NOTE 13—FAIR VALUE MEASUREMENT

Fair Value of Financial Instruments

We use fair value measurements for the initial recording of certain assets and liabilities and periodic remeasurement of certain assets and liabilities on a recurring or nonrecurring basis. The accounting guidance for fair value measurements and disclosures establishes a three-level fair value hierarchy that prioritizes the inputs into the valuation techniques used to measure fair value. The levels of the fair value hierarchy, in priority order, include Level 1, Level 2 and Level 3. We describe the valuation technique for each level in “Note 1—Summary of Significant Accounting Policies.” The following tables present the carrying value and fair value for all of our financial instruments, including those carried at amortized cost, as of May 31, 2018 and 2017. The tables also display the classification within the fair value hierarchy of the valuation technique used in estimating fair value.



	May 31, 2018				Fair Value Measurements Level
(Dollars in thousands)	Carrying Value		Fair Value		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	230,999	$	230,999	$	230,999	$	—	$	—
Restricted cash	7,825		7,825		7,825		—		—
Time deposits	101,000		101,000		—		101,000		—
Investment securities, available for sale	89,332		89,332		89,332		—		—
Investment securities, held to maturity	519,519		515,546		—		515,546		—
Deferred compensation investments	5,194		5,194		5,194		—		—
Loans to members, net	25,159,807		24,167,886		—		—		24,167,886
Accrued interest receivable	127,442		127,442		—		127,442		—
Debt service reserve funds	17,151		17,151		17,151		—		—
Derivative assets	244,526		244,526		—		244,526		—

Liabilities:
Short-term borrowings	$	3,795,910	$	3,795,799	$	—	$	3,695,799	$	100,000
Long-term debt	18,714,960		18,909,276		—		11,373,216		7,536,060
Accrued interest payable	149,284		149,284		—		149,284		—
Guarantee liability	10,589		10,454		—		—		10,454
Derivative liabilities	275,932		275,932		—		275,932		—
Subordinated deferrable debt	742,410		766,088		—		766,088		—
Members’ subordinated certificates	1,379,982		1,380,004		—		—		1,380,004



	May 31, 2017				Fair Value Measurements Level
(Dollars in thousands)	Carrying Value		Fair Value		Level 1		Level 2		Level 3
Assets:
Cash and cash equivalents	$	166,615	$	166,615	$	166,615	$	—	$	—
Restricted cash	21,806		21,806		21,806		—		—
Time deposits	226,000		226,000		—		226,000		—
Investment securities, available for sale	92,554		92,554		92,554		—		—
Deferred compensation investments	4,693		4,693		4,693		—		—
Loans to members, net	24,329,668		24,182,724		—		—		24,182,724
Accrued interest receivable	111,493		111,493		—		111,493		—
Debt service reserve funds	17,151		17,151		17,151		—		—
Derivative assets	49,481		49,481		—		49,481		—

Liabilities:
Short-term borrowings	$	3,342,900	$	3,342,990	$	—	$	3,342,990	$	—
Long-term debt	17,955,594		18,744,331		—		11,215,290		7,529,041
Accrued interest payable	137,476		137,476		—		137,476		—
Guarantee liability	15,241		16,204		—		—		16,204
Derivative liabilities	385,337		385,337		—		385,337		—
Subordinated deferrable debt	742,274		788,079		—		788,079		—
Members’ subordinated certificates	1,419,025		1,419,048		—		—		1,419,048

Following is a description of the valuation techniques we use to estimate fair value, the significant inputs used in those techniques, if applicable, and the classification within the fair value hierarchy.

Cash and Cash Equivalents

Cash and cash equivalents include cash and certificates of deposit with original maturities of less than 90 days. Cash and cash equivalents are valued at the carrying value, which approximates fair value and are classified within Level 1 of the fair value hierarchy.

Restricted Cash

Restricted cash consists of cash and cash equivalents for which use is contractually restricted. The carrying value of restricted cash approximates fair value and is classified within Level 1 of the fair value hierarchy.

