Attached files

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EX-10.2 - EXHIBIT 10.2 CAH PURCHASE AGREEMENT - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201610-qexhibit102.htm
EX-32.2 - EXHIBIT 32.2 CFO SECTION 906 CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201610-qexhibit322.htm
EX-31.1 - EXHIBIT 31.1 CEO SECTION 302 CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201610-qexhibit311.htm
EX-12 - EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201610-qexhibit12.htm
EX-10.1 - EXHIBIT 10.1 FARMER MAC STANDBY PURCHASE AGREEMENT - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201610-qexhibit101.htm
EX-32.1 - EXHIBIT 32.1 CEO SECTION 906 CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201610-qexhibit321.htm
EX-31.2 - EXHIBIT 31.2 CFO SECTION 302 CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201610-qexhibit312.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________________
FORM 10-Q
__________________________

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 2015
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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x  No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer  ¨
Accelerated filer  ¨    Non-accelerated filer   x    Smaller reporting company ¨
(Do not check if a smaller reporting company)

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




ii



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

2
 
Average Balances, Interest Income/Interest Expense and Average Yield/Cost
 
8

3
 
Rate/Volume Analysis of Changes in Interest Income/Interest Expense
 
9

4
 
Derivative Gains (Losses)
 
11

5
 
Derivative Average Notional Balances and Average Interest Rates
 
12

6
 
Loans Outstanding by Type and Member Class
 
14

7
 
Historical Retention Rate and Repricing Selection
 
14

8
 
Total Debt Outstanding
 
15

9
 
Guarantees Outstanding
 
17

10
 
Maturities of Guarantee Obligations
 
18

11
 
Unadvanced Loan Commitments
 
18

12
 
Notional Maturities of Unconditional Committed Lines of Credit
 
19

13
 
Notional Maturities of Unadvanced Loan Commitments
 
19

14
 
Loan Portfolio Security Profile
 
20

15
 
Credit Exposure to 20 Largest Borrowers
 
21

16
 
Impaired Loans
 
23

17
 
Allowance for Loan Losses
 
24

18
 
Rating Triggers for Derivatives
 
25

19
 
Projected Sources and Uses of Liquidity
 
27

20
 
Revolving Credit Agreements
 
29

21
 
Member Investments
 
29

22
 
Financial Ratios under Revolving Credit Agreements
 
30

23
 
Financial Ratios under Indentures
 
31

24
 
Unencumbered Loans
 
31

25
 
Collateral Pledged or on Deposit
 
31

26
 
Principal Maturity of Long-term Debt
 
33

27
 
Interest Rate Gap Analysis
 
34

28
 
Adjusted Financial Measures — Income Statement
 
35

29
 
TIER and Adjusted TIER
 
36

30
 
Adjusted Financial Measures — Balance Sheet
 
36

31
 
Leverage and Debt-to-Equity Ratios
 
37


iii



PART I—FINANCIAL INFORMATION

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains certain statements that are considered “forward-looking statements” within the Securities Act of 1933, as amended, and the Exchange Act of 1934, as amended. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identified by our use of words such as “intend,” “plan,” “may,” “should,” “will,” “project,” “estimate,” “anticipate,” “believe,” “expect,” “continue,” “potential,” “opportunity” and similar expressions, whether in the negative or affirmative. All statements about future expectations or projections, including statements about loan volume, the appropriateness of the allowance for loan losses, operating income and expenses, 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, regulatory and economic conditions in the rural electric industry, non-performance of counterparties to our derivative agreements, the costs and effects of legal or governmental proceedings involving National Rural Utilities Cooperative Finance Corporation (“CFC”) or its members and the factors listed and described under “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended May 31, 2015 (“2015 Form 10-K). Except as required by law, we undertake no obligation to update or publicly release any revisions to forward-looking statements to reflect events, circumstances or changes in expectations after the date on which the statement is made.
INTRODUCTION

National Rural Utilities Cooperative Finance Corporation (“CFC”) is a member-owned cooperative association incorporated under the laws of the District of Columbia in April 1969. CFC’s principal purpose is to provide its members with financing to supplement the loan programs of the Rural Utilities Service (“RUS”) of the United States Department of Agriculture (“USDA”). CFC makes loans to its rural electric members so they can acquire, construct and operate electric distribution, generation, transmission and related facilities. CFC also provides its members with credit enhancements in the form of letters of credit and guarantees of debt obligations. As a cooperative, CFC is owned by and exclusively serves its membership, which consists of not-for-profit entities or subsidiaries or affiliates of not-for-profit entities. CFC is exempt from federal income taxes. As a member-owned cooperative, CFC’s objective is not to maximize profit, but rather to offer its members cost-based financial products and services consistent with sound financial management.

Our financial statements include the consolidated accounts of CFC, Rural Telephone Finance Cooperative (“RTFC”), National Cooperative Services Corporation (“NCSC”) and certain entities created and controlled by CFC to hold foreclosed assets. RTFC was established to provide private financing for the rural telecommunications industry. NCSC was established to provide financing to members of CFC and the for-profit and nonprofit entities that are owned, operated or controlled by, or provide significant benefits to certain members of CFC. CFC controlled and held foreclosed assets in two entities, Caribbean Asset Holdings, LLC (“CAH”) and Denton Realty Partners, LP (“DRP”), during fiscal year 2015. DRP was dissolved during the fourth quarter of fiscal year 2015, subsequent to the sale of the remainder of its assets. CAH, which is the only entity in which we currently hold foreclosed assets, is a holding company for various U.S. Virgin Islands, British Virgin Islands and St. Maarten-based telecommunications operating entities that were transferred to CAH as a result of a loan default by a borrower and subsequent bankruptcy proceedings. These operating entities provide local, long-distance and wireless telephone, cable television and Internet services to residential and commercial customers. See “Item 1. Business—Overview” of our 2015 Form 10-K for additional information on the business activities of each of these entities. Unless stated otherwise, references to “we,” “our” or “us” relate to CFC and its consolidated entities. All references to members within this document include members, associates and affiliates of CFC and its consolidated entities.

1



Management monitors a variety of key indicators to evaluate our business performance. The following MD&A is intended to provide the reader with an understanding of our results of operations, financial condition and liquidity by discussing the drivers of changes from period to period and the key measures used by management to evaluate performance, such as leverage ratios, growth and credit quality metrics. MD&A is provided as a supplement to, and should be read in conjunction with our unaudited condensed consolidated financial statements and related notes in this Report, the more detailed information contained in 2015 Form 10-K, including the risk factors discussed under “Part I—Item 1A. Risk Factors” in our 2015 Form 10-K, and the risk factors under “Part II—Item 1A. Risk Factors” in this Report.
SUMMARY OF SELECTED FINANCIAL DATA

Table 1 provides a summary of selected financial data for the three months ended August 31, 2015 and 2014, and as of August 31, 2015 and May 31, 2015. 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, which we refer to as “adjusted” measures. Our key non-GAAP metrics consist of adjusted times interest earned ratio (“TIER”) and adjusted debt-to-equity ratio. The most comparable GAAP measures are 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 the RUS, subordinated deferrable debt and members’ subordinated certificates; and (iv) adjusting total equity to include subordinated deferrable debt and members’ subordinated certificates. See “Non-GAAP Financial Measures” for a detailed reconciliation of these adjusted measures to the most comparable GAAP measures. We believe our adjusted non-GAAP metrics, which are not a substitute for GAAP and may not be consistent with similarly titled non-GAAP measures used by other companies, provide meaningful information and are useful to investors because the financial covenants in our revolving credit agreements and debt indentures are based on these adjusted metrics.



