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National Rural Utilities Cooperative Finance
10-Q 2019-02-28 Quarter: 2019-02-28
10-Q 2018-11-30 Quarter: 2018-11-30
10-Q 2018-08-31 Quarter: 2018-08-31
10-K 2018-05-31 Annual: 2018-05-31
10-Q 2018-02-28 Quarter: 2018-02-28
10-Q 2017-11-30 Quarter: 2017-11-30
10-Q 2017-08-31 Quarter: 2017-08-31
10-K 2017-05-31 Annual: 2017-05-31
10-Q 2017-02-28 Quarter: 2017-02-28
10-Q 2016-11-30 Quarter: 2016-11-30
10-Q 2016-08-31 Quarter: 2016-08-31
10-K 2016-05-31 Annual: 2016-05-31
10-Q 2016-02-29 Quarter: 2016-02-29
10-Q 2015-11-30 Quarter: 2015-11-30
10-Q 2015-08-31 Quarter: 2015-08-31
10-K 2015-05-31 Annual: 2015-05-31
10-Q 2015-02-28 Quarter: 2015-02-28
10-Q 2014-11-30 Quarter: 2014-11-30
10-Q 2014-08-31 Quarter: 2014-08-31
10-K 2014-05-31 Annual: 2014-05-31
10-Q 2014-02-28 Quarter: 2014-02-28
10-Q 2013-11-30 Quarter: 2013-11-30
8-K 2019-07-17 Officers
8-K 2019-04-29 Other Events, Exhibits
8-K 2019-03-11 Officers
8-K 2019-01-28 Other Events, Exhibits
8-K 2018-12-17 Officers
8-K 2018-11-28 Enter Agreement
8-K 2018-11-15 Off-BS Arrangement
8-K 2018-10-24 Other Events, Exhibits
8-K 2018-06-12 Other Events
8-K 2018-02-26 Enter Agreement
8-K 2018-01-31 Other Events, Exhibits
QCOM Qualcomm 101,850
CERN Cerner 22,320
NVTA Invitae 1,750
RUTH Ruths Hospitality Group 790
RMAX RE/MAX 669
BKS Barnes & Noble 379
SHSP Sharpspring 192
ICBK County Bancorp 122
PVL Permianville Royalty Trust 104
DQWS DSwiss 0
NRU 2019-02-28
Part I-Financial Information
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A")
Item 1. Financial Statements
Note 1-Summary of Significant Accounting Policies
Note 2-Variable Interest Entities
Note 3-Investment Securities
Note 4-Loans
Note 5-Allowance for Loan Losses
Note 6-Short-Term Borrowings
Note 7-Long-Term Debt
Note 8-Subordinated Deferrable Debt
Note 9-Derivative Instruments and Hedging Activities
Note 10-Equity
Note 11-Guarantees
Note 12-Fair Value Measurement
Note 13-Business Segments
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Item 4. Controls and Procedures
Part Ii-Other Information
Item 1. Legal Proceedings
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
EX-31.1 nrufy2019q3form10-qxex311.htm
EX-31.2 nrufy2019q3form10-qxex312.htm
EX-32.1 nrufy2019q3form10-qxex321.htm
EX-32.2 nrufy2019q3form10-qxex322.htm

National Rural Utilities Cooperative Finance Earnings 2019-02-28

NRU 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

10-Q 1 nrufy2019q3form10-q.htm NRU FY2019 Q3 FORM 10-Q Document




 
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, 2019
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 x  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 x  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 x 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 x
 



TABLE OF CONTENTS
 
  
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 
 
 
 
 
 
 

i


INDEX OF MD&A TABLES
 
Table
  
 Description
 
Page
1
 
Summary of Selected Financial Data
 
3

2
 
Average Balances, Interest Income/Interest Expense and Average Yield/Cost
 
10

3
 
Rate/Volume Analysis of Changes in Interest Income/Interest Expense
 
13

4
 
Non-Interest Income
 
15

5
 
Derivative Average Notional Amounts and Average Interest Rates
 
16

6
 
Derivative Gains (Losses)
 
17

7
 
Non-Interest Expense
 
18

8
 
Loans Outstanding by Type and Member Class
 
19

9
 
Historical Retention Rate and Repricing Selection
 
20

10
 
Total Debt Outstanding
 
21

11
 
Member Investments
 
23

12
 
Collateral Pledged
 
24

13
 
Unencumbered Loans
 
24

14
 
Equity
 
25

15
 
Guarantees Outstanding
 
26

16
 
Maturities of Guarantee Obligations
 
27

17
 
Unadvanced Loan Commitments
 
27

18
 
Notional Maturities of Unadvanced Loan Commitments
 
28

19
 
Maturities of Notional Amount of Unconditional Committed Lines of Credit
 
29

20
 
Loan Portfolio Security Profile
 
30

21
 
Credit Exposure to 20 Largest Borrowers
 
32

22
 
Troubled Debt Restructured Loans
 
33

23
 
Allowance for Loan Losses
 
34

24
 
Rating Triggers for Derivatives
 
36

25
 
Available Liquidity
 
37

26
 
Committed Bank Revolving Line of Credit Agreements
 
38

27
 
Short-Term Borrowings—Funding Sources
 
39

28
 
Short-Term Borrowings
 
40

29
 
Issuances and Maturities of Long-Term and Subordinated Debt
 
40

30
 
Principal Maturity of Long-Term and Subordinated Debt
 
41

31
 
Projected Sources and Uses of Liquidity
 
42

32
 
Credit Ratings
 
42

33
 
Interest Rate Gap Analysis
 
44

34
 
Adjusted Financial Measures—Income Statement
 
45

35
 
TIER and Adjusted TIER
 
46

36
 
Adjusted Financial Measures—Balance Sheet
 
46

37
 
Debt-to-Equity Ratio
 
47

38
 
Members’ Equity
 
47


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 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.
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 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 February 28, 2019 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.