Time Deposits

Time deposits with financial institutions in interest-bearing accounts have maturities of less than one year as of the reporting date and are valued at the carrying value, which approximates fair value, and are classified within Level 2 of the fair value hierarchy.

Investment Securities, Available for Sale

Our investments in equity securities consist of investments in Farmer Mac Class A common stock and Series A, Series B and Series C preferred stock. These securities are classified as available for sale and reported at fair value in our consolidated balance sheets. We determine the fair value based on quoted prices on the stock exchange where the stock is traded. That stock exchange with respect to Farmer Mac Class A common stock is an active market based on the volume of shares transacted. Fair values for these securities are classified within Level 1 of the fair value hierarchy.

Investment Securities, Held to Maturity

As discussed above in “Note 3—Investment Securities,” we did not have any securities classified as HTM as of May 31, 2017. During the second quarter of fiscal year 2018, we commenced the purchase of additional investment securities, consisting primarily of certificates of deposit, commercial paper and corporate debt securities, commercial MBS and other ABS traded in secondary markets. We designated these securities as HTM.

Management estimates the fair value of our HTM securities utilizing the assistance of third-party pricing services. Methodologies employed, controls relied upon and inputs used by third-party pricing vendors are subject to management review when such services are provided. This review may consist of, in part, obtaining and evaluating control reports issued and pricing methodology materials distributed. We review the pricing methodologies provided by the vendors in order to determine if observable market information is being used to determine the fair value versus unobservable inputs. Investment securities traded in secondary markets are typically valued using unadjusted vendor prices. These investment securities, which include those measured using unadjusted vendor prices, are generally classified as Level 2 because the valuation typically involves using quoted market prices for similar securities, pricing models, discounted cash flow analyses using significant observable market where available or a combination of multiple valuation techniques for which all significant

assumptions are observable in the market.

Deferred Compensation Investments

CFC offers a nonqualified 457(b) deferred compensation plan to highly compensated employees. Such amounts deferred by employees are invested by the company. The deferred compensation investments are presented as other assets in the consolidated balance sheets in the other assets category at fair value. We calculate fair value based on the daily published and quoted net asset value and these investments are classified within Level 1 of the fair value hierarchy.

Loans to Members, Net

As part of receiving a loan from us, our members have additional requirements and rights that are not typical of other financial institutions, such as the ability to receive a patronage capital allocation, the general requirement to purchase subordinated certificates or member capital securities to meet their capital contribution requirements as a condition of obtaining additional credit from us, the option to select fixed rates from one year to maturity with the fixed rate resetting or repricing at the end of each selected rate term, the ability to convert from a fixed rate to another fixed rate or the variable rate at any time, and certain interest rate discounts that are specific to the borrower’s activity with us. These features make it difficult to obtain market data for similar loans. Therefore, we must use other methods to estimate the fair value.

Fair values for fixed-rate loans are estimated using a discounted cash flow technique by discounting the expected future cash flows using the current rates at which we would make similar loans to new borrowers for the same remaining maturities. The maturity date used in the fair value calculation of loans with a fixed rate for a selected rate term is the next repricing date since these borrowers must reprice their loans at various times throughout the life of the loan at the current market rate.

Loans with different risk characteristics, specifically nonperforming and restructured loans, are valued by using collateral valuations or by adjusting cash flows for credit risk and discounting those cash flows using the current rates at which similar loans would be made by us to borrowers for the same remaining maturities. See below for more details about how we calculate the fair value of certain impaired loans.

The carrying value of our variable-rate loans adjusted for credit risk approximates fair value since variable-rate loans are eligible to be reset at least monthly.

Loans to members are classified within Level 3 of the fair value hierarchy.

Accrued Interest Receivable

Accrued interest receivable represents accrued interest to be collected on our loans to members and derivative instruments and is valued at the carrying value, which approximates fair value. Accrued interest receivable is classified within Level 2 of the fair value hierarchy.

Debt Service Reserve Funds

Debt service reserve funds represent cash and/or investments on deposit with the bond trustee for tax-exempt bonds that we guarantee. Debt service reserve fund investments include actively traded tax-exempt municipal bonds and commercial paper. The carrying value approximates the fair value and the valuation technique is classified as Level 1.

