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EX-12 - EXHIBIT 12 COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201710-qexhibit12.htm
EX-32.2 - EXHIBIT 32.2 CFO CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201710-qexhibit322.htm
EX-32.1 - EXHIBIT 32.1 CEO CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201710-qexhibit321.htm
EX-31.2 - EXHIBIT 31.2 CFO CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201710-qexhibit312.htm
EX-31.1 - EXHIBIT 31.1 CEO CERTIFICATION - NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP /DC/nru1qfy201710-qexhibit311.htm




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

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended August 31, 2016
OR 
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             

Commission File Number: 1-7102
__________________________
NATIONAL RURAL UTILITIES
COOPERATIVE FINANCE CORPORATION
(Exact name of registrant as specified in its charter)
__________________________
District of Columbia
 
52-0891669
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. employer identification no.)
20701 Cooperative Way, Dulles, Virginia, 20166
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (703) 467-1800
__________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x  No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes x  No ¨

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ¨     No x
 







TABLE OF CONTENTS
 
  
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

i






ii





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

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

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

4
 
Derivative Average Notional Amounts and Average Interest Rates
 
11

5
 
Derivative Gains (Losses)
 
12

6
 
Loans Outstanding by Type and Member Class
 
14

7
 
Historical Retention Rate and Repricing Selection
 
15

8
 
Total Debt Outstanding
 
16

9
 
Member Investments
 
17

10
 
Unencumbered Loans
 
18

11
 
Collateral Pledged
 
18

12
 
Guarantees Outstanding
 
20

13
 
Maturities of Guarantee Obligations
 
20

14
 
Unadvanced Loan Commitments
 
21

15
 
Notional Maturities of Unadvanced Loan Commitments
 
21

16
 
Maturities of Notional Amount of Unconditional Committed Lines of Credit
 
22

17
 
Loan Portfolio Security Profile
 
23

18
 
Credit Exposure to 20 Largest Borrowers
 
25

19
 
TDR Loans
 
26

20
 
Allowance for Loan Losses
 
27

21
 
Rating Triggers for Derivatives
 
28

22
 
Short-Term Borrowings
 
29

23
 
Liquidity Reserve
 
30

24
 
Bank Revolving Credit Agreements
 
31

25
 
Issuances and Maturities of Long-Term and Subordinated Debt
 
32

26
 
Principal Maturity of Long-Term Debt and Subordinated Debt
 
33

27
 
Credit Ratings
 
33

28
 
Projected Sources and Uses of Liquidity
 
34

29
 
Financial Covenant Ratios Under Bank Revolving Line of Credit Agreements
 
35

30
 
Financial Ratios Under Debt Indentures
 
35

31
 
Interest Rate Gap Analysis
 
37

32
 
Adjusted Financial Measures — Income Statement
 
38

33
 
TIER and Adjusted TIER
 
39

34
 
Adjusted Financial Measures — Balance Sheet
 
39

35
 
Leverage and Debt-to-Equity Ratios
 
40


iii





PART I—FINANCIAL INFORMATION

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A)

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains certain statements that are considered “forward-looking statements” within the Securities Act of 1933, as amended, and the 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, nonperformance of counterparties to our derivative agreements, the costs and effects of legal or governmental proceedings involving us or our members and the factors listed and described under “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the fiscal year ended May 31, 2016 (“2016 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. CFC funds its activities primarily through a combination of public and private issuances of debt securities, member investments and retained equity. As a tax-exempt, member-owned cooperative, we cannot issue equity securities.

Our financial statements include the consolidated accounts of CFC, Rural Telephone Finance Cooperative (“RTFC”), National Cooperative Services Corporation (“NCSC”) and subsidiaries created and controlled by CFC to hold foreclosed assets resulting from borrower defaults on loans or bankruptcy proceedings. RTFC is a taxable Subchapter T cooperative association that was established to provide private financing for the rural telecommunications industry. NCSC is a taxable cooperative that may provide financing to members of CFC, government or quasi-government entities which own electric utility systems that meet the Rural Electrification Act definition of “rural”, and the for-profit and nonprofit entities that are owned, operated or controlled by, or provide significant benefits to certain members of CFC. See “Item 1. Business—Overview” of our 2016 Form 10-K for additional information on the business activities of each of these entities. Unless stated otherwise, references to “we,” “our” or “us” relate to CFC and its consolidated entities. All references to members within this document include members, associates and affiliates of CFC and its consolidated entities.

1



Management monitors a variety of key indicators to evaluate our business performance. The following MD&A is intended to provide the reader with an understanding of our results of operations, financial condition and liquidity by discussing the drivers of changes from period to period and the key measures used by management to evaluate performance, such as leverage ratios, growth and credit quality metrics. MD&A is provided as a supplement to, and should be read in conjunction with our unaudited condensed consolidated financial statements and related notes in this Report, our audited consolidated financial statements and related notes in our 2016 Form 10-K and additional information contained in our 2016 Form 10-K, including the risk factors discussed under “Part I—Item 1A. Risk Factors,” as well as any risk factors identified under “Part II—Item 1A. Risk Factors” in this Report.
SUMMARY OF SELECTED FINANCIAL DATA

Table 1 provides a summary of selected financial data for the three months ended August 31, 2016 and 2015, and as of August 31, 2016 and May 31, 2016. 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. Our primary non-GAAP metrics include adjusted net income, adjusted net interest income and net interest yield, adjusted times interest earned ratio (“adjusted TIER”), adjusted debt-to-equity ratio and adjusted leverage ratio. The most comparable GAAP measures are net income, net interest income, TIER, debt-to-equity ratio and leverage ratio, respectively. The primary adjustments we make to calculate these non-GAAP measures consist of (i) adjusting interest expense and net interest income to include the impact of net periodic derivative cash settlements; (ii) adjusting net income, senior debt and total equity to exclude the non-cash impact of the accounting for derivative financial instruments; (iii) adjusting senior debt to exclude the amount that funds CFC member loans guaranteed by RUS, subordinated deferrable debt and members’ subordinated certificates; and (iv) adjusting total equity to include subordinated deferrable debt and members’ subordinated certificates. We believe our non-GAAP adjusted 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 management evaluates performance based on these metrics, and the financial covenants in our revolving credit agreements and debt indentures are based on adjusted TIER and the adjusted debt-to-equity ratio. See “Non-GAAP Financial Measures” for a detailed reconciliation of these adjusted measures to the most comparable GAAP measures.




2



Table 1: Summary of Selected Financial Data
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016
 
2015
 
Change
Statement of operations
 
 
 
 
 
 
Interest income
 
$
256,835

 
$
246,116

 
4%
Interest expense
 
(181,080
)
 
(165,700
)
 
9
Net interest income
 
75,755

 
80,416

 
(6)
Provision for loan losses
 
(1,928
)
 
(4,562
)
 
(58)
Fee and other income
 
4,530

 
4,701

 
(4)
Derivative losses(1)
 
(188,293
)
 
(12,017
)
 
1,467
Results of operations of foreclosed assets
 
(1,112
)
 
(1,921
)
 
(42)
Operating expenses(2) 
 
(20,859
)
 
(22,835
)
 
(9)
Other non-interest expense
 
(443
)
 
(357
)
 
24
Income (loss) before income taxes
 
(132,350
)
 
43,425

 
(405)
Income tax expense
 
89

 
(330
)
 
(127)
Net income (loss)
 
$
(132,261
)
 
$
43,095

 
(407)%
 
 
 
 
 
 
 
Adjusted statement of operations
 
 
 
 
 
 
Adjusted interest expense(3)
 
$
(204,470
)
 
$
(185,856
)
 
10%
Adjusted net interest income(3)
 
52,365

 
60,260

 
(13)
Adjusted net income(3)
 
32,642

 
34,956

 
(7)
 
 
 
 
 
 
 
Ratios
 
 
 
 
 
 
Fixed-charge coverage ratio/TIER (4)
 
0.27

 
1.26

 
(99) bps
Adjusted TIER(3)
 
1.16

 
1.19

 
(3)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
August 31, 2016
 
May 31, 2016
 
Change
Balance sheet
 
 
 
 
 
 
Cash, investments and time deposits
 
$
718,581

 
$
632,480

 
14%
Loans to members(5)
 
23,566,225

 
23,162,696

 
2
Allowance for loan losses
 
(33,120
)
 
(33,258
)
 
Loans to members, net
 
23,533,105

 
23,129,438

 
2
Total assets
 
24,677,615

 
24,270,200

 
2
Short-term borrowings
 
3,151,411

 
2,938,848

 
7
Long-term debt
 
17,568,367

 
17,473,603

 
1
Subordinated deferrable debt
 
742,176

 
742,212

 
Members’ subordinated certificates
 
1,443,131

 
1,443,810

 
Total debt outstanding
 
22,905,085

 
22,598,473

 
1
Total liabilities
 
24,024,759

 
23,452,822

 
2
Total equity
 
652,856

 
817,378

 
(20)
Guarantees (6)
 
896,902

 
909,208

 
(1)
 
 
 
 
 
 
 
Ratios
 
 
 
 
 

Leverage ratio(7)
 
38.17

 
29.81

 
836 bps
Adjusted leverage ratio(3)
 
6.20

 
6.08

 
12
Debt-to-equity ratio(8)
 
36.80

 
28.69

 
811
Adjusted debt-to-equity ratio(3)
 
5.94

 
5.82

 
12
____________________________ 
— Change is less than one percent or not meaningful.
(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

3



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 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 presented separately on our consolidated statements of operations.
(3)See “Non-GAAP Financial Measures” for details on the calculation of these non-GAAP adjusted measures and the reconciliation to the most comparable GAAP measures.
(4)Calculated based on net income (loss) plus interest expense for the period divided by interest expense for the period. The fixed-charge coverage ratios and TIER were the same during each period presented because we did not have any capitalized interest during these periods.
(5)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 August 31, 2016 and May 31, 2016.
(6)Reflects the total amount of member obligations for which CFC has guaranteed payment to a third party as of the end of each period. This amount represents our maximum exposure to loss, which significantly exceeds the guarantee liability recorded on our consolidated balance sheets as the guarantee liability is determined based on anticipated losses. See “Note 11—Guarantees” for additional information.
(7)Calculated based on total liabilities and guarantees at period end divided by total equity at period end.
(8)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 a sound financial position required for investment-grade credit ratings on our debt instruments. Our objective is not to maximize net income; therefore, the rates we charge our member-borrowers reflect our adjusted interest expense plus a spread to cover our operating expenses, a provision for loan losses and earnings sufficient to achieve interest coverage to meet our financial objectives. Our goal is to earn an annual minimum adjusted TIER of 1.10 and to maintain an adjusted debt-to-equity ratio below 6.00-to-1.

We are subject to period-to-period volatility in our reported GAAP results due to changes in market conditions and differences in the way our financial assets and liabilities are accounted for under GAAP. Our financial assets and liabilities expose us to interest-rate risk. We use derivatives, primarily interest rate swaps, as part of our strategy in managing this risk. Our derivatives are intended to economically hedge and manage the interest-rate sensitivity mismatch between our financial assets and liabilities. We are required under GAAP to carry derivatives at fair value on our consolidated balance sheet; however, our other financial assets and liabilities are carried at amortized cost. Changes in interest rates and spreads result in periodic fluctuations in the fair value of our derivatives, which may cause volatility in our earnings because we do not apply hedge accounting. As a result, the mark-to-market changes in our derivatives are recorded in earnings. Based on the composition of our derivatives, we generally record derivative losses in earnings when interest rates decline and derivative gains when interest rates rise. This earnings volatility generally is not indicative of the underlying economics of our business, as the derivative forward fair value gains or losses recorded each period may or may not be realized over time, depending on future changes in market conditions and the terms of our derivative instruments. As such, management uses our adjusted non-GAAP results, which include realized net periodic derivative settlements but exclude the impact of unrealized derivative forward fair value gains and losses, to evaluate our operating performance. Because derivative forward fair value gains and losses do not impact our cash flows, liquidity or ability to service our debt costs, our financial debt covenants are also based on our non-GAAP adjusted results.

Financial Performance

Reported Results

We reported a net loss of $132 million and a TIER of 0.27 for the quarter ended August 31, 2016 (“current quarter”), compared with net income of $43 million and a TIER of 1.26 for the same prior-year quarter. The variance in our reported results for the current quarter versus the same prior year quarter was primarily attributable to an increase in derivative losses of $176 million due to a decline in longer-term interest rates during the period. We also experienced a decrease in net interest income of $5 million, which was partially offset by a $3 million decrease in the provision for loan losses to $2 million. Our debt-to-equity ratio increased to 36.80-to-1 as of August 31, 2016, from 28.69-to-1 as of May 31, 2016, largely attributable to a reduction in equity as a result of the current quarter reported net loss of $132 million.



4



Adjusted Non-GAAP Results

Our adjusted net income totaled $33 million and our adjusted TIER was 1.16 for the current quarter, compared with adjusted net income of $35 million and adjusted TIER of 1.19 for the same prior-year quarter. Our adjusted net income for the current quarter reflected the impact of a decline in adjusted net interest income of $8 million, which was partially offset by the decrease in the provision for loan losses of $3 million and the decrease in operating expenses of $2 million. Our adjusted debt-to-equity ratio increased to 5.94-to-1 as of August 31, 2016, from 5.82-to-1 as of May 31, 2016.

Lending Activity

Total loans outstanding, which consists of the unpaid principal balance and excludes deferred loan origination costs, was $23,556 million as of August 31, 2016, an increase of $403 million, or 2%, from May 31, 2016. The increase was primarily due to increases in CFC distribution and power supply loans of $310 million and $36 million, respectively, which were largely attributable to members refinancing with us loans made by other lenders and member advances for capital investments.
             
CFC had long-term fixed-rate loans totaling $172 million that repriced during the three months ended August 31, 2016. Of this total, $142 million repriced to a new long-term fixed rate and $30 million repriced to a long-term variable rate.

Financing Activity

Our outstanding debt volume generally increases and decreases in response to member loan demand. As outstanding loan balances increased during the three months ended August 31, 2016, our debt volume also increased. Total debt outstanding was $22,905 million as of August 31, 2016, an increase of $307 million, or 1%, from May 31, 2016. The increase was primarily attributable to an increase in commercial paper outstanding of $174 million and an advance on August 30, 2016 of $100 million under committed loan facilities from the Federal Financing Bank under the Guaranteed Underwriter Program of the USDA.

Sale of CAH

On July 1, 2016, the sale of Caribbean Asset Holdings, LLC (“CAH”) to ATN VI Holdings, LLC (“Buyer”) was completed. As a result, we did not carry any foreclosed assets on our consolidated balance sheet as of August 31, 2016. Our net proceeds at closing totaled $109 million, which represents the purchase price of $144 million less agreed-upon purchase price adjustments as of the closing date. Upon closing, $16 million of the sale proceeds was deposited into escrow to fund potential indemnification claims for a period of 15 months following the closing. In connection with the sale, RTFC provided a loan in the amount of $60 million to Buyer to finance a portion of the transaction. ATN International, Inc., the parent corporation of Buyer, has provided a guarantee on an unsecured basis of Buyer’s obligations to RTFC pursuant to the financing.

The net proceeds at closing were subject to post-closing adjustments, which were due from Buyer within 60 days of the closing for review by us. The Buyer provided and we agreed upon a net amount due to us of approximately $1 million for post-closing adjustments. See “Consolidated Results of Operations—Non-Interest Income—Results of Operations of Foreclosed Assets” below in this Report and “Note 5—Foreclosed Assets” in our 2016 Form 10-K for additional information on the sale of CAH.

Outlook for the Next 12 Months

We currently expect the amount of new long-term loan advances to exceed scheduled loan repayments over the next 12 months. Although we expect an increase in loans outstanding, we anticipate lower net interest income and adjusted net interest income over the next 12 months, primarily due to a continued decline in the average yield on our loan portfolio, coupled with an expected increase in interest expense.

Long-term debt scheduled to mature over the next 12 months totaled $2,460 million as of August 31, 2016. 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

5



for member loan advances and satisfy our obligations to repay long-term debt maturing over the next 12 months. We also may consider the early redemption of certain maturing debt to reduce large debt maturity amounts when it is economically feasible. As of August 31, 2016, we had access to liquidity reserves totaling $6,946 million, which consisted of $631 million in cash and cash equivalents and time deposits, up to $500 million available under committed loan facilities from the Federal Financing Bank under the Guaranteed Underwriter Program, $3,309 million available under committed bank revolving lines of credit, up to $300 million available under a note purchase agreement with Farmer Mac executed during fiscal year 2016 and, subject to market conditions, up to $2,206 million available under the previously existing revolving note purchase agreement with Farmer Mac.

On September 28, 2016, we received a commitment from RUS to guarantee a loan of $375 million from the Federal Financing Bank under the Guaranteed Underwriter Program of the USDA. The draw period for advances under this loan facility is three years, followed by a 20-year repayment period. Upon closing of the loan, we will have up to $875 million of committed loan facilities available for access under the Guaranteed Underwriter Program.

We believe we can continue to roll over the member outstanding short-term debt of $2,442 million as of August 31, 2016, based on our expectation that our members will continue to reinvest their excess cash in our commercial paper, daily liquidity fund, select notes and medium-term notes. We expect to continue to roll over our outstanding dealer commercial paper of $710 million as of August 31, 2016. We intend to manage our short-term wholesale funding risk by maintaining outstanding dealer commercial paper at an amount below $1,250 million for the foreseeable future. We expect to continue to be in compliance with the covenants under our 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.

Our goal is to maintain the adjusted debt-to-equity ratio at or below 6.00-to-1. Our adjusted debt-to-equity ratio was 5.94 as of August 31, 2016. We expect to maintain our adjusted debt-to-equity ratio at a level of 6.00 or below over the next 12 months.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates and assumptions that affect the amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management’s judgment and estimates in applying these policies is integral to understanding our financial statements. We provide a discussion of our significant accounting policies under “Note 1—Summary of Significant Accounting Policies” in our 2016 Form 10-K.

We have identified certain accounting policies as critical because they involve significant judgments and assumptions about highly complex and inherently uncertain matters, and the use of reasonably different estimates and assumptions could have a material impact on our results of operations or financial condition. Our most critical accounting policies and estimates involve the determination of the allowance for loan losses and fair value. We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as necessary based on changing conditions. There were no material changes in the assumptions used in our critical accounting policies and estimates during the current quarter. Management has discussed significant judgments and assumptions in applying our critical accounting policies with the Audit Committee of our board of directors. We provide information on the methodologies and key assumptions used in our critical accounting policies and estimates under “MD&A—Critical Accounting Policies and Estimates” in our 2016 Form 10-K. See “Item 1A. Risk Factors” in our 2016 Form 10-K for a discussion of the risks associated with management’s judgments and estimates in applying our accounting policies and methods.
ACCOUNTING CHANGES AND DEVELOPMENTS

See “Note 1—Summary of Significant Accounting Policies” for information on accounting standards adopted during the three months ended August 31, 2016, 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 impact in the applicable section(s) of MD&A.

6



CONSOLIDATED RESULTS OF OPERATIONS

The section below provides a comparative discussion of our condensed consolidated results of operations between the three months ended August 31, 2016 and the three months ended August 31, 2015. Following this section, we provide a comparative analysis of our condensed consolidated balance sheets as of August 31, 2016 and May 31, 2016. You should read these sections together with our “Executive Summary—Outlook for the Next 12 Months” where we discuss trends and other factors that we expect will affect our future results of operations.

Net Interest Income

Net interest income represents the difference between the interest income and applicable fees earned on our interest-earning assets, which include loans and investment securities, and the interest expense on our interest-bearing liabilities. Our net interest yield represents the difference between the yield on our interest-earning assets and the cost of our interest-bearing liabilities plus the impact from non-interest bearing funding. We expect net interest income and our net interest yield to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities. We do not fund each individual loan with specific debt. Rather, we attempt to minimize costs and maximize efficiency by funding large aggregated amounts of loans.

Table 2 presents our average balance sheets for the three months ended August 31, 2016 and 2015, and for each major category of our interest-earning assets and interest-bearing liabilities, the interest income earned or interest expense incurred, and the average yield or cost. Table 2 also presents non-GAAP adjusted interest expense, adjusted net interest income and adjusted net interest yield, which reflect the inclusion of net accrued periodic derivative cash settlements in interest expense. We provide reconciliations of our non-GAAP adjusted measures to the most comparable GAAP measures under “Non-GAAP Financial Measures.”


