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Fannie Mae 10-K 2008 Documents found in this filing:
UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO
SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT
OF 1934
For the fiscal year ended December 31, 2007
Commission File No.: 0-50231
Fannie Mae
Registrant’s telephone number, including area code:
(202) 752-7000
Securities registered pursuant to Section 12(b) of the
Act:
None
Securities registered pursuant to Section 12(g) of the
Act:
Common Stock, without par value
Indicate by check mark if the registrant is a well-known
seasoned issuer, as defined in Rule 405 of the Securities
Act. Yes o No þ
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or 15(d) of the
Act. Yes o No þ
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding
12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been
subject to such filing requirements for the past
90 days. Yes þ No o
Indicate by check mark if disclosure of delinquent filers
pursuant to Item 405 of
Regulation S-K
is not contained herein, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in
Part III of this
Form 10-K
or any amendment to this
Form 10-K. o
Indicate by check mark whether the registrant is a large
accelerated filer, an accelerated filer, a non-accelerated
filer, or a smaller reporting company. See the definitions of
“large accelerated filer,” “accelerated
filer” and “smaller reporting company” in
Rule 12b-2
of the Exchange Act. (Check one):
Indicate by check mark whether the registrant is a shell company
(as defined in
Rule 12b-2
of the
Act). Yes o No þ
The aggregate market value of the common stock held by
non-affiliates of the registrant computed by reference to the
price at which the common stock was last sold on June 29,
2007 (the last business day of the registrant’s most
recently completed second fiscal quarter) was approximately
$63,724 million.
As of January 31, 2008, there were 978,284,482 shares
of common stock of the registrant outstanding.
Portions of the registrant’s Proxy Statement for the 2008
Annual Meeting of Shareholders and the registrant’s Current
Report on
Form 8-K
to be filed contemporaneously with the Proxy Statement are
incorporated by reference in this
Form 10-K
in response to Items 10, 11, 12, 13 and 14 of Part III.
Because of the complexity of our business and the industry in
which we operate, we have included in this annual report on
Form 10-K
a glossary under
“Part II—Item 7—Management’s
Discussion and Analysis of Financial Condition and Results of
Operations (“MD&A”)—Glossary of Terms Used
in This Report.”
Fannie Mae’s activities enhance the liquidity and stability
of the mortgage market and contribute to making housing in the
United States more affordable and more available to low-,
moderate- and middle-income Americans. These activities include
providing funds to mortgage lenders through our purchases of
mortgage assets, and issuing and guaranteeing mortgage-related
securities that facilitate the flow of additional funds into the
mortgage market. We also make other investments that increase
the supply of affordable housing.
We are a government-sponsored enterprise (“GSE”)
chartered by the U.S. Congress under the name “Federal
National Mortgage Association” and are aligned with
national policies to support expanded access to housing and
increased opportunities for homeownership. We are subject to
government oversight and regulation. Our regulators include the
Office of Federal Housing Enterprise Oversight
(“OFHEO”), the Department of Housing and Urban
Development (“HUD”), the Securities and Exchange
Commission (“SEC”), and the Department of the Treasury.
Although we are a corporation chartered by the
U.S. Congress, the U.S. government does not guarantee,
directly or indirectly, our securities or other obligations. We
are a stockholder-owned corporation, and our business is
self-sustaining and funded exclusively with private capital. Our
common stock is listed on the New York Stock Exchange, and
traded under the symbol “FNM.” Our debt securities are
actively traded in the over-the-counter market.
We operate in the U.S. residential mortgage market,
specifically in the secondary mortgage market where mortgages
are bought and sold. We discuss below market and economic
factors affecting our business and our role in the secondary
mortgage market.
Our business operates within the U.S. residential mortgage
market, and therefore, we consider the amount of
U.S. residential mortgage debt outstanding to be the best
measure of the size of our overall market. As of
September 30, 2007, the latest date for which information
was available, the amount of U.S. residential mortgage debt
outstanding was estimated by the Federal Reserve to be
approximately $11.8 trillion (including $11.0 trillion of
single-family mortgages). Our mortgage credit book of business,
which includes mortgage assets we hold in our investment
portfolio, our Fannie Mae mortgage-backed securities
(“Fannie Mae MBS”) held by third parties and credit
enhancements that we provide on mortgage assets, was $2.8
trillion as of September 30, 2007, or approximately 23% of
total U.S. residential mortgage debt outstanding.
The table below provides overall housing and mortgage market
statistics for 2007, 2006 and 2005.
Mortgage and housing market conditions, which significantly
affect our business and our financial performance, worsened
progressively through 2007. The housing market downturn that
began in the second half of 2006 continued through 2007 and is
continuing in 2008. The most recent available data show
significant declines in new and existing home sales, housing
starts and mortgage originations compared with prior year
levels. Overall housing demand decreased over the past year due
to a slowdown in the overall economy, affordability constraints,
and declines in demand for investor properties and second homes,
which had been a key driver of overall housing activity. In
addition, inventories of unsold homes have risen significantly
over the past year. The decreased demand and increased supply in
the housing market has put downward pressure on home prices. We
estimate that home prices declined by 3.1% on a national basis
during 2007. With weak housing activity and national home price
declines, growth in total U.S. residential mortgage debt
outstanding slowed to an estimated annual rate of 8% in the
first nine months of 2007, compared with 12% over the first nine
months of 2006.
These challenging market and economic conditions caused a
material increase in mortgage delinquencies and foreclosures
during 2007. The credit performance of subprime and Alt-A loans,
as well as other higher risk loans, has deteriorated sharply
during the past year, and even the prime conventional portion of
the mortgage
market has seen signs of credit distress. Many lenders have
tightened lending standards or elected to stop originating
subprime and other higher risk loans completely, which has
adversely affected many borrowers seeking alternative financing
to refinance out of adjustable-rate mortgages (“ARMs”)
resetting to higher rates.
The reduction in liquidity and funding sources in the mortgage
credit market has led to a substantial shift in mortgage
originations. The share of mortgage originations consisting of
traditional fixed-rate conforming mortgages has increased
substantially, while the share of mortgage originations
consisting of Alt-A and subprime mortgages has dropped
significantly. Moreover, credit concerns and the resulting
liquidity issues have affected the general capital markets.
During the second half of 2007, the capital markets were
characterized by high levels of volatility, reduced levels of
liquidity in the mortgage and broader credit markets,
significantly wider credit spreads and rating agency downgrades
on a growing number of mortgage-related securities. In response
to concerns over liquidity in the financial markets, from August
2007 through January 2008, the Federal Reserve reduced its
discount rate by a total of 275 basis points to 3.50% and
lowered the federal funds rate during this period by a total of
225 basis points to 3.00%. After rising in the first half
of the year, long-term bond yields declined during the second
half of 2007. As short-term interest rates decreased in the
second half of 2007, the spread between long- and short-term
interest rates widened, resulting in a steepening of the yield
curve.
We expect the slower growth trend in U.S. residential
mortgage debt outstanding to continue throughout 2008, and we
believe average home prices are likely to continue to decline in
2008. See “Item 1A—Risk Factors” for a
description of the risks associated with the housing market
downturn and recent home price declines.
The U.S. Congress chartered Fannie Mae and certain other
GSEs to help ensure stability and liquidity within the secondary
mortgage market. In addition, we believe our activities and
those of other GSEs help lower the costs of borrowing in the
mortgage market, which makes housing more affordable and
increases homeownership, especially for low- to moderate-income
families. We believe our activities also increase the supply of
affordable rental housing.
We operate in the secondary mortgage market where mortgages are
bought and sold. We securitize mortgage loans originated by
lenders in the primary mortgage market into Fannie Mae MBS,
which can then be readily bought and sold in the secondary
mortgage market. For a description of the securitization
process, refer to “Business Segments—Single-Family
Credit Guaranty Business—Mortgage Securitizations”
below. By delivering loans to us in exchange for Fannie Mae MBS,
lenders gain the advantage of holding a highly liquid instrument
that offers them the flexibility to determine under what
conditions they will hold or sell the MBS. We also participate
in the secondary mortgage market by purchasing mortgage loans
(often referred to as “whole loans”) and
mortgage-related securities, including Fannie Mae MBS, for our
mortgage portfolio. By selling loans and mortgage-related
securities to us, lenders replenish their funds and,
consequently, are able to make additional loans. Under our
charter, we may not lend money directly to consumers in the
primary mortgage market.
Our principal customers are lenders that operate within the
primary mortgage market where mortgage loans are originated and
funds are loaned to borrowers. Our customers include mortgage
banking companies, investment banks, savings and loan
associations, savings banks, commercial banks, credit unions,
community banks, insurance companies, and state and local
housing finance agencies. Lenders originating mortgages in the
primary mortgage market often sell them in the secondary
mortgage market in the form of whole loans or in the form of
mortgage-related securities.
During 2007, approximately 1,000 lenders delivered mortgage
loans to us, either for securitization or for purchase. We
acquire a significant portion of our single-family mortgage
loans from several large mortgage lenders. During 2007, our top
five lender customers, in the aggregate, accounted for
approximately 56% of our single-family business volume, compared
with 51% in 2006.
Our top customer, Countrywide Financial Corporation (through its
subsidiaries), accounted for approximately 28% of our
single-family business volume in 2007, compared with 26% in
2006. In January 2008, Bank of America Corporation announced
that it had reached an agreement to purchase Countrywide
Financial Corporation. Together, Bank of America and Countrywide
accounted for approximately 32% of our single-family business
volume in 2007. If the merger is completed and the combined
company continues to account for the same percentage of our
business volume as the two prior companies, Bank of America will
become our largest customer. We cannot predict at this time
whether or when this merger will be completed and what effect
the merger, if completed, will have on our relationship with
Countrywide and Bank of America. Due to increasing consolidation
within the mortgage industry, as well as a number of mortgage
lenders having gone out of business since late 2006, we, as well
as our competitors, seek business from a decreasing number of
large mortgage lenders. See “Item 1A—Risk
Factors” for a discussion of the risks that this customer
concentration poses to our business.
We are organized in three complementary business segments:
Single-Family Credit Guaranty, Housing and Community
Development, and Capital Markets. The table below displays net
revenues, net income (loss) and total assets for each of our
business segments for the years ended December 31, 2007,
2006 and 2005.
Business
Segment Summary Financial Information
For information on the results of operations of our business
segments, see
“Part II—Item 7—MD&A—Business
Segment Results.”
Our Single-Family Credit Guaranty (“Single-Family”)
business works with our lender customers to securitize
single-family mortgage loans into Fannie Mae MBS and to
facilitate the purchase of single-family mortgage loans for our
mortgage portfolio. Single-family mortgage loans relate to
properties with four or fewer residential units. Revenues in the
segment are derived primarily from: (i) guaranty fees
received as compensation for assuming the credit risk on the
mortgage loans underlying single-family Fannie Mae MBS
and on the single-family mortgage loans held in our portfolio
and (ii) trust management income, which is a fee we earn
derived from interest earned on cash flows between the date of
remittance of mortgage and other payments to us by servicers and
the date of distribution of these payments to MBS
certificateholders.
The aggregate amount of single-family guaranty fees we receive
in any period depends on the amount of Fannie Mae MBS
outstanding during that period and the applicable guaranty fee
rates. The amount of Fannie Mae MBS outstanding at any time is
primarily determined by the rate at which we issue new Fannie
Mae MBS and by the repayment rate for the loans underlying our
outstanding Fannie Mae MBS. Less significant factors affecting
the amount of Fannie Mae MBS outstanding are the extent to which
Fannie Mae purchases loans from its MBS trusts because of
borrower default (with the amount of these purchases affected by
rates of borrower defaults on the loans) or because the loans do
not conform to the representations made by the lenders.
Our most common type of securitization transaction is referred
to as a “lender swap transaction.” Mortgage lenders
that operate in the primary mortgage market generally deliver
pools of mortgage loans to us in exchange for Fannie Mae MBS
backed by these loans. After receiving the loans in a lender
swap transaction, we place them in a trust that is established
for the sole purpose of holding the loans separate and apart
from our assets. We serve as trustee for the trust. Upon
creation of the trust, we deliver to the lender (or its
designee) Fannie Mae MBS that are backed by the pool of mortgage
loans in the trust and that represent a beneficial ownership
interest in each of the loans. We guarantee to each MBS trust
that we will supplement amounts received by the MBS trust as
required to permit timely payment of principal and interest on
the related Fannie Mae MBS. We retain a portion of the interest
payment as the fee for providing our guaranty. Then, on behalf
of the trust, we make monthly distributions to the Fannie Mae
MBS certificateholders from the principal and interest payments
and other collections on the underlying mortgage loans.
The following diagram illustrates the basic process by which we
create a typical Fannie Mae MBS in the case where a lender
chooses to sell the Fannie Mae MBS to a third-party investor.
We issue both single-class and multi-class Fannie Mae MBS.
Single-class Fannie Mae MBS refers to Fannie Mae MBS where
the investors receive principal and interest payments in
proportion to their percentage ownership of the MBS issue.
Multi-class Fannie Mae MBS refers to Fannie Mae MBS,
including real estate mortgage investment conduits
(“REMICs”), where the cash flows on the underlying
mortgage assets are divided, creating several classes of
securities, each of which represents a beneficial ownership
interest in a separate portion of cash flows. By separating the
cash flows, the resulting classes may consist of:
(1) interest-only payments; (2) principal-only payments;
(3) different portions of the principal and interest
payments; or (4) combinations of each of these. Terms to
maturity of some multi-class Fannie Mae MBS, particularly
REMIC classes, may match or be shorter than the maturity of the
underlying mortgage loans
and/or
mortgage-related securities. As a result, each of the classes in
a multi-class Fannie Mae MBS may have a different coupon
rate, average life, repayment sensitivity or final maturity. We
also issue structured Fannie Mae MBS, which are
multi-class Fannie Mae MBS or single-class Fannie Mae
MBS that are resecuritizations of other single-class Fannie
Mae MBS.
MBS
Trusts
Each of our single-family MBS trusts formed on or after
June 1, 2007 is governed by the terms of our single-family
master trust agreement. Each of our single-family MBS trusts
formed prior to June 1, 2007 is governed either by our
fixed-rate or adjustable-rate trust indenture. In addition, each
MBS trust, regardless of the date of its formation, is governed
by an issue supplement documenting the formation of that MBS
trust and the issuance of the Fannie Mae MBS by that trust. The
master trust agreement or the trust indenture, together with the
issue supplement and any amendments, are the “trust
documents” that govern an individual MBS trust.
In accordance with the terms of our single-family MBS trust
documents, we have the option or the obligation, in some
instances, to purchase specified mortgage loans from an MBS
trust. Our acquisition cost for these loans is the unpaid
principal balance of the loan plus accrued interest.
Optional Purchases
Under our single-family trust documents, we have the right, but
are not required, to purchase a mortgage loan from an MBS trust
under a variety of circumstances. When we elect to purchase a
mortgage loan or real-estate owned (“REO”) property
from an MBS trust, we primarily do so in one of the following
four situations:
We generally exercise our contractual option to purchase a
mortgage loan from an MBS trust when we believe the benefit to
us of owning the loan exceeds the benefit of leaving the loan in
the trust. In deciding whether and when to purchase a loan from
an MBS trust, we consider a variety of factors. In general,
these factors include: our loss mitigation strategies and the
exposure to credit losses we face under our guaranty; our cost
of funds; the effect that a purchase will have on our capital;
relevant market yields; the administrative costs associated with
purchasing and holding the loan; mission and policy
considerations; counterparty exposure to lenders that have
agreed to cover losses associated with delinquent loans; general
market conditions; our statutory obligations under our Charter
Act; and other legal obligations such as those established by
consumer finance laws. We may also purchase loans from an MBS
trust, using the optional purchase provision relating to
delinquent payments, as necessary to ensure compliance with
provisions of the trust documents. Refer to
“Part II—Item 7—MD&A—Critical
Accounting Policies and Estimates” and
“Part II—Item 7—MD&A—
Consolidated Results of Operations” for a description of
our accounting for delinquent loans purchased from MBS trusts
and the effect of these purchases on our 2007 financial results.
