NATIONAL RURAL UTILITIES COOPERATIVE FINANCE CORP DC

This section provides a comparative discussion of our consolidated results of operations between FY2024 and FY2023. Following this section, we provide a discussion and analysis of material changes in amounts reported on our consolidated balance sheet as of May 31, 2024 and 2023. You should read these sections together with our “Executive Summary—Outlook” where we discuss trends and other factors that we expect will affect our future results of operations. See “Item 7. MD&A—Consolidated Results of Operations” in our 2023 Form 10-K for a comparative discussion of our consolidated results of operations between FY2023 and FY2022.

Net Interest Income

Net interest income, which is our largest source of revenue, represents the difference between the interest income earned on our interest-earning assets 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 of 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 proportionately funding large aggregated amounts of loans.

Table 3 presents average balances for FY2024, FY2023 and FY2022, 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 3 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 expense in interest expense. We provide reconciliations of our non-GAAP financial measures to the most comparable U.S. GAAP financial measures under “Non-GAAP Financial Measures and Reconciliations.”

Table 3: Average Balances, Interest Income/Interest Expense and Average Yield/Cost

(1)Interest income on long-term, fixed-rate loans includes loan conversion fees, which are generally deferred and recognized as interest income using the effective interest method.

(2)Consists of late payment fees and net amortization of deferred loan fees and loan origination costs.

(3)The average balance represents average monthly balances, which is calculated based on the month-end balance as of the beginning of the reporting period and the balances as of the end of each month included in the specified reporting period.

(4)Short-term borrowings reported on our consolidated balance sheets consist of borrowings with an original contractual maturity of one year or less. However, short-term borrowings presented in Table 3 consist of commercial paper, select notes, daily liquidity fund notes and secured borrowings under repurchase agreements. Short-term borrowings presented on our consolidated balance sheets related to medium-term notes, Farmer Mac notes payable and other notes payable are reported in the respective category for presentation purposes in Table 3. The period-end amounts reported as short-term borrowings on our consolidated balances sheets, which are excluded from the calculation of average short-term borrowings presented in Table 3, totaled $1,021 million, $367 million and $417 million as of May 31, 2024, 2023 and 2022, respectively.

(5)Net interest spread represents the difference between the average yield on total average interest-earning assets and the average cost of total average interest-bearing liabilities. Adjusted net interest spread represents the difference between the average yield on total average interest-earning assets and the adjusted average cost of total average interest-bearing liabilities.

(6)Includes other liabilities and equity.

(7)Net interest yield is calculated based on net interest income for the period divided by total average interest-earning assets for the period.

(8)Represents the impact of net periodic contractual interest amounts on our interest rate swaps during the period. This amount is added to interest expense to derive non-GAAP adjusted interest expense. The average (benefit)/cost associated with derivatives is calculated based on net periodic swap settlement interest amount during the period divided by the average outstanding notional amount of derivatives during the period. The average outstanding notional amount of interest rate swaps was $7,597 million, $7,668 million and $8,406 million for FY2024, FY2023 and FY2022, respectively.

(9)Adjusted interest expense consists of interest expense plus net periodic derivative cash settlements interest income (expense) during the period. Net periodic derivative cash settlements interest income (expense) is reported on our consolidated statements of operations as a component of derivative gains (losses). Adjusted average cost is calculated based on the adjusted interest expense for the period divided by total average interest-bearing liabilities during the period.

(10)Adjusted net interest yield is calculated based on adjusted net interest income for the period divided by total average interest-earning assets for the period.

Table 4 displays the change in net interest income between periods and the extent to which the variance for each category of interest-earning assets and interest-bearing liabilities is attributable to (i) changes in volume, which represents the change in the average balances of our interest-earning assets and interest-bearing liabilities or volume, and (ii) changes in the rate, which represents the change in the average interest rates of these assets and liabilities. The table also presents the change in adjusted net interest income between periods.

Table 4: Rate/Volume Analysis of Changes in Interest Income/Interest Expense

(1)The changes for each category of interest income and interest expense represent changes in either average balances (volume) or average rates for both interest-earning assets and interest-bearing liabilities. We allocate the amount attributable to the combined impact of volume and rate to the rate variance.

(2)For the net periodic derivative cash settlements interest amount, the variance due to average volume represents the change in the net periodic derivative cash settlements interest amount resulting from the change in the average notional amount of derivative contracts outstanding. The variance due to average rate represents the change in the net periodic derivative cash settlements amount 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 and Reconciliations” for additional information on our adjusted non-GAAP financial measures.

Reported Net Interest Income

Reported net interest income of $254 million for FY2024 decreased $61 million, or 19%, from FY2023, driven by a decrease in the net interest yield of 24 basis points, or 24%, to 0.74%, partially offset by an increase in average interest-earning assets of $2,138 million, or 7%.

