NOTE 9—DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

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 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. Our derivatives transactions are not collateralized and do not include collateralization agreements with counterparties. 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 receivable 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 expense and derivative forward value amounts, are recognized in our condensed 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 recognized in the same line item on our condensed consolidated statements of operations as the earnings effect of the related hedged item. Changes in the fair value of derivatives designated as qualifying cash flow hedges are recorded as a component of AOCI. Those amounts are reclassified into earnings in the same period during which the forecasted transaction impacts earnings and presented in the same line item on our condensed consolidated statements of operations as the earnings effect of the related hedged item.

We generally do not designate interest rate swaps, which represented all of our outstanding derivatives as of November 30, 2019, for hedge accounting. Accordingly, changes in the fair value of interest rate swaps are reported in our condensed consolidated statements of operations under derivative gains (losses). Net periodic cash settlements expense related to interest rate swaps are classified as an operating activity in our consolidated statements of cash flows.

Outstanding Notional Amount of Derivatives Not Designated as Accounting Hedges

The notional amount provides an indication of the volume of our derivatives activity, but this amount is not recorded on our condensed consolidated balance sheets. The notional amount is used only as the basis on which interest payments are determined and is not the amount exchanged. The following table shows the outstanding notional amounts and the weighted-average rate paid and received for our interest rate swaps, by type, as of November 30, 2019 and May 31, 2019. The substantial majority of our interest rate swaps use an index based on LIBOR for either the pay or receive leg of the swap agreement.



	November 30, 2019						May 31, 2019
(Dollars in thousands)	Notional Amount		Weighted- Average Rate Paid		Weighted- Average Rate Received		Notional Amount		Weighted- Average Rate Paid		Weighted- Average Rate Received
Pay-fixed swaps	$	7,271,741	2.84	%	2.00	%	$	7,379,280	2.83	%	2.60	%
Receive-fixed swaps	3,099,000		2.66		2.66		3,399,000		3.25		2.56
Total interest rate swaps	10,370,741		2.78		2.20		10,778,280		2.97		2.58
Forward pay-fixed swaps	65,000						65,000
Total	$	10,435,741					$	10,843,280

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 by derivatives type, as of November 30, 2019 and May 31, 2019.



	November 30, 2019				May 31, 2019
(Dollars in thousands)	Fair Value		Notional Balance		Fair Value		Notional Balance
Derivative assets:
Interest rate swaps	$	53,174	$	2,335,476	$	41,179	$	2,332,104

Derivative liabilities:
Interest rate swaps	$	591,027	$	8,100,265	$	391,724	$	8,511,176

All of our master swap agreements include 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 November 30, 2019 and May 31, 2019, and provides information on the impact of netting provisions and collateral pledged, if any.



	November 30, 2019
	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)	Gross Amount of Recognized Assets/ Liabilities		Gross Amount Offset in the Balance Sheet				Financial Instruments		Cash Collateral Pledged		Net Amount
Derivative assets:
Interest rate swaps	$	53,174	$	—	$	53,174	$	53,174	$	—	$	—
Derivative liabilities:
Interest rate swaps	591,027		—		591,027		53,174		—		537,853



	May 31, 2019
	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)	Gross Amount of Recognized Assets/ Liabilities		Gross Amount Offset in the Balance Sheet				Financial Instruments		Cash Collateral Pledged		Net Amount
Derivative assets:
Interest rate swaps	$	41,179	$	—	$	41,179	$	41,176	$	—	$	3
Derivative liabilities:
Interest rate swaps	391,724		—		391,724		41,176		—		350,548

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 expense and derivative forward value gains (losses). Derivative cash settlements expense represents net contractual interest expense accruals on interest rate swaps during the period. The derivative forward value gains (losses) represent 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 and six months ended November 30, 2019 and 2018.



	Three Months Ended November 30,						Six Months Ended November 30,
(Dollars in thousands)	2019			2018			2019			2018
Derivative gains (losses) attributable to:
Derivative cash settlements expense	$	(14,150	)	$	(11,805	)	$	(25,193	)	$	(24,634	)
Derivative forward value gains (losses)	197,600			75,148			(187,082		)	95,160
Derivative gains (losses)	$	183,450		$	63,343		$	(212,275	)	$	70,526

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 below 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 prevailing fair value, as defined in the agreement, as of the termination date.

Our senior unsecured credit ratings from Moody’s and S&P were A2 and A, respectively, as of November 30, 2019. Both Moody’s and S&P had our ratings on stable outlook as of November 30, 2019. The following table displays the notional amounts of our derivative contracts with rating triggers as of November 30, 2019, 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.



(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⁾	$	47,955	$	(9,457	)	$	—	$	(9,457	)
Falls below Baa1/BBB+	6,861,619		(346,099		)	—		(346,099		)
Falls to or below Baa2/BBB ⁽²⁾	479,629		(13,704		)	—		(13,704		)
Falls below Baa3/BBB-	221,078		(12,385		)	—		(12,385		)
Total	$	7,610,281	$	(381,645	)	$	—	$	(381,645	)

^{____________________________}

⁽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⁾ 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.

We have outstanding notional amount of derivatives with one counterparty subject to a ratings trigger and early termination provision in the event of a downgrade of CFC’s senior unsecured credit ratings below Baa3, BBB- or BBB- by Moody’s, S&P or Fitch, respectively, which is not included in the above table, totaling $165 million as of November 30, 2019. These contracts were in an unrealized loss position of $31 million as of November 30, 2019.

Our largest counterparty exposure, based on the outstanding notional amount, accounted for approximately 23% of the total outstanding notional amount of derivatives as of both November 30, 2019 and May 31, 2019. The aggregate fair value amount, including the credit valuation adjustment, of all interest rate swaps with rating triggers that were in a net liability position was $402 million as of November 30, 2019.