains (losses) recognized in our consolidated statements of income.

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. In addition, we may on occasion use treasury locks to manage the interest rate risk associated with debt that is scheduled to reprice in the future. 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 swap curve and the composition of our derivative portfolio. We generally do not designate our interest rate swaps, which currently account for the substantial majority of our derivatives, for hedge accounting. Accordingly, changes in the fair value of interest rate swaps are reported in our consolidated statements of income under derivative gains (losses). However, we typically designate treasury locks as cash flow hedges. We entered into one treasury lock agreement, which was designated as a cash flow hedge of a forecasted transaction as of

August 31, 2018 and May 31, 2018 .

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 variable 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 interest rate swap settlements during the three months ended August 31, 2018 and 2017 . As indicated in Table 5 , our interest rate swap portfolio currently consists of a higher proportion of pay-fixed swaps than receive-fixed swaps. The profile of our interest rate swap portfolio, however, may change as a result of changes in market conditions and actions taken to manage exposure to interest rate risk.

The average remaining maturity of our pay-fixed and receive-fixed swaps was 19 years and four years, respectively, as of both August 31, 2018 and 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 curve, different changes in the swap curve- parallel, flattening or steepening-will result in differences in the fair value of our derivatives. The chart below provides comparative swap curves as of the end of August 31, 2018 , May 31, 2018 , August 31, 2017 and May 31, 2017.

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Benchmark rates obtained from Bloomberg.

Table 6 presents the components of net derivative gains (losses) recorded in results of operations for the three months ended August 31, 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 (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)

The net derivative gains of $7 million in the current quarter were attributable to a net increase in the fair value of our pay-fixed swaps resulting from a slight increase in medium- and long-term interest rates, as depicted by the August 31, 2018 swap curve presented in the above chart.

The net derivative losses of $46 million in the same prior-year quarter were due to a net decrease in the fair value of our interest rate swaps resulting from a modest flattening of the swap curve, as interest rates on the shorter end of the curve rose while medium and longer-term interest rates declined slightly, as depicted by the May 31, 2017 and August 31, 2017 swap curves presented in the above chart.

See "Note 9-Derivative Instruments and Hedging Activities" for additional information on our derivative instruments.

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.

Table 7 presents the components of non-interest expense recorded in results of operations for the three months ended August 31, 2018 and 2017 .

Table 7 : Non-Interest Expense

Non-interest expense of $31 million for the current quarter increased by $9 million , or 39% , from the comparable prior-year quarter. The increase was largely due to the loss on early extinguishment of debt of $7 million, attributable to the premium paid for the early redemption of $300 million  of the $1 billion  collateral trust bonds, with a coupon rate of 10.375% , that mature on November 1, 2018.

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 less than $1 million for the current quarter. In comparison we recorded a net loss attributable to noncontrolling interests of less than $1 million for the same prior-year quarter.

Total assets of $26,676 million as of August 31, 2018 decreased slightly by $14 million from May 31, 2018 . Total liabilities of $25,170 million as of August 31, 2018 decreased slightly by $15 million from May 31, 2018 . Total equity of $1,507 million as of August 31, 2018 remained relatively unchanged from May 31, 2018 , as our reported net income of $48 million during the current quarter was offset by patronage capital retirement of $48 million in August 2018.

Following is a discussion of changes in the major components of our assets and liabilities during the three months ended August 31, 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.

Loans Outstanding

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

Table 8 : Loans Outstanding by Type and Member Class

Loans to members totaled $25,183 million as of August 31, 2018 , relatively unchanged from May 31, 2018 . CFC distribution loans increased by $87 million , which was offset by decreases in CFC power supply loans, NCSC loans and RTFC loans of $76 million , $6 million and $5 million , respectively. Long-term loan advances totaled $468 million during the current quarter, with approximately 71% 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" in our 2018 Form 10-K. See "Debt- Collateral Pledged " 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 three months ended August 31, 2018 and loans that repriced during fiscal year 2018, 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 98% over the last three fiscal years.

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(1) Does not include NCSC and RTFC loans.

(2) Includes loans totaling $1 million as of May 31, 2018 that were converted to new loans at the repricing date and transferred to a third party as part of our direct loan sale program. See "Note 4-Loans" for information on our sale of loans.

Debt

We utilize both short-term borrowings and long-term debt 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 rollover 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 August 31, 2018 and May 31, 2018 . Table 10 also displays the composition of our debt based on several additional selected attributes.