This Quarterly Report on Form 10-Q (this “Report”) contains certain statements that are considered “forward-looking statements” within the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as amended. Forward-looking statements, which are based on certain assumptions and describe our future plans, strategies and expectations, are generally identified by our use of words such as “intend,” “plan,” “may,” “should,” “will,” “project,” “estimate,” “anticipate,” “believe,” “expect,” “continue,” “potential,” “opportunity” and similar expressions, whether in the negative or affirmative. All statements about future expectations or projections, including statements about loan volume, the appropriateness of the allowance for loan losses, operating income and expenses, leverage and debt-to-equity ratios, borrower financial performance, impaired loans, and sources and uses of liquidity, are forward-looking statements. Although we believe that the expectations reflected in our forward-looking statements are based on reasonable assumptions, actual results and performance may differ materially from our forward-looking statements due to several factors. Factors that could cause future results to vary from our forward-looking statements include, but are not limited to, general economic conditions, legislative changes including those that could affect our tax status, governmental monetary and fiscal policies, demand for our loan products, lending competition, changes in the quality or composition of our loan portfolio, changes in our ability to access external financing, changes in the credit ratings on our debt, valuation of collateral supporting impaired loans, charges associated with our operation or disposition of foreclosed assets, technological changes within the rural electric utility industry, regulatory and economic conditions in the rural electric industry, nonperformance of counterparties to our derivative agreements, the costs and effects of legal or governmental proceedings involving us or our members, the impact of natural disasters or public health emergencies, such as the current outbreak of a novel strain of coronavirus (“COVID-19”) that the World Health Organization (“WHO”) declared a global pandemic in March 2020, and the factors listed and described under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended May 31, 2019 (“2019 Form 10-K”). and under “Item 1A. Risk Factors” of this Report. 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.

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 systems, generation and transmission (“power supply”) systems and related facilities. CFC also provides its members with credit enhancements in the form of letters of credit and guarantees of debt obligations. As a cooperative, CFC is owned by and exclusively serves its membership, which consists of not-for-profit entities or subsidiaries or affiliates of not-for-profit entities. CFC is exempt from federal income taxes under Section 501(c)(4) of the Internal Revenue Code. As a member-owned cooperative, CFC’s objective is not to maximize profit, but rather to offer members cost-based financial products and services. CFC funds its activities primarily through a combination of public and private issuances of debt securities, member investments and retained equity. As a Section 501(c)(4) tax-exempt, member-owned cooperative, we cannot issue equity securities.

Our financial statements include the consolidated accounts of CFC, National Cooperative Services Corporation (“NCSC”), Rural Telephone Finance Cooperative (“RTFC”) and subsidiaries created and controlled by CFC to hold foreclosed assets resulting from defaulted loans or bankruptcy. NCSC is a taxable member-owned cooperative that may provide financing to members of CFC, government or quasi-government entities which own electric utility systems that meet the Rural Electrification Act definition of “rural” and for-profit and nonprofit entities that are owned, operated or controlled by, or provide significant benefits to certain members of CFC. RTFC is a taxable Subchapter T cooperative association that provides financing for its rural telecommunications members and their affiliates. CFC didand its consolidated entities have not hold, and did not haveheld any subsidiaries or other entities that held, foreclosed assets as ofsince the quarter ended August 31, 2019 or May 31, 2019.2017. See “Item 1. Business—Overview” in our 2019 Form 10-K for additional information on the business activities of each of these entities. Unless stated otherwise, references to “we,

“we,” “our” or “us” relate to CFC and its consolidated entities. All references to members within this document include members, associates and affiliates of CFC and its consolidated entities.

Management monitors a variety of key indicators to evaluate our business performance. The following MD&A is intended to provide the reader with an understanding of our consolidated results of operations, financial condition and liquidity by discussing the factors influencing changes from period to period and the key measures used by management to evaluate performance, such as net interest income, net interest yield, loan growth, debt-to-equity ratio, credit quality metrics and also non-GAAP measures. The MD&A section is provided as a supplement to, and should be read in conjunction with our unaudited condensed consolidated financial statements and related notes in this Report, our audited consolidated financial statements and related notes in our 2019 Form 10-K and additional information contained in our 2019 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.

