NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/ [NRUC] Filings

10-Q 1 nru-20221130.htm NRU FY2023 Q2 FORM 10-Q nru-20221130

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

__________________________________

FORM 10-Q

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

For the quarterly period ended November 30, 2022


¨			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

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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

__________________________________

Securities registered pursuant to Section 12(b) of the Act:


Title of Each Class	Trading Symbol(s)	Name of Each Exchange on Which Registered
7.35% Collateral Trust Bonds, due 2026	NRUC 26	New York Stock Exchange
5.50% Subordinated Notes, due 2064	NRUC	New York Stock Exchange

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

The Registrant is a tax-exempt cooperative and therefore does not issue capital stock.

TABLE OF CONTENTS


		Page
PART I—FINANCIAL INFORMATION		1
Item 1.	Financial Statements	54
	Consolidated Statements of Operations	55
	Consolidated Statements of Comprehensive Income (Loss)	56
	Consolidated Balance Sheets	57
	Consolidated Statements of Changes in Equity	58
	Consolidated Statements of Cash Flows	59
	Notes to Consolidated Financial Statements	60
	Note 1 — Summary of Significant Accounting Policies	60
	Note 2 — Interest Income and Interest Expense	61
	Note 3 — Investment Securities	62
	Note 4 — Loans	64
	Note 5 — Allowance for Credit Losses	76
	Note 6 — Short-Term Borrowings	79
	Note 7 — Long-Term Debt	80
	Note 8 — Subordinated Deferrable Debt	83
	Note 9 — Derivative Instruments and Hedging Activities	83
	Note 10 — Equity	86
	Note 11 — Guarantees	87
	Note 12 — Fair Value Measurement	89
	Note 13 — Variable Interest Entities	91
	Note 14 — Business Segments	93

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)	1
	Forward-Looking Statements	1
	Introduction	1
	Summary of Selected Financial Data	2
	Executive Summary	5
	Critical Accounting Estimates	12
	Recent Accounting Changes and Other Developments	12
	Consolidated Results of Operations	13
	Consolidated Balance Sheet Analysis	23
	Enterprise Risk Management	29
	Credit Risk	29
	Liquidity Risk	38
	Market Risk	47
	Non-GAAP Financial Measures	50
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	98
Item 4.	Controls and Procedures	98

PART II—OTHER INFORMATION		98
Item 1.	Legal Proceedings	98
Item 1A.	Risk Factors	98
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	98
Item 3.	Defaults Upon Senior Securities	98
Item 4.	Mine Safety Disclosures	98
Item 5.	Other Information	98
Item 6.	Exhibits	99

SIGNATURES		100

CROSS REFERENCE 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	14
3	Rate/Volume Analysis of Changes in Interest Income/Interest Expense	17
4	Non-Interest Income	20
5	Derivative Gains (Losses)	21
6	Derivatives—Average Notional Amounts and Interest Rates	21
7	Comparative Swap Curves	22
8	Non-Interest Expense	23
9	Debt—Total Debt Outstanding	25
10	Debt—Member Investments	26
11	Equity	28
12	Loans—Loan Portfolio Security Profile	30
13	Loans—Loan Exposure to 20 Largest Borrowers	32
14	Loans—Loan Exposure to Texas-Based Borrowers	33
15	Allowance for Credit Losses by Borrower Member Class and Evaluation Methodology	36
16	Available Liquidity	38
17	Liquidity Coverage Ratios	39
18	Committed Bank Revolving Line of Credit Agreements	40
19	Short-Term Borrowings—Funding Sources	42
20	Long-Term and Subordinated Debt—Issuances and Repayments	43
21	Long-Term and Subordinated Debt—Scheduled Principal Maturities and Amortization	43
22	Collateral Pledged	44
23	Loans—Unencumbered Loans	44
24	Liquidity—Projected Long-Term Sources and Uses of Funds	46
25	Credit Ratings	46
26	Interest Rate Sensitivity Analysis	48
27	LIBOR-Indexed Financial Instruments	50
28	Adjusted Net Income	51
29	TIER and Adjusted TIER	51
30	Adjusted Liabilities and Equity	52
31	Debt-to-Equity Ratio and Adjusted Debt-to-Equity Ratio	53
32	Members’ Equity	53

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 for the quarterly period ended November 30, 2022 (“this Report”) contains certain statements that are considered “forward-looking statements” as defined in and within the meaning of the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements do not represent historical facts or statements of current conditions. Instead, forward-looking statements represent management’s current beliefs and expectations, based on certain assumptions and estimates made by, and information available to, management at the time the statements are made, regarding our future plans, strategies, operations, financial results or other events and developments, many of which, by their nature, are inherently uncertain and outside our control. Forward-looking statements are generally identified by the 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 adequacy of the allowance for credit 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 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. Therefore, you should not place undue reliance on any forward-looking statement and should consider the risks and uncertainties that could cause our current expectations to vary from our forward-looking statements, including, but not limited to, legislative changes that could affect our tax status and other matters, 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, nonperformance of counterparties to our derivative agreements, economic conditions and regulatory or technological changes within the rural electric industry, the costs and impact of legal or governmental proceedings involving us or our members, general economic conditions, governmental monetary and fiscal policies, the occurrence and effect of natural disasters, including severe weather events or public health emergencies, such as the emergence and spread since 2019 of a novel coronavirus (“COVID-19”) 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, 2022 (“2022 Form 10-K”), as well as any risk factors identified under “Part II—Item 1A. Risk Factors” in this Report. Forward-looking statements speak only as of the date they are made, and, except as required by law, we undertake no obligation to update any forward-looking statement to reflect the impact of events, circumstances or changes in expectations that arise after the date any forward-looking statement is made.


INTRODUCTION

Our financial statements include the consolidated accounts of National Rural Utilities Cooperative Finance Corporation (“CFC”), National Cooperative Services Corporation (“NCSC”) and Rural Telephone Finance Cooperative (“RTFC.”) Our principal operations are currently organized for management reporting purposes into three business segments, which are based on the accounts of each of the legal entities included in our consolidated financial statements: CFC, NCSC and RTFC.

CFC is a member-owned, nonprofit finance cooperative association with a principal purpose of providing financing to its members to supplement the loan programs of the Rural Utilities Service (“RUS”) of the United States Department of Agriculture (“USDA”). CFC extends loans to its rural electric members for construction, acquisitions, system and facility repairs and maintenance, enhancements and ongoing operations to support the goal of electric distribution and generation and transmission (“power supply”) systems of providing reliable, affordable power to the customers they service. CFC also provides its members with credit enhancements in the form of letters of credit and guarantees of debt obligations. As a Section 501(c)(4) tax-exempt, member-owned cooperative, CFC’s objective is not to maximize profit, but rather to offer members cost-based financial products and services. Because CFC is a tax-exempt cooperative, we cannot issue equity securities as a source of funding. CFC’s primary funding sources consist of a combination of public and private issuances of debt securities, member investments and retained equity. NCSC is a member-owned taxable cooperative that is permitted to 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 member-owned cooperative association. RTFC’s principal purpose is to provide financing to its rural telecommunications members and their affiliates. See “Item 1. Business” in our 2022 Form 10-K for additional information on the business structure, principal purpose, members and core 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, except where indicated otherwise.