2



Table 1: Summary of Selected Financial Data(1) 
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2015
 
2014
 
Change
Statement of operations
 
 
 
 
 
 
Interest income
 
$
246,116

 
$
237,291

 
4 %

Interest expense
 
(165,700
)
 
(156,552
)
 
6
Net interest income
 
80,416

 
80,739

 
Provision for loan losses
 
(4,562
)
 
6,771

 
(167)
Fee and other income
 
4,701

 
4,357

 
8
Derivative losses(2)
 
(12,017
)
 
(49,878
)
 
(76)
Results of operations of foreclosed assets(3)
 
(1,921
)
 
(2,699
)
 
(29)
Operating expenses(4) 
 
(22,835
)
 
(18,543
)
 
23
Other non-interest expense
 
(357
)
 
61

 
(685)
Income before income taxes
 
43,425

 
20,808

 
109
Income tax expense
 
(330
)
 
(196
)
 
68
Net income
 
$
43,095

 
$
20,612

 
109 %

 
 
 
 
 
 
 
Adjusted statement of operations
 
 
 
 
 
 
Adjusted interest expense(5)
 
$
(185,856
)
 
$
(176,653
)
 
5 %

Adjusted net interest income(5)
 
60,260

 
60,638

 
(1)
Adjusted net income(5)
 
34,956

 
50,389

 
(31)
 
 
 
 
 
 
 
Ratios
 
 
 
 
 
 
Fixed-charge coverage ratio/TIER (6)
 
1.26

 
1.13

 
13
 bps
Adjusted TIER(5)
 
1.19

 
1.29

 
(10)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
August 31, 2015
 
May 31, 2015
 
Change
Balance sheet
 
 
 
 
 
 
Cash, investments and time deposits
 
$
835,115

 
$
818,308

 
2%
Loans to members(7)
 
22,094,387

 
21,469,017

 
3
Allowance for loan losses
 
(38,307
)
 
(33,690
)
 
14
Loans to members, net
 
22,056,080

 
21,435,327

 
3
Total assets
 
23,459,800

 
22,846,059

 
3
Short-term borrowings
 
3,208,704

 
3,127,754

 
3
Long-term debt
 
16,710,748

 
16,244,794

 
3
Subordinated deferrable debt
 
395,717

 
395,699

 
Members’ subordinated certificates
 
1,485,933

 
1,505,420

 
(1)
Total debt outstanding(8)
 
21,801,102

 
21,273,667

 
2
Total liabilities
 
22,544,635

 
21,934,273

 
3
Total equity
 
915,165

 
911,786

 
Guarantees (9)
 
972,486

 
986,500

 
(1)
 
 
 
 
 
 
 
Ratios
 
 
 
 
 

Leverage ratio(10)
 
25.70

 
25.14

 
56
 bps
Adjusted leverage ratio(5)
 
6.83

 
6.58

 
25
Debt-to-equity ratio(11)
 
24.63

 
24.06

 
57
Adjusted debt-to-equity ratio(5)
 
6.52

 
6.26

 
26
____________________________ 
— Change is less than one percent or not meaningful.
(1)In the first quarter of fiscal year 2016, we early-adopted the Financial Accounting Standards Board (“FASB”) guidance that amends the presentation of debt issuance costs in the financial statements by requiring that debt issuance costs related to a recognized debt liability be presented in the balance sheet

3



as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts, rather than as an asset. We applied its provisions retrospectively, which resulted in the reclassification of unamortized debt issuance costs of $47 million as of May 31, 2015, from total assets on our condensed consolidated balance sheet to total debt outstanding. Other than this reclassification, the adoption of the guidance did not impact our consolidated financial statements. See “Note 1—Summary of Significant Accounting Policies—Accounting Standards Adopted in Fiscal Year 2016” for additional information.
(2)Consists of derivative cash settlements and derivative forward value amounts. Derivative cash settlement amounts represent net periodic contractual interest accruals related to derivatives not designated for hedge accounting. Derivative forward value amounts represent changes in fair value during the period, excluding net periodic contractual 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 (“AOCI”) 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.
(3)Includes CAH fair value loss of $2 million for the three months ended August 31, 2015.
(4)Consists of salaries and employee benefits and other general and administrative expenses.
(5)See “Non-GAAP Financial Measures” for details on the calculation of these adjusted non-GAAP ratios and the reconciliation to the most comparable GAAP measures.
(6)Calculated based on net income plus interest expense for the period divided by interest expense for the period. The fixed-charge coverage ratios and TIER were the same for the three months ended August 31, 2015 and 2014 because we did not have any capitalized interest during these periods.
(7)Consists of outstanding principal balance of member loans and deferred loan origination costs of $10 million as of both August 31, 2015 and May 31, 2015.
(8)Includes debt issuance costs, which were previously classified as an asset on our consolidated balance sheets, of $46 million and $47 million as of August 31, 2015 and May 31, 2015, respectively.
(9)Represents the total outstanding guarantee amount as of the end of the each period; however, the amount recorded on our condensed consolidated balance sheets for our guarantee obligations is significantly less than the outstanding guarantee total. See “Note 10—Guarantees” for additional information.
(10)Calculated based on total liabilities and guarantees at period end divided by total equity at period end.
(11)Calculated based on total liabilities at period end divided by total equity at period end.
EXECUTIVE SUMMARY

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

Financial Performance

Reported Results

We reported net income of $43 million for the quarter ended August 31, 2015 (“current quarter”) and TIER of 1.26, compared with net income of $21 million and TIER of 1.13 for the same prior year quarter. Our debt-to-equity ratio increased to 24.63-to-1 as of August 31, 2015, from 24.06-to-1 as of May 31, 2015. Our reported results for the current quarter reflect the impact of relatively flat net interest income and a significant reduction in net derivative losses of $38 million, which was partially offset by a shift in the provision for loan losses of $12 million, as we recorded a provision expense of $5 million in the current quarter versus a negative provision of $7 million in the same prior year quarter.

We expect volatility from period to period in our reported GAAP results due to changes in market conditions that result in periodic fluctuations in the estimated fair value of our derivative instruments, which we mark to market through earnings. As previously noted, we therefore use adjusted non-GAAP measures to evaluate our performance and for compliance with our debt covenants.

Adjusted Non-GAAP Results

Our adjusted net income totaled $35 million and our adjusted TIER was 1.19 for the current quarter, compared with adjusted net income of $50 million and adjusted TIER of 1.29 for the same prior year quarter. Our adjusted debt-to-equity ratio increased to 6.52-to-1 as of August 31, 2015, from 6.26-to-1 as of May 31, 2015. Our adjusted net income for the current quarter reflected a slight decline in net interest income and the unfavorable impact of the $12 million shift in our provision for loan losses.


4



Lending Activity

Total loans outstanding, which consists of the unpaid principal balance and excludes deferred loan origination costs, was $22,085 million as of August 31, 2015, an increase of $625 million, or 3%, from May 31, 2015. The increase was primarily due to an increase in CFC distribution and power supply loans of $480 million and $163 million, respectively, which was attributable to members refinancing with us loans made by other lenders and member advances for capital investments. This increase was partially offset by a decrease in NCSC loans of $6 million and a decrease in RTFC loans of $7 million.

CFC had long-term fixed-rate loans totaling $206 million that repriced during the three months ended August 31, 2015. Of this total, $199 million repriced to a new long-term fixed rate; $6 million repriced to a long-term variable rate; and $1 million were repaid in full.

Funding Activity

Our outstanding debt volume generally increases and decreases in response to member loan demand. As outstanding loan balances increased during the three months ended August 31, 2015, our debt volume also increased. Total debt outstanding was $21,801 million as of August 31, 2015, an increase of $527 million, or 2%, from May 31, 2015. The increase was primarily attributable to the issuance of notes payable of $250 million under the Guaranteed Underwriter Program of the United States Department of Agriculture and $180 million under the note purchase agreement with the Federal Agricultural Mortgage Corporation (“Farmer Mac”). On July 31, 2015, we entered into a new revolving note purchase agreement with Farmer Mac for $300 million.

Outlook for the Next 12 Months

We expect the amount of new long-term loan advances to exceed scheduled loan repayments over the next 12 months. We anticipate a continued increase in earnings from our core lending operations over the next 12 months based on our expectation of an increase in long-term loans outstanding.

We had $1,932 million of long-term debt as of August 31, 2015, scheduled to mature over the next 12 months. We believe we have sufficient liquidity from the combination of existing cash and time deposits, member loan repayments, committed loan facilities 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. We had $751 million in cash and time deposits, up to $500 million available under committed loan facilities from the Federal Financing Bank, $3,419 million available under committed revolving lines of credit with a syndicate of banks, up to $300 million available under a new note purchase agreement with Farmer Mac and, subject to market conditions, up to $2,419 million available under the existing revolving note purchase agreement with Farmer Mac as of August 31, 2015. On September 28, 2015, we received a commitment from RUS to guarantee a loan of $250 million from the Federal Financing Bank of the USDA pursuant to the Guaranteed Underwriter Program. Upon closing of the commitment, we will have an additional $250 million available under the Guaranteed Underwriter Program with a 20-year maturity repayment period during the three-year period following the date of closing. We also have the ability to issue collateral trust bonds and medium-term notes in the capital markets and medium-term notes to members.