Required Purchases
Under our single-family trust documents, we generally are
required to purchase a mortgage loan from an MBS trust if:
We acquire single-family mortgage loans for securitization or
for our investment portfolio through either our flow or bulk
transaction channels. In our flow business, we enter into
agreements that generally set
agreed-upon
guaranty fee prices for a lender’s future delivery of
individual loans to us over a specified time period. Because
these agreements establish guaranty fee prices for an extended
period of time, we may be limited in our ability to renegotiate
the pricing on our flow transactions with individual lenders to
reflect changes in market conditions and the credit risk of
mortgage loans that meet our eligibility standards. These
agreements permit us, however, to charge risk-based price
adjustments that apply to all loans delivered to us with certain
risk characteristics. Flow business represents the majority of
our mortgage acquisition volumes.
Our bulk business consists of transactions in which a defined
set of loans are to be delivered to us in bulk, and we have the
opportunity to review the loans for eligibility and pricing
prior to delivery in accordance with the terms of the applicable
contracts. Guaranty fees and other contract terms for our bulk
mortgage acquisitions are negotiated on an individual
transaction basis. As a result, we generally have a greater
ability to adjust our pricing more rapidly than in our flow
transaction channel to reflect changes in market conditions and
the credit risk of the specific transactions.
We do not perform the day-to-day servicing of the mortgage loans
that are held in our mortgage portfolio or that back our Fannie
Mae MBS (referred to as “primary servicing”). However,
if a primary servicer defaults, we have ultimate responsibility
for servicing the loans we purchase or guarantee until a new
primary servicer can be put in place. We also have certain
ongoing administrative functions in connection with the mortgage
loans we securitize into Fannie Mae MBS. Typically, lenders who
sell single-family mortgage loans to us initially service the
mortgage loans they sell to us. There is an active market in
which lenders sell servicing rights and obligations to other
servicers. Our agreement with lenders requires our approval for
all servicing
transfers. We may at times engage a servicing entity to service
loans on our behalf due to termination of a servicer’s
servicing relationship or for other reasons.
Mortgage servicers typically collect and remit principal and
interest payments, administer escrow accounts, monitor and
report delinquencies, evaluate transfers of ownership interests,
respond to requests for partial releases of security, and handle
proceeds from casualty and condemnation losses. For problem
loans, servicing includes negotiating workouts, engaging in loss
mitigation and, if necessary, inspecting and preserving
properties and processing foreclosures and bankruptcies. We have
the right to remove servicing responsibilities from any servicer
under criteria established in our contractual arrangements with
servicers. We compensate servicers primarily by permitting them
to retain a specified portion of each interest payment on a
serviced mortgage loan, called a “servicing fee.”
Servicers also generally retain prepayment premiums, assumption
fees, late payment charges and other similar charges, to the
extent they are collected from borrowers, as additional
servicing compensation. We also compensate servicers for
negotiating workouts on problem loans.
Refer to “Item 1A—Risk Factors” and
“Part II—MD&A—Risk
Management—Credit Risk Management—Institutional
Counterparty Credit Risk Management” for a discussion of
the risks associated with a default by a mortgage servicer and
how we seek to manage those risks.
Our Single-Family business has responsibility for managing our
credit risk exposure relating to single-family Fannie Mae MBS
held by third parties, as well as managing and pricing the
credit risk of single-family mortgage loans and single-family
Fannie Mae MBS held in our own mortgage portfolio. For a
description of our methods for managing single-family mortgage
credit risk, refer to
“Part II—Item 7—MD&A—Risk
Management—Credit Risk Management—Mortgage Credit Risk
Management.”
Our Housing and Community Development (“HCD”) business
works with our lender customers to securitize multifamily
mortgage loans into Fannie Mae MBS and to facilitate the
purchase of multifamily mortgage loans for our mortgage
portfolio. Our HCD business also makes debt and equity
investments to increase the supply of affordable housing.
Revenues in the segment are derived from a variety of sources,
including the guaranty fees received as compensation for
assuming the credit risk on the mortgage loans underlying
multifamily Fannie Mae MBS and on the multifamily mortgage loans
held in our portfolio, transaction fees associated with the
multifamily business and bond credit enhancement fees. In
addition, HCD’s investments in rental housing projects
eligible for the federal low-income housing tax credit and other
investments generate both tax credits and net operating losses
that reduce our federal income tax liability. Other investments
in rental and for-sale housing generate revenue and losses from
operations and the eventual sale of the assets.
Our HCD business securitizes multifamily mortgage loans into
Fannie Mae MBS. Multifamily mortgage loans relate to properties
with five or more residential units, which may be apartment
communities, cooperative properties or manufactured housing
communities. Our HCD business generally creates multifamily
Fannie Mae MBS in the same manner as our Single-Family business
creates single-family Fannie Mae MBS. See “Single-Family
Credit Guaranty Business—Mortgage Securitizations” for
a description of a typical lender swap securitization
transaction.
MBS
Trusts
Each of our multifamily MBS trusts formed on or after
September 1, 2007 is governed by the terms of our
multifamily master trust agreement. Each of our multifamily MBS
trusts formed prior to September 1, 2007 is governed either
by our fixed-rate or adjustable-rate trust indenture. In
addition, each MBS trust, regardless of
the date of its formation, is governed by an issue supplement
documenting the formation of that MBS trust and the issuance of
the Fannie Mae MBS by that trust.
In accordance with the terms of our multifamily MBS trust
documents, we have the option or the obligation, in some
instances, to purchase specified mortgage loans from a trust.
Our acquisition cost for these loans is the unpaid principal
balance of the loan plus accrued interest. Under our multifamily
trust documents, we have the option to purchase loans from a
multifamily MBS trust under the same conditions and terms
described under “Single-Family Credit Guaranty
Business—MBS Trusts—Optional and Required Purchases of
Mortgage Loans from Single-Family MBS Trusts—Optional
Purchases.” In general, we exercise our option to purchase
a loan from a multifamily MBS trust if the loan is delinquent,
in whole or in part, as to four or more consecutive monthly
payments. After we purchase the loan, we generally work with the
borrower to modify the loan. Under our multifamily trust
documents, we also are required to purchase loans from a
multifamily MBS trust typically under the same conditions
described under “Single-Family Credit Guaranty
Business—MBS Trusts—Optional and Required Purchases of
Mortgage Loans from Single-Family MBS Trusts—Required
Purchases.”
Our HCD business acquires multifamily mortgage loans for
securitization or for our investment portfolio through either
our flow or bulk transaction channels, in substantially the same
manner as described under “Single-Family Credit Guaranty
Business—Mortgage Acquisitions.” In recent years, the
percentage of our multifamily business activity that has
consisted of purchases for our investment portfolio has
increased relative to our securitization activity.
Multifamily mortgage servicing occurs in substantially the same
manner as our single-family mortgage servicing described under
“Single-Family Credit Guaranty Business—Mortgage
Servicing.” However, in the case of multifamily loans,
servicing also may include performing routine property
inspections, evaluating the financial condition of owners, and
administering various types of agreements (including agreements
regarding replacement reserves, completion or repair, and
operations and maintenance).
Our HCD business helps to expand the supply of affordable
housing by investing in rental and for-sale housing projects.
Most of these investments are in rental housing that is eligible
for federal low-income housing tax credits, and the remainder
are in conventional rental and primarily entry-level, for-sale
housing. These investments are consistent with our focus on
serving communities and improving access to affordable housing.
LIHTC Partnerships. Our HCD business invests
predominantly in low-income housing tax credit
(“LIHTC”) limited partnerships or limited liability
companies (referred to collectively as “LIHTC
partnerships”) that directly or indirectly own an interest
in rental housing developed or rehabilitated by the LIHTC
partnerships. By renting a specified portion of the housing
units to qualified low-income tenants over a
15-year
period, the LIHTC partnerships become eligible for the federal
low-income housing tax credit. The LIHTC partnerships are
generally organized by fund manager sponsors who seek
investments with third-party developers that, in turn, develop
or rehabilitate the properties and then manage them. We invest
in these partnerships in a non-controlling capacity, with the
fund manager acting in a controlling capacity. We earn a return
on our investments in LIHTC partnerships through reductions in
our federal income tax liability that result from both our use
of the tax credits for which the LIHTC partnerships qualify and
the deductibility of the LIHTC partnerships’ net operating
losses. For additional information regarding our investments in
LIHTC partnerships and their impact on our financial results,
refer to
“Part II—Item 7—MD&A—Consolidated
Results of
Operations—Losses from Partnership Investments” and
“Part II—Item 7—MD&A—Off-Balance
Sheet Arrangements and Variable Interest Entities.”
Equity Investments. Our HCD business also
makes equity investments in rental and for-sale housing,
typically through fund managers or directly with developers and
operators. Because we invest in a non-controlling capacity, our
exposure is generally limited to the amount of our investment.
Our equity investments in for-sale housing generally involve the
acquisition, development
and/or
construction of entry-level homes or the conversion of existing
housing to entry-level homes.
Debt Investments. Our HCD business also helps
to expand the supply of affordable housing by participating in
specialized debt financing for a variety of customers. These
activities include providing loans to community development
financial institution intermediaries to re-lend for community
revitalization projects that expand the supply of affordable
housing; purchasing participation interests in acquisition,
development and construction loans from lending institutions;
and providing financing for single-family and multifamily
housing to housing finance agencies, public housing authorities
and municipalities.
Our HCD business has responsibility for managing our credit risk
exposure relating to multifamily Fannie Mae MBS held by third
parties, as well as managing and pricing the credit risk of
multifamily mortgage loans and multifamily Fannie Mae MBS held
in our mortgage portfolio. For a description of our methods for
managing multifamily mortgage credit risk, refer to
“Part II—Item 7—MD&A—Risk
Management—Credit Risk Management—Mortgage Credit Risk
Management.”
Our Capital Markets group manages our investment activity in
mortgage loans, mortgage-related securities and other
investments, our debt financing activity, and our liquidity and
capital positions. We fund our investments primarily through
proceeds from our issuance of debt securities in the domestic
and international capital markets.
Our Capital Markets group generates most of its revenue from the
difference, or spread, between the interest we earn on our
mortgage assets and the interest we pay on the debt we issue to
fund these assets. We refer to this spread as our net interest
yield. Changes in the fair value of the derivative instruments
and trading securities we hold impact the net income or loss
reported by the Capital Markets group business segment.
Our mortgage investments include both mortgage-related
securities and mortgage loans. We purchase primarily
conventional (i.e., loans that are not federally insured
or guaranteed) single-family fixed-rate or adjustable-rate,
first lien mortgage loans, or mortgage-related securities backed
by these types of loans. In addition, we purchase loans insured
by the Federal Housing Administration (“FHA”), loans
guaranteed by the Department of Veterans Affairs
(“VA”) or by the Rural Housing Service of the
Department of Agriculture (“RHS”), manufactured
housing loans, multifamily mortgage loans, subordinate lien
mortgage loans (for example, loans secured by second liens) and
other mortgage-related securities. Most of these loans are
prepayable at the option of the borrower. Our investments in
mortgage-related securities include structured mortgage-related
securities such as REMICs. For information on our mortgage
investments, including the composition of our mortgage
investment portfolio by product type, refer to
“Part II—Item 7—MD&A—Consolidated
Balance Sheet Analysis.”
Our Capital Markets group seeks to maximize long-term total
returns while fulfilling our chartered liquidity function. Our
Capital Markets group increases the liquidity of the mortgage
market by maintaining a constant presence as an active investor
in mortgage assets and, in particular, supports the liquidity
and value of Fannie Mae MBS in a variety of market conditions.
The Capital Markets group’s purchases and sales of mortgage
assets in any given period generally are determined by the rates
of return that we expect to earn on the equity capital
underlying our investments. When we expect to earn returns
greater than our other uses of capital, we generally will be an
active purchaser of mortgage loans and mortgage-related
securities. When we believe that few opportunities exist to
deploy capital in mortgage investments, we generally will be a
less active purchaser, and may be a net seller, of mortgage
loans and mortgage-related securities. This investment strategy
is consistent with our chartered liquidity function, as the
periods during which our purchase of mortgage assets is
economically attractive to us generally have been periods in
which market demand for mortgage assets is low.
The spread between the amount we earn on mortgage assets
available for purchase or sale and our funding costs, after
consideration of the net risks associated with the investment,
is an important factor in determining whether we are a net buyer
or seller of mortgage assets. When the spread between the yield
on mortgage assets and our borrowing costs is wide, which is
typically when market demand for mortgage assets is low, we will
look for opportunities to add liquidity to the market primarily
by purchasing mortgage assets and issuing debt to investors to
fund those purchases. When this spread is narrow, which is
typically when market demand for mortgage assets is high, we
will look for opportunities to meet demand by selling mortgage
assets from our portfolio.
Our investment activities are also affected by our capital
requirements and other regulatory constraints, as described
below under “Our Charter and Regulation of Our
Activities—Regulation and Oversight of Our Activities.”
Our Capital Markets group funds its investments primarily
through the issuance of debt securities in the domestic and
international capital markets. The objective of our debt
financing activities is to manage our liquidity requirements
while obtaining funds as efficiently as possible. We structure
our financings not only to satisfy our funding and risk
management requirements, but also to access the capital markets
in an orderly manner using debt securities designed to appeal to
a wide range of investors. International investors, seeking many
of the features offered in our debt programs for their
U.S. dollar-denominated investments, have been a
significant source of funding in recent years.
Our debt trades in the “agency sector” of the capital
markets, along with the debt of other GSEs. Debt in the agency
sector benefits from bank regulations that allow commercial
banks to invest in our debt and other agency debt to a greater
extent than other corporate debt. These factors, along with the
high credit rating of our senior unsecured debt securities and
the manner in which we conduct our financing programs, have
contributed to the favorable trading characteristics of our
debt. As a result, we generally have been able to borrow at
lower interest rates than other corporate debt issuers. For
information on the credit ratings of our long-term and
short-term senior unsecured debt, subordinated debt and
preferred stock, refer to
“Part II—Item 7—MD&A—Liquidity
and Capital Management—Liquidity—Credit Ratings and
Risk Ratings.”
Our Capital Markets group engages in two principal types of
securitization activities:
Our Capital Markets group creates Fannie Mae MBS using mortgage
loans and mortgage-related securities that we hold in our
investment portfolio, referred to as “portfolio
securitizations.” We currently securitize a majority of the
single-family mortgage loans we purchase within the first month
of purchase. Our Capital Markets group may sell these Fannie Mae
MBS into the secondary market or may retain the Fannie Mae MBS
in our investment portfolio. In addition, the Capital Markets
group issues structured Fannie Mae MBS, which are generally
created through swap transactions, typically with our lender
customers or securities dealer customers. In these transactions,
the customer “swaps” a mortgage asset it owns for a
structured Fannie Mae MBS we issue. Our Capital Markets group
earns transaction fees for issuing structured Fannie Mae MBS for
third parties.
Our Capital Markets group provides our lender customers and
their affiliates with services that include: offering to
purchase a wide variety of mortgage assets, including
non-standard mortgage loan products; segregating customer
portfolios to obtain optimal pricing for their mortgage loans;
and assisting customers with the hedging of their mortgage
business. These activities provide a significant flow of assets
for our mortgage portfolio, help to create a broader market for
our customers and enhance liquidity in the secondary mortgage
market.