•Average Interest-Earning Assets: The increase in average interest-earning assets of 7% during FY2024 was primarily attributable to growth in average total loans of $2,222 million, or 7%, from FY2023, driven primarily by an increase in average long-term fixed-rate loans of $1,686 million and an increase in average line of credit loans of $503 million, as members continued to advance loans to fund capital expenditures and for working capital purposes.

•Net Interest Yield: The decrease in the net interest yield of 24 basis points, or 24%, was primarily attributable to thecombined impact ofan increase in our average cost of borrowings of 73 basis points to 4.17%, which was partially offset by an increase in the average yield on interest-earning assets of 45 basis points to 4.64% and an increase in the benefit from non-interest-bearing funding of 4 basis point to 0.27%. Our average yield on interest-earning assets and average cost of borrowings rose mainly due to the sustained increase in the federal funds rate, which increased 25 basis points since May 31, 2023. The increase in average yields on line of credit and variable-rate loans was the primary driver for the increase in the average yield on interest-earning assets. Meanwhile, our average cost of borrowings increased due to higher interest rates on our short-term and variable-rate borrowings.

Adjusted Net Interest Income

Adjusted net interest income of $381 million for FY2024 increased$32 million, or 9%, from FY2023, driven by the combined impact of an increase in average interest-earning assets of $2,138 million, or 7%, and an increase in the adjusted net interest yield of 3 basis points, or 3%, to 1.11%.

•Average Interest-Earning Assets: The increase in average interest-earning assets of 7% during FY2024 was driven by the growth in average total loans of $2,222 million, or 7%, from FY2023, primarily attributable to an increase in average long-term fixed-rate and line of credit loans as discussed above.

•Adjusted Net Interest Yield: The increase in the adjusted net interest yield of 3 basis points, or 3%, reflected the combined impact of an increase in the average yield on interest-earning assets of 45 basis points to 4.64% and an increase in the benefit from non-interest bearing funding of 2 basis points to 0.24%, partially offset by an increase in our adjusted average cost of borrowings of 44 basis points to 3.77%. The increase in both average yield on interest-earning assets and adjusted average cost of borrowings was attributable to the continued high interest-rate environment during FY2024, as discussed above.

Derivative Cash Settlements

We include the net periodic derivative cash settlements interest income (expense) amounts on our interest rate swaps in the calculation of our adjusted average cost of borrowings, which, as a result, also impacts the calculation of adjusted net interest income and adjusted net interest yield. Because our derivative portfolio consists of a higher proportion of pay-fixed swaps than receive-fixed swaps, the net periodic derivative cash settlements interest income (expense) amounts generally change based on changes in the floating interest amount received each period. When floating rates increase during the period, the floating interest amounts received on our pay-fixed swaps increase and, conversely, when floating rates decrease, the floating interest amounts received on our pay-fixed swaps decrease. We recorded net periodic derivative cash settlements interest income of $127 million and $34 million for FY2024 and FY2023, respectively, compared with derivative cash settlements expense of $101 million for FY2022. The increase inderivative cash settlements interest income between FY2024 and FY2023 was due to thehigher floating rates in FY2024, compared with FY2023, respectively.

See “Non-GAAP Financial Measures and Reconciliations” for additional information on our non-GAAP financial measures, including a reconciliation of these measures to the most comparable U.S. GAAP financial measures.

Provision for Credit Losses

Our provision for credit losses each period is driven by changes in our measurement of lifetime expected credit losses for our loan portfolio recorded in the allowance for credit losses. Our allowance for credit losses and allowance coverage ratio was $49 million and 0.14%, respectively, as of May 31, 2024. In comparison, our allowance for credit losses and allowance coverage ratio was $53 million and 0.16%, respectively, as of May 31, 2023.

We recorded a benefit for credit lossesof$5 million for FY2024, resulting from a decrease of $8 million in the asset-specific allowance for a nonperforming CFC power supply loan and a recovery of $1 million attributable to additional loan payments received from Brazos Electric Power Cooperative, Inc. (“Brazos”) and its wholly-owned subsidiary Brazos Sandy Creek Electric Cooperative Inc. (“Brazos Sandy Creek”), partially offset by an increase in the collective allowance of $4 million. The increase in the collective allowance was due to the growth in our loan portfolio, a slight decline in the overall credit quality of our loan portfolio andslightly higher expected default rates derived from a third-party utility sector default data used in estimating the allowance for credit losses. In contrast, we recorded a provision for credit losses of $1 million for FY2023. The provision for credit losses for FY2023 was driven primarily from an increase in the asset-specific allowance for loans to Brazos, Brazos Sandy Creek and for a nonperforming CFC power supply loan, attributable to a reduction and timing change in the expected payments on this loan.

We discuss our methodology for estimating the allowance for credit losses in “Note 1—Summary of Significant Accounting Policies—Allowance for Credit Losses—Loan Portfolio.” We also provide additional information on our allowance for credit losses below under section “Credit Risk—Allowance for Credit Losses” and “Note 5—Allowance for Credit Losses” in this Report.

