NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP DC

Our loan portfolio, which represents the largest component of assets on our balance sheet, accounts for the substantial majority of our credit risk exposure. We also engage in certain nonlending activities that may give rise to counterparty credit risk, such as entering into derivative transactions to manage interest rate risk and purchasing investment securities. We provide additional information on our credit risk-management framework under “Item 7. MD&A—Credit Risk—Credit Risk Management” in our 2023 Form 10-K.

Loan Portfolio Credit Risk

Our primary credit exposure is loans to rural electric cooperatives, which provide essential electric services to end-users, the majority of which are residential customers. We also have a limited portfolio of loans to not-for-profit and for-profit telecommunication companies. Loans outstanding to electric utility organizations totaled $32,994 million and $32,032 million as of November 30, 2023 and May 31, 2023, respectively, representing 98% and 99% of our total loans outstanding as of each respective date. The remaining loans outstanding in our loan portfolio were to RTFC members, affiliates and associates in the telecommunications industry sector. The substantial majority of loans to our borrowers are long-term fixed-rate loans with terms of up to 35 years. Long-term fixed-rate loans accounted for 88% and 87% of total loans outstanding as of November 30, 2023 and May 31, 2023, respectively.

Because we lend primarily to our rural electric utility cooperative members, we have had a loan portfolio inherently subject to single-industry and single-obligor credit concentration risk since our inception in 1969. We historically, however, have experienced limited defaults and losses in our electric utility loan portfolio due to several factors. First, the majority of our electric cooperative borrowers operate in states where electric cooperatives are not subject to rate regulation. Thus, they are able to make rate adjustments to pass along increased costs to the end customer without first obtaining state regulatory approval, allowing them to cover operating costs and generate sufficient earnings and cash flows to service their debt obligations. Second, electric cooperatives face limited competition, as they tend to operate in exclusive territories not serviced by public investor-owned utilities. Third, electric cooperatives typically are consumer-owned, not-for-profit entities that provide an essential service to end-users, the majority of which are residential customers. As not-for-profit entities, rural electric cooperatives, unlike investor-owned utilities, generally are eligible to apply for assistance from the Federal Emergency Management Agency (“FEMA”) and states to help recover from major disasters or emergencies. Fourth, electric cooperatives tend to adhere to a conservative core business strategy model that has historically resulted in a relatively stable, resilient operating environment and overall strong financial performance and credit strength for the electric cooperative network. Finally, we generally lend to our members on a senior secured basis, which reduces the risk of loss in the event of a borrower default.

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

Security Provisions

Except when providing line of credit loans, we generally lend to our members on a senior secured basis. Table 13 presents, by legal entity and member class and by loan type, secured and unsecured loans in our loan portfolio as of November 30, 2023 and May 31, 2023. Of our total loans outstanding, 92% were secured as of both November 30, 2023 and May 31, 2023.

Table 13: Loans—Loan Portfolio Security Profile

(1) Represents the unpaid principal balance, net of discounts, charge-offs and recoveries, of loans as of the end of each period. Excludes unamortized deferred loan origination costs of $13 million as of both November 30, 2023 and May 31, 2023.

Credit Concentration

Concentrations of credit may exist when a lender has large credit exposures to single borrowers, large credit exposures to borrowers in the same industry sector or engaged in similar activities or large credit exposures to borrowers in a geographic region that would cause the borrowers to be similarly impacted by economic or other conditions in the region. As discussed above under “Credit Risk—Loan Portfolio Credit Risk,” because we lend primarily to our rural electric utility cooperative members, our loan portfolio is inherently subject to single-industry and single-obligor credit concentration risk. Loans outstanding to electric utility organizations totaled $32,994 million and $32,032 million as of November 30, 2023 and May 31, 2023, respectively, and represented approximately 98%and 99%of our total loans outstanding as of each respective date. Our credit exposure is partially mitigated by long-term loans guaranteed by RUS, which totaled $118 million and $123 million as of November 30, 2023 and May 31, 2023, respectively.