Our Capital Markets group has responsibility for managing our
interest rate risk, liquidity risk and the credit risk of the
non-Fannie Mae mortgage-related securities held in our
portfolio. For a description of our methods for managing these
and other risks to our business, refer to
“Part II—Item 7—MD&A—Risk
Management.”
Our competitors include the Federal Home Loan Mortgage
Corporation, referred to as Freddie Mac, the Federal Home Loan
Banks, the FHA, financial institutions, securities dealers,
insurance companies, pension funds, investment funds and other
investors.
We compete to acquire mortgage assets in the secondary market
both for our investment portfolio and for securitization into
Fannie Mae MBS. Competition for the acquisition of mortgage
assets is affected by many factors, including the supply of
residential mortgage loans offered for sale in the secondary
market by loan originators and other market participants, the
current demand for mortgage assets from mortgage investors, and
the credit risk and prices associated with available mortgage
investments.
We also compete for the issuance of mortgage-related securities
to investors. Issuers of mortgage-related securities compete on
the basis of the value of their products and services relative
to the prices they charge. An issuer can deliver value through
the liquidity and trading levels of its securities, the range of
products and services it offers, its ability to customize
products based on the specific preferences of individual
investors, and the reliability and consistency with which it
conducts its business. In recent years, there was a significant
increase in the issuance of mortgage-related securities by
non-agency issuers, which caused a decrease in our share of the
market for new issuances of single-family mortgage-related
securities from 2003 to 2006. Non-agency issuers, also referred
to as private-label issuers, are those issuers of
mortgage-related securities other than agency issuers Fannie
Mae, Freddie Mac and the Government National Mortgage
Association (“Ginnie Mae”). The mortgage and credit
market disruption that began in 2007 led many investors to
curtail their purchases of private-label mortgage-related
securities in favor of mortgage-related securities backed by GSE
guaranties. Based on data provided by Inside MBS &
ABS, we estimate that issuances of private-label
mortgage-related securities declined by 83% from the fourth
quarter of 2006 to the fourth quarter of 2007. As a result of
these changes in investor demand, our estimated market share of
new single-family mortgage-related securities issuance increased
significantly to approximately 48.5% for the fourth quarter of
2007 from approximately 24.6% for the fourth quarter of 2006.
Our estimates of market share are based on publicly available
data and exclude previously securitized mortgages.
We also compete for low-cost debt funding with institutions that
hold mortgage portfolios, including Freddie Mac and the Federal
Home Loan Banks.
We are a stockholder-owned corporation, originally established
in 1938, organized and existing under the Federal National
Mortgage Association Charter Act, which we refer to as the
Charter Act or our charter.
The Charter Act sets forth the activities that we are permitted
to conduct, authorizes us to issue debt and equity securities,
and describes our general corporate powers. The Charter Act
states that our purpose is to:
In addition to the alignment of our overall strategy with these
purposes, all of our business activities must be permissible
under the Charter Act. Our charter authorizes us to, among other
things, purchase, service, sell, lend on the security of, and
otherwise deal in certain mortgage loans; issue debt obligations
and mortgage-related securities; and “do all things as are
necessary or incidental to the proper management of [our]
affairs and the proper conduct of [our] business.”
Mortgage loans we purchase or securitize must meet the following
standards required by the Charter Act.
Other Charter Act Limitations and Requirements
In addition to specifying our purpose, authorizing our
activities and establishing various limitations and requirements
relating to the loans we purchase and securitize, the Charter
Act has the following provisions.
As a federally chartered corporation, we are subject to
Congressional legislation and oversight and are regulated by HUD
and OFHEO. In addition, we are subject to regulation by the
Department of the Treasury and by the SEC.
HUD
Regulation
HUD has general regulatory authority to promulgate rules and
regulations to carry out the purposes of the Charter Act,
excluding authority over matters granted exclusively to OFHEO.
We are required under the Charter Act to obtain approval of the
Secretary of HUD for any new conventional mortgage program that
is significantly different from those approved or engaged in
prior to the enactment of the Federal Housing Enterprises
Financial Safety and Soundness Act of 1992 (the “1992
Act”). The Secretary of HUD must approve any new program
unless the Charter Act does not authorize it or the Secretary
finds that it is not in the public interest.
HUD periodically conducts reviews of our activities to ensure
compliance with the Charter Act and other regulatory
requirements. In June 2006, HUD announced that it would conduct
a review of our investments and holdings, including certain
equity and debt investments classified in our consolidated
financial statements as “other assets/other
liabilities,” to determine whether our investment
activities are consistent with our charter authority. We are
fully cooperating with this review. If HUD determines that these
investment activities are not permissible under the Charter Act,
we could be prevented from continuing some of our current
business activities and may be required to modify our investment
approach.
For each calendar year, we are subject to housing goals and
subgoals set by HUD. The goals, which are set as a percentage of
the total number of dwelling units underlying our total mortgage
purchases, are intended to expand housing opportunities
(1) for low- and moderate-income families, (2) in
HUD-defined underserved areas, including central cities and
rural areas, and (3) for low-income families in low-income
areas and for very low-income families, which is referred to as
“special affordable housing.” In addition, HUD has
established three home purchase subgoals that are expressed as
percentages of the total number of mortgages we purchase that
finance the purchase of single-family, owner-occupied properties
located in metropolitan areas, and a subgoal for multifamily
special affordable housing that is expressed as a dollar amount.
We report our progress toward achieving our housing goals to HUD
on a quarterly basis, and we are required to submit a report to
HUD and Congress on our performance in meeting our housing goals
on an annual basis.
The following table compares our performance against the housing
goals and subgoals for 2007, 2006 and 2005. The 2005 and 2006
performance results are final results that have been validated
by HUD. The 2007 performance results are preliminary results
that we have not finalized and that also have not yet been
validated by HUD.
Housing
Goals and Subgoals Performance
As shown by the table above, in 2005, we met each of our three
housing goals and three of the four subgoals, but fell slightly
short of the “low- and moderate-income housing” home
purchase subgoal. We met all of our housing goals and subgoals
in 2006.
In 2007, we believe that we met each of our three housing goals,
as well as the “underserved areas” home purchase
subgoal and “multifamily special affordable housing”
subgoal. However, based on our preliminary calculations, we
believe that we did not meet our “low- and moderate-income
housing” and “special affordable housing” home
purchase subgoals. We expect to submit our 2007 Annual Housing
Activities Report to HUD in March 2008, and HUD will make the
final determination regarding our housing goals performance for
2007.
Declining market conditions and the increased goal levels in
2007 made meeting our housing goals and subgoals even more
challenging than in previous years. Challenges to meeting our
housing goals and subgoals in 2007 included deteriorating
conditions in the mortgage credit markets and reduced housing
affordability. Housing affordability has declined significantly
in the past several years, due to previous increases in home
prices, increases in interest rates from previous historically
low levels and reduced income growth rates. The credit
tightening that began in the second half of 2007 also
contributed to reduced affordability. These difficult market
conditions negatively impacted market opportunities to purchase
mortgages that satisfied the subgoal requirements. We expect
these market conditions to continue to affect our ability to
meet our housing goals and subgoals in 2008. Moreover, all of
the housing goals and one of the housing subgoals have increased
for 2008.
The housing goals are subject to enforcement by the Secretary of
HUD. The subgoals, however, are treated differently. Pursuant to
the 1992 Act, the “low- and moderate-income housing”
and “underserved areas” home purchase subgoals are not
enforceable by HUD. However, HUD has taken the position that the
“special affordable housing” and “multifamily
special affordable housing” subgoals are enforceable. If
our efforts to meet the housing goals and special affordable
housing subgoals prove to be insufficient, we may become subject
to a housing plan that could require us to take additional steps
that could have an adverse effect on our profitability.
HUD’s regulations state that HUD shall require us to submit
a housing plan if we fail to meet one or more housing goals and
HUD determines that achievement was feasible, taking into
account market and economic conditions and our financial
condition. The housing plan must describe the actions we will
take to meet the goal in the next calendar year. If HUD
determines that we have failed to submit a housing plan or to
make a good faith effort to comply with the plan, HUD has the
right to take certain administrative actions. The potential
penalties for failure to comply with the housing plan
requirements are a
cease-and-desist
order and civil money penalties.
There is no penalty for failing to meet the “low- and
moderate-income housing” home purchase subgoal, because it
is not enforceable. However, if HUD determines that achievement
of the “special affordable housing” home purchase
subgoal was feasible in 2007, we may become subject to a housing
plan as described above.
See “Item 1A—Risk Factors” for a description
of how changes we have made to our business strategies in order
to meet HUD’s housing goals and subgoals have increased our
credit losses and may reduce our profitability.
OFHEO is an independent office within HUD that is responsible
for ensuring that we are adequately capitalized and operating
safely in accordance with the 1992 Act. OFHEO has agency
examination authority, and we are required to submit to OFHEO
annual and quarterly reports on our financial condition and
results of operations. OFHEO is authorized to levy annual
assessments on Fannie Mae and Freddie Mac, to the extent
authorized by Congress, to cover OFHEO’s reasonable
expenses. OFHEO’s formal enforcement powers include the
power to impose temporary and final
cease-and-desist
orders and civil monetary penalties on the company and our
directors and executive officers.
In 2003, OFHEO began a special examination of our accounting
policies and practices, internal controls, financial reporting,
corporate governance, and other matters. In May 2006,
concurrently with OFHEO’s release of its final report of
the special examination, we agreed to OFHEO’s issuance of a
consent order that resolved
open matters relating to their investigation of us. Under the
consent order, we neither admitted nor denied any wrongdoing and
agreed to make changes and take actions in specified areas,
including our accounting practices, capital levels and
activities, corporate governance, Board of Directors, internal
controls, public disclosures, regulatory reporting, personnel
and compensation practices.
In the OFHEO consent order, we agreed to the following
additional restrictions relating to our capital activity:
Under the OFHEO consent order, we were initially restricted from
increasing our net mortgage portfolio assets above
$727.75 billion. In September 2007, OFHEO issued an
interpretation of the consent order revising the mortgage
portfolio cap so that it is no longer based on the amount of our
“net mortgage portfolio assets,” which reflects
adjustments under U.S. generally accepted accounting
principles (“GAAP”). The mortgage portfolio cap is now
compared to our “average monthly mortgage portfolio
balance.” Our “average monthly mortgage portfolio
balance” is the cumulative average of the month-end unpaid
principal balances of our mortgage portfolio (as defined and
reported in our Monthly Summary Report, a monthly statistical
report on our business activity, which we file with the SEC in a
current report on
Form 8-K)
for the previous
12-month
period. Through June 2008, however, the reporting period will
begin with and include July 2007 and end with the month covered
by the current Monthly Summary Report. This measure is a
statistical measure rather than an amount computed in accordance
with GAAP, and excludes both consolidated mortgage-related
assets acquired through the assumption of debt and the impact on
the unpaid principal balances recorded on our purchases of
seriously delinquent loans from MBS trusts pursuant to Statement
of Position
No. 03-3,
Accounting for Certain Loans or Debt Securities Acquired in a
Transfer. For purposes of this calculation, OFHEO’s
interpretation sets the July 2007 month-end portfolio
balance at $725 billion. In addition, any net increase in
delinquent loan balances in our portfolio after
September 30, 2007 will be excluded from the month-end
portfolio balance.
The mortgage portfolio cap was set at $735 billion for the
third quarter of 2007 and $742.35 billion for the fourth
quarter of 2007. For each subsequent quarter, the mortgage
portfolio cap increases by 0.5%, not to exceed 2% per year. The
mortgage portfolio cap is currently set at $746 billion for
the first quarter of 2008. Our “average monthly mortgage
portfolio balance” as of December 31, 2007 was
$725.3 billion, which was $17.1 billion below our
applicable portfolio limit of $742.35 billion.
In its Fiscal Year 2007 Performance and Accountability Report,
released November 15, 2007, OFHEO recognized that we had
complied with 88% of the requirements of the OFHEO consent
order. With the filing of this
Form 10-K,
we believe that we are in compliance with all 81 requirements of
the OFHEO consent order.
We are subject to capital adequacy requirements established by
the 1992 Act. The statutory capital framework incorporates two
different quantitative assessments of capital—a minimum
capital requirement and a risk-based capital requirement. The
minimum capital requirement is ratio-based, while the risk-based
capital
requirement is based on simulated stress test performance. The
1992 Act requires us to maintain sufficient capital to meet both
of these requirements in order to be classified as
“adequately capitalized.”
OFHEO is permitted or required to take remedial action if we
fail to meet our capital requirements, depending upon which
requirement we fail to meet. If OFHEO classifies us as
significantly undercapitalized, we would be required to submit a
capital restoration plan and would be subject to additional
restrictions on our ability to make capital distributions. OFHEO
has the ability to take additional supervisory actions if the
Director determines that we have failed to make reasonable
efforts to comply with that plan or are engaging in unapproved
conduct that could result in a rapid depletion of our core
capital, or if the value of the property securing mortgage loans
we hold or have securitized has decreased significantly. The
1992 Act also gives OFHEO the authority, after following
prescribed procedures, to appoint a conservator. Under
OFHEO’s regulations, appointment of a conservator is
mandatory, with limited exceptions, if we are critically
undercapitalized. OFHEO has discretion under its rules to
appoint a conservator if we are significantly undercapitalized
and alternative remedies are unavailable. The 1992 Act and
OFHEO’s rules also specify other grounds for appointing a
conservator.
Statutory Minimum Capital Requirement and OFHEO-directed
Minimum Capital Requirement. OFHEO’s
ratio-based minimum capital standard ties our capital
requirements to the size of our book of business. For purposes
of the statutory minimum capital requirement, we are in
compliance if our core capital equals or exceeds our statutory
minimum capital requirement. Core capital is defined by statute
as the sum of the stated value of outstanding common stock
(common stock less treasury stock), the stated value of
outstanding non-cumulative perpetual preferred stock, paid-in
capital and retained earnings, as determined in accordance with
GAAP. Our statutory minimum capital requirement is generally
equal to the sum of:
Our consent order with OFHEO requires us to maintain a 30%
capital surplus over our statutory minimum capital requirement.
We refer to this requirement as the “OFHEO-directed minimum
capital requirement.” Each quarter, as part of its capital
classification announcement, OFHEO publishes our standing
relative to the statutory minimum capital requirement and the
OFHEO-directed minimum capital requirement. For a description of
the amounts by which our core capital exceeded our statutory
minimum capital requirement and OFHEO-directed minimum capital
requirement as of December 31, 2007 and December 31,
2006, see
“Part II—Item 7—MD&A—Liquidity
and Capital Management—Capital Management—Capital
Classification Measures.”
Statutory Risk-Based Capital
Requirement. OFHEO’s risk-based capital
requirement ties our capital requirements to the risk in our
book of business, as measured by a stress test model. The stress
test simulates our financial performance over a ten-year period
of severe economic conditions characterized by both extreme
interest rate movements and high mortgage default rates.
Simulation results indicate the amount of capital required to
survive this prolonged period of economic stress without new
business or active risk management action. In addition to this
model-based amount, the risk-based capital requirement includes
a 30% surcharge to cover unspecified management and operations
risks.
Our total capital base is used to meet our risk-based capital
requirement. Total capital is defined by statute as the sum of
our core capital plus the total allowance for loan losses and
reserve for guaranty losses in connection with Fannie Mae MBS,
less the specific loss allowance (that is, the allowance
required on individually-impaired loans). Each quarter, OFHEO
runs a detailed profile of our book of business through the
stress test simulation model. The model generates cash flows and
financial statements to evaluate our risk and measure our
capital adequacy during the ten-year stress horizon. As part of
its quarterly capital classification announcement, OFHEO makes
these stress test results publicly available. For a description
of the amounts by which our total capital exceeded our statutory
risk-based capital requirement as of December 31, 2007 and
2006, see
“Part II—Item 7—MD&A—Liquidity
and Capital Management—Capital Management—Capital
Classification Measures.”