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 gains and losses on equity and debt investment securities, which consists of both unrealized and realized gains and losses.

Table 5 presents the components of non-interest income (loss) recorded in our consolidated statements of operations.

Table 5: Non-Interest Income

The significant variance in non-interest income between fiscal years was primarily attributable to changes in the derivative gains recognized in our consolidated statements of operations. In addition, we experienced a favorable shift from losses to gains recorded on our debt and equity investment securities of $16 million for FY2024 compared with FY2023. We expect period-to-period market fluctuations in the fair value of our equity and debt investment securities, which we report together with realized gains and losses from the sale of investment securities on our consolidated statements of operations.

Derivative Gains (Losses)

As of May 31, 2024 and 2023, our derivatives portfolio included interest rate swap agreements not designated for hedge accounting, composed of pay-fixed swaps and receive-fixed swaps, with the benchmark variable rate for the floating rate payments based on daily compounded Secured Overnight Financing Rate (“SOFR”) as of May 31, 2024. Additionally, Treasury locks may be used to manage the interest rate risk associated with future debt issuance or repricing and are typically designated as cash flow hedges.

The total notional amount for our interest rate swaps was $7,366 million and $7,816 million as of May 31, 2024 and 2023, respectively. The portfolio was primarily composed of longer-dated pay-fixed swaps, which accounted for approximately 79% and 78% of the outstanding notional amount as of May 31, 2024 and 2023, respectively. Consequently, changes in medium- and longer-term swap rates generally have a more pronounced impact on the net fair value of our swap portfolio. As of both May 31, 2024 and May 31, 2023, the average remaining maturity of our pay-fixed and receive-fixed swaps was 18 years and two years, respectively.

Table 6 presents the components of net derivative gains (losses) recorded in our consolidated statements of operations. Derivative cash settlements interest income (expense) represents the net periodic contractual interest amount for our interest rate swaps during the reporting period. Derivative forward value gains (losses) represent the change in fair value of our interest rate swaps during the applicable reporting period due to changes in expected future interest rates over the remaining life of our derivative contracts.

Table 6: Derivative Gains (Losses)

We recorded derivative gains of $392 million for FY2024, primarily attributable to increases in the medium- and longer-term swap interest rates during FY2024. In comparison, we recorded derivative gains of $286 million for FY2023, attributable to increases in interest rates across the entire swap curve during the period.

During FY2023, we executed two Treasury lock agreements with an aggregate notional amount of $300 million to hedge interest rate risk on anticipated debt issuances. The Treasury locks were designated as a cash flow hedge of a forecasted transaction. We recorded a settlement gain of $8 million in AOCI upon the termination of the Treasury locks during FY2023. As the hedged forecasted transaction did not occur in the time period specified in the hedge documentation, we reclassified the $8 million gain from AOCI to earnings as a component of derivative gains (losses) in our consolidated statements of operations during FY2024. We did not have any derivatives designated as accounting hedges as of May 31, 2024 or May 31, 2023.

We present comparative swap curves, which depict the relationship between swap rates at varying maturities, for our reported periods in Table 7 below.

Comparative Swap Curves

Table 7 provides comparative swap curves as of May 31, 2024, 2023, 2022 and 2021.

Table 7: Comparative Swap Curves

Benchmark rates obtained from Bloomberg.

See “Note 1—Summary of Significant Accounting Policies—Derivative Instruments” and “Note 10—Derivative Instruments and Hedging Activities” for additional information on our derivative instruments. Also refer to “Note 14—Fair Value Measurement” for information on how we measure the fair value of our derivative instruments.

Non-Interest Expense

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

Table 8 presents the components of non-interest expense recorded in our consolidated statements of operations.

Table 8: Non-Interest Expense

Non-interest expense of $130 million for FY2024, increased $18 million, or 16%, from FY2023, primarily attributable to an increase in operating expenses, driven by higher expenses recorded for salaries and benefits, information technology, and depreciation and amortization expenses. During FY2024, we redeemed $100 million of our $400 million subordinated deferrable debt due 2043, at par plus accrued interest. As a result, we recognized $1 million of losses on early extinguishment of debt related to the unamortized debt issuance costs.

Net Income (Loss) Attributable to Noncontrolling Interests

Net income (loss) attributable to noncontrolling interests represents 100% of the results of operations of NCSC and RTFC, as the members of NCSC and RTFC own or control 100% of the interest in their respective companies. On December 1, 2023, RTFC completed the sale of its business to NCSC and subsequently CFC concluded that it is no longer the primary beneficiary of RTFC and accordingly, deconsolidated RTFC from its consolidated financial statements. The fluctuations in net income (loss) attributable to noncontrolling interests are primarily due to changes in the fair value of NCSC’s derivative instruments recognized in NCSC’s earnings.

We recorded a net income attributable to noncontrolling interests of $1 million and $3 million for FY2024 and FY2022, respectively. Our net income attributable to noncontrolling interests was less than $1 million for FY2023.