Single-Obligor Concentration

Table 14 displays the outstanding loan exposure for our 20 largest borrowers, by legal entity and member class, as of November 30, 2023 and May 31, 2023. Our 20 largest borrowers consisted of 12 distribution systems and eight power supply systems as of November 30, 2023 compared to 10 distribution systems and 10 power supply systems as of May 31, 2023. The largest total exposure to a single borrower or controlled group represented approximately 1%of total loans outstanding as of both November 30, 2023 and May 31, 2023.

Table 14: Loans—Loan Exposure to 20 Largest Borrowers

We entered into a long-term standby purchase commitment agreement with Farmer Mac during fiscal year 2016. Under this agreement, we may designate certain long-term loans to be covered under the commitment, subject to approval by Farmer Mac, and in the event any such loan later goes into payment default for at least 90 days, upon request by us, Farmer Mac must purchase such loan at par value. The aggregate unpaid principal balance of designated and Farmer Mac approved loans was $421 million and $436 million as of November 30, 2023 and May 31, 2023, respectively. Loan exposure to our 20 largest borrowers covered under the Farmer Mac agreement totaled $226 million and $267 million as of November 30, 2023 and May 31, 2023, respectively, which reduced our exposure to the 20 largest borrowers to 19% as of each respective date. No loans have been put to Farmer Mac for purchase pursuant to this agreement.

Geographic Concentration

Although our organizational structure and mission result in single-industry concentration, we serve a geographically diverse group of electric and telecommunications borrowers throughout the U.S. The consolidated number of borrowers with loans outstanding totaled 891 and 884 as of November 30, 2023 and May 31, 2023, respectively, located in 49 states and the District of Columbia. Of the 891 and 884 borrowers with loans outstanding as of November 30, 2023 and May 31, 2023, respectively, 50 and 52 were electric power supply borrowers as of each respective date. Electric power supply borrowers generally require significantly more capital than electric distribution and telecommunications borrowers.

Texas, which had 67 and 69 borrowers with loans outstanding as of November 30, 2023 and May 31, 2023, respectively, accounted for the largest number of borrowers with loans outstanding in any one state as of each respective date, as well as the largest concentration of loan exposure in any one state. Loans outstanding to Texas-based borrowers totaled $5,653 million and $5,529 million as of November 30, 2023 and May 31, 2023, respectively, and accounted for approximately 17% of total loans outstanding as of each respective date. Of the loans outstanding to Texas-based borrowers, $151 million and

$155 million as of November 30, 2023 and May 31, 2023, respectively, were covered by the Farmer Mac standby repurchase agreement, which reduced our credit risk exposure to Texas-based borrowers to $5,502 million and $5,373 million as of each respective date. See “Note 4—Loans” for information on the Texas-based number of borrowers and loans outstanding by legal entity and member class.

Credit Quality Indicators

Assessing the overall credit quality of our loan portfolio and measuring our credit risk is an ongoing process that involves tracking payment status, modifications to borrowers experiencing financial difficulty, nonperforming loans, charge-offs, the internal risk ratings of our borrowers and other indicators of credit risk. We monitor and subject each borrower and loan facility in our loan portfolio to an individual risk assessment based on quantitative and qualitative factors. Payment status trends and internal risk ratings are indicators, among others, of the probability of borrower default and overall credit quality of our loan portfolio. We believe the overall credit quality of our loan portfolio remained strong as of November 30, 2023.

Loan Modifications to Borrowers Experiencing Financial Difficulty

We actively monitor problem 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. Therefore, as part of our loss mitigation efforts, we may provide modifications to a borrower experiencing financial difficulty to improve long-term collectability of the loan and to avoid the need for exercising remedies. We consider the impact of all loan modifications when estimating the credit quality of our loan portfolio and establishing the allowance for credit losses.

On June 1, 2023, we adopted ASU 2022-02, Financial Instruments – Credit Losses (Topic 326) – Troubled Debt Restructurings and Vintage Disclosures, using the prospective adoption method. The ASU eliminated the accounting guidance for TDRs and enhanced the disclosure requirements for loan refinancings and restructurings made with borrowers experiencing financial difficulty, which are to be applied prospectively. For additional information on the adoption of ASU 2022-02 see “Note 1—Summary of Significant Accounting Policies.”