7



Table 2: Average Balances, Interest Income/Interest Expense and Average Yield/Cost
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016
 
2015
Assets:
 
Average Balance
 
Interest Income/Expense
 
Average Yield/Cost
 
Average Balance
 
Interest Income/Expense
 
Average Yield/Cost
Long-term fixed-rate loans(1)
 
$
21,625,527

 
$
244,128

 
4.48
%
 
$
19,914,082

 
$
232,202

 
4.64
%
Long-term variable-rate loans
 
729,846

 
4,527

 
2.46

 
685,897

 
5,020

 
2.91

Line of credit loans
 
1,043,797

 
5,966

 
2.27

 
1,040,028

 
6,198

 
2.37

Restructured loans
 
17,223

 
218

 
5.02

 
11,407

 

 

Interest-based fee income(2)
 

 
(284
)
 

 

 
71

 

Total loans
 
23,416,393

 
254,555

 
4.31

 
21,651,414

 
243,491

 
4.47

Cash, investments and time deposits
 
614,598

 
2,280

 
1.47

 
722,391

 
2,625

 
1.45

Total interest-earning assets
 
$
24,030,991

 
$
256,835

 
4.24
%
 
$
22,373,805

 
$
246,116

 
4.38
%
Other assets, less allowance for loan losses
 
662,248

 
 
 
 
 
873,048

 
 
 
 
Total assets
 
$
24,693,239

 


 
 
 
$
23,246,853

 


 


 
 
 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 


 


 


 


 


Short-term debt
 
$
2,924,285

 
$
4,882

 
0.66
%
 
$
2,799,166

 
$
2,542

 
0.36
%
Medium-term notes
 
3,282,862

 
23,585

 
2.85

 
3,361,129

 
20,153

 
2.39

Collateral trust bonds
 
7,254,420

 
85,049

 
4.65

 
6,782,214

 
82,831

 
4.86

Long-term notes payable
 
7,113,046

 
43,129

 
2.41

 
6,550,307

 
40,085

 
2.43

Subordinated deferrable debt
 
742,155

 
9,426

 
5.04

 
400,000

 
4,783

 
4.76

Subordinated certificates
 
1,442,636

 
15,009

 
4.13

 
1,497,706

 
15,306

 
4.07

Total interest-bearing liabilities
 
$
22,759,404

 
$
181,080

 
3.16
%
 
$
21,390,522

 
$
165,700

 
3.08
%
Other liabilities
 
1,153,537

 
 
 

 
941,094

 

 
 
Total liabilities
 
23,912,941

 
 
 

 
22,331,616

 

 
 
Total equity
 
780,298

 
 
 
 
 
915,237

 

 
 
Total liabilities and equity
 
$
24,693,239

 


 
 
 
$
23,246,853

 


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net interest spread(3)
 
 
 


 
1.08
%
 


 


 
1.30
%
Impact of non-interest bearing funding(4)
 
 
 
 
 
0.18

 
 
 
 
 
0.14

Net interest income/net interest yield(5)
 
 
 
$
75,755

 
1.26
%
 
 
 
$
80,416

 
1.44
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest income/adjusted net interest yield:
 
 
 
 
 


 
 
 
 
 
 
Interest income
 
 
 
$
256,835

 
4.24
%
 
 
 
$
246,116

 
4.38
%
Interest expense
 
 
 
181,080

 
3.16

 
 
 
165,700

 
3.08

Add: Net accrued periodic derivative cash settlements(6)
 
 
 
23,390

 
0.90

 
 
 
20,156

 
0.82

Adjusted interest expense/adjusted average cost(7)
 
 
 
$
204,470

 
3.56
%
 


 
$
185,856

 
3.46
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Adjusted net interest spread(3)
 
 
 
 
 
0.68
%
 

 
 
 
0.92
%
Impact of non-interest bearing funding
 
 
 
 
 
0.18

 
 
 
 
 
0.15

Adjusted net interest income/adjusted net interest yield(8)
 
 
 
$
52,365

 
0.86
%
 

 
$
60,260


1.07
%
____________________________ 
(1)Interest income includes loan conversion fees, which are generally deferred and recognized in interest income using the effective interest method.
(2)Amounts primarily include the amortization of deferred loan origination costs and late payment fees. Up-front loan arranger fees, which are not based on interest rates, are included in fee and other income.
(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.

8



(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 accrued 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 accrued periodic derivative 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 $10,338 million and $9,788 million for the three months ended August 31, 2016 and 2015, respectively.
(7)Adjusted interest expense represents interest expense plus net accrued derivative cash settlements during the period. Net accrued derivative cash settlements are reported on our consolidated statements of operations as a component of derivative gains (losses). Adjusted average cost is calculated based on annualized adjusted interest expense for the period divided by 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 August 31,
2016 versus 2015
 
 
 
 
Variance due to:(1)
(Dollars in thousands)
 
Total
Variance
 
Volume
 
Rate
Interest income:
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
11,926

 
$
20,647

 
$
(8,721
)
Long-term variable-rate loans
 
(493
)
 
336

 
(829
)
Line of credit loans
 
(232
)
 
40

 
(272
)
Restructured loans
 
218

 

 
218

Fee income
 
(355
)
 

 
(355
)
Total loans
 
11,064

 
21,023

 
(9,959
)
Cash, investments and time deposits
 
(345
)
 
(386
)
 
41

Interest income
 
10,719

 
20,637

 
(9,918
)
 
 
 
 
 
 
 
Interest expense:
 
 
 
 
 
 
Short-term debt
 
2,340

 
121

 
2,219

Medium-term notes
 
3,432

 
(415
)
 
3,847

Collateral trust bonds
 
2,218

 
6,010

 
(3,792
)
Long-term notes payable
 
3,044

 
3,563

 
(519
)
Subordinated deferrable debt
 
4,643

 
4,116

 
527

Subordinated certificates
 
(297
)
 
(522
)
 
225

Interest expense
 
15,380

 
12,873

 
2,507

Net interest income
 
$
(4,661
)
 
$
7,764

 
$
(12,425
)
 
 
 
 
 
 
 
Adjusted net interest income:
 
 
 
 
 
 
Interest income
 
$
10,719

 
$
20,637

 
$
(9,918
)
Interest expense
 
15,380

 
12,873

 
2,507

Net accrued periodic derivative cash settlements(2)
 
3,234

 
1,191

 
2,043

Adjusted interest expense(3)
 
18,614

 
14,064

 
4,550

Adjusted net interest income
 
$
(7,895
)
 
$
6,573

 
$
(14,468
)
____________________________ 

9



(1)The changes for each category of interest income and interest expense are divided between the portion of change attributable to the variance in volume and the portion of change attributable to the variance in rate for that category. The amount attributable to the combined impact of volume and rate has been allocated to each category based on the proportionate absolute dollar amount of change for that category.
(2)For net accrued periodic derivative cash settlements, the variance due to average volume represents the change in derivative cash settlements resulting from the change in the average notional amount of derivative contracts outstanding. The variance due to average rate represents the change in derivative cash settlements resulting from the net difference between the average rate paid and the average rate received for interest rate swaps during the period.
(3) See “Non-GAAP Financial Measures” for additional information on our adjusted non-GAAP measures.

Net interest income of $76 million for the current quarter decreased by $5 million, or 6%, from the same prior-year quarter, driven by a decrease in net interest yield of 13% (18 basis points) to 1.26%, which was partially offset by an increase in average interest-earning assets of 7%.

Average Interest-Earning Assets: The increase in average interest-earning assets for the current quarter was primarily attributable to growth in average total loans of $1,765 million, or 8%, over the same prior-year quarter, as members refinanced with us loans made by other lenders and obtained advances to fund capital investments.

Net Interest Yield: The decrease in the net interest yield for the current quarter reflects the combined impact of an increase in our average cost of funds and a decline in the average yield on interest-earning assets. Our average cost of funds increased by 8 basis points during the current quarter to 3.16%. This increase was largely attributable to a shift in our funding mix resulting from the issuance of higher cost, longer-term debt to fund the increase in our loan portfolio, coupled with an increase in the cost of our short-term and medium-term debt as the U.S. Federal Reserve raised the short-term federal funds rate by 25 basis points in December 2015, the first rate change since the federal funds rate was lowered to near zero seven years ago. The decrease in the average yield on interest-earning assets of 14 basis points to 4.24% during the current quarter was largely attributable to reduced rates on fixed-rate loans as longer-term interest rates continued to decline.

Adjusted net interest income of $52 million for the current quarter decreased by $8 million, or 13%, from the same prior-year quarter, driven by a decrease in the adjusted net interest yield of 20% (21 basis points) to 0.86%, which was partially offset by an increase in average interest-earning assets of 7%. The decrease in the adjusted net interest yield reflected the combined impact of an increase in our average cost of funds, coupled with the decline in the average yield on interest-earning assets.

Our adjusted net interest income and adjusted net interest yield include the impact of net accrued periodic derivative cash settlements during the period. We recorded net periodic derivative cash settlement expense of $23 million and $20 million for the three months ended August 31, 2016 and 2015, 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 $2 million and $5 million for the three months ended August 31, 2016 and 2015, respectively. The decrease in the allowance was attributable to an overall reduction in the credit risk exposure of our loan portfolio, due in part to the Farmer Mac long-term standby purchase commitment agreement we entered into during fiscal year 2016 as well as an improvement in the historical default rates used in calculating the allowance. The outstanding principal balance of loans covered under the Farmer Mac long-term standby purchase agreement totaled $887 million as of August 31, 2016, compared with $926 million as of May 31, 2016 and $520 million as of August 31, 2015. No loans had been put to Farmer Mac for purchase, pursuant to this agreement, as of August 31, 2016.

We provide additional information on our allowance for loan losses under “Credit Risk—Allowance for Loan Losses” and “Note 4—Loans and Commitments” of this Report. For information on our allowance methodology, see “MD&A—Critical Accounting Policies and Estimates” and “Note 1—Summary of Significant Accounting Policies” in our 2016 Form 10-K.


10



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 non-interest income losses of $185 million and $9 million for the three months ended August 31, 2016 and 2015, respectively. The variance in non-interest income between periods was primarily attributable to a significant increase in derivative losses for the quarter ended August 31, 2016.

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, the shape of the yield curve and the composition of our derivative portfolio. We generally do not designate interest rate swaps, which presently account for all of our derivatives, for hedge accounting. Accordingly, changes in the fair value of interest rate swaps are reported in our consolidated statements of operations under derivative gains (losses). We did not have any derivatives designated as accounting hedges as of August 31, 2016 or May 31, 2016.

We currently use two types of interest rate swap agreements: (i) we pay a fixed rate and receive a variable rate (“pay-fixed swaps”) and (ii) we pay a variable rate and receive a fixed rate (“receive-fixed swaps”). The benchmark rate for the substantial majority of the floating rate payments under our swap agreements is the London Interbank Offered Rate (“LIBOR”). Table 4 displays the average notional amount outstanding, by swap agreement type, and the weighted-average interest rate paid and received for derivative cash settlements during the three months ended August 31, 2016 and 2015. As indicated in Table 4, our derivative portfolio currently consists of a higher proportion of pay-fixed swaps than receive-fixed swaps. The profile of our derivative portfolio may change as a result of changes in market conditions and actions taken to manage our interest rate risk.

Table 4: Derivative Average Notional Amounts and Average Interest Rates
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended August 31,
 
 
2016
 
2015
(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
 
$
6,839,260

 
2.92
%
 
0.67
%
 
$
5,939,394

 
3.13
%
 
0.29
%
Receive-fixed swaps
 
3,499,000

 
1.03

 
2.82

 
3,849,000

 
0.80

 
3.09

Total
 
$
10,338,260

 
2.28
%
 
1.40
%
 
$
9,788,394

 
2.21
%
 
1.39
%

The average remaining maturity of our pay-fixed and receive-fixed swaps was 18 years and three years, respectively, as of August 31, 2016. In comparison, the average remaining maturity of our pay-fixed and receive-fixed swaps was 17 years and three years, respectively, as of August 31, 2015.

Pay-fixed swaps generally decrease in value as interest rates decline and increase in value as interest rates rise. In contrast, receive-fixed swaps generally increase in value as interest rates decline and decrease in value as interest rates rise. Because our pay-fixed and receive-fixed swaps are referenced to different maturity terms along the swap yield curve, different changes in the swap yield curve— parallel, flattening or steepening—will result in differences in the fair value of our derivatives. The chart below provides comparative yield curves as of the end of each reporting period in the current year and as of the end of the same prior-year reporting periods.


11



nrufy201610_chart-14561a01.jpg
____________________________ 
Benchmark rates obtained from Bloomberg.

We recorded derivative losses of $188 million and $12 million for the three months ended August 31, 2016 and 2015, respectively. Table 5 presents the components of net derivative gains (losses) recorded in our condensed consolidated results of operations for the three months ended August 31, 2016 and 2015. Derivative cash settlements represent the net interest amount accrued during a period for interest-rate swap payments. 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 5: Derivative Gains (Losses)
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016
 
2015
Derivative gains (losses) attributable to:
 
 
 
 
Derivative cash settlements
 
$
(23,390
)
 
$
(20,156
)
Derivative forward value gains (losses)
 
(164,903
)
 
8,139

Derivative losses
 
$
(188,293
)
 
$
(12,017
)

The derivative losses of $188 million recorded for the three months ended August 31, 2016 were primarily attributable to a decline in longer-term interest rates and a flattening of the yield curve during the current quarter.

The derivative losses of $12 million recorded for the three months ended August 31, 2015 reflected the combined impact of net periodic derivative cash settlements, which were partially offset by derivative forward value gains of $8 million. The derivative forward value gains were primarily attributable to an increase in the fair value of our pay-fixed swaps during the period due to a slight steepening of the swap yield curve resulting from a gradual increase in interest rates across the curve.

12




See “Note 9—Derivative Instruments and Hedging Activities” for additional information on our derivative instruments.

Results of Operations of Foreclosed Assets

Results of operations of foreclosed assets consist of the operating results of entities controlled by CFC that hold foreclosed assets, impairment charges related to those entities and gains or losses related to the disposition of the entities.

As discussed above in “Executive Summary,” on July 1, 2016, the sale of CAH was completed. As a result, we did not carry any foreclosed assets on our consolidated balance sheet as of August 31, 2016. Our net proceeds at closing totaled $109 million, which represents the purchase price of $144 million less agreed-upon purchase price adjustments as of the closing date.

The net proceeds at closing were subject to post-closing adjustments, which were due from Buyer within 60 days of the closing for review by us. The Buyer provided and we agreed upon a net amount due to us of approximately $1 million for post-closing adjustments. CFC remains subject to potential indemnification claims, as specified in the Purchase Agreement.We recorded a loss of $1 million in the current quarter, which reflects the combined impact of the July 1, 2016 sale closing and post-closing purchase price adjustments. Upon closing of the sale of CAH, we derecognized the loss of $10 million recorded in accumulated other comprehensive income attributable to actuarial-related changes in CAH’s pension and other postretirement benefit obligations as an offset against the sale proceeds. This derecognition had no effect on our consolidated statement of operations in the current quarter, as the amount was taken into consideration in the measurement of the CAH impairment loss recorded in fiscal year 2016. See “Note 5—Foreclosed Assets” in our 2016 Form 10-K for additional information on the sale of CAH.

We recorded a loss related to CAH of $2 million in the same prior-year quarter. This loss was attributable to valuation adjustments.

Non-Interest Expense

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

We recorded non-interest expense of $21 million and $23 million for the three months ended August 31, 2016 and 2015, respectively. The decrease in non-interest expense of $2 million was primarily attributable to a reduction in other general and administrative expenses during the current quarter.

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 August 31, 2016 and 2015.

13



CONSOLIDATED BALANCE SHEET ANALYSIS

Total assets of $24,678 million as of August 31, 2016 increased by $407 million, or 2%, from May 31, 2016, primarily due to growth in our loan portfolio. Total liabilities of $24,025 million as of August 31, 2016 increased by $572 million, or 2%, from May 31, 2016, primarily due to debt issuances to fund our loan portfolio growth. Total equity decreased by $165 million to $653 million as of August 31, 2016. The decrease in total equity for the three months ended August 31, 2016 was primarily attributable to the net loss of $132 million and to the patronage capital retirement of $42 million.
Following is a discussion of changes in the major components of our assets and liabilities during the three months ended August 31, 2016. Period-end balance sheet amounts may vary from average balance sheet amounts due to liquidity and balance sheet management activities that are intended to manage liquidity requirements for the company and our customers and our market risk exposure in accordance with our risk appetite.

Loan Portfolio

We offer long-term fixed- and variable-rate loans and line of credit variable-rate loans. Borrowers may choose a fixed or variable interest rate for periods of one to 35 years. When a selected fixed-rate term expires, the borrower may select either another fixed-rate term or a variable rate or elect to repay the loan in full. 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.

Loans Outstanding

Loans outstanding consist of advances from either new approved loans or from the unadvanced portion of loans previously approved. Table 6 summarizes total loans outstanding, by type and by member class, as of August 31, 2016 and May 31, 2016.

Table 6: Loans Outstanding by Type and Member Class
 
 
August 31, 2016
 
May 31, 2016
 
Increase/
(Dollars in thousands)
 
Amount
 
% of Total
 
Amount
 
% of Total
 
(Decrease)
Loans by type:(1)
 
 
 
 
 
 
 
 
 
 
Long-term loans:
 
 
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
21,761,313

 
92
%
 
$
21,390,576

 
93
%
 
$
370,737

Long-term variable-rate loans
 
717,772

 
3

 
757,500

 
3

 
(39,728
)
Total long-term loans(2)
 
22,479,085

 
95

 
22,148,076

 
96

 
331,009

Line of credit loans
 
1,076,658

 
5

 
1,004,441

 
4

 
72,217

Total loans outstanding(3)
 
$
23,555,743

 
100
%
 
$
23,152,517

 
100
%
 
$
403,226

 
 
 
 
 
 
 
 
 
 
 
Loans by member class:(1)
 
 
 
 
 
 
 
 
 
 
CFC:
 
 
 
 
 
 
 
 
 
 
Distribution
 
$
17,984,617

 
76
%
 
$
17,674,335

 
76
%
 
$
310,282

Power supply
 
4,437,621

 
19

 
4,401,185

 
20

 
36,436

Statewide and associate
 
56,267

 

 
54,353

 

 
1,914

CFC total(2)
 
22,478,505

 
95

 
22,129,873

 
96

 
348,632

RTFC
 
392,176

 
2

 
341,842

 
1

 
50,334

NCSC
 
685,062

 
3

 
680,802

 
3

 
4,260

Total loans outstanding(3)
 
$
23,555,743

 
100
%
 
$
23,152,517

 
100
%
 
$
403,226

____________________________ 
(1) Includes nonperforming and restructured loans.

14



(2) Includes long-term loans guaranteed by RUS totaling $172 million and $174 million as of August 31, 2016 and May 31, 2016, respectively, and long-term loans covered under the Farmer Mac standby purchase commitment agreement totaling $887 million and $926 million of as of August 31, 2016 and May 31, 2016, respectively.
(3)Total loans outstanding represents the outstanding unpaid principal balance of loans. Unamortized deferred loan origination costs, which totaled $10 million as of August 31, 2016 and May 31, 2016, are excluded from total loans outstanding. These costs, however, are included in loans to members reported on the condensed consolidated balance sheets.

Total loans outstanding of $23,556 million as of August 31, 2016 increased by $403 million, or 2%, from May 31, 2016. The increase was primarily due to increases in CFC distribution and power supply loans of $310 million and $36 million, respectively, which were largely attributable to members refinancing with us loans made by other lenders and member advances for capital investments.

We provide additional information on our loan product types in “Item 1. Business—Loan Programs” and “Note 4—Loans and Commitments” in our 2016 Form 10-K. See “Debt—Secured Borrowings” below for information on encumbered and unencumbered loans and “Credit Risk Management” for information on the credit risk profile of our loan portfolio.

Loan Retention Rate

Table 7 compares the historical retention rate of long-term fixed-rate loans that repriced during the three months ended August 31, 2016 and the year ended May 31, 2016, and provides information on 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. As indicated in Table 7, the average retention rate of repriced loans has been 99% over the presented periods.

Table 7: Historical Retention Rate and Repricing Selection
 
 
Three Months Ended August 31, 2016
 
Year Ended May 31, 2016
(Dollars in thousands)
 
Amount
 
% of Total
 
Amount
 
% of Total
Loans retained:
 
 
 
 
 
 
 
 
Long-term fixed rate selected
 
$
142,467

 
83
%
 
$
1,001,118

 
93
%
Long-term variable rate selected
 
29,543

 
17

 
54,796

 
5

Loans repriced and sold by CFC
 

 

 
4,459

 

Total loans retained
 
172,010

 
100

 
1,060,373

 
98

Total loans repaid
 

 

 
17,956

 
2

Total
 
$
172,010

 
100
%
 
$
1,078,329

 
100
%

Debt

We utilize both short-term and long-term borrowings as part of our funding strategy and asset/liability management. We seek to maintain diversified funding sources across products, programs and markets to manage funding concentrations and reduce our liquidity or debt roll-over risk. Our funding sources include a variety of secured and unsecured debt securities in a wide range of maturities to our members and affiliates and in the capital markets.