The following MD&A is intended to enhance the understanding of our consolidated financial statements by providing material information that we believe is relevant in evaluating our results of operations, financial condition and liquidity and the potential impact of material known events or uncertainties that, based on management’s assessment, are reasonably likely to cause the financial information included in this Report not to be necessarily indicative of our future financial performance. Management monitors a variety of key indicators and metrics to evaluate our business performance. We discuss these key measures and factors influencing changes from period to period. Our MD&A is provided as a supplement to, and should be read in conjunction with, the unaudited consolidated financial statements included in this Report, our audited consolidated financial statements and related notes for the fiscal year ended May 31, 2022 (“fiscal year 2022”) included in our 2022 Form 10-K and additional information, including the risk factors discussed under “Item 1A. Risk Factors,” contained in our 2022 Form 10-K, as well as additional information contained elsewhere in this Report.


SUMMARY OF SELECTED FINANCIAL DATA

In addition to financial measures determined in conformity with generally accepted accounting principles in the United States (“U.S. GAAP”), management also evaluates performance based on certain non-GAAP measures and metrics, which we refer to as “adjusted” 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 (“TIER”) and adjusted debt-to-equity ratio. The most comparable U.S. 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 expense amounts; (ii) adjusting net income, total liabilities and total equity to exclude the non-cash impact of the accounting for derivative financial instruments; (iii) adjusting total liabilities 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 should not be considered in isolation or as a substitute for measures determined in conformity with U.S. GAAP, provide meaningful information and are useful to investors because management evaluates performance based on these metrics for purposes of (i) establishing short- and long-term performance goals; (ii) budgeting and forecasting; (iii) comparing period-to-period operating results, analyzing changes in results and identifying potential trends; and (iv) making compensation decisions. In addition, certain of the financial covenants in our committed bank revolving line of credit agreements and debt indentures are based on non-GAAP adjusted measures, as the forward fair value gains and losses related to our interest rate swaps that are excluded from our non-GAAP measures do not affect our cash flows, liquidity or ability to service our debt. Our non-GAAP adjusted measures may not be comparable to similarly titled measures reported by other companies due to differences in the way that these measures are calculated.

We provide a reconciliation of our non-GAAP adjusted measures to the most directly comparable U.S. GAAP measures in the section “Non-GAAP Financial Measures.”

Table 1 provides a summary of selected financial data and key metrics used by management in evaluating performance for the three and six months ended November 30, 2022 and 2021, and as of November 30, 2022 and May 31, 2022.

Table 1: Summary of Selected Financial Data(1)


	Three Months Ended						Six Months Ended
	November 30,						November 30,
(Dollars in thousands)	2022		2021		Change		2022		2021		Change
Statement of operations
Net interest income:
Interest income	$	324,194	$	283,152	14	%	$	631,172	$	566,420	11	%
Interest expense	(245,444)		(173,596)		41		(454,912)		(348,373)		31
Net interest income	78,750		109,556		(28)			176,260		218,047	(19)
Fee and other income	4,166		4,831		(14)		8,222		8,772		(6)
Total revenue	82,916		114,387		(28)			184,482		226,819	(19)
Benefit (provision) for credit losses	(11,628)		3,400		**		(15,124)		(603)		2,408
Derivative gains (losses):
Derivative cash settlements interest income (expense)(2)	4,801		(25,952)		**		(5,984)		(53,515)		(89)
Derivative forward value gains (losses)(3)	141,989		72,038		97		246,361		(72,562)		**
Derivative gains (losses)	146,790		46,086		219			240,377	(126,077)		**
Other non-interest income	(493)		(4,344)		(89)		(4,172)		(6,569)		(36)
Operating expenses(4)	(27,247)		(23,095)		18		(52,766)		(47,305)		12
Other non-interest expense	(355)		(431)		(18)		(677)		(687)		(1)
Income before income taxes	189,983		136,003		40		352,120		45,578		673
Income tax provision	(219)		(274)		(20)		(482)		(181)		166
Net income	$	189,764	$	135,729	40		$	351,638	$	45,397	675

Adjusted statement of operations measures
Interest income	$	324,194	$	283,152	14	%	$	631,172	$	566,420	11	%
Interest expense	(245,444)		(173,596)		41		(454,912)		(348,373)		31
Include: Derivative cash settlements interest income (expense)(2)	4,801		(25,952)		**		(5,984)		(53,515)		(89)
Adjusted interest expense(5)	(240,643)		(199,548)		21		(460,896)		(401,888)		15
Adjusted net interest income(5)	$	83,551	$	83,604	—		$	170,276	$	164,532	3

Net income	$	189,764	$	135,729	40		$	351,638	$	45,397	675
Exclude: Derivative forward value gains (losses)(3)	141,989		72,038		97		246,361		(72,562)		**
Adjusted net income(5)	$	47,775	$	63,691	(25)		$	105,277	$	117,959	(11)


Profitability ratios
Times interest earned ratio (“TIER”)(6)	1.77		1.78		(1)	%	1.77		1.13		57	%
Adjusted TIER(5)	1.20		1.32		(9)		1.23		1.29		(5)
Net interest yield(7)	0.99	%	1.49	%	(50)	bps	1.12	%	1.48	%	(36)	bps
Adjusted net interest yield(5)(8)	1.05		1.13		(8)		1.08		1.11		(3)

Credit quality ratios
Net charge-off rate(9)	0.19		—		19		0.10		—		10


(Dollars in thousands)	November 30, 2022		May 31, 2022		Change
Balance sheet
Assets:
Cash, cash equivalents and restricted cash	$	281,648	$	161,114	75	%
Investment securities	607,728		599,904		1
Loans to members(10)	31,577,351		30,063,386		5
Allowance for credit losses	(67,615)		(67,560)		—
Loans to members, net	31,509,736		29,995,826		5
Total assets	33,188,370		31,251,382		6
Liabilities and equity:
Short-term borrowings	5,594,212		4,981,167		12
Long-term debt	22,537,424		21,545,440		5
Subordinated deferrable debt	986,624		986,518		—
Members’ subordinated certificates	1,238,552		1,234,161		—
Total debt outstanding	30,356,812		28,747,286		6
Total liabilities	30,754,658		29,109,413		6
Total equity	2,433,712		2,141,969		14

Adjusted balance sheet measures
Adjusted total liabilities(5)	$	28,269,133	$	26,629,324	6	%
Adjusted total equity(5)	4,320,533		4,270,476		1
Members’ equity(5)	2,067,373		2,019,952		2

Debt ratios
Debt-to-equity ratio(11)	12.64		13.59		(7)	%
Adjusted debt-to-equity ratio(5)	6.54		6.24		5
Liquidity coverage ratio(12)	0.95		0.99		(4)


Credit quality ratios
Nonperforming loans ratio(13)	0.64	%	0.76	%	(12)	bps
Criticized loans ratio(14)	1.48		1.65		(17)
Allowance coverage ratio(15)	0.21		0.22		(1)

____________________________

**Calculation of percentage change is not meaningful.

(1)Certain reclassifications may have been made for prior periods to conform to the current-period presentation.