We believe we can continue to roll over the member outstanding short-term debt of $2,294 million as of August 31, 2015, based on our expectation that our members will continue to reinvest their excess cash in our commercial paper, daily liquidity fund and select notes. We believe we can also continue to roll over our outstanding dealer commercial paper of $915 million as of August 31, 2015. We intend to manage our short-term wholesale funding risk by maintaining our dealer commercial paper within an approximate range between $1,000 million and $1,250 million for the foreseeable future. We expect to continue to be in compliance with the covenants under our revolving credit agreements, which will allow us to mitigate our roll-over risk as we can draw on these facilities to repay dealer or member commercial paper that cannot be rolled over due to potential adverse changes in market conditions.

Our goal is to maintain the adjusted debt-to-equity ratio at or below 6.00-to-1. However, because of the increase in outstanding loan balances during the first quarter of fiscal 2016 and the expected further increase during the remainder of the fiscal year, we anticipate additional borrowings to support our loan growth. As a result, our adjusted debt-to-equity ratio will likely continue to be higher than 6.00-to-1 in the near term.


5



As part of our strategy to manage our credit risk exposure, we entered into a long-term standby purchase commitment agreement with Farmer Mac on August 31, 2015. Under this agreement, we may designate certain loans, as approved by Farmer Mac, and in the event any such loan later goes into material default for at least 90 days, upon request by us, Farmer Mac must purchase such loan at par value. We have designated and Farmer Mac has approved an initial tranche of loans of $520 million as of August 31, 2015. We expect to designate an additional tranche of loans in the second quarter of fiscal year 2016.

On September 30, 2015, CFC entered into a Purchase Agreement (the “Purchase Agreement”) with CAH, ATN VI Holdings, LLC (“Atlantic”) and Atlantic Tele-Network, Inc., the parent corporation of Atlantic, to sell all of the issued and outstanding membership interests of CAH to Atlantic for a purchase price of $145 million, subject to certain adjustments. We expect to complete the transaction during the second half of calendar year 2016, subject to the satisfaction or waiver of various closing conditions under the Purchase Agreement, including, among other things, the receipt of required communications regulatory approvals in the United States, United States Virgin Islands, British Virgin Islands and St. Maarten, the expiration or termination of applicable waiting periods under applicable competition laws, and the absence of a material adverse effect or material adverse regulatory event. See “Consolidated Results of Operations—Results of Foreclosed Assets” below and “Note 4—Foreclosed Assets” for additional information related to CAH.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in accordance with U.S. 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 2015 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 assumptions used in our critical accounting policies and estimates during the current quarter. Management has discussed significant judgments and assumptions in applying our critical accounting policies with the Audit Committee of our Board of Directors. We provide information on the methodologies and key assumptions used in our critical accounting policies and estimates under “MD&A—Critical Accounting Policies and Estimates” in our 2015 Form 10-K. See “Item 1A. Risk Factors” for a discussion of the risks associated with management’s judgments and estimates in applying our accounting policies and methods in our 2015 Form 10-K.
ACCOUNTING CHANGES AND DEVELOPMENTS

See “Note 1—Summary of Significant Accounting Policies” for information on accounting standards adopted during the three months ended August 31, 2015, as well as recently issued accounting standards not yet required to be adopted and the expected impact 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 results of operations, financial condition or liquidity, we discuss the impacts in the applicable section(s) of MD&A.

6



CONSOLIDATED RESULTS OF OPERATIONS

The section below provides a comparative discussion of our condensed consolidated results of operations between the three months ended August 31, 2015 and the three months ended August 31, 2014. Following this section, we provide a comparative analysis of our condensed consolidated balance sheets as of August 31, 2015 and May 31, 2015. 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 and applicable fees earned on our interest-earning assets, which include loans and investment securities, and the interest expense on our interest-bearing liabilities. Our net interest yield represents the difference between the yield on our interest-earning assets and the cost of our interest-bearing liabilities plus the impact from non-interest bearing funding. We expect net interest income and our net interest yield to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities. We do not fund each individual loan with specific debt. Rather, we attempt to minimize costs and maximize efficiency by funding large aggregated amounts of loans.

Table 2 presents our average balance sheets for the three months ended August 31, 2015 and 2014, 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 periodic derivative cash settlements in interest expense. We provide reconciliations of our non-GAAP adjusted measures to the most comparable GAAP measures under “Non-GAAP Financial Measures.”



7



Table 2: Average Balances, Interest Income/Interest Expense and Average Yield/Cost
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2015
 
2014
Assets:
 
Average Balance
 
Interest Income/Expense
 
Average Yield/Cost
 
Average Balance
 
Interest Income/Expense
 
Average Yield/Cost
Long-term fixed-rate loans(1)
 
$
19,914,082

 
$
232,202

 
4.64
%
 
$
18,458,181

 
$
222,328

 
4.78
%
Long-term variable-rate loans
 
685,897

 
5,020

 
2.91

 
754,707

 
5,360

 
2.82

Line of credit loans
 
1,040,028

 
6,198

 
2.37

 
1,156,811

 
6,942

 
2.38

Restructured loans
 
11,407

 

 

 
7,585

 

 

Nonperforming loans
 

 

 

 
2,071

 

 

Interest-based fee income(2)
 

 
71

 

 

 
89

 

Total loans
 
21,651,414

 
243,491

 
4.47

 
20,379,355

 
234,719

 
4.57

Cash, investments and time deposits
 
722,391

 
2,625

 
1.45

 
995,975

 
2,572

 
1.02

Total interest-earning assets
 
$
22,373,805

 
$
246,116

 
4.38
%
 
$
21,375,330

 
$
237,291

 
4.40
%
Other assets, less allowance for loan losses
 
873,048

 
 
 
 
 
900,480

 
 
 
 
Total assets
 
$
23,246,853

 


 
 
 
$
22,275,810

 


 


 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 


 


 


 


 


Short-term debt
 
$
2,799,166

 
$
2,542

 
0.36
%
 
$
3,799,388

 
$
3,141

 
0.33
%
Medium-term notes
 
3,361,129

 
20,153

 
2.39

 
2,760,202

 
17,159

 
2.47

Collateral trust bonds
 
6,782,214

 
82,831

 
4.86

 
6,017,423

 
76,182

 
5.02

Subordinated deferrable debt
 
400,000

 
4,783

 
4.76

 
400,000

 
4,767

 
4.73

Subordinated certificates
 
1,497,706

 
15,306

 
4.07

 
1,542,924

 
16,746

 
4.31

Long-term notes payable
 
6,550,307

 
40,085

 
2.43

 
5,859,435

 
38,557

 
2.61

Total interest-bearing liabilities
 
$
21,390,522

 
$
165,700

 
3.08
%
 
$
20,379,372

 
$
156,552

 
3.05
%
Other liabilities
 
941,094

 
 
 

 
929,881

 

 
 
Total liabilities
 
22,331,616

 
 
 

 
21,309,253

 

 
 
Total equity
 
915,237

 
 
 
 
 
966,557

 

 
 
Total liabilities and equity
 
$
23,246,853

 


 
 
 
$
22,275,810

 


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread(3)
 
 
 


 
1.30
%
 


 


 
1.35
%
Impact of non-interest bearing funding(4)
 
 
 
 
 
0.14

 
 
 
 
 
0.16

Net interest income/net interest yield(5)
 
 
 
$
80,416

 
1.44
%
 
 
 
$
80,739

 
1.51
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest income/adjusted net interest yield:
 
 
 
 
 


 
 
 
 
 
 
Interest income
 
 
 
$
246,116

 
4.38
%
 
 
 
$
237,291

 
4.40
%
Interest expense
 
 
 
165,700

 
3.08

 
 
 
156,552

 
3.05

Add: Net derivative cash settlement cost(6)
 
 
 
20,156

 
0.82

 
 
 
20,101

 
0.94

Adjusted interest expense/adjusted average cost(7)
 
 
 
$
185,856

 
3.46
%
 


 
$
176,653

 
3.43
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest spread(4)
 
 
 
 
 
0.92
%
 

 
 
 
0.97
%
Impact of non-interest bearing funding
 
 
 
 
 
0.15

 
 
 
 
 
0.16

Adjusted net interest income/adjusted net interest yield(8)
 
 
 
$
60,260

 
1.07
%
 

 
$
60,638


1.13
%
____________________________ 
(1) Includes loan conversion fees, which are deferred and recognized in interest income using the effective interest method. Also includes a small portion of conversion fees, which are intended to cover the administrative costs related to the conversion and are recognized into income immediately at conversion.
(2) Primarily related to loan origination and late loan payment fees.

