Attached files

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EX-12 - COMPUTATIONS OF RATIO OF EARNINGS TO FIXED CHARGES - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru2qfy201610-qexhibit12.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru2qfy201610-qexhibit311.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru2qfy201610-qexhibit322.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru2qfy201610-qexhibit321.htm
EX-31.2 - SECTION 302 CFO CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru2qfy201610-qexhibit312.htm
EX-10.1 - AMENDED REVOLVING CREDIT AGREEMENT MATURING NOVEMBER 19, 2018 - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru2qfy201610-qexhibit101.htm
EX-10.2 - AMENDED REVOLVING CREDIT AGREEMENT MATURING NOVEMBER 19, 2020 - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru2qfy201610-qexhibit102.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 November 30, 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
 
10

4
 
Derivative Gains (Losses)
 
12

5
 
Derivative Average Notional Balances and Average Interest Rates
 
13

6
 
Loans Outstanding by Type and Member Class
 
15

7
 
Historical Retention Rate and Repricing Selection
 
16

8
 
Total Debt Outstanding
 
16

9
 
Collateral Pledged or on Deposit
 
17

10
 
Unencumbered Loans
 
18

11
 
Guarantees Outstanding
 
20

12
 
Maturities of Guarantee Obligations
 
21

13
 
Unadvanced Loan Commitments
 
21

14
 
Notional Maturities of Unconditional Committed Lines of Credit
 
21

15
 
Notional Maturities of Unadvanced Loan Commitments
 
22

16
 
Loan Portfolio Security Profile
 
23

17
 
Credit Exposure to 20 Largest Borrowers
 
24

18
 
TDR Loans
 
25

19
 
Nonperforming Loans
 
25

20
 
Allowance for Loan Losses
 
26

21
 
Rating Triggers for Derivatives
 
27

22
 
Liquidity Reserve Access
 
28

23
 
Projected Sources and Uses of Liquidity
 
29

24
 
Revolving Credit Agreements
 
31

25
 
Member Investments
 
32

26
 
Principal Maturity of Long-Term Debt
 
33

27
 
Credit Ratings
 
34

28
 
Financial Ratios under Revolving Credit Agreements
 
34

29
 
Financial Ratios under Indentures
 
35

30
 
Interest Rate Gap Analysis
 
36

31
 
Adjusted Financial Measures — Income Statement
 
37

32
 
TIER and Adjusted TIER
 
38

33
 
Adjusted Financial Measures — Balance Sheet
 
38

34
 
Leverage and Debt-to-Equity Ratios
 
39


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 may provide financing to members of CFC, government or quasi-government entities which own electric utility systems that meet the Rural Electrification Act definition of “rural”, and 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. 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

1



of CAH to Atlantic for a purchase price of $145 million, subject to certain adjustments. 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.
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 and six months ended November 30, 2015 and 2014, and as of November 30, 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.



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Table 1: Summary of Selected Financial Data
 
 
Three Months Ended November 30,
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
 
Change
 
2015
 
2014
 
Change
Statement of operations
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
256,325

 
$
235,235

 
9 %

 
$
502,441

 
$
472,526

 
6 %

Interest expense
 
(167,124
)
 
(158,275
)
 
6
 
(332,824
)
 
(314,827
)
 
6
Net interest income
 
89,201

 
76,960

 
16
 
169,617

 
157,699

 
8
Provision for loan losses
 
(1,240
)
 
(992
)
 
25
 
(5,802
)
 
5,779

 
(200)
Fee and other income
 
7,031

 
9,872

 
(29)
 
11,732

 
14,229

 
(18)
Derivative losses(1)
 
(101,184
)
 
(74,561
)
 
36
 
(113,201
)
 
(124,439
)
 
(9)
Results of operations of foreclosed assets
 
2,054

 
(28,991
)
 
(107)
 
133

 
(31,690
)
 
(100)
Operating expenses(2) 
 
(20,231
)
 
(18,237
)
 
11
 
(43,066
)
 
(36,780
)
 
17
Other non-interest expense
 
(9
)
 
(4
)
 
125
 
(366
)
 
57

 
(742)
Income before income taxes
 
(24,378
)
 
(35,953
)
 
(32)
 
19,047

 
(15,145
)
 
(226)
Income tax expense
 
(110
)
 
41

 
(368)
 
(440
)
 
(155
)
 
184
Net income (loss)
 
$
(24,488
)
 
$
(35,912
)
 
(32) %

 
$
18,607

 
$
(15,300
)
 
(222)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted statement of operations
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted interest expense(3)
 
$
(189,697
)
 
$
(180,039
)
 
5 %

 
$
(375,553
)
 
$
(356,692
)
 
5 %

Adjusted net interest income(3)
 
66,628

 
55,196

 
21
 
126,888

 
115,834

 
10
Adjusted net income(3)
 
54,123

 
16,885

 
221
 
89,079

 
67,274

 
32
 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios
 
 
 
 
 
 
 
 
 
 
 
 
Fixed-charge coverage ratio/TIER (4)
 
0.85

 
0.77

 
8
 bps
 
1.06

 
0.95

 
11
 bps
Adjusted TIER(3)
 
1.29

 
1.09

 
20
 
1.24

 
1.19

 
5
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
November 30, 2015
 
May 31, 2015
 
Change
Balance sheet
 
 
 
 
 
 
 
 
 
 
 
 
Cash, investments and time deposits
 
 
 
 
 
 
 
$
669,977

 
$
818,308

 
(18)%
Loans to members(5)
 
 
 
 
 
 
 
22,673,529

 
21,469,017

 
6
Allowance for loan losses
 
 
 
 
 
 
 
(39,600
)
 
(33,690
)
 
18
Loans to members, net
 
 
 
 
 
 
 
22,633,929

 
21,435,327

 
6
Total assets(6)
 
 
 
 
 
 
 
23,850,982

 
22,846,059

 
4
Short-term borrowings
 
 
 
 
 
 
 
3,542,802

 
3,127,754

 
13
Long-term debt
 
 
 
 
 
 
 
16,858,024

 
16,244,794

 
4
Subordinated deferrable debt
 
 
 
 
 
 
 
395,736

 
395,699

 
Members’ subordinated certificates
 
 
 
 
 
 
 
1,479,562

 
1,505,420

 
(2)
Total debt outstanding(6)(7)
 
 
 
 
 
 
 
22,276,124

 
21,273,667

 
5
Total liabilities(6)
 
 
 
 
 
 
 
22,957,467

 
21,934,273

 
5
Total equity
 
 
 
 
 
 
 
893,515

 
911,786

 
(2)
Guarantees (8)
 
 
 
 
 
 
 
961,250

 
986,500

 
(3)
 
 
 
 
 
 
 
 
 
 
 
 
 
Ratios
 
 
 
 
 
 
 
 
 
 
 

Leverage ratio(9)
 
 
 
 
 
 
 
26.77

 
25.14

 
163
 bps
Adjusted leverage ratio(3)
 
 
 
 
 
 
 
6.84

 
6.58

 
26
Debt-to-equity ratio(10)
 
 
 
 
 
 
 
25.69

 
24.06

 
163
Adjusted debt-to-equity ratio(3)
 
 
 
 
 
 
 
6.53

 
6.26

 
27
____________________________ 
— Change is less than one percent or not meaningful.


3



(1)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.
(2)Consists of the salaries and employee benefits and the other general and administrative expenses components of non-interest expense, each of which are presently separately on our consolidated statements of operations.
(3)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.
(4)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 during each period presented because we did not have any capitalized interest during these periods.
(5)Loans to members consists of the outstanding principal balance of member loans plus unamortized deferred loan origination costs, which totaled $10 million as of both November 30, 2015 and May 31, 2015.
(6)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 as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts, rather than as an asset. We retrospectively applied this guidance, 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.
(7)Total debt includes debt issuance costs, which were previously classified as an asset on our consolidated balance sheets, of $50 million and $47 million as of November 30, 2015 and May 31, 2015, respectively.
(8)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.
(9)Calculated based on total liabilities and guarantees at period end divided by total equity at period end.
(10)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 a net loss of $24 million and $36 million for the quarter ended November 30, 2015 (“current quarter”) and same prior-year quarter, respectively, and TIER of 0.85 and 0.77, respectively. We reported net income of $19 million and TIER of 1.06 for the six months ended November 30, 2015, compared with a net loss of $15 million and TIER of 0.95 for the same prior year period. Our debt-to-equity ratio increased to 25.69-to-1 as of November 30, 2015, from 24.06-to-1 as of May 31, 2015.

Our reported net losses of $24 million and $36 million in the current quarter and the same prior quarter, respectively, were primarily driven by fair value losses of $101 million and $75 million, respectively, on the derivatives we use to economically hedge the interest rate risk related to certain financial assets and liabilities that are not measured at fair value. Although we recorded higher derivative losses in the current quarter than the same prior year quarter, our reported net loss was lower because of an increase in net interest income of $12 million, driven by an increase in average total loans of $1,746 million, or 9%, and a reduction in losses from foreclosed assets of $31 million, attributable to the absence of an impairment charge of $27 million related to CAH recorded in the prior year quarter.

Our reported net income of $19 million for the six months ended November 30, 2015 and net loss of $15 million for the six months ended November 30, 2014 also reflected the unfavorable impact of derivative losses, which totaled $113 million and $124 million, respectively. The lower derivative losses during the six months ended November 30, 2015, compared with the

4



same prior year period, coupled with an increase in net interest income of $12 million, driven by an increase in average total loans of $1,508 million, or 7%, and the absence of the CAH impairment charge of $27 million were the primary drivers of the improvement in our reported results for the six months ended November 30, 2015.

We expect volatility in our reported GAAP results from period to period due to changes in market conditions that result in periodic fluctuations in the estimated fair value of our derivative instruments, which serve as economic hedges. While we mark to market our derivatives through earnings, the corresponding hedged items are not subject to mark-to-market treatment. As such, our debt covenants are based on our adjusted non-GAAP results, which we also use to evaluate our core operating performance.

Adjusted Non-GAAP Results

Our adjusted net income totaled $54 million and $17 million for the current quarter and same prior-year quarter, respectively, and our adjusted TIER was 1.29 and 1.09, respectively. Our adjusted net income was $89 million and $67 million for the six months ended November 30, 2015 and 2014, respectively, and our adjusted TIER was 1.24 and 1.19, respectively, for the same prior-year period. Our adjusted debt-to-equity ratio increased to 6.53-to-1 as of November 30, 2015, from 6.26-to-1 as of May 31, 2015.

The increases in adjusted net income in the current quarter and six months ended November 30, 2015 over the same prior-year periods were primarily driven by a significant increase in adjusted net interest income resulting from the growth in average loan balances and the absence of the CAH impairment charge of $27 million recorded in the prior year quarter.

Lending Activity

Total loans outstanding, which consists of the unpaid principal balance and excludes deferred loan origination costs, was $22,664 million as of November 30, 2015, an increase of $1,204 million, or 6%, from May 31, 2015. The increase was primarily due to an increase in CFC distribution and power supply loans of $1,058 million and $199 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 $27 million and a decrease in RTFC loans of $21 million.
             
CFC had long-term fixed-rate loans totaling $510 million that repriced during the six months ended November 30, 2015. Of this total, $481 million repriced to a new long-term fixed rate; $22 million repriced to a long-term variable rate; and $7 million were repaid in full.

Financing Activity

Our outstanding debt volume generally increases and decreases in response to member loan demand. As outstanding loan balances increased during the six months ended November 30, 2015, our debt volume also increased. Total debt outstanding was $22,276 million as of November 30, 2015, an increase of $1,002 million, or 5%, from May 31, 2015. The increase was primarily attributable to an advance of $180 million under the note purchase agreement with the Federal Agricultural Mortgage Corporation (“Farmer Mac”), an advance of $250 million under the Guaranteed Underwriter Program of the USDA and the issuance of $750 million aggregate principal amount of collateral trust bonds.

In July 2015, we executed a new three-year $300 million secured revolving note purchase agreement with Farmer Mac to provide us additional funding flexibility. In November 2015, we amended and restated our $1,665 million three-year and $1,645 million five-year revolving credit agreements to extend the maturity dates to November 19, 2018 and November 19, 2020, respectively, from October 28, 2017 and October 28, 2019, respectively. We provide additional information on our financing activities below under “Consolidated Balance Sheet Analysis—Debt” and “Liquidity Risk.”

Outlook for the Next 12 Months

We 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.


5



Long-term debt scheduled to mature over the next 12 months totaled $1,515 million as of November 30, 2015. 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 $583 million in cash and time deposits, up to $500 million available under committed loan facilities from the Federal Financing Bank (“FFB”), $3,309 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 $2,428 million available under the existing revolving note purchase agreement with Farmer Mac as of November 30, 2015. On September 28, 2015, we received a commitment from the RUS to guarantee a loan of $250 million from the FFB pursuant to the Guaranteed Underwriter Program. We expect to close the new committed loan facility with RUS during the third quarter of fiscal year 2016. 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 $2,523 million as of November 30, 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 expect to continue to roll over our outstanding dealer commercial paper of $1,020 million as of November 30, 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 significant increase in outstanding loan balances over the last 18 months, it has been necessary to increase our borrowings to fund the loan growth. As a result, our adjusted debt-to-equity ratio will likely continue to be higher than 6.00-to-1 for an extended period of time.

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 designated, and Farmer Mac approved an initial tranche of loans with an aggregate outstanding principal balance of $520 million as of August 31, 2015. As a result of principal payments, the balance of these loans totaled $515 million as of November 30, 2015.

As previously disclosed, on September 30, 2015, CFC entered into a Purchase Agreement with CAH, 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 continue to 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.


6



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 six months ended November 30, 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.
CONSOLIDATED RESULTS OF OPERATIONS

The section below provides a comparative discussion of our condensed consolidated results of operations between the three months ended November 30, 2015 and 2014 and between the six months ended November 30, 2015 and 2014. Following this section, we provide a comparative analysis of our condensed consolidated balance sheets as of November 30, 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 and six months ended November 30, 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 November 30,
(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)
 
$
20,516,596

 
$
243,601

 
4.78
%
 
$
18,688,811

 
$
222,023

 
4.77
%
Long-term variable-rate loans
 
691,793

 
4,822

 
2.80

 
693,758

 
4,902

 
2.83

Line of credit loans
 
1,057,682

 
6,386

 
2.43

 
1,141,369

 
6,687

 
2.35

Restructured loans
 
10,333

 
130

 
5.06

 
7,555

 
10

 
0.53

Nonperforming loans
 
2,787

 
29

 
4.18

 
1,695

 

 

Interest-based fee income(2)
 

 
(600
)
 

 

 
64

 

Total loans
 
22,279,191

 
254,368

 
4.59

 
20,533,188

 
233,686

 
4.56

Cash, investments and time deposits
 
631,995

 
1,957

 
1.25

 
720,433

 
1,549

 
0.86

Total interest-earning assets
 
$
22,911,186

 
$
256,325

 
4.50
%
 
$
21,253,621

 
$
235,235

 
4.44
%
Other assets, less allowance for loan losses
 
878,481

 
 
 
 
 
1,132,713

 
 
 
 
Total assets
 
$
23,789,667

 
 
 
 
 
$
22,386,334

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Short-term debt
 
$
3,150,623

 
$
3,382

 
0.43
%
 
$
3,826,661

 
$
5,663

 
0.59
%
Medium-term notes
 
3,369,780

 
20,819

 
2.48

 
2,864,538

 
17,707

 
2.48

Collateral trust bonds
 
6,660,248

 
81,769

 
4.94

 
6,079,894

 
77,082

 
5.09

Subordinated deferrable debt
 
391,381

 
4,788

 
4.92

 
400,000

 
4,803

 
4.82

Subordinated certificates
 
1,469,916

 
15,097

 
4.13

 
1,523,922

 
16,105

 
4.24

Long-term notes payable
 
6,740,850

 
41,269

 
2.46

 
5,771,706

 
36,915

 
2.57

Total interest-bearing liabilities
 
$
21,782,798

 
$
167,124

 
3.09
%
 
$
20,466,721

 
$
158,275

 
3.10
%
Other liabilities
 
1,083,069

 
 
 
 
 
963,240

 
 
 
 
Total liabilities
 
22,865,867

 
 
 
 
 
21,429,961

 
 
 
 
Total equity
 
923,800

 
 
 
 
 
956,373

 
 
 
 
Total liabilities and equity
 
$
23,789,667

 
 
 
 
 
$
22,386,334

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread(3)
 
 
 
 
 
1.41
%
 
 
 
 
 
1.34
%
Impact of non-interest bearing funding(4)
 
 
 
 
 
0.15

 
 
 
 
 
0.11

Net interest income/net interest yield(5)
 
 
 
$
89,201

 
1.56
%
 
 
 
$
76,960

 
1.45
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest income/adjusted net interest yield:
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
 
 
$
256,325

 
4.50
%
 
 
 
$
235,235

 
4.44
%
Interest expense
 
 
 
167,124

 
3.09

 
 
 
158,275

 
3.10

Add: Net derivative cash settlement cost(6)
 
 
 
22,573

 
0.92

 
 
 
21,764

 
1.03

Adjusted interest expense/adjusted average cost(7)
 
 
 
$
189,697

 
3.50
%
 
 
 
$
180,039

 
3.52
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest spread(4)
 
 
 
 
 
1.00
%
 
 
 
 
 
0.92
%
Impact of non-interest bearing funding
 
 
 
 
 
0.17

 
 
 
 
 
0.12

Adjusted net interest income/adjusted net interest yield(8)
 
 
 
$
66,628

 
1.17
%
 
 
 
$
55,196

 
1.04
%

8



 
 
Six Months Ended November 30,
(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)
 
$
20,213,693

 
$
475,803

 
4.71
%
 
$
18,572,866

 
$
444,351

 
4.77
%
Long-term variable-rate loans
 
688,829

 
9,842

 
2.86

 
724,399

 
10,262

 
2.83

Line of credit loans
 
1,048,807

 
12,584

 
2.40

 
1,149,132

 
13,629

 
2.37

Restructured loans
 
10,873

 
130

 
2.39

 
7,570

 
10

 
0.26

Nonperforming loans
 
1,386

 
29

 
4.18

 
1,884

 

 

Interest-based fee income(2)
 

 
(529
)
 

 

 
153

 

Total loans
 
21,963,588

 
497,859

 
4.53

 
20,455,851

 
468,405

 
4.57

Cash, investments and time deposits
 
677,440

 
4,582

 
1.35

 
858,957

 
4,121

 
0.96

Total interest-earning assets
 
$
22,641,028

 
$
502,441

 
4.44
%
 
$
21,314,808

 
$
472,526

 
4.42
%
Other assets, less allowance for loan losses
 
875,749

 
 
 
 
 
1,015,962

 
 
 
 
Total assets
 
$
23,516,777

 


 
 
 
$
22,330,770

 


 


 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 


 


 


 


 


Short-term debt
 
$
2,973,934

 
$
5,924

 
0.40
%
 
$
3,812,950

 
$
8,804

 
0.46
%
Medium-term notes
 
3,365,431

 
40,972

 
2.43

 
2,812,085

 
34,866

 
2.47

Collateral trust bonds
 
6,721,564

 
164,600

 
4.90

 
6,048,488

 
153,264

 
5.05

Subordinated deferrable debt
 
395,714

 
9,571

 
4.84

 
400,000

 
9,570

 
4.77

Subordinated certificates
 
1,483,887

 
30,403

 
4.10

 
1,533,475

 
32,851

 
4.27

Long-term notes payable
 
6,645,058

 
81,354

 
2.45

 
5,815,810

 
75,472

 
2.59

Total interest-bearing liabilities
 
$
21,585,588

 
$
332,824

 
3.08
%
 
$
20,422,808

 
$
314,827

 
3.07
%
Other liabilities
 
1,011,694

 
 
 

 
946,469

 

 
 
Total liabilities
 
22,597,282

 
 
 

 
21,369,277

 

 
 
Total equity
 
919,495

 
 
 
 
 
961,493

 

 
 
Total liabilities and equity
 
$
23,516,777

 


 
 
 
$
22,330,770

 


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread(3)
 
 
 


 
1.36
%
 


 


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

 
 
 
 
 
0.13

Net interest income/net interest yield(5)
 
 
 
$
169,617

 
1.50
%
 
 
 
$
157,699

 
1.48
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest income/adjusted net interest yield:
 
 
 
 
 


 
 
 
 
 
 
Interest income
 
 
 
$
502,441

 
4.44
%
 
 
 
$
472,526

 
4.42
%
Interest expense
 
 
 
332,824

 
3.08

 
 
 
314,827

 
3.07

Add: Net derivative cash settlement cost(6)
 
 
 
42,729

 
0.87

 
 
 
41,865

 
0.98

Adjusted interest expense/adjusted average cost(7)
 
 
 
$
375,553

 
3.48
%
 


 
$
356,692

 
3.48
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest spread(4)
 
 
 
 
 
0.96
%
 

 
 
 
0.94
%
Impact of non-interest bearing funding
 
 
 
 
 
0.16

 
 
 
 
 
0.14

Adjusted net interest income/adjusted net interest yield(8)
 
 
 
$
126,888

 
1.12
%
 

 
$
115,834


1.08
%
____________________________ 
(1)Interest income includes loan conversion fees, which are generally deferred and recognized in interest income using the effective interest method. A small portion of conversion fees that are intended to cover the administrative costs related to the conversion are recognized into interest income immediately at the date of conversion.
(2)Amounts primarily include the amortization of deferred loan origination costs and late payment fees. Excludes up-front loan arranger fees, which are not not based on interest rates, for the three and six months ended November 30, 2015. These fees are included in fee and other income.