Short-Term Borrowings

Short-term borrowings consist of commercial paper, select notes, bank bid notes, daily liquidity fund notes, medium-term notes and notes payable. The fair value of short-term borrowings with maturities less than or equal to 90 days is carrying value, which is a reasonable estimate of fair value. The fair value of short-term borrowings with maturities greater than 90 days is estimated based on discounted cash flows using discount rates consistent with current market rates for similar products with similar remaining terms. Short-term borrowings classified within Level 2 of the fair value hierarchy include dealer commercial paper, daily liquidity fund notes, member commercial paper and select notes.

Short-term borrowings classified within Level 2 also include our medium-term notes with an original maturity equal to or less than one year. The fair value of short-term medium-term notes classified within Level 2 of the fair value hierarchy were determined based on discounted cash flows using a pricing model that incorporates available market information such as indicative benchmark yields and credit spread assumptions that are provided by third-party pricing services such as the banks that underwrite our other debt transactions.

Short-term borrowings classified within Level 3 include notes payable with an original maturity equal to or less than one year. These short-term notes payable are issued in private placement transactions and there is no secondary trading of such debt. As these short-term notes payable are issued at a variable rate and with a maturity of less than 90 days, the fair value equals the carrying value, which is a reasonable estimate of fair value.

Long-Term Debt

Long-term debt consists of collateral trust bonds, medium-term notes and long-term notes payable. We issue substantially all collateral trust bonds and some medium-term notes in underwritten public transactions. Collateral trust bonds and medium-term notes are classified within Level 2 of the fair value hierarchy. The fair value of long-term debt classified within Level 2 of the fair value hierarchy was determined based on discounted cash flows. There is no active secondary trading for the underwritten collateral trust bonds and medium-term notes; therefore, dealer quotes and recent market prices are both used in estimating fair value. There is essentially no secondary market for the medium-term notes issued to our members or in transactions that are not underwritten; therefore, fair value is estimated based on observable benchmark yields and spreads for similar instruments supplied by banks that underwrite our other debt transactions.

The long-term notes payable are issued in private placement transactions and there is no secondary trading of such debt. Long-term notes payable are classified within Level 3 of the fair value hierarchy. The fair value was determined based on discounted cash flows using benchmark yields and spreads for similar instruments supplied by underwriter quotes for similar instruments, if available. Secondary trading quotes for our debt instruments used in the determination of fair value incorporate our credit risk.

Accrued Interest Payable

Accrued interest payable represents accrued interest to be paid on our debt and derivative instruments and is valued at the carrying value, which approximates fair value. Accrued interest payable is classified within Level 2 of the fair value hierarchy.

Guarantees

The fair value of our guarantee liability is based on the fair value of our contingent and noncontingent exposure related to our guarantees. The fair value of our contingent exposure for guarantees is based on management’s estimate of our exposure to losses within the guarantee portfolio using a discounted cash flow method. The fair value of our noncontingent exposure for guarantees issued is estimated based on the total unamortized balance of guarantee fees paid and guarantee fees to be paid discounted at our current short-term funding rate, which represents management’s estimate of the fair value of our obligation to stand ready to perform. Guarantees are classified within Level 3 of the fair value hierarchy.

Subordinated Deferrable Debt

Subordinated deferrable debt outstanding was issued in underwritten public transactions. There is no active secondary trading for this subordinated deferrable debt; therefore, dealer quotes and recent market prices are both used in estimating fair value based on a discounted cash flow method. Subordinated deferrable debt is classified within Level 2 of the fair value hierarchy.

Members’ Subordinated Certificates

Members’ subordinated certificates include (i) membership subordinated certificates issued to our members, (ii) loan and guarantee subordinated certificates issued as a condition of obtaining loan funds or guarantees and (iii) member capital securities issued as voluntary investments by our members. Generally, members’ subordinated certificates are nontransferable other than among members with CFC’s consent and there is no ready market from which to obtain fair value quotes. These certificates are valued at par and are classified within Level 3 of the fair value hierarchy.