8




(3)Net interest spread represents the difference between the average yield on interest-earning assets and the average cost of interest-bearing funding. Adjusted net interest spread represents the difference between the average yield on interest-earning assets and the adjusted average cost of interest-bearing funding.
(4)Includes other liabilities and equity.
(5)Net interest yield is calculated based on annualized net interest income for the period divided by average interest-earning assets for the period.
(6)Represents the impact of net periodic derivative cash settlements during the period, which is added to interest expense to derive non-GAAP adjusted interest expense. The average (benefit)/cost associated with derivatives is calculated based on the annualized net periodic cash settlements during the period divided by the average outstanding notional amount of derivatives during the period. The average outstanding notional amount of derivatives was $9,788 million and $8,484 million for the three months ended August 31, 2015 and 2014, respectively.
(7)Adjusted average cost is calculated based on annualized adjusted interest expense for the period divided by average interest-bearing funding during the period.
(8)Adjusted net interest yield is calculated based on annualized adjusted net interest income for the period divided by average interest-earning assets for the period.

Table 3 displays the change in our 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.
 
Table 3: Rate/Volume Analysis of Changes in Interest Income/Interest Expense
 
 
Three Months Ended August 31,
2015 versus 2014
 
 
 
 
Variance due to:(1)
(Dollars in thousands)
 
Total
Variance
 
Volume
 
Rate
Interest income:
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
9,874

 
$
16,881

 
$
(7,007
)
Long-term variable-rate loans
 
(340
)
 
(502
)
 
162

Line of credit loans
 
(744
)
 
(718
)
 
(26
)
Fee income
 
(18
)
 

 
(18
)
Total loans
 
8,772

 
15,661

 
(6,889
)
Cash, investments and time deposits
 
53

 
(712
)
 
765

Interest income
 
8,825

 
14,949

 
(6,124
)
 
 
 
 
 
 
 
Interest expense:
 
 
 
 
 
 
Short-term debt
 
(599
)
 
(833
)
 
234

Medium-term notes
 
2,994

 
3,679

 
(685
)
Collateral trust bonds
 
6,649

 
9,448

 
(2,799
)
Subordinated deferrable debt
 
16

 
(13
)
 
29

Subordinated certificates
 
(1,440
)
 
(535
)
 
(905
)
Long-term notes payable
 
1,528

 
4,428

 
(2,900
)
Interest expense
 
9,148

 
16,174

 
(7,026
)
Net interest income
 
$
(323
)
 
$
(1,225
)
 
$
902

 
 
 
 
 
 
 
Adjusted net interest income:
 
 
 
 
 
 
Interest income
 
$
8,825

 
$
14,949

 
$
(6,124
)
Interest expense
 
9,148

 
16,174

 
(7,026
)
Derivative cash settlements(2)
 
55

 
3,026

 
(2,971
)
Adjusted interest expense(3)
 
9,203

 
19,200

 
(9,997
)
Adjusted net interest income
 
$
(378
)
 
$
(4,251
)
 
$
3,873

____________________________ 

9



(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 derivative cash settlements, variance due to average volume represents the change in derivative cash settlements that resulted from the change in the average notional amount of derivative contracts outstanding. Variance due to average rate represents the change in derivative cash settlements that resulted 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 the our adjusted non-GAAP measures.

Net interest income of $80 million for the current quarter decreased slightly from the same prior year quarter, driven by a decrease in net interest yield of 5% (7 basis points) to 1.44%, which was largely offset by an increase in average interest-earning assets of 5%.

Average Interest-Earning Assets: The increase in average interest-earning assets reflected loan advances that exceeded loan payments as members refinanced with us loans made by other lenders and obtained advances to fund capital investments.

Net Interest Yield: The decrease in the net interest yield was attributable to the combined impact of an increase in our average cost of funds and a decline in the average yield on interest-earning assets. Our average cost of funds increased by 3 basis points to 3.08% during the three months ended August 31, 2015, largely due to our decision in the third quarter of fiscal year 2015 to significantly reduce our outstanding dealer commercial paper balance, which has a much lower cost. The decrease in the average yield on interest-earning assets of 2 basis points to 4.38% during the three months ended August 31, 2015 was largely attributable to reduced rates on fixed-rate loans, reflecting the repricing of higher rate loans to lower interest rates and lower interest rates on new loan originations as a result of the overall low interest rate environment. As a cost-based lender, our fixed interest rates for loans are intended to reflect our cost of borrowing plus a spread to cover our cost of operations and provision for loan losses and to provide earnings sufficient to achieve interest coverage to meet financial objectives. As benchmark treasury rates remained low and our credit spread tightened over the past few years, there was a continued reduction in the rates we had to pay to obtain funding in the capital markets. We therefore lowered the long-term fixed rates on our new loans.

Adjusted net interest income of $60 million for the current quarter also decreased slightly from the same prior year quarter, driven by a decrease in the adjusted net interest yield of 5% (6 basis points) to 1.07%, offset by the 5% increase in average interest-earning assets.

Our adjusted net interest income and adjusted net interest yield include the impact of net periodic derivative cash settlements during the period. We recorded net periodic derivative cash settlement expense of $20 million for the three months ended August 31, 2015 and 2014. See “Non-GAAP Financial Measures” for additional information on our adjusted measures.

Provision for Loan Losses

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

We recorded a provision for loan losses of $5 million for the three months ended August 31, 2015, compared with a benefit for loan losses of $7 million for the same prior year period. The shift in the provision was attributable to the increase in loan balances and a slight deterioration in the overall credit risk profile of our loan portfolio. Specifically, certain loans experienced negative migration through our internal risk rating process. As a result, our allowance for loan losses increased to $38 million as of August 31, 2015, from $34 million as of May 31, 2015. The benefit for loan losses recorded in the prior year period was due to modest improvement in the credit quality and overall credit risk profile of our loan portfolio and relatively flat loan balances. We provide additional information on our allowance for loan losses under “Credit Risk—Allowance for Loan Losses” and “Note 3—Loans and Commitments” of this Report. For information on our allowance methodology, see “MD&A—Critical Accounting Policies and Estimates” and “Note 1—Summary ” in our 2015 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.

10




We recorded losses from non-interest income of $9 million and $48 million for the three months ended August 31, 2015 and 2014, respectively. The decrease in losses of $39 million was primarily attributable to a reduction in derivative losses of $38 million during the three months ended August 31, 2015.

Derivative Gains (Losses)

Our derivative instruments are an integral part of our interest rate risk management strategy. Our principal purpose in using derivatives is to manage our aggregate interest rate risk profile within prescribed risk parameters. The derivative instruments we use primarily include interest rate swaps, which we typically hold to maturity. The primary factors affecting the fair value of our derivatives and derivative gains (losses) recorded in our results of operations include changes in interest rates, yield curves and implied interest rate volatility and the composition and balance of instrument types in our derivative portfolio. We generally do not designate interest rate swaps, which represent the substantial majority of our derivatives, for hedge accounting. Accordingly, changes in the fair value of interest rate swaps are reported in our consolidated statements of operations under derivative gains (losses). We did not have any derivatives designated as accounting hedges as of August 31, 2015 or May 31, 2015.

We recorded derivative losses of $12 million and $50 million for the three months ended August 31, 2015 and 2014, respectively. Table 4 presents the components of net derivative gains (losses) recorded in our condensed consolidated results of operations for the three months ended August 31, 2015 and 2014. The derivative gains (losses) relate to interest rate swap agreements. Derivative cash settlements represent net contractual interest expense accruals on interest rate swaps during the period. The derivative forward value represents 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 4: Derivative Gains (Losses)
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2015
 
2014
Derivative gains (losses) attributable to:
 
 
 
 
Derivative cash settlements
 
$
(20,156
)
 
$
(20,101
)
Derivative forward value
 
8,139

 
(29,777
)
Derivative losses
 
$
(12,017
)
 
$
(49,878
)

We currently use two types of interest rate swap agreements: (i) we pay a fixed rate and receive a variable rate (“pay-fixed swaps”) and (ii) we pay a variable rate and receive a fixed rate (“receive-fixed swaps”). Pay-fixed swaps generally decrease in value as interest rates decline and increase in value as interest rates rise. In contrast, receive-fixed swaps generally increase in value as interest rates decline and decrease in value as interest rates rise. The composition of our pay-fixed and receive-fixed swaps varies across the swap yield curve. As a result, the overall fair value gains and losses of our derivatives also are sensitive to flattening and steepening of the swap yield curve. See “Note 12—Fair Value of Financial Instruments” for information on how we estimate the fair value of our derivative instruments.