Table 1 provides a summary of consolidated selected financial data for the three and nine months ended August 31,February 29, 2020 and February 28, 2019, and 2018, and as of August 31, 2019February 29, 2020 and May 31, 2019. In addition to financial measures determined in accordance with generally accepted accounting principles in the United States (“GAAP”), management also evaluates performance based on certain non-GAAP measures and metrics, which we refer to as “adjusted” measures. Certain financial covenant provisions in our credit agreements are also based on non-GAAP financial measures. Our key non-GAAP financial measures are adjusted net income, adjusted net interest income, adjusted interest expense, adjusted net interest yield, adjusted times interest earned ratio (“adjusted TIER”) and adjusted debt-to-equity ratio. The most comparable GAAP measures are net income, net interest income, interest expense, net interest yield, TIER and debt-to-equity ratio, respectively. The primary adjustments we make to calculate these non-GAAP measures consist of (i) adjusting interest expense and net interest income to include the impact of net periodic derivative cash settlements expense; (ii) adjusting net income, total liabilities and total equity to exclude the non-cash impact of the accounting for derivative financial instruments; (iii) adjusting total liabilities to exclude the amount that funds CFC member loans guaranteed by RUS, subordinated deferrable debt and members’ subordinated certificates; and (iv) adjusting total equity to include subordinated deferrable debt and members’ subordinated certificates and exclude cumulative derivative forward value gains and losses and accumulated other comprehensive income (“AOCI”). We believe our non-GAAP adjusted measures, which are not a substitute for GAAP and may not be consistent with similarly titled non-GAAP measures used by other companies, provide meaningful information and are useful to investors because management evaluates performance based on these metrics, and certain financial covenants in our committed bank revolving line of credit agreements and debt indentures are based on adjusted measures. See “Non-GAAP Financial Measures” for a detailed reconciliation of these adjusted measures to the most comparable GAAP measures.

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 profit; therefore, the rates we charge our member-borrowers reflect our funding costs plus a spread to cover our operating expenses, a provision for loan losses and earnings sufficient to achieve interest coverage to meet our financial objectives. Our goal is to earn an annual minimum adjusted TIER of 1.10 and to maintain an adjusted debt-to-equity ratio at approximately 6.00-to-1 or below 6.00-to-1.below.

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

The variance of $372$206 million between our reported net loss of $324$277 million for the current quarter and our reported net incomeloss of $48$71 million for the same prior-year quarter was driven by a shiftan increase in derivative fair value changeslosses of $403$206 million. We recorded derivative losses of $396$338 million duringand $132 million for the current quarter dueand same prior-year quarter, respectively. The derivative losses in both periods were primarily attributable to decreasesa decrease in the fair value of our pay-fixed swaps resulting from a decline in interest rates across the swap curve, with medium- and longer-termcurve. The decrease in interest rates, experiencing a steeper decline than short-term rates. The swap curve remained inverted, as short-term interest rates continued to exceed medium- and longer-term interest rates as of the end ofhowever, was more pronounced during the current quarter. In comparison, we recorded derivative gains of $7 million duringquarter relative to the comparablesame prior-year quarter, due to a net increaseresulting in the fair value of our pay-fixed swaps resulting from a slight rise in medium and longer-term interest rates.significantly higher derivative losses. Net interest income, which represented 88%accounted for 96% and 95% of total revenue for both the current quarter and same prior-year quarter, respectively, increased $8by $6 million, or 12%8%, to $84 million. The increase was attributable to the combined impact of an increase in our average interest-earning assets of $784 million, or 3%, and an increase in the net interest yield of 104 basis points, or 10%3%, to 1.14%1.23%.

The variance of $455 million between our reported net loss of $359 million for the nine months ended February 29, 2020, and our reported net income of $96 million for the same prior-year period was driven by an unfavorable shift in derivative fair value changes of $489 million. We recorded derivative losses of $550 million and $62 million for the nine months ended February 29, 2020 and February 28, 2019, respectively, largely due to a decrease in the fair value of our pay-fixed swaps in both periods, resulting from a decline in interest rates across the swap curve during the nine months ended February 29, 2020 and a decline in medium- and longer-term interest rates during the comparable prior-year period. Net interest income, which accounted for 93% and 95% of total revenue for the nine months ended February 29, 2020 and February 28, 2019, respectively, increased $16 million, or 7%, to $240 million. The increase was attributable to the combined impact of an increase in average interest-earning assets of $914 million, or 3%, and an increase in our average interest-earning assetsthe net interest yield of $833 million,4 basis points, or 3%4%, to 1.18%. The increase in the net interest yield reflected the combined impact of an increase in the average yield on interest-earning assets of 5 basis pointswas due to 4.30% and a reduction in our average cost of funds of 410 basis points to 3.36%3.26%, which was partially offset by a decrease in the average yield on interest-earning assets of 6 basis point to 4.25%. The decrease in our average cost of funds was largely due toreflects the impact of the interest savings from the repayment of the 10.375% collateral trust bonds in the first half of fiscal year 2019 and the replacement of this