Debt Outstanding

Table 8 displays the composition, by product type, of our outstanding debt as of August 31, 2016 and May 31, 2016. Table 8 also displays the composition of our debt based on several additional selected attributes.

15



Table 8: Total Debt Outstanding
(Dollars in thousands)
 
August 31, 2016
 
May 31, 2016
 
Increase/
(Decrease)
Debt product type:
 
 
 
 
 
 
Commercial paper:
 
 
 
 
 
 
Members, at par
 
$
972,363

 
$
848,007

 
$
124,356

Dealer, net of discounts
 
709,908

 
659,935

 
49,973

Total commercial paper
 
1,682,271

 
1,507,942

 
174,329

Select notes to members
 
737,006

 
701,849

 
35,157

Daily liquidity fund notes to members
 
540,079

 
525,959

 
14,120

Collateral trust bonds
 
7,256,921

 
7,253,096

 
3,825

Guaranteed Underwriter Program notes payable
 
4,868,036

 
4,777,111

 
90,925

Farmer Mac notes payable
 
2,293,561

 
2,303,123

 
(9,562
)
Medium-term notes:
 
 
 
 
 


Members, at par
 
635,003

 
654,058

 
(19,055
)
Dealer, net of discounts
 
2,665,896

 
2,648,369

 
17,527

Total medium-term notes
 
3,300,899

 
3,302,427

 
(1,528
)
Other notes payable
 
41,005

 
40,944

 
61

Subordinated deferrable debt
 
742,176

 
742,212

 
(36
)
Members’ subordinated certificates:
 
 
 
 
 
 
Membership subordinated certificates
 
630,063

 
630,063

 

Loan and guarantee subordinated certificates
 
592,022

 
593,701

 
(1,679
)
Member capital securities
 
221,046

 
220,046

 
1,000

Total members’ subordinated certificates
 
1,443,131

 
1,443,810

 
(679
)
Total debt outstanding
 
$
22,905,085

 
$
22,598,473


$
306,612

 
 
 
 
 
 
 
Security type:
 
 
 
 
 
 
Unsecured debt
 
37
%
 
37
%
 
 
Secured debt
 
63

 
63

 
 
Total
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
Funding source:
 
 
 
 
 
 
Members
 
19
%
 
18
%
 
 
Private placement
 
31

 
32

 
 
Capital markets
 
50

 
50

 
 
Total
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
Interest rate type including impact of swaps:
 
 
 
 
 
 
Fixed-rate debt(1)
 
88
%
 
88
%
 
 
Variable-rate debt(2)
 
12

 
12

 
 
Total
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
Interest rate type:
 
 
 
 
 
 
Fixed-rate debt
 
74
%
 
74
%
 
 
Variable-rate debt
 
26

 
26

 
 
Total
 
100
%
 
100
%
 
 
 
 
 
 
 
 
 
Original contractual maturity:
 
 
 
 
 
 
Short-term borrowings
 
14
%
 
13
%
 
 
Long-term and subordinated debt(3)
 
86

 
87

 
 
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.

16



(2) Includes fixed-rate debt that has been swapped to a variable rate net of any variable-rate debt that has been swapped to a fixed rate. Also includes commercial paper notes, which generally have maturities of less than 90 days. The interest rate on commercial paper notes does not change once the note has been issued; however, the rates on new commercial paper notes change daily.
(3) Consists of long-term debt, subordinated deferrable debt and total members’ subordinated debt reported on the condensed consolidated balance sheets.

Total debt outstanding of $22,905 million as of August 31, 2016 increased by $307 million, or 1%, from May 31, 2016, primarily due to debt issuances to fund our loan portfolio growth. The increase was attributable primarily to an increase of $174 million in our commercial paper outstanding and an advance on August 30, 2016 of $100 million under committed loan facilities from the Federal Financing Bank under the Guaranteed Underwriter Program of the USDA.

Member Investments

Debt securities issued to our members represent an important, stable source of funding. Table 9 displays outstanding member debt, by debt product type, as of August 31, 2016 and May 31, 2016.

Table 9: Member Investments
 
 
August 31, 2016
 
May 31, 2016
 
Increase/
(Decrease)
(Dollars in thousands)
 
Amount
 
% of Total (1)
 
Amount
 
% of Total (1)
 
Commercial paper
 
$
972,363

 
58
%
 
$
848,007

 
56
%
 
$
124,356

Select notes
 
737,006

 
100

 
701,849

 
100

 
35,157

Daily liquidity fund notes
 
540,079

 
100

 
525,959

 
100

 
14,120

Medium-term notes
 
635,003

 
19

 
654,058

 
20

 
(19,055
)
Members’ subordinated certificates
 
1,443,131

 
100

 
1,443,810

 
100

 
(679
)
Total
 
$
4,327,582

 
 
 
$
4,173,683

 
 
 
$
153,899

 
 
 
 
 
 
 
 
 
 
 
Percentage of total debt outstanding
 
19
%
 
 
 
18
%
 
 
 
 

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

Member investments accounted for 19% and 18% of total debt outstanding as of August 31, 2016 and May 31, 2016, respectively. Over the last three years, outstanding member investments have averaged $4,187 million.

Short-Term Borrowings

Short-term borrowings consist of borrowings with an original contractual maturity of one year or less and do not include the current portion of long-term debt. Short-term borrowings totaled $3,151 million and accounted for 14% of total debt outstanding as of August 31, 2016, compared with $2,939 million, or 13%, of total debt outstanding as of May 31, 2016.

Long-Term and Subordinated Debt

Long-term debt, defined as debt with an original contractual maturity term of greater than one year, primarily consists of medium-term notes, collateral trust bonds, notes payable under the Guaranteed Underwriter Program and notes payable under our note purchase agreement with Farmer Mac. Subordinated debt consists of subordinated deferrable debt and members’ subordinated certificates. Our subordinated deferrable debt and members’ subordinated certificates have original contractual maturity terms of greater than one year. Long-term and subordinated debt totaled $19,754 million and accounted for 86% of total debt outstanding as of August 31, 2016, compared with $19,659 million, or 87%, of total debt outstanding as of May 31, 2016. As discussed above, the increase in total debt outstanding, including long-term and subordinated debt, was primarily due to the issuance of debt to fund loan portfolio growth.


17



Collateral Pledged

We are required to pledge loans or other collateral in borrowing transactions under our collateral trust bond indentures, note purchase agreements with Farmer Mac and bond agreements under the Guaranteed Underwriter Program of the USDA. We are required to maintain pledged collateral equal to at least 100% of the outstanding amount of borrowings. However, we typically maintain pledged collateral in excess of the required percentage to ensure that required collateral levels are maintained and to facilitate the timely execution of debt issuances by reducing or eliminating the lead time to pledge additional collateral. Under the provisions of our bank revolving credit agreements, the excess collateral that we are allowed to pledge cannot exceed 150% of the outstanding borrowings under our collateral trust bond indentures, Farmer Mac or the Guaranteed Underwriter Program of the USDA. In certain cases, provided that all conditions of eligibility under the different programs are satisfied, we may withdraw excess pledged collateral or transfer collateral from one borrowing program to another to facilitate a new debt issuance.

Of our total debt outstanding of $22,905 million as of August 31, 2016, $14,433 million, or 63%, was secured by pledged loans. In comparison, of our total debt outstanding of $22,598 million as of May 31, 2016, $14,348 million, or 63%, was secured by pledged loans. Table 10 displays the unpaid principal balance of loans pledged for secured debt, the excess collateral pledged and unencumbered loans as of August 31, 2016 and May 31, 2016.

Table 10: Unencumbered Loans
(Dollars in thousands)
 
August 31, 2016
 
May 31, 2016
Total loans outstanding(1) 
 
$
23,555,743

 
$
23,152,517

Less: Total secured debt
 
(14,724,465
)
 
(14,643,108
)
 Excess collateral pledged (2)
 
(1,490,297
)
 
(1,673,404
)
Unencumbered loans
 
$
7,340,981

 
$
6,836,005

Unencumbered loans as a percentage of total loans
 
31
%
 
30
%
____________________________ 
(1)Excludes unamortized deferred loan origination costs of $10 million as of August 31, 2016 and May 31, 2016.
(2) Excludes cash collateral pledged to secure debt. If there is an event of default under most of our indentures, we can only withdraw the excess collateral if we substitute cash or permitted investments of equal value.

Table 11 displays the collateral coverage ratios as of August 31, 2016 and May 31, 2016 for the debt agreements noted above that require us to pledge collateral.

Table 11: Collateral Pledged
 
 
Requirement/Limit
 
Actual
Debt Agreement
 
Debt Indenture
Minimum
 
Revolving Credit Agreements
Maximum
 
August 31, 2016
 
May 31, 2016
Collateral trust bonds 1994 indenture
 
100
%
 
150
%
 
119
%
 
121
%
Collateral trust bonds 2007 indenture
 
100

 
150

 
109

 
110

Guaranteed Underwriter Program notes payable(1)
 
100

 
150

 
108

 
110

Farmer Mac notes payable
 
100

 
150

 
116

 
117

Clean Renewable Energy Bonds Series 2009A
 
100

 
150

 
110

 
115

____________________________ 
(1) Represents notes payable under the Guaranteed Underwriter Program of the USDA, which supports the Rural Economic Development Loan and Grant program. The Federal Financing Bank provides the financing for these notes, and RUS provides a guarantee of repayment.We are required to pledge collateral in an amount at least equal to the outstanding principal amount of the notes payable.

We provide additional information on our borrowings, including the maturity profile, below in “Liquidity Risk.” We provide a more detailed description of each of our debt product types in “Note 6—Short-Term Borrowings,” “Note 7—Long-Term Debt,” “Note 8—Subordinated Deferrable Debt” and “Note 9—Members’ Subordinated Certificates” in our 2016 Form

18



10-K. Refer to “Note 4—Loans and Commitments—Pledging of Loans” for additional information related to pledged collateral.

Equity

The decrease in total equity of $165 million to $653 million as of August 31, 2016, was attributable to our reported net loss of $132 million for the three months ended August 31, 2016 and the patronage capital retirement of $42 million.

In July 2016, the CFC Board of Directors authorized the allocation of fiscal year 2016 adjusted net income as follows: $1 million to the Cooperative Educational Fund, $86 million to the members’ capital reserve and $84 million to members in the form of patronage capital. The amount of patronage capital allocated each year by CFC’s Board of Directors is based on adjusted non-GAAP net income, which excludes the impact of derivative forward value gains (losses). See “Non-GAAP Financial Measures” for information on adjusted net income.

In July 2016, the CFC Board of Directors also authorized the retirement of patronage capital totaling $42 million, which represented 50% of the fiscal year 2016 allocation. This amount was returned to members in cash in September 2016. The remaining portion of the allocated amount will be retained by CFC for 25 years under guidelines adopted by the CFC Board of Directors in June 2009.

The CFC Board of Directors is required to make annual allocations of net earnings, if any. CFC has made annual retirements of allocated net earnings in 36 of the last 37 fiscal years; however, future retirements of allocated amounts are determined based on 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 laws. See “Item 1. Business—Allocation and Retirement of Patronage Capital” of our 2016 Form 10-K for additional information.
OFF-BALANCE SHEET ARRANGEMENTS

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

Guarantees

We provide guarantees for certain contractual obligations of our members to assist them in obtaining various forms of financing. We use the same credit policies and monitoring procedures in providing guarantees as we do for loans and commitments. If a member defaults on its obligation, we are obligated to pay required amounts pursuant to our guarantees. Meeting our guarantee obligations satisfies the underlying obligation of our member systems and prevents the exercise of remedies by the guarantee beneficiary based upon a payment default by a member. In general, the member is required to repay any amount advanced by us with interest, pursuant to the documents evidencing the member’s reimbursement obligation. Table 12 displays our guarantees outstanding, by guarantee type and by company, as of August 31, 2016 and May 31, 2016.

19



Table 12: Guarantees Outstanding
(Dollars in thousands)
 
August 31, 2016
 
May 31, 2016
 
Increase/
(Decrease)
Guarantee type:
 
 
 
 
 
 
Long-term tax-exempt bonds
 
$
474,965

 
$
475,965

 
$
(1,000
)
Letters of credit
 
308,551

 
319,596

 
(11,045
)
Other guarantees
 
113,386

 
113,647

 
(261
)
Total
 
$
896,902

 
$
909,208

 
$
(12,306
)
Company:
 
 

 
 
 
 
CFC
 
$
878,247

 
$
892,289

 
$
(14,042
)
RTFC
 
1,574

 
1,574

 

NCSC
 
17,081

 
15,345

 
1,736

Total
 
$
896,902

 
$
909,208

 
$
(12,306
)

We recorded a guarantee liability of $16 million and $17 million as of August 31, 2016 and May 31, 2016, respectively, related to the contingent and noncontingent exposures for guarantee and liquidity obligations associated with our members’ debt. Of our total guarantee amounts, 67% and 66% as of August 31, 2016 and May 31, 2016, respectively, were secured by a mortgage lien on substantially all of the system’s assets and future revenue of the borrowers.

We had outstanding letters of credit for the benefit of our members totaling $309 million as of August 31, 2016. Of this amount, $233 million was related to 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 repay the advance amount to us. The remaining $76 million of letters of credit are intended to provide liquidity for pollution control bonds.

In addition to the letters of credit presented in Table 12, we had master letter of credit facilities in place as of August 31, 2016, under which we may be required to issue up to an additional $84 million in letters of credit to third parties for the benefit of our members. All of our master letter of credit facilities as of August 31, 2016 were subject to material adverse change clauses at the time of issuance. Prior to issuing a letter of credit under 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 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 long-term variable-rate, tax-exempt bonds issued for our member cooperatives totaling $481 million as of August 31, 2016. 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 discussed above and included in Table 12 as a component of the letters of credit amount of $309 million as of August 31, 2016. We were not required to perform as liquidity provider pursuant to these obligations during the three months ended August 31, 2016. In addition to being a liquidity provider, we also provided a guarantee of payment of principal and interest on $405 million of these bonds, included in the above table, as of August 31, 2016.

Table 13 presents the maturities for each of the next five fiscal years and thereafter of the notional amount of our outstanding guarantee obligations as of August 31, 2016.

Table 13: Maturities of Guarantee Obligations
 
 
 Outstanding
Balance
 
Maturities of Guaranteed Obligations
(Dollars in thousands)
 
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
Guarantees
 
$
896,902

 
$
144,403

 
$
228,086

 
$
31,868

 
$
122,966

 
$
35,397

 
$
334,182



20



We provide additional information about our guarantee obligations in “Note 11—Guarantees.”

Unadvanced Loan Commitments

Unadvanced commitments represent approved and executed loan contracts for which funds have not been advanced to borrowers. The table below displays the amount of unadvanced loan commitments, which consist of line of credit and long-term loan commitments, as of August 31, 2016 and May 31, 2016. 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 14: Unadvanced Loan Commitments
 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Amount
 
% of Total
 
Amount
 
% of Total
Line of credit commitments:
 
 
 
 
 
 
 
 
Conditional(1)
 
$
5,824,731

 
45
%
 
$
6,248,546

 
47
%
Not conditional(2)
 
2,543,328

 
19

 
2,447,902

 
19

Total line of credit unadvanced commitments
 
8,368,059


64

 
8,696,448

 
66

Total long-term loan unadvanced commitments(1)
 
4,616,153


36

 
4,508,562

 
34

Total unadvanced loan commitments
 
$
12,984,212


100
%
 
$
13,205,010

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

Unadvanced line of credit commitments are typically revolving facilities for periods not to exceed five years. Historically, borrowers have not drawn the full commitment amount for line of credit facilities, and we have experienced a very low utilization rate on line of credit loan facilities, regardless of whether or not a material adverse change clause exists at the time of advance. We believe this borrowing pattern is likely to continue because electric cooperatives generate a significant amount of cash from the collection of revenue from their customers and therefore generally do not need to draw down on loan commitments to supplement operating cash flow. In addition, the majority of the unadvanced line of credit commitments serve as supplemental back-up liquidity to our borrowers. See “MD&A—Off-Balance Sheet Arrangements” in our 2016 Form 10-K for additional information.

Table 15 presents the amount of unadvanced commitments, by loan type, as of August 31, 2016 and the maturities of the commitment amounts for each of the next five fiscal years and thereafter.

Table 15: Notional Maturities of Unadvanced Loan Commitments
 
 
Available
Balance
 
Notional Maturities of Unadvanced Commitments
(Dollars in thousands)
 
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
Line of credit
 
$
8,368,059

 
$
379,658

 
$
5,159,912

 
$
906,050

 
$
926,739

 
$
648,255

 
$
347,445

Long-term loans
 
4,616,153

 
881,044

 
723,437

 
1,018,401

 
865,482

 
849,510

 
278,279

Total
 
$
12,984,212

 
$
1,260,702

 
$
5,883,349

 
$
1,924,451

 
$
1,792,221

 
$
1,497,765

 
$
625,724


Based on our historical experience, we expect that the majority of the unadvanced commitments will expire without being fully drawn upon. Accordingly, the total unadvanced commitment amount of $12,984 million as of August 31, 2016 is not necessarily representative of future cash funding requirements.

Unadvanced Commitments—Conditional

The substantial majority of our line of credit commitments and all of our unadvanced long-term loan commitments include material adverse change clauses. Unadvanced commitments subject to material adverse change clauses totaled $10,441 million and $10,757 million as of August 31, 2016 and May 31, 2016, respectively, and accounted for 80% and 81% of the combined total of unadvanced line of credit and long-term loan commitments as of August 31, 2016 and May 31, 2016,

21



respectively. Prior to making advances on these facilities, we 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 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.

Unadvanced Commitments—Not Conditional

Unadvanced commitments not subject to material adverse change clauses at the time of each advance consisted of unadvanced committed lines of credit totaling $2,543 million and $2,448 million as of August 31, 2016 and May 31, 2016, respectively. 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. We record a liability for credit losses on our 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.

Loan syndications, where the pricing is set at a spread over a market index as agreed upon by all of the participating banks based on market conditions at the time of syndication, accounted for 79% of unconditional line of credit commitments as of August 31, 2016. New advances accounted for the remaining 21% of the unconditional committed line of credit loans as of August 31, 2016. Any new advance would be made at rates determined by us based on our cost, and we have the option to pass on to the borrower any cost increase related to the advance.

Table 16 presents the maturities for each of the next five fiscal years and thereafter of the notional amount of unconditional committed lines of credit not subject to a material adverse change clause as of August 31, 2016.

Table 16: Maturities of Notional Amount of Unconditional Committed Lines of Credit
 
 
Available
Balance
 
Notional Maturities of Unconditional Committed Lines of Credit
(Dollars in thousands)
 
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
Committed lines of credit
 
$
2,543,328

 
$
65,887

 
$
508,670

 
$
606,565

 
$
710,208

 
$
443,333

 
$
208,665

RISK MANAGEMENT

Overview

We face a variety of risks that can significantly affect our financial performance, liquidity, reputation and ability to meet the expectations of our members, investors and other stakeholders. As a financial services company, the major categories of risk exposures inherent in our business activities include credit risk, liquidity risk, market risk and operational risk. These risk categories are summarized below.

Credit risk is the risk that a borrower or other counterparty will be unable to meet its obligations in accordance with agreed-upon terms.

Liquidity risk is the risk that we will be unable to fund our operations and meet our contractual obligations or that we will be unable to fund new loans to borrowers at a reasonable cost and tenor in a timely manner.

Market risk is the risk that changes in market variables, such as movements in interest rates, may adversely affect the match between the timing of the contractual maturities, re-pricing and prepayments of our financial assets and the related financial liabilities funding those assets.

Operational risk is the risk of loss resulting from inadequate or failed internal controls, processes, systems, human error or external events. Operational risk also includes compliance risk, fiduciary risk, reputational risk and litigation risk.


22



Effective risk management is critical to our overall operations and in achieving our primary objective of providing cost-based financial products to our rural electric members while maintaining the sound financial results required for investment-grade credit ratings on our debt instruments. Accordingly, we have a risk management framework that is intended to govern the principal risks we face in conducting our business and the aggregate amount of risk we are willing to accept, referred to as risk appetite, in the context of CFC’s mission and strategic objectives and initiatives. We provide information on our risk management framework in our 2016 Form 10-K under “Item 7. MD&A—Risk Management—Risk Management Framework.”
CREDIT RISK

Our loan portfolio, which represents the largest component of assets on our balance sheet, and guarantees account for the substantial majority of our credit risk exposure. We also engage in certain non-lending activities that may give rise to credit and counterparty settlement risk, including the purchase of investment securities and entering into derivative transactions to manage our interest rate risk.