9



(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 $9,922 million and $8,493 million for the three months ended November 30, 2015 and 2014, respectively. The average outstanding notional amount of derivatives was $9,855 million and $8,489 million for the six months ended November 30, 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 November 30,
2015 versus 2014
 
Six Months Ended November 30,
2015 versus 2014
 
 
 
 
Variance due to:(1)
 
 
 
Variance due to:(1)
(Dollars in thousands)
 
Total
Variance
 
Volume
 
Rate
 
Total
Variance
 
Volume
 
Rate
Interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
21,578

 
$
21,048

 
$
530

 
$
31,452

 
$
37,935

 
$
(6,483
)
Long-term variable-rate loans
 
(80
)
 
(27
)
 
(53
)
 
(420
)
 
(531
)
 
111

Line of credit loans
 
(301
)
 
(507
)
 
206

 
(1,045
)
 
(1,224
)
 
179

Restructured loans
 
120

 
4

 
116

 
120

 
4

 
116

Nonperforming loans
 
29

 

 
29

 
29

 

 
29

Fee income
 
(664
)
 

 
(664
)
 
(682
)
 

 
(682
)
Total loans
 
20,682

 
20,518

 
164

 
29,454

 
36,184

 
(6,730
)
Cash, investments and time deposits
 
408

 
(194
)
 
602

 
461

 
(880
)
 
1,341

Interest income
 
21,090

 
20,324

 
766

 
29,915

 
35,304

 
(5,389
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest expense:
 
 
 
 
 
 
 
 
 
 
 
 
Short-term debt
 
(2,281
)
 
(1,013
)
 
(1,268
)
 
(2,880
)
 
(1,956
)
 
(924
)
Medium-term notes
 
3,112

 
3,066

 
46

 
6,106

 
6,747

 
(641
)
Collateral trust bonds
 
4,687

 
7,127

 
(2,440
)
 
11,336

 
16,590

 
(5,254
)
Subordinated deferrable debt
 
(15
)
 
(116
)
 
101

 
1

 
(128
)
 
129

Subordinated certificates
 
(1,008
)
 
(613
)
 
(395
)
 
(2,448
)
 
(1,149
)
 
(1,299
)
Long-term notes payable
 
4,354

 
6,081

 
(1,727
)
 
5,882

 
10,526

 
(4,644
)
Interest expense
 
8,849

 
14,532

 
(5,683
)
 
17,997

 
30,630

 
(12,633
)
Net interest income
 
$
12,241

 
$
5,792

 
$
6,449

 
$
11,918

 
$
4,674

 
$
7,244

 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest income:
 
 
 
 
 
 
 
 
 
 
 
 
Interest income
 
$
21,090

 
$
20,324

 
$
766

 
$
29,915

 
$
35,304

 
$
(5,389
)
Interest expense
 
8,849

 
14,532

 
(5,683
)
 
17,997

 
30,630

 
(12,633
)
Derivative cash settlements(2)
 
809

 
3,593

 
(2,784
)
 
864

 
6,605

 
(5,741
)
Adjusted interest expense(3)
 
9,658

 
18,125

 
(8,467
)
 
18,861

 
37,235

 
(18,374
)
Adjusted net interest income
 
$
11,432

 
$
2,199

 
$
9,233

 
$
11,054

 
$
(1,931
)
 
$
12,985


10



____________________________ 
(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, the variance due to average volume represents the change in derivative cash settlements resulting from the change in the average notional amount of derivative contracts outstanding. The variance due to average rate represents the change in derivative cash settlements resulting from the net difference between the average rate paid and the average rate received for interest rate swaps during the period.
(3) See “Non-GAAP Financial Measures” for additional information on our adjusted non-GAAP measures.

Net interest income of $89 million for the current quarter increased by $12 million, or 16% from the same prior year quarter, driven by an increase in average interest-earning assets of 8% and an increase in net interest yield of 8% (11 basis points) to 1.56%.

Net interest income of $170 million for the six months ended November 30, 2015, increased by $12 million, or 8%, from the same prior-year period, driven by an increase in average interest-earning assets of 6% and an increase in net interest yield of 1% (2 basis points) to 1.50%.


Average Interest-Earning Assets: The increase in average interest-earning assets for the current quarter and six months ended November 30, 2015 was primarily attributable to growth in average total loans of $1,746 million, or 9%, and $1,508 million, or 7%, respectively, over the same prior year periods, as members refinanced with us loans made by other lenders and obtained advances to fund capital investments.

Net Interest Yield: The increase in the net interest yield for the current quarter and six months ended November 30, 2015 reflects the combined impact of a reduction in our average cost of funds and an increase in the average yield on interest-earning assets. 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. 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. We therefore lowered the contractual long-term fixed rates on new loans during this period. The impact of the accelerated recognition of deferred loan conversion fees during the current quarter and six months ended November 30, 2015 due to loan payoffs more than offset the reduction in the contractual long-term fixed rates, resulting in the overall increase in average yield on interest-earning assets.

Adjusted net interest income of $67 million for the current quarter increased by $11 million, or 21%, from the same prior- year quarter, driven by the increase in average interest-earning assets of 8% and an increase in adjusted net interest yield of 13% (13 basis points) to 1.17%.

Adjusted net interest income of $127 million for the six months ended November 30, 2015 increased by $11 million, or 10%, from the same prior-year period, driven by the increase in average interest-earning assets of 6% and an increase in the adjusted net interest yield of 4% (4 basis points) to 1.12%.

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 $23 million and $22 million for the three months ended November 30, 2015 and 2014, respectively, and $43 million and $42 million for the six months ended November 30, 2015 and 2014, respectively. See “Non-GAAP Financial Measures” for additional information on our adjusted measures.

Provision for Loan Losses

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

We recorded a provision for loan losses of $1 million for the three months ended November 30, 2015 and 2014. We recorded a provision for loan losses of $6 million for the six months ended November 30, 2015, compared with a negative provision of $6 million for the six months ended November 30, 2014. The growth in our loan portfolio was the primary driver of the provision expense of $6 million for the six months ended November 30, 2015. In comparison, outstanding loans remained

11



relatively flat during the same prior year period, and we experienced modest improvement in the credit quality and overall credit risk profile of our loan portfolio, which together resulted in the negative provision of $6 million for the six months ended November 30, 2014.

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.

We recorded losses from non-interest income of $92 million and $94 million for the three months ended November 30, 2015 and 2014, respectively. We recorded losses from non-interest income of $101 million and $142 million for the six months ended November 30, 2015 and 2014, respectively. The variances in non-interest income for three and six months ended November 30, 2015, from the same prior year periods were primarily attributable to changes in net derivative losses recognized in our consolidated statements of operations and an impairment charge of $27 million related to CAH recorded in the three months ended November 30, 2014.

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 November 30, 2015 or May 31, 2015.

We recorded derivative losses of $101 million and $75 million for the three months ended November 30, 2015 and 2014, respectively, and derivative losses $113 million and $124 million for the six months ended November 30, 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 and six months ended November 30, 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 November 30,
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
 
2015
 
2014
Derivative gains (losses) attributable to:
 
 
 
 
 
 
 
 
Derivative cash settlements
 
$
(22,573
)
 
$
(21,764
)
 
$
(42,729
)
 
$
(41,865
)
Derivative forward value
 
(78,611
)
 
(52,797
)
 
(70,472
)
 
(82,574
)
Derivative losses
 
$
(101,184
)
 
$
(74,561
)
 
$
(113,201
)
 
$
(124,439
)

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

12



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 and six months ended November 30, 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.

Table 5: Derivative Average Notional Balances and Average Interest Rates
 
 
Three Months Ended November 30,
 
 
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
 
$
6,188,639

 
3.07
%
 
0.33
%
 
$
5,543,655

 
3.30
%
 
0.24
%
Receive-fixed swaps
 
3,733,066

 
0.80

 
3.02

 
2,949,000

 
0.83

 
3.60

Total
 
$
9,921,705

 
2.21
%
 
1.35
%
 
$
8,492,655

 
2.45
%
 
1.41
%
 
 
Six Months Ended November 30,
 
 
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
 
$
6,063,335

 
3.10
%
 
0.31
%
 
$
5,481,180

 
3.31
%
 
0.24
%
Receive-fixed swaps
 
3,791,350

 
0.80

 
3.05

 
3,007,333

 
0.84

 
3.61

Total
 
$
9,854,685

 
2.21
%
 
1.37
%
 
$
8,488,513

 
2.43
%
 
1.44
%

The derivative losses of $101 million and $113 million recorded in the three and six months ended November 30, 2015, were primarily attributable to a net decrease in the fair value of our pay-fixed swaps due to a flattening of the swap yield curve resulting from a gradual decline in interest rates across the medium and longer end of the yield curve.

The net derivative losses of $75 million and $124 million recorded for the three and six months ended November 30, 2014, respectively, were primarily attributable to a flattening of the swap yield curve during the period, as the overall level of interest rates on the longer end of the yield curve declined. This decline resulted in a net decrease in the fair value of our pay-fixed swaps and a net increase in the fair value of our receive-fixed swaps. Because of the composition of our derivative portfolio, the decline in the fair value of our pay-fixed swaps more than offset the increase in the fair value of our receive-fixed swaps.

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 a gain from the results of operations of foreclosed assets of $2 million for the three months ended November 30, 2015, compared with a loss of $29 million for the three months ended November 30, 2014. We recorded a gain from the results of foreclosed assets of less than $1 million for the six months ended November 30, 2015, compared with a loss of $32 million for the six months ended November 30, 2014. The gains recorded during the three and six months ended November 30, 2015 were primarily attributable to purchase price adjustments related to CAH, while the losses recorded

13



during the prior year periods were primarily attributable to a CAH impairment charge of $27 million recorded in the second quarter of fiscal year 2015.

As discussed above under “Introduction” and “Executive Summary,” on September 30, 2015, CFC entered into a Purchase Agreement with CAH, 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 $117 million as of November 30, 2015 reflects the expected net proceeds, including agreed-upon purchase price adjustments and estimated 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.

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 $20 million and $18 million for the three months ended November 30, 2015 and 2014, respectively, and non-interest expense of $43 million and $37 million for the six months ended November 30, 2015 and 2014, respectively. The increase for the current year periods over the same prior-year periods was primarily attributable to an increase in salaries and employee benefit expense, costs related to system infrastructure enhancements and higher 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. The fluctuations in net income (loss) attributable to noncontrolling interests are primarily due to fluctuations in the fair value of NCSC’s derivative instruments.

We recorded a net loss attributable to noncontrolling interests of less than $1 million for the three months ended November 30, 2015 and 2014, and a net loss of less than $1 million and a net gain of less than $1 million for the six months ended November 30, 2015 and 2014, respectively.
CONSOLIDATED BALANCE SHEET ANALYSIS

Total assets of $23,851 million as of November 30, 2015 increased by $1,005 million, or 4%, from May 31, 2015, primarily due to growth in our loan portfolio. Total liabilities of $22,957 million as of November 30, 2015 increased by $1,023 million, or 5%, from May 31, 2015, primarily due to debt issuances to fund our loan portfolio growth. Total equity decreased by $18 million to $894 million as of November 30, 2015. The decrease in total equity was primarily attributable to the patronage capital retirement of $39 million in September 2015, which was partially offset by our net income of $19 million for the six months ended November 30, 2015.
Following is a discussion of changes in the major components of our assets and liabilities during the six months ended November 30, 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.


14



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. We also offer a conversion option to members with long-term loan agreements, which allows borrowers to change the rate and term prior to the repricing date. Borrowers are generally charged a conversion fee when converting from a fixed to a variable rate, or a fixed rate to another fixed rate.

Table 6 summarizes total loans outstanding, by type and by member class, as of November 30, 2015 and May 31, 2015.

Table 6: Loans Outstanding by Type and Member Class
 
 
November 30, 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
 
$
20,601,694

 
91
%
 
$
19,543,274

 
91
%
 
$
1,058,420

Long-term variable-rate loans
 
712,955

 
3

 
698,495

 
3

 
14,460

Loans guaranteed by RUS
 
176,425

 
1

 
179,241

 
1

 
(2,816
)
Total long-term loans
 
21,491,074

 
95

 
20,421,010

 
95

 
1,070,064

Line of credit loans
 
1,172,574

 
5

 
1,038,210

 
5

 
134,364

Total loans outstanding(1)
 
$
22,663,648

 
100
%
 
$
21,459,220

 
100
%
 
$
1,204,428

 
 
 
 
 
 
 
 
 
 
 
Loans by member class:
 
 
 
 
 
 
 
 
 
 
CFC:
 
 
 
 
 
 
 
 
 
 
Distribution
 
$
17,153,380

 
76
%
 
$
16,095,043

 
75
%
 
$
1,058,337

Power supply
 
4,380,665

 
19

 
4,181,481

 
20

 
199,184

Statewide and associate
 
60,061

 

 
65,466

 

 
(5,405
)
CFC
 
21,594,106

 
95

 
20,341,990

 
95

 
1,252,116

RTFC
 
364,739

 
2

 
385,709

 
2

 
(20,970
)
NCSC
 
704,803

 
3

 
731,521

 
3

 
(26,718
)
Total loans outstanding(1)
 
$
22,663,648

 
100
%
 
$
21,459,220

 
100
%
 
$
1,204,428

____________________________ 
(1)Total loans outstanding represents the outstanding unpaid principal balance of loans. Unamortized deferred loan origination costs, which totaled $10 million as of November 30, 2015 and May 31, 2015, are excluded from total loans outstanding. These costs are, however, included in loans to members reported on the condensed consolidated balance sheets.

Total loans outstanding of $22,664 million as of November 30, 2015 increased by $1,204 million, or 6%, from May 31, 2015. The increase was primarily due to an increase in CFC distribution and power supply loans of $1,058 million and $199 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 $27 million and a decrease in RTFC loans of $21 million.

Table 7 compares the historical retention rate for long-term fixed-rate loans that repriced during the six months ended November 30, 2015, with the historical retention rate for loans that repriced during the fiscal year ended May 31, 2015. Table 7 also displays the percentage of borrowers that selected either another fixed-rate term or a variable rate. The retention rate is calculated based on the election made by the borrower at the repricing date.




  


15



Table 7: Historical Retention Rate and Repricing Selection
 
 
Six Months Ended November 30, 2015
 
Year Ended May 31, 2015
(Dollars in thousands)
 
Amount
 
%
 
Amount
 
%
Loans retained:
 
 
 
 
 
 
 
 
Long-term fixed rate selected
 
$
480,988

 
94
%
 
$
991,279

 
81
%
Long-term variable rate selected
 
22,399

 
5

 
154,946

 
13

Loans repriced and sold by CFC
 

 

 
3,904

 

Total loans retained
 
503,387

 
99

 
1,150,129

 
94

Total loans repaid
 
6,849

 
1

 
76,380

 
6

Total loans repriced
 
$
510,236

 
100
%
 
$
1,226,509

 
100
%


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 November 30, 2015 and May 31, 2015.

Table 8: Total Debt Outstanding
(Dollars in thousands)
 
November 30, 2015
 
May 31, 2015
 
Increase/
(Decrease)
Debt product type:
 
 
 
 
 
 
Commercial paper sold through dealers, net of discounts
 
$
1,020,287

 
$
984,954

 
$
35,333

Commercial paper sold directly to members, at par
 
759,815

 
736,162

 
23,653

Select notes
 
809,298

 
671,635

 
137,663

Daily liquidity fund notes
 
740,142

 
509,131

 
231,011

Collateral trust bonds
 
6,850,660

 
6,755,067

 
95,593

Guaranteed Underwriter Program notes payable to FFB
 
4,643,790

 
4,406,465

 
237,325

Farmer Mac notes payable
 
2,072,040

 
1,910,688

 
161,352

Medium-term notes
 
3,458,237

 
3,352,023

 
106,214

Other notes payable(3)
 
46,557

 
46,423

 
134

Subordinated deferrable debt
 
395,736

 
395,699

 
37

Membership certificates
 
629,977

 
645,035

 
(15,058
)
Loan and guarantee certificates
 
629,589

 
640,889

 
(11,300
)
Member capital securities
 
219,996

 
219,496

 
500

Total debt outstanding
 
$
22,276,124

 
$
21,273,667

 
$
1,002,457

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


Variable-rate debt(2)
 
18

 
19

 
 
Total
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
Original contractual maturity:
 
 
 
 
 
 
Long-term debt
 
84
%
 
85
%
 
 
Short-term debt
 
16

 
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.

16



(3) Other notes payable includes 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 of $22,276 million as of November 30, 2015 increased by $1,002 million, or 5%, from May 31, 2015, primarily due to debt issuances to fund our loan portfolio growth. The increase was primarily attributable to an advance of $180 million under the note purchase agreement with the Farmer Mac, an advance of $250 million under the Guaranteed Underwriter Program of the USDA and the issuance of $350 million aggregate principal amount of 2.30% collateral trust bonds due 2020 and $400 million aggregate principal amount of 3.25% collateral trust bonds due 2025. Significant financing-related developments during the six months ended November 30, 2015 are summarized below.

On July 7, 2015, we received an advance of $180 million under the revolving note purchase agreement with Farmer Mac.

On July 31, 2015, we received an advance of $250 million with a 20-year final maturity under the Guaranteed Underwriter Program of the USDA.

On July 31, 2015, we executed a new three-year $300 million revolving note purchase agreement with Farmer Mac to provide us additional funding flexibility.

On October 27, 2015, we issued $350 million aggregate principal amount of 2.30% collateral trust bonds due 2020, and $400 million aggregate principal amount of 3.25% collateral trust bonds due 2025.

On November 19, 2015, we amended and extended our revolving credit agreements, which reduced the total commitment from third parties to $3,310 million as of November 30, 2015, from $3,420 million as of May 31, 2015. Prior to this amendment, NCSC assumed $155 million in commitments from one of the banks, which was reduced to $110 million as part of amendment. Although the total commitment amount under our new revolving credit agreements is unchanged from the previous total of $3,420 million, NCSC’s commitment amount is excluded from the commitment amount from third parties of $3,310 million because NCSC receives all of its funding from CFC and NCSC’s financial results are consolidated with CFC. See “Liquidity Risk” for additional information.

Pledging of Loans and Loans on Deposit

We are required to pledge collateral equal to at least 100% of the outstanding balance of debt issued under our collateral trust bond indentures and note purchase agreements with Farmer Mac. In addition, we are required to maintain collateral on deposit equal to at least 100% of the outstanding balance of debt to the FFB under the Guaranteed Underwriter Program of the USDA, which supports the Rural Economic Development Loan and Grant program, for which distribution and power supply loans may be deposited. Table 9 summarizes the amount of notes pledged or on deposit as collateral as a percentage of the related debt outstanding under the debt agreements noted above as of November 30, 2015 and May 31, 2015.

Table 9: Collateral Pledged or on Deposit
 
 
Requirement/Limit
 
Actual
Debt Agreement
 
Debt Indenture
Minimum
 
Revolving Credit Agreements
Maximum
 
November 30, 2015
 
May 31, 2015
Collateral trust bonds 1994 indenture
 
100
%
 
150
%
 
109
%
 
106
%
Collateral trust bonds 2007 indenture
 
100

 
150

 
118

 
108

Farmer Mac
 
100

 
150

 
113

 
113

Clean Renewable Energy Bonds Series 2009A
 
100

 
150

 
110

 
117

FFB Notes (1) (2)
 
100

 
150

 
118

 
112

____________________________ 
(1)Represents collateral on deposit as a percentage of the related debt outstanding.
(2)All pledge agreements previously entered into with RUS and U.S. Bank National Association were consolidated into one amended, restated and consolidated pledge agreement in December 2012.


17



Table 10 summarizes the balance of loans pledged or on deposit for secured debt, the excess collateral pledged and unencumbered loans as of November 30, 2015 and May 31, 2015.

Table 10: Unencumbered Loans
(Dollars in thousands)
 
November 30, 2015
 
May 31, 2015
Total loans outstanding(1) 
 
$
22,663,648

 
$
21,459,220

Less: Total secured debt or debt requiring collateral on deposit
 
(13,880,377
)
 
(13,386,713
)
 Excess collateral pledged or on deposit (2)
 
(2,305,242
)
 
(1,351,255
)
Unencumbered loans
 
$
6,478,029

 
$
6,721,252

Unencumbered loans as a percentage of total loans
 
29
%
 
31
%
____________________________ 
(1)Excludes unamortized deferred loan origination costs of $10 million as of November 30, 2015 and May 31, 2015.
(2) Excludes cash collateral pledged to secure debt. Unless and until there is an event of default, we can withdraw excess collateral as long as there is 100% coverage of the secured debt. If there is an event of default under most of our indentures, we can only withdraw this excess collateral if we substitute cash or permitted investments of equal value.

See “Note 3—Loans and Commitments—Pledging of Loans and Loans on Deposit” for additional information related to collateral.

Equity

Total equity of $894 million as of November 30, 2015 decreased by $18 million from May 31, 2015. The decrease was primarily attributable to the board authorized patronage capital retirement of $39 million, which was partially offset by our net income of $19 million for the six months ended November 30, 2015.

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 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 26.77-to-1 as of November 30, 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 $1,023 million in total liabilities and the decrease of $18 million in total equity, partially offset by the decrease of $25 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.


18



The adjusted leverage ratio was 6.84-to-1 and 6.58-to-1 as of November 30, 2015 and May 31, 2015, respectively. The increase in the adjusted leverage ratio was due to the increase of $1,015 million in adjusted liabilities, partially offset by the increase of $27 million in adjusted equity and by the decrease of $25 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 25.69-to-1 as of November 30, 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 $1,023 million in total liabilities and the decrease of $18 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 6.53-to-1 as of November 30, 2015, compared with 6.26-to-1 as of May 31, 2015. The increase in the adjusted debt-to-equity ratio was due to the increase of $1,015 million in adjusted liabilities, partially offset by the increase of $27 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.
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.

19




Table 11 shows our guarantees outstanding, by guarantee type and by company, as of November 30, 2015 and May 31, 2015.

Table 11: Guarantees Outstanding
(Dollars in thousands)
 
November 30, 2015
 
May 31, 2015
 
Increase/
(Decrease)
Guarantee type:
 
 
 
 
 
 
Long-term tax-exempt bonds
 
$
483,730

 
$
489,520

 
$
(5,790
)
Letters of credit
 
363,441

 
382,233

 
(18,792
)
Other guarantees
 
114,079

 
114,747

 
(668
)
Total
 
$
961,250

 
$
986,500

 
$
(25,250
)
Company:
 
 

 
 
 
 
CFC
 
$
920,993

 
$
952,875

 
$
(31,882
)
RTFC
 
1,574

 
1,574

 

NCSC
 
38,683

 
32,051

 
6,632

Total
 
$
961,250

 
$
986,500

 
$
(25,250
)

In addition to the letters of credit listed in the above table, we had master letter of credit facilities in place as of November 30, 2015, under which we may be required to issue up to an additional $85 million in letters of credit to third parties for the benefit of our members. All of our master letter of credit facilities as of November 30, 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 $489 million as of November 30, 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 11. We were not required to perform as liquidity provider pursuant to these obligations during the six months ended November 30, 2015. In addition to being a liquidity provider, we also provided a guarantee for payment of all principal and interest amounts on $413 million of these bonds as of November 30, 2015, which is included in long-term tax-exempt bond guarantees in Table 11.

Of our total guarantee amounts, 64% and 56% as of November 30, 2015 and May 31, 2015, respectively, 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 six months ended November 30, 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 November 30, 2015 and May 31, 2015, related to the contingent and non-contingent exposures for guarantee and liquidity obligations associated with our members’ debt.

Table 12 summarizes our off-balance sheet obligations as of November 30, 2015, and maturity of amounts during each of the next five fiscal years and thereafter.

20



Table 12: Maturities of Guarantee Obligations
 
 
 Outstanding
Balance
 
Maturities of Guaranteed Obligations
(Dollars in thousands)
 
 
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
Guarantees
 
$
961,250

 
$
95,478

 
$
117,785

 
$
215,525

 
$
17,923

 
$
61,210

 
$
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 November 30, 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 13: Unadvanced Loan Commitments
(Dollars in thousands)
 
November 30, 2015
 
% of Total
 
May 31, 2015
 
% of Total
Line of credit commitments:
 
 
 
 
 
 
 
 
Not conditional(1)
 
$
2,643,810

 
19
%
 
$
2,764,968

 
20
%
Conditional(2)
 
6,638,428

 
47

 
6,529,159

 
46

Total line of credit unadvanced commitments
 
9,282,238


66

 
9,294,127

 
66

Total long-term loan unadvanced commitments
 
4,762,678


34

 
4,835,623

 
34

Total
 
$
14,044,916


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 13, unadvanced line of credit commitments not subject to material adverse change clauses at the time of each advance totaled $2,644 million and $2,765 million as of November 30, 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 14 summarizes the available balance under committed lines of credit that are not subject to a material adverse change clause as of November 30, 2015, and the maturity of available amounts during each of the next five fiscal years and thereafter.