Other factors affecting the variance between our current quarter results for the nine months ended February 29, 2020 and the comparable prior-year quarterperiod include an increase in fee income of $7 million due to higher prepayment fees, during the current quarter, a gain of $8 million recorded in connection with the July 22, 2019 sale of land and the absence of the loss of $7 million on the early redemption of $300 million of 10.375% collateral trust bonds recorded in the same prior-year quarter.period.

Loans to members totaled $26,300$26,823 million as of August 31, 2019,February 29, 2020, an increase of $383$906 million, or 1%3%, from May 31, 2019. CFC distribution loans, CFC power supply loans and RTFC loans increased by $329 million, $92 million and $6 million, respectively, which was partially offset by a decrease in NCSC loans of $45 million. The increase in loans was driven by a net increase in long-term loans of $479$858 million. CFC distribution loans, CFC power supply loans, CFC statewide and associate loans and RTFC loans increased by $842 million, which was offset$103 million, $9 million and $8 million, respectively, while NCSC loans decreased by a net decrease in revolving line-of-credit loans of $96$57 million.

Long-term loan advances totaled $888$1,950 million during the current quarter,nine months ended February 29, 2020, with approximately 73%77% of those advances for capital expenditures by members and 19%18% for the refinancing of loans made by other lenders. In comparison, long-term loan advances totaled $468$1,441 million during the same prior-year quarter,period, with approximately 71%85% of those advances for capital expenditures and 25%13% for the refinancing of loans made by other lenders. CFC had long-term fixed-rate loans totaling $110$350 million that were scheduled to reprice during the current quarter.nine months ended February 29, 2020. Of this total, $109$330 million repriced to a new long-term fixed rate, $10 million repriced to a long-term variable rate and $1$10 million was repaid in full. In comparison, CFC had long-term fixed-rate loans totaling $193$676 million that were scheduled to reprice during the same prior-year quarter,period, of which $96$490 million repriced to a new long-term fixed rate, $48$119 million repriced to a long-term variable rate and $49$67 million was repaid in full.

The overall credit quality of our loan portfolio remained high as of August 31, 2019,February 29, 2020, as evidenced by our continued strong credit performance metrics. We had no delinquent or nonperforming loans as of August 31, 2019,February 29, 2020, and we have not experienced any loan defaults or charge-offs since fiscal year 2017. Outstanding loans to electric utility organizations represented approximately 99% of total outstanding loan portfolio as of August 31, 2019,February 29, 2020, unchanged from May 31, 2019. We historically have had limited defaults and losses on loans in our electric utility loan portfolio. We generally lend to members on a senior secured basis, which reduces the risk of loss in the event of a borrower default. Of our total loans

We issue debt primarily to fund growth in our loan portfolio. As such, our outstanding debt volume generally increases and decreases in response to member loan demand. Total debt outstanding increased by $303$631 million, or 1%3%, to $25,464$25,793 million as of August 31, 2019,February 29, 2020, from May 31, 2019, due to an increase in borrowings to fund the increase in loans to members. The increase was primarily attributable to a net increase in member commercial paper, select notes and daily liquidity fund notes totaling $519$324 million, which wasa net increase in dealer commercial paper outstanding of $300 million, a net increase in medium-term notes of $205 million and a net increase in borrowings under USDA’s Guaranteed Underwriter Program (“Guaranteed Underwriter Program”) of $255 million. These increases were partially offset by a net decrease in dealer commercial papercollateral trust bonds of $115$199 million and a net decrease in Federal Agricultural Mortgage Corporation (“Farmer Mac”) notes payable of $92 million and a net decrease in borrowings under USDA’s Guaranteed Underwriter Program (“Guaranteed Underwriter Program”) of $23$228 million. Outstanding dealer commercial paper totaled $830$1,245 million as of August 31, 2019,February 29, 2020, below our targeted maximum threshold of $1,250 million.