1



Our principal operations are currently organized for management reporting purposes into three business segments: CFC, NCSC and RTFC. Loans to members totaled $26,018 million as of February 28, 2019, of which 96% was attributable to CFC. Total revenue, which consists of net interest income and fee and other income, was $235 million for the nine months ended February 28, 2019, of which 99% was attributable to CFC, compared with $231 million for the same prior-year period. We provide information on the financial performance of each of our business segments in “Note 13—Business Segments.”

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 consolidated 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. 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.
SUMMARY OF SELECTED FINANCIAL DATA

Table 1 provides a summary of consolidated selected financial data for the three and nine months ended February 28, 2019 and 2018, and as of February 28, 2019 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 (“AOCI”). 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.


2



Table 1: Summary of Selected Financial Data
 
 
Three Months Ended February 28,
 
 
 
Nine Months Ended February 28,
 
 
(Dollars in thousands)
 
2019
 
2018
 
Change
 
2019
 
2018
 
Change
Statement of operations:
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
285,566

 
$
271,468

 
   5%
 
$
845,310

 
$
803,206

 
   5%
Interest expense
 
(207,335
)
 
(198,071
)
 
5
 
(621,732
)
 
(585,972
)
 
6
Net interest income
 
78,231

 
73,397

 
7
 
223,578

 
217,234

 
3
Fee and other income
 
3,714

 
3,935

 
(6)
 
11,220

 
13,422

 
(16)
Total revenue
 
81,945

 
77,332

 
6
 
234,798

 
230,656

 
2
Benefit (provision) for loan losses
 
(182
)
 
(1,105
)
 
(84)
 
1,715

 
(503
)
 
**
Derivative gains (losses)(1)
 
(132,174
)
 
168,048

 
**
 
(61,648
)
 
247,443

 
**
Results of operations of foreclosed assets
 

 

 
**
 

 
(34
)
 
**
Operating expenses(2) 
 
(22,998
)
 
(22,212
)
 
4
 
(70,073
)
 
(65,762
)
 
7
Other non-interest expense
 
1,789

 
(402
)
 
**
 
(8,405
)
 
(1,542
)
 
445
Income (loss) before income taxes
 
(71,620
)
 
221,661

 
**
 
96,387

 
410,258

 
(77)
Income tax benefit (expense)
 
149

 
(632
)
 
**
 
(154
)
 
(1,491
)
 
(90)
Net income (loss)
 
$
(71,471
)
 
$
221,029

 
**
 
$
96,233

 
$
408,767

 
(76)
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted operational financial measures
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted interest expense(3)
 
$
(217,134
)
 
$
(216,995
)
 
 
$
(656,165
)
 
$
(644,753
)
 
2
Adjusted net interest income(3)
 
68,432

 
54,473

 
26
 
189,145

 
158,453

 
19
Adjusted net income(3)
 
50,904

 
34,057

 
49
 
123,448

 
102,543

 
20
 
 
 
 
 
 
 
 
 
 
 
 
 
Selected ratios
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-charge coverage ratio/TIER(4)
 
0.66

 
2.12

 
(146) bps
 
1.15

 
1.70

 
(55) bps
Adjusted TIER(3)
 
1.23

 
1.16

 
7
 
1.19

 
1.16

 
3
Net interest yield(5)
 
1.19
%
 
1.16
%
 
3
 
1.14
%
 
1.15
%
 
(1)
Adjusted net interest yield(3)(6)
 
1.04

 
0.86

 
18
 
0.96

 
0.84

 
12



3



 
 
 
 
 
 
 
 
February 28, 2019
 
May 31, 2018
 
Change
Balance sheet
 
 
 
 
 
 
 
 
 
 
 
 
Cash, cash equivalents and restricted cash
 
 
 
 
 
 
 
$
230,628

 
$
238,824

 
     (3)%
Investment securities
 
 
 
 
 
 
 
650,532

 
609,851

 
7
Loans to members(7)
 
 
 
 
 
 
 
26,017,679

 
25,178,608

 
  3
Allowance for loan losses
 
 
 
 
 
 
 
(17,086
)
 
(18,801
)
 
  (9)
Loans to members, net
 
 
 
 
 
 
 
26,000,593

 
25,159,807

 
  3
Total assets
 
 
 
 
 
 
 
27,410,061

 
26,690,204

 
  3
Short-term borrowings
 
 
 
 
 
 
 
3,651,941

 
3,795,910

 
  (4)
Long-term debt
 
 
 
 
 
 
 
19,564,933

 
18,714,960

 
  5
Subordinated deferrable debt
 
 
 
 
 
 
 
742,516

 
742,410

 
Members’ subordinated certificates
 
 
 
 
 
 
 
1,357,419

 
1,379,982

 
  (2)
Total debt outstanding
 
 
 
 
 
 
 
25,316,809

 
24,633,262

 
  3
Total liabilities
 
 
 
 
 
 
 
25,857,449

 
25,184,351

 
  3
Total equity
 
 
 
 
 
 
 
1,552,612

 
1,505,853

 
  3
Guarantees(8)
 
 
 
 
 
 
 
786,031

 
805,161

 
  (2)
 
 
 
 
 
 
 
 
 
 
 
 
 
Selected ratios period end
 
 
 
 
 
 
 
 
 
 
 

Allowance coverage ratio(9)
 
 
 
 
 
 
 
0.07
%
 
0.07
%
 
Debt-to-equity ratio(10)
 
 
 
 
 
 
 
16.65

 
16.72

 
(7)
Adjusted debt-to-equity ratio(3)
 
 
 
 
 
 
 
6.29

 
6.18

 
11
____________________________ 
** 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 condensed 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.
(7)Consists of the outstanding principal balance of member loans plus unamortized deferred loan origination costs, which totaled $11 million as of both February 28, 2019 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.