We had one loan modification to a RTFC borrower experiencing financial difficulty during Q2 FY2024 and YTD FY2024. This loan received a term extension and had an amortized cost of $3 million as of November 30, 2023, representing 1% of the RTFC loan portfolio. Loans modified to borrowers experiencing financial difficulty totaled $3 million as of November 30, 2023, consisting of one RTFC loan as discussed above, which was performing in accordance with the terms of the loan agreement. There were no unadvanced loan commitments related to this loan.

Troubled Debt Restructurings—Prior to Adoption of ASU 2022-02

As discussed above, ASU 2022-02 eliminated the accounting guidance for TDRs. Prior to the adoption of ASU 2022-02, aloan restructuring or modification of terms is accounted foras TDR if, for economic or legal reasons related to the borrower’s financial difficulties, a concession is granted to the borrower that we would not otherwise consider.

We had loans outstanding to two borrowers totaling $8 million which have been performing in accordance with the terms of their respective restructured loan agreement for an extended period of time and were classified as performing TDR loans and on accrual status as of May 31, 2023. We had loans outstanding to Brazos totaling $23 million classified as nonperforming TDR loans during the three months ended February 28, 2023 (“Q3 FY2023”), which were on non-accrual status as of May 31, 2023. During Q1 FY2024, we received the remaining payment of Brazos’ loans outstanding of $23 million in accordance with the provisions of Brazos’ plan of reorganization to repay its loans in full. Prior to the Brazos loan restructuring, we have not had any loan modifications that were required to be accounted for as TDRs since fiscal year 2016.

Nonperforming Loans

We classify 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 a loan to one CFC electric power supply borrower totaling $85 million classified as nonperforming as of November 30, 2023. In comparison, we had loans to two CFC electric power supply borrowers totaling $89 million classified as nonperforming as of May 31, 2023. Nonperforming loans represented 0.25% and 0.27% of total loans outstanding as of November 30, 2023 and May 31, 2023, respectively. The reduction in nonperforming loans of $4 million was due to the receiptof $4 million in loan payments from Brazos Sandy Creek to pay off its nonperforming loan outstanding during the YTD FY2024.

We provide additional information on nonperforming loans in “Note 4—Loans—Credit Quality Indicators—Nonperforming Loans.”

Net Charge-Offs

We had no charge-offs during Q2 FY2024 and YTD FY2024. We received a total of $28 million in loan payments from Brazos and Brazos Sandy Creek to repay their $27 million of total loans outstanding in full during Q1 FY2024. The additional payment received of $1 million was recorded as a loan recovery on the Brazos and Brazos Sandy Creek previously charged-off loan amounts, which resulted in an annualized net recovery rate of 0.01% for YTD FY2024. In comparison, we had charge-offs totaling $15 million for the CFC electric power supply loan portfolio related to Brazos and Brazos Sandy Creek nonperforming loans during Q2 FY2023 and YTD FY2023, which resulted in an annualized net charge-off rate of 0.19% and 0.10% for Q2 FY2023 and YTD FY2023, respectively. Prior to Brazos’ and Brazos Sandy Creek’s bankruptcy filings, we had not experienced any defaults or charge-offs in our electric utility and telecommunications loan portfolios since fiscal year 2013 and 2017, respectively.

Borrower Risk Ratings

As part of our management of credit risk, we maintain a credit risk rating framework under which we employ a consistent process for assessing the credit quality of our loan portfolio. We evaluate each borrower and loan facility in our loan portfolio and assign internal borrower and loan facility risk ratings based on consideration of a number of quantitative and qualitative factors. We categorize loans in our portfolio based on our internally assigned borrower risk ratings, which are intended to assess the general creditworthiness of the borrower and probability of default. Our borrower risk ratings align with the U.S. federal banking regulatory agencies’ credit risk definitions of pass and criticized categories, with the criticized category further segmented among special mention, substandard and doubtful. Pass ratings reflect relatively low probability of default, while criticized ratings have a higher probability of default. Our internally assigned borrower risk ratings serve as the primary credit quality indicator for our loan portfolio. Because our internal borrower risk ratings provide important information on the probability of default, they are a key input in determining our allowance for credit losses.