Derivative Instruments

We account for derivative instruments in the consolidated balance sheets as either an asset or liability measured at fair value. We only enter into swap agreements with counterparties that are participating in our revolving lines of credit at the time the exchange agreements are executed. All of our swap agreements are subject to master netting agreements. There is not an active secondary market for the types of interest rate swaps we use. We determine the fair value of our derivatives using models that incorporate observable market inputs, such as spot LIBOR rates, Eurodollar futures contracts and market swap rates. These inputs can vary depending on the type of derivative and nature of the underlying rate, price or index upon which the derivative’s value is based. The impact of counterparty nonperformance risk is considered when measuring the fair value of derivative assets. Internal pricing is compared against additional pricing sources, such as external valuation agents and other sources. Pricing variances among different pricing sources are analyzed and validated. The technique for determining the fair value for our interest rate swaps is classified as Level 2.

Commitments

The fair value of our commitments is estimated based on the carrying value, or zero. Extensions of credit under these commitments, if exercised, would result in loans priced at market rates.

Recurring Fair Value Measurements

The following table presents the carrying value and fair value of financial instruments reported in our consolidated financial statements at fair value on a recurring basis as of May 31, 2018 and 2017 and the classification of the valuation technique within the fair value hierarchy.



	May 31,
	2018						2017
(Dollars in thousands)	Level 1		Level 2		Total		Level 1		Level 2		Total
Investment securities available for sale	$	89,332	$	—	$	89,332	$	92,554	$	—	$	92,554
Deferred compensation investments	5,194		—		5,194		4,693		—		4,693
Derivative assets	—		244,526		244,526		—		49,481		49,481
Derivative liabilities	—		275,932		275,932		—		385,337		385,337

Transfers Between Levels

We monitor the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy and transfer between Level 1, Level 2 and Level 3 accordingly. Observable market data includes, but is not limited to, quoted prices and market transactions. Changes in economic conditions or market liquidity generally will drive changes in availability of observable market data. Changes in availability of observable market data, which also may result in changes in the valuation technique used, are generally the cause of transfers between levels. We did not have any transfers between levels for financial instruments measured at fair value on a recurring basis for the years ended May 31, 2018 and 2017.

Nonrecurring Fair Value Measurements

We may be required, from time to time, to measure certain assets at fair value on a nonrecurring basis in accordance with GAAP. Any adjustments to fair value usually result from application of lower-of-cost or fair value accounting or write-downs of individual assets. Assets measured at fair value on a nonrecurring basis as of May 31, 2018 and 2017 consisted of certain impaired loans. The fair value of these assets is determined based on the use of significant unobservable inputs, which are considered Level 3 in the fair value hierarchy.

We did not have any assets or liabilities reported in our consolidated financial statements at fair value on a nonrecurring basis during the years ended May 31, 2018 and 2017.

Significant Unobservable Level 3 Inputs

Impaired Loans

We utilize the fair value of estimated cash flows or the collateral underlying the loan to determine the fair value and specific allowance for impaired loans. The valuation technique used to determine fair value of the impaired loans provided by both our internal staff and third-party specialists includes market multiples (i.e., comparable companies). The significant unobservable inputs used in the determination of fair value for individually impaired loans is a multiple of earnings before interest, taxes, depreciation and amortization based on various factors (i.e., financial condition of the borrower). In estimating the fair value of the collateral, we may use third-party valuation specialists, internal estimates or a combination of both. The significant unobservable inputs for estimating the fair value of impaired collateral-dependent loans are reviewed by our Credit Risk Management group to assess the reasonableness of the assumptions used and the accuracy of the work performed. In cases where we rely on third-party inputs, we use the final unadjusted third-party valuation analysis as support for any adjustments to our consolidated financial statements and disclosures.

Because of the limited amount of impaired loans as of May 31, 2018 and 2017, we do not believe that potential changes in the significant unobservable inputs used in the determination of the fair value for impaired loans will have a material impact on the fair value measurement of these assets or our results of operations.