(2)Consists of net periodic contractual interest amounts on our interest rate swaps, which we refer to as derivatives cash settlements interest expense.

(3)Consists of derivative forward value gains (losses), which represent changes in fair value during the period, excluding net periodic contractual interest settlement amounts, attributable to derivatives not designated for hedge accounting.

(4)Consists of the total non-interest expense components (i) salaries and employee benefits and (ii) other general and administrative expenses, each of which is presented separately on the consolidated statements of operations.

(5)See “Item 7. MD&A—Non-GAAP Financial Measures” in our 2022 Form 10-K for a description of each of our non-GAAP measures. See the section “Non-GAAP Financial Measures” for a reconciliation of the non-GAAP measures presented in this Report to the most comparable U.S. GAAP measure.

(6)Calculated based on net income (loss) plus interest expense for the period divided by interest expense for the period.

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

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

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

(10)Consists of the unpaid principal balance of member loans plus unamortized deferred loan origination costs of $13 million and $12 million as of November 30, 2022 and May 31, 2022, respectively.

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

(12)Calculated based on available liquidity at period end, divided by the amount of maturing debt obligations over the next 12 months at period end, as of each respective date.

(13)Calculated based on total nonperforming loans at period end divided by total loans outstanding at period end.

(14)Calculated based on loans outstanding at period end to borrowers with a risk rating that falls within the criticized risk rating category, which consists of special mention, substandard and doubtful, divided by total loans outstanding at period end.

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


EXECUTIVE SUMMARY

As a member-owned, nonprofit finance cooperative, our primary objective is to provide our rural electric utility members with access to affordable, flexible financing products while also maintaining a sound, stable financial position and adequate liquidity to meet our financial obligations and maintain ongoing investment-grade credit ratings. Because maximizing profit is not our primary objective, the interest rates on lending products offered to our member borrowers reflect our funding costs plus a spread to cover operating expenses and estimated credit losses and generate sufficient earnings to cover interest owed on our debt obligations and achieve certain financial target goals. Our financial goals focus on earning an annual minimum adjusted TIER of 1.10 and maintaining an adjusted debt-to-equity ratio at approximately 6.00-to-1 or below.

We are subject to period-to-period volatility in our reported U.S. GAAP results due to changes in market conditions and differences in the way our financial assets and liabilities are accounted for under U.S. 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 U.S. GAAP to carry derivatives at fair value on our consolidated balance sheets; 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 swap 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, the majority of which are longer dated, than receive-fixed swaps, the majority of which are shorter dated, 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. Therefore, as discussed above under “Summary of Selected Financial Data,” management uses our non-GAAP adjusted measures to evaluate financial performance. Our adjusted financial results include the realized net periodic contractual interest expense amounts on our interest rate swaps but exclude the unrealized forward fair value gains and losses.

Financial Performance

Reported Results

We reported net income of $190 million and TIER of 1.77 for the three months ended November 30, 2022 (“current quarter”), compared with net income of $136 million and TIER of 1.78 for the three months ended November 30, 2021 (“same prior-year quarter”). We reported net income of $352 million and TIER of 1.77 for the six months ended November 30, 2022 (“current year-to-date period”), compared with net income of $45 million and TIER of 1.13 for the six months ended November 30, 2021 (“same prior year-to-date period”). The significant variances between our reported results for the current quarter and year-to-date period and the same prior-year quarter and year-to-date period are attributable to mark-to-market changes in the fair value of our derivative instruments. Our debt-to-equity ratio decreased to 12.64 as of November 30, 2022, from 13.59 as of May 31, 2022, primarily due to an increase in equity resulting from our reported net income of $352 million for the current year-to-date period, which was partially offset by a decrease in equity attributable to the CFC Board of Directors’ authorized patronage capital retirement in July 2022 of $59 million.

Current Quarter Reported Results

The increase in our reported net income of $54 million to $190 million for the current quarter from $136 million for the same prior-year quarter was driven by an increase in derivative gains of $101 million, partially offset by a decrease in net interest income of $31 million and an unfavorable shift in the provision for credit losses of $15 million. We recorded derivative gains of $147 million for the current quarter, attributable to increases in interest rates across the entire swap curve. In comparison, we recorded derivative gains of $46 million for the same prior-year quarter, primarily attributable to increases in medium- and longer-term swap interest rates. As noted above, the substantial majority of our swap portfolio consists of longer-dated, pay-fixed swaps. Therefore, increases and decreases in medium- and longer-term swap rates generally have a more pronounced corresponding impact on the change in the net fair value of our swap portfolio.

The decrease in net interest income of $31 million, or 28%, to $79 million for the current quarter was attributable to a decrease in the net interest yield of 50 basis points, or 34%, to 0.99%, partially offset by an increase in average interest-earning assets of $2,207 million, or 7%. The decrease in the net interest yield reflected the combined impact of an increase in our average cost of borrowings of 79 basis points to 3.31%, partially offset by an increase in the average yield on our interest-earning assets of 25 basis points to 4.09% and an increase in the benefit from non-interest bearing funding of 4 basis points to 0.21%. The increase in our average cost of borrowings and average yield on interest-earning assets were

driven by the continued increase in the federal funds rate. The increase in average interest-earning assets was primarily driven by growth in average total loans.

We recorded a provision for credit losses of $12 million for the current quarter. In contrast, we recorded a benefit for credit

losses of $3 million for the same prior-year quarter. The current quarter provision for credit losses stemmed primarily from an increase in the asset-specific allowance for a nonperforming CFC power supply loan, attributable to a decrease in the expected payments on this loan. The benefit for credit losses recorded in the same prior-year quarter stemmed from the elimination of an asset-specific allowance of $3 million attributable to nonperforming loans to two RTFC borrowers totaling $9 million as a result of our receipt of full payment of all amounts due on these loans during the period.

Other factors affecting the variance between our reported results for the current quarter and the same prior-year quarter include the unfavorable impact of an increase in operating expenses of $4 million, attributable to higher expenses recorded for salaries, business travel and in-person corporate meetings and events, offset by a decrease in losses recorded on our investment securities of $4 million, primarily due to period-to-period market fluctuations in fair value.

Year-to-Date Reported Results

The increase in our reported net income of $307 million to $352 million for the current year-to-date period from $45 million for the same prior year-to-date period was driven by a favorable shift in the change in the fair value of our derivatives of $366 million, partially offset by a decrease in net interest income of $42 million and an increase in the provision for credit losses of $15 million. We recorded derivative gains of $240 million for the current year-to-date period, attributable to increases in interest rates across the entire swap curve. In comparison, we recorded derivative losses of $126 million for the same prior year-to-date period, attributable to a decrease in the net fair value of our swap portfolio resulting from decreases of longer-term swap interest rates during the period.