In October 2007, OFHEO announced a proposed rule that would
change the mortgage loan loss severity formulas used in the
regulatory risk-based capital stress test. If adopted, the
proposed changes would increase our risk-based capital
requirement. Using data from the third and fourth quarters of
2006, OFHEO’s recalculation of the risk-based capital
requirement for those periods using the proposed formulas showed
that our total capital base would continue to exceed the revised
risk-based capital requirements.
Statutory Critical Capital Requirement. Our
critical capital requirement is the amount of core capital below
which we would be classified as critically undercapitalized and
generally would be required to be placed in conservatorship. Our
critical capital requirement is generally equal to the sum of:
For a description of the amounts by which our core capital
exceeded our statutory critical capital requirement as of
December 31, 2007 and 2006, see
“Part II—Item 7—MD&A—Liquidity
and Capital Management—Capital Management—Capital
Classification Measures.”
In September 2006 and June 2007, five federal financial
regulatory agencies jointly issued guidance on risks posed by
nontraditional mortgage products (that is, mortgage products
that allow borrowers to defer repayment of principal or
interest) and by subprime mortgages. The interagency guidance
directed regulated financial institutions that originate
nontraditional and subprime mortgage loans to follow prudent
lending practices, including following safe and sound
underwriting practices and providing borrowers with clear and
balanced information about the relative benefits and risks of
these products sufficiently early in the process to enable them
to make informed decisions. OFHEO directed us to apply the risk
management, underwriting and consumer protection principles of
the interagency guidance to the mortgage loans and
mortgage-related securities that we acquire for our portfolio
and for securitization into Fannie Mae MBS. Accordingly, we have
made changes to our underwriting standards implementing the
interagency guidance.
In February 2008, Congress passed legislation that temporarily
increases the conforming loan limit in high-cost metropolitan
areas for loans originated between July 1, 2007 and
December 31, 2008. For a one-family residence, the loan
limit increased to 125% of the area’s median house price,
up to a maximum of 175% of the otherwise applicable loan limit.
The Securities Industry and Financial Markets Association has
initially determined that mortgage-related securities backed by
these “jumbo conforming” loans are not eligible to be
traded in the TBA market. The TBA, or “to be
announced,” securities market is a forward, or delayed
delivery, market for mortgage-related securities backed by
30-year and
15-year
single-family mortgage loans issued by us and other agency
issuers. Most of our single-class, single-family Fannie Mae MBS
are sold by lenders in the TBA market. Accordingly, the
inability of mortgage-related securities backed by jumbo
conforming mortgages to trade in this market may limit the
liquidity of these securities and make the execution less
favorable. In addition, we will be required to implement changes
to our systems in order to be able to acquire and securitize
jumbo conforming loans, particularly due to the variation in the
conforming loan limit by metropolitan statistical area.
There is legislation pending before the U.S. Congress that
would change the regulatory framework under which we, Freddie
Mac and the Federal Home Loan Banks operate. On May 22,
2007, the House of Representatives approved a bill that would
establish a new, independent regulator for us and the other
GSEs, with broad authority over both safety and soundness and
mission.
As of the date of this filing, one GSE reform bill has been
introduced in the Senate and another is expected. For a
description of how the changes in the regulation of our business
contemplated by these GSE reform bills and other legislative
proposals could materially adversely affect our business and
earnings, see “Item 1A—Risk Factors.”
Our current executive officers are listed below. They have
provided the following information about their principal
occupation, business experience and other matters.
Daniel H. Mudd, 49, has served as President and Chief
Executive Officer of Fannie Mae since June 2005. Mr. Mudd
previously served as Vice Chairman of Fannie Mae’s Board of
Directors and interim Chief Executive Officer, from December
2004 to June 2005, and as Vice Chairman and Chief Operating
Officer from February 2000 to December 2004. Prior to his
employment with Fannie Mae, Mr. Mudd was President and
Chief Executive Officer of GE Capital, Japan, a diversified
financial services company and a wholly-owned subsidiary of the
General Electric Company, from April 1999 to February 2000. He
also served as President of GE Capital, Asia Pacific, from May
1996 to June 1999. Mr. Mudd has served as a director of the
Fannie Mae Foundation since March 2000, serving as Chairman
since June 2005, interim Chairman from December 2004 to June
2005, and Vice Chairman from September 2003 to December 2004.
Mr. Mudd serves as a director of Fortress Investment Group
LLC. Mr. Mudd has been a Fannie Mae director since February
2000.
Kenneth J. Bacon, 53, has been Executive Vice
President—Housing and Community Development since
July 2005. He was interim head of Housing and Community
Development from January 2005 to July 2005. He was Senior Vice
President—Multifamily Lending and Investment from May 2000
to January 2005, and Senior Vice President—American
Communities Fund from October 1999 to May 2000. From August 1998
to October 1999 he was Senior Vice President of the Community
Development Capital Corporation. He was Senior Vice President of
Fannie Mae’s Northeastern Regional Office in Philadelphia
from May 1993 to August 1998. Mr. Bacon has served as a
director of the Fannie Mae Foundation since January 1995 and as
Vice Chairman since January 2005. Mr. Bacon is also a
director of Comcast Corporation and the Corporation for
Supportive Housing. He is a member of the Executive Leadership
Council and the Real Estate Round Table.
Enrico Dallavecchia, 46, has been Executive Vice
President and Chief Risk Officer since June 2006. Prior to
joining Fannie Mae, Mr. Dallavecchia was with JP Morgan
Chase, where he served as Head of Market Risk for Retail
Financial Services, Chief Investment Office and Asset Wealth
Management from April 2005 to May 2006 and as Market Risk
Officer for Global Treasury, Retail Financial Services, Credit
Cards and Proprietary Positioning Division and Co-head of Market
Risk Technology from December 1998 to March 2005.
Linda K. Knight, 58, has been Executive Vice
President—Enterprise Operations since April 2007. Prior to
her present appointment, Ms. Knight served as Executive
Vice President—Capital Markets from March 2006 to April
2007. Before that, Ms. Knight served as Senior Vice
President and Treasurer from February 1993 to March 2006, and
Vice President and Assistant Treasurer from November 1986 to
February 1993. Ms. Knight held the position of Director,
Treasurer’s Office from November 1984 to November 1986, and
Assistant Director, Treasurer’s Office from February 1984
to November 1984. Ms. Knight joined Fannie Mae in August
1982 as a senior market analyst.
Robert J. Levin, 52, has been Executive Vice President
and Chief Business Officer since November 2005. Mr. Levin
was Fannie Mae’s interim Chief Financial Officer from
December 2004 to January 2006. Prior to that position,
Mr. Levin was the Executive Vice President of Housing and
Community Development from June 1998 to December 2004. From June
1990 to June 1998, he was Executive Vice
President—Marketing. Mr. Levin joined Fannie Mae in
1981. Mr. Levin has previously served as a director and as
treasurer of the Fannie Mae Foundation.
Thomas A. Lund, 49, has been Executive Vice
President—Single-Family Mortgage Business since July 2005.
He was interim head of Single-Family Mortgage Business from
January 2005 to July 2005 and Senior Vice President—Chief
Acquisitions Office from January 2004 to January 2005.
Mr. Lund served as Senior Vice President—Investor
Channel from August 2000 to January 2004, Senior Vice
President—Southwestern
Regional Office, Dallas, Texas from July 1996 to July 2000, and
Vice President for marketing from January 1995 to July 1996.
Rahul N. Merchant, 51, has been Executive Vice President
and Chief Information Officer since November 2006. Prior to
joining Fannie Mae, Mr. Merchant was with Merrill
Lynch & Co., where he served as Head of Technology
from 2004 to 2006 and as Head of Global Business Technology for
Merrill Lynch’s Global Markets and Investment Banking
division from 2000 to 2004. Before joining Merrill, he served as
Executive Vice President at Dresdner, Kleinwort and Benson, a
global investment bank, from 1998 to 2000. He also previously
served as Senior Vice President at Sanwa Financial Products and
First Vice President at Lehman Brothers, Inc. Mr. Merchant
serves on the board of advisors of the American India Foundation.
Peter S. Niculescu, 48, has been Executive Vice
President—Capital Markets (previously Mortgage Portfolio)
since November 2002. Mr. Niculescu joined Fannie Mae in
March 1999 as Senior Vice President—Portfolio Strategy and
served in that position until November 2002.
William B. Senhauser, 45, has been Senior Vice President
and Chief Compliance Officer since December 2005. Prior to his
present appointment, Mr. Senhauser was Vice President for
Regulatory Agreements and Restatement from October 2004 to
December 2005, Vice President for Operating Initiatives from
January 2003 to September 2004, and Vice President, Deputy
General Counsel from November 2000 to January 2003.
Mr. Senhauser joined Fannie Mae in 2000 as Vice President
for Fair Lending.
Stephen M. Swad, 46, has been Executive Vice President
and Chief Financial Officer since August 2007. Mr. Swad
previously served as Executive Vice President and Chief
Financial Officer Designate from May 2007 to August 2007. Prior
to joining Fannie Mae, Mr. Swad was Executive Vice
President and Chief Financial Officer at AOL, LLC, from February
2003 to February 2007. Before joining AOL, Mr. Swad served
as Executive Vice President of Finance and Administration at
Turner Broadcasting System Inc.’s Turner Entertainment
Group, from April 2002 to February 2003. From 1998 through 2002,
he was with Time Warner, where he served in various corporate
finance roles. Mr. Swad also previously served as a partner
in KPMG’s national office and as the Deputy Chief
Accountant at the U.S. Securities and Exchange Commission.
Beth A. Wilkinson, 45, has been Executive Vice
President—General Counsel and Corporate Secretary since
February 2006. Prior to joining Fannie Mae, Ms. Wilkinson
was a partner and Co-Chair, White Collar Practice Group at
Latham & Watkins LLP, from 1998 to 2006. Before
joining Latham, she served at the Department of Justice as a
prosecutor and special counsel for U.S. v. McVeigh and
Nichols from 1996 to 1998. During her tenure at the
Department of Justice, Ms. Wilkinson was appointed
principal deputy of the Terrorism & Violent Crime
Section in 1995, and served as Special Counsel to the Deputy
Attorney General from 1995 to 1996. Ms. Wilkinson also
served as an Assistant U.S. Attorney in the Eastern
District of New York from 1991 to 1995. Prior to that time,
Ms. Wilkinson was a Captain in the U.S. Army serving
as an assistant to the general counsel of the Army for
Intelligence & Special Operations from 1987 to 1991.
Ms. Wilkinson serves on the board of directors of Equal
Justice Works.
Michael J. Williams, 50, has been Executive Vice
President and Chief Operating Officer since November 2005.
Mr. Williams was Fannie Mae’s Executive Vice President
for Regulatory Agreements and Restatement from February 2005 to
November 2005. Mr. Williams also served as
President—Fannie Mae eBusiness from July 2000 to February
2005 and as Senior Vice
President—e-commerce
from July 1999 to July 2000. Prior to this, Mr. Williams
served in various roles in the Single-Family and Corporate
Information Systems divisions of the company. Mr. Williams
joined Fannie Mae in 1991.
As of December 31, 2007, we employed approximately
5,700 personnel, including full-time and part-time
employees, term employees and employees on leave.
WHERE YOU
CAN FIND ADDITIONAL INFORMATION
We file reports, proxy statements and other information with the
SEC. We make available free of charge through our Web site our
annual reports on
Form 10-K,
quarterly reports on
Form 10-Q,
current reports on
Form 8-K
and all other SEC reports and amendments to those reports as
soon as reasonably practicable after we electronically file the
material with, or furnish it to, the SEC. Our Web site address
is www.fanniemae.com. Materials that we file with the SEC are
also available from the SEC’s Web site, www.sec.gov. In
addition, these materials may be inspected, without charge, and
copies may be obtained at prescribed rates, at the SEC’s
Public Reference Room at 100 F Street, NE,
Room 1580, Washington, DC 20549. You may obtain information
on the operation of the Public Reference Room by calling the SEC
at
1-800-SEC-0330.
You may also request copies of any filing from us, at no cost,
by telephone at
(202) 752-7000
or by mail at 3900 Wisconsin Avenue, NW, Washington, DC 20016.
Pursuant to SEC regulations, public companies are required to
disclose certain information when they incur a material direct
financial obligation or become directly or contingently liable
for a material obligation under an off-balance sheet
arrangement. The disclosure must be made on a current report on
Form 8-K
under Item 2.03 or, if the obligation is incurred in
connection with certain types of securities offerings, in
prospectuses for that offering that are filed with the SEC.
Fannie Mae’s securities offerings are exempted from SEC
registration requirements. As a result, we are not required to
and do not file registration statements or prospectuses with the
SEC with respect to our securities offerings. To comply with the
disclosure requirements of
Form 8-K
relating to the incurrence of material financial obligations, we
report our incurrence of these types of material obligations
either in offering circulars or prospectuses (or supplements
thereto) that we post on our Web site or in a current report on
Form 8-K,
in accordance with a “no-action” letter we received
from the SEC Staff. In cases where the information is disclosed
in a prospectus or offering circular posted on our Web site, the
document will be posted on our Web site within the same time
period that a prospectus for a non-exempt securities offering
would be required to be filed with the SEC.
The Web site address for disclosure about our debt securities is
www.fanniemae.com/debtsearch. From this address, investors can
access the offering circular and related supplements for debt
securities offerings under Fannie Mae’s universal debt
facility, including pricing supplements for individual issuances
of debt securities.
Disclosure about our off-balance sheet obligations pursuant to
some of the MBS we issue can be found at
www.fanniemae.com/mbsdisclosure. From this address, investors
can access information and documents about our MBS, including
prospectuses and related prospectus supplements.
We are providing our Web site addresses and the Web site address
of the SEC solely for your information. Information appearing on
our Web site or on the SEC’s Web site is not incorporated
into this annual report on
Form 10-K.
This report contains forward-looking statements, which are
statements about matters that are not historical facts. In
addition, our senior management may from time to time make
forward-looking statements orally to analysts, investors, the
news media and others. Forward-looking statements often include
words such as “expects,” “anticipates,”
“intends,” “plans,” “believes,”
“seeks,” “estimates,” “would,”
“should,” “could,” “may,” or
similar words.
Among the forward-looking statements in this report are
statements relating to:
Forward-looking statements reflect our management’s
expectations or predictions of future conditions, events or
results based on various assumptions and management’s
estimates of trends and economic factors in the markets in which
we are active, as well as our business plans. They are not
guarantees of future performance. By their nature,
forward-looking statements are subject to risks and
uncertainties. Our actual results and financial condition may
differ, possibly materially, from the anticipated results and
financial condition indicated in these forward-looking
statements. There are a number of factors that could cause
actual conditions, events or results to differ materially from
those described in the forward-looking statements contained in
this report, including those factors described in
“Item 1A—Risk Factors” of this report.
Readers are cautioned to place forward-looking statements in
this report or that we make from time to time into proper
context by carefully considering the factors discussed in
“Item 1A—Risk Factors” in evaluating these
forward-looking statements. These forward-looking statements are
representative only as of the date they are made, and we
undertake no obligation to update any forward-looking statement
as a result of new information, future events or otherwise,
except as required under the federal securities laws.