Outlook forOn November 26, 2019, we amended the Next 12 Months

On December 20, 2019, we terminated the $300 million revolving note purchase agreement with Farmer Mac. As a result of the termination of this revolving note purchase agreement, the commitment amount under the $5,200 million revolving note purchase agreement with Farmer Mac subjectincreased to market conditions; and (v) up to $300$5,500 million available under a committed revolving note purchase agreement with Farmer Mac. effective December 20, 2019.

On September 25, 2019,February 13, 2020, we received a commitment letter for the guarantee by RUS ofclosed on a $500 million committed loan facility (“Series P”) from the Federal Financing Bank under the Guaranteed Underwriter Program. Pursuant to this facility, we may borrow any time before July 15, 2024. Each advance is subject to quarterly amortization and a final maturity not longer than 30 years from the date of the advance. With the closing of this committed loan facility, the amount available for access under the Guaranteed Underwriter Program increased to $1,525 million as of February 29, 2020.

COVID-19 has spread globally, including to every state in the United States, and has resulted in the WHO declaring COVID-19 to be a global pandemic. On March 13, 2020, the United States declared a national emergency with respect to COVID-19. The initial 15-day social distancing guidelines issued by the U.S. federal government, which were due to expire on March 30, 2020, have been extended through April 30, 2020, and may be extended further, as a measure to reduce the escalation of the spread of COVID-19 in the United States. More than 40 states and certain U.S. territories, including the District of Columbia, have issued orders requiring the closure of non-essential businesses and/or requiring residents to stay at home. We believeare following guidelines established by the Centers for Disease Control and WHO and orders issued by the state and local governments where we operate. We have taken a number of precautionary steps to safeguard our business and our employees from COVID-19, including, but not limited to, implementing employee travel restrictions and telecommuting arrangements, while maintaining business continuity so that we can continue to roll over outstandingdeliver service to and meet the demands of our members. As of March 18, 2020, most of our employees were working remotely, with only certain operationally critical employees working on site at our headquarters. We are monitoring and assessing the impact of the COVID-19 pandemic on a daily basis to ensure that we continue to adhere to guidelines and orders issued by federal, state and local governments.

The effects of COVID-19 and the response to the virus have negatively impacted financial markets and overall economic conditions. On March 27, 2020, the U.S. President signed into law a $2.2 trillion relief bill, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), that is intended to provide emergency relief to several groups and individuals impacted by the COVID-19 pandemic. Among the numerous provisions contained in the CARES Act is the creation of a $349 billion Paycheck Protection Program that provides federal government loan forgiveness for Small Business Administration Section 7(a) loans for small businesses, which may include our members or our members’ customers, to pay up to eight weeks of basic expenses, including utilities such as electric and telephone bills. The CARES Act also adds $45 billion for the disaster relief fund administered by the Federal Emergency Management Agency (“FEMA”) that our members may rely on to restore power after storms and emergencies. In addition, the CARES Act includes funds totaling $900 million for the Low-Income Home Energy Assistance Program, which may assist low-income and moderate-income consumers located in our members’ territories in paying their utility bills. We will continue to evaluate the provisions of the CARES Act and its impact on CFC and our employees as well as our rural utility member short-termcooperatives and their customers.

In light of the extreme volatility and disruptions in the capital and credit markets in early March 2020 resulting from the COVID-19 crisis, including a significant decline in corporate debt and equity issuances and a deterioration in the commercial paper market, we took a number of $3,198precautionary actions in March to enhance our financial flexibility by bolstering our cash position to ensure we have adequate cash readily available to meet both expected and unexpected cash needs without adversely affecting our daily operations. These actions included, but are not limited to, drawing additional advances under our committed credit facilities, revising our objective for the use of our held-to-maturity investment portfolio from previously serving as a supplemental source of liquidity to serving as a readily available source of liquidity and executing a plan for the orderly liquidation of a portion of debt securities from our investment portfolio. We borrowed an additional $625 million under the Guaranteed Underwriter Program and $250 million under the Farmer Mac note purchase agreement. Table 2 below displays our liquidity sources as of March 31, 2020.