4



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 funding costs 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 the shape of the yield curve 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. Because our derivative portfolio consists of a higher proportion of pay-fixed swaps than receive-fixed swaps, we generally record derivative losses 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 a net loss of $71 million and a TIER of 0.66 for the quarter ended February 28, 2019 (“current quarter”), compared with net income of $221 million and a TIER of 2.12 for the same prior-year quarter. We reported net income of $96 million and a TIER of 1.15 for the nine months ended February 28, 2019, compared with net income of $409 million and a TIER of 1.70 for the same prior-year period. The significant variance between our reported results for the current year periods and the same prior-year periods was primarily attributable to mark-to-market changes in the fair value of our derivatives. Our debt-to-equity ratio decreased to 16.65 as of February 28, 2019, from 16.72 as of May 31, 2018, primarily due to an increase in equity resulting from our reported net income of $96 million for the nine months ended February 28, 2019, which was partially offset by patronage capital retirement of $48 million in August 2018.

The variance of $293 million between our reported net loss of $71 million for the current quarter and our reported net income of $221 million for the same prior-year quarter was driven by a shift in derivative fair value changes of $300 million. We recorded derivative losses of $132 million during the current quarter due to decreases in the fair value of our pay-fixed swaps, as interest rates decreased across the swap yield curve. In comparison, we reported derivative gains of $168 million during the same prior-year quarter due to a rise in interest rates across the swap yield curve. Net interest income, which represented 95% of total revenue for both the current quarter and same prior-year quarter, increased $5 million, or 7%, attributable to the combined impact of an increase in the net interest yield of 3 basis points, or 3%, to 1.19%, and an increase in our average interest-earning assets of $963 million, or 4%. On July 12, 2018, we early redeemed $300 million of the $1 billion aggregate principal amount of 10.375% collateral trust bonds, due November 1, 2018, and repaid the remaining $700 million principal amount of these bonds at maturity. We replaced this high-cost debt with lower-cost funding. While we experienced a slight increase in our average cost of funds during the current quarter, the cost savings from the 10.375% collateral trust bonds in the current quarter mitigated the increase.


5



The variance of $313 million between our reported net income of $96 million for the nine months ended February 28, 2019 and our reported net income of $409 million was driven by a shift in derivative fair value changes of $309 million. We recorded derivative losses of $62 million for the nine months ended February 28, 2019, due to a decline in medium and longer-term interest rates as of the end of the period. We recorded derivative gains of $247 million during the comparable prior-year period due to an increase in interest rates across the yield curve. Net interest income, which represented 95% and 94% of total revenue for the nine months ended February 28, 2019 and 2018, respectively, increased $6 million, or 3%. The increase was attributable to an increase in average interest-earning assets of $933 million, or 4%, which was partially offset by a decline in the net interest yield of 1 basis point, or 1%, to 1.14%. In addition, we experienced an increase in operating expenses of $4 million and recorded a loss on the early extinguishment of debt of $7 million during the nine months ended February 28, 2019.

Adjusted Non-GAAP Results

Our adjusted net income totaled $51 million and our adjusted TIER was 1.23 for the current quarter, compared with adjusted net income of $34 million and adjusted TIER of 1.16 for the same prior-year quarter. Our adjusted net income totaled $123 million and our adjusted TIER was 1.19 for the nine months ended February 28, 2019, compared with adjusted net income of $103 million and adjusted TIER of 1.16 for the same prior-year period. Our adjusted debt-to-equity ratio increased to 6.29 as of February 28, 2019, from 6.18 as of May 31, 2018, primarily attributable to an increase in debt outstanding to fund loan growth.

The increase in adjusted net income of $17 million in the current quarter from the same prior-year quarter was primarily driven by an increase in adjusted net interest income of $14 million, or 26%, attributable to an increase in the adjusted net interest yield of 18 basis points, or 21%, to 1.04%, coupled with the increase in average interest-earning assets of 4%. The increase in the adjusted net interest yield was largely attributable to a reduction in our adjusted average cost of funds of 13 basis points to 3.49%. This reduction was primarily due to the interest expense savings resulting from the early redemption and maturity of $1 billion aggregate principal amount of 10.375% collateral trust bonds due November 1, 2018, which we replaced with lower-cost funding, and a decrease in net periodic derivative cash settlement amounts due to higher short-term interest rates relative to the same prior-year quarter.

The increase in adjusted net income of $21 million for the nine months ended February 28, 2019, from the comparable prior-year period was attributable to an increase in adjusted net interest income of $31 million, or 19%, which was partially offset by a loss on the early extinguishment of debt of $7 million and an increase in operating expenses of $4 million. The increase in adjusted net interest income was driven by an increase in the adjusted net interest yield of 12 basis points, or 14%, to 0.96% and the increase in average interest-earning assets of 4%. The increase in the adjusted net interest yield was primarily due to a reduction in our adjusted average cost of funds of 7 basis points to 3.54%. This reduction was also largely attributable to the interest savings from the early redemption and maturity of the $1 billion aggregate principal amount of the 10.375% collateral trust bonds that we replaced with lower-cost funding and a decrease in net periodic derivative settlement amounts due to higher short-term interest rates during the nine months ended February 28, 2019, relative to the same prior-year period.

See “Non-GAAP Financial Measures” for additional information on our adjusted measures, including a reconciliation of these measures to the most comparable GAAP measures.

Lending Activity

Loans to members totaled $26,018 million as of February 28, 2019, an increase of $839 million, or 3%, from May 31, 2018. CFC distribution loans and power supply loans increased by $724 million and $123 million, respectively, which was partially offset by decreases in NCSC loans and RTFC loans of $15 million and $10 million, respectively.