This section identifies specific risks that should be considered
carefully in evaluating our business. The risks described in
“Company Risks” are specific to us and our business,
while those described in “Risks Relating to Our
Industry” relate to the industry in which we operate. Any
of these risks could adversely affect our business, earnings,
cash flows or financial condition. We believe that these risks
represent the material risks relevant to us, our business and
our industry, but new material risks to our business may emerge
that we are currently unable to predict. The risks discussed
below could cause our actual results to differ materially from
our historical results or the results contemplated by the
forward-looking statements contained in this report. Refer to
“Part II—Item 7—MD&A—Risk
Management” for a more detailed description of the primary
risks to our business and how we seek to manage those risks.
COMPANY
RISKS
We are exposed to credit risk relating to both the mortgage
assets that we hold in our investment portfolio and the mortgage
assets that back our guaranteed Fannie Mae MBS. Borrowers of
mortgage loans that we own or that back our guaranteed Fannie
Mae MBS may fail to make required payments of principal and
interest on those loans, exposing us to the risk of credit
losses.
We have experienced increased mortgage loan delinquencies and
credit losses, which had a material adverse effect on our
earnings, financial condition and capital position in 2007. Weak
economic conditions in the Midwest and home price declines on a
national basis, particularly in Florida, California, Nevada and
Arizona, increased our single-family serious delinquency rate
and contributed to higher default rates and loan loss severities
in 2007. We are experiencing high serious delinquency rates and
credit losses across our conventional single-family mortgage
credit book of business, especially for loans to borrowers with
low credit scores and loans with high loan-to-value
(“LTV”) ratios. In addition, in 2007 we experienced
particularly rapid increases in serious delinquency rates and
credit losses in some higher risk loan categories, such as Alt-A
loans, adjustable-rate loans, interest-only loans, negative
amortization loans, loans made for the purchase of condominiums
and loans with second liens. Many of these higher risk loans
were originated in 2006 and the first half of 2007. Refer to
“Part II—Item 7—MD&A—Risk
Management—Credit Risk Management—Mortgage Credit Risk
Management” for the percentage that each of these loan
categories represents of our total conventional single-family
mortgage credit book of business.
We expect these trends to continue and that we will experience
increased delinquencies and credit losses in 2008 as compared
with 2007. The amount by which delinquencies and credit losses
will increase in 2008 will depend on a variety of factors,
including the extent of national and regional declines in home
prices, interest rates and employment rates. In particular, we
expect that the onset of a recession, either in the United
States
as a whole or in specific regions of the country, would
significantly increase the level of our delinquencies and credit
losses. Increases in our credit-related expenses would reduce
our earnings and adversely affect our capital position and
financial condition.
During 2007, we experienced an increase in losses on trading
securities and in unrealized losses on available-for-sale
securities due to a significant widening of credit spreads. Our
net losses on trading securities totaled $365 million in
2007. In addition, we recorded $814 million in
other-than-temporary impairment on available-for-sale securities
in 2007. Of this amount, $160 million related to
other-than-temporary impairment on our investments in subprime
private-label securities. We also recorded in accumulated other
comprehensive income (“AOCI”) an additional
$3.3 billion in unrealized losses on Alt-A and subprime
private-label securities classified as available-for-sale. We
have not recognized other-than-temporary impairment with respect
to these securities because we believe it is probable we will
collect all of the contractual amounts due and we currently have
the intent and ability to hold these securities until they
recover their value or until maturity. As market conditions
continue to evolve, however, the fair value of these securities
could decline further. The credit ratings of some of the
subprime and Alt-A private-label securities held in our
portfolio have been downgraded or placed under review for
possible downgrade in recent months. Mortgage loan delinquencies
and credit losses have also increased in recent months,
particularly in the subprime and Alt-A sectors. If, in the
future, we determine that additional subprime and Alt-A
private-label securities classified as available-for-sale and in
unrealized loss positions have become other-than-temporarily
impaired, or if we change our investment intent with respect to
these securities and no longer expect to hold the securities
until they recover their value or until maturity, we would
experience further significant losses or other-than-temporary
impairment relating to these securities. See
“Part II—Item 7—MD&A—Consolidated
Balance Sheet Analysis—Investments in Alt-A and Subprime
Mortgage-Related Securities” for more detailed information
on our investments in private-label securities backed by
subprime and Alt-A loans.
The significant widening of credit spreads that has occurred
since July 2007 also could further reduce the fair value of our
other investment securities, particularly those securities that
are less liquid and more subject to volatility, such as
commercial mortgage-backed securities and mortgage revenue
bonds. As a result, we also could experience further significant
losses or other-than-temporary impairment on other investment
securities in our mortgage portfolio or our liquid investment
portfolio.
In addition, market illiquidity has increased the amount of
management judgment required to value certain of our securities.
Subsequent valuations, in light of factors then prevailing, may
result in significant changes in the value of our investment
securities in the future. If we decide to sell any of these
securities, the price we ultimately realize will depend on the
demand and liquidity in the market at that time and may be
materially lower than their current fair value. Any of these
factors could require us to take further write-downs in the
value of our investment portfolio, which would have an adverse
effect on our earnings, liquidity, capital position and
financial condition in the future.
Continued
declines in our earnings would have a negative effect on our
regulatory capital position.
We are required to meet various capital standards, including a
requirement that our core capital equal or exceed both our
statutory minimum capital requirement and a higher
OFHEO-directed minimum capital requirement. Our retained
earnings are a component of our core capital. Accordingly, the
level of our core capital can fluctuate significantly depending
on our financial results. We recorded a net loss of
$2.1 billion in 2007. We expect some or all of the market
conditions that contributed to this loss to continue and
therefore to continue to adversely affect our earnings and, as a
result, the amount of our core capital. In order to continue to
meet our statutory and OFHEO-directed minimum capital
requirements, we may be required to take actions, or refrain
from taking actions, to ensure that we maintain or increase our
core capital. These actions have included, and in the future may
include, reducing the size of our investment portfolio through
liquidations or by selling assets at a time when we believe that
it would be economically advantageous to continue to hold
the assets, limiting or forgoing attractive opportunities to
acquire or securitize assets, reducing or eliminating our common
stock dividend, and issuing additional preferred equity
securities, which in general is a more expensive method of
funding our operations than issuing debt securities. We also may
issue convertible preferred securities or additional shares of
common stock to maintain or increase our core capital, which we
expect would dilute the investment in the company of the
existing holders of our common stock. These actions also may
reduce our future earnings.
We
depend on our institutional counterparties to provide services
that are critical to our business. If one or more of our
institutional counterparties defaults on its obligations to us
or becomes insolvent, it could materially adversely affect our
earnings, liquidity, capital position and financial
condition.
We face the risk that one or more of our institutional
counterparties may fail to fulfill their contractual obligations
to us. Our primary exposures to institutional counterparty risk
are with: mortgage servicers that service the loans we hold in
our investment portfolio or that back our Fannie Mae MBS;
third-party providers of credit enhancement on the mortgage
assets that we hold in our investment portfolio or that back our
Fannie Mae MBS, including mortgage insurers, lenders with risk
sharing arrangements, and financial guarantors; custodial
depository institutions that hold principal and interest
payments for Fannie Mae MBS certificateholders; issuers of
securities held in our liquid investment portfolio; and
derivatives counterparties. Refer to
“Part II—Item 7—MD&A—Risk
Management—Credit Risk Management—Institutional
Counterparty Credit Risk Management” for a detailed
description of the risk posed by each of these types of
counterparties.
The challenging mortgage and credit market conditions have
adversely affected, and will likely continue to adversely
affect, the liquidity and financial condition of a number of our
institutional counterparties, particularly those whose
businesses are concentrated in the mortgage industry. One or
more of these institutions may default in its obligations to us
for a number of reasons, such as changes in financial condition
that affect their credit ratings, a reduction in liquidity,
operational failures or insolvency. Several of our institutional
counterparties have experienced ratings downgrades and liquidity
constraints, including Countrywide Financial Corporation and its
affiliates, which is our largest lender customer and mortgage
servicer. These and other key institutional counterparties may
become subject to serious liquidity problems that, either
temporarily or permanently, negatively affect the viability of
their business plans or reduce their access to funding sources.
The financial difficulties that a number of our institutional
counterparties are currently experiencing may negatively affect
the ability of these counterparties to meet their obligations to
us and the amount or quality of the products or services they
provide to us. A default by a counterparty with significant
obligations to us could result in significant financial losses
to us and could materially adversely affect our ability to
conduct our operations, which would adversely affect our
earnings, liquidity, capital position and financial condition.
Our business with our lender customers, mortgage servicers,
mortgage insurers, financial guarantors, custodial depository
institutions and derivatives counterparties is heavily
concentrated. For example, ten single-family mortgage servicers
serviced 74% of our single-family mortgage credit book of
business as of December 31, 2007. In addition, Countrywide
Financial Corporation and its affiliates, our largest
single-family mortgage servicer, serviced 23% of our
single-family mortgage credit book of business as of
December 31, 2007. Also, seven mortgage insurance companies
provided over 99% of our total mortgage insurance coverage of
$104.1 billion as of December 31, 2007, and our ten
largest custodial depository institutions held 89% of our
$32.5 billion in deposits for scheduled MBS payments in
December 2007.
Moreover, many of our counterparties provide several types of
services to us. For example, many of our lender customers or
their affiliates also act as mortgage servicers, custodial
depository institutions and document custodians for us.
Accordingly, if one of these counterparties were to become
insolvent or otherwise default on its obligations to us, it
could harm our business and financial results in a variety of
ways. A default by any counterparty with significant obligations
to us could adversely affect our ability to conduct our
operations
efficiently and at cost-effective rates, which in turn could
materially adversely affect our earnings, liquidity, capital
position and financial condition. Refer to
“Part II—Item 7—MD&A—Risk
Management—Credit Risk Management—Institutional
Counterparty Credit Risk Management” for a detailed
description of our business concentrations with each type of
counterparty.
Our ability to generate revenue from the purchase and
securitization of mortgage loans depends on our ability to
acquire a steady flow of mortgage loans from the originators of
those loans. We acquire a significant portion of our mortgage
loans from several large mortgage lenders. During 2007, our top
five lender customers accounted for approximately 56% of our
single-family business volume. Accordingly, maintaining our
current business relationships and business volumes with our top
lender customers is critical to our business. Some of our lender
customers are experiencing, or may experience in the future,
liquidity problems that would affect the volume of business they
are able to generate. If any of our key lender customers
significantly reduces the volume or quality of mortgage loans
that the lender delivers to us or that we are willing to buy
from them, we could lose significant business volume that we
might be unable to replace, which could adversely affect our
business and result in a decrease in our market share and
earnings. In addition, a significant reduction in the volume of
mortgage loans that we securitize could reduce the liquidity of
Fannie Mae MBS, which in turn could have an adverse effect on
their market value.
Our largest lender customer, Countrywide Financial Corporation
and its affiliates, accounted for approximately 28% of our
single-family business volume during 2007. In January 2008, Bank
of America Corporation announced that it had reached an
agreement to purchase Countrywide Financial Corporation.
Together, Bank of America and Countrywide accounted for
approximately 32% of our single-family business volume in 2007.
We cannot predict at this time whether or when this merger will
be completed and what effect the merger, if completed, will have
on our relationship with Countrywide and Bank of America.
Following the merger, we could lose significant business volume
that we might be unable to replace, which could adversely affect
our business and result in a decrease in our earnings and market
share.
We fund our operations primarily through the issuance of debt
and invest our funds primarily in mortgage-related assets that
permit the mortgage borrowers to prepay the mortgages at any
time. These business activities expose us to market risk, which
is the risk of loss from adverse changes in market conditions.
Our most significant market risks are interest rate risk and
option-adjusted spread risk. Changes in interest rates affect
both the value of our mortgage assets and prepayment rates on
our mortgage loans.
Option-adjusted spread risk is the risk that the option-adjusted
spreads on our mortgage assets relative to those on our funding
and hedging instruments (referred to as the “OAS of our net
mortgage assets”) may increase or decrease. These increases
or decreases may be a result of market supply and demand
dynamics. A widening, or increase, of the OAS of our net
mortgage assets typically causes a decline in the fair value of
the company and a decrease in our earnings and capital. A
narrowing, or decrease, of the OAS of our net mortgage assets
reduces our opportunities to acquire mortgage assets and
therefore could have a material adverse effect on our future
earnings and financial condition. We do not attempt to actively
manage or hedge the impact of changes in the OAS of our net
mortgage assets after we purchase mortgage assets, other than
through asset monitoring and disposition.
Changes in interest rates could have a material adverse effect
on our earnings, liquidity, capital position and financial
condition. Our ability to manage interest rate risk depends on
our ability to issue debt instruments with a range of maturities
and other features at attractive rates and to engage in
derivative transactions. We must exercise judgment in selecting
the amount, type and mix of debt and derivative instruments that
will most effectively manage our interest rate risk. The amount,
type and mix of financial instruments we select
may not offset possible future changes in the spread between our
borrowing costs and the interest we earn on our mortgage assets.
We make significant use of business and financial models to
measure and monitor our risk exposures. The information provided
by these models is also used in making business decisions
relating to strategies, initiatives, transactions and products.
Models are inherently imperfect predictors of actual results
because they are based on data available to us and our
assumptions about factors such as future loan demand, prepayment
speeds, default rates, severity rates and other factors that may
overstate or understate future experience. When market
conditions change rapidly and dramatically, as they have since
July of 2007, the assumptions that we use for our models may not
keep pace with changing conditions. Incorrect data or
assumptions in our models are likely to produce unreliable
results. If our models fail to produce reliable results, we may
not make appropriate risk management or business decisions,
which could adversely affect our earnings, liquidity, capital
position and financial condition.
In
many cases, our accounting policies and methods, which are
fundamental to how we report our financial condition and results
of operations, require management to make judgments and
estimates about matters that are inherently uncertain.
Management also may rely on the use of models in making
estimates about these matters.
Our accounting policies and methods are fundamental to how we
record and report our financial condition and results of
operations. Our management must exercise judgment in applying
many of these accounting policies and methods so that these
policies and methods comply with GAAP and reflect
management’s judgment of the most appropriate manner to
report our financial condition and results of operations. In
some cases, management must select the appropriate accounting
policy or method from two or more alternatives, any of which
might be reasonable under the circumstances but might affect the
amounts of assets, liabilities, revenues and expenses that we
report. See “Notes to Consolidated Financial
Statements—Note 1, Summary of Significant Accounting
Policies” for a description of our significant accounting
policies.
We have identified three accounting policies as critical to the
presentation of our financial condition and results of
operations. These accounting policies are described in
“Part II—Item 7—MD&A—Critical
Accounting Policies and Estimates.” We believe these
policies are critical because they require management to make
particularly subjective or complex judgments about matters that
are inherently uncertain and because of the likelihood that
materially different amounts would be reported under different
conditions or using different assumptions. Due to the complexity
of these critical accounting policies, our accounting methods
relating to these policies involve substantial use of models.
Models are inherently imperfect predictors of actual results
because they are based on assumptions, including assumptions
about future events. Our models may not include assumptions that
reflect very positive or very negative market conditions and,
accordingly, our actual results could differ significantly from
those generated by our models. As a result, the estimates that
we use to prepare our financial statements, as well as our
estimates of our future results of operations, may be
inaccurate, potentially significantly.
The issuance of short-term and long-term debt securities in the
domestic and international capital markets is our primary source
of funding for our purchases of assets for our mortgage
portfolio and for repaying or refinancing our existing debt.
Moreover, a primary source of our revenue is the net interest
income we earn from the difference, or spread, between the
return that we receive on our mortgage assets and our borrowing
costs. Our ability to obtain funds through the issuance of debt,
and the cost at which we are able to obtain these funds, depends
on many factors, including:
If we are unable to issue debt securities at attractive rates in
amounts sufficient to operate our business and meet our
obligations, it would have a material adverse effect on our
liquidity, earnings and financial condition.
