10-Q: CFC Reports Q2 FY2026 Net Income Decline Amid Derivative Losses

National Rural Utilities Cooperative Finance Corporation reported a significant decrease in net income for Q2 FY2026, primarily due to derivative losses, despite growth in its loan portfolio.

Summary

• Net income for Q2 FY2026 was $19,558 thousand, a significant decrease from $144,803 thousand in Q2 FY2025.
• Year-to-date net income for FY2026 was $24,240 thousand, an increase from a net loss of $(19,523) thousand in YTD FY2025.
• The Times Interest Earned Ratio (TIER) for Q2 FY2026 decreased to 1.05 from 1.41 in Q2 FY2025, while YTD FY2026 TIER increased to 1.03 from 0.97 in YTD FY2025.
• Adjusted net income for Q2 FY2026 was $55,784 thousand, down from $62,171 thousand in Q2 FY2025, and YTD FY2026 adjusted net income was $112,937 thousand, down from $128,231 thousand in YTD FY2025.
• Total loans to members increased by $762 million, or 2%, to $37,842 million as of November 30, 2025, from May 31, 2025.
• Total debt outstanding increased by $827 million, or 2%, to $35,596 million as of November 30, 2025, primarily to fund loan growth.
• The debt-to-equity ratio increased to 11.58 as of November 30, 2025, from 11.20 as of May 31, 2025, driven by increased debt and a decrease in total equity due to patronage capital retirement.
• Available liquidity totaled $7,975 million as of November 30, 2025, which was $2,515 million less than total scheduled debt obligations of $10,490 million over the next 12 months.
• The liquidity coverage ratio declined to 0.76 as of November 30, 2025, from 0.87 as of May 31, 2025.
• The allowance for credit losses increased to $43 million as of November 30, 2025, from $41 million as of May 31, 2025, primarily due to loan portfolio growth.

Sentiment

Score: 4

Explanation: While the company experienced strong loan growth and maintained good credit quality, the significant drop in reported net income due to derivative losses and a decline in liquidity coverage ratios indicate a challenging quarter. The forward outlook projects some improvements but also anticipates increased operating expenses and a higher debt-to-equity ratio.

Positives

• Net interest income increased by $7 million for Q2 FY2026 and $16 million for YTD FY2026, driven by higher average interest-earning assets and an increased net interest yield.
• Average interest-earning assets grew by $2,109 million (6%) for Q2 FY2026 and $2,166 million (6%) for YTD FY2026.
• The loan portfolio expanded by $762 million (2%) to $37,842 million as of November 30, 2025, reflecting net increases in long-term and line of credit loans.
• Credit quality remained strong with no loan charge-offs during YTD FY2026 and YTD FY2025.
• A nonperforming loan balance was reduced from $26 million to $24 million, with a subsequent payment further reducing it to $13 million.
• Fitch Ratings and S&P Global Inc. affirmed CFC's credit ratings and stable outlook during YTD FY2026.
• Committed bank revolving line of credit agreements were amended to extend maturity dates and increase total commitments by $200 million to $3,500 million.
• An additional $450 million loan facility from the U.S. Treasury Department's Federal Financing Bank (FFB) was secured under the Guaranteed Underwriter Program.
• Projected net loan growth of $2,095 million is anticipated over the next 12 months.
• Projected increases in reported net interest income and net interest yield are expected over the next 12 months.

Negatives

• Net income for Q2 FY2026 significantly decreased by $125,245 thousand compared to Q2 FY2025, primarily due to a $128 million shift from derivative gains to losses.
• The TIER for Q2 FY2026 decreased to 1.05 from 1.41 in Q2 FY2025.
• Adjusted net income decreased by $6,387 thousand for Q2 FY2026 and $15,294 thousand for YTD FY2026.
• The adjusted TIER decreased for both Q2 FY2026 and YTD FY2026.
• The debt-to-equity ratio increased to 11.58 from 11.20, driven by increased debt and a decrease in total equity.
• Available liquidity of $7,975 million was $2,515 million less than total scheduled debt obligations of $10,490 million over the next 12 months.
• The liquidity coverage ratio declined from 0.87 as of May 31, 2025, to 0.76 as of November 30, 2025.
• S&P withdrew its A-2 short-term issue ratings on CFC's commercial paper program on June 2, 2025.
• Derivative losses of $18,641 thousand for Q2 FY2026 and $50,845 thousand for YTD FY2026 were recorded, primarily due to declines in short-term and longer-term swap interest rates.
• Gains on investment securities decreased by $3 million for Q2 FY2026 and $6 million for YTD FY2026.
• Operating and other expenses increased by $2 million for Q2 FY2026 and $6 million for YTD FY2026.
• A patronage capital retirement of $53 million authorized by the CFC Board of Directors in July 2025 contributed to the decrease in total equity.
• A projected decrease in adjusted net income over the next 12 months is expected due to an increase in projected operating expenses.
• A slight decrease in adjusted TIER is projected over the next 12 months.
• An increase in the adjusted debt-to-equity ratio is projected due to anticipated growth in the loan portfolio requiring additional funding.