Loan and Guarantee Portfolio Credit Risk

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

Security Provisions

Except when providing line of credit loans, we generally lend to our members on a senior secured basis. Long-term loans are generally secured on parity with other secured lenders (primarily RUS), if any, by all assets and revenue of the borrower with exceptions typical in utility mortgages. Line of credit loans are generally unsecured. In addition to the collateral pledged to secure our loans, borrowers also are required to set rates charged to customers to achieve certain financial ratios. Of our total loans outstanding, 92% were secured and 8% were unsecured as of both August 31, 2016 and May 31, 2016. Table 17 presents, by loan type and by company, the amount and percentage of secured and unsecured loans in our loan portfolio.

Table 17: Loan Portfolio Security Profile
 
 
August 31, 2016
(Dollars in thousands)
 
Secured
 
% of Total
 
Unsecured
 
% of Total
 
Total
Loan type:(1)
 
 
 
 
 
 
 
 
 
 
Long-term loans:
 
 
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
21,005,176

 
97
%
 
$
756,137

 
3
%
 
$
21,761,313

Long-term variable-rate loans
 
650,271

 
91

 
67,501

 
9

 
717,772

Total long-term loans(2)
 
21,655,447

 
96

 
823,638

 
4

 
22,479,085

Line of credit loans
 
81,842

 
8

 
994,816

 
92

 
1,076,658

Total loans outstanding(3)
 
$
21,737,289

 
92
%
 
$
1,818,454

 
8
%
 
$
23,555,743

 
 
 
 
 
 
 
 
 
 
 
Company:(1)
 
 
 
 
 
 
 
 
 
 
CFC(2)
 
$
20,939,231

 
93
%
 
$
1,539,274

 
7
%
 
$
22,478,505

RTFC
 
375,334

 
96

 
16,842

 
4

 
392,176

NCSC
 
422,724

 
62

 
262,338

 
38

 
685,062

Total loans outstanding(3)
 
$
21,737,289

 
92
%
 
$
1,818,454

 
8
%
 
$
23,555,743



23



 
 
May 31, 2016
(Dollars in thousands)
 
Secured
 
% of Total
 
Unsecured
 
% of Total
 
Total
Loan type:(1)
 
 
 
 
 
 
 
 
 
 
Long-term loans:
 
 
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
20,611,221

 
96
%
 
$
779,355

 
4
%
 
$
21,390,576

Long-term variable-rate loans
 
688,572

 
91

 
68,928

 
9

 
757,500

Total long-term loans(2)
 
21,299,793

 
96

 
848,283

 
4

 
22,148,076

Line of credit loans
 
48,256

 
5

 
956,185

 
95

 
1,004,441

Total loans outstanding(3)
 
$
21,348,049

 
92
%
 
$
1,804,468

 
8
%
 
$
23,152,517

 
 
 
 
 
 
 
 
 
 
 
Company:(1)
 
 
 
 
 
 
 
 
 
 
CFC(2)
 
$
20,590,529

 
93
%
 
$
1,539,344

 
7
%
 
$
22,129,873

RTFC
 
330,696

 
97

 
11,146

 
3

 
341,842

NCSC
 
426,824

 
63

 
253,978

 
37

 
680,802

Total loans outstanding(3)
 
$
21,348,049

 
92
%
 
$
1,804,468

 
8
%
 
$
23,152,517

____________________________ 
(1) Includes nonperforming and restructured loans.
(2) Includes long-term loans guaranteed by RUS totaling $172 million and $174 million as of August 31, 2016 and May 31, 2016, respectively, and long-term loans covered under the Farmer Mac standby purchase commitment agreement totaling $887 million and $926 million of as of August 31, 2016 and May 31, 2016, respectively.
(3) Excludes deferred loan origination costs of $10 million as of August 31, 2016 and May 31, 2016.

As part of our strategy in managing our credit risk exposure, we entered into a long-term standby purchase commitment agreement with Farmer Mac on August 31, 2015, as amended on May 31, 2016. Under this agreement, we may designate certain loans to be covered under the commitment, 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 loans that had an aggregate outstanding principal balance of $887 million as of August 31, 2016, down from $926 million as of May 31, 2016.

Loan Concentration

We serve electric and telecommunications members throughout the United States and its territories, including 49 states, the District of Columbia, American Samoa and Guam. The largest concentration of loans to borrowers in any one state represented approximately 15% of total loans outstanding as of both August 31, 2016 and May 31, 2016.

Table 18 displays the outstanding exposure of the 20 largest borrowers, by exposure type and by company, as of August 31, 2016 and May 31, 2016. The 20 largest borrowers consisted of 10 distribution systems and 10 power supply systems as of August 31, 2016. The 20 largest borrowers consisted of 11 distribution systems and nine power supply systems as of May 31, 2016. The largest total outstanding exposure to a single borrower or controlled group represented approximately 2% of total loans and guarantees outstanding as of both August 31, 2016 and May 31, 2016.


24



Table 18: Credit Exposure to 20 Largest Borrowers
  
 
August 31, 2016
 
May 31, 2016
 
Increase/
(Decrease)
(Dollars in thousands)
 
Amount
 
% of Total
 
Amount
 
% of Total
 
By exposure type:
 
 
 
 
 
 
 
 
 
 
Loans
 
$
5,659,910

 
24
 %
 
$
5,638,217

 
23
 %
 
$
21,693

Guarantees
 
360,807

 
1

 
365,457

 
2

 
(4,650
)
Total exposure to 20 largest borrowers
 
6,020,717

 
25
 %
 
6,003,674

 
25
 %
 
17,043

Less: Loans covered under Farmer Mac standby purchase commitment(1)
 
(407,491
)
 
(2
)%
 
(402,244
)
 
(2
)%
 
(5,247
)
Net exposure to 20 largest borrowers
 
5,613,226

 
23
 %
 
5,601,430

 
23
 %
 
11,796

 
 
 
 
 
 
 
 
 
 
 
By company:
 
 
 
 
 
 
 
 
 
 
CFC
 
$
6,008,717

 
25
 %
 
$
5,991,674

 
25
 %
 
$
17,043

NCSC
 
12,000

 

 
12,000

 

 

Total exposure to 20 largest borrowers
 
6,020,717

 
25
 %
 
6,003,674

 
25
 %
 
17,043

Less: Loans covered under Farmer Mac standby purchase commitment
 
(407,491
)
 
(2
)%
 
(402,244
)
 
(2
)%
 
(5,247
)
Net exposure to 20 largest borrowers
 
$
5,613,226

 
23
 %
 
$
5,601,430

 
23
 %
 
$
11,796



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 4—Loans and Commitments,” 0.2% of the loans in our portfolio were classified as criticized as of both August 31, 2016 and May 31, 2016. 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 TDR loans. 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. Interest accrued but not collected at the date a loan is placed on nonaccrual status is reversed against earnings. 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. Table 19 presents the carrying value of modified loans, all of which met the definition of a TDR, as of August 31, 2016 and May 31, 2016. These loans were considered individually impaired as of the end of each period presented.

25




Table 19: TDR Loans
 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Amount
 
% of Total Loans
 
Amount
 
% of Total Loans
TDR loans:
 
 
 
 
 
 
 
 
CFC
 
$
6,581

 
0.03
%
 
$
6,716

 
0.03
%
RTFC
 
6,967

 
0.03

 
10,598

 
0.04

Total TDR loans
 
$
13,548

 
0.06
%
 
$
17,314

 
0.07
%
 
 
 
 
 
 
 
 
 
TDR loans performance status:
 
 
 
 
 
 
 
 
Performing TDR loans
 
$
13,548

 
0.06
%
 
$
13,808

 
0.06
%
Nonperforming TDR loans
 

 

 
3,506

 
0.01

Total TDR loans
 
$
13,548

 
0.06
%
 
$
17,314

 
0.07
%
 
Loans classified as performing TDR loans as of August 31, 2016 and May 31, 2016, as disclosed in Table 19, were performing in accordance with the terms of their respective restructured loan agreement as of the respective reported dates. All TDR loans classified as performing as of August 31, 2016 and May 31, 2016 were on accrual status as of that date.

As indicated in Table 19, there were no TDR loans classified as nonperforming as of August 31, 2016. All TDR loans classified as nonperforming as of May 31, 2016 were on nonaccrual status as of that date.

Nonperforming Loans

In addition to nonperforming TDR loans, we may 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 placed on nonaccrual status is reversed against earnings. We had no loans classified as nonperforming as of August 31, 2016. As discussed above, we had nonperforming TDR loans totaling $4 million as of May 31, 2016.

We provide additional information on the credit quality of our loan portfolio in “Note 4—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 months ended August 31, 2016 and a comparison of the allowance by company as of August 31, 2016 and May 31, 2016.


26



Table 20: Allowance for Loan Losses
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016
 
2015
Beginning balance
 
$
33,258

 
$
33,690

Provision for loan losses
 
1,928

 
4,562

Net (charge-offs) recoveries
 
(2,066
)
 
55

Ending balance
 
$
33,120

 
$
38,307

`
 
 
 
 
(Dollars in thousands)
 
August 31, 2016
 
May 31, 2016
Allowance for loan losses by company:
 
 
 
 
  CFC
 
$
25,062

 
$
24,559

  RTFC
 
4,777

 
5,565

  NCSC
 
3,281

 
3,134

Total
 
$
33,120

 
$
33,258

 
 
 
 
 
Allowance coverage ratios:
 
 
 
 
Percentage of total loans outstanding
 
0.14
%
 
0.14
%
Percentage of total performing TDR loans outstanding
 
244.46

 
240.86

Percentage of total nonperforming TDR loans outstanding
 

 
948.60

Percentage of loans on nonaccrual status
 

 
948.60


The allowance for loan losses decreased slightly during the three months ended August 31, 2016 to $33 million; however, the allowance coverage ratio remained at 0.14% as of August 31, 2016, unchanged from May 31, 2016. The slight decrease in the allowance for loan losses was attributable to a decline in the specific reserve for loans individually evaluated for impairment. This decrease was partially offset by an increase in the collective allowance for loans not individually evaluated for impairment due to the increase in our loan portfolio. Loans designated as individually impaired loans totaled $14 million and $17 million as of August 31, 2016 and May 31, 2016, respectively, and the specific allowance related to these loans totaled $1 million and $3 million, respectively.

We discuss our methodology for determining the allowance for loan losses above in “MD&A—Critical Accounting Policies and Estimates” and in “Note 1—Summary of Significant Accounting Policies” in our 2016 Form 10-K. Also see “Results of Operations—Provision for Loan Losses” and “Note 4—Loans and Commitments” for additional information on our allowance for loan losses.

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 generally have an original maturity of less than one year.

We manage our derivative counterparty credit risk by requiring that derivative counterparties participate in one of our revolving credit agreements, monitoring the overall credit worthiness of each counterparty, using counterparty specific credit risk limits, executing master netting arrangements and diversifying our derivative transactions among multiple counterparties. Our derivative counterparties had credit ratings ranging from Aa3 to Baa3 by Moody’s Investors Service (“Moody’s”) and from AA-to BBB+ by Standard & Poor’s Ratings Services (“S&P”) as of August 31, 2016. Our largest counterparty exposure, based on the outstanding notional amount, represented approximately 25% of the total outstanding notional amount of derivatives as of both August 31, 2016 and May 31, 2016.


27



Credit Risk-Related Contingent Features

Our derivative contracts typically contain mutual early termination provisions, generally in the form of a credit rating trigger. Under the mutual credit rating trigger provisions, either counterparty may, but is not obligated to, terminate and settle the agreement if the credit rating of the other counterparty falls to a level specified in the agreement. If a derivative contract is terminated, the amount to be received or paid by us would be equal to the mark-to-market value, as defined in the agreement, as of termination date.

Our senior unsecured credit ratings from Moody’s and S&P were A2 and A, respectively, as of August 31, 2016. Both Moody’s and S&P had our ratings on stable outlook as of August 31, 2016. Table 21 displays the notional amounts of our derivative contracts with rating triggers as of August 31, 2016, 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 below A3/A-, below Baa1/BBB+, to or below Baa2/BBB, below Baa3/BBB-, or to or below 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 counterparty's master netting agreements. 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
Impact of rating downgrade trigger:
 
 
 
 
 
 
 
 
Falls below A3/A-(1)
 
$
63,295

 
$
(19,039
)
 
$

 
$
(19,039
)
Falls below Baa1/BBB+(2)
 
6,699,031

 
(435,093
)
 

 
(435,093
)
Falls to or below Baa2/BBB (3)(4)
 
159,237

 
(5,215
)
 

 
(5,215
)
Falls below Baa3/BBB-
 
384,111

 
(30,581
)
 

 
(30,581
)
Total
 
$
7,305,674

 
$
(489,928
)
 
$

 
$
(489,928
)
____________________________ 
(1) Rating trigger for CFC falls below A3/A-, while rating trigger for counterparty falls below Baa1/BBB+ by Moody’s or S&P, respectively.  
(2) Excludes $56 million notional amount of a forward-starting swap with an effective start date of July 31, 2018, which was outstanding as of August 31, 2016.  
(3) Excludes $56 million notional amount of a forward-starting swap with an effective start date of July 31, 2018, which was outstanding as of August 31, 2016.  
(4) Rating trigger for CFC falls to or below Baa2/BBB, while rating trigger for counterparty falls to or below Ba2/BB+ by Moody’s or S&P, respectively.

The aggregate amount, excluding and including the credit risk valuation adjustment, of all derivatives with rating triggers that were in a net liability position was $490 million and $479 million, respectively, as of August 31, 2016. There were no interest rate swaps with rating triggers that were in a net asset position as of August 31, 2016. There were no counterparties that fell below the rating trigger levels in our interest swap contracts as of August 31, 2016. If a counterparty has a credit rating that falls below the rating trigger level specified in the interest swap contract, we have the option to terminate all derivatives with the counterparty. However, we generally do not terminate such agreements early because our interest rate swaps are critical to our matched funding strategy.

See “Item 1A. Risk Factors” in our 2016 Form 10-K for additional information about credit risk related to our business.

28



LIQUIDITY RISK

Our liquidity risk management framework is designed to meet our liquidity objectives of providing a reliable source of funding to members, meet maturing debt and other obligations, issue new debt and fund our operations on a cost-effective basis under normal operating conditions as well as under CFC-specific and/or market stress conditions.

Short-Term Borrowings

We rely primarily on cash flows from our operations along with short-term borrowings, which we refer to as our short-term funding portfolio, as sources of funding to meet our near-term, day-to-day liquidity needs. Our short-term funding portfolio consists of commercial paper, which we offer to members and dealers, select notes and daily liquidity fund notes to members, bank-bid notes and medium-term notes to members and dealers. Table 22 displays the composition of our short-term borrowings as of August 31, 2016 and May 31, 2016.

Table 22: Short-Term Borrowings
 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Amount
 Outstanding
 
% of Total Debt Outstanding
 
Amount
Outstanding
 
% of Total Debt Outstanding
Short-term borrowings:
 
 
 
 
 
 
 
 
Commercial paper:
 
 
 
 
 
 
 
 
Commercial paper sold through dealers, net of discounts
 
$
709,908

 
3
%
 
$
659,935

 
3
%
Commercial paper sold directly to members, at par
 
972,363

 
4

 
848,007

 
4

Total commercial paper
 
1,682,271

 
7

 
1,507,942

 
7

Select notes
 
737,006

 
3

 
701,849

 
3

Daily liquidity fund notes
 
540,079

 
3

 
525,959

 
2

Medium-term notes sold to members
 
192,055

 
1

 
203,098

 
1

Total short-term borrowings
 
$
3,151,411

 
14
%
 
$
2,938,848

 
13
%

Our short-term borrowings totaled $3,151 million and accounted for 14% of total debt outstanding as of August 31, 2016, compared with $2,939 million, or 13%, of total debt outstanding as of May 31, 2016. Of the total outstanding commercial paper, $710 million and $660 million was issued to dealers as of August 31, 2016 and May 31, 2016, respectively. During fiscal year 2015, we began reducing the level of dealer commercial paper to an amount below $1,250 million to manage our short-term wholesale funding risk. We expect to continue to maintain our outstanding dealer commercial paper at a level below this amount for the foreseeable future.

Liquidity Reserve

As part of our strategy in meeting our liquidity objectives, we seek to maintain a liquidity reserve in the form of both on-balance sheet and off-balance sheet funding sources that are readily accessible for immediate liquidity needs. Table 23 below presents the components of our liquidity reserve and a comparison of the amounts available as of August 31, 2016 and May 31, 2016.


29



Table 23: Liquidity Reserve
 
 
August 31, 2016
 
May 31, 2016
(Dollars in millions)
 
Total
 
Accessed
 
Available
 
Total
 
Accessed
 
Available
Cash and cash equivalents and time deposits
 
$
631

 
$

 
$
631

 
$
545

 
$

 
$
545

Committed bank revolving line of credit agreements—unsecured(1)
 
3,310

 
1

 
3,309

 
3,310

 
1

 
3,309

Guaranteed Underwriter Program committed facilities—secured(2)
 
5,423

 
4,923

 
500

 
5,423

 
4,823

 
600

Farmer Mac revolving note purchase agreement, dated March 24, 2011—secured(3)
 
4,500

 
2,294

 
2,206

 
4,500

 
2,303

 
2,197

Farmer Mac revolving note purchase agreement, dated July 31, 2015—secured
 
300

 

 
300

 
300

 

 
300

Total
 
$
14,164

 
$
7,218

 
$
6,946

 
$
14,078

 
$
7,127

 
$
6,951

____________________________ 
(1)The accessed amount of $1 million relates to a letter of credit issued pursuant to the line of credit agreement.
(2) The committed facilities under the Guaranteed Underwriting program are non-revolving.
(3) Availability subject to market conditions.

Cash and cash equivalents and time deposits are a source of liquidity available to support our operations. As noted in Table 23, cash and cash equivalents and time deposits increased by $86 million during the current quarter to $631 million as of August 31, 2016.

Borrowing Capacity

In addition to cash and time deposits, our liquidity reserve includes access to funds under committed revolving line of credit agreements with banks, committed loan facilities under the Guaranteed Underwriter Program of the USDA and our revolving note purchase agreements with Farmer Mac. Below, we discuss our borrowing capacity under each of these facilities.

Committed Bank Revolving Line of Credit Agreements—Unsecured

Our bank revolving lines of credit may be used for general corporate purposes; however, we generally rely on them as a backup source of liquidity to our short-term funding portfolio. Our short-term funding portfolio consists of member and dealer commercial paper, select notes to members and daily liquidity fund investments by members. We had $3,420 million commitments under revolving credit agreements as of both August 31, 2016 and May 31, 2016. 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 amount under the facilities. NCSC’s commitment amount of $110 million 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 commitment of $110 million under the revolving credit agreements also reduces the total letters of credit available 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 August 31, 2016. We did not have any outstanding borrowings under our bank revolving line of credit agreements as of August 31, 2016.


30



Table 24: Bank Revolving Credit Agreements
 
 
August 31, 2016
 
 
 
 
(Dollars in millions)
 
Total Commitment
 
Letters of Credit Outstanding
 
Net Available for Advance (1)
 
Maturity
 
Annual Facility Fee (2)
3-year agreement
 
$
25

 
$

 
$
25

 
October 28, 2017
 
7.5 bps
3-year agreement
 
1,640

 

 
1,640

 
November 19, 2018
 
7.5 bps
  Total 3-year agreement
 
1,665

 

 
1,665

 
 
 
 
5-year agreement
 
45

 

 
45

 
October 28, 2019
 
10 bps
5-year agreement
 
1,600

 
1

 
1,599

 
November 19, 2020
 
10 bps
  Total 5-year agreement
 
1,645

 
1

 
1,644

 
 
 
 
Total
 
$
3,310

 
$
1

 
$
3,309

 
 
 
 
____________________________ 
(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 rating triggers that would limit the banks’ obligations to provide funding under the terms of the agreements; however, we must be in compliance with the covenants to draw on the facilities. We have been and expect to continue to be in compliance with the covenants under our revolving credit agreements. As such, we could draw on these facilities to repay dealer or member commercial paper that cannot be rolled over. See “Debt Covenants and Financial Ratios” below for additional information, including the specific financial ratio requirements under our bank revolving line of credit agreements.

In September 2016, NCSC assigned a total of $50 million of its commitment to another financial institution in the facility, with $25 million expiring in October 2017 and $25 million expiring in October 2019. As a result, the CFC commitment amount from third parties increased to $3,360 million, while the NCSC commitment was reduced to $60 million.

Guaranteed Underwriter Program Committed Facilities—Secured

Under the Guaranteed Underwriter Program of the USDA, we can borrow from the Federal Financing Bank and use the proceeds to make loans to electric cooperatives or to refinance existing indebtedness. As part of the program, we pay fees, based on outstanding borrowings, that support the USDA Rural Economic Development Loan and Grant program. The borrowings under this program are guaranteed by RUS.