Our borrowing costs and our broad access to the debt capital
markets depend in large part on our high credit ratings,
particularly on our senior unsecured debt. Our ratings are
subject to revision or withdrawal at any time by the rating
agencies. Any reduction in our credit ratings could increase our
borrowing costs, limit our access to the capital markets and
trigger additional collateral requirements under our derivatives
contracts and other borrowing arrangements. A substantial
reduction in our credit ratings would reduce our earnings and
materially adversely affect our liquidity, our ability to
conduct our normal business operations and our financial
condition. Our credit ratings and ratings outlook is included in
“Part II—Item 7—MD&A—Liquidity
and Capital Management—Liquidity—Credit Ratings and
Risk Ratings.”
As a federally chartered corporation, we are subject to the
limitations imposed by the Charter Act, extensive regulation,
supervision and examination by OFHEO and HUD, and regulation by
other federal agencies, including the Department of the Treasury
and the SEC. We are also subject to many laws and regulations
that affect our business, including those regarding taxation and
privacy. In addition, the policy, approach or regulatory
philosophy of these agencies can materially affect our business.
Regulation by OFHEO could adversely affect our earnings and
financial condition. OFHEO has broad authority to
regulate our operations and management in order to ensure our
financial safety and soundness. For example, pursuant to our
consent order with OFHEO, we currently may not increase our net
mortgage portfolio assets above a specified amount that is
adjusted on a quarterly basis, and we are required to maintain a
30% capital surplus over our statutory minimum capital
requirement. These restrictions limit the amount of mortgage
assets that we are able to purchase and securitize, which limits
our ability to grow our mortgage credit book of business. As a
result, these restrictions could negatively impact our earnings.
Similarly, any new or additional regulations that OFHEO may
adopt in the future could adversely affect our future earnings
and
financial condition. If we fail to comply with any of our
agreements with OFHEO or with any OFHEO regulation, including
those relating to our capital requirements, we may incur
penalties and could be subject to further restrictions on our
activities and operations, or to investigation and enforcement
actions by OFHEO.
Regulation by HUD and Charter Act limitations could adversely
affect our market share, earnings and financial
condition. HUD supervises our compliance with the
Charter Act, which defines our permissible business activities.
For example, we may not purchase single-family loans in excess
of the conforming loan limits. In addition, under the Charter
Act, our business is limited to the U.S. housing finance
sector. As a result of these limitations on our ability to
diversify our operations, our financial condition and earnings
depend almost entirely on conditions in a single sector of the
U.S. economy, specifically, the U.S. housing market.
Our substantial reliance on conditions in the U.S. housing
market may adversely affect the investment returns we are able
to generate. In addition, the Secretary of HUD must approve any
new Fannie Mae conventional mortgage program that is
significantly different from those that we engaged in or that
had been approved prior to the enactment of the 1992 Act. As a
result, our ability to respond quickly to changes in market
conditions by offering new programs designed to respond to these
changes is subject to HUD’s prior approval process. These
restrictions on our business operations may negatively affect
our ability to compete successfully with other companies in the
mortgage industry from time to time, which in turn may reduce
our market share, our earnings and our financial condition.
HUD has established housing goals and subgoals for our business.
HUD’s housing goals require that a specified portion of our
mortgage purchases during each calendar year relate to the
purchase or securitization of mortgage loans that finance
housing for low- and moderate-income households, housing in
underserved areas and qualified housing under the definition of
special affordable housing. Most of these goals and subgoals
have increased in 2008 over 2007 levels. These increases in goal
levels and recent housing and mortgage market conditions,
particularly the significant changes in the housing market that
began in the third quarter of 2007, have made it increasingly
challenging to meet our housing goals and subgoals. If we do not
meet any housing goal or enforceable subgoal, we may become
subject to increased HUD oversight for the following year or be
subject to civil money penalties.
In addition, our efforts to meet the housing goals and subgoals
established by HUD have reduced our profitability. In order to
obtain business that contributes to our housing goals and
subgoals, we made significant adjustments to our mortgage loan
acquisition strategies during the past several years. These
strategies included entering into some purchase and
securitization transactions with lower expected economic returns
than our typical transactions. We also relaxed some of our
eligibility criteria to obtain goals-qualifying mortgage loans
and increased our investments in higher risk mortgage loan
products that were more likely to serve the borrowers targeted
by HUD’s goals and subgoals. These efforts to meet our
housing goals and subgoals often result in our acquisition of
higher risk loans, and we typically incur proportionately more
credit losses on these loans than on other types of loans.
Accordingly, these efforts contributed to our higher credit
losses in 2007 and may lead to further increases in our credit
losses.
Regulation by the Department of the Treasury could adversely
affect our liquidity, earnings and financial
condition. We are subject to regulation by the
Department of the Treasury. In June 2006, the Department of the
Treasury announced that it would undertake a review of its
process for approving our issuances of debt, which could
adversely impact our flexibility in issuing debt securities in
the future, including our ability to issue securities that are
responsive to the marketplace. Because our ability to operate
our business, meet our obligations and generate net interest
income depends primarily on our ability to issue substantial
amounts of debt frequently, any limitations on our ability to
issue debt could adversely affect our liquidity, earnings and
financial condition. We cannot predict whether the outcome of
this review will materially impact our current business
activities.
The U.S. Congress continues to consider legislation that,
if enacted, could materially restrict our operations and
adversely affect our liquidity, earnings and financial
condition. In May 2007, the House of Representatives
approved a bill, H.R. 1427, that would establish a new,
independent regulator for us and the other GSEs, with broad
authority over both safety and soundness and mission. The bill,
if enacted into law, would:
In addition, in October 2007, the House passed H.R. 2895, a bill
to establish a National Affordable Housing Trust Fund to
support housing that is affordable to low-income families. This
Trust Fund would consist in part of amounts provided by us
and Freddie Mac under the affordable housing fund provisions of
H.R. 1427. H.R. 2895 does not seek to impose any new obligations
on us that do not already exist under H.R. 1427 and is dependent
upon passage of H.R. 1427 for funding.
As of the date of this filing, the only comprehensive GSE reform
bill that has been introduced in the Senate is S. 1100. This
bill is substantially similar to a bill that was approved by the
Senate Committee on Banking, Housing, and Urban Affairs in July
2005, and differs from H.R. 1427 in a number of respects. It is
expected that a version of GSE reform legislation more similar
to H.R. 1427 could be introduced in the Senate, but the timing
is uncertain. Further, we cannot predict the content of any
Senate bill that may be introduced or its prospects for
Committee approval or passage by the full Senate.
In addition, S. 2391, the “GSE Mission Improvement
Act,” has been introduced in the Senate. This bill would
establish an affordable housing program funded by us and Freddie
Mac. The sponsor of the bill has estimated our combined payment
under the bill to be $500 million to $900 million per
year. The bill would also modify our affordable housing goals
and create a new statutory duty to serve specified underserved
markets.
Enactment of legislation similar to these bills could
significantly increase the costs of our compliance with
regulatory requirements and limit our ability to compete
effectively in the market, resulting in a material adverse
effect on our liquidity, earnings and financial condition. We
cannot predict the prospects for the enactment, timing or
content of any congressional legislation, or the impact that any
enacted legislation could have on our liquidity, earnings or
financial condition.
We
must evaluate our ability to realize the tax benefits associated
with our deferred tax assets quarterly. In the future, we may be
required to record a material expense to establish a valuation
allowance against our deferred tax assets, which likely would
materially adversely affect our earnings, financial condition
and capital position.
As of December 31, 2007, we had approximately
$13.0 billion in net deferred tax assets on our
consolidated balance sheet that we must evaluate for realization
on a quarterly basis under Statement of Financial Accounting
Standards (“SFAS”) No. 109, Accounting for
Income Taxes (“SFAS 109”). Deferred tax
assets refer to assets on our consolidated balance sheets that
relate to amounts that may be used to reduce any subsequent
period’s income tax expense. Consequently, our ability to
use these deferred tax assets in future periods depends on our
ability to generate sufficient taxable income in the future.
If, in a future period, negative evidence regarding our ability
to realize our deferred tax assets (such as a reduction in our
projected future taxable income) outweighed positive evidence,
we could be required to
record a material expense to establish a valuation allowance
against our deferred tax assets at that time. Recording a
material expense of this type would likely have a material
adverse effect on our earnings, financial condition and capital
position. Refer to “Notes to Consolidated Financial
Statements—Note 11, Income Taxes” for a
description of our deferred tax assets.
Shortcomings or failures in our internal processes, people or
systems could have a material adverse effect on our risk
management, liquidity, financial condition and results of
operations; disrupt our business; and result in legislative or
regulatory intervention, damage to our reputation and liability
to customers. For example, our business is dependent on our
ability to manage and process, on a daily basis, a large number
of transactions across numerous and diverse markets. These
transactions are subject to various legal and regulatory
standards. We rely on the ability of our employees and our
internal financial, accounting, cash management, data processing
and other operating systems, as well as technological systems
operated by third parties, to process these transactions and to
manage our business. Due to events that are wholly or partially
beyond our control, these employees or third parties could
engage in improper or unauthorized actions, or these systems
could fail to operate properly, which could lead to financial
losses, business disruptions, legal and regulatory sanctions,
and reputational damage.
Because we use a process of delegated underwriting in which
lenders make specific representations and warranties about the
characteristics of the single-family mortgage loans we purchase
and securitize, we do not independently verify most borrower
information that is provided to us. This exposes us to the risk
that one or more of the parties involved in a transaction (the
borrower, seller, broker, appraiser, title agent, lender or
servicer) will engage in fraud by misrepresenting facts about a
mortgage loan. We may experience significant financial losses
and reputational damage as a result of mortgage fraud.
Our operations rely on the secure processing, storage and
transmission of a large volume of private borrower information,
such as names, residential addresses, social security numbers,
credit rating data and other consumer financial information.
Despite the protective measures we take to reduce the likelihood
of information breaches, this information could be exposed in
several ways, including through unauthorized access to our
computer systems, employee error, computer viruses that attack
our computer systems, software or networks, accidental delivery
of information to an unauthorized party and loss of unencrypted
media containing this information. Any of these events could
result in significant financial losses, legal and regulatory
sanctions, and reputational damage.
During 2007, we remediated eight material weaknesses in our
internal control over financial reporting that existed as of
December 31, 2006, as described in
“Part II—Item 9A—Controls and
Procedures” and in our quarterly report on
Form 10-Q
for the quarter ended September 30, 2007. In order to
remediate these material weaknesses, we implemented many new
processes and reporting procedures in 2007. We may not
effectively maintain these new controls. Remediated material
weaknesses could recur, or we could identify new material
weaknesses or significant deficiencies in our internal control
over financial reporting that we have not identified to date.
Any material weaknesses in our internal control over financial
reporting could result in errors in our reported results and
have a material adverse effect on our operations, investor
confidence in our business and the trading prices of our
securities.
We compete to acquire mortgage assets for our mortgage portfolio
or to securitize mortgage assets into Fannie Mae MBS based on a
number of factors, including our speed and reliability in
closing transactions, our products and services, the liquidity
of Fannie Mae MBS, our reputation and our pricing. We face
competition in the secondary mortgage market from other GSEs and
from commercial banks, savings and loan institutions, securities
dealers, investment funds, insurance companies and other
financial institutions. In addition, increased consolidation
within the financial services industry has created larger
financial institutions, increasing pricing pressure. This
competition may adversely affect our earnings and financial
condition.
The manner in which we compete and the products for which we
compete are affected by changing conditions in the mortgage
industry and capital markets. If we do not effectively respond
to these changes, or if our strategies to respond to these
changes are not as successful as our prior business strategies,
our earnings and financial condition could be adversely
affected. Additionally, we may not be able to execute any new or
enhanced strategies that we adopt to address changing conditions
and, even if fully implemented, these strategies may not
increase our earnings due to factors beyond our control.
We are a party to several lawsuits that, if decided against us,
could require us to pay substantial judgments, settlements or
other penalties, including: a consolidated shareholder class
action lawsuit relating to our accounting restatement; a
proposed consolidated class action lawsuit alleging violations
of the Employee Retirement Income Security Act of 1974
(“ERISA”); a proposed class action lawsuit alleging
violations of federal and state antitrust laws and state
consumer protection laws in connection with the setting of our
guaranty fees; and a proposed class action lawsuit alleging that
we violated purported fiduciary duties with respect to certain
escrow accounts for FHA-insured multifamily mortgage loans. We
are unable at this time to estimate our potential liability in
these matters, but may be required to pay substantial judgments,
settlements or other penalties and incur significant expenses in
connection with these lawsuits, which could have a material
adverse effect on our earnings, liquidity and financial
condition. More information regarding these lawsuits is included
in “Item 3—Legal Proceedings” and
“Notes to Consolidated Financial
Statements—Note 20, Commitments and
Contingencies.”
The continued deterioration of the U.S. housing market and
national decline in home prices in 2007, along with the expected
continued decline in 2008, are likely to result in increased
delinquencies or defaults on the mortgage assets we own and that
back our guaranteed Fannie Mae MBS. Further, the features of a
significant portion of mortgage loans made in recent years,
including loans with adjustable interest rates that may reset to
higher payments either once or throughout their term, and loans
that were made based on limited or no credit or income
documentation, also increase the likelihood of future increases
in delinquencies or defaults on mortgage loans. An increase in
delinquencies or defaults will result in a higher level of
credit losses and credit-related expenses, which in turn will
reduce our earnings and adversely affect our capital position.
Higher credit losses and credit-related expenses also could
adversely affect our financial condition.
Our business volume is affected by the rate of growth in total
U.S. residential mortgage debt outstanding and the size of
the U.S. residential mortgage market. Recently, the rate of
growth in total U.S. residential mortgage debt outstanding
has slowed sharply in response to the reduced activity in the
housing market and national declines in home prices. Total
mortgage originations declined by an estimated 10% in 2007 from
$2.8 trillion
in 2006 to $2.5 trillion in 2007. A decline in the rate of
growth in mortgage debt outstanding reduces the number of
mortgage loans available for us to purchase or securitize, which
in turn could lead to a reduction in our net interest income and
guaranty fee income. If we do not continue to increase our share
of the secondary mortgage market, this decline in mortgage
originations could adversely affect our earnings and financial
condition.
Our earnings and financial condition may be adversely affected
by changes in general market and economic conditions in the
United States and abroad. These conditions include short-term
and long-term interest rates, the value of the U.S. dollar
compared with the value of foreign currencies, the rate of
inflation, fluctuations in both the debt and equity capital
markets, employment growth and unemployment rates, and the
strength of the U.S. national economy and local economies
in the United States and economies of other countries with
investors that hold our debt. These conditions are beyond our
control and may change suddenly and dramatically.
Changes in market and economic conditions could adversely affect
us in many ways, including the following:
We expect the current disruption in the housing and mortgage
markets to continue and worsen in 2008. The disruption has
adversely affected the U.S. economy in general and the
housing and mortgage markets in particular and likely will
continue to do so. In addition, a variety of legislative,
regulatory and other proposals have been or may be introduced in
an effort to address the disruption. Depending on the scope and
nature of legislative, regulatory or other initiatives, if any,
that are adopted to respond to this disruption, our earnings,
liquidity, capital position and financial condition could be
adversely affected.
We routinely enter into a high volume of transactions with
counterparties in the financial services industry. The financial
soundness of many financial institutions may be closely
interrelated as a result of credit, trading or other
relationships between the institutions. As a result, concerns
about, or a default or threatened default by, one institution
could lead to significant market-wide liquidity problems, losses
or defaults by other institutions. This may adversely affect
financial intermediaries, such as clearing agencies, clearing
houses, banks, securities firms and exchanges, with which we
interact on a daily basis, and therefore could adversely affect
our business.