As indicated in the above tables, our available liquidity of $8,761 million as of March 31, 2020 was $1,852 million, or 1.3 times, in excess of our expected debt obligations of $6,909 million over the next 12 months. Our members historically have maintained a relatively stable level of short-term investments in CFC in the form of commercial paper, select notes, daily liquidity fund notes and medium-term notes. We currently expect that our members will continue to reinvest their excess cash in our commercial paper, daily liquidity fund notes, select notes and medium-term notes. We expect to continue accessing the dealer commercial paper market as a cost-effective means of satisfying ourthese short-term liquidity needs. Although the intra-period amount of outstanding dealer commercial paper may fluctuate based on our liquidity requirements, we intend to manage our short-term wholesale funding risk by maintaining outstanding dealer commercial paper at an amount near or below $1,250 million for the foreseeable future. We expect to continue to be in compliance with the covenants under our committed bank revolving line of credit agreements, which will allow us to mitigate roll-over risk, as we can draw on these facilities to repay dealer or member commercial paper that cannot be refinanced with similar debt.

Although we anticipatecurrently believe that our adjusted debt-to-equity ratioexcess liquidity along with the ability to access the capital markets as a well-known seasoned issuer of debt will remainbe more than sufficient to cover our debt obligations over the next 12 months subsequent to March 31, 2020, as well as meet the borrowing needs of our members, we continue to review actions that we may take to further enhance our financial flexibility in the event that market conditions deteriorate further and for an extended period.

We provide additional information on our management of liquidity risk, our primary sources and uses of liquidity and our liquidity profile below under “Liquidity.”

In April 2020, management determined that we would not complete an ongoing project to develop a new internal-use loan origination and servicing platform with the current vendor. The project was intended to update our target thresholdloan platform to provide increased functionality and flexibility and enhance the operational efficiency of 6.00-to-1.our lending, loan servicing and loan accounting processes. As a result of the decision to abandon the existing project and select a new vendor, we recognized a non-cash impairment charge of $31 million in the fourth quarter of fiscal year 2020. This non-cash impairment charge represents the total capitalized amount, which is included as a component of fixed assets, on our consolidated balance sheet as of March 31, 2020, for the development of this platform.

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 2019 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. Management has discussed significant judgments and assumptions in applying our critical accounting policies with the Audit Committee of our board of directors. We provide additional information on our critical accounting policies and estimates under “MD&A—Critical Accounting Policies and Estimates” in our 2019 Form 10-K. See “Item 1A. Risk Factors” in our 2019 Form 10-K for a discussion of the risks associated with management’s judgments and estimates in applying our accounting policies and methods.

Reported net interest income of $77$84 million for the current quarter was up $8$6 million, or 12%8%, from the comparable prior-year quarter, primarily driven by an increase in the net interest yield of 10% (103% (4 basis points) to 1.14%, coupled with1.23% and an increase in average interest-earning assets of 3%.

Reported net interest income of $240 million for the samenine months ended February 29, 2020 was up $16 million, or 7%, from the comparable prior-year quarter,period, driven by an increase in the net interest yield of 4% (4 basis points) to 1.18%, coupled with an increase in average interest-earning assets of 3%.

We recorded a provision for loan losses of $2 million and $1 million for the three and nine months ended February 29, 2020. In comparison, we recorded a provision for loan losses of less than $1 million for the current quarter. In comparison, we recordedthree months ended February 28, 2019 and a benefit for loan losses of less than $1$2 million for the same prior-year quarter.nine months ended February 28, 2019. The credit quality and performance statistics of our loan portfolio remain strong.remained strong as of February 29, 2020. We had no payment defaults or charge-offs during the quarter, and no delinquent loans or nonperforming loans in our loan portfolio as of August 31, 2019February 29, 2020 or May 31, 2019.

We provide additional information on our allowance for loan losses under “Credit Risk—Allowance for Loan Losses” and “Note 5—Allowance for Loan Losses” of this Report. For a description of our methodology for determining the allowance for loan losses, see “MD&A—Critical Accounting Policies and Estimates—Allowance for Loan Losses” and “Note 1—Summary of Significant Accounting Policies—Allowance for Loan Losses” in our 2019 Form 10-K.

Non-interest income consists of fee and other income, gains and losses on derivatives not accounted for in hedge accounting relationships and unrealized gains and losses on equity securities.

 

Table 46 presents the components of non-interest income for the three and nine months ended August 31, 2019February 29, 2020 and 2018.February 28, 2019.