We borrowed $100 million with a 20 year final maturity under the Guaranteed Underwriter Program of the USDA during the three months ended August 31, 2016. As part of this program, we had committed loan facilities from the Federal Financing Bank of up to $500 million available as of August 31, 2016. Of this amount, $250 million is available for advance through October 15, 2017 and $250 million is available for advance through January 15, 2019. On September 28, 2016, we received a commitment from the RUS to guarantee a loan of $375 million from the Federal Financing Bank under the Guaranteed Underwriter Program of the USDA. The draw period for advances under this loan is three years followed by a 20-year repayment period. Upon closing of the loan, we will have up to $875 million of committed loan facilities available under the Guaranteed Underwriter Program.

We are required to pledge eligible distribution system or power supply system loans as collateral in an amount at least equal to the total outstanding borrowings under the Guaranteed Underwriter Program. See “Consolidated Balance Sheet Analysis—Debt—Collateral Pledged” and “Note 4—Loans and Commitments” for additional information on pledged collateral.

Farmer Mac Revolving Note Purchase Agreements—Secured

As indicated in Table 23, we have two revolving note purchase agreements with Farmer Mac, which together allow us to borrow up to $4,800 million from Farmer Mac. Under the terms of the first revolving note purchase agreement with Farmer Mac dated March 24, 2011, as amended, we can borrow up to $4,500 million at any time 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

31



anniversary date, Farmer Mac provides us with a notice that the draw period will not be extended beyond the remaining term. This revolving note purchase agreement allows us to borrow, repay and re-borrow funds at any time through maturity, as market conditions permit, provided that the outstanding principal amount at any time does not exceed the total available under the agreement. Each borrowing under the revolving 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. The available borrowing amount totaled $2,206 million as of August 31, 2016.

Under the terms of the second revolving note purchase agreement with Farmer Mac dated July31, 2015, we can borrow up to $300 million at any time through July 31, 2018. This agreement also allows us to borrow, repay and re-borrow funds at any time through maturity, provided that the outstanding principal amount at any time does not exceed the total available under the agreement. We did not borrow any amounts under this note purchase agreement during the three months ended August 31, 2016; thus, the available borrowing amount was $300 million as of August 31, 2016.

Pursuant to both Farmer Mac revolving note purchase agreements, 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. See “Consolidated Balance Sheet Analysis—Debt—Collateral Pledged” and “Note 4—Loans and Commitments” for additional information on pledged collateral.

Long-Term and Subordinated Debt

Long-term and subordinated debt represents the most significant component of our funding. The issuance of long-term debt allows us to reduce our reliance on short-term borrowings and manage our refinancing and interest rate risk, due in part to the multi-year contractual maturity structure of long-term debt. In addition to private debt issuances, we also issue debt in the public capital markets. Under the SEC rules, we are classified as a “well-known seasoned issuer.” In September 2016, we filed a new shelf registration statement for our collateral trust bonds under which we can register an unlimited amount of collateral trust bonds until September 2019. See “MD&A—Liquidity Risk” of our 2016 Form 10-K for additional information on our shelf registration statements with the SEC.

As discussed in Consolidated Balance Sheet Analysis—Debt, long-term and subordinated debt totaled $19,754 million and accounted for 86% of total debt outstanding as of August 31, 2016, compared with $19,659 million, or 87%, of total debt outstanding as of May 31, 2016. The increase in total debt outstanding, including long-term and subordinated debt, was primarily due to the issuance of debt to fund our loan portfolio growth.

Table 25 summarizes long-term and subordinated debt issuances and principal maturities, including repurchases and redemptions, during the three months ended August 31, 2016.

Table 25: Issuances and Maturities of Long-Term and Subordinated Debt
 
 
August 31, 2016
(Dollars in thousands)
 
Issuances
 
Maturities
Long-term and subordinated debt activity:
 
 
 
 
Guaranteed Underwriter Program notes payable
 
$
100,000

 
$
9,082

Farmer Mac notes payable
 

 
9,562

Medium-term notes sold to members
 
78,439

 
86,451

Medium-term notes sold to dealers
 
107,100

 
88,018

Members’ subordinated certificates
 
1,236

 
1,915

   Total
 
$
286,775

 
$
195,028


Table 26 summarizes the maturities of the principal amount of long-term debt, subordinated deferrable debt and members‘ subordinated certificates as of August 31, 2016.


32



Table 26: Principal Maturity of Long-Term Debt and Subordinated Debt
(Dollars in thousands)
 
Amount
Maturing (1)
 
% of Total
Fiscal year ending:
 
 
 
 
May 31, 2017
 
$
2,156,503

 
11
%
May 31, 2018
 
1,136,779

 
6

May 31, 2019
 
2,215,622

 
11

May 31, 2020
 
1,065,381

 
5

May 31, 2021
 
1,307,629

 
7

Thereafter
 
11,770,566

 
60

Total
 
$
19,652,480

 
100
%
____________________________ 
(1)Excludes member loan subordinated certificates totaling $101 million that amortize annually based on the outstanding balance of the related loan and $0.3 million in subscribed and unissued member subordinated 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 member loan subordinated certificates. Over the past fiscal year, annual amortization on these member loan subordinated certificates was $16 million. In fiscal year 2016, amortization represented 15% of amortizing member loan subordinated certificates outstanding.

Credit Ratings

Our funding and liquidity, borrowing capacity, ability to access capital markets and other sources of funds and the cost
of these funds are partially dependent on our credit ratings. 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. Table 27 displays our credit ratings as of August 31, 2016.

Table 27: Credit Ratings
 
 
August 31, 2016
 
 
Moody’s
 
S&P
 
Fitch
Long-term issuer credit rating
 
 
A
 
A
Senior secured debt(1)
 
A1
 
A
 
  A+
Senior unsecured debt(2)
 
A2
 
A
 
A
Commercial paper
 
P-1
 
A-1
 
F1
Outlook
 
Stable
 
Stable
 
Stable
___________________________ 
(1)Applies to our collateral trust bonds.
(2)Applies to our medium-term notes.

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. In addition, the notes payable to the Federal Financing Bank under the Guaranteed Underwriter Program of the USDA contain a provision that if during any portion of the fiscal year, our senior secured credit ratings do 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, we may not make cash patronage capital distributions in excess of 5% of total patronage capital. See “Credit Risk—Counterparty Credit Risk—Credit Risk-Related Contingent Features” above for information on credit rating provisions related to our derivative contracts.

Projected Near-Term Sources and Uses of Liquidity

As discussed above, our primary sources of liquidity include cash flows from operations, our short-term funding portfolio, our liquidity reserve and the issuance of long-term and subordinated debt, as well as loan principal and interest payments.

33



Our primary uses of liquidity include loan advances to members, principal and interest payments on borrowings, periodic settlement payments related to derivative contracts, costs related to the disposition of foreclosed assets and operating expenses.

Table 28 displays our projected sources and uses of cash, by quarter, over the next six quarters through the quarter ending February 28, 2018. In projecting our liquidity position, we assume that the amount of time deposit investments will remain consistent with current levels over the next six quarters. Our assumptions include the following: (i) the estimated issuance of long-term debt, including collateral trust bonds and private placement of term debt, is based on maintaining a matched funding position within our loan portfolio with our bank revolving lines of credit serving as a backup liquidity facility for commercial paper; (ii) long-term loan scheduled amortization payments represent the scheduled long-term loan payments for loans outstanding as of August 31, 2016 and our current estimate of long-term loan prepayments, which the amount and timing of are subject to change; (iii) other loan repayments and other loan advances primarily relate to line of credit repayments and advances; (iv) long-term debt maturities reflect scheduled maturities of outstanding term debt for the periods presented; (v) long-term loan advances reflect our current estimate of member demand for loans, which the amount and timing of are subject to change.

Table 28: Projected Sources and Uses of Liquidity(1) 

 
 
Projected Sources of Liquidity
 
Projected Uses of Liquidity
 
 
(Dollars in millions)
 
Commercial Paper Debt Issuance
 
Long-Term Debt Issuance
 
Long-Term Loan Scheduled Amortization Payments
 
Total Projected
Sources of
Liquidity
 
Long-Term Debt Maturities(3)
 
Long-Term
 Loan Advances
 
Other Loan Advances
 
Total Projected
Uses of
Liquidity
 
Cumulative
Excess
Sources/(Uses) of
Liquidity
(2)
1Q17
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
$
631

2Q17
 
$
250

 
$
242

 
$
312

 
$
804

 
$
433

 
$
497

 
$
42

 
$
972

 
463

3Q17
 
50

 
680

 
341

 
1,071

 
460

 
533

 
27

 
1,020

 
514

4Q17
 
150

 
1,330

 
297

 
1,777

 
1,439

 
334

 

 
1,773

 
518

1Q18
 
50

 
135

 
316

 
501

 
128

 
364

 

 
492

 
527

2Q18
 

 
135

 
289

 
424

 
59

 
410

 

 
469

 
482

3Q18
 

 
835

 
290

 
1,125

 
738

 
406

 

 
1,144

 
463

Total
 
$
500

 
$
3,357

 
$
1,845

 
$
5,702

 
$
3,257

 
$
2,544

 
$
69

 
$
5,870

 
 
____________________________ 
(1)The dates presented represent the end of each quarterly period through the quarter ending February 28, 2018.
(2)Cumulative excess sources/(uses) of liquidity includes cash and time deposits.
(3)Long-term debt maturities also includes medium-term notes with an original maturity of one year or less.

As shown in Table 28, we currently expect the amount of new long-term loan advances to exceed scheduled loan repayments over the next 12 months by approximately $462 million. The estimates presented above are developed at a particular point in time based on our expected future business growth and funding. Our actual results and future estimates may vary, perhaps significantly, from the current projections, as a result of changes in market conditions, management actions or other factors.

Debt Covenants and Financial Ratios

We were in compliance with all covenants and conditions under our bank revolving line of credit agreements and senior debt indentures as of August 31, 2016. As discussed above in “Summary of Selected Financial Data,” the financial covenants set forth in our bank revolving line of credit agreements and senior debt indentures are based on adjusted financial measures. These adjusted measures consist of adjusted TIER and adjusted senior debt-to-total equity ratio. We provide a reconciliation of these measurements to the most comparable GAAP measures and an explanation of the adjustments below in “Non-GAAP Financial Measures.”

Covenants—Bank Revolving Line of Credit Agreements

Table 29 presents the required and actual financial ratios under our bank revolving line of credit agreements as of August 31, 2016 and May 31, 2016.

34




Table 29: Financial Covenant Ratios Under Bank Revolving Line of Credit Agreements(1) 
 
 
 
 
Actual
 
 
Requirement
 
August 31, 2016
 
May 31, 2016
 
 
 
 
 
 
 
Minimum average adjusted TIER over the six most recent fiscal quarters
 
1.025

 
1.25
 
1.26
 
 
 
 
 
 
 
Minimum adjusted TIER for the most recent fiscal year
 
1.05

 
1.21
 
1.21
 
 
 
 
 
 
 
Maximum ratio of adjusted senior debt-to-total equity
 
10.00

 
5.67
 
5.52
____________________________ 
(1) Adjusted TIER is calculated based on adjusted net income (loss) plus adjusted interest expense for the period, divided by adjusted interest expense for the period. In addition to the adjustments made to the leverage ratio set forth under “Non-GAAP Financial Measures,” adjusted senior debt excludes guarantees to member systems that have certain investment-grade credit ratings from Moody’s and S&P.

In addition to the financial covenants, our bank revolving line of credit agreements generally prohibit liens on loans to members except for the liens pursuant to the following:

under terms of our indentures,
related to taxes that are being contested or are not delinquent,
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 under this provision for all three of our bank revolving line of credit agreements was $7,177 million as of August 31, 2016.

Covenants—Debt Indentures

Table 30 presents the 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 August 31, 2016 and May 31, 2016.

Table 30 : Financial Ratios Under Debt Indentures
 
 
 
 
Actual
 
 
Requirement
 
August 31, 2016
 
May 31, 2016
Maximum ratio of adjusted senior debt to total equity (1)
 
20.00
 
7.95
 
7.33
____________________________ 
(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 noncash impact of derivative financial instruments and adjustments from total liabilities and total equity.

In addition to the above financial covenant requirement, we are required to pledge collateral 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—Collateral Pledged.”

Debt Ratio Analysis

We provide the calculations for our primary debt ratios, which include the adjusted leverage and adjusted debt-to-equity ratios, and a reconciliation to the most comparable GAAP measures (the leverage and debt-to-equity ratios) below in “Non-GAAP Financial Measures.” We also explain the basis for the adjustments made to derive the adjusted ratios.




35



Leverage Ratio

The leverage ratio was 38.17-to-1 as of August 31, 2016, compared with 29.81-to-1 as of May 31, 2016. The increase in the leverage ratio was due to an increase in total liabilities of $572 million, attributable to the increase in debt to fund our loan portfolio growth and an increase in our derivative liability resulting from changes in interest rates, and the decrease in total equity of $165 million, resulting from our net loss and retirement of patronage capital, partially offset by the decrease of $12 million in total guarantees.

The leverage ratio under the financial covenants of our bank revolving line of credit agreements is adjusted to exclude certain items, which are detailed in Table 34. The adjusted leverage ratio was 6.20-to-1 as of as of August 31, 2016, compared with 6.08-to-1 as of May 31, 2016. The increase in the adjusted leverage ratio was due to the increase of $407 million in adjusted liabilities, attributable to the increase in debt to fund our loan portfolio growth, partially offset by the decrease of $12 million in total guarantees.

Debt-to-Equity Ratio

The debt-to-equity ratio was 36.80-to-1 as of August 31, 2016, compared with 28.69-to-1 as of May 31, 2016. The increase in the debt-to-equity ratio was attributable to the increase in total liabilities of $572 million and the decrease in total equity of $165 million.

The adjusted debt-to-equity ratio was 5.94-to-1 as of August 31, 2016, compared with 5.82-to-1 as of May 31, 2016. The increase in the adjusted debt-to-equity ratio was attributable to the increase in adjusted liabilities of $407 million.
MARKET RISK

Interest rate risk represents our primary market risk. Interest rate risk is the risk arising from movements in interest
rates that may result in differences between the timing of contractual maturities, re-pricing characteristics and
prepayments on our assets and their related liabilities.

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.

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 31. 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.


36



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 both August 31, 2016 and May 31, 2016.

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 31 displays the scheduled amortization and repricing of fixed-rate assets and liabilities outstanding as of August 31, 2016.

Table 31: Interest Rate Gap Analysis
(Dollars in millions)
 
Prior to 5/31/17
 
Two Years 6/1/17 to 5/31/19
 
Two Years 6/1/19 to
5/31/21
 
Five Years 6/1/21 to
5/31/26
 
10 Years 6/1/26 to 5/31/36
 
6/1/36 and Thereafter
 
Total
Asset amortization and repricing
 
$
1,625

 
$
3,699

 
$
2,700

 
$
5,148

 
$
6,025

 
$
2,564

 
$
21,761

Liabilities and members’ equity:
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Long-term debt
 
$
1,790

 
$
4,130

 
$
2,488

 
$
4,654

 
$
3,935

 
$
1,064

 
$
18,061

Subordinated certificates
 
15

 
43

 
58

 
920

 
277

 
691

 
2,004

Members’ equity (1)
 

 

 
26

 
89

 
322

 
810

 
1,247

Total liabilities and members’ equity
 
$
1,805

 
$
4,173

 
$
2,572

 
$
5,663

 
$
4,534

 
$
2,565

 
$
21,312

Gap (2)
 
$
(180
)
 
$
(474
)
 
$
128

 
$
(515
)
 
$
1,491

 
$
(1
)
 
$
449

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cumulative gap
 
(180
)
 
(654
)
 
(526
)
 
(1,041
)
 
450

 
449

 
 
Cumulative gap as a % of total assets
 
(0.73
)%
 
(2.65
)%
 
(2.13
)%
 
(4.22
)%
 
1.82
%
 
1.82
%
 
 
Cumulative gap as a % of adjusted total assets(3)
 
(0.73
)
 
(2.66
)
 
(2.14
)
 
(4.23
)
 
1.83

 
1.83

 
 
____________________________ 
(1)Includes the portion of the allowance for loan losses and subordinated deferrable debt allocated to fund fixed-rate assets and excludes noncash adjustments from the accounting for derivative financial instruments.
(2)Calculated based on the amount of assets amortizing and repricing less total liabilities and members’ equity.
(3)Adjusted total assets represents total assets reported in our condensed consolidated balance sheets less derivative assets.

The difference, or gap, of $449 million between the fixed-rate loans scheduled for amortization or repricing of $21,761 million and the fixed-rate liabilities and equity funding the loans of $21,312 million presented in Table 31 reflects the amount of fixed-rate assets that are funded with short-term debt as of August 31, 2016. The gap of $449 million represented 1.82% of total assets and 1.83% of adjusted total assets (total assets excluding derivative assets) as of August 31, 2016.

We maintain an unmatched position on our fixed-rate assets within a limited percentage of adjusted total assets. The limited unmatched position is intended to provide 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 increase the gross yield on our fixed rate assets without taking what we would consider to be excessive risk.

Our Asset Liability Committee provides oversight over maintaining our interest rate position within prescribed policy limits using approved strategies. Our primary strategies for managing our exposure to interest rate risk include the use of

37



derivatives and 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. 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 discuss how we manage our liquidity risk in our 2016 Form 10-K under “Item 7. MD&A—Liquidity Risk.”
NON-GAAP FINANCIAL MEASURES

In addition to financial measures determined in accordance with GAAP, management evaluates performance based on certain non-GAAP measures, which we refer to as “adjusted” measures. We provide a discussion of each of these non-GAAP measures in our 2016 Form 10-K under “Item 7. MD&A—Non-GAAP Measures.” Below we provide a reconciliation of our adjusted measures to the most comparable GAAP measures. We believe our non-GAAP adjusted 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 and management uses these metrics to compare operating results across financial reporting periods, for internal budgeting and forecasting purposes, for compensation decisions and for short- and long-term strategic planning decisions.

Statements of Operations Non-GAAP Adjustments and Calculation of Adjusted TIER

Table 32 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 32: Adjusted Financial Measures — Income Statement
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016

2015
Interest expense
 
$
(181,080
)
 
$
(165,700
)
Plus: Derivative cash settlements
 
(23,390
)
 
(20,156
)
Adjusted interest expense
 
$
(204,470
)
 
$
(185,856
)
 
 
 
 
 
Net interest income
 
$
75,755

 
$
80,416

Less: Derivative cash settlements
 
(23,390
)
 
(20,156
)
Adjusted net interest income
 
$
52,365

 
$
60,260

 
 
 
 
 
Net income (loss)
 
$
(132,261
)
 
$
43,095

Less: Derivative forward value
 
164,903

 
(8,139
)
Adjusted net income
 
$
32,642

 
$
34,956


We consider the cost of derivatives to be an inherent cost of funding and hedging our loan portfolio and, therefore, economically similar to the interest expense that we recognize on debt issued for funding. We therefore include derivative cash settlements in our adjusted interest expense and exclude the unrealized forward value of derivatives from our adjusted net income.

TIER Calculation

Table 33 presents our TIER and adjusted TIER for the three months ended August 31, 2016 and 2015.






38



Table 33: TIER and Adjusted TIER
 
 
Three Months Ended August 31,
 
 
2016
 
2015
TIER (1)
 
0.27

 
1.26

 
 
 
 
 
Adjusted TIER (2)
 
1.16

 
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 34 provides a reconciliation between the liabilities and equity used to calculate the leverage and debt-to-equity ratios and the adjusted leverage and adjusted debt-to-equity ratios as of August 31, 2016 and May 31, 2016. As indicated in the table below, subordinated debt is treated in the same manner as equity in calculating our adjusted leverage and adjusted-debt-to-equity ratios pursuant to the financial covenants under our bank revolving line of credit agreements.