The occurrence of a major natural disaster, terrorist attack or
health epidemic in the United States could increase our
delinquency rates and credit losses in the affected region or
regions, which could have a material adverse effect on our
earnings, liquidity and financial condition. For example, we
experienced an increase in our delinquency rates and credit
losses in 2005 as a result of Hurricane Katrina.
The contingency plans and facilities that we have in place may
be insufficient to prevent a disruption in the infrastructure
that supports our business and the communities in which we are
located from having an adverse effect on our ability to conduct
business. Substantially all of our senior management and
investment personnel work out of our offices in the Washington,
DC metropolitan area. If a disruption occurs and our senior
management or other employees are unable to occupy our offices,
communicate with other personnel or travel to other locations,
our ability to service and interact with each other and with our
customers may suffer, and we may not be successful in
implementing contingency plans that depend on communication or
travel.
None.
We own our principal office, which is located at 3900 Wisconsin
Avenue, NW, Washington, DC, as well as additional Washington, DC
facilities at 3939 Wisconsin Avenue, NW and 4250 Connecticut
Avenue, NW. We also own two office facilities in Herndon,
Virginia, as well as two additional facilities located in
Reston, Virginia, and Urbana, Maryland. These owned facilities
contain a total of approximately 1,459,000 square feet of
space. We lease the land underlying the 4250 Connecticut Avenue
building pursuant to a ground lease that automatically renews on
July 1, 2029 for an additional 49 years unless we
elect to terminate the lease by providing notice to the landlord
of our decision to terminate at least one year prior to the
automatic renewal date. In addition, we lease approximately
428,000 square feet of office space at 4000 Wisconsin
Avenue, NW, which is adjacent to our principal office. The
present lease term for 4000 Wisconsin Avenue expires in April
2013. We have one additional
5-year
renewal option remaining under the original lease. We also lease
an additional approximately 471,000 square feet of office
space at seven locations in Washington, DC, suburban Virginia
and Maryland. We maintain approximately 454,000 square feet
of office space in leased premises in Pasadena, California;
Atlanta, Georgia; Chicago, Illinois; Philadelphia, Pennsylvania;
and Dallas, Texas.
This item describes our material legal proceedings. In addition
to the matters specifically described in this item, we are
involved in a number of legal and regulatory proceedings that
arise in the ordinary course of business that do not have a
material impact on our business. Litigation claims and
proceedings of all types are subject to many factors that
generally cannot be predicted accurately.
We record reserves for claims and lawsuits when they are
probable and reasonably estimable. We presently cannot determine
the ultimate resolution of the matters described below. For
matters where the likelihood or extent of a loss is not probable
or cannot be reasonably estimated, we have not recognized in our
consolidated financial statements the potential liability that
may result from these matters. If one or more of these matters
is determined against us, it could have a material adverse
effect on our earnings, liquidity and financial condition.
Beginning on September 23, 2004, 13 separate complaints
were filed by holders of our securities against us, as well as
certain of our former officers, in three federal district
courts. All of the cases were consolidated
and/or
transferred to the U.S. District Court for the District of
Columbia. The court entered an order naming the Ohio
Public Employees Retirement System and State Teachers Retirement
System of Ohio as lead plaintiffs. The lead plaintiffs filed a
consolidated complaint on March 4, 2005 against us and
certain of our former officers. That complaint was subsequently
amended on April 17, 2006 and then again on August 14,
2006. The lead plaintiffs’ second amended complaint also
added KPMG LLP and Goldman, Sachs & Co. as additional
defendants. The lead plaintiffs allege that the defendants made
materially false and misleading statements in violation of
Sections 10(b) and 20(a) of the Securities Exchange Act of
1934, and SEC
Rule 10b-5
promulgated thereunder, largely with respect to accounting
statements that were inconsistent with the GAAP requirements
relating to hedge accounting and the amortization of premiums
and discounts. The lead plaintiffs contend that the alleged
fraud resulted in artificially inflated prices for our common
stock and seek unspecified compensatory damages, attorneys’
fees, and other fees and costs.
On January 7, 2008, the court issued an order that
certified the action as a class action, and appointed the lead
plaintiffs as class representatives and their counsel as lead
counsel. The court defined the class as all purchasers of Fannie
Mae common stock and call options and all sellers of publicly
traded Fannie Mae put options during the period from
April 17, 2001 through December 22, 2004.
On December 12, 2006, we filed suit against KPMG LLP, our
former outside auditor and a co-defendant in the shareholder
class action suit, in the Superior Court of the District of
Columbia. The complaint alleges state law negligence and breach
of contract claims related to certain audit and other services
provided by KPMG. We filed an amended complaint on
February 15, 2008, adding additional allegations. We are
seeking compensatory damages in excess of $2 billion to
recover costs related to our restatement and other damages. On
December 12, 2006, KPMG removed the case to the
U.S. District Court for the District of Columbia, and it
has been consolidated for pretrial purposes with the shareholder
class action suit.
On April 16, 2007, KPMG LLP filed cross-claims against us
in this action for breach of contract, fraudulent
misrepresentation, fraudulent inducement, negligent
misrepresentation and contribution. KPMG amended these
cross-claims on February 15, 2008. KPMG is seeking
unspecified compensatory, consequential, restitutionary,
rescissory and punitive damages, including purported damages
related to legal costs, exposure to legal liability, costs and
expenses of responding to investigations related to our
accounting, lost fees, attorneys’ fees, costs and expenses.
Our motion to dismiss certain of KPMG’s cross-claims was
denied.
In addition, two individual securities cases were filed by
institutional investor shareholders in the U.S. District
Court for the District of Columbia. The first case was filed on
January 17, 2006 by Evergreen Equity Trust, Evergreen
Select Equity Trust, Evergreen Variable Annuity Trust and
Evergreen International Trust against us and certain current and
former officers and directors. The second individual securities
case was filed on January 25, 2006 by 25 affiliates of
Franklin Templeton Investments against us, KPMG LLP, and certain
current and former officers and directors. On April 27,
2007, KPMG also filed cross-claims against us in this action
that are essentially identical to those it alleges in the
consolidated shareholder class action case. On June 29,
2006 and then again on August 14 and 15, 2006, the individual
securities plaintiffs filed first amended complaints and then
second amended complaints. The second amended complaints each
added Radian Guaranty Inc. as a defendant.
The individual securities actions asserted various federal and
state securities law and common law claims against us and
certain of our current and former officers and directors based
upon essentially the same alleged conduct as that at issue in
the consolidated shareholder class action, and also assert
insider trading claims against certain former officers. Both
cases sought unspecified compensatory and punitive damages,
attorneys’ fees, and other fees and costs. In addition, the
Evergreen plaintiffs sought an award of treble damages under
state law. The court consolidated these individual securities
actions into the consolidated shareholder class action for
pretrial purposes and possibly through final judgment.
On July 31, 2007, the court dismissed all of the individual
securities plaintiffs’ claims against the current and
former officer and director defendants, except for Franklin D.
Raines and J. Timothy Howard. In addition, the court dismissed
the individual securities plaintiffs’ state law claims and
certain of their federal securities law claims against us,
Franklin D. Raines, J. Timothy Howard and Leanne Spencer. It
also limited the individual securities plaintiffs’ insider
trading claims against Franklin D. Raines, J. Timothy Howard and
Leanne Spencer. On February 12, 2008 and February 15,
2008, respectively, upon motions by the plaintiffs to dismiss
their actions, the court dismissed the individual securities
plaintiffs’ separate actions without prejudice to their
rights to recover as class members in the consolidated
securities class action.
We believe we have valid defenses to the claims in the remaining
lawsuits described above and intend to defend these lawsuits
vigorously.
Beginning on September 28, 2004, ten plaintiffs filed
twelve shareholder derivative actions (i.e., lawsuits
filed by shareholder plaintiffs on our behalf) in three
different federal district courts and the Superior Court of the
District of Columbia against certain of our current and former
officers and directors and against us as a nominal defendant.
All of these shareholder derivative actions have been
consolidated into the U.S. District Court for the District
of Columbia and the court entered an order naming Pirelli
Armstrong Tire Corporation Retiree Medical Benefits Trust and
Wayne County Employees’ Retirement System as co-lead
plaintiffs. A consolidated complaint was filed on
September 26, 2005 against certain of our current and
former officers and directors and against us as a nominal
defendant. The consolidated complaint alleges that the
defendants purposefully misapplied GAAP, maintained poor
internal controls, issued a false and misleading proxy statement
and falsified documents to cause our financial performance to
appear smooth and stable, and that Fannie Mae was harmed as a
result. The claims are for breaches of the duty of care, breach
of fiduciary duty, waste, insider trading, fraud, gross
mismanagement, violations of the Sarbanes-Oxley Act of 2002, and
unjust enrichment. Plaintiffs seek unspecified compensatory
damages, punitive damages, attorneys’ fees, and other fees
and costs, as well as injunctive relief directing us to adopt
certain proposed corporate governance policies and internal
controls.
The lead plaintiffs filed an amended complaint on
September 1, 2006, which added certain third parties as
defendants. The amended complaint also added allegations
concerning the nature of certain transactions between these
entities and Fannie Mae, and added additional allegations from
OFHEO’s May 2006 report on its special investigation of
Fannie Mae and from a report by the law firm of Paul, Weiss,
Rifkind & Garrison LLP on its investigation of Fannie
Mae. On May 31, 2007, the court dismissed this consolidated
lawsuit in its entirety against all defendants. On June 27,
2007, plaintiffs filed a Notice of Appeal, which is currently
pending with the U.S. Court of Appeals for the District of
Columbia.
On September 20, 2007, James Kellmer, a shareholder who had
filed one of the derivative actions that was consolidated into
the consolidated derivative case, filed a motion for
clarification or, in the alternative, for relief of judgment
from the Court’s May 31, 2007 Order dismissing the
consolidated case. Mr. Kellmer’s motion seeks
clarification that the Court’s May 31, 2007 dismissal
order does not apply to his January 10, 2005 action, and
that his case can now proceed. This motion is pending.
On June 29, 2007, Mr. Kellmer also filed a new
derivative action in the U.S. District Court for the
District of Columbia. Mr. Kellmer’s new complaint
alleges that he made a demand on the Board of Directors on
September 24, 2004, and that this new action should now be
allowed to proceed. On December 18, 2007, Mr. Kellmer
filed an amended complaint that narrowed the list of named
defendants to certain of our current and former directors,
Goldman Sachs Group, Inc. and us, as a nominal defendant. The
factual allegations in Mr. Kellmer’s 2007 amended
complaint are largely duplicative of those in the amended
consolidated complaint and his amended complaint’s claims
are based on theories of breach of fiduciary duty,
indemnification, negligence, violations of the Sarbanes-Oxley
Act of 2002 and unjust enrichment. His amended complaint seeks
unspecified money damages, including legal fees and expenses,
disgorgement and punitive damages, as well as injunctive relief.
In addition, on July 6, 2007, Arthur Middleton filed a
derivative action in the U.S. District Court for the
District of Columbia that is also based on
Mr. Kellmer’s alleged September 24, 2004 demand.
This complaint names as defendants certain of our current and
former officers and directors, the Goldman Sachs Group, Inc.,
Goldman, Sachs & Co. and us, as a nominal defendant.
The allegations in this new complaint are essentially identical
to the allegations in the amended consolidated complaint
referenced above, and this plaintiff seeks
identical relief. On July 27, 2007, Mr. Kellmer filed
a motion to consolidate these two new derivative cases and to be
appointed lead counsel. We filed a motion to dismiss
Mr. Middleton’s complaint for lack of standing on
October 3, 2007, and a motion to dismiss
Mr. Kellmer’s 2007 complaint for lack of subject
matter jurisdiction on October 12, 2007. These motions
remain pending.
On November 26, 2007, Patricia Browne Arthur filed a
derivative action in the U.S. District Court for the
District of Columbia against certain of our current and former
officers and directors and against us as a nominal defendant.
The complaint alleges that the defendants wrongfully failed to
disclose our exposure to the subprime mortgage crisis and that
this failure artificially inflated our stock price and allowed
certain of the defendants to profit by selling their shares
based on material inside information; and that the Board
improperly authorized the company to buy back $100 million
in shares while the stock price was artificially inflated. The
complaint alleges that the defendants’ actions violated
Sections 10(b) and 20(a) of the Securities Exchange Act of
1934 and SEC
Rule 10b-5
promulgated thereunder. It also alleges breaches of fiduciary
duty (including duties of care, loyalty, reasonable inquiry,
oversight, good faith and supervision); misappropriation of
information and breach of fiduciary duties of loyalty and good
faith (specifically in connection with stock sales); waste of
corporate assets; and unjust enrichment. Plaintiff seeks
damages; corporate governance changes; equitable relief in the
form of attaching, impounding or imposing a constructive trust
on the individual defendants’ assets; restitution; and
attorneys’ fees and costs.
On October 15, 2004, David Gwyer filed a proposed class
action complaint in the U.S. District Court for the
District of Columbia. Two additional proposed class action
complaints were filed by other plaintiffs on May 6, 2005
and May 10, 2005. These cases are based on the Employee
Retirement Income Security Act of 1974 (“ERISA”) and
name us, our Board of Directors’ Compensation Committee and
certain of our former and current officers and directors as
defendants.
These cases were consolidated on May 24, 2005 in the
U.S. District Court for the District of Columbia and a
consolidated complaint was filed on June 15, 2005. The
plaintiffs in this consolidated ERISA-based lawsuit purport to
represent a class of participants in our Employee Stock
Ownership Plan between January 1, 2001 and the present.
Their claims are based on alleged breaches of fiduciary duty
relating to accounting matters. Plaintiffs seek unspecified
damages, attorneys’ fees, and other fees and costs, and
other injunctive and equitable relief. On July 23, 2007,
the Compensation Committee of our Board of Directors filed a
motion to dismiss, which remains pending.
We believe we have valid defenses to the claims in this lawsuit
and intend to defend this lawsuit vigorously.
On September 19, 2005, Franklin D. Raines, our former
Chairman and Chief Executive Officer, initiated arbitration
proceedings against Fannie Mae before the American Arbitration
Association concerning our obligations under his employment
agreement. On April 24, 2006, the arbitrator issued a
decision regarding the effective date of Mr. Raines’s
retirement. As a result of this decision, on November 7,
2006, the parties entered into a consent award, which partially
resolved the issue of amounts due Mr. Raines. In accordance
with the consent award, we paid Mr. Raines
$2.6 million on November 17, 2006 under his employment
agreement. By agreement, final resolution of the unresolved
issues was deferred until after our accounting restatement
results were announced. On June 26, 2007, counsel for
Mr. Raines notified the arbitrator that the parties have
been unable to resolve the following issues:
Mr. Raines’s entitlement to additional shares of
common stock under our performance share plan for the three-year
performance share cycle that ended in 2003;
Mr. Raines’s entitlement to shares of common stock
under our performance share plan for the three-year performance
share cycles that ended in each of 2004, 2005 and 2006; and
Mr. Raines’s entitlement to additional compensation of
approximately $140,000.
Since January 18, 2005, we have been served with 11
proposed class action complaints filed by single-family
borrowers that allege that we and Freddie Mac violated federal
and state antitrust and consumer protection statutes by agreeing
to artificially fix, raise, maintain or stabilize the price of
our and Freddie Mac’s guaranty fees. Two of these cases
were filed in state courts. The remaining cases were filed in
federal court. The two state court actions were voluntarily
dismissed. The federal court actions were consolidated in the
U.S. District Court for the District of Columbia.