Table 5 displays the average notional amount outstanding, by swap agreement type, and the weighted-average interest rate paid and received for derivative cash settlements during the three months ended August 31, 2015 and 2014. As indicated in Table 5, our derivative portfolio currently consists of a higher proportion of pay-fixed swaps than receive-fixed swaps, which is subject to change based on changes in market conditions and actions taken to manage our interest rate risk.


11



Table 5: Derivative Average Notional Balances and Average Interest Rates
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended August 31,
 
 
2015
 
2014
(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
 
$
5,939,394

 
3.13
%
 
0.29
%
 
$
5,419,383

 
3.32
%
 
0.24
%
Receive-fixed swaps
 
3,849,000

 
0.80

 
3.09

 
3,065,033

 
0.86

 
3.62

Total
 
$
9,788,394

 
2.21
%
 
1.39
%
 
$
8,484,416

 
2.42
%
 
1.48
%

The derivative losses of $12 million recognized during the three months ended August 31, 2015 reflected the combined impact of net derivative forward value gains of $8 million, which was offset by a net loss related to the periodic cash settlements as we were a net payer on our interest-rate swaps based on the terms of the instruments. The net derivative forward value gains of $8 million were primarily attributable to a net increase in the fair value of our pay-fixed swaps during the period due to a steepening of the swap yield curve resulting from a gradual increase in interest rates across the curve.

Of the total derivative losses of $50 million recorded for the three months ended August 31, 2014, $30 million related to derivative forward value losses and the remainder related to the net periodic contractual interest settlements. The derivative forward value losses were primarily attributable to a flattening of the swap yield curve during the period, with rates on the shorter end of the yield curve increasing and rates on the longer end of the yield curve declining. Due to the overall composition of our derivative portfolio, we experienced an overall decline in the fair value of both our pay-fixed and receive-fixed swaps during the quarter.

See “Note 8—Derivative Financial Instruments” for additional information on our derivative instruments.

Results of Operations of Foreclosed Assets

The financial operating results of entities controlled by CFC that hold foreclosed assets are reported in our consolidated statements of operations under results of operations of foreclosed assets. We previously had two entities, CAH and DRP, that held foreclosed assets. We dissolved DRP during the fourth quarter of fiscal 2015, following the sale of DRP’s remaining assets.

We recorded losses from the results of operations of foreclosed assets of $2 million for the three months ended August 31, 2015, compared with losses of $3 million for the same prior year period. The losses recorded during the three months ended August 31, 2015 were primarily attributable to valuation adjustments related to CAH, while the losses recorded during the same prior year period related to CAH’s results of operations.

As discussed above under “Executive Summary,” on September 30, 2015, CFC entered into a Purchase Agreement with Atlantic and Atlantic Tele-Network, Inc., the parent corporation of Atlantic, to sell all of the issued and outstanding membership interests of CAH to Atlantic for a purchase price of $145 million, subject to certain adjustments. The amount recorded on our condensed consolidated balance sheet for CAH of $114 million as of August 31, 2015 reflects the expected net proceeds, including estimated adjustments to the selling price and selling costs, from the completion of the CAH sales transaction.

We expect to complete the transaction during the second half of calendar year 2016, subject to the satisfaction or waiver of various closing conditions under the Purchase Agreement, including, among other things, the receipt of required communications regulatory approvals in the United States, United States Virgin Islands, British Virgin Islands and St. Maarten, the expiration or termination of applicable waiting periods under applicable competition laws, and the absence of a material adverse effect or material adverse regulatory event.


12



Non-Interest Expense

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

We recorded non-interest expense of $23 million for the three months ended August 31, 2015, an increase of $5 million, or, 25% from the same prior year period was primarily due to an increase in other general and administrative expenses related to system infrastructure enhancements and legal fees.

Net Income (Loss) Attributable to Noncontrolling Interests

Net income (loss) attributable to noncontrolling interests represents 100% of the results of operations of RTFC and NCSC, as the members of RTFC and NCSC own or control 100% of the interest in their respective companies.

We recorded a net loss attributable to noncontrolling interests of less than $1 million for the three months ended August 31, 2015, and net income of less than $1 million during the three months ended August 31, 2014. The fluctuations in net income (loss) attributable to noncontrolling interests are primarily due to fluctuations in the fair value of NCSC’s derivative instruments.
CONSOLIDATED BALANCE SHEET ANALYSIS

Total assets of $23,460 million as of August 31, 2015 increased by $614 million, or 3%, from May 31, 2015, primarily due to growth in our loan portfolio. Total liabilities of $22,545 million as of August 31, 2015 increased by $610 million, or 3%, from May 31, 2015, primarily due to debt issuances to fund the growth in our loan portfolio. Total equity increased by $3 million to $915 million as of August 31, 2015. The increase in total equity was primarily attributable to our net income of $43 million for the three months ended August 31, 2015, which was partially offset by the patronage capital retirement of $39 million authorized by our Board of Directors in July 2015.
Following is a discussion of changes in the major components of our assets and liabilities during the three months ended August 31, 2015. 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. Borrowers may choose a fixed or variable interest rate for periods of one to 35 years. When a selected fixed-rate term expires, the borrower may select either another fixed-rate term or a variable rate or elect to repay the loan in full.

Table 6 summarizes loans outstanding by type and by member class as of August 31, 2015 and May 31, 2015.


13



Table 6: Loans Outstanding by Type and Member Class
 
 
August 31, 2015
 
May 31, 2015
 
Increase/
(Dollars in thousands)
 
Amount
 
% of Total
 
Amount
 
% of Total
 
(Decrease)
Loans by type:
 
 
 
 
 
 
 
 
 
 
Long-term loans:
 
 
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
20,017,697

 
91
%
 
$
19,543,274

 
91
%
 
$
474,423

Long-term variable-rate loans
 
711,437

 
3

 
698,495

 
3

 
12,942

Loans guaranteed by RUS
 
177,840

 
1

 
179,241

 
1

 
(1,401
)
Total long-term loans
 
20,906,974

 
95

 
20,421,010

 
95

 
485,964

Line of credit loans
 
1,177,577

 
5

 
1,038,210

 
5

 
139,367

Total loans outstanding(1)
 
$
22,084,551

 
100
%
 
$
21,459,220

 
100
%
 
$
625,331

 
 
 
 
 
 
 
 
 
 
 
Loans by member class:
 
 
 
 
 
 
 
 
 
 
CFC:
 
 
 
 
 
 
 
 
 
 
Distribution
 
$
16,575,202

 
75
%
 
$
16,095,043

 
75
%
 
$
480,159

Power supply
 
4,344,867

 
20

 
4,181,481

 
20

 
163,386

Statewide and associate
 
60,377

 

 
65,466

 

 
(5,089
)
CFC total
 
20,980,446

 
95

 
20,341,990

 
95

 
638,456

RTFC
 
379,033

 
2

 
385,709

 
2

 
(6,676
)
NCSC
 
725,072

 
3

 
731,521

 
3

 
(6,449
)
Total loans outstanding(1)
 
$
22,084,551

 
100
%
 
$
21,459,220

 
100
%
 
$
625,331

____________________________ 
(1)Excludes deferred loan origination costs of $10 million as of August 31, 2015 and May 31, 2015.

The balance of loans outstanding of $22,085 million as of August 31, 2015 increased by $625 million from May 31, 2015. The increase was primarily due to the increase in CFC distribution and power supply loans of $480 million and $163 million, respectively, which was partially offset by a decrease in NCSC loans of $6 million and a decrease in RTFC loans of
$7 million. The increase in CFC distribution and power supply loans was attributable to members refinancing with us loans made by other lenders and member advances for capital investments. We provide additional information on loans in “Note 3—Loans and Commitments.” See also “Liquidity Risk” for information on unencumbered loans.

Table 7 displays our historical retention rate for long-term fixed-rate loans that repriced during the quarterly period ended August 31, 2015 and the year ended May 31, 2015. Table 7 also displays the percentage of borrowers that select another fixed-rate term or a variable rate. The retention rate is calculated based on the election made by the borrower at the repricing date.