Table 34: Adjusted Financial Measures — Balance Sheet
(Dollars in thousands)
 
August 31, 2016

May 31, 2016
Total liabilities
 
$
24,024,759

 
$
23,452,822

Less:
 
 
 
 
Derivative liabilities
 
(761,491
)
 
(594,820
)
Debt used to fund loans guaranteed by RUS
 
(172,019
)
 
(173,514
)
Subordinated deferrable debt
 
(742,176
)
 
(742,212
)
Subordinated certificates
 
(1,443,131
)
 
(1,443,810
)
Adjusted total liabilities
 
$
20,905,942

 
$
20,498,466

 
 
 
 
 
Total equity
 
$
652,856

 
$
817,378

Less:
 
 
 
 
Prior year cumulative derivative forward value adjustments
 
520,357

 
299,274

Year-to-date derivative forward value (gains) losses, net
 
164,903

 
221,083

Accumulated other comprehensive income (1)
 
(4,290
)
 
(4,487
)
Plus:
 

 
 
Subordinated certificates
 
1,443,131

 
1,443,810

Subordinated deferrable debt
 
742,176

 
742,212

Adjusted total equity
 
$
3,519,133

 
$
3,519,270

Guarantees (2)
 
$
896,902

 
$
909,208

____________________________ 
(1) Represents the accumulated other comprehensive income related to derivatives. Excludes $7 million of accumulated other comprehensive income as of August 31, 2016 and May 31, 2016 related to the unrecognized gains on our investments. It also excludes $10 million of accumulated other comprehensive loss related to foreclosed assets as of May 31, 2016 and $1 million of accumulated other comprehensive loss related to a defined benefit pension plan as of August 31, 2016 and May 31, 2016.
(2) Guarantees are used in the calculation of leverage and adjusted leverage ratios below.

Table 35 displays the calculations of our leverage and debt-to-equity ratios and our adjusted leverage and debt-to-equity ratios as of August 31, 2016 and May 31, 2016.


39



Table 35: Leverage and Debt-to-Equity Ratios
 
 
August 31, 2016
 
May 31, 2016
Leverage ratio (1)
 
38.17

 
29.81

Adjusted leverage ratio (2)
 
6.20

 
6.08

Debt-to-equity ratio (3)
 
36.80

 
28.69

Adjusted debt-to-equity ratio (4)
 
5.94

 
5.82

____________________________ 
(1) Calculated based on total liabilities and guarantees as of the end of the period divided by total equity as of the end of the period.
(2) Calculated based on adjusted total liabilities and guarantees as of the end of the period divided by adjusted total equity as of the end of the period. See Table 34 for the adjustments to reconcile total liabilities and guarantees and total equity to adjusted total liabilities and guarantees and adjusted total equity.
(3) Calculated based on total liabilities as of the end of the period divided by total equity as of the end of the period.
(4) Calculated based on adjusted total liabilities at period end divided by adjusted total equity at period end.

40


Item 1.
Financial Statements
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


41


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

 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016

2015
Interest income
 
$
256,835

 
$
246,116

Interest expense
 
(181,080
)
 
(165,700
)
Net interest income
 
75,755

 
80,416

Provision for loan losses
 
(1,928
)
 
(4,562
)
Net interest income after provision for loan losses
 
73,827

 
75,854

Non-interest income:
 
 

 
 

Fee and other income
 
4,530

 
4,701

Derivative losses
 
(188,293
)
 
(12,017
)
Results of operations of foreclosed assets
 
(1,112
)
 
(1,921
)
Total non-interest income
 
(184,875
)
 
(9,237
)
Non-interest expense:
 
 

 
 

Salaries and employee benefits
 
(11,424
)
 
(11,490
)
Other general and administrative expenses
 
(9,435
)
 
(11,345
)
Other
 
(443
)
 
(357
)
Total non-interest expense
 
(21,302
)
 
(23,192
)
Income (loss) before income taxes
 
(132,350
)
 
43,425

Income tax expense
 
89

 
(330
)
Net income (loss)
 
(132,261
)
 
43,095

Less: Net loss attributable to noncontrolling interests
 
690

 
230

Net income (loss) attributable to CFC
 
$
(131,571
)
 
$
43,325

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.



42









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

 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016

2015
Net income (loss )
 
$
(132,261
)
 
$
43,095

Other comprehensive income (loss):
 
 

 
 

Unrealized losses on available-for-sale investment securities
 
(11
)
 
(664
)
Reclassification of losses on foreclosed assets to net income
 
9,823

 

Reclassification of derivative gains to net income
 
(197
)
 
(235
)
Defined benefit plan adjustments
 
44

 
44

Other comprehensive income (loss)
 
9,659

 
(855
)
Total comprehensive income (loss)
 
(122,602
)
 
42,240

Less: Total comprehensive loss attributable to noncontrolling interests
 
690

 
232

Total comprehensive income (loss) attributable to CFC
 
$
(121,912
)
 
$
42,472

 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.
 

43






NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
       CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
(Dollars in thousands)
 
August 31, 2016

May 31, 2016
Assets:
 
 
 
 
Cash and cash equivalents
 
$
290,651

 
$
204,540

Restricted cash
 
21,319

 
4,628

Time deposits
 
340,000

 
340,000

Investment securities available for sale, at fair value
 
87,930

 
87,940

Loans to members
 
23,566,225

 
23,162,696

Less: Allowance for loan losses
 
(33,120
)
 
(33,258
)
Loans to members, net
 
23,533,105

 
23,129,438

Accrued interest receivable
 
109,785

 
113,272

Other receivables
 
51,270

 
51,478

Fixed assets, net
 
115,723

 
112,563

Debt service reserve funds
 
17,151

 
17,151

Foreclosed assets, net
 

 
102,967

Derivative assets
 
81,734

 
80,095

Other assets
 
28,947

 
26,128

Total assets
 
$
24,677,615

 
$
24,270,200

 
 
 
 
 
Liabilities:
 


 
 
Accrued interest payable
 
$
194,928

 
$
132,996

Debt outstanding:
 
 
 
 
Short-term borrowings
 
3,151,411

 
2,938,848

Long-term debt
 
17,568,367

 
17,473,603

Subordinated deferrable debt
 
742,176

 
742,212

Members’ subordinated certificates:
 
 

 
 

Membership subordinated certificates
 
630,063

 
630,063

Loan and guarantee subordinated certificates
 
592,022

 
593,701

Member capital securities
 
221,046

 
220,046

Total members’ subordinated certificates
 
1,443,131

 
1,443,810

Total debt outstanding
 
22,905,085

 
22,598,473

Patronage capital retirement payable
 
41,509

 

Deferred income
 
75,878

 
78,651

Derivative liabilities
 
761,491

 
594,820

Other liabilities
 
45,868

 
47,882

Total liabilities
 
24,024,759

 
23,452,822

 
 
 
 
 
Commitments and contingencies
 


 


 
 
 
 
 
Equity:
 
 
 
 
CFC equity:
 
 

 
 

Retained equity
 
616,124

 
790,234

Accumulated other comprehensive income
 
10,717

 
1,058

Total CFC equity
 
626,841

 
791,292

Noncontrolling interests
 
26,015

 
26,086

Total equity
 
652,856

 
817,378

Total liabilities and equity
 
$
24,677,615

 
$
24,270,200

 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.

44






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, 2016
 
$
2,772

 
$
713,853

 
$
587,219

 
$
(513,610
)
 
$
790,234

 
$
1,058

 
$
791,292

 
$
26,086

 
$
817,378

Net loss
 

 

 

 
(131,571
)
 
(131,571
)
 

 
(131,571
)
 
(690
)
 
(132,261
)
Other comprehensive income
 

 

 

 

 

 
9,659

 
9,659

 

 
9,659

Patronage capital retirement
 

 
(42,129
)
 

 

 
(42,129
)
 

 
(42,129
)
 

 
(42,129
)
Other
 
(410
)
 

 

 

 
(410
)
 

 
(410
)
 
619

 
209

Balance as of August 31, 2016
 
$
2,362

 
$
671,724

 
$
587,219

 
$
(645,181
)
 
$
616,124

 
$
10,717

 
$
626,841

 
$
26,015

 
$
652,856

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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
 

 

 

 
43,325

 
43,325

 

 
43,325

 
(230
)
 
43,095

Other comprehensive loss
 

 

 

 

 

 
(853
)
 
(853
)
 
(2
)
 
(855
)
Patronage capital retirement
 

 
(39,210
)
 

 

 
(39,210
)
 

 
(39,210
)
 

 
(39,210
)
Other
 
(361
)
 

 

 

 
(361
)
 

 
(361
)
 
710

 
349

Balance as of August 31, 2015
 
$
2,382

 
$
629,770

 
$
501,731

 
$
(249,887
)
 
$
883,996

 
$
3,227

 
$
887,223

 
$
27,942

 
$
915,165

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated financial statements.


45






NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016
 
2015
Cash flows from operating activities:
 
 
 
 
Net income (loss)
 
$
(132,261
)
 
$
43,095

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Amortization of deferred income
 
(2,991
)
 
(2,683
)
Amortization of debt issuance costs and deferred charges
 
2,271

 
2,052

Amortization of discount on long-term debt
 
2,308

 
2,110

Amortization of issuance costs for revolving bank lines of credit
 
1,342

 
2,087

Depreciation and amortization
 
1,723

 
1,899

Provision for loan losses
 
1,928

 
4,562

Results of operations of foreclosed assets
 
1,112

 
1,921

Derivative forward value
 
164,903

 
(8,139
)
Changes in operating assets and liabilities:
 
 
 
 
Accrued interest receivable
 
3,487

 
806

Accrued interest payable
 
61,932

 
66,946

Deferred income
 
218

 
(399
)
Other
 
(5,323
)
 
(3,561
)
      Net cash provided by operating activities
 
100,649

 
110,696

Cash flows from investing activities:
 
 
 
 
Advances on loans
 
(2,209,301
)
 
(2,279,165
)
Principal collections on loans
 
1,864,009

 
1,653,889

Net investment in fixed assets
 
(4,883
)
 
(2,058
)
Net cash proceeds from sale of foreclosed assets
 
46,259

 

Proceeds from foreclosed assets
 
4,036

 
1,333

Investments in foreclosed assets
 

 
(1,000
)
Change in restricted cash
 
(16,691
)
 
(4,710
)
     Net cash used in investing activities
 
(316,571
)
 
(631,711
)
Cash flows from financing activities:
 
 
 
 
Proceeds from issuances of short-term borrowings, net
 
256,572

 
146,190

Proceeds from issuances of short-term borrowings with original maturity greater than 90 days
 
195,576

 
131,496

Repayments of short term-debt with original maturity greater than 90 days
 
(239,585
)
 
(196,736
)
Proceeds from issuance of long-term debt
 
283,330

 
551,808

Payments for retirement of long-term debt
 
(193,113
)
 
(89,998
)
Issuance cost of subordinated deferrable debt
 
(68
)
 

Proceeds from issuance of members’ subordinated certificates
 
1,236

 
746

Payments for retirement of members’ subordinated certificates
 
(1,915
)
 
(5,020
)
Net cash provided by financing activities
 
302,033

 
538,486

Net increase in cash and cash equivalents
 
86,111

 
17,471

Beginning cash and cash equivalents
 
204,540

 
248,836

Ending cash and cash equivalents
 
$
290,651

 
$
266,307

Supplemental disclosure of cash flow information:
 
 
 
 
Cash paid for interest
 
$
113,226

 
$
92,505

Cash paid for income taxes
 
199

 
4

 
 
 
 
 
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. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts and related disclosures. The most significant estimates and assumptions involve establishing the allowance for loan losses and determining the fair value of financial instruments and other assets and liabilities. While management makes its best judgment, actual amounts or results could differ from these estimates. Certain reclassifications have been made to previously reported amounts to conform to the current-period presentation. 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, 2016 (“2016 Form 10-K”).

Principles of Consolidation

Our accompanying condensed 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 had one entity, Caribbean Asset Holdings, LLC (“CAH”), that held foreclosed assets as of May 31, 2016. On July 1, 2016, the sale of CAH was completed. As a result, we did not carry any foreclosed assets on our condensed consolidated balance sheet as of August 31, 2016. Unless stated otherwise, references to “we,” “our” or “us” relate to CFC and its consolidated entities.

Interest Income

The following table presents interest income, categorized by loan and investment type, for the three months ended August 31, 2016 and 2015.


47




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

 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016
 
2015
Interest income on loans and investments:
 
 
 
 
Long-term fixed-rate loans(1)
 
$
244,128

 
$
232,202

Long-term variable-rate loans
 
4,527

 
5,020

Line of credit loans
 
5,966

 
6,198

Restructured loans
 
218

 

Investments
 
2,280

 
2,625

Fee income(2)
 
(284
)
 
71

Total interest income
 
$
256,835

 
$
246,116

____________________________ 
(1) Includes loan conversion fees, which are deferred and recognized in interest income using the effective interest method.
(2) Primarily related to amortization of loan origination costs and late payment fees. Up-front loan arranger fees, which are not based on interest rates, are included in fee and other income.

Deferred income on the condensed consolidated balance sheets consists primarily of deferred loan conversion fees, which totaled $69 million and $71 million as of August 31, 2016 and May 31, 2016, respectively.

Interest Expense

The following table presents interest expense, categorized by debt product type, for the three months ended August 31, 2016 and 2015.
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016
 
2015
Interest expense on debt:(1)(2)(3)
 
 
 
 
Short-term borrowings
 
$
4,882

 
$
2,542

Medium-term notes
 
23,585

 
20,153

Collateral trust bonds
 
85,049

 
82,831

Long-term notes payable
 
43,129

 
40,085

Subordinated deferrable debt
 
9,426

 
4,783

Subordinated certificates
 
15,009

 
15,306

Total interest expense
 
$
181,080

 
$
165,700

____________________________ 
(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 2017

Amendments to the Consolidation Analysis

In February 2015, 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 in

48




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

the first quarter of fiscal year 2017. The adoption of the guidance did not impact our condensed consolidated financial statements.

Recently Issued But Not Yet Adopted Accounting Standards

Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments

In June 2016, FASB issued ASU 2016-13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments, which changes the accounting for credit losses on certain financial assets to an expected loss model from the incurred loss model currently in use. The new guidance will result in earlier recognition of credit losses based on measuring the expected credit losses over the estimated life of financial assets held at each reporting date. The expected loss model will be the basis for determining the allowance for credit losses for loans and leases, unfunded lending commitments, held-to-maturity debt securities and other debt instruments measured at amortized cost. In addition, the new guidance modifies the other-than-temporary impairment model for available-for-sale debt securities to require the recognition of credit losses through a valuation allowance when fair value is less than amortized cost, regardless of whether the impairment is considered to be other-than-temporary, which allows for the reversal of credit impairments in future periods. The new guidance is effective for public entities in fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. This update is effective for us in the first quarter of fiscal year 2020 with a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year of adoption. We are in the process of evaluating the impact this new guidance will have on our consolidated financial statements.

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

In January 2016, 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 (our own credit risk) separately in other comprehensive income. The accounting for other financial instruments, such as loans and 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 consolidated financial statements.

Revenue from Contracts with Customers

In May 2014, FASB issued ASU 2014-09, Revenue from Contracts with Customers, which clarifies the principles for recognizing revenue from contracts with customers and will replace most existing revenue recognition in GAAP when it becomes effective. In July 2015, FASB approved a one year deferral of the effective date of this standard, with a revised effective date for fiscal years beginning after December 15, 2017. Early adoption is permitted, although not prior
to fiscal years beginning after December 15, 2016. The new accounting guidance, which does not apply to financial instruments, is effective beginning in the first quarter of fiscal year 2018. We do not expect the new guidance to have a material impact on our consolidated financial statements, as CFC’s primary business and source of revenue is from lending.

49




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

NOTE 2—VARIABLE INTEREST ENTITIES

Based on the accounting standards governing consolidations, we are required to consolidate the financial results of RTFC and NCSC because CFC is the primary beneficiary of RTFC and NCSC.

CFC manages the lending activities of RTFC and NCSC. 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 that is automatically renewable on an annual basis unless terminated by either party. RTFC funds its lending programs through loans from CFC or debt guaranteed by CFC. In connection with these guarantees, RTFC must pay a guarantee fee. 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. CFC had guaranteed $45 million of NCSC debt, derivative instruments and guarantees with third parties as of August 31, 2016, and CFC’s maximum potential exposure for these instruments totaled $48 million. The maturities for NCSC obligations guaranteed by CFC extend through 2031. Guarantees of NCSC debt and derivative instruments are not presented in the amount in “Note 11—Guarantees” as the debt and derivatives are reported on the condensed consolidated balance sheets. CFC guaranteed $2 million of RTFC guarantees with third parties as of August 31, 2016. The maturities for RTFC obligations guaranteed by CFC extend through 2017. All CFC loans to RTFC and NCSC are secured by all assets and revenue of RTFC and NCSC. RTFC had total assets of $495 million including loans outstanding to members of $392 million, and NCSC had total assets of $697 million including loans outstanding of $685 million as of August 31, 2016. CFC had committed to lend RTFC up to $4,000 million, of which $375 million was outstanding, as of August 31, 2016. CFC had committed to provide up to $3,000 million of credit to NCSC, of which $710 million was outstanding, representing $665 million of outstanding loans and $45 million of credit enhancements as of August 31, 2016.
NOTE 3—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 August 31, 2016 and May 31, 2016.
 
 
August 31, 2016
(Dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Farmer Mac—Series A Non-Cumulative Preferred Stock
 
$
30,000

 
$
978

 
$

 
$
30,978

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

 
1,980

 

 
26,980

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

 
1,750

 

 
26,750

Farmer Mac—Class A Common Stock
 
538

 
2,684

 

 
3,222

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

 
$
7,392

 
$

 
$
87,930



50




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

 
 
May 31, 2016
(Dollars in thousands)
 
Amortized Cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
Farmer Mac—Series A Non-Cumulative Preferred Stock
 
$
30,000

 
$
780

 
$

 
$
30,780

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

 
2,600

 

 
27,600

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

 
1,650

 

 
26,650

Farmer Mac—Class A Common Stock
 
538

 
2,372

 

 
2,910

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

 
$
7,402

 
$

 
$
87,940


We did not have any investment securities in an unrealized loss position as of August 31, 2016 and May 31, 2016. For additional information regarding the unrealized gains (losses) recorded on our available-for-sale investment securities, see “Note 10—Equity—Accumulated Other Comprehensive Income.”
NOTE 4—LOANS AND COMMITMENTS
        
The following table 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 August 31, 2016 and May 31, 2016.

 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Loans
Outstanding
 
Unadvanced
Commitments (1)
 
Loans
Outstanding
 
Unadvanced
Commitments (1)
Loan type: (2)
 
 
 
 
 
 
 
 
Long-term loans:
 
 
 
 
 
 
 
 
Long-term fixed-rate loans
 
$
21,761,313

 
$

 
$
21,390,576

 
$

Long-term variable-rate loans
 
717,772

 
4,616,153

 
757,500

 
4,508,562

Total long-term loans(3)
 
22,479,085

 
4,616,153

 
22,148,076

 
4,508,562

Line of credit loans
 
1,076,658

 
8,368,059

 
1,004,441

 
8,696,448

Total loans outstanding(4)
 
23,555,743

 
12,984,212

 
23,152,517

 
13,205,010

Deferred loan origination costs
 
10,482

 

 
10,179

 

Loans to members
 
$
23,566,225

 
$
12,984,212

 
$
23,162,696

 
$
13,205,010

 
 
 
 
 
 
 
 
 
Member class:(2)
 
 
 
 
 
 
 
 
CFC:
 
 
 
 
 
 
 
 
Distribution
 
$
17,984,617

 
$
8,704,420

 
$
17,674,335

 
$
8,967,730

Power supply
 
4,437,621

 
3,256,137

 
4,401,185

 
3,191,873

Statewide and associate
 
56,267

 
149,544

 
54,353

 
155,129

CFC total(3)
 
22,478,505

 
12,110,101

 
22,129,873

 
12,314,732

RTFC
 
392,176

 
247,246

 
341,842

 
246,657

NCSC
 
685,062

 
626,865

 
680,802

 
643,621

Total loans outstanding(4)
 
$
23,555,743

 
$
12,984,212

 
$
23,152,517

 
$
13,205,010

____________________________ 
(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.

51




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

(3) Includes long-term loans guaranteed by RUS totaling $172 million and $174 million as of August 31, 2016 and May 31, 2016, respectively, and long-term loans covered under the Farmer Mac standby purchase commitment agreement totaling $887 million and $926 million as of August 31, 2016 and May 31, 2016, respectively.
(4) Represents the unpaid principal balance excluding deferred loan origination costs.

Unadvanced Loan Commitments

Unadvanced loan commitments totaled $2,543 million and $2,448 million as of August 31, 2016 and May 31, 2016, 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 are 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 August 31, 2016.
 
 
Available
Balance
 
Notional Maturities of Unconditional Committed Lines of Credit
(Dollars in thousands)
 
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
Committed lines of credit
 
$2,543,328

$
65,887


$508,670

$606,565

$710,208

$443,333
 
$208,665

The remaining unadvanced commitments totaling $10,441 million and $10,757 million as of August 31, 2016 and May 31, 2016, 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 August 31, 2016 and the related maturities by fiscal year and thereafter by loan type:
 
 
Available
Balance
 
Notional Maturities of Unadvanced Commitments
(Dollars in thousands)
 
 
2017
 
2018
 
2019
 
2020
 
2021
 
Thereafter
Line of credit loans
 
$
8,368,059


$
379,658


$
5,159,912


$
906,050


$
926,739


$
648,255


$
347,445

Long-term loans
 
4,616,153


881,044


723,437


1,018,401


865,482


849,510


278,279

Total
 
$
12,984,212


$
1,260,702


$
5,883,349


$
1,924,451


$
1,792,221


$
1,497,765


$
625,724


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 transfer, from time to time, loans to third parties under our direct loan sale program. Our transfer of loans, which are generally at par value, meets the applicable accounting criteria for sale accounting. Accordingly, we remove the loans from our condensed consolidated balance sheets when control has been surrendered. Because the loans are sold at par, we record immaterial losses on the sale of these loans for unamortized deferred loan origination costs.We retain the servicing

52




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

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. 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 $20 million and $52 million, at par for cash, during the three months ended August 31, 2016 and 2015, respectively.

Credit Quality

We closely monitor loan performance trends to manage and evaluate our credit risk exposure. We seek to provide a balance between meeting the credit needs of our members while also ensuring the sound credit quality of our loan portfolio. Payment status and internal risk rating trends are key indicators, among others, of the level of credit risk within our loan portfolio.

As part of our strategy in managing our credit risk exposure, we entered into a long-term standby purchase commitment agreement with Farmer Mac on August 31, 2015, as amended on May 31, 2016. Under this agreement, we may designate certain loans to be covered under the commitment, subject to approval 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, loans that had an aggregate outstanding principal balance of $887 million as of August 31, 2016. Under the agreement, we are required to pay Farmer Mac a monthly fee based on the unpaid principal balance of loans covered under the purchase commitment. No loans had been put to Farmer Mac for purchase, pursuant to this agreement, as of August 31, 2016.

Payment Status of Loans

The tables below present the payment status of loans outstanding by member class as of August 31, 2016 and May 31, 2016.
 
 
August 31, 2016
(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
 
$
17,984,617

 
$

 
$

 
$

 
$
17,984,617

 
$

Power supply
 
4,437,621

 

 

 

 
4,437,621

 

Statewide and associate
 
56,267

 

 

 

 
56,267

 

CFC total
 
22,478,505

 

 

 

 
22,478,505

 

RTFC
 
392,176

 

 

 

 
392,176

 

NCSC
 
685,062

 

 

 

 
685,062

 

Total loans outstanding
 
$
23,555,743

 
$

 
$

 
$

 
$
23,555,743

 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
As a % of total loans
 
100.00
%
 
%
 
%
 
%
 
100.00
%
 
%


53




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

 
 
May 31, 2016
(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
 
$
17,674,335

 
$

 
$

 
$

 
$
17,674,335

 
$

Power supply
 
4,401,185

 

 

 

 
4,401,185

 

Statewide and associate
 
54,353

 

 

 

 
54,353

 

CFC total
 
22,129,873

 

 

 

 
22,129,873

 

RTFC
 
338,336

 

 
3,506

 
3,506

 
341,842

 
3,506

NCSC
 
680,802

 

 

 

 
680,802

 

Total loans outstanding
 
$
23,149,011

 
$

 
$
3,506

 
$
3,506

 
$
23,152,517

 
$
3,506

 
 
 
 
 
 
 
 
 
 
 
 
 
As a % of total loans
 
99.98
%
 
%
 
0.02
%
 
0.02
%
 
100.00
%
 
0.02
%
____________________________ 
(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.

(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 following the receipt of the borrower’s audited financial statements; however, interim risk rating downgrades or 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 August 31, 2016 and May 31, 2016.

54




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

 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Pass
 
Criticized
 
Total
 
Pass
 
Criticized
 
Total
CFC:
 
 
 
 
 
 
 
 
 
 
 
 
Distribution
 
$
17,960,782

 
$
23,835

 
$
17,984,617

 
$
17,640,928

 
$
33,407

 
$
17,674,335

Power supply
 
4,437,621

 

 
4,437,621

 
4,401,185

 

 
4,401,185

Statewide and associate
 
54,739

 
1,528

 
56,267

 
54,100

 
253

 
54,353

CFC total
 
22,453,142

 
25,363

 
22,478,505

 
22,096,213

 
33,660

 
22,129,873

RTFC
 
384,180

 
7,996

 
392,176

 
330,167

 
11,675

 
341,842

NCSC
 
678,825

 
6,237

 
685,062

 
678,552

 
2,250

 
680,802

Total loans outstanding
 
$
23,516,147

 
$
39,596

 
$
23,555,743

 
$
23,104,932

 
$
47,585

 
$
23,152,517


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 three months ended August 31, 2016 and 2015.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended August 31, 2016
(Dollars in thousands)
 
CFC
 
RTFC
 
NCSC
 
Total
Balance as of May 31, 2016
 
$
24,559

 
$
5,565

 
$
3,134

 
$
33,258

Provision for loan losses
 
450

 
1,331

 
147

 
1,928

Charge-offs
 

 
(2,119
)
 

 
(2,119
)
Recoveries
 
53

 

 

 
53

Balance as of August 31, 2016
 
$
25,062

 
$
4,777

 
$
3,281

 
$
33,120

 
 
Three Months Ended August 31, 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
 
3,380

 
1,019

 
163

 
4,562

Recoveries
 
55

 

 

 
55

Balance as of August 31, 2015
 
$
27,151

 
$
5,552

 
$
5,604

 
$
38,307


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 August 31, 2016 and May 31, 2016.


55




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

 
 
August 31, 2016
(Dollars in thousands)
 
CFC
 
RTFC
 
NCSC
 
Total
Ending balance of the allowance:
 
 
 
 
 
 
 
 
Collectively evaluated loans
 
$
25,062

 
$
3,492

 
$
3,281

 
$
31,835

Individually evaluated loans
 

 
1,285

 

 
1,285

Total ending balance of the allowance
 
$
25,062

 
$
4,777

 
$
3,281

 
$
33,120

 
 
 
 
 
 
 
 
 
Recorded investment in loans:
 
 
 
 
 
 
 
 
Collectively evaluated loans
 
$
22,471,924

 
$
385,209

 
$
685,062

 
$
23,542,195

Individually evaluated loans
 
6,581

 
6,967

 

 
13,548

Total recorded investment in loans
 
$
22,478,505

 
$
392,176

 
$
685,062

 
$
23,555,743

 
 
 
 
 
 
 
 
 
Loans to members, net (1)
 
$
22,453,443

 
$
387,399

 
$
681,781

 
$
23,522,623


 
 
May 31, 2016
(Dollars in thousands)
 
CFC
 
RTFC
 
NCSC
 
Total
Ending balance of the allowance:
 
 
 
 
 
 
 
 
Collectively evaluated
 
$
24,559

 
$
2,465

 
$
3,134

 
$
30,158

Individually evaluated
 

 
3,100

 

 
3,100

Total ending balance of the allowance
 
$
24,559

 
$
5,565

 
$
3,134

 
$
33,258

 
 
 
 
 
 
 
 
 
Recorded investment in loans:
 
 
 
 
 
 
 
 
Collectively evaluated
 
$
22,123,157

 
$
331,244

 
$
680,802

 
$
23,135,203

Individually evaluated
 
6,716

 
10,598

 

 
17,314

Total recorded investment in loans
 
$
22,129,873

 
$
341,842

 
$
680,802

 
$
23,152,517

 
 
 
 
 
 
 
 
 
Loans to members, net(1)
 
$
22,105,314

 
$
336,277

 
$
677,668

 
$
23,119,259

____________________________ 
(1) Excludes unamortized deferred loan origination costs of $10 million as of August 31, 2016 and May 31, 2016.

Impaired Loans

The following table provides information on loans classified as individually impaired loans as of August 31, 2016 and May 31, 2016 are summarized below.

 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Recorded
Investment
 
Related
Allowance
 
Recorded
Investment
 
Related
Allowance
With no specific allowance recorded:
 
 
 
 
 
 
 
 
CFC
 
$
6,581

 
$

 
$
6,716

 
$

 
 
 
 
 
 
 
 
 
With a specific allowance recorded:
 
 
 
 
 
 
 
 
RTFC
 
6,967

 
1,285

 
10,598

 
3,100

Total impaired loans
 
$
13,548

 
$
1,285

 
$
17,314

 
$
3,100



56




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

The following table represents the average recorded investment in individually impaired loans and the interest income recognized, by company, for the three months ended August 31, 2016 and 2015.
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended August 31,
 
 
2016
 
2015
 
2016
 
2015
(Dollars in thousands)
 
Average Recorded Investment 
 
Interest Income Recognized 
CFC
 
$
6,671

 
$
7,221

 
$
130

 
$

RTFC
 
9,346

 
4,166

 
88

 

Total impaired loans
 
$
16,017

 
$
11,387

 
$
218

 
$


Troubled Debt Restructured (“TDR”) and Nonperforming Loans

TDR Loans

The following table summarizes modified loans accounted for and reported as TDRs, the performance status of these loans, and the related unadvanced commitments, by member class, as of August 31, 2016 and May 31, 2016.
 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Loans
Outstanding
 
% of Total Loans
 
Unadvanced
Commitments
 
Loans
Outstanding
 
% of Total Loans
 
Unadvanced
Commitments
TDR loans:
 
 
 
 
 
 
 
 
 
 
 
 
Nonperforming TDR loans:
 
 
 
 
 
 
 
 
 
 
 
 
RTFC
 
$

 
%
 
$

 
$
3,506

 
0.01
%
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
Performing TDR loans:
 
 
 
 
 
 
 
 
 
 
 
 
CFC/Distribution
 
6,581

 
 
 

 
6,716

 
 
 

RTFC
 
6,967

 
 
 

 
7,092

 
 
 

Total performing TDR loans
 
13,548

 
0.06

 

 
13,808

 
0.06

 

Total TDR loans
 
$
13,548

 
0.06
%
 
$

 
$
17,314

 
0.07
%
 
$


All loans classified as performing TDR loans were performing in accordance with the terms of the restructured loan agreement and were on accrual as of August 31, 2016 and May 31, 2016.

Nonperforming Loans

We had no loans classified as nonperforming as of August 31, 2016. As discussed above, we had nonperforming TDR loans totaling $4 million as of May 31, 2016.

The following table shows foregone interest income for loans on nonaccrual status for the three months ended August 31, 2016 and 2015.
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016
 
2015
Nonperforming loans
 
$

 
$
13

Performing TDR loans
 

 
166

Nonperforming TDR loans
 
31

 

Total
 
$
31

 
$
179


57




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


Pledging of Loans

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, notes payable to Farmer Mac and notes payable under the Guaranteed Underwriter Program of the USDA and the amount of the corresponding debt outstanding as of August 31, 2016 and May 31, 2016, See “Note 6—Short-Term Borrowings” and “Note 7—Long-Term Debt” for information on our borrowings.
(Dollars in thousands)
 
August 31, 2016
 
May 31, 2016
Collateral trust bonds:
 
 
 
 
2007 indenture:
 
 
 
 
Distribution system mortgage notes
 
$
7,204,894

 
$
7,246,973

RUS guaranteed loans qualifying as permitted investments
 
150,389

 
151,687

Total pledged collateral
 
$
7,355,283

 
$
7,398,660

Collateral trust bonds outstanding
 
6,747,711

 
6,747,711

 
 
 
 
 
1994 indenture:
 
 
 
 
Distribution system mortgage notes
 
$
954,691

 
$
968,030

Collateral trust bonds outstanding
 
800,000

 
800,000

 
 
 
 
 
Farmer Mac:
 
 
 
 
Distribution and power supply system mortgage notes
 
$
2,651,938

 
$
2,683,806

Notes payable outstanding
 
2,293,561

 
2,303,122

 
 
 
 
 
Clean Renewable Energy Bonds Series 2009A:
 
 
 
 
Distribution and power supply system mortgage notes
 
$
16,357

 
$
17,081

Notes payable outstanding
 
14,871

 
14,871

 
 
 
 
 
FFB:
 
 
 
 
Distribution and power supply system mortgage notes
 
$
5,236,493

 
$
5,248,935

Notes payable outstanding
 
4,868,322

 
4,777,404

 
NOTE 5—FORECLOSED ASSETS

Foreclosed assets consist of operating entities or other assets acquired through lending activities in satisfaction of indebtedness. On July 1, 2016, the sale of CAH to ATN VI Holdings, LLC (“Buyer”) was completed. As a result, we did not carry any foreclosed assets on our consolidated balance sheet as of August 31, 2016.

Our net proceeds at closing totaled $109 million, which represents the purchase price of $144 million less agreed-upon purchase price adjustments as of the closing date. Upon closing, $16 million of the sale proceeds was deposited into escrow to fund potential indemnification claims for a period of 15 months following the closing. In connection with the sale, RTFC provided a loan in the amount of $60 million to Buyer to finance a portion of the transaction. ATN International, Inc., the

58




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

parent corporation of Buyer, has provided a guarantee on an unsecured basis of Buyer’s obligations to RTFC pursuant to the financing.

The net proceeds at closing were subject to post-closing adjustments, which were due from Buyer within 60 days of the closing for review by us. The Buyer provided and we agreed upon a net amount due to us of approximately $1 million for post-closing adjustments.CFC remains subject to potential indemnification claims, as specified in the Purchase Agreement. We recorded a loss of $1 million in the current quarter, which reflects the combined impact of the July 1, 2016 sale closing and post-closing purchase price adjustments. Upon closing of the sale of CAH, we derecognized the loss of $10 million recorded in accumulated other comprehensive income attributable to actuarial-related changes in CAH’s pension and other postretirement benefit obligations as an offset against the sale proceeds. This derecognition had no effect on our consolidated statement of operations in the current quarter, as the amount was taken into consideration in the measurement of the CAH impairment loss recorded in fiscal year 2016.
NOTE 6—SHORT-TERM BORROWINGS

Our short-term borrowings totaled $3,151 million and accounted for 14% of total debt outstanding as of August 31, 2016, compared with $2,939 million, or 13%, of total debt outstanding as of May 31, 2016.
 
 
 
 
 
Revolving Credit Agreements

We had $3,420 million of commitments under revolving credit agreements as of August 31, 2016 and May 31, 2016. 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 amount under the facilities. NCSC’s commitment amount $110 million 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 commitment of $110 million 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 August 31, 2016 and May 31, 2016.
 
 
August 31, 2016

May 31, 2016

 

 
(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)
3-year agreement
 
$
25


$


$
25


$
25


$


$
25


October 28, 2017

7.5 bps
3-year agreement
 
1,640




1,640


1,640




1,640


November 19, 2018

7.5 bps
  Total 3-year agreement
 
1,665

 

 
1,665

 
1,665

 

 
1,665

 
 
 
 
5-year agreement
 
45




45


45




45


October 28, 2019

10 bps
5-year agreement
 
1,600


1


1,599


1,600


1


1,599


November 19, 2020

10 bps
  Total 5-year agreement
 
1,645

 
1

 
1,644

 
1,645

 
1

 
1,644

 
 
 
 
Total
 
$
3,310


$
1


$
3,309


$
3,310


$
1


$
3,309


 

 
____________________________ 
(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.

In September 2016, NCSC assigned a total of $50 million of its commitment to another financial institution in the facility, with $25 million expiring in October 2017 and $25 million expiring in October 2019. As a result, the CFC commitment amount from third parties increased to $3,360 million, while the NCSC commitment was reduced to $60 million.

59




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

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 August 31, 2016 and May 31, 2016.
NOTE 7—LONG-TERM DEBT

The following table displays long-term debt outstanding, by debt type, as of August 31, 2016 and May 31, 2016.
(Dollars in thousands)
 
August 31, 2016
 
May 31, 2016
Unsecured long-term debt:
 
 
 
 
Medium-term notes sold through dealers
 
$
2,687,358

 
$
2,668,276

Medium-term notes sold to members
 
442,948

 
450,960

Subtotal medium-term notes
 
3,130,306

 
3,119,236

Unamortized discount
 
(495
)
 
(537
)
Debt issuance costs
 
(20,967
)
 
(19,370
)
Total unsecured medium-term notes
 
3,108,844

 
3,099,329

Unsecured notes payable
 
27,092

 
27,092

Unamortized discount
 
(465
)
 
(496
)
Debt issuance costs
 
(115
)
 
(123
)
Total unsecured notes payable
 
26,512

 
26,473

Total unsecured long-term debt
 
3,135,356

 
3,125,802

Secured long-term debt:
 
 

 
 

Collateral trust bonds
 
7,547,711

 
7,547,711

Unamortized discount
 
(263,602
)
 
(265,837
)
Debt issuance costs
 
(27,188
)
 
(28,778
)
Total collateral trust bonds
 
7,256,921

 
7,253,096

Guaranteed Underwriter Program notes payable
 
4,868,322

 
4,777,404

Debt issuance costs
 
(286
)
 
(293
)
Total Guaranteed Underwriter Program notes payable
 
4,868,036

 
4,777,111

Farmer Mac notes payable
 
2,293,561

 
2,303,123

Other secured notes payable
 
14,871

 
14,871

Debt issuance costs
 
(378
)
 
(400
)
Total other secured notes payable
 
14,493

 
14,471

Total secured notes payable
 
7,176,090

 
7,094,705

Total secured long-term debt
 
14,433,011

 
14,347,801

Total long-term debt
 
$
17,568,367

 
$
17,473,603


Secured Notes Payable

As of August 31, 2016 and May 31, 2016, we had secured notes payable totaling $4,868 million and $4,777 million, respectively, outstanding under a bond purchase agreement with the Federal Financing Bank and a bond guarantee agreement with RUS issued under the Guaranteed Underwriter Program, which provides guarantees to the Federal Financing Bank. We pay RUS a fee of 30 basis points per year on the total amount borrowed. As of August 31, 2016 and May 31, 2016, $4,868 million and $4,777 million of secured notes payable outstanding under the Guaranteed Underwriter Program require us to pledge mortgage notes in an amount at least equal to the principal balance of the notes outstanding. See “Note 4—Loans and Commitments” for additional information on the collateral pledged to secure notes payable under this program. During the three months ended August 31, 2016, we borrowed $100 million under our committed loan

60




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

facilities with the Federal Financing Bank. As of August 31, 2016, we had up to $500 million available under committed loan facilities from the Federal Financing Bank as part of this program.

As of August 31, 2016 and May 31, 2016, secured notes payable also include $2,294 million and 2,303 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 us 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 also have an additional revolving note purchase agreement with Farmer Mac totaling $300 million. Under the terms of this 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. As of August 31, 2016 and May 31, 2016, we had no notes payable outstanding under this revolving note purchase agreement with Farmer Mac.

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 4—Loans and Commitments” for additional information on the collateral pledged to secure notes payable under these programs.

As of August 31, 2016 and May 31, 2016, we were in compliance with all covenants and conditions under our senior debt indentures.
NOTE 8—SUBORDINATED DEFERRABLE DEBT

The following table presents subordinated deferrable debt outstanding as of August 31, 2016 and May 31, 2016.

 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Amount
 
Amount
4.75% due 2043 with a call date of April 30, 2023
 
$
400,000

 
$
400,000

5.25% due 2046 with a call date of April 20, 2026
 
350,000

 
350,000

Debt issuance costs
 
(7,824
)
 
(7,788
)
    Total subordinated deferrable debt
 
$
742,176

 
$
742,212


NOTE 9—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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.



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 net accrued 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). Net periodic 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 August 31, 2016 and May 31, 2016.

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 August 31, 2016 and May 31, 2016. The substantial majority of our interest rate swaps use an index based on the London Interbank Offered Rate (“LIBOR”) for either the pay or receive leg of the swap agreement.
 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Notional
   Amount(1)
 
Weighted-
Average
Rate Paid
 
Weighted-
Average
Rate Received
 
Notional
Amount
(2)
 
Weighted-
Average
Rate Paid
 
Weighted-
Average
Rate Received
Pay fixed swaps
 
$
6,817,474

 
2.92
%
 
0.70
%
 
$
6,661,471

 
2.95
%
 
0.63
%
Receive fixed swaps
 
3,499,000

 
1.11

 
2.82

 
3,499,000

 
1.02

 
2.82

Total interest rate swaps
 
$
10,316,474

 
2.30

 
1.42

 
$
10,160,471

 
2.29

 
1.39

____________________________ 
(1)Excludes $112 million notional amount of forward-starting swaps outstanding as of August 31, 2016. These swaps had an effective start date of July 31, 2018.
(2)Excludes $40 million notional amount of forward-starting swap outstanding as of May 31, 2016, These swaps had an effective start date of June 30, 2016.

Although the notional amount of swaps displayed in the above table exclude forward-starting swaps, we have recorded the fair value of these swaps as of August 31, 2016 and May 31, 2016 in our condensed consolidated financial statements.

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 August 31, 2016 and May 31, 2016.
 
 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Fair Value
 
Notional Balance(1)
 
Fair Value
 
Notional Balance(2)
Derivative assets
 
$
81,734

 
$
2,649,000

 
$
80,095

 
$
2,879,567

Derivative liabilities
 
(761,491
)
 
7,667,474

 
(594,820
)
 
7,280,904

Total
 
$
(679,757
)
 
$
10,316,474

 
$
(514,725
)
 
$
10,160,471

____________________________ 
(1)Excludes $112 million notional amount of forward-starting swaps outstanding as of August 31, 2016. These swaps had an effective start date of July 31, 2018. However, the fair value of these swaps as of August 31, 2016 is included in the above table and in our condensed consolidated financial statements.
(2) Excludes $40 million notional amount of forward-starting swap outstanding as of May 31, 2016, These swaps had an effective start date of June 30, 2016. However, the fair value of these swaps as of May 31, 2016 is included in the above table and in our condensed consolidated financial statements.

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 by individual contracts. The following table presents the gross fair value of derivative assets and liabilities reported on our condensed consolidated balance sheets as of August 31, 2016 and May 31, 2016, and provides information on the impact of netting provisions and collateral pledged.

 
 
August 31, 2016
 
 
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
 
$
81,734

 
$

 
$
81,734

 
$
81,734

 
$

 
$

Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
761,491

 

 
761,491

 
81,734

 

 
679,757



61




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

 
 
May 31, 2016
 
 
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
 
$
80,095

 
$

 
$
80,095

 
$
80,095

 
$

 
$

Derivative liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swaps
 
594,820

 

 
594,820

 
80,095

 

 
514,725


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.

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 months ended August 31, 2016 and 2015.
 
 
Three Months Ended August 31,
(Dollars in thousands)
 
2016
 
2015
Derivative cash settlements
 
$
(23,390
)
 
$
(20,156
)
Derivative forward value
 
(164,903
)
 
8,139

Derivative losses
 
$
(188,293
)
 
$
(12,017
)

Credit-Risk-Related Contingent Features

Our derivative contracts typically contain mutual early termination provisions, generally in the form of a credit rating trigger. Under the mutual credit rating trigger provisions, either counterparty may, but is not obligated to, terminate and settle the agreement if the credit rating of the other counterparty falls to a level specified in the agreement. If a derivative contract is terminated, the amount to be received or paid by us would be equal to the mark-to-market value, as defined in the agreement, as of termination date.

Our senior unsecured credit ratings from Moody’s and S&P were A2 and A, respectively, as of August 31, 2016. Both Moody’s and S&P had our ratings on stable outlook as of August 31, 2016. The following table displays the notional amounts of our derivative contracts with rating triggers as of August 31, 2016 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 below A3/A-, below Baa1/BBB+, to or below Baa2/BBB, below Baa3/BBB-, or to or below 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.

62




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

(Dollars in thousands)
 
Notional
 Amount
 
Payable Due From CFC
 
Receivable
Due to CFC
 
Net (Payable)/Receivable
Impact of rating downgrade trigger:
 
 
 
 
 
 
 
 
Falls below A3/A-(1)

$
63,295


$
(19,039
)

$


$
(19,039
)
Falls below Baa1/BBB+(2)
 
6,699,031


(435,093
)



(435,093
)
Falls to or below Baa2/BBB (3)(4)
 
159,237


(5,215
)



(5,215
)
Falls below Baa3/BBB-
 
384,111

 
(30,581
)
 

 
(30,581
)
Total
 
$
7,305,674


$
(489,928
)

$


$
(489,928
)
____________________________ 
(1) Rating trigger for CFC falls below A3/A-, while rating trigger for counterparty falls below Baa1/BBB+ by Moody’s or S&P, respectively.  
(2) Excludes $56 million notional amount of a forward-starting swap with an effective start date of July 31, 2018, which was outstanding as of August 31, 2016.  
(3) Excludes $56 million notional amount of a forward-starting swap with an effective start date of July 31, 2018, which was outstanding as of August 31, 2016.  
(4) Rating trigger for CFC falls to or below Baa2/BBB, while rating trigger for counterparty falls to or below Ba2/BB+ by Moody’s or S&P, respectively.

The aggregate fair value amount, excluding and including the credit risk valuation adjustment, of all interest rate swaps with rating triggers that were in a net liability position was $490 million and $479 million, respectively, as of August 31, 2016. There were no interest rate swaps with rating triggers that were in a net asset position as of August 31, 2016.
NOTE 10—EQUITY

The following table presents the components of equity as of August 31, 2016 and May 31, 2016. Total equity decreased by $165 million during the three months ended August 31, 2016 to $653 million as of August 31, 2016. The decrease in total equity was primarily attributable to our net loss of $132 million for the period and the patronage capital retirement of $42 million.

(Dollars in thousands)
 
August 31, 2016
 
May 31, 2016
Membership fees
 
$
974

 
$
974

Educational fund
 
1,388

 
1,798

Total membership fees and educational fund
 
2,362

 
2,772

Patronage capital allocated
 
671,724

 
713,853

Members’ capital reserve
 
587,219

 
587,219

Unallocated net loss:
 
 
 
 
Current-year derivative forward value loss
 
(164,212
)
 
(220,827
)
Prior-year cumulative derivative forward value losses
 
(507,904
)
 
(287,077
)
Current year cumulative derivative forward value losses
 
(672,116
)
 
(507,904
)
Other unallocated net income (loss)
 
26,935

 
(5,706
)
Unallocated net loss
 
(645,181
)
 
(513,610
)
CFC retained equity
 
616,124

 
790,234

Accumulated other comprehensive income
 
10,717

 
1,058

Total CFC equity
 
626,841

 
791,292

Noncontrolling interests
 
26,015

 
26,086

Total equity
 
$
652,856

 
$
817,378



63




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

In July 2016, the CFC Board of Directors authorized the allocation of the fiscal year 2016 net earnings as follows: $1 million to the Cooperative Educational Fund, $86 million to the members’ capital reserve and $84 million to members in the form of patronage.

In July 2016, the CFC Board of Directors authorized the retirement of allocated net earnings totaling $42 million, representing 50% of the fiscal year 2016 allocation. This amount was returned to members in cash in the second quarter of fiscal year 2017. 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 following tables summarize, by component, the activity in the accumulated other comprehensive income as of and for the three months ended August 31, 2016 and 2015.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended August 31, 2016
(Dollars in thousands)
 
Unrealized Gains (Losses)
AFS Securities
 
Unrealized Gains
Derivatives
 
Unrealized Losses Foreclosed Assets
 
Unrealized Losses Defined Benefit Plan
 
Total
Beginning balance
 
$
7,402

 
$
4,487

 
$
(9,823
)
 
$
(1,008
)
 
$
1,058

Unrealized gains
 
(11
)
 

 

 

 
(11
)
Losses reclassified into earnings
 

 

 
9,823

 
44

 
9,867

Gains reclassified into earnings
 

 
(197
)
 

 

 
(197
)
Other comprehensive income
 
(11
)
 
(197
)
 
9,823

 
44

 
9,659

Ending balance
 
$
7,391

 
$
4,290

 
$

 
$
(964
)
 
$
10,717

 
 
Three Months Ended August 31, 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
 
(664
)
 

 

 

 
(664
)
Losses reclassified into earnings
 

 

 

 
44

 
44

Gains reclassified into earnings
 

 
(233
)
 

 

 
(233
)
Other comprehensive income
 
(664
)
 
(233
)
 

 
44

 
(853
)
Ending balance
 
$
3,270

 
$
5,138

 
$
(4,248
)
 
$
(933
)
 
$
3,227


We expect to reclassify approximately $1 million of amounts in accumulated other comprehensive income related to unrealized derivative gains into earnings over the next 12 months.

64




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

NOTE 11—GUARANTEES

The following table summarizes total guarantees by type of guarantee and member class as of August 31, 2016 and May 31, 2016.
(Dollars in thousands)
 
August 31, 2016
 
May 31, 2016
Total by type:
 
 
 
 
Long-term tax-exempt bonds
 
$
474,965

 
$
475,965

Letters of credit
 
308,551

 
319,596

Other guarantees
 
113,386

 
113,647

Total
 
$
896,902

 
$
909,208

 
 
 
 
 
Total by member class:
 
 
 
 
CFC:
 
 
 
 
Distribution
 
$
123,297

 
$
127,890

Power supply
 
749,903

 
759,345

Statewide and associate
 
5,047

 
5,054

CFC total
 
878,247

 
892,289

RTFC
 
1,574

 
1,574

NCSC
 
17,081

 
15,345

Total
 
$
896,902

 
$
909,208


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 August 31, 2016, our maximum potential exposure for the $70 million of fixed-rate tax-exempt bonds is $98 million, representing principal and interest. Of the amounts shown in the table above for long-term tax-exempt bonds, $405 million and $406 million as of August 31, 2016 and May 31, 2016, 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. Generally our maximum potential exposure is secured by mortgage liens on 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 $125 million is secured as of August 31, 2016. As of August 31, 2016 and May 31, 2016, 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 August 31, 2016, we may be required to issue up to an additional $84 million in letters of credit to third parties for the benefit of our members. As of August 31, 2016, 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.


65




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

The maturities for other guarantees listed in the table run through calendar year 2025. The maximum potential exposure for these other guarantees is $114 million, all of which is unsecured.

As of August 31, 2016 and May 31, 2016, we had $297 million and $308 million of guarantees, respectively, representing 33% and 34%, 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 August 31, 2016, we were the liquidity provider for a total of $481 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 three months ended August 31, 2016, we were not required to perform as liquidity provider pursuant to these obligations.

Guarantee Liability

As of August 31, 2016 and May 31, 2016, we recorded a guarantee liability of $16 million and $17 million respectively, which represents the contingent and noncontingent exposures related to guarantees and liquidity obligations. The contingent guarantee liability as of August 31, 2016 and May 31, 2016 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 $15 million and $16 million as of August 31, 2016 and May 31, 2016, respectively, relates to our noncontingent 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.
NOTE 12—FAIR VALUE MEASUREMENT

We use fair value measurements for the initial recording of certain assets and liabilities and periodic remeasurement of certain assets and liabilities on a recurring or nonrecurring basis. The accounting guidance for fair value measurements and disclosures establishes a three-level fair value hierarchy that prioritizes the inputs into the valuation techniques used to measure fair value. The levels of the fair value hierarchy, in priority order, include Level 1, Level 2 and Level 3. For additional information regarding the fair value hierarchy and a description of the methodologies we use to measure fair value, see “Note 14—Fair Value Measurement” to the Consolidated Financial Statements in our 2016 Form 10-K. The following tables present the carrying value and fair value for all of our financial instruments, including those carried at amortized cost, as of August 31, 2016 and May 31, 2016. The table also displays the classification within the fair value hierarchy of the valuation technique used in estimating fair value.

66




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

 
 
August 31, 2016
 
Fair Value Measurements Using
(Dollars in thousands)
 
Carrying Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
290,651

 
$
290,651

 
$
290,651

 
$

 
$

Restricted cash
 
21,319

 
21,319

 
21,319

 

 

Time deposits
 
340,000

 
340,000

 

 
340,000

 

Investment securities, available for sale
 
87,930

 
87,930

 
87,930

 

 

Deferred compensation investments
 
4,511

 
4,511

 
4,511

 

 

Loans to members, net
 
23,533,105

 
24,320,697

 

 

 
24,320,697

Accrued interest receivable
 
109,785

 
109,785

 

 
109,785

 

Debt service reserve funds
 
17,151

 
17,151

 
17,151

 

 

Derivative assets
 
81,734

 
81,734

 

 
81,734

 

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
$
3,151,411

 
$
3,151,103

 
$
1,250,079

 
$
1,901,024

 
$

Long-term debt
 
17,568,367

 
18,821,746

 

 
11,424,873

 
7,396,873

Accrued interest payable
 
194,928

 
194,928

 

 
194,928

 

Guarantee liability
 
16,329

 
18,122

 

 

 
18,122

Derivative liabilities
 
761,491

 
761,491

 

 
761,491

 

Subordinated deferrable debt
 
742,176

 
777,343

 

 
777,343

 

Members’ subordinated certificates
 
1,443,131

 
1,443,155

 

 

 
1,443,155



67




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

 
 
May 31, 2016
 
Fair Value Measurements Using
(Dollars in thousands)
 
Carrying Value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Assets:
 
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
204,540

 
$
204,540

 
$
204,540

 
$

 
$

Restricted cash
 
4,628

 
4,628

 
4,628

 

 

Time deposits
 
340,000

 
340,000

 

 
340,000

 

Investment securities, available for sale
 
87,940

 
87,940

 
87,940

 

 

Deferred compensation investments
 
4,326

 
4,326

 
4,326

 

 

Loans to members, net
 
23,129,438

 
23,297,924

 

 

 
23,297,924

Accrued interest receivable
 
113,272

 
113,272

 

 
113,272

 

Debt service reserve funds
 
17,151

 
17,151

 
17,151

 

 

Derivative assets
 
80,095

 
80,095

 

 
80,095

 

 
 
 
 
 
 
 
 
 
 
 
Liabilities:
 
 
 
 
 
 
 
 
 
 
Short-term borrowings
 
$
2,938,848

 
$
2,938,716

 
$
1,185,959

 
$
1,752,757

 
$

Long-term debt
 
17,473,603

 
18,577,261

 

 
11,327,004

 
7,250,257

Accrued interest payable
 
132,996

 
132,996

 

 
132,996

 

Guarantee liability
 
17,109

 
19,019

 

 

 
19,019

Derivative liabilities
 
594,820

 
594,820

 

 
594,820

 

Subordinated deferrable debt
 
742,212

 
751,395

 

 
751,395

 

Members’ subordinated certificates
 
1,443,810

 
1,443,834

 

 

 
1,443,834


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 changes in 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 three months ended August 31, 2016 and 2015.

Recurring Fair Value Measurements

The following table 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 August 31, 2016 and May 31, 2016, and the classification of the valuation technique within the fair value hierarchy.
 
 
August 31, 2016
 
May 31, 2016
(Dollars in thousands)
 
Level 1
 
Level 2
 
Total
 
Level 1
 
Level 2
 
Total
Investment securities available for sale
 
$
87,930

 
$

 
$
87,930

 
$
87,940

 
$

 
$
87,940

Deferred compensation investments
 
4,511

 

 
4,511

 
4,326

 

 
4,326

Derivative assets
 

 
81,734

 
81,734

 

 
80,095

 
80,095

Derivative liabilities
 

 
761,491

 
761,491

 

 
594,820

 
594,820

 


68




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

Nonrecurring Fair Value

The following table 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 August 31, 2016 and May 31, 2016, and unrealized losses for the three months ended August 31, 2016 and 2015.
 
 
Level 3 Fair Value
 
Unrealized Losses
Three Months Ended August 31,
(Dollars in thousands)
 
August 31, 2016
 
May 31, 2016
 
2016
 
2015
Impaired loans, net of specific reserves (1)
 
$
5,682

 
$
7,498

 
$
(116
)
 
$
(1,151
)
____________________________ 
(1) Excludes impaired loans for which there is no specific allowance recorded.

Significant Unobservable Level 3 Inputs

Impaired Loans

We utilize the fair value of estimated cash flows or the collateral underlying the loan to determine the fair value and specific allowance for impaired loans. 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 individually impaired loans is a multiple of earnings before interest, taxes, depreciation and amortization based on various factors (i.e., financial condition of the borrower). In estimating the fair value of the collateral, we may use third-party valuation specialists, internal estimates or a combination of both. 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 August 31, 2016 and May 31, 2016, 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.

69




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

NOTE 13—BUSINESS SEGMENTS

The following tables display segment results for the three months ended August 31, 2016 and 2015, and assets attributable to each segment as of August 31, 2016 and 2015.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended August 31, 2016
(Dollars in thousands)
 
CFC
 
Other
 
Elimination
 
Consolidated Total
Statement of operations:
 
 
 
 
 
 
 
 
Interest income
 
$
254,017

 
$
11,222

 
$
(8,404
)
 
$
256,835

Interest expense
 
(180,832
)
 
(8,676
)
 
8,428

 
(181,080
)
Net interest income
 
73,185

 
2,546

 
24

 
75,755

Provision for loan losses
 
(1,928
)
 

 

 
(1,928
)
Net interest income after provision for loan losses
 
71,257

 
2,546

 
24

 
73,827

Non-interest income:
 
 
 
 
 
 
 
 
Fee and other income
 
4,328

 
897

 
(695
)
 
4,530

Derivative losses
 
(186,822
)
 
(1,471
)
 

 
(188,293
)
Results of operations of foreclosed assets
 
(1,112
)
 

 

 
(1,112
)
Total non-interest income
 
(183,606
)
 
(574
)
 
(695
)
 
(184,875
)
Non-interest expense:
 
 
 
 
 
 
 
 
General and administrative expenses
 
(18,779
)
 
(2,080
)
 

 
(20,859
)
Other
 
(443
)
 
(671
)
 
671

 
(443
)
Total non-interest expense
 
(19,222
)
 
(2,751
)
 
671

 
(21,302
)
Loss before income taxes
 
(131,571
)
 
(779
)
 

 
(132,350
)
Income tax expense
 

 
89

 

 
89

Net loss
 
$
(131,571
)
 
$
(690
)
 
$

 
$
(132,261
)
 
 
 
 
 
 
 
 
 
 
 
August 31, 2016
 
 
CFC
 
Other
 
Elimination
 
Consolidated Total
Assets:
 
 
 
 
 
 
 
 
Total loans outstanding
 
$
23,518,828

 
$
1,077,238

 
$
(1,040,323
)
 
$
23,555,743

Deferred origination costs
 
10,482

 

 

 
10,482

Less: Allowance for loan losses
 
(33,120
)
 

 

 
(33,120
)
Loans to members, net
 
23,496,190

 
1,077,238

 
(1,040,323
)
 
23,533,105

Other assets
 
1,130,356

 
114,968

 
(100,814
)
 
1,144,510

Total assets
 
$
24,626,546

 
$
1,192,206

 
$
(1,141,137
)
 
$
24,677,615


70




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

 
 
Three Months Ended August 31, 2015
(Dollars in thousands)
 
CFC
 
Other
 
Elimination
 
Consolidated Total
Statement of operations:
 
 
 
 
 
 
 
 
Interest income
 
$
243,051

 
$
11,850

 
$
(8,785
)
 
$
246,116

Interest expense
 
(165,382
)
 
(9,103
)
 
8,785

 
(165,700
)
Net interest income
 
77,669

 
2,747

 

 
80,416

Provision for loan losses
 
(4,562
)
 

 

 
(4,562
)
Net interest income after provision for loan losses
 
73,107

 
2,747

 

 
75,854

Non-interest income:
 
 
 
 
 
 
 
 
Fee and other income
 
4,599

 
818

 
(716
)
 
4,701

Derivative losses
 
(11,827
)
 
(190
)
 

 
(12,017
)
Results of operations of foreclosed assets
 
(1,921
)
 

 

 
(1,921
)
Total non-interest income
 
(9,149
)
 
628

 
(716
)
 
(9,237
)
Non-interest expense:
 
 
 
 
 
 
 
 
General and administrative expenses
 
(20,276
)
 
(2,812
)
 
253

 
(22,835
)
Other
 
(357
)
 
(463
)
 
463

 
(357
)
Total non-interest expense
 
(20,633
)
 
(3,275
)
 
716

 
(23,192
)
Income before income taxes
 
43,325

 
100

 

 
43,425

Income tax expense
 

 
(330
)
 

 
(330
)
Net income (loss)
 
$
43,325

 
$
(230
)
 
$

 
$
43,095

 
 
 
 
 
 
 
 
 
 
 
August 31, 2015
 
 
CFC
 
Other
 
Elimination
 
Consolidated Total
Assets:
 
 
 
 
 
 
 
 
Total loans outstanding
 
$
22,045,237

 
$
1,104,105

 
$
(1,064,791
)
 
$
22,084,551

Deferred origination costs
 
9,836

 

 

 
9,836

Less: Allowance for loan losses
 
(38,307
)
 

 

 
(38,307
)
Loans to members, net
 
22,016,766

 
1,104,105

 
(1,064,791
)
 
22,056,080

Other assets
 
1,203,978

 
119,366

 
80,376

 
1,403,720

Total assets
 
$
23,220,744

 
$
1,223,471

 
$
(984,415
)
 
$
23,459,800



71



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 9—Derivative Instruments and Hedging Activities.”

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 August 31, 2016 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 (the “Court”) in response to the notice of deficiency. The BIR filed an answer to RTFC’s petition on December 11, 2015. The matter remains pending before the Court. 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 2016 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 2016 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.

72




Item 6. Exhibits

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


EXHIBIT INDEX
Exhibit No.
 
Description
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.

73



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: October 11, 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)    
        






74