Table 14: 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
 
Thereafter
Committed lines of credit
 
$
2,643,810

 
$
61,000

 
$
199,257

 
$
727,065

 
$
854,128

 
$
605,110

 
$
197,250


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 11 above because we consider them to be conditional.


21



Table 15 summarizes the available balance under unadvanced commitments as of November 30, 2015 and the related maturities by fiscal year and thereafter by loan type:

Table 15: 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
 
$
9,282,238

 
$
506,565

 
$
5,261,366

 
$
1,152,930

 
$
1,074,118

 
$
776,995

 
$
510,264

Long-term loans
 
4,762,678

 
277,585

 
1,144,251

 
784,664

 
1,061,634

 
1,006,845

 
487,699

Total
 
$
14,044,916

 
$
784,150

 
$
6,405,617

 
$
1,937,594

 
$
2,135,752

 
$
1,783,840

 
$
997,963


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.
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.

22



Of our total loans outstanding, 92% were secured and 8% were unsecured as of November 30, 2015. As of May 31, 2015, of our total loans outstanding, 91% were secured and 9% were unsecured. Table 16 presents, by loan type and by company, the amount and percentage of secured and unsecured loans in our loan portfolio.

Table 16 : Loan Portfolio Security Profile
 
 
November 30, 2015
(Dollars in thousands)
 
Secured
 
%
 
Unsecured
 
%
 
Total
Loan type:
 
 
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
19,726,095

 
96
%
 
$
875,599

 
4
%
 
$
20,601,694

Long-term variable-rate loans
 
639,626

 
90

 
73,329

 
10

 
712,955

Loans guaranteed by RUS
 
176,425

 
100

 

 

 
176,425

Line of credit loans
 
237,042

 
20

 
935,532

 
80

 
1,172,574

Total loans outstanding(1)
 
$
20,779,188

 
92

 
$
1,884,460

 
8

 
$
22,663,648

 
 
 
 
 
 
 
 
 
 
 
Company:
 
 
 
 
 
 
 
 
 
 
CFC
 
$
19,990,006

 
93
%
 
$
1,604,100

 
7
%
 
$
21,594,106

RTFC
 
347,623

 
95

 
17,116

 
5

 
364,739

NCSC
 
441,559

 
63

 
263,244

 
37

 
704,803

Total loans outstanding(1)
 
$
20,779,188

 
92

 
$
1,884,460

 
8

 
$
22,663,648


 
 
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 November 30, 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 with an aggregate outstanding principal balance of $520 million as of August 31, 2015, which were reduced by subsequent loan principal payments to $515 million as of November 30, 2015.

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

23



represented approximately 14% and 15%, respectively, of total loans outstanding as of November 30, 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 November 30, 2015 and May 31, 2015. The 20 largest borrowers consisted of 12 distribution systems and 8 power supply systems as of November 30, 2015 and May 31, 2015. Table 17 displays the outstanding exposure of the 20 largest borrowers, by exposure type and by company, as of November 30, 2015 and May 31, 2015.

Table 17: Credit Exposure to 20 Largest Borrowers
  
 
November 30, 2015
 
May 31, 2015
 
Increase/
(Decrease)
(Dollars in thousands)
 
Amount
 
% of Total
 
Amount
 
% of Total
 
By exposure type:
 
 
 
 
 
 
 
 
 
 
Loans
 
$
5,282,738

 
23
%
 
$
5,478,977

 
24
%
 
$
(196,239
)
Guarantees
 
533,459

 
2

 
374,189

 
2

 
159,270

Total exposure to 20 largest borrowers
 
$
5,816,197

 
25
%
 
$
5,853,166

 
26
%
 
$
(36,969
)
 
 
 
 
 
 
 
 
 
 
 
By company:
 
 
 
 
 
 
 
 
 
 
CFC
 
$
5,801,338

 
25
%
 
$
5,837,463

 
26
%
 
$
(36,125
)
NCSC
 
14,859

 

 
15,703

 

 
(844
)
Total exposure to 20 largest borrowers
 
$
5,816,197

 
25
%
 
$
5,853,166

 
26
%
 
$
(36,969
)

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 November 30, 2015 and May 31, 2015. Below we provide information on certain additional credit quality indicators, including modified loans classified as troubled debt restructurings (“TDRs”) and nonperforming loans.

Troubled Debt Restructurings

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 a TDR. Loans modified in a TDR are generally initially 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 $10 million and $12 million as of November 30, 2015 and May 31, 2015, respectively. Table 18 presents TDR loans as of November 30, 2015 and May 31, 2015. These loans were considered individually impaired as of the end of each period presented.

24




Table 18: TDR Loans
 
 
November 30, 2015
 
May 31, 2015
(Dollars in thousands)
 
Amount
 
% of Total Loans
 
Amount
 
% of Total Loans
TDR loans:
 
 
 
 
 
 
 
 
CFC/Distribution
 
$
6,716

 
0.03
%
 
$
7,221

 
0.03
%
NCSC
 

 

 
294

 

RTFC
 
3,515

 
0.02

 
4,221

 
0.02

Total TDR loans
 
$
10,231

 
0.05
%
 
$
11,736

 
0.05
%
 
 
 
 
 
 
 
 
 
TDR loans performance status:
 
 
 
 
 
 
 
 
Performing TDR loans
 
$
6,716

 
0.03
%
 
$
11,736

 
0.05
%
Nonperforming TDR loans
 
3,515

 
0.02

 

 

Total TDR loans
 
$
10,231

 
0.05
%
 
$
11,736

 
0.05
%
 
Nonperforming Loans

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

Table 19 below presents nonperforming loans as of November 30, 2015 and May 31, 2015.

Table 19: Nonperforming Loans
 
 
November 30, 2015
 
May 31, 2015
(Dollars in thousands)
 
Amount
 
% of Total Loans
 
Amount
 
% of Total Loans
Nonperforming loans:(1)
 
 
 
 
 
 
 
 
RTFC
 
$
10,529

 
0.05
%
 
$

 
%
Total
 
$
10,529

 
0.05
%
 
$

 
%
____________________________ 
(1)Foregone interest on nonperforming loans, including nonperforming TDR loans presented above in Table 18, was less than $1 million for the three and six months ended November 30, 2015 and 2014.

We provide additional information on the credit quality of our loan portfolio in “Note 3—Loans and Commitments.”

Allowance for Loan Losses

The allowance for loan losses is determined based upon evaluation of the loan portfolio, past loss experience, specific problem loans, economic conditions and other pertinent factors that, in management’s judgment, could affect the risk of loss in the loan portfolio. We review and adjust the allowance quarterly to cover estimated probable losses in the portfolio. All loans are written off in the period that it becomes evident that collectability is highly unlikely; however, our efforts to recover all charged-off amounts may continue. Management believes the allowance for loan losses is appropriate to cover estimated probable portfolio losses.

Table 20 summarizes activity in the allowance for loan losses for the three and six months ended November 30, 2015 and a comparison of the allowance by company as of November 30, 2015 and May 31, 2015.

25




Table 20: Allowance for Loan Losses
 
 
Three Months Ended November 30, 2015
 
Six Months Ended November 30, 2015
Beginning balance
 
$
38,307

 
$
33,690

Provision for loan losses
 
1,240

 
5,802

Net recoveries
 
53

 
108

Ending balance
 
$
39,600

 
$
39,600

`
 
 
 
 
 
 
November 30, 2015
 
May 31, 2015
Allowance for loan losses by company:
 
 
 
 
  CFC
 
$
27,700

 
$
23,716

  RTFC
 
5,918

 
4,533

  NCSC
 
5,982

 
5,441

Total
 
$
39,600

 
$
33,690

 
 
 
 
 
Allowance coverage ratios:
 
 
 
 
Percentage of total loans outstanding
 
0.17
%
 
0.16
%
Percentage of total performing TDR loans outstanding
 
589.64

 
287.07

Percentage of total nonperforming TDR loans outstanding
 
1,126.60

 

Percentage of total nonperforming loans outstanding
 
376.10

 

Percentage of loans on nonaccrual status
 
281.97

 
287.07


Our allowance for loan losses increased by $6 million during the six months ended November 30, 2015 to $40 million as of November 30, 2015. The increase reflected an overall increase in loan balances and a slight deterioration in the credit quality and overall credit risk profile of our loan portfolio. Specifically, certain loans experienced negative migration through our internal risk rating process.

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. On a quarterly basis, we review all restructured and nonperforming loans, as well as certain additional loans selected based on known facts and circumstances, to evaluate whether the loans are impaired and if there have been changes in the status of previously identified impaired loans. We calculate impairment for loans identified as individually impaired based on the fair value of the underlying collateral securing the loan for collateral-dependent loans or based on the expected future cash flows for loans that are not collateral dependent. As events related to the borrower take place and economic conditions and our assumptions change, the impairment calculations may change. Our individually impaired loans totaled $21 million and $12 million as of
November 30, 2015 and May 31, 2015, respectively, and the specific allowance related to these loans totaled $4 million and $0.4 million, respectively.

See “Results of Operations—Provision for Loan Losses” and “Note 3—Loans and Commitments” for additional information on our allowance for loan losses. We discuss our allowance methodology in “Note 1—Summary of Significant Accounting Policies” in our 2015 Form 10-K.


26



Counterparty Credit Risk

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

Our derivative counterparties must be participants in one of our revolving credit agreements. We manage our derivate credit exposure through master netting arrangements and by diversifying our derivative transactions with multiple counterparties.
Our largest single counterparty exposure, based on the outstanding notional amount, represented approximately 17% and 19% of our total outstanding notional amount of derivatives as of November 30, 2015 and May 31, 2015, respectively. Our derivative counterparties had credit ratings ranging from Aa2 to Baa3 by Moody’s Investors Service (“Moody’s”) and from AA- to BBB+ by Standard & Poor’s Ratings Services (“S&P”).

Rating Triggers for Derivatives

The majority of our interest rate swap agreements have credit risk-related contingent features referred to as rating triggers. Under these rating triggers, if the credit rating for either counterparty falls to the level specified in the agreement, the other counterparty may, but is not obligated to, terminate the agreement.

We regularly evaluate the overall credit worthiness of our counterparties. Table 21 displays the notional amounts of our derivative contracts with rating triggers as of November 30, 2015 and the payments that would be required if the contracts were terminated as of that date because of a downgrade of our unsecured credit ratings or the counterparty's unsecured credit ratings to or below Baa1/BBB+, Baa3/BBB- or Ba2/BB+ by Moody’s or S&P, respectively. In calculating the payment amounts that would be required upon termination of the derivative contracts, we assumed that the amounts for each counterparty would be netted in accordance with the provisions of the master netting agreements for each counterparty. The net payment amounts are based on the fair value of the underlying derivative instrument, excluding the credit risk valuation adjustment, plus any unpaid accrued interest amounts.

Table 21: Rating Triggers for Derivatives
(Dollars in thousands)
 
Notional
Amount
 
Payable Due From CFC
 
Receivable Due to CFC
 
Net (Payable)/Receivable
Mutual rating trigger if ratings:
 
 
 
 
 
 
 
 
Falls below Baa1/BBB+
 
$
5,629,362

 
$
(218,630
)
 
$

 
$
(218,630
)
Falls to or below Baa3/BBB-
 
1,696,699

 
(33,362
)
 

 
(33,362
)
Falls below Baa3/BBB-
 
572,011

 
(26,702
)
 

 
(26,702
)
Falls to or below Ba2/BB+(1)
 
102,009

 
(335
)
 

 
(335
)
Total
 
$
8,000,081

 
$
(279,029
)
 
$

 
$
(279,029
)
____________________________ 
(1) Rating trigger for counterparty falls to or below Ba2/BB+, while rating trigger for CFC falls to or below Baa2/BBB by Moody’s or S&P, respectively.

The aggregate amount, including the credit risk valuation adjustment, of all interest rate swaps with rating triggers that were in a net liability position was $283 million as of November 30, 2015. There were no interest rate swaps with rating triggers that were in a net asset position as of November 30, 2015. There were no counterparties that fell below the rating trigger levels in our interest swap contracts as of November 30, 2015. If a counterparty has a rating that falls below the rating trigger level specified in the interest swap contract, we have the option to terminate all interest rate swaps with the counterparty. However, we generally do not terminate such agreements early because our interest rate swaps are critical to our matched funding strategy.

For additional information about the risks related to our business, see “Item 1A. Risk Factors” in our 2015 Form 10-K.

27



LIQUIDITY RISK

We face liquidity risk in funding our loan portfolio and refinancing our maturing obligations. Our Asset Liability Committee monitors liquidity risk by establishing and monitoring liquidity targets, as well as strategies and tactics to meet those targets, and ensuring that sufficient liquidity is available for unanticipated contingencies. We manage our rollover risk by maintaining liquidity reserves. Table 22 below presents a comparison of the composition of our liquidity reserves as of November 30, 2015 and May 31, 2015.

Table 22: Liquidity Reserve Access
(Dollars in millions)
 
November 30, 2015
 
May 31, 2015
Cash and time deposits
 
$
583

 
$
734

Committed revolving line of credit agreements with banks
 
3,309

 
3,419

Committed loan facilities from the FFB
 
500

 
750

Revolving note purchase agreement with Farmer Mac dated July 31, 2015
 
300

 

Revolving note purchase agreement with Farmer Mac dated March 24, 2011(1)
 
2,428

 
2,589

Liquidity reserve access
 
$
7,120

 
$
7,492

____________________________ 
(1)Availability subject to market conditions.

Under the terms of the revolving note purchase agreement with Farmer Mac dated July 31, 2015, we can borrow up to $300 million at any time through July 31, 2018. This agreement with Farmer Mac is a revolving credit facility that allows us to borrow, repay and re-borrow funds at any time through maturity or from time to time, provided that the principal amount at any time outstanding is not more than the total available under the agreement.

Under the terms of the revolving note purchase agreement with Farmer Mac dated March 24, 2011, we can borrow up to $4,500 million at any time through January 11, 2020, and thereafter automatically extend the agreement on each anniversary date of the closing for an additional year, unless prior to any such anniversary date, Farmer Mac provides CFC with a notice that the draw period would not be extended beyond the remaining term. The agreement with Farmer Mac is a revolving credit facility that allows us to borrow, repay and re-borrow funds at any time through maturity or from time to time as market conditions permit, provided that the principal amount at any time outstanding is not more than the total available under the agreement.

We use our bank revolving lines of credit primarily as backup liquidity for dealer and member commercial paper. As indicated in Table 22 above, we had $3,309 million in available revolving lines of credit with various financial institutions as of November 30, 2015. We have been and expect to continue to be in compliance with the covenants under our revolving credit agreements; therefore, we could draw on these facilities to repay dealer or member commercial paper that cannot be rolled over in the event of market disruptions.

Commercial paper, select notes and daily liquidity fund notes, including member investments, scheduled to mature during the next 12 months totaled $3,330 million as of November 30, 2015. We expect to continue to maintain member investments in commercial paper, select notes and daily liquidity fund notes at recent levels of approximately $2,309 million. Dealer commercial paper increased to $1,020 million as of November 30, 2015, from $985 million as of May 31, 2015. We intend to maintain our dealer commercial paper within a range of between $1,000 million and $1,250 million for the foreseeable future.

Long-term debt maturing in the next 12 months and medium-term notes with an original maturity of one year or less totaled $1,515 million as of November 30, 2015. In addition to our access to the dealer and member commercial paper markets as discussed above, we believe we will be able to refinance these maturing obligations through the capital markets and private debt issuances as discussed in further detail under “Sources of Liquidity.”

As discussed in further detail under “Off-Balance Sheet Arrangements,” we were the liquidity provider for variable-rate tax-exempt bonds issued for our member cooperatives totaling $489 million as of November 30, 2015. We were not required to perform as liquidity provider pursuant to these obligations during the six months ended November 30, 2015.

28




We had letters of credit outstanding for the benefit of our members totaling $363 million as of November 30, 2015. This amount includes $76 million of letters of credit that provide liquidity for pollution control bonds. The remaining $287 million represents obligations for which we may be required to advance funds based on various trigger events specified in the letters of credit agreements. If we are required to advance funds, the member is obligated to pay such amounts to CFC.

Below we summarize our expected near-term sources and uses of liquidity and provide a discussion of our primary sources and uses of liquidity. We also provide information on compliance with our debt covenants and collateral pledged.

Projected Near-Term Sources and Uses of Liquidity

Table 23 shows the projected sources and uses of cash by quarter through the quarter ending May 31, 2017. In analyzing our projected liquidity position, we track key items identified in the table below. Our estimates assume that the balance of our time deposit investments will remain consistent with current levels over the next six quarters. The long-term debt maturities represent the scheduled maturities of our outstanding term debt for the period presented. The long-term loan advances represent our current best estimate of the member demand for our loans, the amount and the timing of which are subject to change. The long-term loan amortization and repayments represent the scheduled long-term loan amortization for the outstanding loans as of November 30, 2015, as well as our current estimate for the repayment of long-term loans. The estimate of the amount and timing of long-term loan repayments is subject to change. The other loan repayments and advances in the table primarily include line of credit advances and repayments. Such amounts represent the current best estimate of activity communicated to us by our members and, as such, the amount and timing of these amounts are subject to change. We only include such estimates for the near term. We assumed the issuance of commercial paper, medium-term notes and other long-term debt, including collateral trust bonds and private placement of term debt, to maintain matched funding within our loan portfolio and to allow our revolving lines of credit to provide backup liquidity for our outstanding commercial paper. As displayed in Table 23, we expect that estimated long-term loan advances over the next six quarters of $2,624 million will exceed expected long-term loan repayments of $1,905 million by $719 million.

Table 23: Projected Sources and Uses of Liquidity(1) 
 
 
Projected Sources of Liquidity
 
Projected Uses of Liquidity
 
 
(Dollars in millions)
 
Long-term Loan Amortization and Repayments
 
Other Loan Repayments
 
Long-term Debt Issuance
 
Total
Sources of
Liquidity
 
Long-term
 Loan Advances
 
Other Loan Advances
 
Long-term Debt Maturities(3)
 
Total
Uses of
Liquidity
 
Cumulative
Excess
Sources over Uses of Liquidity(2)
Nov15
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
583

Feb16
 
$
415

 
$
137

 
$
370

 
$
922

 
$
647

 
$
69

 
$
290

 
$
1,006

 
499

May16
 
303

 

 
750

 
1,053

 
369

 
6

 
668

 
1,043

 
509

Aug16
 
302

 

 
50

 
352

 
207

 

 
154

 
361

 
500

Nov16
 
289

 

 
400

 
689

 
280

 

 
403

 
683

 
506

Feb17
 
318

 

 
620

 
938

 
561

 

 
371

 
932

 
512

May17
 
278

 

 
1,650

 
1,928

 
560

 

 
1,376

 
1,936

 
504

Total
 
$
1,905

 
$
137

 
$
3,840

 
$
5,882

 
$
2,624

 
$
75

 
$
3,262

 
$
5,961

 
 
____________________________ 
(1)The dates presented are intended to reflect the end of each quarterly period through the quarter ending May 31, 2017.
(2)Cumulative excess sources over uses of liquidity includes cash and time deposits.
(3)Long-term debt maturities also includes medium-term notes with an original maturity of less than one year.

The information presented above in Table 23 represents our best estimate of our funding requirements and how we expect to manage those requirements through May 31, 2017. We expect that these estimates will change quarterly based on the factors described above.




29



Primary Sources of Liquidity

Capital Market Debt Issuance

As a well-known seasoned issuer, we have the following effective shelf registration statements on file with the SEC for the issuance of debt:
unlimited amount of collateral trust bonds until September 2016;
unlimited amount of senior and subordinated debt securities, including medium-term notes, member capital securities and subordinated deferrable debt, until November 2017; and
daily liquidity fund notes for a total of $20,000 million with a $3,000 million limitation on the aggregate principal amount outstanding at any time until April 2016.

While we register member capital securities and the daily liquidity fund with the SEC, these securities are not available for sale to the general public. Medium-term notes are available for sale to both the general public and members.

In October 2015, we issued $350 million of 2.30% collateral trust bonds due 2020 and $400 million of 3.25% collateral trust bonds due 2025.

Commercial paper issued through dealers totaled $1,020 million and represented 5% of total debt outstanding as of November 30, 2015.

Private Debt Issuance

We have access to liquidity from private debt issuances through note purchase agreements with Farmer Mac. Under the terms of our March 2011 note purchase agreement as amended, we can borrow up to $4,500 million at any time from the date of the agreement through January 11, 2020 and such date shall automatically extend on each anniversary date of the closing for an additional year, unless prior to any such anniversary date, Farmer Mac provides CFC with a notice that the draw period will not be extended beyond the remaining term. During the six months ended November 30, 2015, we borrowed a total of $180 million under the note purchase agreement with Farmer Mac. The agreement with Farmer Mac is a revolving credit facility that allows us to borrow, repay and re-borrow funds at any time through maturity or from time to time as market conditions permit. Each borrowing under the note purchase agreement is evidenced by a secured note setting forth the interest rate, maturity date and other related terms as we may negotiate with Farmer Mac at the time of each such borrowing. We may select a fixed rate or variable rate at the time of each advance with a maturity as determined in the applicable pricing agreement. We had up to $2,428 million available under this revolving note purchase agreement with Farmer Mac as of November 30, 2015.

On July 31, 2015, we entered into a new revolving note purchase agreement with Farmer Mac totaling $300 million. Under the terms of the new agreement, we can borrow up to $300 million at any time through July 31, 2018. This agreement with Farmer Mac is a revolving credit facility that allows us to borrow, repay and re-borrow funds at any time through maturity or from time to time. Each borrowing under the note purchase agreement is evidenced by a secured note setting forth the maturity date and other related terms. We had up to $300 million available under this revolving note purchase agreement with Farmer Mac as of November 30, 2015.

We also have access to unsecured notes payable under bond purchase agreements with the FFB and a bond guarantee agreement with RUS issued under the Guaranteed Underwriter Program which supports the Rural Economic Development Loan and Grant program and provides guarantees to the FFB. During the quarter ended November 30, 2015, we borrowed $250 million under the Guaranteed Underwriter Program. As of November 30, 2015, we had up to $500 million available under committed loan facilities from the FFB as part of this program, of which a total of $250 million is available for advance through October 15, 2016 and a total of $250 million is available for advance through October 15, 2017. On September 28, 2015, we received a commitment from RUS to guarantee a loan from the Federal Financing Bank for additional funding of $250 million as part of the Guaranteed Underwriter Program. As a result, 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.