Criticized loans totaled $300 million and $323 million as of November 30, 2023 and May 31, 2023, respectively, and represented approximately 1% of total loans outstanding as of each respective date. The decrease of $23 million in criticized loans was primarily due to loan payments received from Brazos and Brazos Sandy Creek in the doubtful category, partially offset by an increase in loans outstanding for one CFC electric distribution borrower in the special mention category during YTD FY2024. Each of the borrowers with loans outstanding in the criticized category was current with regard to all principal and interest amounts due to us as of November 30, 2023. In contrast, each of the borrowers with loans outstanding in the criticized category, with the exception of Brazos Sandy Creek, was current with regard to all principal and interest amounts due to us as of May 31, 2023.

We provide additional information on our borrower risk rating framework in our 2023 Form 10-K under “Item 7. MD&A Credit Risk—Loan Portfolio Credit Risk—Credit Quality Indicators.” See “Note 4—Loans” of this Report for detail, by member class, on loans outstanding in each borrower risk rating category.

Allowance for Credit Losses

We are required to maintain an allowance based on a current estimate of credit losses that are expected to occur over the remaining contractual term of the loans in our portfolio. Our allowance for credit losses consists of a collective allowance and an asset-specific allowance. The collective allowance is established for loans in our portfolio that share similar risk characteristics and are therefore evaluated on a collective, or pool, basis in measuring expected credit losses. The asset- specific allowance is established for loans in our portfolio that do not share similar risk characteristics with other loans in our portfolio and are therefore evaluated on an individual basis in measuring expected credit losses.

Table 15 presents, by legal entity and member class, loans outstanding and the related allowance for credit losses and allowance coverage ratio as of November 30, 2023 and May 31, 2023 and the allowance components as of each date.

Table 15: Allowance for Credit Losses by Borrower Member Class and Evaluation Methodology

(1) Represents the unpaid principal balance, net of discounts, charge-offs and recoveries, of loans as of each period end. Excludes unamortized deferred loan origination costs of $13 million as of both November 30, 2023 and May 31, 2023.

(2)Calculated based on the allowance for credit losses attributable to each member class and allowance components at period end divided by the related loans outstanding at period end.

(3)Calculated based on the total allowance for credit losses at period end divided by loans outstanding on nonaccrual status at period end. Nonaccrual loans represented 0.25% and 0.35% of total loans outstanding as of November 30, 2023 and May 31, 2023, respectively. We provide additional information on our nonaccrual loans in “Note 4—Loans” in this Report.

The allowance for credit losses and allowance coverage ratio increased to $56 million and 0.17%, respectively, as of November 30, 2023, from $53 million and 0.16%, respectively, as of May 31, 2023. The $3 million increase in the allowance for credit losses reflected an increase in the collective allowance of $4 million, partially offset by a reduction in the asset-specific allowance of $1 million. The increase in the collective allowance was primarily due to loan portfolio growth and a slight decline in the overall credit quality and risk profile of our loan portfolio. The decrease in theasset-specific allowance was attributable to a timing change in the expected payments on a nonperforming CFC power supply loan.

We discuss our methodology for estimating the allowance for credit losses under the CECL model in “Note 1—Summary of Significant Accounting Policies—Allowance for Credit Losses” and provide information on management’s judgment and the uncertainties involved in our determination of the allowance for credit losses in “MD&A—Critical Accounting Estimates—Allowance for Credit Losses” in our 2023 Form 10-K. We provide additional information on our loans and allowance for credit losses under “Note 4—Loans” and “Note 5—Allowance for Credit Losses” of this Report.