Table 7: Historical Retention Rate and Repricing Selection
 
 
August 31, 2015
 
May 31, 2015
(Dollars in thousands)
 
Amount
 
%
 
Amount
 
%
Loans retained:
 
 
 
 
 
 
 
 
Long-term fixed rate selected
 
$
198,576

 
97
%
 
$
991,279

 
81
%
Long-term variable rate selected
 
6,133

 
3

 
154,946

 
13

Loans repriced and sold by CFC
 

 

 
3,904

 

Total loans retained
 
204,709

 
100

 
1,150,129

 
94

Total loans repaid
 
849

 

 
76,380

 
6

Total loans repriced
 
$
205,558

 
100
%
 
$
1,226,509

 
100
%


14



Debt

Table 8 displays the composition of our debt outstanding, by debt product type, by interest rate type and by original contractual maturity, as of August 31, 2015 and May 31, 2015.

Table 8: Total Debt Outstanding
(Dollars in thousands)
 
August 31, 2015
 
May 31, 2015
 
Increase/
(Decrease)
Debt product type:
 
 
 
 
 
 
Commercial paper sold through dealers, net of discounts
 
$
914,954

 
$
984,954

 
$
(70,000
)
Commercial paper sold directly to members, at par
 
838,180

 
736,162

 
102,018

Select notes
 
667,669

 
671,635

 
(3,966
)
Daily liquidity fund notes
 
592,654

 
509,131

 
83,523

Collateral trust bonds
 
6,758,598

 
6,755,067

 
3,531

Guaranteed Underwriter Program notes payable
 
4,651,481

 
4,406,465

 
245,016

Farmer Mac notes payable
 
2,081,398

 
1,910,688

 
170,710

Medium-term notes
 
3,368,028

 
3,352,023

 
16,005

Other notes payable(3)
 
46,490

 
46,423

 
67

Subordinated deferrable debt
 
395,717

 
395,699

 
18

Membership certificates
 
629,821

 
645,035

 
(15,214
)
Loan and guarantee certificates
 
636,116

 
640,889

 
(4,773
)
Member capital securities
 
219,996

 
219,496

 
500

Total debt outstanding
 
$
21,801,102

 
$
21,273,667

 
$
527,435

 
 
 
 
 
 
 
Interest rate type:
 
 
 
 
 
 
Fixed-rate debt(1)
 
82
%
 
81
%
 


Variable-rate debt(2)
 
18

 
19

 
 
Total
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
Original contractual maturity:
 
 
 
 
 
 
Long-term debt
 
85
%
 
85
%
 
 
Short-term debt
 
15

 
15

 
 
Total
 
100
%
 
100
%
 
 
____________________________ 
(1) Includes variable-rate debt that has been swapped to a fixed rate net of any fixed-rate debt that has been swapped to a variable rate.
(2) Includes fixed-rate debt that has been swapped to a variable rate net of any variable-rate debt that has been swapped to a fixed rate. Also includes commercial paper notes, which generally have maturities of less than 90 days. The interest rate on commercial paper notes does not change once the note has been issued; however, the rates on new commercial paper notes change daily.
(3) Other notes payable included unsecured and secured Clean Renewable Energy Bonds. We are required to pledge eligible mortgage notes from distribution and power supply system borrowers in an amount at least equal to the outstanding principal amount under the Clean Renewable Energy Bonds Series 2009A note purchase agreement. The remaining other notes payable relate to unsecured notes payable issued by NCSC.

Total debt outstanding was $21,801 million as of August 31, 2015, an increase of $527 million, or 2%, from May 31, 2015. The increase primarily reflected the issuance of notes payable during the three months ended August 31, 2015 totaling $250 million under the Guaranteed Underwriter Program and $180 million under a note purchase agreement with Farmer Mac. On July 31, 2015, we entered into a new revolving note purchase agreement with Farmer Mac for an additional $300 million.


15



Equity

Total equity increased by $3 million to $915 million as of August 31, 2015 from May 31, 2015. The increase in total equity was primarily attributable to our net income of $43 million for the three months ended August 31, 2015, partially offset by the board authorized patronage capital retirement of $39 million.

In July 2015, the CFC Board of Directors authorized additional allocations of fiscal year 2015 net earnings that included $1 million to the Cooperative Educational Fund, $16 million to the members’ capital reserve and $78 million to members in the form of patronage capital. In July 2015, the CFC Board of Directors also authorized the retirement of allocated net earnings totaling $39 million, which represented 50% of the fiscal year 2015 allocation. This amount was returned to members in cash in September 2015.

Future allocations and retirements of net earnings may be made annually as determined by the CFC Board of Directors taking into consideration CFC’s financial condition. The CFC Board of Directors has the authority to change the current practice for allocating and retiring net earnings at any time, subject to applicable cooperative law. The NCSC Board of Directors has the authority to determine if and when net earnings will be allocated and retired. Likewise, the RTFC Board of Directors has the authority to determine if and when net earnings will be allocated and retired.

The amount of patronage capital allocated each year by CFC’s Board of Directors is based on non-GAAP adjusted net income, which excludes the impact of derivative forward value gains (losses). See “Non-GAAP Financial Measures” for information on adjusted net income.

Debt Ratio Analysis

Leverage Ratio

The leverage ratio is calculated by dividing the sum of total liabilities and guarantees outstanding by total equity. Based on this formula, the leverage ratio was 25.70-to-1 as of August 31, 2015, an increase from 25.14-to-1 as of May 31, 2015. The increase in the leverage ratio was due to the increase of $610 million in total liabilities, partially offset by the increase of $3 million in total equity and by the decrease of $14 million in total guarantees.

For covenant compliance under our revolving credit agreements and for internal management purposes, the leverage ratio calculation is adjusted to exclude derivative liabilities, debt used to fund loans guaranteed by RUS, subordinated deferrable debt and subordinated certificates from liabilities; uses members’ equity rather than total equity; and adds subordinated deferrable debt and subordinated certificates to calculate adjusted equity.

The adjusted leverage ratio was 6.83-to-1 and 6.58-to-1 as of August 31, 2015 and May 31, 2015, respectively. The increase in the adjusted leverage ratio was due to the increase of $647 million in adjusted liabilities and the decrease of $24 million in adjusted equity, partially offset by the decrease of $14 million in guarantees as discussed under “Off-Balance Sheet Arrangements.” See “Non-GAAP Financial Measures” for further explanation and a reconciliation of the adjustments we make to our leverage ratio calculation to derive the adjusted leverage ratio.

Debt-to-Equity Ratio

The debt-to-equity ratio is calculated by dividing the sum of total liabilities outstanding by total equity. The debt-to-equity ratio was 24.63-to-1 as of August 31, 2015, an increase from 24.06-to-1 as of May 31, 2015. The increase in the debt-to-equity ratio is due to the increase of $610 million in total liabilities, partially offset by the increase of $3 million in total equity.

We adjust the components of the debt-to-equity ratio to calculate an adjusted debt-to-equity ratio that is used for internal management analysis purposes. The adjusted debt-to-equity ratio was 6.52-to-1 and 6.26-to-1 as of August 31, 2015 and May 31, 2015, respectively. The increase in the adjusted debt-to-equity ratio was due to the increase of $647 million in adjusted liabilities and decrease of $24 million in adjusted equity. See “Non-GAAP Financial Measures” for further explanation and a reconciliation of the adjustments made to the debt-to-equity ratio calculation to derive the adjusted debt-to-equity ratio.

16



OFF-BALANCE SHEET ARRANGEMENTS

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

Guarantees

We provide guarantees for certain contractual obligations of our members to assist them in obtaining various forms of financing. We use the same credit policies and monitoring procedures in providing guarantees as we do for loans and commitments. If a member defaults on its obligation, we are obligated to pay required amounts pursuant to our guarantees. Meeting our guarantee obligations satisfies the underlying obligation of our member systems and prevents the exercise of remedies by the guarantee beneficiary based upon a payment default by a member. In general, the member is required to repay any amount advanced by us with interest, pursuant to the documents evidencing the member's reimbursement obligation.

Table 9 shows our guarantees outstanding, by guarantee type and by company, as of August 31, 2015 and May 31, 2015.