30



Member Loan Repayments

We expect long-term loan repayments from scheduled loan amortization and prepayments to be $1,309 million over the next 12 months.

Member Loan Interest Payments

During the six months ended November 30, 2015, interest income on the loan portfolio was $498 million. For the past three fiscal years, interest income on the loan portfolio has averaged $948 million. As of November 30, 2015, 92% of the total loans outstanding had a fixed rate of interest, and 8% of loans outstanding had a variable rate of interest.

Bank Revolving Credit Agreements

Our bank revolving lines of credit may be used for general corporate purposes; however, we use them primarily as backup liquidity for dealer and member commercial paper. We had $3,420 million commitments under revolving credit agreements as of November 30, 2015 and May 31, 2015. Under our current revolving credit agreements, we have the ability to request up to $300 million of letters of credit, which would result in a reduction in the remaining available under the facilities. On November 19, 2015, we amended and restated the $1,665 million three-year and $1,645 million five-year revolving credit agreements to extend the maturity dates to November 19, 2018 and November 19, 2020, respectively, from October 28, 2017 and October 28, 2019, respectively. Commitments of $25 million under the three-year agreement will expire at the prior maturity date of October 28, 2017. Commitments of $45 million under the five-year agreement will expire at the prior maturity date of October 28, 2019. Also, as part of the amendment, the commitments from three banks were increased by $45 million.

Prior to this amendment, NCSC assumed $155 million in commitments from one of the banks, which was reduced to $110 million as part of the amendment on November 19, 2015. Although the total commitment amount under our new revolving credit agreements is unchanged from the previous total of $3,420 million, NCSC’s commitment amount is excluded from the commitment amount from third parties of $3,310 million because NCSC receives all of its funding from CFC and NCSC’s financial results are consolidated with CFC. The NCSC assumption of $110 million of commitments under the revolving credit agreements also reduces the total letters of credit from third parties, to $290 million.

Table 24 presents the total commitment, the net amount available for use and the outstanding letters of credit under our revolving credit agreements as of November 30, 2015 and May 31, 2015.

Table 24: Revolving Credit Agreements(1) 
 
 
November 30, 2015
 
May 31, 2015
 
 
 
 
(Dollars in millions)
 
Total Commitment
 
Letters of Credit Outstanding
 
Net Available for Use
 
Total Commitment
 
Letters of Credit Outstanding
 
Net Available for Use
 
Maturity
 
Annual Facility Fee (2)
3-year agreement
 
$
25

 
$

 
$
25

 
$
1,720

 
$

 
$
1,720

 
October 28, 2017
 
7.5 bps
5-year agreement
 
45

 

 
45

 
1,700

 
1

 
1,699

 
October 28, 2019
 
10 bps
3-year agreement
 
1,640

 

 
1,640

 

 

 

 
November 19, 2018
 
7.5 bps
5-year agreement
 
1,600

 
1

 
1,599

 

 

 

 
November 19, 2020
 
10 bps
Total
 
$
3,310

 
$
1

 
$
3,309

 
$
3,420

 
$
1

 
$
3,419

 
 
 
 
____________________________ 
(1) Reflects amounts available from unaffiliated third parties that are not consolidated by CFC.
(2) Facility fee determined by CFC’s senior unsecured credit ratings based on the pricing schedules put in place at the inception of the related agreement.

The revolving credit agreements do not contain a material adverse change clause or ratings triggers that limit the banks’ obligations to fund under the terms of the agreements, but we must be in compliance with their requirements to draw down on the facilities, including financial ratios. As shown below in Table 28, we were in compliance with all covenants and conditions under our revolving credit agreements and senior debt indentures as of November 30, 2015.


31



Member Investments

Table 25 shows the components of our member investments included in total debt outstanding as of November 30, 2015 and May 31, 2015.

Table 25: Member Investments
 
 
November 30, 2015
 
May 31, 2015
 
Increase/
(Decrease)
(Dollars in thousands)
 
Amount
 
% of Total (1)
 
Amount
 
% of Total (1)
 
Commercial paper
 
$
759,815

 
43
%
 
$
736,162

 
43
%
 
$
23,653

Select notes
 
809,298

 
100

 
671,635

 
100

 
137,663

Daily liquidity fund notes
 
740,142

 
100

 
509,131

 
100

 
231,011

Medium-term notes
 
596,854

 
17

 
618,170

 
18

 
(21,316
)
Members’ subordinated certificates
 
1,479,562

 
100

 
1,505,420

 
100

 
(25,858
)
Total
 
$
4,385,671

 
 
 
$
4,040,518

 
 
 
$
345,153

 
 
 
 
 
 
 
 
 
 
 
Percentage of total debt outstanding
 
20
%
 
 
 
19
%
 
 
 
 

____________________________ 
(1) Represents the percentage of each line item outstanding to our members.

Member investments averaged $4,205 million outstanding over the last three years. We view member investments as a more stable source of funding than capital market issuances.

Cash, Investments and Time Deposits

Cash and time deposits totaled $583 million as of November 30, 2015. The interest rate earned on the time deposits provides an overall benefit to our net interest yield. The total balance of cash and time deposits represents an additional source of liquidity that is available to support our operations.

Cash Flows from Operations

Cash flows provided by operating activities totaled $96 million for the six months ended November 30, 2015, compared with $103 million for the same prior-year period. Our cash flows from operating activities are driven primarily by a combination of cash flows from operations and the timing and amount of loan interest payments we received compared with interest payments we made on our debt.

Primary Uses of Liquidity

Loan Advances

Loan advances are either from new loans approved to a borrower or from the unadvanced portion of loans previously approved. Unadvanced loan commitments totaled $14,045 million as of November 30, 2015. Of that total, $2,644 million represented unadvanced commitments related to line of credit loans that are not subject to a material adverse change clause at the time of each loan advance. As such, we would be required to advance amounts on these committed facilities as long as the borrower is in compliance with the terms and conditions of the loan. New advances under 20% of these $2,644 million committed line of credit loans would be advanced at rates determined by CFC based on our cost and, therefore, any increase in CFC’s costs to obtain funding required to make the advance could be passed on to the borrower. The other 80% of committed line of credit loans represent loan syndications where the pricing is set at a spread over a market index as agreed upon by all of the participating banks and market conditions at the time of syndication. The remaining $11,401 million of unadvanced loan commitments as of November 30, 2015 were generally subject to material adverse change clauses. Prior to making an advance on these facilities, we would confirm that there has been no material adverse change in the borrower's business or condition, financial or otherwise, since the time the loan was approved and confirm that the borrower is currently in compliance with loan terms and conditions. In some cases, the borrower’s access to the full amount of the facility is further constrained by use of proceeds restrictions, imposition of borrower-specific restrictions or by additional

32



conditions that must be met prior to advancing funds.

Since we generally do not charge a fee for the borrower to have an unadvanced amount on a loan facility that is subject to a material adverse change clause, our borrowers tend to request amounts in excess of their immediate estimated loan requirements. Historically, we have not experienced significant loan advances from the long-term unadvanced loan amounts that are subject to material adverse change clauses at the time of the loan advance. We have a very low historical average utilization rate on all our line of credit facilities, including committed line of credit facilities. Unadvanced commitments related to line of credit loans are typically revolving facilities for periods not to exceed five years. Long-term unadvanced commitments generally expire five years from the date of the loan agreement. These reasons, together with the other limitations on advances as described above, all contribute to our expectation that the majority of the unadvanced commitments reported will expire without being fully drawn upon and that the total commitment amount does not necessarily represent future cash funding requirements as of November 30, 2015.

We currently expect to make long-term loan advances to our members totaling approximately $1,503 million over the next 12 months.

Principal Repayments on Long-Term Debt

Table 26 summarizes the principal amount of long-term debt, subordinated deferrable debt and members' subordinated certificates maturing by fiscal year and thereafter as of November 30, 2015.

Table 26: Principal Maturity of Long-Term Debt
(Dollars in thousands)
 
Amount
Maturing (1)
 
Percentage of Total
May 31, 2016
 
$
836,262

 
4
%
May 31, 2017
 
2,207,304

 
12

May 31, 2018
 
1,032,364

 
6

May 31, 2019
 
1,843,201

 
10

May 31, 2020
 
954,428

 
5

Thereafter
 
11,743,751

 
63

Total
 
$
18,617,310

 
100
%
____________________________ 
(1)Excludes loan subordinated certificates totaling $116 million that amortize annually based on the outstanding balance of the related loan and $0.3 million in subscribed and unissued certificates for which a payment has been received. There are many items that affect the amortization of a loan, such as loan conversions, loan repricing at the end of an interest rate term and prepayments; therefore, an amortization schedule cannot be maintained for these certificates. Over the past fiscal year, annual amortization on these certificates was $11 million. In fiscal year 2015, amortization represented 10% of amortizing loan subordinated certificates outstanding.

Interest Expense on Debt

Interest expense on debt totaled $333 million for the six months ended November 30, 2015. Annual interest expense on debt over the past three fiscal years has averaged $661 million.

Patronage Capital Retirements

CFC has made annual retirements of allocated net earnings in 35 of the last 36 fiscal years. In July 2015, the CFC Board of Directors approved the allocation of $78 million from fiscal year 2015 net earnings to CFC’s members. CFC made a cash payment of $39 million to its members in September 2015 as retirement of 50% of allocated net earnings from the prior year as approved by the CFC Board of Directors. The remaining portion of allocated net earnings will be retained by CFC for 25 years under guidelines adopted by the CFC Board of Directors in June 2009. The board of directors has the authority to change the current practice for allocating and retiring net earnings at any time, subject to applicable laws and regulation.


33



Credit Ratings

Our credit ratings impact our ability to access capital markets and our borrowing costs. Rating agencies base their ratings on numerous factors, including liquidity, capital adequacy, industry position, member support, management, asset quality, quality of earnings and the probability of systemic support. Significant changes in these factors could result in different ratings. Our credit ratings are presented in Table 27.

Table 27: Credit Ratings
 
 
November 30, 2015
 
 
Senior Secured Debt
 
Senior Unsecured Debt
 
Commercial Paper
 
Outlook
Moody’s
 
  A1
 
  A2
 
 P-1
 
Stable
S&P
 
A
 
A
 
 A-1
 
Negative
Fitch
 
  A+
 
A
 
F1
 
Stable

The notes payable to the FFB under the Guaranteed Underwriter Program of $4,644 million as of November 30, 2015 contain a rating trigger provision that pertains to our senior secured credit ratings from Moody’s, S&P and Fitch. A rating trigger event occurs if our senior secured debt does not have at least two of the following ratings: (i) A3 or higher from Moody’s, (ii) A- or higher from S&P, (iii) A- or higher from Fitch or (iv) an equivalent rating from a successor rating agency to any of the above rating agencies. If our senior secured credit ratings fall below the levels listed above, the mortgage notes on deposit at that time, which totaled $5,461 million as of November 30, 2015, would be pledged as collateral rather than held on deposit. Also, if during any portion of a fiscal year, our senior secured credit ratings fall below the levels listed above, we may not make cash patronage capital distributions in excess of 5% of total patronage capital.

In order to access the commercial paper markets at attractive rates, we believe we need to maintain our current commercial
paper credit ratings of P-1 by Moody’s, A-1 by S&P and F1 by Fitch.

The majority of our interest rate swap agreements have credit risk-related contingent features referred to as rating triggers. Under these rating triggers, if the senior unsecured credit rating for either counterparty falls to the level specified in the agreement, the other counterparty may, but is not obligated to, terminate the agreement. We provide additional information on derivative counterparty rating triggers above under “Credit Risk—Counterparty Credit Risk.”

There have been no changes in our ratings or outlook by Moody’s, S&P or Fitch since November 30, 2015.

Compliance with Debt Covenants

We were in compliance with all covenants and conditions under our revolving credit agreements and senior debt indentures as of November 30, 2015. Table 28 represents our required and actual financial ratios under the revolving credit agreements at or for the periods ended November 30, 2015 and May 31, 2015.

Table 28: Financial Ratios under Revolving Credit Agreements
 
 
 
 
Actual
 
 
Requirement
 
November 30, 2015
 
May 31, 2015
 
 
 
 
 
 
 
Minimum average adjusted TIER over the six most recent fiscal quarters(1)
 
1.025

 
1.28
 
1.28
 
 
 
 
 
 
 
Minimum adjusted TIER for the most recent fiscal year (1) (2)
 
1.05

 
1.30
 
1.30
 
 
 
 
 
 
 
Maximum ratio of adjusted senior debt-to-total equity (1)
 
10.00

 
6.18
 
5.93
____________________________ 
(1) In addition to the adjustments made to the leverage ratio set forth under “Non-GAAP Financial Measures,” senior debt excludes guarantees to member systems that have certain investment-grade ratings from Moody’s and S&P. The TIER and debt-to-equity calculations include the adjustments set forth under “Non-GAAP Financial Measures” and exclude the results of operations and other comprehensive income for CAH.
(2) We must meet this requirement to retire patronage capital.

34




The revolving credit agreements prohibit liens on loans to members except liens:
under our indentures,
related to taxes that are not delinquent or contested,
stemming from certain legal proceedings that are being contested in good faith,
created by CFC to secure guarantees by CFC of indebtedness, the interest on which is excludable from the gross income of the recipient for federal income tax purposes,
granted by any subsidiary to CFC, and
to secure other indebtedness of CFC of up to $10,000 million plus an amount equal to the incremental increase in CFC’s allocated Guaranteed Underwriter Program obligations, provided that the aggregate amount of such indebtedness may not exceed $12,500 million. The amount of our secured indebtedness for purposes of this provision of all three revolving credit agreements was $6,733 million as of November 30, 2015.

The revolving credit agreements limit total investments in foreclosed assets held by CAH to $275 million without consent by the required banks. These investments did not exceed this limit as of November 30, 2015.

Table 29 summarizes our required and actual financial ratios, as defined under our 1994 collateral trust bonds indenture and our medium-term notes indentures in the U.S. markets, as of November 30, 2015 and May 31, 2015.

Table 29: Financial Ratios under Indentures
 
 
 
 
Actual
 
 
Requirement
 
November 30, 2015
 
May 31, 2015
Maximum ratio of adjusted senior debt to total equity (1)
 
20.00
 
7.90
 
7.41
____________________________ 
(1) The ratio calculation includes the adjustments made to the leverage ratio under “Non-GAAP Financial Measures,” with the exception of the adjustments to exclude the non-cash impact of derivative financial instruments and adjustments from total liabilities and total equity.

In addition to the above financial ratio requirements, we are required to pledge or maintain collateral on deposit pursuant to the provisions of certain of our borrowing agreements. We provide information on collateral pledged or on deposit above under “Consolidated Balance Sheet Analysis—Debt—Pledging of Loans and Loans on Deposit.”
MARKET RISK

Market risk is the potential for adverse changes in the value of our assets and liabilities resulting from volatility in market variables such as interest rates and credit spreads. Interest rate risk represents our primary market risk.

Interest Rate Risk

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


35



Matched Funding Practice

We provide our members with many options on loans with regard to interest rates, the term for which the selected interest rate is in effect and the ability to convert or prepay the loan. Long-term loans have maturities of up to 35 years. Borrowers may select fixed interest rates for periods of one year through the life of the loan. We do not match fund the majority of our fixed-rate loans with a specific debt issuance at the time the loans are advanced. To monitor and mitigate interest rate risk in the funding of fixed-rate loans, we perform a monthly interest rate gap analysis that provides a comparison between fixed-rate assets repricing or maturing by year and fixed-rate liabilities and members’ equity maturing by year, which is presented in Table 30 below. Fixed-rate liabilities include debt issued at a fixed rate as well as variable-rate debt swapped to a fixed rate using interest rate swaps. Fixed-rate debt swapped to a variable rate using interest rate swaps is excluded from the analysis since it is used to match fund the variable-rate loan pool. With the exception of members’ subordinated certificates, which are generally issued with extended maturities, and commercial paper, our liabilities have average maturities that closely match the repricing terms (but not the maturities) of our fixed-interest-rate loans.

We fund the amount of fixed-rate assets that exceed fixed-rate debt and members’ equity with short-term debt, primarily commercial paper. We also have the option to enter into pay fixed-receive variable interest rate swaps. Our funding objective is to manage the matched funding of asset and liability repricing terms within a range of total assets (excluding derivative assets) deemed appropriate by the Asset Liability Committee based on the current environment and extended outlook for interest rates. Due to the flexibility we offer our borrowers, there is a possibility of significant changes in the composition of the fixed-rate loan portfolio, and the management of the interest rate gap is very fluid. We may use interest rate swaps to manage the interest rate gap based on our needs for fixed-rate or variable-rate funding as changes arise. We consider the interest rate risk on variable-rate loans to be minimal as the loans are eligible to be repriced at least monthly, which minimizes the variance to the cost of variable-rate debt used to fund the loans. Loans with variable interest rates accounted for 8% of our total loan portfolio as of November 30, 2015 and May 31, 2015.

Interest Rate Gap Analysis

Our interest rate gap analysis allows us to consider various scenarios in order to evaluate the impact on adjusted TIER of issuing certain amounts of debt with various maturities at a fixed rate. See “Non-GAAP Financial Measures” for further explanation and a reconciliation of the adjustments to TIER to derive adjusted TIER.

Table 30 shows the scheduled amortization and repricing of fixed-rate assets and liabilities outstanding as of November 30, 2015.

Table 30: Interest Rate Gap Analysis
(Dollars in millions)
 
Prior to 5/31/16
 
Two Years 6/1/16 to 5/31/18
 
Two Years 6/1/18 to
5/31/20
 
Five Years 6/1/20 to
5/31/25
 
Ten Years 6/1/25 to 5/31/35
 
6/1/35 and Thereafter
 
Total
Asset amortization and repricing
 
$
1,005

 
$
3,902

 
$
2,870

 
$
4,925

 
$
5,476

 
$
2,591

 
$
20,769

Liabilities and members’ equity:
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Long-term debt
 
$
880

 
$
3,747

 
$
2,920

 
$
3,921

 
$
3,656

 
$
1,168

 
$
16,292

Subordinated certificates
 
13

 
53

 
42

 
673

 
302

 
756

 
1,839

Members’ equity (1)
 

 

 
26

 
89

 
348

 
668

 
1,131

Total liabilities and members’ equity
 
$
893

 
$
3,800

 
$
2,988

 
$
4,683

 
$
4,306

 
$
2,592

 
$
19,262

Gap (2)
 
$
112

 
$
102

 
$
(118
)
 
$
242

 
$
1,170

 
$
(1
)
 
$
1,507

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cumulative gap
 
112

 
214

 
96

 
338

 
1,508

 
1,507

 
 
Cumulative gap as a % of total assets
 
0.47
%
 
0.90
%
 
0.40
%
 
1.42
%
 
6.32
%
 
6.32
%
 
 
Cumulative gap as a % of adjusted total assets(3)
 
0.47

 
0.90

 
0.40

 
1.42

 
6.34

 
6.34

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

36



(2)Calculated based on the amount of assets amortizing and repricing less total liabilities and members’ equity displayed in Table 30.
(3)Adjusted total assets represents total assets reported in our condensed consolidated balance sheets less derivative assets.

We had $20,769 million of fixed-rate assets amortizing or repricing as of November 30, 2015. These assets were funded by $16,292 million of fixed-rate liabilities maturing during the next 30 years and $2,970 million of members’ equity and members’ subordinated certificates. A portion of members' equity does not have a scheduled maturity. The difference, or gap, of $1,507 million reflects the amount of fixed-rate assets that are funded with short-term debt as of November 30, 2015. The gap of $1,507 million represented 6.32% of total assets and 6.34% of total assets excluding derivative assets, or adjusted total assets, as of November 30, 2015.

Our Asset Liability Committee believes it is necessary to maintain an unmatched position on our fixed-rate assets within a limited percentage of adjusted total assets. Our limited unmatched position is intended to provide the flexibility to ensure that we are able to match the current maturing portion of long-term fixed rate loans based on maturity date and the opportunity in the current low interest rate environment to maximize the gross yield on our fixed rate assets without taking what we would consider to be excessive risk. Funding fixed-rate loans with short-term debt increases interest rate and liquidity risk, as the maturing debt would need to be replaced to fund the fixed-rate loans through their repricing or maturity date. We manage interest rate risk through the use of derivatives and by limiting the amount of fixed-rate assets that can be funded by short-term debt to a specified percentage of adjusted total assets based on market conditions. We discuss how we manage our liquidity risk above under “Liquidity Risk.”
NON-GAAP FINANCIAL MEASURES

In addition to financial measures determined in accordance with GAAP, management also evaluates performance based on certain non-GAAP measures, which we refer to as “adjusted” measures. We provide a reconciliation of our adjusted measures to the most comparable GAAP measures in this section. We believe these adjusted non-GAAP metrics 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 measures.

Statements of Operations Non-GAAP Adjustments and Calculation of TIER

Table 31 provides a reconciliation of adjusted interest expense, adjusted net interest income and adjusted net income to the comparable GAAP measures. The adjusted amounts are used in the calculation of our adjusted net interest yield and adjusted TIER.

Table 31: Adjusted Financial Measures — Income Statement
 
 
Three Months Ended November 30,
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
 
2015

2014
Interest expense
 
$
(167,124
)
 
$
(158,275
)
 
$
(332,824
)
 
$
(314,827
)
Plus: Derivative cash settlements
 
(22,573
)
 
(21,764
)
 
(42,729
)
 
(41,865
)
Adjusted interest expense
 
$
(189,697
)
 
$
(180,039
)
 
$
(375,553
)
 
$
(356,692
)
 
 
 
 
 
 
 
 
 
Net interest income
 
$
89,201

 
$
76,960

 
$
169,617

 
$
157,699

Less: Derivative cash settlements
 
(22,573
)
 
(21,764
)
 
(42,729
)
 
(41,865
)
Adjusted net interest income
 
$
66,628

 
$
55,196

 
$
126,888

 
$
115,834

 
 
 
 
 
 
 
 
 
Net income
 
$
(24,488
)
 
$
(35,912
)
 
$
18,607

 
$
(15,300
)
Less: Derivative forward value
 
78,611

 
52,797

 
70,472

 
82,574

Adjusted net income
 
$
54,123

 
$
16,885

 
$
89,079

 
$
67,274



37



TIER Calculation

Table 32 presents our TIER and adjusted TIER for the three and three and six months ended November 30, 2015 and 2014.

Table 32: TIER and Adjusted TIER
 
 
Three Months Ended November 30,
 
Six Months Ended November 30,
 
 
2015
 
2014
 
2015
 
2014
TIER (1)
 
0.85

 
0.77

 
1.06

 
0.95

 
 
 
 
 
 
 
 
 
Adjusted TIER (2)
 
1.29

 
1.09

 
1.24

 
1.19

____________________________ 
(1) TIER is calculated based on net income plus interest expense for the period divided by interest expense for the period.
(2) Adjusted TIER is calculated based on adjusted net income plus adjusted interest expense for the period divided by adjusted interest expense for the period.
 
Adjustments to the Calculation of Leverage and Debt-to-Equity Ratios

Table 33 provides a reconciliation between the liabilities and equity used to calculate the leverage and debt-to-equity ratios and these financial measures adjusted to exclude the non-cash effects of derivatives and foreign currency adjustments, to subtract debt used to fund loans that are guaranteed by RUS from total liabilities, and to subtract from total liabilities, and add to total equity, debt with equity characteristics.

Table 33: Adjusted Financial Measures — Balance Sheet
(Dollars in thousands)
 
November 30, 2015

May 31, 2015
Total liabilities
 
$
22,957,467

 
$
21,934,273

Less:
 
 
 
 
Derivative liabilities
 
(445,537
)
 
(408,382
)
Debt used to fund loans guaranteed by RUS
 
(176,425
)
 
(179,241
)
Subordinated deferrable debt
 
(395,736
)
 
(395,699
)
Subordinated certificates
 
(1,479,562
)
 
(1,505,420
)
Adjusted liabilities
 
$
20,460,207

 
$
19,445,531

 
 
 
 
 
Total equity
 
$
893,515

 
$
911,786

Less:
 
 
 
 
Prior year cumulative derivative forward
 
 
 
 
value and foreign currency adjustments
 
299,274

 
185,181

Current year-to-date derivative forward value (gains) losses, net
 
70,472

 
114,093

Accumulated other comprehensive income (1)
 
(4,902
)
 
(5,371
)
Plus:
 

 
 
Subordinated certificates
 
1,479,562

 
1,505,420

Subordinated deferrable debt
 
395,736

 
395,699

Adjusted total equity
 
$
3,133,657

 
$
3,106,808

Guarantees (2)
 
$
961,250

 
$
986,500

____________________________ 
(1) Represents the accumulated other comprehensive income related to derivatives. Excludes $7 million and $4 million of accumulated other comprehensive income as of November 30, 2015 and May 31, 2015, respectively, related to the unrecognized gains on our investments. It also excludes $4 million of accumulated other comprehensive loss related to foreclosed assets as of November 30, 2015 and May 31, 2015 and $1 million of accumulated other comprehensive loss related to a defined benefit pension plan.
(2) Guarantees are used in the calculation of leverage and adjusted leverage ratios below.


38



Table 34 presents the calculations of our leverage and debt-to-equity ratios and our adjusted leverage and debt-to-equity ratios as of November 30, 2015 and May 31, 2015.

Table 34: Leverage and Debt-to-Equity Ratios
 
 
November 30, 2015
 
May 31, 2015
Leverage ratio (1)
 
26.77

 
25.14

Adjusted leverage ratio (2)
 
6.84

 
6.58

Debt-to-equity ratio (3)
 
25.69

 
24.06

Adjusted debt-to-equity ratio (4)
 
6.53

 
6.26

____________________________ 
(1) Calculated based on total liabilities and guarantees at period end divided by total equity at period end.
(2) Calculated based on adjusted total liabilities and guarantees at period end divided by adjusted total equity at period end, such calculation is presented in Table 33 above.
(3) Calculated based on total liabilities at period end divided by total equity at period end.
(4) Calculated based on adjusted total liabilities at period end divided by adjusted total equity at period end, such calculation is presented in Table 33 above.

39


Item 1.
Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


40


NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
        CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

 
 
Three Months Ended November 30,
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
 
2015

2014
Interest income
 
$
256,325

 
$
235,235

 
$
502,441

 
$
472,526

Interest expense
 
(167,124
)
 
(158,275
)
 
(332,824
)
 
(314,827
)
Net interest income
 
89,201

 
76,960

 
169,617

 
157,699

Provision for loan losses
 
(1,240
)
 
(992
)
 
(5,802
)
 
5,779

Net interest income after provision for loan losses
 
87,961

 
75,968

 
163,815

 
163,478

Non-interest income:
 
 

 
 

 
 

 
 

Fee and other income
 
7,031

 
9,872

 
11,732

 
14,229

Derivative losses
 
(101,184
)
 
(74,561
)
 
(113,201
)
 
(124,439
)
Results of operations of foreclosed assets
 
2,054

 
(28,991
)
 
133

 
(31,690
)
Total non-interest income
 
(92,099
)
 
(93,680
)
 
(101,336
)
 
(141,900
)
Non-interest expense:
 
 

 
 

 
 

 
 

Salaries and employee benefits
 
(10,943
)
 
(10,528
)
 
(22,433
)
 
(21,325
)
Other general and administrative expenses
 
(9,288
)
 
(7,709
)
 
(20,633
)
 
(15,455
)
Other
 
(9
)
 
(4
)
 
(366
)
 
57

Total non-interest expense
 
(20,240
)
 
(18,241
)
 
(43,432
)
 
(36,723
)
Income (loss) before income taxes
 
(24,378
)
 
(35,953
)
 
19,047

 
(15,145
)
Income tax (expense) benefit
 
(110
)
 
41

 
(440
)
 
(155
)
Net income (loss)
 
(24,488
)
 
(35,912
)
 
18,607

 
(15,300
)
Less: Net (income) loss attributable to noncontrolling interests
 
351

 
207

 
581

 
(4
)
Net income (loss) attributable to CFC
 
$
(24,137
)
 
$
(35,705
)
 
$
19,188

 
$
(15,304
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.



41









NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
        CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
 
 
Three Months Ended November 30,
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
 
2015

2014
Net income
 
$
(24,488
)
 
$
(35,912
)
 
$
18,607

 
$
(15,300
)
Other comprehensive income (loss):
 
 

 
 

 
 

 
 

Unrealized gains (losses) on available-for-sale investment securities
 
3,550

 
902

 
2,886

 
3,602

Reclassification of derivative gains to net income
 
(236
)
 
(242
)
 
(471
)
 
(483
)
Defined benefit plan adjustments
 
44

 

 
88

 

Other comprehensive income
 
3,358

 
660

 
2,503

 
3,119

Total comprehensive income (loss)
 
(21,130
)
 
(35,252
)
 
21,110

 
(12,181
)
Less: Total comprehensive loss attributable to noncontrolling interests
 
351

 
209

 
583

 
1

Total comprehensive income (loss) attributable to CFC
 
$
(20,779
)
 
$
(35,043
)
 
$
21,693

 
$
(12,180
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.
 

42






NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
       CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
(Dollars in thousands)
 
November 30, 2015

May 31, 2015
Assets:
 
 
 
 
Cash and cash equivalents
 
$
242,619

 
$
248,836

Restricted cash
 
6,175

 
485

Time deposits
 
340,000

 
485,000

Investment securities available for sale, at fair value
 
87,358

 
84,472

Loans to members
 
22,673,529

 
21,469,017

Less: Allowance for loan losses
 
(39,600
)
 
(33,690
)
Loans to members, net
 
22,633,929

 
21,435,327

Accrued interest and other receivables
 
179,844

 
197,828

Fixed assets, net
 
111,345

 
110,540

Debt service reserve funds
 
25,602

 
25,602

Foreclosed assets, net
 
116,939

 
116,507

Derivative assets
 
81,687

 
115,276

Other assets
 
25,484

 
26,186

Total assets
 
$
23,850,982

 
$
22,846,059

 
 
 
 
 
Liabilities:
 


 
 
Accrued interest payable
 
$
125,419

 
$
123,697

Debt outstanding:
 
 
 
 
Short-term debt
 
3,542,802

 
3,127,754

Long-term debt
 
16,858,024

 
16,244,794

Subordinated deferrable debt
 
395,736

 
395,699

Members’ subordinated certificates:
 
 

 
 

Membership subordinated certificates
 
629,977

 
645,035

Loan and guarantee subordinated certificates
 
629,589

 
640,889

Member capital securities
 
219,996

 
219,496

Total members’ subordinated certificates
 
1,479,562

 
1,505,420

Total debt outstanding
 
22,276,124

 
21,273,667

Deferred income
 
64,086

 
75,579

Derivative liabilities
 
445,537

 
408,382

Other liabilities
 
46,301

 
52,948

Total liabilities
 
22,957,467

 
21,934,273

 
 
 
 
 
Commitments and contingencies
 


 


 
 
 
 
 
Equity:
 
 
 
 
CFC equity:
 
 

 
 

Retained equity
 
859,514

 
880,242

Accumulated other comprehensive income
 
6,585

 
4,080

Total CFC equity
 
866,099

 
884,322

Noncontrolling interests
 
27,416

 
27,464

Total equity
 
893,515

 
911,786

Total liabilities and equity
 
$
23,850,982

 
$
22,846,059

 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.

43






NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
 CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(UNAUDITED)

(Dollars in thousands)
 
Membership
Fees and
Educational
Fund
 
Patronage
Capital
Allocated
 
Members’
Capital
Reserve
 
Unallocated
Net Income
(Loss)
 
CFC
Retained
Equity
 
Accumulated
Other
Comprehensive
Income
 
Total
CFC
Equity
 
Non-controlling
Interests
 
Total
Equity
Balance as of May 31, 2015
 
$
2,743

 
$
668,980

 
$
501,731

 
$
(293,212
)
 
$
880,242

 
$
4,080

 
$
884,322

 
$
27,464

 
$
911,786

Net income
 

 

 

 
19,188

 
19,188

 

 
19,188

 
(581
)
 
18,607

Other comprehensive income
 

 

 

 

 

 
2,505

 
2,505

 
(2
)
 
2,503

Patronage capital retirement
 

 
(39,376
)
 

 

 
(39,376
)
 

 
(39,376
)
 
(341
)
 
(39,717
)
Other
 
(540
)
 

 
(429
)
 
429

 
(540
)
 

 
(540
)
 
876

 
336

Balance as of November 30, 2015
 
$
2,203

 
$
629,604

 
$
501,302

 
$
(273,595
)
 
$
859,514

 
$
6,585

 
$
866,099

 
$
27,416

 
$
893,515

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance as of May 31, 2014
 
$
2,751

 
$
630,340

 
$
485,447

 
$
(178,650
)
 
$
939,888

 
$
3,649

 
$
943,537

 
$
26,837

 
$
970,374

Net income
 

 

 

 
(15,304
)
 
(15,304
)
 

 
(15,304
)
 
4

 
(15,300
)
Other comprehensive income
 

 

 

 

 

 
3,124

 
3,124

 
(5
)
 
3,119

Patronage capital retirement
 

 
(39,662
)
 

 

 
(39,662
)
 

 
(39,662
)
 

 
(39,662
)
Other
 
(529
)
 
(1
)
 
1

 

 
(529
)
 

 
(529
)
 
824

 
295

Balance as of November 30, 2014
 
$
2,222

 
$
590,677

 
$
485,448

 
$
(193,954
)
 
$
884,393

 
$
6,773

 
$
891,166

 
$
27,660

 
$
918,826

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.


44






NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
Cash flows from operating activities:
 
 
 
 
Net income (loss)
 
$
18,607

 
$
(15,300
)
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Amortization of deferred income
 
(12,697
)
 
(5,781
)
Amortization of debt issuance costs and deferred charges
 
4,106

 
3,630

Amortization of discount on long-term debt
 
4,238

 
3,605

Amortization of issuance costs for revolving bank lines of credit
 
2,887

 
4,213

Depreciation
 
3,735

 
2,920

Provision for loan losses
 
5,802

 
(5,779
)
Results of operations of foreclosed assets
 
(133
)
 
31,690

Derivative forward value
 
70,472

 
82,574

Changes in operating assets and liabilities:
 
 
 
 
Accrued interest and other receivables
 
3,051

 
2,298

Accrued interest payable
 
1,723

 
(1,427
)
Deferred income
 
1,203

 
6,495

Other
 
(6,993
)
 
(5,818
)
      Net cash provided by operating activities
 
96,001

 
103,320

Cash flows from investing activities:
 
 
 
 
Advances on loans
 
(4,345,065
)
 
(4,116,020
)
Principal collections on loans
 
3,140,744

 
3,809,772

Net investment in fixed assets
 
(4,662
)
 
(4,565
)
Proceeds from foreclosed assets
 
2,685

 
7,404

Investments in foreclosed assets
 
(2,984
)
 
(6,650
)
Proceeds from sale of time deposits
 
145,000

 
55,000

Investments in equity securities available for sale
 

 
(25,000
)
Change in restricted cash
 
(5,690
)
 
(1,012
)
     Net cash used in investing activities
 
(1,069,972
)
 
(281,071
)
Cash flows from financing activities:
 
 
 
 
Proceeds from issuances of short-term debt, net
 
437,486

 
150,891

Proceeds from issuances of short-term debt with original maturity greater than 90 days
 
313,337

 
240,662

Repayments of short term-debt with original maturity greater than 90 days
 
(335,775
)
 
(268,480
)
Payments for issuance costs for revolving bank lines of credit
 
(2,906
)
 
(2,822
)
Proceeds from issuance of long-term debt
 
1,484,044

 
748,073

Payments for retirement of long-term debt
 
(879,121
)
 
(431,260
)
Proceeds from issuance of members’ subordinated certificates
 
2,838

 
54,560

Payments for retirement of members’ subordinated certificates
 
(13,483
)
 
(101,251
)
Payments for retirement of patronage capital
 
(38,666
)
 
(38,836
)
Net cash provided by financing activities
 
967,754

 
351,537

Net increase (decrease) in cash and cash equivalents
 
(6,217
)
 
173,786

Beginning cash and cash equivalents
 
248,836

 
338,715

Ending cash and cash equivalents
 
$
242,619

 
$
512,501

 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.



45






NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

 
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid for interest
 
$
319,870

 
$
304,806

Cash paid for income taxes
 
72

 
81

Non-cash financing and investing activities:
 
 
 
 
Increase to patronage capital retirement payable
 
$
176

 
$

Net decrease in debt service reserve funds/debt service reserve certificates
 

 
(13,751
)
 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.


46




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


NOTE 1—SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company

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

Basis of Presentation and Use of Estimates

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information. Certain prior period amounts have been reclassified to conform to the current period presentation. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and related disclosures. These estimates are based on information available as of the date of the consolidated financial statements. While management makes its best judgment, actual amounts or results could differ from these estimates. In the opinion of management, all normal, recurring adjustments have been included for a fair presentation of this interim financial information. The results of operations in the interim financial statements are not necessarily indicative of the results that may be expected for the full year.

These interim unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements, and related notes thereto, included in CFC’s Annual Report on Form 10-K for the fiscal year ended May 31, 2015 (“2015 Form 10-K”).

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of CFC, Rural Telephone Finance Cooperative (“RTFC”), National Cooperative Services Corporation (“NCSC”) and subsidiaries created and controlled by CFC to hold foreclosed assets. All intercompany balances and transactions have been eliminated. RTFC was established to provide private financing for the rural telecommunications industry. NCSC may provide financing to members of CFC, government or quasi-government entities which own electric utility systems that meet the Rural Electrification Act definition of “rural”, and the for-profit and nonprofit entities that are owned, operated or controlled by, or provide significant benefits to certain members of CFC. CFC currently has one entity, Caribbean Asset Holdings, LLC (“CAH”), that holds foreclosed assets. CAH, which is classified as held for sale, 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. Unless stated otherwise, references to “we,” “our” or “us” relate to CFC and its consolidated entities.

Variable Interest Entities

Based on the accounting standards governing consolidations, equity and earnings of RTFC and NCSC are reported as noncontrolling interest.

CFC manages the lending activities of RTFC and NCSC. We are required to consolidate the financial results of RTFC and NCSC because CFC is the primary beneficiary of variable interests in RTFC and NCSC due to its exposure to absorbing the majority of their expected losses.

47




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Under separate guarantee agreements, RTFC and NCSC pay CFC a fee to indemnify them against loan losses. CFC is the sole lender to and manages the business operations of RTFC through a management agreement in effect until December 1, 2016, which is automatically renewed for one-year terms thereafter unless terminated by either party. CFC is the primary source of funding to, and manages the lending activities of, NCSC through a management agreement that is automatically renewable on an annual basis unless terminated by either party. NCSC funds its lending programs through loans from CFC or debt guaranteed by CFC. In connection with these guarantees, NCSC must pay a guarantee fee.

RTFC and NCSC creditors have no recourse against CFC in the event of a default by RTFC and NCSC, unless there is a guarantee agreement under which CFC has guaranteed NCSC or RTFC debt obligations to a third party. As of November 30, 2015, CFC had guaranteed $68 million of NCSC debt, derivative instruments and guarantees with third parties, and CFC’s maximum potential exposure for these instruments totaled $72 million. The maturities for NCSC obligations guaranteed by CFC extend through 2031. Guarantees of NCSC debt and derivative instruments are not included in Note 10, Guarantees, as the debt and derivatives are reported on the condensed consolidated balance sheets. As of November 30, 2015, CFC guaranteed $2 million of RTFC guarantees with third parties. The maturities for RTFC obligations guaranteed by CFC extend through 2016 and are renewed on an annual basis. All CFC loans to RTFC and NCSC are secured by all assets and revenue of RTFC and NCSC, respectively. As of November 30, 2015, RTFC had total assets of $473 million including loans outstanding to members of $365 million, and NCSC had total assets of $716 million including loans outstanding of $705 million. As of November 30, 2015, CFC had committed to lend RTFC up to $4,000 million, of which $345 million was outstanding. As of November 30, 2015, CFC had committed to provide up to $3,000 million of credit to NCSC, of which $750 million was outstanding, representing $682 million of outstanding loans and $68 million of credit enhancements.

Interest Income

Interest income on loans is recognized using the effective interest method. The following table presents the components of interest income for the three and six months ended November 30, 2015 and 2014.

 
 
Three Months Ended November 30,
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
 
2015
 
2014
Interest on long-term fixed-rate loans(1) 
 
$
243,601

 
$
222,023

 
$
475,803

 
$
444,351

Interest on long-term variable-rate loans
 
4,822

 
4,902

 
9,842

 
10,262

Interest on line of credit loans
 
6,386

 
6,687

 
12,584

 
13,629

Interest on restructured loans
 
130

 
10

 
130

 
10

Interest on nonperforming loans
 
29

 

 
29

 

Interest on investments
 
1,957

 
1,549

 
4,582

 
4,121

Fee income(2)
 
(600
)
 
64

 
(529
)
 
153

Total interest income
 
$
256,325

 
$
235,235

 
$
502,441

 
$
472,526

____________________________ 
(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 amortization of loan origination costs and late payment fees. For the three and six months ended November 30, 2015, it excludes loan upfront and arranger fees, which are not based on interest rates and are included in the fee and other income line of the condensed consolidated statements of operations.

Deferred income on the condensed consolidated balance sheets primarily consists of deferred loan conversion fees, which totaled $60 million and $70 million as of November 30, 2015 and May 31, 2015, respectively.


48




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Interest Expense

The following table presents the components of interest expense for the three and six months ended November 30, 2015 and 2014.

 
 
Three Months Ended November 30,
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
 
2015
 
2014
Interest expense on debt:(1)(2)(3)
 
 
 
 
 
 
 
 
Short-term debt
 
$
3,382

 
$
5,663

 
$
5,924

 
$
8,804

Medium-term notes
 
20,819

 
17,707

 
40,972

 
34,866

Collateral trust bonds
 
81,769

 
77,082

 
164,600

 
153,264

Subordinated deferrable debt
 
4,788

 
4,803

 
9,571

 
9,570

Subordinated certificates
 
15,097

 
16,105

 
30,403

 
32,851

Long-term notes payable
 
41,269

 
36,915

 
81,354

 
75,472

Total interest expense
 
$
167,124

 
$
158,275

 
$
332,824

 
$
314,827

____________________________ 
(1) Represents interest expense and the amortization of discounts on debt.
(2) Includes underwriter’s fees, legal fees, printing costs and certain accounting fees, which are deferred and recognized in interest expense using the effective interest method. Also includes issuance costs related to dealer commercial paper, which are recognized immediately as incurred.
(3) Includes fees related to funding activities, including fees paid to banks participating in our revolving credit agreements. Amounts are recognized as incurred or amortized on a straight-line basis over the life of the agreement.

Accounting Standards Adopted in Fiscal Year 2016

Simplifying the Presentation of Debt Issuance Costs

In April 2015, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2015-03, Simplifying the Presentation of Debt Issuance Costs, which amends the current 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 as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. Prior to the issuance of ASU 2015-03, debt issuance costs were required to be presented as an asset in the balance sheet. The guidance, which does not affect the recognition and measurement requirements for debt issuance costs, is effective for us in the first quarter of fiscal year 2017. However, we early-adopted this guidance in the first quarter of fiscal year 2016, and 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. We previously presented debt issuance costs as a separate line item under total assets on our condensed consolidated balance sheets. Other than this reclassification, the adoption of the guidance did not impact our consolidated financial statements.

Recently Issued but Not Yet Adopted Accounting Standards

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

In January 2016, the FASB issued ASU 2016-01, Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, which changes how entities measure certain equity investments and present changes in the fair value of financial liabilities measured under the fair value option that are attributable to their own credit. Under the new guidance, entities will be required to measure equity investments that do not result in consolidation and are not accounted for under the equity method at fair value and recognize any changes in fair value in net income unless the investments qualify for the new practicability exception. For financial liabilities measured using the fair value option, entities will be required to record changes in fair value caused by a change in instrument-specific credit risk (own credit risk) separately in other comprehensive income. The accounting for other financial instruments, such as loans and

49




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

investments in debt securities is largely unchanged. The classification and measurement guidance is effective for public entities in fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. This update will be effective for us in the first quarter of fiscal year 2019. We are in the process of evaluating the impact of this update on our financial condition, results of operations or liquidity.

Amendments to the Consolidation Analysis

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis, which is intended to improve upon and simplify the consolidation assessment required to evaluate whether organizations should consolidate certain legal entities such as limited partnerships, limited liability corporations, and securitization structures. This update is effective for us in the first quarter of fiscal year 2017. We do not expect the adoption of the update to have a material impact on our financial condition, results of operations or liquidity.

Revenue from Contracts with Customers

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, which clarifies the principles for recognizing revenue from contracts with customers. The new accounting guidance, which does not apply to financial instruments, is effective for us beginning in the first quarter of fiscal year 2018. On April 1, 2015, the FASB voted to propose to defer the effective date of the new revenue recognition standard by one year. We do not expect the new guidance to have a material impact on our financial condition, results of operations or liquidity, as CFC’s primary business and source of revenue is from lending.
NOTE 2—INVESTMENT SECURITIES

Our investment securities consist of holdings of Federal Agricultural Mortgage Corporation (“Farmer Mac”) preferred and common stock. The following tables present the amortized cost, gross unrealized gains and losses and fair value of our investment securities, all of which are classified as available for sale, as of November 30, 2015 and May 31, 2015.
 
 
November 30, 2015
(Dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Farmer Mac—Series A Non-Cumulative Preferred Stock
 
$
30,000

 
$
1,500

 
$

 
$
31,500

Farmer Mac—Series B Non-Cumulative Preferred Stock
 
25,000

 
2,050

 

 
27,050

Farmer Mac—Series C Non-Cumulative Preferred Stock
 
25,000

 
1,760

 

 
26,760

Farmer Mac—Class A Common Stock
 
538

 
1,510

 

 
2,048

Total available-for-sale investment securities
 
$
80,538

 
$
6,820

 
$

 
$
87,358


 
 
May 31, 2015
(Dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Farmer Mac—Series A Non-Cumulative Preferred Stock
 
$
30,000

 
$
264

 
$

 
$
30,264

Farmer Mac—Series B Non-Cumulative Preferred Stock
 
25,000

 
1,250

 

 
26,250

Farmer Mac—Series C Non-Cumulative Preferred Stock
 
25,000

 
900

 

 
25,900

Farmer Mac—Class A Common Stock
 
538

 
1,520

 

 
2,058

Total available-for-sale investment securities
 
$
80,538

 
$
3,934

 
$

 
$
84,472



50




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

We did not have any investment securities in an unrealized loss position as of November 30, 2015 and May 31, 2015. For additional information regarding the unrealized gains (losses) recorded on our available-for-sale investment securities, see “Note 9—Equity—Accumulated Other Comprehensive Income ”.
NOTE 3—LOANS AND COMMITMENTS
        
The table below presents the outstanding principal balance of loans to members, including deferred loan origination costs, and unadvanced loan commitments, by loan type and member class, as of November 30, 2015 and May 31, 2015.

 
 
November 30, 2015
 
May 31, 2015
(Dollars in thousands)
 
Loans
Outstanding
 
Unadvanced
Commitments (1)
 
Loans
Outstanding
 
Unadvanced
Commitments (1)
Loan type: (2)
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
20,601,694

 
$

 
$
19,543,274

 
$

Long-term variable-rate loans
 
712,955

 
4,762,678

 
698,495

 
4,835,623

Loans guaranteed by RUS
 
176,425

 

 
179,241

 

Line of credit loans
 
1,172,574

 
9,282,238

 
1,038,210

 
9,294,127

Total loans outstanding (3)
 
22,663,648

 
14,044,916

 
21,459,220

 
14,129,750

Deferred loan origination costs
 
9,881

 

 
9,797

 

Loans to members
 
$
22,673,529

 
$
14,044,916

 
$
21,469,017

 
$
14,129,750

 
 
 
 
 
 
 
 
 
Member class:(2)
 
 
 
 
 
 
 
 
CFC:
 
 
 
 
 
 
 
 
Distribution
 
$
17,153,380

 
$
9,583,769

 
$
16,095,043

 
$
9,474,568

Power supply
 
4,380,665

 
3,224,200

 
4,181,481

 
3,273,501

Statewide and associate
 
60,061

 
141,025

 
65,466

 
127,473

CFC total
 
21,594,106

 
12,948,994

 
20,341,990

 
12,875,542

RTFC
 
364,739

 
281,141

 
385,709

 
288,810

NCSC
 
704,803

 
814,781

 
731,521

 
965,398

Total loans outstanding(3)
 
$
22,663,648

 
$
14,044,916

 
$
21,459,220

 
$
14,129,750

____________________________ 
(1) The interest rate on unadvanced commitments is not set until drawn; therefore, the long-term unadvanced loan commitments have been classified in this table as variable-rate unadvanced commitments. However, at the time of the advance, the borrower may select a fixed or a variable rate on the new loan.
(2) Includes nonperforming and restructured loans.
(3) Represents the unpaid principal balance excluding deferred loan origination costs.

Unadvanced Loan Commitments

A total of $2,644 million and $2,765 million of unadvanced commitments as of November 30, 2015 and May 31, 2015, respectively, related to committed lines of credit loans that are not subject to a material adverse change clause at the time of each loan advance. As such, we will be required to advance amounts on these committed facilities as long as the borrower is in compliance with the terms and conditions of the facility.

The following table summarizes the available balance under unconditional committed lines of credit, and the related maturities by fiscal year and thereafter, as of November 30, 2015.

51




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
Available
Balance
 
Notional Maturities of Unconditional Committed Lines of Credit
(Dollars in thousands)
 
 
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
Committed lines of credit
 
$2,643,810

$
61,000


$199,257

$727,065

$854,128

$605,110
 
$197,250

The remaining unadvanced commitments totaling $11,401 million and $11,365 million as of November 30, 2015 and May 31, 2015, respectively, were generally subject to material adverse change clauses. Prior to making an advance on these facilities, we confirm that there has been no material adverse change in the business or condition, financial or otherwise, of the borrower since the time the loan was approved and confirm that the borrower is currently in compliance with loan terms and conditions. In some cases, the borrower’s access to the full amount of the facility is further constrained by the designated purpose, imposition of borrower-specific restrictions or by additional conditions that must be met prior to advancing funds.

The following table summarizes the available balance under unadvanced commitments as of November 30, 2015 and the related maturities by fiscal year and thereafter by loan type:
 
 
Available
Balance
 
Notional Maturities of Unadvanced Commitments
(Dollars in thousands)
 
 
2016
 
2017
 
2018
 
2019
 
2020
 
Thereafter
Line of credit loans
 
$
9,282,238


$
506,565


$
5,261,366


$
1,152,930


$
1,074,118


$
776,995


$
510,264

Long-term loans
 
4,762,678


277,585


1,144,251


784,664


1,061,634


1,006,845


487,699

Total
 
$
14,044,916


$
784,150


$
6,405,617


$
1,937,594


$
2,135,752


$
1,783,840


$
997,963


Unadvanced commitments related to line of credit loans are typically for periods not to exceed five years and are generally revolving facilities used for working capital and backup liquidity purposes. Historically, we have experienced a very low utilization rate on line of credit loan facilities, whether or not there is a material adverse change clause. Since we generally do not charge a fee on the unadvanced portion of the majority of our loan facilities, our borrowers will typically request long-term facilities to fund construction work plans and other capital expenditures for periods of up to five years and draw down on the facility over that time. In addition, borrowers will typically request an amount in excess of their immediate estimated loan requirements to avoid the expense related to seeking additional loan funding for unexpected items. These factors contribute to our expectation that the majority of the unadvanced commitments will expire without being fully drawn upon and that the total unadvanced amount does not necessarily represent future cash funding requirements.

Loan Sales

We account for the transfer of loans resulting from direct loan sales to third parties by removing the loans from our condensed consolidated balance sheets when control has been surrendered. We retain the servicing performance obligations on these loans and recognize related servicing fees on an accrual basis over the period for which servicing activity is provided, as we believe the servicing fee represents adequate compensation. Because the loans are sold at par, we record immaterial losses on the sale of these loans for unamortized deferred loan origination costs. We do not hold any continuing interest in the loans sold to date other than servicing performance obligations. We have no obligation to repurchase loans from the purchaser, except in the case of breaches of representations and warranties.

We sold CFC loans with outstanding balances totaling $64 million and $14 million, at par for cash, during the six months ended November 30, 2015 and 2014, respectively.

Credit Quality

We closely monitor loan performance trends to manage and evaluate our credit risk exposure. Our goal is to provide a balance between the credit needs of our members while also ensuring sound credit quality of our loan portfolio. Payment status and internal risk rating trends are indicators, among others, of the level of credit risk within our loan portfolios. As part of our strategy to reduce 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,

52




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

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 with an aggregate outstanding principal balance of $520 million as of August 31, 2015, which were reduced by subsequent loan principal payments to $515 million as of November 30, 2015. We are paying Farmer Mac a monthly fee based on the unpaid principal balance of the loans in the tranche(s) for the commitment to purchase loans under the agreement.

Payment Status of Loans

The tables below present the payment status of loans outstanding by member class as of November 30, 2015 and May 31, 2015.
 
 
November 30, 2015
(Dollars in thousands)
 
Current
 
30-89 Days Past Due
 
90 Days or More
Past Due (1)
 
Total
Past Due
 
Total Financing
Receivables
 
Nonaccrual Loans
CFC:
 
 
 
 
 
 
 
 
 
 
 
 
Distribution
 
$
17,153,380

 
$

 
$

 
$

 
$
17,153,380

 
$

Power supply
 
4,380,665

 

 

 

 
4,380,665

 

Statewide and associate
 
60,061

 

 

 

 
60,061

 

CFC total
 
21,594,106

 

 

 

 
21,594,106

 

RTFC
 
361,224

 

 
3,515

 
3,515

 
364,739

 
14,044

NCSC
 
704,803

 

 

 

 
704,803

 

Total loans outstanding
 
$
22,660,133

 
$

 
$
3,515

 
$
3,515

 
$
22,663,648

 
$
14,044

 
 
 
 
 
 
 
 
 
 
 
 
 
As a % of total loans
 
99.98
%
 
%
 
0.02
%
 
0.02
%
 
100.00
%
 
0.06
%

 
 
May 31, 2015
(Dollars in thousands)
 
Current
 
30-89 Days Past Due
 
90 Days or More
Past Due (1)
 
Total
Past Due
 
Total Financing
Receivables
 
Nonaccrual Loans
CFC:
 
 
 
 
 
 
 
 
 
 
 
 
Distribution
 
$
16,095,043

 
$

 
$

 
$

 
$
16,095,043

 
$
7,221

Power supply
 
4,181,481

 

 

 

 
4,181,481

 

Statewide and associate
 
65,466

 

 

 

 
65,466

 

CFC total
 
20,341,990

 

 

 

 
20,341,990

 
7,221

RTFC
 
385,709

 

 

 

 
385,709

 
4,221

NCSC
 
731,521

 

 

 

 
731,521

 
294

Total loans outstanding
 
$
21,459,220

 
$

 
$

 
$

 
$
21,459,220

 
$
11,736

 
 
 
 
 
 
 
 
 
 
 
 
 
As a % of total loans
 
100.00
%
 
%
 
%
 
%
 
100.00
%
 
0.05
%
____________________________ 
(1) All loans 90 days or more past due are on nonaccrual status.

Internal Risk Ratings of Loans

We evaluate the credit quality of our loans using an internal risk rating system that employs similar criteria for all member classes. Our internal risk rating system is based on a determination of a borrower’s risk of default utilizing both quantitative and qualitative measurements. We have grouped our risk ratings into the categories of pass and criticized based on the criteria below.


53




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

(i)   Pass:  Borrowers that are not experiencing difficulty and/or not showing a potential or well-defined credit weakness.
(ii) Criticized:  Includes borrowers categorized as special mention, substandard and doubtful as described below:
Special mention:  Borrowers that may be characterized by a potential credit weakness or deteriorating financial condition that is not sufficiently serious to warrant a classification of substandard or doubtful.
Substandard:  Borrowers that display a well-defined credit weakness that may jeopardize the full collection of principal and interest.
Doubtful:  Borrowers that have a well-defined weakness and the full collection of principal and interest is questionable or improbable.

Borrowers included in the pass, special mention, and substandard categories are generally reflected in the general portfolio of loans. Borrowers included in the doubtful category are reflected in the impaired portfolio of loans. Each risk rating is reassessed annually based on the receipt of the borrower’s audited financial statements; however, interim downgrades and upgrades may take place at any time as significant events or trends occur.

The following table presents our loan portfolio by risk rating category and member class based on available data as of November 30, 2015 and May 31, 2015.
 
 
November 30, 2015
 
May 31, 2015
(Dollars in thousands)
 
Pass
 
Criticized
 
Total
 
Pass
 
Criticized
 
Total
CFC:
 
 
 
 
 
 
 
 
 
 
 
 
Distribution
 
$
17,121,804

 
$
31,576

 
$
17,153,380

 
$
16,062,516

 
$
32,527

 
$
16,095,043

Power supply
 
4,380,665

 

 
4,380,665

 
4,181,481

 

 
4,181,481

Statewide and associate
 
59,801

 
260

 
60,061

 
65,200

 
266

 
65,466

CFC total
 
21,562,270

 
31,836

 
21,594,106

 
20,309,197

 
32,793

 
20,341,990

RTFC
 
350,696

 
14,043

 
364,739

 
373,087

 
12,622

 
385,709

NCSC
 
701,104

 
3,699

 
704,803

 
727,159

 
4,362

 
731,521

Total loans outstanding
 
$
22,614,070

 
$
49,578

 
$
22,663,648

 
$
21,409,443

 
$
49,777

 
$
21,459,220


Allowance for Loan Losses

We maintain an allowance for loan losses at a level estimated by management to provide for probable losses inherent in the loan portfolio as of each balance sheet date. The tables below summarize changes, by company, in the allowance for loan losses as of and for the six months ended November 30, 2015 and 2014.
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended November 30, 2015
(Dollars in thousands)
 
CFC
 
RTFC
 
NCSC 
 
Total
Balance as of August 31, 2015
 
$
27,151

 
$
5,552

 
$
5,604

 
$
38,307

Provision for loan losses
 
496

 
366

 
378

 
1,240

Recoveries
 
53

 

 

 
53

Balance as of November 30, 2015
 
$
27,700

 
$
5,918

 
$
5,982

 
$
39,600


54




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended November 30, 2014
(Dollars in thousands)
 
CFC
 
RTFC
 
NCSC 
 
Total
Balance as of August 31, 2014
 
$
40,461

 
$
4,288

 
$
4,962

 
$
49,711

Provision for loan losses
 
670

 
739

 
(417
)
 
992

Recoveries
 
54

 

 

 
54

Balance as of November 30, 2014
 
$
41,185

 
$
5,027

 
$
4,545

 
$
50,757

 
 
Six Months Ended November 30, 2015
(Dollars in thousands)
 
CFC
 
RTFC
 
NCSC
 
Total
Balance as of May 31, 2015
 
$
23,716

 
$
4,533

 
$
5,441

 
$
33,690

Provision for loan losses
 
3,876

 
1,385

 
541

 
5,802

Recoveries
 
108

 

 

 
108

Balance as of November 30, 2015
 
$
27,700

 
$
5,918

 
$
5,982

 
$
39,600

 
 
Six Months Ended November 30, 2014
(Dollars in thousands)
 
CFC
 
RTFC
 
NCSC
 
Total
Balance as of May 31, 2014
 
$
45,600

 
$
4,282

 
$
6,547

 
$
56,429

Provision for loan losses
 
(4,522
)
 
745

 
(2,002
)
 
(5,779
)
Recoveries
 
107

 

 

 
107

Balance as of November 30, 2014
 
$
41,185

 
$
5,027

 
$
4,545

 
$
50,757


Our allowance for loan losses consists of a specific allowance for loans individually evaluated for impairment and a collective allowance for loans collectively evaluated for impairment. The tables below present, by company, the components of our allowance for loan losses and the recorded investment of the related loans as of November 30, 2015 and May 31, 2015.

 
 
November 30, 2015
(Dollars in thousands)
 
CFC
 
RTFC
 
NCSC
 
Total
Ending balance of the allowance:
 
 
 
 
 
 
 
 
Collectively evaluated
 
$
27,700

 
$
2,291

 
$
5,982

 
$
35,973

Individually evaluated
 

 
3,627

 

 
3,627

Total ending balance of the allowance
 
$
27,700

 
$
5,918

 
$
5,982

 
$
39,600

 
 
 
 
 
 
 
 
 
Recorded investment in loans:
 
 
 
 
 
 
 
 
Collectively evaluated
 
$
21,587,390

 
$
350,695

 
$
704,803

 
$
22,642,888

Individually evaluated
 
6,716

 
14,044

 

 
20,760

Total recorded investment in loans
 
$
21,594,106

 
$
364,739

 
$
704,803

 
$
22,663,648

 
 
 
 
 
 
 
 
 
Loans to members, net (1)
 
$
21,566,406

 
$
358,821

 
$
698,821

 
$
22,624,048



55




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
May 31, 2015
(Dollars in thousands)
 
CFC
 
RTFC
 
NCSC
 
Total
Ending balance of the allowance:
 
 
 
 
 
 
 
 
Collectively evaluated
 
$
23,716

 
$
4,138

 
$
5,441

 
$
33,295

Individually evaluated
 

 
395

 

 
395

Total ending balance of the allowance
 
$
23,716

 
$
4,533

 
$
5,441

 
$
33,690

 
 
 
 
 
 
 
 
 
Recorded investment in loans:
 
 
 
 
 
 
 
 
Collectively evaluated
 
$
20,334,769

 
$
381,488

 
$
731,227

 
$
21,447,484

Individually evaluated
 
7,221

 
4,221

 
294

 
11,736

Total recorded investment in loans
 
$
20,341,990

 
$
385,709

 
$
731,521

 
$
21,459,220

 
 
 
 
 
 
 
 
 
Loans to members, net(1)
 
$
20,318,274

 
$
381,176

 
$
726,080

 
$
21,425,530

____________________________ 
(1) Excludes deferred origination costs of $10 million as of November 30, 2015 and May 31, 2015.

Impaired Loans

Our recorded investment in individually-impaired loans, which consists of the unpaid principal balance, and the related specific valuation allowance, by member class, as of November 30, 2015 and May 31, 2015 are summarized below.

 
 
November 30, 2015
 
May 31, 2015
(Dollars in thousands)
 
Recorded
Investment
 
Related
Allowance
 
Recorded
Investment
 
Related
Allowance
With no specific allowance recorded:
 
 
 
 
 
 
 
 
CFC/Distribution
 
$
6,716

 
$

 
$
7,221

 
$

NCSC
 

 

 
294

 

Total
 
6,716

 

 
7,515

 

 
 
 
 
 
 
 
 
 
With a specific allowance recorded:
 
 
 
 
 
 
 
 
RTFC
 
14,044

 
3,627

 
4,221

 
395

Total
 
14,044

 
3,627

 
4,221

 
395

Total impaired loans
 
$
20,760

 
$
3,627

 
$
11,736

 
$
395


The tables below represent the average recorded investment in impaired loans and the interest income recognized, by member class, for the three and six months ended November 30, 2015 and 2014.
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended November 30,
 
 
2015
 
2014
 
2015
 
2014
(Dollars in thousands)
 
Average Recorded Investment 
 
Interest Income Recognized 
CFC/Distribution
 
$
6,716

 
$
7,221

 
$
130

 
$

NCSC
 

 
325

 

 
10

RTFC
 
9,746

 
1,695

 
29

 

Total impaired loans
 
$
16,462

 
$
9,241

 
$
159

 
$
10


56




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
Six Months Ended November 30,
 
 
2015
 
2014
 
2015
 
2014
(Dollars in thousands)
 
Average Recorded Investment 
 
Interest Income Recognized 
CFC/Distribution
 
$
6,969

 
$
7,403

 
$
130

 
$

NCSC
 

 
344

 

 
10

RTFC
 
6,956

 
1,695

 
29

 

Total impaired loans
 
$
13,925

 
$
9,442

 
$
159

 
$
10


Troubled Debt Restructured (“TDR”) and Nonperforming Loans

The table below summarizes modified loans accounted for and reported as TDRs and nonperforming, the performance status of the loan, and the related unadvanced commitments, by loan type and by company, as of November 30, 2015 and May 31, 2015.

 
 
November 30, 2015
 
May 31, 2015
(Dollars in thousands)
 
Loans
Outstanding
 
Unadvanced
Commitments(1)
 
Loans
Outstanding
 
Unadvanced
Commitments(1)
TDR loans:
 
 
 
 
 
 
 
 
Nonperforming TDR loans:
 
 
 
 
 
 
 
 
RTFC:
 
 
 
 
 
 
 
 
Long-term variable-rate loans
 
$
3,515

 
$

 
$

 
$

Total nonperforming TDR loans
 
3,515

 

 

 

 
 
 
 
 
 
 
 
 
Performing TDR loans:
 
 
 
 
 
 
 
 
CFC:
 
 
 
 
 
 
 
 
Long-term fixed-rate loans(2)
 
6,716

 

 
7,221

 

NCSC:
 
 
 
 
 
 
 
 
       Line of credit loans
 

 

 
294

 

RTFC:
 
 
 
 
 
 
 
 
Long-term variable-rate loans
 

 

 
4,221

 

Total performing TDR loans
 
6,716

 

 
11,736

 

Total TDR loans
 
$
10,231

 
$

 
$
11,736

 
$

     Percent of total loans outstanding
 
0.05
%
 
%
 
0.05
%
 
%
 
 
 
 
 
 
 
 
 
Nonperforming loans:
 
 
 
 
 
 
 
 
RTFC:
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
8,559

 
$

 
$

 
$

       Line of credit loans
 
1,970

 

 

 

Total nonperforming loans
 
$
10,529

 
$

 
$

 
$

     Percent of total loans outstanding
 
0.05
%
 
%
 
%
 
%
____________________________ 
(1) The interest rate on unadvanced commitments is not set until drawn; therefore, the long-term unadvanced loan commitments have been classified in this table as variable-rate unadvanced commitments. However, at the time of the advance, the borrower may select a fixed or a variable rate on the new loan.
(2) A borrower in this category also had a line of credit loan outstanding that was classified as performing as of November 30, 2015 and May 31, 2015. Unadvanced commitments related to this line of credit loan totaled $3 million and $2 million as of November 30, 2015 and May 31, 2015, respectively.

57




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The following table shows foregone interest income as a result of holding loans on nonaccrual status for the three and six months ended November 30, 2015 and 2014.
 
 
Three Months Ended November 30,
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
 
2015
 
2014
Nonperforming loans
 
$
12

 
$
25

 
$
12

 
$
51

Performing TDR loans
 

 
127

 
166

 
264

Nonperforming TDR loans
 
33

 

 
46

 

Total
 
$
45

 
$
152

 
$
224

 
$
315


Pledging of Loans and Loans on Deposit

We are required to pledge eligible mortgage notes in an amount at least equal to the outstanding balance of our secured debt.

The following table summarizes our loans outstanding as collateral pledged to secure our collateral trust bonds, Clean Renewable Energy Bonds and notes payable to Farmer Mac and the amount of the corresponding debt outstanding as of November 30, 2015 and May 31, 2015, See “Note 5—Short-Term Debt and Credit Arrangements” and “Note 6—Long-Term Debt”) for information on our borrowings.
(Dollars in thousands)
 
November 30, 2015
 
May 31, 2015
Collateral trust bonds:
 
 
 
 
2007 indenture:
 
 
 
 
Distribution system mortgage notes
 
$
7,335,182

 
$
6,551,836

RUS guaranteed loans qualifying as permitted investments
 
154,215

 
156,665

Total pledged collateral
 
$
7,489,397

 
$
6,708,501

Collateral trust bonds outstanding
 
6,347,711

 
6,197,711

 
 
 
 
 
1994 indenture:
 
 
 
 
Distribution system mortgage notes
 
$
873,976

 
$
905,656

Collateral trust bonds outstanding
 
800,000

 
855,000

 
 
 
 
 
Farmer Mac:
 
 
 
 
Distribution and power supply system mortgage notes
 
$
2,343,470

 
$
2,160,805

Notes payable outstanding
 
2,072,040

 
1,910,688

 
 
 
 
 
Clean Renewable Energy Bonds Series 2009A:
 
 
 
 
Distribution and power supply system mortgage notes
 
$
18,150

 
$
19,260

Cash
 
1,488

 
485

Total pledged collateral
 
$
19,638

 
$
19,745

Notes payable outstanding
 
16,529

 
16,529

 
We are required to maintain collateral on deposit in an amount at least equal to the balance of debt outstanding to the Federal Financing Bank (“FFB”) of the United States Treasury issued under the Guaranteed Underwriter Program of the USDA (the “Guaranteed Underwriter Program”). See “Note 5—Short-Term Debt and Credit Arrangements” and “Note 6—Long-Term Debt.”


58




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The following table shows the collateral on deposit and the amount of the corresponding debt outstanding as of November 30, 2015 and May 31, 2015.
(Dollars in thousands)
 
November 30, 2015
 
May 31, 2015
FFB:
 
 
 
 
Distribution and power supply system mortgage notes on deposit
 
$
5,460,626

 
$
4,943,746

Notes payable outstanding
 
4,644,097

 
4,406,785

NOTE 4—FORECLOSED ASSETS

CAH is the only entity in which we held foreclosed assets as of November 30, 2015. CAH had total assets, which consisted primarily of property, plant and equipment and goodwill and other intangible assets of $167 million as of November 30, 2015. CAH had total liabilities of $242 million as of November 30, 2015 and an equity deficit of $75 million. CAH’s total liabilities included loans and interest payable to CFC, which have been eliminated in consolidation, of $188 million as of November 30, 2015.

Sale of CAH

On September 30, 2015, CFC entered into a 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.

Foreclosed Asset Activity

The table below summarizes amounts recorded in our consolidated financial statements for CAH as of and for the six months ended November 30, 2015. The balance of $117 million as of November 30, 2015 reflects the expected net proceeds, including estimated adjustments to the selling price and selling costs, from the completion of the CAH sales transaction.
 
 
Six Months Ended November 30, 2015
(Dollars in thousands)
 
Balance as of May 31, 2015
 
$
116,507

Change in estimated net proceeds(1)
 
432

Balance as of November 30, 2015
 
$
116,939

____________________________ 
(1)Included as a component of results of foreclosed assets on our consolidated statements of operations.

59




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 5—SHORT-TERM DEBT AND CREDIT ARRANGEMENTS

The following is a summary of short-term debt outstanding as of November 30, 2015 and May 31, 2015.
(Dollars in thousands)
 
November 30, 2015

May 31, 2015
Short-term debt:
 
 
 
 
Commercial paper sold through dealers, net of discounts (1)
 
$
1,020,287

 
$
984,954

Commercial paper sold directly to members, at par (1)(2)
 
759,815

 
736,162

Select notes
 
809,298

 
671,635

Daily liquidity fund notes
 
740,142

 
509,131

Medium-term notes sold to members
 
213,260

 
225,872

    Total short-term debt
 
$
3,542,802

 
$
3,127,754

____________________________ 
(1) Backup liquidity is provided by our revolving credit agreements.
(2) Includes commercial paper sold directly to associates and affiliates.


Revolving Credit Agreements

We had $3,420 million of commitments under revolving credit agreements as of November 30, 2015 and May 31, 2015.
Under our current revolving credit agreements, we have the ability to request up to $300 million of letters of credit, which would result in a reduction in the remaining available under the facilities. On November 19, 2015, we amended and restated the $1,665 million three-year and $1,645 million five-year revolving credit agreements to extend the maturity dates to November 19, 2018 and November 19, 2020, respectively, from October 28, 2017 and October 28, 2019, respectively. Commitments of $25 million under the three-year agreement will expire at the prior maturity date of October 28, 2017. Commitments of $45 million under the five-year agreement will expire at the prior maturity date of October 28, 2019. Also, as part of the amendment, the commitments from three banks were increased by $45 million.

Prior to this amendment, NCSC assumed $155 million in commitments from one of the banks, which was reduced to $110 million as part of the amendment on November 19, 2015. Although the total commitment amount under our new revolving credit agreements is unchanged from the previous total of $3,420 million, NCSC’s commitment amount is excluded from the commitment amount from third parties of $3,310 million because NCSC receives all of its funding from CFC and NCSC's financial results are consolidated with CFC. The NCSC assumption of $110 million of commitments under the revolving credit agreements also reduces the total letters of credit from third parties, to $290 million.

The following table presents the total commitment, the net amount available for use and the outstanding letters of credit under our revolving credit agreements as of November 30, 2015 and May 31, 2015.

 
 
November 30, 2015

May 31, 2015

 

 
(Dollars in millions)
 
Total Commitment

Letters of Credit Outstanding

Net Available for Use(1)

Total Commitment

Letters of Credit Outstanding

Net Available for Use(1)

Maturity

Annual Facility Fee (2)
Three-year agreement
 
$
25


$


$
25


$
1,720


$


$
1,720


October 28, 2017

7.5 bps
Five-year agreement
 
45




45


1,700


1


1,699


October 28, 2019

10 bps
Three-year agreement
 
1,640




1,640








November 19, 2018

7.5 bps
Five-year agreement
 
1,600


1


1,599








November 19, 2020

10 bps
Total
 
$
3,310


$
1


$
3,309


$
3,420


$
1


$
3,419


 

 
____________________________ 
(1)Reflects amounts available from unaffiliated third parties that are not consolidated by CFC.

60




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

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

The following represents our required and actual financial ratios under the revolving credit agreements as of November 30, 2015 and May 31, 2015.
 
 
 
 
Actual
 
 
Requirement
 
November 30, 2015

May 31, 2015
Minimum average adjusted TIER over the six most recent fiscal quarters(1)
 
1.025

 
1.28
 
1.28
Minimum adjusted TIER for the most recent fiscal year (1) (2)
 
1.05

 
1.30
 
1.30
Maximum ratio of adjusted senior debt to total equity (1)
 
10.00

 
6.18
 
5.93
____________________________ 
(1) In addition to the adjustments made to the leverage ratio set forth in “Item 7. MD&A—Non-GAAP Financial Measures,” senior debt excludes guarantees to member systems that have certain investment-grade ratings by Moody’s and S&P. The TIER and debt-to-equity calculations include the adjustments set forth in “Item 7. MD&A—Non-GAAP Financial Measures” and exclude the results of operations and other comprehensive income for CAH.
(2) We must meet or exceed the required ratios in order to retire patronage capital.

We were in compliance with all covenants and conditions under our revolving credit agreements and there were no borrowings outstanding under these agreements as of November 30, 2015 and May 31, 2015

61




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 6—LONG-TERM DEBT

The following is a summary of long-term debt outstanding as of November 30, 2015 and May 31, 2015.
(Dollars in thousands)
 
November 30, 2015
 
May 31, 2015
Unsecured long-term debt:
 
 
 
 
Medium-term notes sold through dealers
 
$
2,878,577

 
$
2,749,894

Medium-term notes sold to members
 
383,594

 
392,298

Subtotal medium-term notes
 
3,262,171

 
3,142,192

Unamortized discount
 
(622
)
 
(706
)
Debt issuance costs
 
(16,572
)
 
(15,335
)
Total unsecured medium-term notes
 
3,244,977

 
3,126,151

Guaranteed Underwriter Program notes payable
 
4,644,097

 
4,406,785

Debt issuance costs
 
(307
)
 
(320
)
Total Guaranteed Underwriter Program notes payable
 
4,643,790

 
4,406,465

Other unsecured notes payable
 
31,167

 
31,168

Unamortized discount
 
(557
)
 
(626
)
Debt issuance costs
 
(138
)
 
(155
)
Total other unsecured notes payable
 
30,472

 
30,387

Total unsecured notes payable
 
4,674,262

 
4,436,852

Total unsecured long-term debt
 
7,919,239

 
7,563,003

Secured long-term debt:
 
 

 
 

Collateral trust bonds
 
7,147,711

 
7,052,711

Unamortized discount
 
(268,775
)
 
(271,201
)
Debt issuance costs
 
(28,276
)
 
(26,443
)
Total collateral trust bonds
 
6,850,660

 
6,755,067

Farmer Mac notes payable
 
2,072,040

 
1,910,688

Other secured notes payable
 
16,529

 
16,529

Debt issuance costs
 
(444
)
 
(493
)
Total other secured notes payable
 
16,085

 
16,036

Total secured notes payable
 
2,088,125

 
1,926,724

Total secured long-term debt
 
8,938,785

 
8,681,791

Total long-term debt
 
$
16,858,024

 
$
16,244,794


Collateral Trust Bonds

In October 2015, we issued $350 million of 2.30% collateral trust bonds due 2020 and $400 million of 3.25% collateral trust bonds due 2025.

Unsecured Notes Payable
As of November 30, 2015 and May 31, 2015, we had unsecured notes payable totaling $4,644 million and $4,407 million, respectively, outstanding under bond purchase agreements with the FFB and a bond guarantee agreement with RUS issued under the Guaranteed Underwriter Program, which provides guarantees to the FFB. We pay RUS a fee of 30 basis points per year on the total amount borrowed. As of November 30, 2015, $4,644 million of unsecured notes payable outstanding under the Guaranteed Underwriter Program require us to place mortgage notes on deposit in an amount at least equal to the principal balance of the notes outstanding. See “Note 3—Loans and Commitments” for additional information on the mortgage notes held on deposit and the triggering events that result in these mortgage notes becoming pledged as collateral. During the six months ended November 30, 2015, we borrowed $250 million under the Guaranteed Underwriter Program.

62




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

As of November 30, 2015, we had up to $500 million available under committed loan facilities from the Federal Financing Bank as part of this program. We are required to maintain collateral on deposit in an amount at least equal to the balance of debt outstanding to the FFB under this program. On September 28, 2015, we received a commitment from RUS to guarantee a loan from the Federal Financing Bank for additional funding of $250 million as part of the Guaranteed Underwriter Program. As a result, 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.

Secured Notes Payable

As of November 30, 2015 and May 31, 2015, secured notes payable include $2,072 million and $1,911 million, respectively, in debt outstanding to Farmer Mac under a note purchase agreement totaling $4,500 million. Under the terms of the note purchase agreement, we can borrow up to $4,500 million at any time through January 11, 2020, and thereafter automatically extend the agreement on each anniversary date of the closing for an additional year, unless prior to any such anniversary date, Farmer Mac provides CFC with a notice that the draw period would not be extended beyond the remaining term. During the six months ended November 30, 2015, we borrowed a total of $180 million under the note purchase agreement with Farmer Mac. The agreement with Farmer Mac is a revolving credit facility that allows us to borrow, repay and re-borrow funds at any time through maturity or from time to time as market conditions permit, provided that the principal amount at any time outstanding is not more than the total available under the agreement.

On July 31, 2015, we entered into a new revolving note purchase agreement with Farmer Mac totaling $300 million. Under the terms of the new agreement, we can borrow up to $300 million at any time through July 31, 2018. This agreement with Farmer Mac is a revolving credit facility that allows us to borrow, repay and re-borrow funds at any time through maturity or from time to time, provided that the principal amount at any time outstanding is not more than the total available under the agreement.

We are required to pledge eligible distribution system or power supply system loans as collateral in an amount at least equal to the total principal amount of notes outstanding under the Farmer Mac agreements. See “Note 3—Loans and Commitments” for additional information on the collateral pledged to secure notes payable under these programs.

As of November 30, 2015 and May 31, 2015, we were in compliance with all covenants and conditions under our senior debt indentures.
NOTE 7—SUBORDINATED DEFERRABLE DEBT

As of both November 30, 2015 and May 31, 2015, we had $396 million of 4.75% subordinated deferrable debt outstanding due in 2043. The outstanding balance is presented net of $4 million in unamortized debt issuance costs for both periods. Subordinated deferrable debt currently outstanding is callable at par on or after April 30, 2023.

NOTE 8—DERIVATIVE FINANCIAL INSTRUMENTS

Use of Derivatives

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






63




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Accounting for Derivatives

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

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

We generally do not designate interest rate swaps, which 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). Cash settlements related to interest rate swaps are classified as an operating activity in our consolidated statements of cash flows.

We typically designate treasury rate locks as cash flow hedges of forecasted debt issuances. Accordingly, changes in the fair value of the derivative instruments are recorded as a component of OCI and reclassified to interest expense when the forecasted transaction occurs using the effective interest method. Any ineffectiveness in the hedging relationship is recognized as a component of derivative gains (losses) in our consolidated statements of operations. We did not have any derivatives designated as accounting hedges as of November 30, 2015 and May 31, 2015.

Outstanding Notional Amount of Derivatives

The notional amount provides an indication of the volume of our derivatives activity, but this amount is not recorded on our condensed consolidated balance sheets. The notional amount is used only as the basis on which interest payments are determined and is not the amount exchanged. The following table shows the outstanding notional amounts and the weighted-average rate paid and received for our interest rate swaps, by type, as of November 30, 2015 and May 31, 2015. The substantial majority of our interest rate exchange agreements use an index based on the London Interbank Offered Rate (“LIBOR”) for either the pay or receive leg of the swap agreement.
 
 
November 30, 2015
 
May 31, 2015
(Dollars in thousands)
 
Notional
Amount
 
Weighted-
Average
Rate Paid
 
Weighted-
Average
Rate Received
 
Notional
Amount
 
Weighted-
Average
Rate Paid
 
Weighted-
Average
Rate Received
Pay-fixed swaps
 
$
6,215,910

 
3.06
%
 
0.34
%
 
$
5,776,533

 
3.15
%
 
0.28
%
Receive-fixed swaps
 
3,799,000

 
0.82

 
2.98

 
3,849,000

 
0.79

 
3.09

Total interest rate swaps
 
$
10,014,910

 
2.21

 
1.34

 
$
9,625,533

 
2.21

 
1.40



64




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Impact of Derivatives on Condensed Consolidated Balance Sheets

The following table displays the fair value of the derivative assets and derivative liabilities recorded on our condensed consolidated balance sheets and the related outstanding notional amount of our interest rate swaps as of November 30, 2015 and May 31, 2015.
 
 
 
November 30, 2015
 
May 31, 2015
(Dollars in thousands)
 
Fair Value
 
Notional Balance
 
Fair Value
 
Fair Value
Derivative assets
 
$
81,687

 
$
2,694,338

 
$
115,276

 
$
3,448,615

Derivative liabilities
 
(445,537
)
 
7,320,572

 
(408,382
)
 
6,176,918

Total
 
$
(363,850
)
 
$
10,014,910

 
$
(293,106
)
 
$
9,625,533


All of our master swap agreements include legally enforceable netting provisions that allow for offsetting of all contracts with a given counterparty in the event of default by one of the two parties. However, as indicated above, we report derivative asset and liability amounts on a gross basis based on individual contracts. The following table presents the gross fair value of derivative assets and liabilities reported on our condensed consolidated balance sheets as of November 30, 2015 and May 31, 2015, and provides information on the impact of netting provisions and collateral pledged.

 
 
November 30, 2015
 
 
Gross Amount
of Recognized
Assets/ Liabilities
 
Gross Amount
Offset in the
Balance Sheet
 
Net Amount of Assets/ Liabilities
Presented
in the
Balance Sheet
 
Gross Amount
Not Offset in the
Balance Sheet
 
 
(Dollars in thousands)
 
 
 
 
Financial
Instruments
 
Cash
Collateral
Pledged
 
Net
Amount
Derivative assets:
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
81,687

 
$

 
$
81,687

 
$
81,687

 
$

 
$

Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
445,537

 

 
445,537

 
81,687

 

 
363,850


 
 
May 31, 2015
 
 
Gross Amount
of Recognized
Assets/ Liabilities
 
Gross Amount
Offset in the
Balance Sheet
 
Net Amount of Assets/ Liabilities
Presented
in the
Balance Sheet
 
Gross Amount
Not Offset in the
Balance Sheet
 
 
(Dollars in thousands)
 
 
 
 
Financial
Instruments
 
Cash
Collateral
Pledged
 
Net
Amount
Derivative assets:
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
$
115,276

 
$

 
$
115,276

 
$
115,276

 
$

 
$

Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
408,382

 

 
408,382

 
115,276

 

 
293,106


Impact of Derivatives on Condensed Consolidated Statements of Operations

Derivative gains (losses) reported in our condensed consolidated statements of operations consist of derivative cash settlements and derivative forward value. 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 the estimate of future interest rates over the remaining life of our derivative contracts.

65




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The following table presents the components of the derivative gains (losses) reported in our condensed consolidated statements of operations for our interest rate swaps for the three and six months ended November 30, 2015 and 2014.

 
 
Three Months Ended November 30,
 
Six Months Ended November 30,
(Dollars in thousands)
 
2015
 
2014
 
2015
 
2014
Derivative cash settlements
 
$
(22,573
)
 
$
(21,764
)
 
$
(42,729
)
 
$
(41,865
)
Derivative forward value
 
(78,611
)
 
(52,797
)
 
(70,472
)
 
(82,574
)
Derivative losses
 
$
(101,184
)
 
$
(74,561
)
 
$
(113,201
)
 
$
(124,439
)

Credit-Risk-Related Contingent Features in Derivatives

The majority of our interest rate swap agreements have credit risk-related contingent features referred to as rating triggers. Under these rating triggers, if the credit rating for either counterparty falls to the level specified in the agreement, the other counterparty may, but is not obligated to, terminate the agreement. Our senior unsecured credit ratings from Moody’s and S&P were A2 and A, respectively, as of November 30, 2015. Moody’s had our ratings on stable outlook as of November 30, 2015, while S&P had our ratings on negative outlook as of November 30, 2015.

The table below displays the notional amounts of our derivative contracts with rating triggers as of November 30, 2015 and the payments that would be required if the contracts were terminated as of that date because of a downgrade of our unsecured credit ratings or the counterparty's unsecured credit ratings to or below Baa1/BBB+, Baa3/BBB- or Ba2/BB+ by Moody’s or S&P, respectively. In calculating the payment amounts that would be required upon termination of the derivative contracts, we assumed that the amounts for each counterparty would be netted in accordance with the provisions of the master netting agreements for each counterparty. The net payment amounts are based on the fair value of the underlying derivative instrument, excluding the credit risk valuation adjustment, plus any unpaid accrued interest amounts.
(Dollars in thousands)
 
Notional
Amount
 
Payment
Required by CFC
 
Payment
Due to CFC
 
Net (Payable)
Due
Impact of mutual rating downgrade trigger:
 
 
 
 
 
 
 
 
Falls below Baa1/BBB+

$
5,629,362


$
(218,630
)

$


$
(218,630
)
Falls to or below Baa3/BBB-
 
1,696,699


(33,362
)



(33,362
)
Falls below Baa3/BBB-
 
572,011


(26,702
)



(26,702
)
Falls to or below Ba2/BB+(1)
 
102,009

 
(335
)
 

 
(335
)
Total
 
$
8,000,081


$
(279,029
)

$


$
(279,029
)
____________________________ 
(1) Rating trigger for counterparty falls to or below Ba2/BB+, while rating trigger for CFC falls to or below Baa2/BBB by Moody’s or S&P, respectively.

The aggregate amount, including the credit risk valuation adjustment, of all interest rate swaps with rating triggers that were in a net liability position was $283 million as of November 30, 2015. There were no interest rate swaps with rating triggers that were in a net asset position as of November 30, 2015.

66




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 9—EQUITY

Total equity decreased by $18 million during the six months ended November 30, 2015 to $894 million as of November 30, 2015. The decrease in total equity was primarily attributable to our net income of $19 million for the period, which was partially offset by patronage capital retirement of $39 million.

In July 2015, the CFC Board of Directors authorized the allocation of the fiscal year 2015 net earnings as follows: $1 million to the Cooperative Educational Fund, $16 million to the members’ capital reserve and $78 million to members in the form of patronage.

In July 2015, the CFC Board of Directors authorized the retirement of allocated net earnings totaling $39 million, representing 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 with due regard for its financial condition. The CFC Board of Directors has the authority to change the current practice for allocating and retiring net earnings at any time, subject to applicable laws and regulations.

Accumulated Other Comprehensive Income

The activity in the accumulated other comprehensive income account is summarized below by component as of and for the three and six months ended November 30, 2015 and 2014.
 
 
Three Months Ended November 30, 2015
(Dollars in thousands)
 
Unrealized Gains (Losses)
AFS Securities
 
Unrealized Gains
Derivatives
 
Unrealized Losses Foreclosed Assets
 
Unrealized Losses Defined Benefit Plan
 
Total
Beginning balance
 
$
3,270

 
$
5,137

 
$
(4,248
)
 
$
(933
)
 
$
3,226

Unrealized gains
 
3,550

 

 

 

 
3,550

Losses reclassified into earnings
 

 

 

 
44

 
44

Gains reclassified into earnings
 

 
(235
)
 

 

 
(235
)
Other comprehensive income
 
3,550

 
(235
)
 

 
44

 
3,359

Ending balance
 
$
6,820

 
$
4,902

 
$
(4,248
)
 
$
(889
)
 
$
6,585

 
 
Three Months Ended November 30, 2014
(Dollars in thousands)
 
Unrealized Gains (Losses)
AFS Securities
 
Unrealized Gains
Derivatives
 
Unrealized Losses Foreclosed Assets
 
Total
Beginning balance
 
$
2,339

 
$
6,082

 
$
(2,310
)
 
$
6,111

Unrealized gains
 
902

 

 

 
902

Gains reclassified into earnings
 

 
(240
)
 

 
(240
)
Other comprehensive income
 
902

 
(240
)
 

 
662

Ending balance
 
$
3,241

 
$
5,842

 
$
(2,310
)
 
$
6,773


67




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
Six Months Ended November 30, 2015
(Dollars in thousands)
 
Unrealized Gains (Losses)
AFS Securities
 
Unrealized Gains
Derivatives
 
Unrealized Losses Foreclosed Assets
 
Unrealized Losses Defined Benefit Plan
 
Total
Beginning balance
 
$
3,934

 
$
5,371

 
$
(4,248
)
 
$
(977
)
 
$
4,080

Unrealized gains
 
2,886

 

 

 

 
2,886

Losses reclassified into earnings
 

 

 

 
88

 
88

Gains reclassified into earnings
 

 
(469
)
 

 

 
(469
)
Other comprehensive income
 
2,886

 
(469
)
 

 
88

 
2,505

Ending balance
 
$
6,820

 
$
4,902

 
$
(4,248
)
 
$
(889
)
 
$
6,585

 
 
Six Months Ended November 30, 2014
(Dollars in thousands)
 
Unrealized Gains (Losses)
AFS Securities
 
Unrealized Gains
Derivatives
 
Unrealized Losses Foreclosed Assets
 
Total
Beginning balance
 
$
(361
)
 
$
6,320

 
$
(2,310
)
 
$
3,649

Unrealized gains
 
3,602

 

 

 
3,602

Gains reclassified into earnings
 

 
(478
)
 

 
(478
)
Other comprehensive income
 
3,602

 
(478
)
 

 
3,124

Ending balance
 
$
3,241

 
$
5,842

 
$
(2,310
)
 
$
6,773


NOTE 10—GUARANTEES

The following table summarizes total guarantees by type of guarantee and member class as of November 30, 2015 and May 31, 2015.
(Dollars in thousands)
 
November 30, 2015
 
May 31, 2015
Total by type:
 
 
 
 
Long-term tax-exempt bonds
 
$
483,730

 
$
489,520

Letters of credit
 
363,441

 
382,233

Other guarantees
 
114,079

 
114,747

Total
 
$
961,250

 
$
986,500

 
 
 
 
 
Total by member class:
 
 
 
 
CFC:
 
 
 
 
Distribution
 
$
156,276

 
$
172,104

Power supply
 
747,669

 
763,746

Statewide and associate
 
17,048

 
17,025

CFC total
 
920,993

 
952,875

RTFC
 
1,574

 
1,574

NCSC
 
38,683

 
32,051

Total
 
$
961,250

 
$
986,500



68




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The maturities for the long-term tax-exempt bonds and the related guarantees run through calendar year 2042. Amounts in the table represent the outstanding principal amount of the guaranteed bonds. As of November 30, 2015, our maximum potential exposure for the $70 million of fixed-rate tax-exempt bonds is $100 million, representing principal and interest. Of the amounts shown in the table above for long-term tax-exempt bonds, $413 million and $418 million as of November 30, 2015 and May 31, 2015, respectively, are adjustable or floating-rate bonds that may be converted to a fixed rate as specified in the applicable indenture for each bond offering. We are unable to determine the maximum amount of interest that we could be required to pay related to the remaining adjustable and floating-rate bonds. Many of these bonds have a call provision that in the event of a default allow us to trigger the call provision. This would limit our exposure to future interest payments on these bonds. Our maximum potential exposure is secured by mortgage liens on all of the systems' assets and future revenue. If a system's debt is accelerated because of a determination that the interest thereon is not tax-exempt, the system’s obligation to reimburse us for any guarantee payments will be treated as a long-term loan.

The maturities for letters of credit run through calendar year 2024. The amounts shown in the table above represent our maximum potential exposure, of which $134 million is secured as of November 30, 2015. As of November 30, 2015 and May 31, 2015, the letters of credit include $76 million to provide the standby liquidity for adjustable and floating-rate tax-exempt bonds issued for the benefit of our members, respectively. Security provisions include a mortgage lien on substantially all of the system’s assets, future revenue and the system’s investment in our commercial paper.

In addition to the letters of credit listed in the table above, under master letter of credit facilities in place as of November 30, 2015, we may be required to issue up to an additional $85 million in letters of credit to third parties for the benefit of our members. As of November 30, 2015, all of our master letter of credit facilities were subject to material adverse change clauses at the time of issuance. Prior to issuing a letter of credit, 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.

The maturities for other guarantees listed in the table run through calendar year 2025. The maximum potential exposure for these other guarantees is $115 million, all of which is unsecured.

As of November 30, 2015 and May 31, 2015, we had $343 million and $434 million of guarantees, respectively, representing 36% and 44%, respectively, of total guarantees, under which our right of recovery from our members was not secured.

In addition to the guarantees described above, as of November 30, 2015, we were the liquidity provider for a total of $489 million of variable-rate tax-exempt bonds issued for our member cooperatives. While the bonds are in variable-rate mode, in return for a fee, we have unconditionally agreed to purchase bonds tendered or put for redemption if the remarketing agents are unable to sell such bonds to other investors. During the six months ended November 30, 2015, we were not required to perform as liquidity provider pursuant to these obligations.

Guarantee Liability

As of November 30, 2015 and May 31, 2015, we recorded a guarantee liability of $19 million and $20 million respectively, which represents the contingent and non-contingent exposures related to guarantees and liquidity obligations associated with our members’ debt. The contingent guarantee liability as of November 30, 2015 and May 31, 2015 was $1 million based on management’s estimate of exposure to losses within the guarantee portfolio. The remaining balance of the total guarantee liability of $18 million and $19 million as of November 30, 2015 and May 31, 2015, respectively, relates to our non-contingent obligation to stand ready to perform over the term of our guarantees and liquidity obligations that we have entered into or modified since January 1, 2003.

69




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 11—FAIR VALUE MEASUREMENTS

We use fair value measurements to record fair value adjustments for certain assets and liabilities and to determine fair value disclosures. Fair value is defined as the price that would be received for an asset or paid to transfer a liability in an orderly transaction between market participants on the measurement date (also referred to as an exit price). Assets and liabilities accounted for and reported at fair value in our consolidated financial statements on a recurring basis each reporting period include our available-for-sale investment securities and derivative instruments. Assets that are not measured at fair value each reporting period but are subject to fair value measurements on a nonrecurring basis in certain circumstances include impaired loans and long-lived assets classified as held for sale. The adjustments related to assets measured at fair value on a nonrecurring basis usually result from the application of lower-of-cost-market accounting or impairment of individual assets.

Fair Value Hierarchy

The fair value accounting guidance provides a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on the markets in which the assets or liabilities trade and whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Fair value measurement of a financial asset or liability is assigned a level based on the lowest level of any input that is significant to the fair value measurement in its entirety. The three levels of the fair value hierarchy are summarized below:

Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities
Level 2: Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities
Level 3: Unobservable inputs

For additional information regarding the fair value hierarchy and a description of the methodologies we use to measure fair value, see “Note 13—Fair Value Measurements” and “Note 14—Fair Value of Financial Instruments” to the Consolidated Financial Statements in our 2015 Form 10-K.

Recurring Fair Value Measurements

The table below presents the carrying value and fair value of financial instruments reported in our condensed consolidated financial statements at fair value on a recurring basis as of November 30, 2015 and May 31, 2015, and the classification level of the fair value methodology within the fair value measurement hierarchy.
 
 
November 30, 2015
 
May 31, 2015
(Dollars in thousands)
 
Level 1
 
Level 2
 
Total
 
Level 1
 
Level 2
 
Total
Investment securities, available for sale
 
$
87,358

 
$

 
$
87,358

 
$
84,472

 
$

 
$
84,472

Deferred compensation investments
 
4,401

 

 
4,401

 
4,294

 

 
4,294

Derivative assets
 

 
81,687

 
81,687

 

 
115,276

 
115,276

Derivative liabilities
 

 
445,537

 
445,537

 

 
408,382

 
408,382

 
Transfers Between Levels

We monitor the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy and transfer between Level 1, Level 2, and Level 3 accordingly. Observable market data includes but is not limited to quoted prices and market transactions. Changes in economic conditions or market liquidity generally will drive changes in availability of observable market data. Changes in availability of observable market data, which also may result in changing the valuation technique used, are generally the cause of transfers between levels. We did not have any transfers between levels for financial instruments measured at fair value on a recurring basis for the six months ended November 30, 2015 and 2014.

70




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


Nonrecurring Fair Value

The table below presents the carrying value and fair value of assets reported in our condensed consolidated financial statements at fair value on a nonrecurring basis as of November 30, 2015 and May 31, 2015, and unrealized losses for the three and six months ended November 30, 2015 and 2014.
 
 
Level 3 Fair Value
 
Unrealized Losses
 Three Months Ended November 30,
 
Unrealized Losses
Six Months Ended November 30,
(Dollars in thousands)
 
November 30, 2015
 
May 31, 2015
 
2015
 
2014
 
2015
 
2014
Impaired loans, net of specific reserves
 
$
10,417

 
$

 
$
(1,190
)
 
$
(724
)
 
$
(2,011
)
 
$
(950
)

Significant Unobservable Level 3 Inputs

Impaired Loans

We utilize the fair value of the collateral underlying the loan or the estimated cash flows to determine the fair value and specific allowance for impaired loans. In estimating the fair value of the collateral, we may use third-party valuation specialists, internal estimates or a combination of both. The valuation technique used to determine fair value of the impaired loans provided by both our internal staff and third-party specialists includes market multiples (i.e., comparable companies). The significant unobservable inputs used in the determination of fair value for the specific impaired loans is a multiple of earnings before interest, taxes, depreciation and amortization of 4.0x. The significant unobservable inputs for estimating the fair value of impaired collateral-dependent loans are reviewed by our Credit Risk Management group to assess the reasonableness of the assumptions used and the accuracy of the work performed. In cases where we rely on third-party inputs, we use the final unadjusted third-party valuation analysis as support for any adjustments to our consolidated financial statements and disclosures.

Because of the limited amount of impaired loans as of November 30, 2015 and May 31, 2015, we do not believe that potential changes in the significant unobservable inputs used in the determination of the fair value for impaired loans will have a material impact on the fair value measurement of these assets or our results of operations.

71




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 12—FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents the carrying value and fair value, and the classification level within the fair value measurement hierarchy, of our financial instruments as of November 30, 2015 and May 31, 2015.

 
 
November 30, 2015
 
Fair Value Measurements Using
(Dollars in thousands)
 
Carrying Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
242,619

 
$
242,619

 
$
242,619

 
$

 
$

Restricted cash
 
6,175

 
6,175

 
6,175

 

 

Time deposits
 
340,000

 
340,000

 

 
340,000

 

Investment securities, available for sale
 
87,358

 
87,358

 
87,358

 

 

Deferred compensation investments
 
4,401

 
4,401

 
4,401

 

 

Loans to members, net
 
22,633,929

 
22,529,568

 

 

 
22,529,568

Debt service reserve funds
 
25,602

 
25,602

 
25,602

 

 

Derivative assets
 
81,687

 
81,687

 

 
81,687

 

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
Short-term debt
 
3,542,802

 
3,542,517

 
1,760,494

 
1,782,023

 

Long-term debt
 
16,858,024

 
17,760,009

 

 
10,929,779

 
6,830,230

Guarantee liability
 
18,747

 
21,188

 

 

 
21,188

Derivative liabilities
 
445,537

 
445,537

 

 
445,537

 

Subordinated deferrable debt
 
395,736


397,124

 

 
397,124

 

Members’ subordinated certificates
 
1,479,562


1,479,586

 

 

 
1,479,586


72




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
May 31, 2015
 
Fair Value Measurements Using
(Dollars in thousands)
 
Carrying Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
248,836

 
$
248,836

 
$
248,836

 
$

 
$

Restricted cash
 
485

 
485

 
485

 

 

Time deposits
 
485,000

 
485,000

 

 
485,000

 

Investment securities, available for sale
 
84,472

 
84,472

 
84,472

 

 

Deferred compensation investments
 
4,294

 
4,294

 
4,294

 

 

Loans to members, net
 
21,435,327

 
21,961,048

 

 

 
21,961,048

Debt service reserve funds
 
25,602

 
25,602

 
25,602

 

 

Derivative instruments
 
115,276

 
115,276

 

 
115,276

 

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
Short-term debt
 
3,127,754

 
3,127,541

 
1,494,131

 
1,633,410

 

Long-term debt
 
16,244,794

 
17,356,223

 

 
10,878,302

 
6,477,921

Guarantee liability
 
19,917

 
22,545

 

 

 
22,545

Derivative instruments
 
408,382

 
408,382

 

 
408,382

 

Subordinated deferrable debt
 
395,699

 
406,000

 

 
406,000

 

Members’ subordinated certificates
 
1,505,420

 
1,505,444

 

 

 
1,505,444


We consider observable prices in the principal market in our valuations where possible. Fair value estimates were developed at the reporting date and may not necessarily be indicative of amounts that could ultimately be realized in a market transaction at a future date. For additional information regarding the fair value hierarchy and a description of the methodologies we use to measure fair value, see “Note 13—Fair Value Measurements” and “Note 14—Fair Value of Financial Instruments” to the Consolidated Financial Statements in our 2015 Form 10-K. See “Note 11—Fair Value Measurement for additional information on assets and liabilities reported at fair value on a recurring and nonrecurring basis on our condensed consolidated balance sheets.

73




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 13—SEGMENT INFORMATION

The following tables display segment results for the three and six months ended November 30, 2015 and 2014, and assets attributable to each segment as of November 30, 2015 and 2014.
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended November 30, 2015
(Dollars in thousands)
 
CFC
 
Other
 
Elimination
 
Consolidated Total
Statement of operations:
 
 
 
 
 
 
 
 
Interest income
 
$
253,625

 
$
11,476

 
$
(8,776
)
 
$
256,325

Interest expense
 
(166,807
)
 
(9,093
)
 
8,776

 
(167,124
)
Net interest income
 
86,818

 
2,383

 

 
89,201

Provision for loan losses
 
(1,240
)
 

 

 
(1,240
)
Net interest income after provision for loan losses
 
85,578

 
2,383

 

 
87,961

Non-interest income:
 
 
 
 
 
 
 
 
Fee and other income
 
6,080

 
2,096

 
(1,145
)
 
7,031

Derivative losses
 
(99,963
)
 
(1,221
)
 

 
(101,184
)
Results of operations of foreclosed assets
 
2,054

 

 

 
2,054

Total non-interest income
 
(91,829
)
 
875

 
(1,145
)
 
(92,099
)
Non-interest expense:
 
 
 
 
 
 
 
 
General and administrative expenses
 
(17,877
)
 
(2,609
)
 
255

 
(20,231
)
Other
 
(9
)
 
(890
)
 
890

 
(9
)
Total non-interest expense
 
(17,886
)
 
(3,499
)
 
1,145

 
(20,240
)
Loss before income taxes
 
(24,137
)
 
(241
)
 

 
(24,378
)
Income tax expense
 

 
(110
)
 

 
(110
)
Net loss
 
$
(24,137
)
 
$
(351
)
 
$

 
$
(24,488
)
 
 
 
 
 
 
 
 
 

74




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended November 30, 2014
(Dollars in thousands)
 
CFC
 
Other
 
Elimination
 
Consolidated Total
Statement of operations:
 
 
 
 
 
 
 
 
Interest income
 
$
232,168

 
$
11,328

 
$
(8,261
)
 
$
235,235

Interest expense
 
(157,918
)
 
(8,618
)
 
8,261

 
(158,275
)
Net interest income
 
74,250

 
2,710

 

 
76,960

Provision for loan losses
 
(992
)
 

 

 
(992
)
Net interest income after provision for loan losses
 
73,258

 
2,710

 

 
75,968

Non-interest income:
 
 
 
 
 
 
 

Fee and other income
 
9,646

 
1,369

 
(1,143
)
 
9,872

Derivative losses
 
(73,061
)
 
(1,500
)
 

 
(74,561
)
Results of operations from foreclosed assets
 
(28,991
)
 

 

 
(28,991
)
Total non-interest income
 
(92,406
)
 
(131
)
 
(1,143
)
 
(93,680
)
Non-interest expense:
 
 
 
 
 
 
 

General and administrative expenses
 
(16,553
)
 
(1,940
)
 
256

 
(18,237
)
Other
 
(4
)
 
(887
)
 
887

 
(4
)
Total non-interest expense
 
(16,557
)
 
(2,827
)
 
1,143

 
(18,241
)
Loss before income taxes
 
(35,705
)
 
(248
)
 

 
(35,953
)
Income tax benefit
 

 
41

 

 
41

Net loss
 
$
(35,705
)
 
$
(207
)
 
$

 
$
(35,912
)
 
 
 
 
 
 
 
 
 

75




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
Six Months Ended November 30, 2015
(Dollars in thousands)
 
CFC
 
Other
 
Elimination
 
Consolidated Total
Statement of operations:
 
 
 
 
 
 
 
 
Interest income
 
$
496,676

 
$
23,326

 
$
(17,561
)
 
$
502,441

Interest expense
 
(332,189
)
 
(18,196
)
 
17,561

 
(332,824
)
Net interest income
 
164,487

 
5,130

 

 
169,617

Provision for loan losses
 
(5,802
)
 

 

 
(5,802
)
Net interest income after provision for loan losses
 
158,685

 
5,130

 

 
163,815

Non-interest income:
 
 
 
 
 
 
 
 
Fee and other income
 
10,679

 
2,914

 
(1,861
)
 
11,732

Derivative losses
 
(111,790
)
 
(1,411
)
 

 
(113,201
)
Results of operations of foreclosed assets
 
133

 

 

 
133

Total non-interest income
 
(100,978
)
 
1,503

 
(1,861
)
 
(101,336
)
Non-interest expense:
 
 
 
 
 
 
 
 
General and administrative expenses
 
(38,153
)
 
(5,421
)
 
508

 
(43,066
)
Other
 
(366
)
 
(1,353
)
 
1,353

 
(366
)
Total non-interest expense
 
(38,519
)
 
(6,774
)
 
1,861

 
(43,432
)
Income (loss) before income taxes
 
19,188

 
(141
)
 

 
19,047

Income tax expense
 

 
(440
)
 

 
(440
)
Net income (loss)
 
$
19,188

 
$
(581
)
 
$

 
$
18,607

 
 
 
 
 
 
 
 
 
 
 
November 30, 2015
Assets:
 
 
 
 
 
 
 
 
Total loans outstanding
 
$
22,621,617

 
$
1,069,542

 
$
(1,027,511
)
 
$
22,663,648

Deferred loan origination costs
 
9,881

 

 

 
9,881

Less: Allowance for loan losses
 
(39,600
)
 

 

 
(39,600
)
Loans to members, net
 
22,591,898

 
1,069,542

 
(1,027,511
)
 
22,633,929

Other assets
 
1,203,916

 
119,388

 
(106,251
)
 
1,217,053

Total assets
 
$
23,795,814

 
$
1,188,930

 
$
(1,133,762
)
 
$
23,850,982


76




NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
 
Six Months Ended November 30, 2014
(Dollars in thousands)
 
CFC
 
Other
 
Elimination
 
Consolidated Total
Statement of operations:
 
 
 
 
 
 
 
 
Interest income
 
$
466,308

 
$
23,135

 
$
(16,917
)
 
$
472,526

Interest expense
 
(314,146
)
 
(17,598
)
 
16,917

 
(314,827
)
Net interest income
 
152,162

 
5,537

 

 
157,699

Provision for loan losses
 
5,779

 

 

 
5,779

Net interest income after provision for loan losses
 
157,941

 
5,537

 

 
163,478

Non-interest income:
 
 
 
 
 
 
 
 
Fee and other income
 
13,872

 
1,731

 
(1,374
)
 
14,229

Derivative losses
 
(122,232
)
 
(2,207
)
 

 
(124,439
)
Results of operations from foreclosed assets
 
(31,690
)
 

 

 
(31,690
)
Total non-interest income
 
(140,050
)
 
(476
)
 
(1,374
)
 
(141,900
)
Non-interest expense:
 
 
 
 
 
 
 
 
General and administrative expenses
 
(33,252
)
 
(4,015
)
 
487

 
(36,780
)
Other
 
57

 
(887
)
 
887

 
57

Total non-interest expense
 
(33,195
)
 
(4,902
)
 
1,374

 
(36,723
)
Income (loss) before income taxes
 
(15,304
)
 
159

 

 
(15,145
)
Income tax expense
 

 
(155
)
 

 
(155
)
Net income (loss)
 
$
(15,304
)
 
$
4

 
$

 
$
(15,300
)
 
 
 
 
 
 
 
 
 
 
 
November 30, 2014
Assets:
 
 
 
 
 
 
 
 
Total loans outstanding
 
$
20,739,565

 
$
1,098,127

 
$
(1,064,412
)
 
$
20,773,280

Deferred loan origination costs
 
9,706

 

 

 
9,706

Less: Allowance for loan losses
 
(50,757
)
 

 

 
(50,757
)
Loans to members, net
 
20,698,514

 
1,098,127

 
(1,064,412
)
 
20,732,229

Other assets
 
1,818,603

 
137,686

 
(115,415
)
 
1,840,874

Total assets
 
$
22,517,117

 
$
1,235,813

 
$
(1,179,827
)
 
$
22,573,103



77




Item 3.
Quantitative and Qualitative Disclosures About Market Risk

For quantitative and qualitative disclosures about market risk, see “Part I—Item 2. MD&A—Market Risk” and “Note 8—Derivatives.”

Item 4.
Controls and Procedures

As of the end of the period covered by this report, senior management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. Based on this evaluation process, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective. There were no changes in our internal control over financial reporting that occurred during the three months ended November 30, 2015 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1.
Legal Proceedings

From time to time, CFC is subject to certain legal proceedings and claims in the ordinary course of business, including litigation with borrowers related to enforcement or collection actions. Management presently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not materially harm our financial position, liquidity, or results of operations. CFC establishes reserves for specific legal matters when it determines that the likelihood of an unfavorable outcome is probable and the loss is reasonably estimable. Accordingly, no reserve has been recorded with respect to any legal proceedings at this time. In June 2015, RTFC received a notice of deficiency from the Virgin Islands Bureau of Internal Revenue (“BIR”) alleging that RTFC owes tax or other amounts, plus interest, in connection with tax years 1996 and 1997, and 1999 through 2005. On September 4, 2015, RTFC filed a petition with the District Court of the Virgin Islands in response to the BIR's notice of deficiency. The BIR filed an answer to RTFC's petition with the District Court of the Virgin Islands on December 11, 2015. RTFC believes that these allegations are without merit and will continue to contest this determination.

Item 1A.
Risk Factors

Refer to “Part I— Item 1A. Risk Factors” in our 2015 Form 10-K for information regarding factors that could affect our results of operations, financial condition and liquidity. We are not aware of any material changes in the risk factors set forth under “Part I— Item 1A. Risk Factors” in our 2015 Form 10-K.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

Item 3.
Defaults Upon Senior Securities

Not applicable.

Item 4.
Mine Safety Disclosures

Not applicable.

Item 5.
Other Information

None.

78




Item 6. Exhibits

The following exhibits are incorporated by reference or filed as part of this Report.

EXHIBIT INDEX
Exhibit No.
 
Description
10.1*
Amended and Restated Revolving Credit Agreement dated November 19, 2015 maturing on November 19, 2018.
10.2*
Amended and Restated Revolving Credit Agreement dated November 19, 2015 maturing on November 19, 2020.
12*
Computation of Ratio of Earnings to Fixed Charges
31.1*
Certification of the Chief Executive Officer required by Section 302 of the Sarbanes-Oxley Act of 2002
31.2*
Certification of the Chief Financial Officer required by Section 302 of the Sarbanes-Oxley Act of 2002
32.1†
Certification of the Chief Executive Officer required by Section 906 of the Sarbanes-Oxley Act of 2002
32.2†
Certification of the Chief Financial Officer required by Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*
XBRL Instance Document
101.SCH*
XBRL Taxonomy Extension Schema Document
101.CAL*
XBRL Taxonomy Calculation Linkbase Document
101.LAB*
XBRL Taxonomy Label Linkbase Document
101.PRE*
XBRL Taxonomy Presentation Linkbase Document
101.DEF*
XBRL Taxonomy Definition Linkbase Document
____________________________ 
*Indicates a document being filed with this Report.
^ Identifies a management contract or compensatory plan or arrangement.
Indicates a document that is furnished with this Report, which shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that Section.

79



SIGNATURES


Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


NATIONAL RURAL UTILITIES
COOPERATIVE FINANCE CORPORATION
 
Date: January 13, 2016                     
By:
/s/ J. ANDREW DON
 
J. Andrew Don
 
Senior Vice President and Chief Financial Officer
                                
    
By:
 /s/ ROBERT E. GEIER
 
Robert E. Geier
 
Controller (Principal Accounting Officer)    
        






80