The decrease in net interest income of $42 million, or 19%, to $176 million for the current year-to-date period was attributable to a decrease in the net interest yield of 36 basis points, or 24%, to 1.12%, partially offset by an increase in average interest-earning assets of $2,024 million, or 7%. The decrease in the net interest yield reflected the combined impact of an increase in our average cost of borrowings of 56 basis points to 3.08%, partially offset by an increase in the average yield on our interest-earning assets of 16 basis points to 4.00% and an increase in the benefit from non-interest bearing funding of 4 basis points to 0.20%. The increase in average interest-earning assets was primarily driven by growth in average total loans.

As mentioned above under “Current Quarter Reported Results,” the increases in the average cost of borrowings and average yield on interest-earning assets were driven by the continued increase in the federal funds rate. Specifically, we experienced an increase in our short-term and variable-rate borrowings and line of credit and variable-rate loans attributable to an overall increase in the federal funds rate of 375 basis points since November 30, 2021. On March 16, 2022, the Federal Open Market Committee (“FOMC”) of the Federal Reserve raised the target range for the federal funds rate by 0.25% to a range of 0.25% to 0.50%, the first rate increase since December 2018. The FOMC further raised the target range for the federal funds rate at each of its subsequent meetings held through November 2022, with the federal funds rate reaching a target range of 3.75% to 4.00% as of November 30, 2022.

We recorded a provision for credit losses of $15 million for the current year-to-date period, compared with a provision for credit losses of less than $1 million for the same prior year-to-date period. The current year-to-date period provision stemmed primarily from an increase in the asset-specific allowance for a nonperforming CFC power supply loan, attributable to a decrease in the expected payments on this loan. The provision for credit losses for the same prior year-to-date period reflected the offsetting impact of an increase in the collective allowance of $4 million and a decrease in the asset-specific allowance of $3 million, discussed further below under “Consolidated Results of Operations.”

Other factors affecting the variance between our reported results for the current year-to-date period and the same prior year-to-date period include the unfavorable impact of an increase in operating expenses of $5 million, attributable to higher expenses recorded for salaries, business travel and in-person corporate meetings and events, partially offset by a decrease in losses recorded on our investment securities of $2 million, primarily due to period-to-period market fluctuations in fair value.

Non-GAAP Adjusted Results

Adjusted net income totaled $48 million and adjusted TIER was 1.20 for the current quarter, compared with adjusted net income of $64 million and adjusted TIER of 1.32 for the same prior-year quarter. Adjusted net income totaled $105 million and adjusted TIER was 1.23 for the current year-to-date period, compared with adjusted net income of $118 million and adjusted TIER of 1.29 for the same prior year-to-date period. The adjusted TIER for the current periods and the same prior-year periods was well above our target of 1.10. While our goal is to maintain an adjusted debt-to-equity ratio of approximately 6.00-to-1, the adjusted debt-to-equity ratio increased to 6.54 as of November 30, 2022 from 6.24 as of May 31, 2022, and was above our targeted goal, largely due to an increase in adjusted liabilities resulting from additional borrowings to fund growth in our loan portfolio and the CFC Board of Directors’ authorized patronage capital retirement in July 2022 of $59 million, partially offset by our current year-to-date period adjusted net income.

Current Quarter Adjusted Results

The decrease in adjusted net income of $16 million to $48 million for the current quarter, from $64 million for the same prior-year quarter was due primarily to an unfavorable shift in the provision for credit losses of $15 million and an increase in operating expenses of $4 million, partially offset by a decrease in losses recorded on our investment securities of $4 million, as discussed above under “Current Quarter Reported Results.”

Adjusted net interest income was $84 million for both the current quarter and the same prior-year quarter, as the increase in average interest-earning assets of $2,207 million, or 7%, primarily due to growth in average total loans, was offset by the decrease in the adjusted net interest yield of 8 basis points, or 7%, to 1.05%. The decrease in the adjusted net interest yield reflected the combined impact of an increase in our adjusted average cost of borrowings of 36 basis points to 3.25%, partially offset by an increase in the average yield on interest-earning assets of 25 basis points to 4.09% and an increase in the benefit from non-interest bearing funding of 3 basis points to 0.21%, driven by the continued increase in the federal funds rate, as discussed above.

Year-to-Date Adjusted Results

The decrease in adjusted net income of $13 million to $105 million for the current year-to-date period, from $118 million for the same prior year-to-date period was due primarily to an increase in the provision for credit losses of $15 million and an increase in operating expenses of $5 million, partially offset by an increase in adjusted net interest income of $6 million and a decrease in losses recorded on our investment securities of $2 million. See above under “Year-to-Date Reported Results” for a discussion on the drivers of the current year-to-date period increase in the provision for credit losses and operating expenses, and decrease in the losses recorded on our investment securities.

The increase in adjusted net interest income of $6 million, or 3%, to $170 million, was attributable primarily to an increase in average interest-earning assets of $2,024 million, or 7%, due to growth in average total loans, partially offset by the decrease in the adjusted net interest yield of 3 basis points, or 3%, to 1.08%. The decrease in the adjusted net interest yield reflected the combined impact of an increase in our adjusted average cost of borrowings of 21 basis points to 3.12%, partially offset by an increase in the average yield on interest-earning assets of 16 basis points to 4.00% and an increase in the benefit from non-interest bearing funding of 2 basis points to 0.20%, driven by the continued increase in the federal funds rate, as discussed above.

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

Lending Activity

Loans to members totaled $31,577 million as of November 30, 2022, an increase of $1,514 million, or 5%, from May 31, 2022, reflecting net increases in long-term and line of credit loans of $825 million and $688 million, respectively. The $688 million increase in line of credit loans was largely attributable to funding provided for higher operating costs that our members experienced and broadband bridge loan financing. We experienced increases in CFC distribution loans, CFC power supply loans, NCSC loans and RTFC loans of $1,012 million, $292 million, $201 million and $9 million, respectively, partially offset by a decrease in CFC statewide and associate loans of $1 million.

Long-term loan advances totaled $1,651 million during the current year-to-date period, of which approximately 95% was provided to members for capital expenditures and approximately 2% was provided for the refinancing of loans made by other lenders. In comparison, long-term loan advances totaled $1,506 million during the same prior year-to-date period, of which approximately 69% was provided to members for capital expenditures and approximately 29% was provided to members for other expenses, primarily to fund operating expenses attributable to the elevated power cost obligations incurred during the February 2021 polar vortex. Of the $1,651 million total long-term loans advanced during the current year-to-date period, $1,478 million were fixed-rate loan advances with a weighted average fixed-rate term of 18 years.

Of the total long-term loans advanced for capital expenditures during the current year-to-date period, approximately $397 million was to provide funding for CFC electric distribution cooperative members’ infrastructure investments in broadband projects. Our aggregate loans outstanding to CFC electric distribution cooperative members relating to broadband projects, which we started tracking in October 2017, increased to an estimated $2,000 million as of November 30, 2022, from approximately $1,647 million as of May 31, 2022.

Credit Quality

We believe the overall credit quality of our loan portfolio remained strong as of November 30, 2022. Historically, we have had limited defaults and losses on loans in our electric utility loan portfolio largely because of the essential nature of the service provided by electric utility cooperatives as well as other factors, such as limited rate regulation and competition, which we discuss further in the section “Credit Risk—Loan Portfolio Credit Risk.” In addition, we generally lend to members on a senior secured basis, which reduces the risk of loss in the event of a borrower default. Loans outstanding to electric utility organizations of $31,088 million and $29,584 million as of November 30, 2022 and May 31, 2022, respectively, represented approximately 98% of total loans outstanding as of each respective date. Of our total loans outstanding, 92% and 93% were secured as of November 30, 2022 and May 31, 2022, respectively.

We had loans to the same three CFC electric power supply borrowers totaling $203 million and $228 million classified as nonperforming as of November 30, 2022 and May 31, 2022, respectively. Nonperforming loans represented 0.64% and 0.76% of total loans outstanding as of November 30, 2022 and May 31, 2022, respectively. The reduction in nonperforming loans of $25 million during the current quarter was due to the partial charge-offs related to the nonperforming loans to Brazos Electric Power Cooperative, Inc. (“Brazos”) and its wholly-owned subsidiary Brazos Sandy Creek Electric Cooperative Inc. (“Brazos Sandy Creek,”) and the receipt of loan principal payments on the remaining outstanding nonperforming loan to a CFC electric power supply borrower. Loans to Brazos and Brazos Sandy Creek accounted for $99 million and $114 million of our total nonperforming loans as of November 30, 2022 and May 31, 2022, respectively. The nonperforming loans to these two borrowers were attributable to the borrowers’ respective bankruptcy filings as a result of the impact of elevated wholesale electric power costs in Texas during the February 2021 polar vortex.

We experienced charge-offs totaling $15 million for the CFC electric power supply loan portfolio related to Brazos and Brazos Sandy Creek nonperforming loans during the three and six months ended November 30, 2022, which resulted in an annualized net charge-off rate of 0.19% and 0.10% for the three and six months ended November 30, 2022, respectively. In comparison we had no loan charge-offs during the same prior-year periods. Prior to Brazos’ and Brazos Sandy Creek’s bankruptcy filings, we had not experienced any defaults or charge-offs in our electric utility and telecommunications loan portfolios since fiscal year 2013 and 2017, respectively.

In December 2022, we received a total of $56 million in payments from Brazos in accordance with the provisions of the plan of reorganization, including the full amount of the secured portion of the loan. These payments reduced our loans outstanding to Brazos to $22 million as of December 31, 2022, the entirety of which is unsecured, that we expect to receive

over the next six to 12 months. See section “Credit Risk—Credit Quality Indicators—Nonperforming Loans” below for additional information on Brazos and Brazos Sandy Creek.

Our allowance for credit losses was $68 million as of both November 30, 2022 and May 31, 2022, while the allowance coverage ratio decreased slightly to 0.21% as of November 30, 2022 from 0.22% as of May 31, 2022. The allowance for credit losses reflected an increase in the collective allowance of $2 million, primarily due to loan portfolio growth, offset by a decrease in the asset-specific allowance of $2 million.

We provide additional information on the credit quality of our loan portfolio and the allowance for credit losses in the sections “Critical Accounting Estimates,” “Credit Risk—Credit Quality Indicators” and “Credit Risk—Allowance for Credit Losses,” and in “Note 4—Loans” and “Note 5—Allowance for Credit Losses” of this Report.

Financing Activity

We issue debt primarily to fund growth in our loan portfolio. As such, our debt outstanding generally increases and decreases in response to member loan demand. Total debt outstanding increased $1,610 million, or 6%, to $30,357 million as of November 30, 2022, due to borrowings to fund the increase in loans to members. Outstanding dealer commercial paper of $1,351 million as of November 30, 2022 was within our quarter-end target range. We provide additional information on our financing activities under the “Consolidated Balance Sheet Analysis—Debt” section of this Report.

On September 7, 2022, Fitch affirmed CFC’s credit ratings and stable outlook. On December 7, 2022, S&P affirmed CFC’s credit ratings and stable outlook. Table 25 presents our credit ratings for each CFC debt product type as of November 30, 2022, which remain unchanged as of the date of this Report, in the “Liquidity Risk—Credit Ratings” section of this Report.

Liquidity

In addition to cash on hand, our primary sources of funds include member loan principal repayments, securities held in our investment portfolio, committed bank revolving lines of credit, committed loan facilities under the USDA Guaranteed Underwriter Program (“Guaranteed Underwriter Program”), revolving note purchase agreements with the Federal Agricultural Mortgage Corporation (“Farmer Mac”) and proceeds from debt issuances to our members and in the public capital markets. Although as a non-bank financial institution we are not subject to regulatory liquidity requirements, we monitor our liquidity and funding positions on an ongoing basis and assess our ability to meet our scheduled debt obligations and other cash flow requirements based on point-in-time metrics as well as forward-looking projections. Our liquidity and funding assessment takes into consideration amounts available under existing liquidity sources, the expected rollover of member short-term investments and scheduled loan principal repayment amounts, as well as our continued ability to access the private placement and public capital markets.

As of November 30, 2022, our available liquidity totaled $7,164 million, consisting of: (i) cash and cash equivalents of $272 million; (ii) investments in debt securities with an aggregate fair value of $567 million, which is subject to change based on market fluctuations; (iii) up to $2,597 million available under committed bank revolving line of credit agreements; (iv) up to $775 million available under committed loan facilities under the Guaranteed Underwriter Program; and (v) up to $2,953 million available under a Farmer Mac revolving note purchase agreement, subject to market conditions. In addition to our existing available liquidity of $7,164 million as of November 30, 2022, we expect to receive $1,491 million from scheduled long-term loan principal payments over the next 12 months.

Debt scheduled to mature over the next 12 months totaled $7,538 million as of November 30, 2022, consisting of short-term borrowings of $5,594 million and long-term and subordinated debt of $1,944 million. The short-term borrowings scheduled maturity amount of $5,594 million consists of member investments of $3,853 million, dealer commercial paper of $1,351 million and borrowings under a securities repurchase transaction of $390 million. The long-term and subordinated scheduled debt obligations over the next 12 months of $1,944 million consist of debt maturities and scheduled debt payment amounts.

Our available liquidity of $7,164 million as of November 30, 2022 was $374 million below our total scheduled debt obligations over the next 12 months of $7,538 million. We believe we can continue to roll over our member short-term investments of $3,853 million as of November 30, 2022, based on our expectation that our members will continue to

reinvest their excess cash in short-term investment products offered by CFC. Our members historically have maintained a relatively stable level of short-term investments in CFC in the form of commercial paper, select notes, daily liquidity fund notes and medium-term notes. Member short-term investments in CFC have averaged $3,672 million over the last 12 fiscal quarter-end reporting periods. In addition, we expect to receive $1,491 million from scheduled long-term loan principal payments over the next 12 months. Our available liquidity of $7,164 million as of November 30, 2022 was $3,479 million in excess of, or 1.9 times, our total scheduled debt obligations, excluding member short-term investments, over the next 12 months of $3,685 million.

We expect to continue accessing the dealer commercial paper market as a cost-effective means of satisfying our incremental short-term liquidity needs. Although the intra-period amount of dealer commercial paper outstanding may fluctuate based on our liquidity requirements, our intent is to manage our short-term wholesale funding risk by maintaining dealer commercial paper outstanding at each quarter-end within a range of $1,000 million and $1,500 million. Maintaining our committed bank revolving line of credit agreements and continuing to be in compliance with the covenants of these agreements serve to mitigate our rollover risk, as we can draw on these facilities, if necessary, to repay dealer or member commercial paper that cannot be refinanced with similar debt. In addition, under master repurchase agreements we have with counterparties, we can obtain short-term funding in secured borrowing transactions by selling investment-grade corporate debt securities from our investment securities portfolio subject to an obligation to repurchase the same or similar securities at an agreed-upon price and date.

The issuance of long-term debt, which represents the most significant component of our funding, allows us to reduce our reliance on short-term borrowings, as well as effectively manage our refinancing and interest rate risk. We expect to continue to issue debt in the private placement and public capital markets to meet our funding needs and believe that we have sufficient sources of liquidity to meet our debt obligations and support our operations over the next 12 months.

We provide additional information on our liquidity profile and our primary sources and uses of funds, including projected amounts, by quarter, over each of the next six fiscal quarters through the quarter ending May 31, 2024, in the “Liquidity Risk” section of this Report.

COVID-19

We believe that the COVID-19 pandemic has not adversely affected our primary objective of providing our members with the credit products they need to fund their operations and that we have been able to successfully navigate the challenges of the COVID-19 pandemic to date. To date, we believe that the pandemic has not had a significant negative impact on the overall financial performance and credit quality of our members.

CFC has been able to maintain business continuity throughout the pandemic and has experienced no pandemic-related employee furloughs or layoffs. Although most health and safety restrictions in response to COVID-19 have been lifted, we cannot predict the potential future impact that the COVID-19 pandemic may have on our operations and financial performance, or the specific ways the pandemic may uniquely impact our members. We provide additional information on actions taken in response to the pandemic to protect the safety and health of our employees under “Item 1. Business—Human Capital Management” and “Item 7. MD&A—Executive Summary” in our 2022 Form 10-K. We discuss the potential adverse impact of natural disasters, including weather-related events such as the February 2021 polar vortex, and widespread health emergencies, such as COVID-19, on our business, results of operations, financial condition and liquidity under “Item 1A. Risk Factors—Operations and Business Risks” in our 2022 Form 10-K.

Electric Cooperative Industry Trends and Developments

We believe there are emerging developments and trends in the electric cooperative sector that continue to present opportunities as well as challenges for our electric cooperative members. These trends include: (i) expanded investments by many electric cooperatives to deploy broadband services to their members; (ii) inflation and supply chain disruptions; (iii) an increased focus on enhancing electric system resiliency and reliability; (iv) evolving relationships between certain electric cooperative power supply systems and electric cooperative distribution systems to increase investments in renewable power supply; and (v) growing support of beneficial electrification strategies to reduce overall carbon emissions, while also providing benefits to cooperative members. We provide additional information on these emerging developments and trends in the electric cooperative sector in “Item 7. MD&A—Executive Summary” in our 2022 Form 10-K.

On August 16, 2022, the U.S. Inflation Reduction Act (the “IRA”) was signed into law and it includes opportunities for electric cooperatives to fund clean energy projects such as solar, wind, stand-alone energy storage, carbon capture, and nuclear energy by allowing these entities to treat certain credits as direct payment rather than as a credit against their federal income tax liabilities. The IRA also provides nearly $10 billion in grants and loans specifically for electric cooperatives to invest in clean energy projects and related infrastructure.

Outlook

As further described below in the “Liquidity Risk—Projected Near-Term Sources and Uses of Funds” section, we currently anticipate net long-term loan growth of $1,254 million over the next 12 months. On December 15, 2022, the FOMC of the Federal Reserve raised the target range for the federal funds rate by 50 basis points, with the federal funds rate reaching a target range of 4.25% to 4.50%. The FOMC also signaled an expectation of ongoing increases in the federal funds rate and pointed to a consensus target rate of 5.10% by December 31, 2023, an increase from its September 2022 estimated target rate of 4.60%, stating its continued objective of returning the inflation rate to 2% over the longer-run. The yield curve has flattened throughout 2022, and has been inverted since June 2022, as shorter-term rates rose above longer-term rates, attributable to the increase in the target range for the federal funds rate by the FOMC. The consensus market outlook for interest rates as of December 2022 pointed to rising interest rates across the yield curve, with the yield curve remaining inverted until at least the third calendar quarter of 2024. Based on this yield curve forecast, we anticipate a decrease in our reported net interest income and reported net interest yield over the next 12 months relative to the prior 12-month period ended November 30, 2022. We also expect a modest decrease in our adjusted net interest income and adjusted net interest yield over the next 12 months relative to the prior 12-month period ended November 30, 2022, due to an anticipated significant reduction in our derivative net periodic cash settlements expense, which reduce our adjusted cost of borrowings.

We expect that our adjusted net income will remain flat over the next 12 months. However, we believe that our adjusted TIER will decrease slightly over the next 12 months, primarily attributable to our projected decrease in adjusted net interest yield based on our assumption that short-term interest rates will increase over the next 12 months. We believe that our adjusted debt-to-equity ratio will remain elevated above our target threshold of 6.00-to-1 due to a projected increase in total debt outstanding to fund anticipated growth in our loan portfolio. As discussed above, we are subject to earnings volatility, often significant, because we do not apply hedge accounting to our interest rate swaps. Therefore, the periodic unrealized fluctuations in the fair value of our interest rate swaps are recorded in our earnings. The variances in our earnings between periods are generally attributable to significant shifts in recorded unrealized derivative forward value gain and loss amounts. We exclude the impact of unrealized derivative forward fair value gains and losses from our non-GAAP adjusted measures.

We are unable to provide a reconciliation of our projected adjusted net income, adjusted TIER and adjusted debt-to-equity ratio to the most directly comparable GAAP measures or directional guidance for the most directly comparable GAAP measures on a forward-looking basis without unreasonable effort due to the significant shifts in the unrealized derivative forward value gains and losses recorded each period. The majority of our swaps are long-term, with an average remaining life of approximately 15 years as of November 30, 2022. We can reasonably estimate the realized net periodic derivative cash settlement amounts over the next 12 months for our interest rate swaps, which are typically based on the 3-month London Interbank Offered Rate (“LIBOR”) and the fixed rate of the swap. In contrast, the unrealized periodic derivative forward value gains and losses are largely based on future expected changes in longer-term interest rates, which we are unable to accurately predict for each reporting period over the next 12 months. Because unrealized periodic derivative forward value gain and loss amounts are a key driver of changes in our earnings between periods, this unavailable information is likely to have a significant impact on our reported net income, TIER and debt-to-equity ratio, which represent the most directly comparable GAAP measures. We provide reconciliations of our non-GAAP adjusted net income, adjusted TIER and adjusted debt-to-equity ratio to the most directly comparable GAAP measures for each reporting period included in this Report in the section “Non-GAAP Financial Measures.” These reconciliations illustrate the potential significant impact that unrealized derivative forward value gains and losses could have on our future reported net income, reported TIER and reported adjusted debt-to-equity ratio.


CRITICAL ACCOUNTING ESTIMATES

The preparation of financial statements in conformity with U.S. GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in our 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 in “Note 1—Summary of Significant Accounting Policies” in our 2022 Form 10-K.

Certain accounting estimates are considered 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. The determination of the allowance for expected credit losses over the remaining expected life of the loans in our loan portfolio involves a significant degree of management judgment and level of estimation uncertainty. As such, we have identified our accounting policy governing the estimation of the allowance for credit losses as a critical accounting estimate. We describe our allowance methodology and process for estimating the allowance for credit losses under “Note 1—Summary of Significant Accounting Policies—Allowance for Credit Losses–Loan Portfolio—Current Methodology” in our 2022 Form 10-K.

We identify the key inputs used in determining the allowance for credit losses, discuss the assumptions that require the most significant management judgment and contribute to the estimation uncertainty and disclose the sensitivity of our allowance to hypothetical changes in the assumptions underlying the calculation of our reported allowance for credit losses under “Item 7. MD&A—Critical Accounting Estimates” in our 2022 Form 10-K. Management established policies and control procedures intended to ensure that the methodology used for determining our allowance for credit losses, including any judgments and assumptions made as part of such method, are well-controlled and applied consistently from period to period. We regularly evaluate the key inputs and assumptions used in determining the allowance for credit losses and update them, as necessary, to better reflect present conditions, including current trends in credit performance and borrower risk profile, portfolio concentration risk, changes in risk-management practices, changes in the regulatory environment and other factors relevant to our loan portfolio segments. We did not change our allowance methodology or the nature of the underlying key inputs and assumptions used in measuring our allowance for credit losses during the current quarter.

Our allowance for credit losses was $68 million as of both November 30, 2022 and May 31, 2022, while the allowance coverage ratio decreased slightly to 0.21% as of November 30, 2022 from 0.22% as of May 31, 2022. The allowance for credit losses reflected an increase in the collective allowance of $2 million offset by a decrease in the asset-specific allowance of $2 million.

We discuss the risks and uncertainties related to management’s judgments and estimates in applying accounting policies that have been identified as a critical accounting estimates under “Item 1A. Risk Factors—Regulatory and Compliance Risks” in our 2022 Form 10-K. We provide additional information on the allowance for credit losses under the section “Credit Risk—Allowance for Credit Losses” and in “Note 5—Allowance for Credit Losses” of this Report.


RECENT ACCOUNTING CHANGES AND OTHER DEVELOPMENTS

Recent Accounting Changes

We provide information on recently adopted accounting standards and the adoption impact on CFC’s consolidated financial statements and recently issued accounting standards not yet required to be adopted and the expected adoption impact in “Note 1—Summary of Significant Accounting Policies.” To the extent we believe the adoption of new accounting standards has had or will have a material impact on our consolidated results of operations, financial condition or liquidity, we discuss the impact in the applicable section(s) of this MD&A.


CONSOLIDATED RESULTS OF OPERATIONS

This section provides a comparative discussion of our consolidated results of operations between the three months ended November 30, 2022 and November 30, 2021 and between the six months ended November 30, 2022 and November 30, 2021. Following this section, we provide a discussion and analysis of material changes between amounts reported on our consolidated balance sheet as of November 30, 2022 and amounts reported as of May 31, 2022. You should read these sections together with our “Executive Summary—Outlook” where we discuss trends and other factors that we expect will affect our future results of operations.

Net Interest Income

Net interest income, which is our largest source of revenue, represents the difference between the interest income earned on our interest-earning assets 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 of 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 six months ended November 30, 2022 and 2021, 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 expense in interest expense. We provide reconciliations of our non-GAAP adjusted measures to the most comparable U.S. GAAP measures under “Non-GAAP Financial Measures.”

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



	Three Months Ended November 30,
	2022					2021
(Dollars in thousands)	Average Balance		Interest Income/Expense		Average Yield/Cost	Average Balance		Interest Income/Expense		Average Yield/Cost
Assets:
Long-term fixed-rate loans(1)	$	27,405,209	$	280,590	4.11%	$	25,676,752	$	263,569	4.12%
Long-term variable-rate loans	823,877		9,446		4.60	782,452		4,334		2.22
Line of credit loans	2,516,283		29,001		4.62	2,124,507		11,640		2.20
Troubled debt restructuring (“TDR”) loans	8,560		177		8.29	9,533		182		7.66
Nonperforming loans	217,643		—		—	227,857		—		—
Other, net(2)	—		(377)		—	—		(357)		—
Total loans	30,971,572		318,837		4.13	28,821,101		279,368		3.89
Cash and investment securities	794,794		5,357		2.70	738,204		3,784		2.06
Total interest-earning assets	$	31,766,366	$	324,194	4.09%	$	29,559,305	$	283,152	3.84%
Other assets, less allowance for credit losses(3)	1,080,049					393,926
Total assets(3)	$	32,846,415				$	29,953,231

Liabilities:
Commercial paper	$	2,901,962	$	24,179	3.34%	$	2,274,073	$	1,809	0.32%
Other short-term borrowings	2,262,768		17,007		3.01	2,178,515		1,267		0.23
Short-term borrowings(4)	5,164,730		41,186		3.20	4,452,588		3,076		0.28
Medium-term notes	5,689,824		41,506		2.93	4,504,988		26,115		2.33
Collateral trust bonds	7,366,514		66,995		3.65	7,125,605		62,688		3.53
Guaranteed Underwriter Program notes payable	6,247,517		44,634		2.87	6,162,377		42,470		2.76
Farmer Mac notes payable	3,028,920		24,757		3.28	3,189,139		12,775		1.61
Other notes payable	4,748		29		2.45	8,253		48		2.33
Subordinated deferrable debt	986,590		12,887		5.24	986,382		12,890		5.24
Subordinated certificates	1,237,156		13,450		4.36	1,253,323		13,534		4.33
Total interest-bearing liabilities	$	29,725,999	$	245,444	3.31%	$	27,682,655	$	173,596	2.52%
Other liabilities(3)	794,873					950,203
Total liabilities(3)	30,520,872					28,632,858
Total equity(3)	2,325,543					1,320,373
Total liabilities and equity(3)	$	32,846,415				$	29,953,231
Net interest spread(5)					0.78%					1.32%
Impact of non-interest bearing funding(6)					0.21					0.17
Net interest income/net interest yield(7)			$	78,750	0.99%			$	109,556	1.49%

Adjusted net interest income/adjusted net interest yield:
Interest income			$	324,194	4.09%			$	283,152	3.84%
Interest expense			245,444		3.31			173,596		2.52
Add: Net periodic derivative cash settlements interest (income) expense(8)			(4,801)		(0.25)			25,952		1.22
Adjusted interest expense/adjusted average cost(9)			$	240,643	3.25%			$	199,548	2.89%
Adjusted net interest spread(7)					0.84					0.95
Impact of non-interest bearing funding(6)					0.21					0.18
Adjusted net interest income/adjusted net interest yield(10)			$	83,551	1.05%			$	83,604	1.13%


	Six Months Ended November 30,
	2022					2021
(Dollars in thousands)	Average Balance		Interest Income/Expense		Average Yield/Cost	Average Balance		Interest Income/Expense		Average Yield/Cost
Assets:
Long-term fixed-rate loans(1)	$	27,255,211	$	556,715	4.07%	$	25,561,046	$	526,654	4.11%
Long-term variable-rate loans	791,958		16,317		4.11	773,048		8,612		2.22
Line of credit loans	2,412,464		48,880		4.04	2,133,233		23,261		2.17
TDR loans..	8,848		355		8.00	9,730		374		7.67
Nonperforming loans	221,231		—		—	230,765		—		—
Other, net(2)	—		(750)		—	—		(714)		—
Total loans	30,689,712		621,517		4.04	28,707,822		558,187		3.88
Cash and investment securities	788,413		9,655		2.44	746,389		8,233		2.20
Total interest-earning assets	$	31,478,125	$	631,172	4.00%	$	29,454,211	$	566,420	3.84%
Other assets, less allowance for credit losses(3)	887,210					469,698
Total assets(3)	$	32,365,335				$	29,923,909

Liabilities:
Commercial paper	$	2,878,740	$	38,792	2.69%	$	2,399,544	$	3,957	0.33%
Other short-term borrowings	2,216,736		26,603		2.39	2,072,422		2,512		0.24
Short-term borrowings(4)	5,095,476		65,395		2.56	4,471,966		$	6,469	0.29
Medium-term notes	5,779,703		77,421		2.67	4,409,663		51,887		2.35
Collateral trust bonds	7,139,270		128,562		3.59	7,159,683		125,830		3.51
Guaranteed Underwriter Program notes payable	6,166,294		86,630		2.80	6,205,812		86,040		2.77
Farmer Mac notes payable	3,018,163		44,132		2.92	3,071,120		25,116		1.63
Other notes payable	4,732		57		2.40	8,247		96		2.32
Subordinated deferrable debt	986,563		25,775		5.21	986,357		25,772		5.21
Subordinated certificates	1,235,497		26,940		4.35	1,253,649		27,163		4.32
Total interest-bearing liabilities	$	29,425,698	$	454,912	3.08%	$	27,566,497	$	348,373	2.52%
Other liabilities(3)	688,239					1,021,369
Total liabilities(3)	30,113,937					28,587,866
Total equity(3)	2,251,398					1,336,043
Total liabilities and equity(3)	$	32,365,335				$	29,923,909
Net interest spread(5)					0.92%					1.32%
Impact of non-interest bearing funding(6)					0.20					0.16
Net interest income/net interest yield(7)			$	176,260	1.12%			$	218,047	1.48%

Adjusted net interest income/adjusted net interest yield:
Interest income			$	631,172	4.00%			$	566,420	3.84%
Interest expense			454,912		3.08			348,373		2.52
Add: Net periodic derivative cash settlements interest expense(8)			5,984		0.15			53,515		1.23
Adjusted interest expense/adjusted average cost(9)			$	460,896	3.12%			$	401,888	2.91%
Adjusted net interest spread(7)					0.88					0.93
Impact of non-interest bearing funding(6)					0.20					0.18
Adjusted net interest income/adjusted net interest yield(10)			$	170,276	1.08%			$	164,532	1.11%

___________________________

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

(3)The average balance represents average monthly balances, which is calculated based on the month-end balance as of the beginning of the reporting period and the balances as of the end of each month included in the specified reporting period.

(4)Short-term borrowings reported on our consolidated balance sheets consist of borrowings with an original contractual maturity of one year or less. However, short-term borrowings presented in Table 2 consist of commercial paper, select notes, daily liquidity fund notes and secured borrowings under repurchase agreements. Short-term borrowings presented on our consolidated balance sheets related to medium-term notes, Farmer Mac notes payable and other notes payable are reported in the respective category for presentation purposes in Table 2. The period-end amounts reported as short-term borrowings on our consolidated balances sheets, which are excluded from the calculation of average short-term borrowings presented in Table 2, totaled $398 million and $399 million as of November 30, 2022 and 2021, respectively.

(5)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.

(6)Includes other liabilities and equity.

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

(8)Represents the impact of net periodic contractual interest amounts on our interest rate swaps 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 the annualized net periodic swap settlement interest amount 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 $7,753 million and $8,566 million for the three months ended November 30, 2022 and 2021, respectively. The average outstanding notional amount of interest rate swaps was $7,864 million and $8,654 million for the six months ended November 30, 2022 and 2021, respectively.

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

(10)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 for each category of interest-earning assets and interest-bearing liabilities is attributable to: (i) changes in volume, which represents the change in the average balances of our interest-earning assets and interest-bearing liabilities or volume and (ii) changes in the rate, which represents the change in the average interest rates of these assets and liabilities. The table also presents the change in adjusted net interest income between periods.

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


	Three Months Ended November 30,						Six Months Ended November 30,
	2022 versus 2021						2022 versus 2021
	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	$	17,021	$	17,742	$	(721)	$	30,061	$	34,906	$	(4,845)
Long-term variable-rate loans	5,112		229		4,883		7,705		211		7,494
Line of credit loans	17,361		2,147		15,214		25,619		3,045		22,574
TDR loans	(5)		(19)		14		(19)		(34)		15

Other, net	(20)		—		(20)		(36)		—		(36)
Total loans	39,469		20,099		19,370		63,330		38,128		25,202
Cash and investment securities	1,573		290		1,283		1,422		464		958
Total interest income	41,042		20,389		20,653		64,752		38,592		26,160

Interest expense:
Commercial paper	22,370		499		21,871		34,835		790		34,045
Other short-term borrowings	15,740		49		15,691		24,091		175		23,916
Short-term borrowings	38,110		548		37,562		58,926		965		57,961
Medium-term notes	15,391		6,868		8,523		25,534		16,121		9,413
Collateral trust bonds	4,307		2,119		2,188		2,732		(359)		3,091
Guaranteed Underwriter Program notes payable	2,164		587		1,577		590		(548)		1,138
Farmer Mac notes payable	11,982		(642)		12,624		19,016		(433)		19,449
Other notes payable	(19)		(20)		1		(39)		(41)		2
Subordinated deferrable debt	(3)		3		(6)		3		5		(2)
Subordinated certificates	(84)		(175)		91		(223)		(393)		170
Total interest expense	71,848		9,288		62,560		106,539		15,317		91,222
Net interest income	$	(30,806)	$	11,101	$	(41,907)	$	(41,787)	$