Table 9: Guarantees Outstanding
(Dollars in thousands)
 
August 31, 2015
 
May 31, 2015
 
Increase/
(Decrease)
Guarantee type:
 
 
 
 
 
 
Long-term tax-exempt bonds
 
$
489,020

 
$
489,520

 
$
(500
)
Letters of credit
 
369,391

 
382,233

 
(12,842
)
Other guarantees
 
114,075

 
114,747

 
(672
)
Total
 
$
972,486

 
$
986,500

 
$
(14,014
)
Company:
 
 

 
 
 
 
CFC
 
$
937,343

 
$
952,875

 
$
(15,532
)
RTFC
 
1,574

 
1,574

 

NCSC
 
33,569

 
32,051

 
1,518

Total
 
$
972,486

 
$
986,500

 
$
(14,014
)

In addition to the letters of credit listed in the above table, we had master letter of credit facilities in place as of August 31, 2015, under which we may be required to issue up to an additional $84 million in letters of credit to third parties for the benefit of our members. All of our master letter of credit facilities as of August 31, 2015 were subject to material adverse change clauses at the time of issuance. Prior to issuing a letter of credit under these facilities, we would confirm that there has been no material adverse change in the business or condition, financial or otherwise, of the borrower since the time the loan was approved and confirm that the borrower is currently in compliance with the letter of credit terms and conditions.

In addition to the guarantees described above, we were the liquidity provider for variable-rate, tax-exempt bonds, issued for our member cooperatives, totaling $493 million as of August 31, 2015. As liquidity provider on these tax-exempt bonds, we may be required to purchase bonds that are tendered or put by investors. Investors provide notice to the remarketing agent that they will tender or put a certain amount of bonds at the next interest rate reset date. If the remarketing agent is unable to sell such bonds to other investors by the next interest rate reset date, we have unconditionally agreed to purchase such bonds. Our obligation as liquidity provider is in the form of a letter of credit on $76 million of the tax-exempt bonds, which is included in the letters of credit amount in Table 9. We were not required to perform as liquidity provider pursuant to these obligations during the three months ended August 31, 2015. In addition to being a liquidity provider, we also provided a guarantee for payment of all principal and interest amounts on $417 million of these bonds as of August 31, 2015, which is included in long-term tax-exempt bond guarantees in Table 9.


17



Of our total guarantee amounts, 56% as of August 31, 2015 and May 31, 2015 were secured by a mortgage lien on substantially all of the system’s assets and future revenue of the borrowers.

The decrease in total guarantees during the three months ended August 31, 2015 was primarily due to a decrease in the total amount of letters of credit outstanding. We recorded a guarantee liability of $19 million and $20 million respectively, as of August 31, 2015 and May 31, 2015, related to the contingent and non-contingent exposures for guarantee and liquidity obligations associated with our members’ debt.

Table 10 summarizes our off-balance sheet obligations as of August 31, 2015, and maturity of amounts during each of the next five fiscal years and thereafter.

Table 10: Maturities of Guarantee Obligations
 
 
 Outstanding
Balance
 
Maturities of Guaranteed Obligations
(Dollars in thousands)
 
 
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
Guarantees
 
$
972,486

 
$
164,078

 
$
60,507

 
$
212,846

 
$
18,787

 
$
62,939

 
$
453,329


See “Note 10—Guarantees” for additional information.

Unadvanced Loan Commitments

Unadvanced commitments represent approved and executed loan contracts for which funds have not been advanced to borrowers. The table below displays the amount of unadvanced loan commitments, which consist of line of credit and long-term loan commitments, as of August 31, 2015 and May 31, 2015. Our line of credit commitments include both contracts that are not subject to material adverse change clauses and contracts that are subject to material adverse change clauses.

Table 11: Unadvanced Loan Commitments
(Dollars in thousands)
 
August 31, 2015
 
% of Total
 
May 31, 2015
 
% of Total
Line of credit commitments:
 
 
 
 
 
 
 
 
Not conditional(1)
 
$
2,686,842

 
19
%
 
$
2,764,968

 
20
%
Conditional(2)
 
6,706,480

 
47

 
6,529,159

 
46

Total line of credit unadvanced commitments
 
9,393,322


66

 
9,294,127

 
66

Total long-term loan unadvanced commitments
 
4,903,121


34

 
4,835,623

 
34

Total
 
$
14,296,443


100
%
 
$
14,129,750

 
100
%
____________________________ 
(1)Represents amount related to facilities that are not subject to material adverse change clauses.
(2)Represents amount related to facilities that are subject to material adverse change clauses.

For contracts not subject to a material adverse change clause, we are generally required to advance amounts on the committed facilities as long as the borrower is in compliance with the terms and conditions of the facility. As displayed in Table 11, unadvanced line of credit commitments not subject to material adverse change clauses at the time of each advance totaled $2,687 million and $2,765 million as of August 31, 2015 and May 31, 2015, respectively. We record a liability for credit losses on our condensed consolidated balance sheets for unadvanced commitments related to facilities that are not subject to a material adverse change clause because we do not consider these commitments to be conditional. Table 12 summarizes the available balance under committed lines of credit that are not subject to a material adverse change clause as of August 31, 2015, and the maturity of amounts during each of the next five fiscal years.


18



Table 12: Notional Maturities of Unconditional Committed Lines of Credit
 
 
Available
Balance
 
Notional Maturities of Unconditional Committed Lines of Credit
(Dollars in thousands)
 
 
2016
 
2017
 
2018
 
2019
 
2020
Committed lines of credit
 
$
2,686,842

 
$
79,077

 
$
297,416

 
$
717,942

 
$
950,728

 
$
641,679


For contracts subject to a material adverse change clause, the advance of additional amounts is conditional. Prior to making an advance on these facilities, we confirm that there have been no material adverse changes in the business or condition, financial or otherwise, of the borrower since the time the loan was approved and confirm that the borrower is currently in compliance with the loan terms and conditions. The substantial majority of our line of credit commitments relate to contracts that include material adverse change clauses. Unadvanced commitments that are subject to a material adverse change clause are classified as contingent liabilities. We do not record a reserve for credit losses on our condensed consolidated balance sheets for these commitments, nor do we include them in our off-balance sheet guarantee amounts in Table 9 above because we consider them to be conditional.

Table 13 summarizes the available balance under unadvanced commitments as of August 31, 2015 and the related maturities by fiscal year and thereafter by loan type:

Table 13: Notional Maturities of Unadvanced Loan Commitments
 
 
Available
Balance
 
Notional Maturities of Unadvanced Commitments
(Dollars in thousands)
 
 
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
Line of credit loans
 
$
9,393,322

 
$
595,623

 
$
5,337,933

 
$
1,135,540

 
$
1,108,910

 
$
856,000

 
$
359,316

Long-term loans
 
4,903,121

 
559,969

 
1,124,419

 
807,421

 
1,114,284

 
1,044,739

 
252,289

Total
 
$
14,296,443

 
$
1,155,592

 
$
6,462,352

 
$
1,942,961

 
$
2,223,194

 
$
1,900,739

 
$
611,605


Line of credit commitments are generally revolving facilities for periods that do not exceed five years. Historically, borrowers have not fully drawn the commitment amounts for line of credit loans, and the utilization rates have been low regardless of whether a material adverse change clause provision exists at the time of advance. Also, borrowers historically have not fully drawn the commitments related to long-term loans, and borrowings have generally been advanced in multiple transactions over an extended period of time. We believe these conditions are likely to continue because of the nature of the business of our electric cooperative borrowers and the terms of our loan commitments. See “MD&A—Off-Balance Sheet Arrangements” in our 2015 Form 10-K for additional information.
RISK MANAGEMENT

The CFC Board of Directors is responsible for the oversight and direction of risk management, while CFC’s management has primary responsibility for day-to-day management of the risks associated with CFC’s business. In fulfilling its risk management oversight duties, the CFC Board of Directors receives periodic reports on business activities from executive management and from various operating groups and committees across the organization, including the Credit Risk Management group, Internal Audit group and the Corporate Compliance group, as well as the Asset Liability Committee, the Corporate Credit Committee and the Disclosure Committee. The CFC Board of Directors also reviews CFC’s risk profile and management’s response to those risks throughout the year at its meetings. The board of directors establishes CFC’s loan policies and has established a Loan Committee of the board comprising no fewer than 10 directors that reviews the performance of the loan portfolio in accordance with those policies.

For additional information about the role of the CFC Board of Directors in risk oversight, see “Item 10. Directors, Executive Officers and Corporate Governance” in our 2015 Form 10-K for additional information.

19



CREDIT RISK

Credit risk is the risk of loss associated with a borrower or counterparty’s failure to meet its obligations in accordance with agreed upon terms. Our loan portfolio, which represents the largest component of assets on our balance sheet, and guarantees account for the substantial majority of our credit risk exposure. We also engage in certain non-lending activities that may give rise to credit and counterparty settlement risk, including the purchase of investment securities and entering into derivative transactions to manage our interest rate risk.