Long-term loan advances totaled $1,441 million during the nine months ended February 28, 2019, with approximately 85% of those advances for capital expenditures by members and 13% for the refinancing of loans made by other lenders. In comparison, 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 and 25% for refinancing of loans made by other lenders. The decrease in long-term loan advances from the same prior-year period reflects weaker demand from borrowers, due to more limited refinancings by our members of loans made by other lenders.

6



CFC had long-term fixed-rate loans totaling $676 million that were scheduled to reprice during the nine months ended February 28, 2019. Of this total, $490 million repriced to a new long-term fixed rate; $119 million repriced to a long-term variable rate; and $67 million was repaid in full.

Credit Quality

The overall credit quality of our loan portfolio remained high as of February 28, 2019, as evidenced by our strong credit performance metrics. We had no delinquent or nonperforming loans as of February 28, 2019, and no loan defaults or charge-offs during the nine months ended February 28, 2019. Outstanding loans to electric utility organizations represented approximately 99% of total outstanding loan portfolio as of February 28, 2019, 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, 91% were secured and 9% were unsecured as of February 28, 2019, compared to 93% secured and 7% unsecured as of 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 increased by $684 million, or 3%, to $25,317 million as of February 28, 2019, from May 31, 2018, due to an increase in borrowings to fund the increase in loans to members. The increase was primarily attributable to a net increase in borrowings under the Guaranteed Underwriter Program of the USDA (“Guaranteed Underwriter Program”) of $578 million, a net increase in Federal Agricultural Mortgage Corporation (“Farmer Mac”) notes payable of $281 million and a net increase in dealer medium-term notes of $278 million. These increases were partially offset by net decreases in collateral trust bonds outstanding of $259 million and in member commercial paper, select notes and daily liquidity fund notes of $142 million. Outstanding dealer commercial paper of $1,069 million as of February 28, 2019 was below our targeted limit 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, tier, adjusted tier, net interest yield and adjusted net interest yield will increase over the next 12 months, largely due to the cost savings from the early redemption and maturity of the $1 billion aggregate principal amount of 10.375% collateral trust bonds due November 1, 2018, which we replaced with lower-cost funding.

Long-term debt scheduled to mature over the next 12 months totaled $2,216 million as of February 28, 2019. 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 under the 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 February 28, 2019, sources of liquidity readily available for access totaled $6,873 million, consisting of (i) $223 million in cash and cash equivalents; (ii) up to $1,350 million available under committed loan facilities under the Guaranteed Underwriter Program; (iii) up to $2,972 million available for access under committed bank revolving line of credit agreements; (iv) up to $200 million available under a committed revolving note purchase agreement with Farmer Mac; and (v) up to $2,128 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 $2,483 million as of February 28, 2019, 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. We expect to continue accessing the dealer commercial paper market to help meet our liquidity needs. Although the intra-period amount of outstanding dealer commercial paper may fluctuate based on our liquidity requirements, we intend to manage our short-term wholesale funding risk by maintaining outstanding dealer commercial paper at an amount near or below $1,250 million for the foreseeable future. We expect to

7



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 6.29 as of February 28, 2019, above our targeted threshold. Based on our forecast of loan advances and adjusted equity over the next 12 months, we anticipate that our adjusted debt-to-equity ratio will decrease to be closer to or below our target ratio of 6.00-to-1.
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 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 nine months ended February 28, 2019. 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.
RECENT 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 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.

8



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, 2019 and 2018 and the nine months ended February 28, 2019 and 2018. Following this section, we provide a comparative analysis of our condensed consolidated balance sheets as of February 28, 2019 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 and nine months ended February 28, 2019 and 2018, 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.”


9



Table 2: Average Balances, Interest Income/Interest Expense and Average Yield/Cost
 
 
Three Months Ended February 28,
(Dollars in thousands)
 
2019
 
2018
Assets:
 
Average Balance
 
Interest Income/Expense
 
Average Yield/Cost
 
Average Balance
 
Interest Income/Expense
 
Average Yield/Cost
Long-term fixed-rate loans(1)
 
$
22,821,326

 
$
251,149

 
4.46
%
 
$
22,706,134

 
$
250,201

 
4.47
%
Long-term variable-rate loans
 
1,107,669

 
10,711

 
3.92

 
972,399

 
7,020

 
2.93

Line of credit loans
 
1,861,104

 
17,178

 
3.74

 
1,512,664

 
10,367

 
2.78

TDR loans(2)
 
12,060

 
209

 
7.03

 
12,808

 
221

 
7.00

Other income, net(3)
 

 
(291
)
 

 

 
(314
)
 

Total loans
 
25,802,159

 
278,956

 
4.38

 
25,204,005

 
267,495

 
4.30

Cash, time deposits and investment securities
 
904,775

 
6,610

 
2.96

 
539,728

 
3,973

 
2.99

Total interest-earning assets
 
$
26,706,934

 
$
285,566

 
4.34
%
 
$
25,743,733

 
$
271,468

 
4.28
%
Other assets, less allowance for loan losses
 
1,141,344

 
 
 
 
 
853,563

 
 
 
 
Total assets
 
$
27,848,278

 
 
 
 
 
$
26,597,296

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
$
4,105,330

 
$
27,070

 
2.67
%
 
$
3,777,158

 
$
14,593

 
1.57
%
Medium-term notes
 
3,888,915

 
34,329

 
3.58

 
3,392,554

 
28,051

 
3.35

Collateral trust bonds
 
7,215,271

 
61,405

 
3.45

 
7,590,459

 
83,730

 
4.47

Guaranteed Underwriter Program notes payable
 
5,074,697

 
36,911

 
2.95

 
4,899,496

 
34,233

 
2.83

Farmer Mac notes payable
 
2,808,774

 
23,691

 
3.42

 
2,507,350

 
13,316

 
2.15

Other notes payable
 
27,592

 
302

 
4.44

 
32,970

 
369

 
4.54

Subordinated deferrable debt
 
742,491


9,416

 
5.14

 
742,351


9,414

 
5.14

Subordinated certificates
 
1,363,731

 
14,211

 
4.23

 
1,372,508

 
14,365

 
4.24

Total interest-bearing liabilities
 
$
25,226,801

 
$
207,335

 
3.33
%
 
$
24,314,846

 
$
198,071

 
3.30
%
Other liabilities
 
1,002,547

 
 
 
 
 
954,482

 
 
 
 
Total liabilities
 
26,229,348

 
 
 
 
 
25,269,328

 
 
 
 
Total equity
 
1,618,930

 
 
 
 
 
1,327,968

 
 
 
 
Total liabilities and equity
 
$
27,848,278

 
 
 
 
 
$
26,597,296

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread(4)
 
 
 
 
 
1.01
%
 
 
 
 
 
0.98
%
Impact of non-interest bearing funding(5)
 
 
 
 
 
0.18

 
 
 
 
 
0.18

Net interest income/net interest yield(6)
 
 
 
$
78,231

 
1.19
%
 
 
 
$
73,397

 
1.16
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest income/adjusted net interest yield:
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
 
 
$
285,566

 
4.34
%
 
 
 
$
271,468

 
4.28
%
Interest expense
 
 
 
207,335

 
3.33

 
 
 
198,071

 
3.30

Add: Net accrued periodic derivative cash settlements(7)
 
 
 
9,799

 
0.36

 
 
 
18,924

 
0.71

Adjusted interest expense/adjusted average cost(8)
 
 
 
$
217,134

 
3.49
%
 
 
 
$
216,995

 
3.62
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest spread(4)
 
 
 
 
 
0.85
%
 
 
 
 
 
0.66
%
Impact of non-interest bearing funding(5)
 
 
 
 
 
0.19

 
 
 
 
 
0.20

Adjusted net interest income/adjusted net interest yield(9)
 
 
 
$
68,432

 
1.04
%
 
 
 
$
54,473

 
0.86
%
 
 
 
 
 
 
 
 
 
 
 
 
 

10



 
 
Nine Months Ended February 28,
(Dollars in thousands)
 
2019
 
2018
Assets:
 
Average Balance
 
Interest Income/Expense
 
Average Yield/Cost
 
Average Balance
 
Interest Income/Expense
 
Average Yield/Cost
Long-term fixed-rate loans(1)
 
$
22,734,570

 
$
756,290

 
4.45
%
 
$
22,510,725

 
$
748,491

 
4.45
%
Long-term variable-rate loans
 
1,091,929

 
30,158

 
3.69

 
900,067

 
18,980

 
2.82

Line of credit loans
 
1,543,686

 
40,563

 
3.51

 
1,398,346

 
27,662

 
2.64

TDR loans(2)
 
12,267

 
638

 
6.95

 
12,954

 
669

 
6.90

Other income, net(3)
 

 
(867
)
 

 

 
(852
)
 

Total loans
 
25,382,452

 
826,782

 
4.35

 
24,822,092

 
794,950

 
4.28

Cash, time deposits and investment securities
 
848,767

 
18,528

 
2.92

 
476,532

 
8,256

 
2.32

Total interest-earning assets
 
$
26,231,219

 
$
845,310

 
4.31
%
 
$
25,298,624

 
$
803,206

 
4.24
%
Other assets, less allowance for loan losses
 
984,554

 
 
 
 
 
645,712

 
 
 
 
Total assets
 
$
27,215,773

 


 
 
 
$
25,944,336

 


 


 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 


 


 


 


 


Short-term borrowings
 
$
3,811,774

 
$
69,108

 
2.42
%
 
$
3,330,949

 
$
35,248

 
1.41
%
Medium-term notes
 
3,851,758

 
100,555

 
3.49

 
3,258,159

 
80,711

 
3.31

Collateral trust bonds
 
7,319,359

 
208,044

 
3.80

 
7,621,435

 
254,328

 
4.46

Guaranteed Underwriter Program notes payable
 
4,918,616

 
107,259

 
2.92

 
4,987,617

 
105,523

 
2.83

Farmer Mac notes payable
 
2,718,697

 
64,499

 
3.17

 
2,503,828

 
36,753

 
1.96

Other notes payable
 
29,139

 
946

 
4.34

 
34,511

 
1,150

 
4.46

Subordinated deferrable debt
 
742,456

 
28,250

 
5.09

 
742,318

 
28,247

 
5.09

Subordinated certificates
 
1,372,977

 
43,071

 
4.19

 
1,402,077

 
44,012

 
4.20

Total interest-bearing liabilities
 
$
24,764,776

 
$
621,732

 
3.36
%
 
$
23,880,894

 
$
585,972

 
3.28
%
Other liabilities
 
891,089

 
 
 

 
882,937

 

 
 
Total liabilities
 
25,655,865

 
 
 

 
24,763,831

 

 
 
Total equity
 
1,559,908

 
 
 
 
 
1,180,505

 

 
 
Total liabilities and equity
 
$
27,215,773

 


 
 
 
$
25,944,336

 


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread(4)
 
 
 


 
0.95
%
 


 


 
0.96
%
Impact of non-interest bearing funding(5)
 
 
 
 
 
0.19

 
 
 
 
 
0.19

Net interest income/net interest yield(6)
 
 
 
$
223,578

 
1.14
%
 
 
 
$
217,234

 
1.15
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest income/adjusted net interest yield:
 
 
 
 
 


 
 
 
 
 
 
Interest income
 
 
 
$
845,310

 
4.31
%
 
 
 
$
803,206

 
4.24
%
Interest expense
 
 
 
621,732

 
3.36

 
 
 
585,972

 
3.28

Add: Net accrued periodic derivative cash settlements(7)
 
 
 
34,433

 
0.42

 
 
 
58,781

 
0.73

Adjusted interest expense/adjusted average cost(8)
 
 
 
$
656,165

 
3.54
%
 


 
$
644,753

 
3.61
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest spread(4)
 
 
 
 
 
0.77
%
 

 
 
 
0.63
%
Impact of non-interest bearing funding(5)
 
 
 
 
 
0.19

 
 
 
 
 
0.21

Adjusted net interest income/adjusted net interest yield(9)
 
 
 
$
189,145

 
0.96
%
 

 
$
158,453


0.84
%
____________________________ 
(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.

11



(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 $10,980 million and $10,841 million for the three months ended February 28, 2019 and 2018, respectively. The average outstanding notional amount of interest rate swaps was $11,019 million and $10,808 million for the nine months ended February 28, 2019 and 2018, 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 condensed 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. 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.
 

12



Table 3: Rate/Volume Analysis of Changes in Interest Income/Interest Expense
 
 
Three Months Ended February 28,
 
Nine Months Ended February 28,
 
 
2019 versus 2018
 
2019 versus 2018
 
 
Total
 
Variance due to:(1)
 
Total
 
Variance due to:(1)
(Dollars in thousands)
 
Variance
 
Volume
 
Rate
 
Variance
 
Volume
 
Rate
Interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
948

 
$
1,269

 
$
(321
)
 
$
7,799

 
$
7,443

 
$
356

Long-term variable-rate loans
 
3,691

 
977

 
2,714

 
11,178

 
4,046

 
7,132

Line of credit loans
 
6,811

 
2,388

 
4,423

 
12,901

 
2,875

 
10,026

Restructured loans
 
(12
)
 
(13
)
 
1

 
(31
)
 
(35
)
 
4

Other income, net
 
23

 

 
23

 
(15
)
 

 
(15
)
Total loans
 
11,461

 
4,621

 
6,840

 
31,832

 
14,329

 
17,503

Cash, time deposits and investment securities
 
2,637

 
2,687

 
(50
)
 
10,272

 
6,449

 
3,823

Interest income
 
14,098

 
7,308

 
6,790

 
42,104

 
20,778

 
21,326

 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense:
 
 
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
12,477

 
1,268

 
11,209

 
33,860

 
5,088

 
28,772

Medium-term notes
 
6,278

 
4,104

 
2,174

 
19,844

 
14,705

 
5,139

Collateral trust bonds
 
(22,325
)
 
(4,139
)
 
(18,186
)
 
(46,284
)
 
(10,080
)
 
(36,204
)
Guaranteed Underwriter Program notes payable
 
2,678

 
1,224

 
1,454

 
1,736

 
(1,460
)
 
3,196

Farmer Mac notes payable
 
10,375

 
1,601

 
8,774

 
27,746

 
3,154

 
24,592

Other notes payable
 
(67
)
 
(60
)
 
(7
)
 
(204
)
 
(179
)
 
(25
)
Subordinated deferrable debt
 
2

 
2

 

 
3

 
5

 
(2
)
Subordinated certificates
 
(154
)
 
(92
)
 
(62
)
 
(941
)
 
(913
)
 
(28
)
Interest expense
 
9,264

 
3,908

 
5,356

 
35,760

 
10,320

 
25,440

Net interest income
 
$
4,834

 
$
3,400

 
$
1,434

 
$
6,344

 
$
10,458

 
$
(4,114
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
14,098

 
$
7,308

 
$
6,790

 
$
42,104

 
$
20,778

 
$
21,326

Interest expense
 
9,264

 
3,908

 
5,356

 
35,760

 
10,320

 
25,440

Net accrued periodic derivative cash settlements(2)
 
(9,125
)
 
242

 
(9,367
)
 
(24,348
)
 
1,149

 
(25,497
)
Adjusted interest expense(3)
 
139

 
4,150

 
(4,011
)
 
11,412

 
11,469

 
(57
)
Adjusted net interest income
 
$
13,959

 
$
3,158

 
$
10,801

 
$
30,692

 
$
9,309

 
$
21,383

____________________________ 
(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.

Reported Net Interest Income
Reported net interest income of $78 million for the current quarter was up $5 million, or 7%, from the comparable prior-year quarter, driven by an increase in the net interest yield of 3% (3 basis points) to 1.19% and an increase in average interest-earning assets of 4%.

13



Net Interest Yield: The increase of 3 basis points in the net interest yield for the current quarter reflected the combined impact of an increase in the average yield on interest-earning assets of 6 basis points to 4.34%, which was partially offset by an increase in the average cost of funds of 3 basis points to 3.33%. The increase in the average yield on interest-earning assets was attributable to higher rates for our line of credit and variable-rate loans due to a rise in short-term interest rates. On July 12, 2018, we early redeemed $300 million aggregate principal amount of our 10.375% collateral trust bonds due November 1, 2018, and repaid the remaining $700 million principal amounts of these bonds at maturity. We replaced this high-cost debt with lower-cost funding. Although we experienced a slight increase in our average cost of funds for the current quarter due to higher interest rates on our shorter and medium-term borrowings, the cost savings associated with the redemption and maturity of the $1 billion aggregate principal amount of 10.375% collateral trust bonds mitigated the increase in interest expense and our average cost of funds resulting from the overall increase in our average borrowings and the increased cost of our short- and medium-term borrowings.

Average Interest-Earning Assets: The increase in average interest-earning assets of 4% for the current quarter was attributable to growth in average total loans of $598 million, or 2%, and an increase in our investment securities portfolio.
Reported net interest income of $224 million for the nine months ended February 28, 2019 was up $6 million, or 3%, from the comparable prior-year period, driven by an increase in average interest-earning assets of 4%, which was partially offset by a decrease in net interest yield of 1% (1 basis point) to 1.14%.

Net Interest Yield: The decrease of 1 basis point in the net interest yield reflected the impact of an 8 basis point increase in the average cost of funds to 3.36%, which was largely offset by a 7 basis point increase in the average yield on interest-earning assets to 4.31%. The increase in the average yield on interest-earning assets and the increase in the average cost of funds were both largely due to an increase in rates on short-term and variable-rate loans and borrowings as a result of a rise in short-term interest rates. The 3-month London Interbank Offered Rate (“LIBOR”) was 2.62% as of February 28, 2019, an increase of 60 basis points from February 28, 2018, while the federal funds target rate was 2.50% as of February 28, 2019, up 100 basis points from February 28, 2018.

Average Interest-Earning Assets: The increase in average interest-earning assets of 4% for the nine months ended February 28, 2019 was attributable to growth in average total loans of $560 million, or 2%, and an expansion of our investment securities portfolio.

Adjusted Net Interest Income

Adjusted net interest income of $68 million for the current quarter was up $14 million, or 26%, from the comparable prior-year quarter, driven by an increase in the adjusted net interest yield of 18 basis points, or 21%, to 1.04% and the increase in average interest-earning assets of 4%. The increase in the adjusted net interest yield reflected the benefit from a reduction in our adjusted average cost of funds of 13 basis points to 3.49%. This reduction was primarily due to the cost savings from the early redemption and maturity of $1 billion aggregate principal amount of 10.375% collateral trust bonds due November 1, 2018, which we replaced with lower-cost funding. The cost savings from the collateral trust bonds largely offset the increase in interest expense on our short-term, variable-rate borrowings resulting from the increase in short-term interest rates. The increase in short-term interest rates resulted in a decrease in our periodic derivative cash settlement expense amounts, which also had a favorable impact on the adjusted average cost of funds and adjusted net interest yield.
 
Adjusted net interest income of $189 million for the nine months ended February 28, 2019 was up $31 million, or 19%, from the comparable prior-year period, driven by an increase in the adjusted net interest yield of 12 basis points, or 14%, to 0.96% and the increase in average interest-earning assets of 4%. The increase in the adjusted net interest yield was primarily due to a reduction in our adjusted average cost of funds of 7 basis points to 3.54%, attributable to the early redemption and maturity of the $1 billion aggregate principal amount of the 10.375% collateral trust bonds, which offset the increase in the average cost associated with our short-term, variable rate borrowing due to higher short-term interest rates. In addition, the net periodic derivative settlement expense declined as a result of higher short-term interest rates during the period.

Net periodic derivative cash settlement expense of $10 million for the current quarter decreased by $9 million, or 48%, from $19 million for the same prior-year quarter. Net periodic derivative cash settlement expense of $34 million for the nine months ended February 28, 2019 decreased by $24 million, or 41%, from $59 million for the same prior-year period. The reduction in net periodic derivative cash settlements was attributable to the rise in short-term interest rates, which resulted in

14



an increase in the periodic floating interest rate amounts due to us on our pay-fixed swaps. The floating rate payments on our interest rate swaps are typically determined based on the 3-month LIBOR.

We include net accrued periodic derivative cash settlements during the period in the calculation of our adjusted average cost of funds, which, as a result, also impacts the calculation of adjusted net interest income and adjusted net interest yield. See “Non-GAAP Financial Measures” for additional information on our adjusted measures, including a reconciliation of these measures to the most comparable GAAP 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 less than $1 million for the three months ended February 28, 2019 and a benefit for loan losses of $2 million for the nine months ended February 28, 2019. In comparison, we recorded a provision for loan losses of $1 million for the same prior-year periods. The credit quality and performance statistics of our loan portfolio continued to remain strong. We had no payment defaults or charge-offs during the nine months ended February 28, 2019, and no delinquent loans or nonperforming loans in our loan portfolio as of February 28, 2019 or May 31, 2018.

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 and nine months ended February 28, 2019 and 2018.

Table 4: Non-Interest Income
 
 
Three Months Ended February 28,
 
Nine Months Ended February 28,
(Dollars in thousands)
 
2019
 
2018
 
2019

2018
Non-interest income:
 
 
 
 
 
 
 
 
Fee and other income
 
$
3,714

 
$
3,935

 
$
11,220

 
$
13,422

Derivative gains (losses)
 
(132,174
)
 
168,048

 
(61,648
)
 
247,443

Results of operations of foreclosed assets
 

 

 

 
(34
)
Total non-interest income
 
$
(128,460
)
 
$
171,983

 
$
(50,428
)
 
$
260,831


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

15



accounting. Accordingly, changes in the fair value of interest rate swaps are reported in our condensed consolidated statements of operations under derivative gains (losses). However, we typically designate treasury locks as cash flow hedges. We did not have any derivatives designated as accounting hedges as of February 28, 2019.

We currently use two types of interest rate swap agreements: (i) we pay a fixed rate of interest and receive a variable rate of interest (“pay-fixed swaps”); and (ii) we pay a variable rate of interest and receive a fixed rate of interest (“receive-fixed swaps”). The interest amounts are based on a specified notional balance, which is used for calculation purposes only.
The benchmark variable rate for the substantial majority of the floating rate payments under our swap agreements is 3-month 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 and nine months ended February 28, 2019 and 2018.

Table 5: Derivative Average Notional Amounts and Average Interest Rates
 
 
Three Months Ended February 28,
 
 
2019
 
2018
(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
 
$
7,373,993

 
2.76
%
 
2.66
%
 
$
7,004,710

 
2.84
%
 
1.65
%
Receive-fixed swaps
 
3,605,666

 
3.22

 
2.49

 
3,836,499

 
2.18

 
2.61

Total
 
$
10,979,659

 
2.91
%
 
2.60
%
 
$
10,841,209

 
2.60
%
 
2.00
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended February 28,
 
 
2019
 
2018
(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
 
$
7,330,332

 
2.72
%
 
2.42
%
 
$
7,004,166

 
2.84
%
 
1.42
%
Receive-fixed swaps
 
3,688,835

 
3.08

 
2.51

 
3,803,670

 
1.98

 
2.63

Total
 
$
11,019,167

 
2.84
%
 
2.45
%
 
$
10,807,836

 
2.53
%
 
1.85
%

The average remaining maturity of our pay-fixed and receive-fixed swaps was 19 years and four years, respectively, as of February 28, 2019. In comparison, the average remaining maturity of our pay-fixed and receive-fixed swaps was 19 years and five years, respectively, as of February 28, 2018.

As indicated in Table 5, our derivative portfolio consists of a higher proportion of pay-fixed swaps than receive-fixed swaps, with pay-fixed swaps representing approximately 69% and 65% of the outstanding notional amount of our derivative portfolio as of February 28, 2019 and May 31, 2018, respectively. As interest rates decline, pay-fixed swaps generally decrease in value and result in the recognition of derivative losses, as the amount of interest we pay remains fixed, while the amount of interest we receive declines. In contrast, as interest rates rise, pay-fixed swaps generally increase in value and result in the recognition of derivative gains, as the amount of interest we pay remains fixed, but the amount we receive decreases. With a receive-fixed swap, the opposite results occur as interest rates decline or 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 also impact the fair value of our derivatives. The chart below provides comparative swap curves as of the end of February 28, 2019, November 30, 2018, May 31, 2018, February 28, 2018 and May 31, 2017.



16



chart-cb815d05324c5492b98.jpg
____________________________ 
Benchmark rates obtained from Bloomberg.

Table 6 presents the components of net derivative gains (losses) recorded in results of operations for the three and nine months ended February 28, 2019 and 2018. 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)
 
 
Three Months Ended February 28,
 
Nine Months Ended February 28,
(Dollars in thousands)
 
2019
 
2018
 
2019
 
2018
Derivative gains (losses) attributable to:
 
 
 
 
 
 
 
 
Derivative cash settlements
 
$
(9,799
)
 
$
(18,924
)
 
$
(34,433
)
 
$
(58,781
)
Derivative forward value gains (losses)
 
(122,375
)
 
186,972

 
(27,215
)
 
306,224

Derivative gains (losses)
 
$
(132,174
)
 
$
168,048

 
$
(61,648
)
 
$
247,443


The net derivative losses of $132 million and $62 million for the three and nine months ended February 28, 2019, were attributable to a decrease in the fair value of our pay-fixed swaps resulting from a decrease in medium- and longer-term

17



interest rates, as depicted by the February 28, 2019 swap curve presented in the above chart. As discussed above, pay-fixed swaps, which represent a higher proportion of our derivative portfolio, typically decrease in fair value and result in derivative losses when interest rates decline.

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

The reduction in net periodic derivative cash settlements was attributable to higher short-term interest rates relative to the comparable prior-year periods, which resulted in an increase in the periodic floating interest rate amounts due to us on our pay-fixed swaps, as the floating interest rate payment amounts are typically determined based on the 3-month LIBOR.

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 and nine months ended February 28, 2019 and 2018.

Table 7: Non-Interest Expense
 
 
Three Months Ended February 28,
 
Nine Months Ended February 28,
(Dollars in thousands)
 
2019
 
2018
 
2019
 
2018
Non-interest expense:
 
 
 
 
 
 
 
 
Salaries and employee benefits
 
$
(13,020
)
 
$
(13,011
)
 
$
(38,094
)
 
$
(36,843
)
Other general and administrative expenses
 
(9,978
)
 
(9,201
)
 
(31,979
)
 
(28,919
)
Losses on early extinguishment of debt
 

 

 
(7,100
)
 

Other non-interest expense
 
1,789

 
(402
)
 
(1,305
)
 
(1,542
)
Total non-interest expense
 
$
(21,209
)
 
$
(22,614
)
 
$
(78,478
)
 
$
(67,304
)

Non-interest expense of $21 million for the current quarter decreased by $1 million, or 6%, from the comparable prior-year quarter, primarily due to decreases in other non-interest expense.

Non-interest expense of $78 million for the nine months ended February 28, 2019 increased by $11 million, or 17%, 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 matured 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 a net loss attributable to noncontrolling interests of $1 million and less than $1 million for the three and nine months ended February 28, 2019, respectively. We recorded net income attributable to noncontrolling interests of $2 million and $3 million for the three and nine months ended February 28, 2018, respectively.

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CONSOLIDATED BALANCE SHEET ANALYSIS

Total assets of $27,410 million as of February 28, 2019 increased by $720 million, or 3%, from May 31, 2018, primarily due to growth in our loan portfolio. Total liabilities of $25,857 million as of February 28, 2019 increased by $673 million, or 3%, from May 31, 2018, largely due to debt issuances to fund loan growth. Total equity increased by $47 million to $1,553 million as of February 28, 2019, attributable to our reported net income of $96 million during the nine months ended February 28, 2019, which was partially 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 nine months ended February 28, 2019. 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 February 28, 2019 and May 31, 2018. As indicated in Table 8, long-term fixed-rate loans accounted for 88% and 90% of loans to members as of February 28, 2019 and May 31, 2018, respectively.

Table 8: Loans Outstanding by Type and Member Class
 
 
February 28, 2019
 
May 31, 2018
 

(Dollars in thousands)
 
Amount
 
% of Total
 
Amount
 
% of Total
 
Change
Loans by type:
 
 
 
 
 
 
 
 
 
 
Long-term loans:
 
 
 
 
 
 
 
 
 
 
Fixed-rate
 
$
22,960,860

 
88
%
 
$
22,696,185

 
90
%
 
$