Risks

• Credit risk, primarily from the loan portfolio, which is inherently subject to single-industry (rural electric cooperatives) and single-obligor concentration risk.
• Liquidity risk, including the ability to fund operations, meet contractual obligations, and fund new loans, with reliance on rolling over member short-term investments.
• Market risk, particularly interest rate risk, due to differences in timing between the maturity or repricing of loans and funding liabilities, and the impact of interest rate volatility on derivatives not accounted for under hedge accounting.
• Operational risk, encompassing losses from inadequate or failed internal controls, processes, systems, human error, or external events like natural disasters and public health emergencies, as well as cybersecurity, compliance, fiduciary, reputational, and litigation risks.
• Counterparty credit risk from derivative transactions and investments in debt and equity securities.
• Credit rating downgrade risk, which could trigger early termination provisions in derivative contracts or limit cash patronage capital distributions.
• Macroeconomic conditions, governmental monetary and fiscal policies, and natural disasters, including severe weather events, can significantly affect financial performance.
• Legislative changes that could impact CFC's tax status and other operational matters.
• Competition for loan products in the lending market.
• Changes in the quality or composition of the loan portfolio.
• Changes in the ability to access external financing.
• Fluctuations in interest rates and market volatility.
• Valuation of collateral supporting impaired loans.
• Charges associated with the operation or disposition of foreclosed assets.
• Nonperformance of counterparties to derivative agreements.
• Economic conditions and regulatory or technological changes within the rural electric industry.
• Costs and impact of legal or governmental proceedings involving CFC or its members.

Future Outlook

The Federal Open Market Committee (FOMC) cut its target range for the federal funds rate by 25 basis points to 3.50%-3.75% in December 2025, with expectations for two additional 25 basis point rate cuts in calendar year 2026, leading to a projected range of 3.00%-3.25% by year-end. The market anticipates declining short-term interest rates and a steepening yield curve. Real GDP growth for 2026 is projected at 2.3%, up from 1.8%, while Personal Consumption Expenditures (PCE) inflation is expected to decline to 2.4% from 2.6%. The U.S. unemployment rate is projected to average 4.4% in 2026. CFC projects increases in reported net interest income and net interest yield over the next 12 months. Adjusted net interest income is also expected to increase slightly, driven by projected loan growth and lower adjusted average cost of funding, though partially offset by lower expected average yield on interest rate swaps and higher refinancing costs for maturing lower-cost debt. Adjusted net income is projected to decrease due to increased operating expenses, leading to a slight decrease in adjusted TIER. The adjusted debt-to-equity ratio is expected to increase due to anticipated loan portfolio growth funding. Net loan growth of $2,095 million is anticipated over the next 12 months. CFC expects to continue rolling over member short-term investments and accessing the dealer commercial paper market, as well as issuing long-term debt in public capital markets and through non-capital market arrangements.

Management Comments

• Our financial goals focus on earning an annual minimum adjusted TIER of 1.10.
• Our financial goals focus on maintaining an adjusted debt-to-equity ratio at approximately 8.5-to-1 or below.
• We believe we can continue to roll over our member short-term investments based on our expectation that our members will continue to reinvest their excess cash primarily in short-term investment products offered by CFC.
• We believe we have sufficient sources of liquidity to meet our debt obligations and support our operations over the next 12 months.
• We expect that the majority of the long-term unadvanced loan commitments of $8,122 million will be advanced prior to the expiration of the commitment.
• Management presently believes that the ultimate outcome of these proceedings, individually and in the aggregate, will not materially harm our financial position, liquidity or results of operations.

Industry Context

CFC operates primarily within the rural electric utility cooperative sector, providing essential electric services. These cooperatives often benefit from operating in states without rate regulation, allowing for cost recovery through rate adjustments, and face limited competition in their exclusive territories. As not-for-profit entities, they are typically eligible for federal and state disaster assistance. The industry generally follows a conservative business model, contributing to stable operating environments. While investment in broadband projects by member electric cooperatives has slowed, it is expected to continue at a reduced pace. The broader financial market is characterized by anticipated federal funds rate cuts and a steepening yield curve, which will influence funding costs and derivative valuations across the financial services industry.

Comparison to Industry Standards

• CFC's borrower risk ratings align with the U.S. federal banking regulatory agencies' credit risk definitions of pass and criticized categories.
• CFC's investment policy guidelines require all fixed-income debt securities, at the time of purchase, to be rated at least investment grade by external credit rating agencies (e.g., S&P, Moody's, Fitch).

Corporate Governance

Legal Proceedings

• CFC is subject to certain legal proceedings and claims in the ordinary course of business, including litigation with borrowers related to enforcement or collection actions.
• Management believes the ultimate outcome of these proceedings will not materially harm CFC's financial position, liquidity, or results of operations.
• No reserve has been recorded for any legal proceedings at this time.

Related Party Transactions

• National Cooperative Services Corporation (NCSC) is a variable interest entity (VIE) consolidated by CFC, with CFC being the primary source of funding and unconditionally guaranteeing NCSC's loan losses.
• CFC manages NCSC's business operations under a management agreement and charges NCSC a management fee.
• CFC loans to NCSC are secured by all assets and revenue of NCSC.
• NCSC is a Class C member of CFC.
• Member investments in CFC debt securities (commercial paper, select notes, daily liquidity fund notes, medium-term notes) represent an important and stable source of funding, accounting for 14% of total debt outstanding as of November 30, 2025.

Stakeholder Impact

• Shareholders (members) received a patronage capital retirement of $53 million in cash in September 2025, and fiscal year 2025 adjusted net income was allocated to patronage capital ($67 million) and members capital reserve ($176 million).
• Employees experienced higher expenses recorded for salaries and employee benefits.
• Customers (borrowers) continue to benefit from loan growth and available financing for capital expenditures, working capital, and emergency recovery costs (e.g., Hurricane Helene), as well as broadband projects.
• Creditors and lenders benefit from the affirmation of CFC's credit ratings and stable outlook by Fitch and S&P, as well as increased total commitment amounts under revolving credit agreements and compliance with all debt covenants.
• Regulatory bodies are impacted by CFC's compliance with SEC filing requirements and ongoing evaluation of internal controls.

Next Steps

• Fund $150 million of the $600 million private placement of subordinated notes in Q3 FY2026.
• Fund the remaining $450 million of the $600 million private placement of subordinated notes in Q4 FY2026.
• Continue to roll over member short-term investments.
• Continue accessing the dealer commercial paper market.
• Continue issuing long-term debt in public capital markets and under other non-capital market debt arrangements.
• Monitor and manage interest rate risk using Asset Liability Management (ALM) models and various methodologies.
• Evaluate the impact of new accounting standards (ASU 2025-08 and ASU 2025-06) on consolidated financial statements and disclosures.
• Adopt ASU 2025-08, Financial Instruments—Credit Losses (Topic 326): Purchased Loans, on June 1, 2027.
• Adopt ASU 2025-06, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Targeted Improvements to the Accounting for Internal-Use Software, on June 1, 2028.
• Adopt ASU 2024-03, Income Statement—Reporting Comprehensive Income—Expense Disaggregation Disclosures (Subtopic 220-40), in the annual report for the fiscal year ended May 31, 2028, and interim disclosure requirements in the quarterly report for the quarter ended August 31, 2028.

Key Dates

Recommendation

While the significant drop in reported net income due to derivative losses and the decline in liquidity coverage ratios are concerning, the underlying business fundamentals remain strong with consistent loan portfolio growth and stable credit quality. The company's proactive management of its credit facilities and positive outlook for net interest income in the coming year provide some reassurance. However, the projected increase in operating expenses and debt-to-equity ratio warrant a cautious 'Hold' stance, advising investors to monitor future performance and the interest rate environment closely.

Keywords

Rural Utilities, Cooperative Finance, SEC Filing, 10-Q, Financial Results, Loan Portfolio, Debt, Liquidity, Credit Risk, Interest Rates, Derivatives, Financial Performance, Energy Sector, Telecommunications, Credit Ratings, Capital Markets, Patronage Capital, SEC