Loan and Guarantee Portfolio Credit Risk

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

Security Provisions

Except when providing line of credit loans, we generally lend to our members on a senior secured basis. Long-term loans are generally secured on parity with other secured lenders (primarily RUS), if any, by all assets and revenue of the borrower with exceptions typical in utility mortgages. Line of credit loans are generally unsecured. In addition to the collateral pledged to secure our loans, borrowers also are required to set rates charged to customers to achieve certain financial ratios. Of our total loans outstanding, 91% were secured and 9% were unsecured as of both August 31, 2015 and May 31, 2015. Table 14 presents, by loan type and by company, the amount and percentage of secured and unsecured loans in our loan portfolio.

Table 14 : Loan Portfolio Security Profile
 
 
August 31, 2015
(Dollars in thousands)
 
Secured
 
%
 
Unsecured
 
%
 
Total
Loan type:
 
 
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
19,074,885

 
95
%
 
$
942,812

 
5
%
 
$
20,017,697

Long-term variable-rate loans
 
645,333

 
91

 
66,104

 
9

 
711,437

Loans guaranteed by RUS
 
177,840

 
100

 

 

 
177,840

Line of credit loans
 
235,359

 
20

 
942,218

 
80

 
1,177,577

Total loans outstanding(1)
 
$
20,133,417

 
91

 
$
1,951,134

 
9

 
$
22,084,551

 
 
 
 
 
 
 
 
 
 
 
Company:
 
 
 
 
 
 
 
 
 
 
CFC
 
$
19,332,978

 
92
%
 
$
1,647,468

 
8
%
 
$
20,980,446

RTFC
 
359,107

 
95

 
19,926

 
5

 
379,033

NCSC
 
441,332

 
61

 
283,740

 
39

 
725,072

Total loans outstanding(1)
 
$
20,133,417

 
91

 
$
1,951,134

 
9

 
$
22,084,551



20



 
 
May 31, 2015
(Dollars in thousands)
 
Secured
 
%
 
Unsecured
 
%
 
Total
Loan type:
 
 
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
18,526,068

 
95
%
 
$
1,017,206

 
5
%
 
$
19,543,274

Long-term variable-rate loans
 
628,115

 
90

 
70,380

 
10

 
698,495

Loans guaranteed by RUS
 
179,241

 
100

 

 

 
179,241

Line of credit loans
 
107,781

 
10

 
930,429

 
90

 
1,038,210

Total loans outstanding(1)
 
$
19,441,205

 
91

 
$
2,018,015

 
9

 
$
21,459,220

 
 
 
 
 
 
 
 
 
 
 
Company:
 
 
 
 
 
 
 
 
 
 
CFC
 
$
18,635,818

 
92
%
 
$
1,706,172

 
8
%
 
$
20,341,990

RTFC
 
370,924

 
96

 
14,785

 
4

 
385,709

NCSC
 
434,463

 
59

 
297,058

 
41

 
731,521

Total loans outstanding(1)
 
$
19,441,205

 
91

 
$
2,018,015

 
9

 
$
21,459,220

____________________________ 
(1) Excludes deferred loan origination costs of $10 million as of August 31, 2015 and May 31, 2015.

As part of our strategy to manage our credit risk exposure, we entered into a long-term standby purchase commitment agreement with Farmer Mac on August 31, 2015. Under this agreement, we may designate certain loans, as approved by Farmer Mac, and in the event any such loan later goes into material default for at least 90 days, upon request by us, Farmer Mac must purchase such loan at par value. We have designated and Farmer Mac has approved an initial tranche of loans of $520 million as of August 31, 2015, and we expect to designate additional tranches of loans.

Loan Concentration

We serve electric and telecommunications members throughout the United States and its territories, including 49 states, the District of Columbia, American Samoa and Guam. The largest concentration of loans to borrowers in any one state represented approximately 14% and 15%, respectively, of total loans outstanding as of August 31, 2015 and May 31, 2015.

The largest total outstanding exposure to a single borrower or controlled group represented approximately 2% of total loans and guarantees outstanding as of August 31, 2015 and May 31, 2015. The 20 largest borrowers consisted of 12 distribution systems and 8 power supply systems as of August 31, 2015 and May 31, 2015. Table 15 displays the outstanding exposure of the 20 largest borrowers, by exposure type and by company, as of August 31, 2015 and May 31, 2015.

Table 15: Credit Exposure to 20 Largest Borrowers
  
 
August 31, 2015
 
May 31, 2015
 
Increase/
(Decrease)
(Dollars in thousands)
 
Amount
 
% of Total
 
Amount
 
% of Total
 
By exposure type:
 
 
 
 
 
 
 
 
 
 
Loans
 
$
5,434,547

 
23
%
 
$
5,478,977

 
24
%
 
$
(44,430
)
Guarantees
 
363,522

 
2

 
374,189

 
2

 
(10,667
)
Total exposure to 20 largest borrowers
 
$
5,798,069

 
25
%
 
$
5,853,166

 
26
%
 
$
(55,097
)
 
 
 
 
 
 
 
 
 
 
 
By company:
 
 
 
 
 
 
 
 
 
 
CFC
 
$
5,782,366

 
25
%
 
$
5,837,463

 
26
%
 
$
(55,097
)
NCSC
 
15,703

 

 
15,703

 

 

Total exposure to 20 largest borrowers
 
$
5,798,069

 
25
%
 
$
5,853,166

 
26
%
 
$
(55,097
)


21



Credit Performance

As part of our credit risk management process, we monitor and evaluate each borrower and loan in our loan portfolio and assign numeric internal risk ratings based on quantitative and qualitative assessments. Our ratings are aligned to regulatory definitions of pass and criticized categories with criticized divided between special mention, substandard and doubtful. Internal risk rating and payment status trends are indicators, among others, of the level of credit risk in our loan portfolio. As displayed in “Note 3—Loans and Commitments,” less than 1% of the loans in our portfolio were classified as criticized as of August 31, 2015 and May 31, 2015. Below we provide information on certain additional credit quality indicators, including nonperforming, restructured and individually impaired loans.

Nonperforming Loans

We classify loans as nonperforming at the earlier of the date when we determine: (i) interest or principal payments on the loan is past due 90 days or more; (ii) as a result of court proceedings, the collection of interest or principal payments based on the original contractual terms is not expected; or (iii) the full and timely collection of interest or principal is otherwise uncertain. Once a loan is classified as nonperforming, we generally place the loan on nonaccrual status. Interest accrued but not collected at the date a loan is classified as nonperforming is reversed against earnings.
 
Restructured Loans

We actively monitor underperforming loans and, from time to time, attempt to work with borrowers to manage such exposures through loan workouts or modifications that better align with the borrower's current ability to pay. Modified loans in which we grant one or more concessions to a borrower experiencing financial difficulty are accounted for and reported as troubled debt restructurings (“TDRs”). Loans modified in a TDR are generally placed on nonaccrual status, although in many cases such loans were already on nonaccrual status prior to modification. These loans may be returned to performing status and the accrual of interest resumed if the borrower performs under the modified terms for an extended period of time and we expect the borrower to continue to perform in accordance with the modified terms. In certain limited circumstances in which a modified loan is current at the modification date, the loan is not placed on nonaccrual status at the time of modification. We had modified loans, all of which met the definition of a TDR, totaling $11 million and $12 million as of August 31, 2015 and May 31, 2015, respectively.

Impaired Loans

We consider a loan to be individually impaired when, based on an assessment of the borrower’s financial condition and the adequacy of collateral, if any, it is probable that we will be unable to collect all amounts due in accordance with the original contractual terms of the loan. Individually impaired loans are subject to the specific allowance methodology. A loan that has been modified in a TDR is generally considered to be individually impaired until it matures, is repaid, or is otherwise liquidated, regardless of whether the borrower performs under the modified terms.

Table 16 presents nonperforming and performing TDR loans as of August 31, 2015 and May 31, 2015. These loans represent the population of loans identified as individually impaired as of the end of each period presented.


22



Table 16: Impaired Loans
(Dollars in thousands)
 
August 31, 2015
 
May 31, 2015
Modified TDR loans:
 
 
 
 
CFC/Distribution
 
$
7,221

 
$
7,221

NCSC
 

 
294

RTFC
 
4,156

 
4,221

Total TDR loans
 
$
11,377

 
$
11,736

 
 
 
 
 
TDR loan ratio: