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 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.

Basis of Presentation and Use of Estimates

The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”). The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts and related disclosures during the period. Management’s most significant estimates and assumptions involve determining the allowance for loan losses and the fair value of financial assets and liabilities. Actual results could differ from these estimates. We believe these financial statements reflect all adjustments of a normal, recurring nature that are, in the opinion of management, necessary for the fair presentation of the results for the interim period. The results of operations for interim periods are not necessarily indicative of results for the entire fiscal year. Certain reclassifications have been made to prior periods to conform to the current presentation.

The accompanying 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, 2019 (“2019 Form 10-K”). Refer to “Note 1—Summary of Significant Accounting Policies” in our 2019 Form 10-K for a discussion of our significant accounting policies.

Principles of Consolidation

The accompanying condensed consolidated financial statements include the accounts of CFC, variable interest entities (“VIEs”) where CFC is the primary beneficiary and subsidiary entities created and controlled by CFC to hold foreclosed assets. CFC did not have any entities that held foreclosed assets as of November 30, 2019 or May 31, 2019. All intercompany balances and transactions have been eliminated. National Cooperative Services Corporation (“NCSC”) and Rural Telephone Finance Cooperative (“RTFC”) are VIEs that are required to be consolidated by CFC. 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. Unless stated otherwise, references to “we,” “our” or “us” relate to CFC and its consolidated entities.

Restricted Cash

Restricted cash, which consists primarily of member funds held in escrow for certain specifically designed cooperative programs, totaled $11 million and $8 million as of November 30, 2019 and May 31, 2019, respectively.

Assets Held for Sale

On March 14, 2018, CFC entered into a purchase and sale agreement (“the agreement”), which was subsequently amended, for the sale of a parcel of land, consisting of approximately 28 acres, located in Loudoun County, Virginia. We designated the property, which had a carrying value of $14 million, as held for sale and reclassified it from fixed assets, net to other assets on our consolidated balance sheet. On July 22, 2019, we closed on the sale of the land and received net proceeds of $22 million, resulting in a gain of $8 million on the sale of this property, which is reported in other non-interest income (expense) on our condensed consolidated statements of operations.

Interest Income

The following table presents interest income, by interest-earning asset category, 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
Interest income by interest-earning asset type:
Long-term fixed-rate loans⁽¹⁾	$	260,714		$	253,340		$	519,192		$	505,141
Long-term variable-rate loans	8,131			10,066			17,887			19,447
Line of credit loans	12,678			11,752			28,711			23,385
TDR loans⁽²⁾	212			211			418			429
Other income, net⁽³⁾	(287		)	(251		)	(571		)	(576		)
Total loans	281,448			275,118			565,637			547,826
Cash, time deposits and investment securities	5,589			6,135			11,415			11,918
Total interest income	$	287,037		$	281,253		$	577,052		$	559,744

^{____________________________}

⁽¹⁾Includes loan conversion fees, which are generally deferred and recognized as interest income using the effective interest method.

⁽²⁾Troubled debt restructured (“TDR”) loans.

⁽³⁾Consists of late payment fees, commitment fees and net amortization of deferred loan fees and loan origination costs.

Deferred income of $54 million and $58 million as of November 30, 2019 and May 31, 2019, respectively, consists primarily of deferred loan conversion fees totaling $48 million and $52 million, respectively. Deferred loan conversion fees are recognized in interest income using the effective interest method.

Interest Expense

The following table presents interest expense, by debt product type, 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
Interest expense by debt product type:⁽¹⁾⁽²⁾
Short-term borrowings	$	22,112	$	22,619	$	44,934	$	42,038
Medium-term notes	31,440		33,816		63,516		66,226
Collateral trust bonds	64,523		68,934		129,904		146,639
Guaranteed Underwriter Program notes payable	39,786		35,014		80,219		70,348
Farmer Mac notes payable	22,654		19,697		47,728		40,808
Other notes payable	230		322		484		644
Subordinated deferrable debt	12,884		9,417		25,766		18,834
Subordinated certificates	14,242		14,347		28,591		28,860
Total interest expense	$	207,871	$	204,166	$	421,142	$	414,397

^{____________________________}

⁽¹⁾ Includes amortization of debt discounts and debt issuance costs, which are generally deferred and recognized as interest expense using the effective interest method. Issuance costs related to dealer commercial paper, however, are recognized as interest expense immediately as incurred.

⁽²⁾ Includes fees related to funding arrangements, such as up-front fees paid to banks participating in our committed bank revolving line of credit agreements. Depending on the nature of the fee, amounts may be deferred and recognized as interest expense ratably over the term of the arrangement or recognized immediately as incurred.

Recent Accounting Changes and Other Developments

Accounting Standards Adopted in Fiscal Year 2020

Derivatives and Hedging—Targeted Improvements to Accounting for Hedging Activities

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging—Targeted Improvements to Accounting for Hedging Activities, which expands the types of risk management strategies that qualify for hedge accounting treatment to more closely align the results of hedge accounting with the economics of certain risk management activities and simplifies certain hedge documentation and assessment requirement. It also eliminates the concept of separately recording hedge ineffectiveness and expands disclosure requirements. The guidance is effective for public entities for fiscal years beginning after December 15, 2018, including interim periods within those years. Early adoption is permitted in any interim period or fiscal year before the effective date. We adopted this guidance on June 1, 2019. Hedge accounting is elective, and we currently apply hedge accounting on a limited basis, specifically when we enter into treasury rate lock agreements. The adoption of this guidance did not have an impact on our consolidated financial statements or cash flows. If we continue to elect not to apply hedge accounting to our interest rate swaps, the guidance will not have an impact on our consolidated financial statements or cash flows.

Receivables—Nonrefundable Fees and Other Cost

In March 2017, the FASB issued ASU 2017-08, Receivables—Nonrefundable Fees and Other Costs, which shortens the amortization period for the premium on certain callable debt securities to the earliest call date rather the maturity date. The guidance is applicable to any individual debt security, purchased at a premium, with an explicit and noncontingent call feature with a fixed price on a preset date. The guidance does not impact the accounting for purchased callable debt securities held at a discount. The guidance is effective for public entities in fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. We adopted this guidance on June 1, 2019. The adoption of this guidance did not have a material impact on our consolidated financial statements or cash flows.

Leases

In February 2016, the FASB issued ASU 2016-02, Leases, which provides new guidance that is intended to improve financial reporting about leasing transactions. The new guidance requires the recognition of a right-of use asset and lease liability on the consolidated balance sheet by lessees for those leases classified as operating leases under previous guidance. It also requires new disclosures to help investors and other financial statement users better understand the amount, timing, and uncertainty of cash flows arising from leases. The guidance is effective for fiscal years and interim periods within those fiscal years beginning after December 15, 2018. We adopted this guidance on June 1, 2019. The adoption of this guidance did not have a material impact on our consolidated financial statements or cash flows.

Accounting Standards Issued But Not Yet Adopted

Fair Value Measurement—Changes to the Disclosure Requirements for Fair Value Measurement

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement—Changes to the Disclosure Requirements for Fair Value Measurement, which eliminates, adds and modifies certain disclosure requirements for fair value measurements as part of its disclosure framework project. The guidance is effective for public entities for fiscal years beginning after December 15, 2019, including interim periods within those years. Early adoption is permitted in any interim period or fiscal year before the effective date. The guidance is effective for us beginning June 1, 2020. We do not expect that the adoption of this guidance will have a material impact on our consolidated financial statements or cash flows.

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

In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments, which replaces the existing incurred credit loss model and establishes a single credit loss framework based on a current expected credit loss model for financial assets carried at amortized cost, including loans and held-to- maturity debt securities. The current expected loss model requires an entity to estimate credit losses expected over the life of the credit exposure upon initial recognition of that exposure when the financial asset is originated or acquired, which will generally result in earlier recognition of credit losses. The guidance also amends the other-than-temporary model for available-for-sale debt securities by requiring the use of an allowance, rather than directly reducing the carrying value of the security. The new guidance also requires expanded credit quality disclosures. The new guidance is effective for fiscal years and interim periods within those fiscal years, beginning after December 15, 2019. This guidance is effective for us on June 1, 2020. While early adoption is permitted, we have decided not to elect that option. We are continuing to evaluate the impact of the guidance on our consolidated financial statements, including assessing and evaluating assumptions and models to estimate losses. Upon adoption of the guidance on June 1, 2020, we will be required to record a cumulative effect adjustment to retained earnings for the impact as of the date of adoption. The impact will depend on our portfolio composition and credit quality at the date of adoption, as well as forecasts at that time.