Counterparty Credit Risk

In addition to credit exposure from our borrowers, we enter into other types of financial transactions in the ordinary course of business that expose us to counterparty credit risk, primarily related to transactions involving our cash and cash equivalents, time deposits, securities held in our investment securities portfolio and derivatives. We mitigate our risk by only entering into these transactions with counterparties with investment-grade ratings, establishing operational guidelines and counterparty exposure limits and monitoring our counterparty credit risk position. We evaluate our counterparties based on certain quantitative and qualitative factors and periodically assign internal risk rating grades to our counterparties.

Cash, Time Deposits and Investments Securities Counterparty Credit Exposure

Our cash and cash equivalents, time deposits and investment securities totaled $129 million, $400 million and $417 million, respectively, as of November 30, 2023. The primary credit exposure associated with investments held in our investments portfolio is that issuers will not repay principal and interest in accordance with the contractual terms. Our cash and cash equivalents and time deposits with financial institutions generally have an original maturity of less than one year and pursuant to our investment policy guidelines, all fixed-income debt securities, at the time of purchase, must be rated at least investment grade based on external credit ratings from at least two of the leading global credit rating agencies, when available, or the corresponding equivalent, when not available. We therefore believe that the risk of default by these counterparties is low. As of November 30, 2023, our overall counterparty credit risk was deemed to be satisfactory and not materially changed compared with May 31, 2023.

We provide additional information on the holdings in our investment portfolio below under “Liquidity Risk—Investment Portfolio” and in “Note 3—Investment Securities.”

Derivative Counterparty Credit Exposure

Our derivative counterparty credit exposure relates principally to interest-rate swap contracts. We generally engage in over-the-counter (“OTC”) derivative transactions, which expose us to individual counterparty credit risk because these transactions are executed and settled directly between us and each counterparty. We are exposed to the risk that an individual derivative counterparty defaults on payments due to us, which we may not be able to collect or which may require us to seek a replacement derivative from a different counterparty. This replacement may be at a higher cost, or we may be unable to find a suitable replacement.

We manage our derivative counterparty credit exposure by executing derivative transactions with financial institutions that have investment-grade credit ratings and maintaining enforceable master netting arrangements with these counterparties, which allow us to net derivative assets and liabilities with the same counterparty. We had 12 active derivative counterparties with credit ratings ranging from Aa1 to Baa1 by Moody’s Investors Service (“Moody’s”) as of both November 30, 2023 and May 31, 2023, and from AA- to BBB+ and AA- to A- by S&P as of November 30, 2023 and May 31, 2023, respectively. The total outstanding notional amount of derivatives with these counterparties was $7,621 million and $7,816 million as of November 30, 2023 and May 31, 2023, respectively. The highest single derivative counterparty concentration, by outstanding notional amount, accounted for approximately 23% of the total outstanding notional amount of our derivatives as of both November 30, 2023 and May 31, 2023.

While our derivative 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, we report the fair value of our derivatives on a gross basis by individual contract as either a derivative asset or derivative liability on our consolidated balance sheets. However, we estimate our exposure to credit loss on our derivatives by calculating the replacement cost to settle at current market prices, as defined in our derivative agreements, all outstanding derivatives in a net gain position at the counterparty level where a right of legal offset exists. We provide information on the impact of netting provisions under our master swap agreements and collateral pledged, if any, in “Note 9—Derivative Instruments and Hedging Activities—Impact of Derivatives on Consolidated Balance Sheets.” We believe our exposure to derivative counterparty risk, at any point in time, is equal to the amount of our outstanding derivatives in a net gain position, at the individual counterparty level, which totaled $587 million and $349 million as of November 30, 2023 and May 31, 2023, respectively.

We provide additional detail on our derivative agreements, including a discussion of derivative contracts with credit rating triggers and settlement amounts that would be required in the event of a ratings trigger, in “Note 9—Derivative Instruments and Hedging Activities.”

See “Item 1A. Risk Factors” in our 2023 Form 10-K and “Item 1A. Risk Factors” of this Report for additional information about credit risks related to our business.