Plaintiffs filed a consolidated amended complaint on
August 5, 2005. Plaintiffs in the consolidated action seek
to represent a class of consumers whose loans allegedly
“contain a guarantee fee set by” us or Freddie Mac
between January 1, 2001 and the present. Plaintiffs seek
unspecified damages, treble damages, punitive damages, and
declaratory and injunctive relief, as well as attorneys’
fees and costs.
We and Freddie Mac filed a motion to dismiss on October 11,
2005, which remains pending.
We believe we have valid defenses to the claims in this lawsuit
and intend to defend this lawsuit vigorously.
A complaint was filed against us in the U.S. District Court
for the Eastern District of Texas (Texarkana Division) on
June 2, 2004, in which plaintiffs purport to represent a
class of multifamily borrowers whose mortgages are insured under
Sections 221(d)(3), 236 and other sections of the National
Housing Act and are held or serviced by us. The complaint
identified as a proposed class low- and moderate-income
apartment building developers who maintained uninvested escrow
accounts with us or our servicer. Plaintiffs Casa Orlando
Apartments, Ltd., Jasper Housing Development Company and the
Porkolab Family Trust No. 1 allege that we violated
fiduciary obligations that they contend we owed to borrowers
with respect to certain escrow accounts and that we were
unjustly enriched. In particular, plaintiffs contend that,
starting in 1969, we misused these escrow funds and are
therefore liable for any economic benefit we received from the
use of these funds. Plaintiffs seek a return of any profits,
with accrued interest, earned by us related to the escrow
accounts at issue, as well as attorneys’ fees and costs.
Our motions to dismiss and for summary judgment with respect to
the statute of limitations were denied.
Plaintiffs filed an amended complaint on December 16, 2005.
On January 3, 2006, plaintiffs filed a motion for class
certification, which remains pending.
We believe we have valid defenses to the claims in this lawsuit
and intend to defend this lawsuit vigorously.
On November 6, 2007, the New York Attorney General’s
Office issued a letter to us discussing that Office’s
investigation into appraisal practices in the mortgage industry.
The letter also discussed a complaint filed by the Attorney
General’s Office against First American Corporation and its
subsidiary eAppraiseIT alleging inappropriate appraisal
practices engaged in by First American and eAppraiseIT with
respect to loans appraised for Washington Mutual, Inc. We are
cooperating with the Attorney General and have agreed to appoint
an independent examiner to review these matters. On
November 7, 2007, the Attorney General’s Office issued
a subpoena to us regarding appraisals and valuations as they may
relate to our mortgage purchases and securitizations.
Fannie Mae’s 2007 annual meeting of shareholders was held
on December 14, 2007. At the meeting, shareholders voted on
the following matters:
1. The election of 12 directors;
3. The approval of an amendment to the Fannie Mae Stock
Compensation Plan of 2003;
4. A shareholder proposal to require a shareholder advisory
vote on executive compensation; and
5. A shareholder proposal to authorize cumulative voting
for directors.
The following individuals were elected as directors for a term
expiring at the next annual meeting of shareholders.
In addition to the directors elected by the shareholders, the
President of the United States has the authority to appoint five
members of Fannie Mae’s Board. The terms of office of the
most recent Presidential appointees to Fannie Mae’s Board
expired on May 25, 2004, and the President has not
reappointed or replaced any of them. Pursuant to the Charter
Act, those five board positions will remain open unless and
until the President names new appointees.
The selection of Deloitte & Touche LLP as independent
registered public accounting firm for 2007 was ratified as
follows:
There were no broker non-votes with respect to the ratification
of the selection of Deloitte & Touche LLP.
The amendment to the Fannie Mae Stock Compensation Plan of 2003
was approved as follows:
A shareholder proposal to require a shareholder advisory vote on
executive compensation was not approved as follows:
A shareholder proposal to authorize cumulative voting for
directors was not approved as follows:
Our common stock is publicly traded on the New York and Chicago
stock exchanges and is identified by the ticker symbol
“FNM.” The transfer agent and registrar for our common
stock is Computershare, P.O. Box 43081, Providence,
Rhode Island 02940.
The following table shows, for the periods indicated, the high
and low sales prices per share of our common stock in the
consolidated transaction reporting system as reported in the
Bloomberg Financial Markets service, as well as the dividends
per share declared in each period.
The table set forth under “Common Stock Data” above
presents the dividends we declared on our common stock from the
first quarter of 2006 through and including the fourth quarter
of 2007. In January 2008, the Board of Directors decreased the
common stock dividend to $0.35 per share, beginning with the
first quarter of 2008. Our Board of Directors will continue to
assess dividend payments for each quarter based upon the facts
and conditions existing at the time.
Our payment of dividends is subject to certain restrictions,
including the submission of prior notification to OFHEO
detailing the rationale and process for the proposed dividend
and prior approval by the Director of OFHEO of any dividend
payment that would cause our capital to fall below specified
capital levels. See
“Part I—Item 1—Business—Our
Charter and Regulation of Our Activities—Regulation and
Oversight of Our Activities—OFHEO Regulation—Capital
Adequacy Requirements” for a description of these
restrictions. Payment of dividends on our common stock is also
subject to the prior payment of dividends on our 15 series of
preferred stock, representing an aggregate of
466,375,000 shares outstanding as of December 31,
2007. Annual dividends declared on the shares of our preferred
stock outstanding totaled $503 million for the year ended
December 31, 2007. See “Notes to Consolidated
Financial Statements—Note 17, Preferred Stock”
for detailed information on our preferred stock dividends.
As of January 31, 2008, we had approximately 21,000
registered holders of record of our common stock, including
holders of our restricted stock.
First
Quarter 2007
Information about sales and issuances of our unregistered
securities during the quarter ended March 31, 2007 was
provided in a current report on
Form 8-K
filed with the SEC on May 9, 2007.
Second
Quarter 2007
Information about sales and issuances of our unregistered
securities during the quarter ended June 30, 2007 was
provided in a current report on
Form 8-K
filed with the SEC on August 9, 2007.
Third
Quarter 2007
Information about sales and issuances of our unregistered
securities during the quarter ended September 30, 2007 was
provided in our quarterly report on
Form 10-Q
for the quarter ended September 30, 2007, filed with the
SEC on November 9, 2007.
Fourth
Quarter 2007
Under the Fannie Mae Stock Compensation Plan of 1993 and the
Fannie Mae Stock Compensation Plan of 2003 (the
“Plans”), we regularly provide stock compensation to
employees and members of the Board of Directors to attract,
motivate and retain these individuals and promote an identity of
interests with shareholders.
During the quarter ended December 31, 2007, we issued
299,556 shares of common stock upon the exercise of stock
options for an aggregate exercise price of approximately
$15.5 million, of which approximately $5.9 million was
paid in cash and the remainder was paid by the delivery to us of
151,885 shares of common stock. Options granted under the
Plans typically vest 25% per year beginning on the first
anniversary of the date of grant and expire ten years after the
grant. No options have been granted since May 2005.
On June 15, 2007, our Board of Directors determined that a
portion of contingent shares under our Performance Share Program
would be awarded. Accordingly, during the quarter ended
December 31, 2007, we awarded 161,109 shares of common
stock, as a result of which 94,019 shares of common stock
were issued and 67,090 shares of common stock that
otherwise would have been issued were withheld by us in lieu of
requiring the recipients to pay us the withholding taxes due
upon awarding.
In consideration of services rendered or to be rendered, we also
issued 15,800 shares of restricted stock during the quarter
ended December 31, 2007. In addition, 18,533 restricted
stock units vested, as a result of which 12,676 shares of
common stock were issued and 5,857 shares of common stock
that otherwise would have been issued were withheld by us in
lieu of requiring the recipients to pay us the withholding taxes
due upon vesting. Shares of restricted stock and restricted
stock units granted under the Plans typically vest in equal
annual installments over three or four years beginning on the
first anniversary of the date of grant. Each restricted stock
unit represents the right to receive a share of common stock at
the time of vesting. As a result, restricted stock units are
generally similar to restricted stock, except that restricted
stock units do not confer voting rights on their holders.
All options, shares of restricted stock and restricted stock
units were granted to persons who were employees or members of
the Board of Directors of Fannie Mae.
As reported in a current report on
Form 8-K
filed with the SEC on November 21, 2007, we issued
20 million shares of 7.625% Rate Non-Cumulative Preferred
Stock, Series R, with an aggregate stated value of
$500 million, on November 21, 2007. As reported in a
current report on
Form 8-K
filed with the SEC on December 20, 2007, we issued an
additional 1.2 million shares of Series R Preferred
Stock, with an aggregate stated value of $30 million, on
December 14, 2007.
As reported in a current report on
Form 8-K
filed with the SEC on December 11, 2007, we issued
280 million shares of Fixed-to-Floating Rate Non-Cumulative
Preferred Stock, Series S, with an aggregate stated value
of $7 billion, on December 11, 2007.
The securities we issue are “exempted securities”
under laws administered by the SEC to the same extent as
securities that are obligations of, or are guaranteed as to
principal and interest by, the United States. As a result, we do
not file registration statements with the SEC with respect to
offerings of our securities.
Purchases
of Equity Securities by the Issuer
The following table shows shares of our common stock we
repurchased during the fourth quarter of 2007.
The selected consolidated financial data presented below is
summarized from our results of operations for the five-year
period ended December 31, 2007, as well as selected
consolidated balance sheet data as of the end of each year
within this five-year period. The data presented below should be
read in conjunction with the audited consolidated financial
statements and related notes and with
“Item 7—MD&A” included in this annual
report on
Form 10-K.
46
Note:
This discussion should be read in conjunction with our
consolidated financial statements as of December 31, 2007
and related notes. Readers should also review carefully
“Part I—Item 1—Business—Forward-Looking
Statements” and
“Part I—Item 1A—Risk Factors” for
a description of the forward-looking statements in this report
and a discussion of the factors that might cause our actual
results to differ, perhaps materially, from these
forward-looking statements. Please refer to “Glossary of
Terms Used in This Report” for an explanation of key terms
used throughout this discussion.
EXECUTIVE
SUMMARY
Our financial results for 2007 were severely affected by the
disruption in the mortgage and credit markets during the second
half of 2007 and continued weakness in the housing markets. We
recorded a net loss of $2.1 billion and a diluted loss per
share of $2.63 in 2007, compared with net income and diluted
earnings per share of $4.1 billion and $3.65 in 2006, and
$6.3 billion and $6.01 in 2005.
Our financial results for the first half of 2007 differed
markedly from our financial results for the second half of 2007.
For the first half of 2007, we recorded net income of
$2.9 billion and diluted earnings per share of $2.72. The
second half of 2007, however, was marked by significant
disruption and uncertainty in the housing, mortgage and credit
markets. For the second half of 2007, we recorded a net loss of
$5.0 billion, as market factors such as significant
increases in serious delinquency rates and foreclosures, home
price declines, widening credit spreads, shifts in interest
rates and illiquidity in the capital markets had a material
adverse effect on our results, more than offsetting the income
we earned in the first half of the year.
The following factors had the most significant adverse effect on
our 2007 financial results:
The effect of these adverse factors more than offset the
favorable impact of an increase of $821 million in our
guaranty fee income.
We are experiencing a significant disruption in the housing,
mortgage and credit markets. The market downturn that began in
2006 continued throughout 2007, and is continuing in 2008, with
significant declines in new and existing home sales, housing
starts, mortgage originations and home prices, as well as
significant increases in inventories of unsold homes, mortgage
delinquencies and foreclosures. During the second half of 2007,
the capital markets also were characterized by high levels of
volatility, reduced levels of liquidity in the mortgage and
broader credit markets, significantly wider credit spreads and
rating agency downgrades on a growing number of mortgage-related
securities. We discuss these and other market and economic
factors that affect our business in more detail in
“Part I—Item 1—Business—Residential
Mortgage Market Overview—Market and Economic Factors
Affecting Our Business.”
These challenging market conditions contributed to our net loss
in 2007 and adversely affected our regulatory capital position.
The adverse effects of market conditions on our 2007 financial
results included:
The factors that negatively affected our financial results and
regulatory capital position included losses primarily reflecting
market–based valuations related to the adverse conditions
in the housing, mortgage and credit markets during the second
half of 2007. The table below shows the effect of these
market-based valuations on our 2007 earnings.
We discuss how we account for and record various financial
instruments in our financial statements in “Critical
Accounting Policies and Estimates—Fair Value of Financial
Instruments.” We provide a more detailed discussion of key
factors affecting year-over-year changes in our results of
operations in “Consolidated Results of Operations,”
“Business Segment Results,” “Consolidated Balance
Sheet Analysis” and “Supplemental
Non-GAAP Information—Fair Value Balance Sheets.”
We expect continued weakness in the housing and mortgage markets
will continue to adversely affect our financial results and
regulatory capital position in 2008, while at the same time
offering us the opportunity over the longer term to build a
stronger competitive position within our market. Our principal
strategy for responding to the current challenging market
conditions is to prudently manage and preserve our capital,
while building a solid mortgage credit book of business and
continuing to fulfill our chartered mission of providing
liquidity, stability and affordability to the secondary mortgage
market. We identify below a number of the steps we have taken
and are taking to achieve that strategy.
During the second half of 2007, our business activities were
constrained by our need to maintain regulatory capital at
required levels. We took steps to bolster our regulatory capital
position during the second half of 2007 by:
We have implemented a variety of measures designed to help us
manage and mitigate the credit exposure we face as a result of
our investment and guarantee activities. These measures include:
The mortgage and credit market disruption has created a need for
additional credit and liquidity in the secondary mortgage
market. To respond to this need and to fulfill our mission of
providing liquidity, stability and affordability to the
secondary mortgage market, we are continuing to increase our
participation in the securitization of mortgage loans. These
actions had the following positive effects on our business in
2007:
issuances increasing to approximately 48.5% for the fourth
quarter of 2007, from approximately 24.6% for the fourth quarter
of 2006; and
We expect housing market weakness to continue in 2008, leading
to increased delinquencies, defaults and foreclosures on
mortgage loans, and slower growth in U.S. residential
mortgage debt outstanding. Based on our current market outlook,
we expect that our credit losses and credit-related expenses
will continue to increase during 2008, as will our guaranty fee
income. We also believe that our single-family guaranty book of
business will grow at a faster rate than the rate of overall
growth in U.S. residential mortgage debt outstanding. We
have experienced an increased level of volatility and a
significant decrease in the fair value of our net assets since
the end of 2007, due to the continued widening of credit spreads
since the end of the year and the ongoing disruption in the
mortgage and credit markets. If current market conditions
persist, we expect the fair value of our net assets will decline
in 2008 from the estimated fair value of $35.8 billion as
of December 31, 2007.
To date, our access to sources of liquidity has been adequate to
meet both our capital and funding needs. If the current
challenging market conditions continue or worsen, however, we
may take further actions to meet our regulatory capital
requirements, including reducing the size of our investment
portfolio through liquidations or by selling assets, issuing
preferred, convertible preferred or common stock, reducing or
eliminating our common stock dividend, forgoing purchase and
guaranty opportunities, and changing our current business
practices to reduce our losses and expenses.
We provide additional detail on trends that may affect our
result of operations, financial condition and regulatory capital
position in future periods in “Consolidated Results of
Operations” below.
The preparation of financial statements in accordance with GAAP
requires management to make a number of judgments, assumptions
and estimates that affect our reported results of operations and
financial condition. Understanding our accounting policies and
the extent to which we use management judgment and estimates in
applying these policies is integral to understanding our
financial statements. We describe our most significant
accounting policies in “Notes to Consolidated Financial
Statements—Note 1, Summary of Significant Accounting
Policies.”
We have identified three of our accounting policies as critical
because they involve significant judgments and assumptions about
highly complex and inherently uncertain matters and the use of
reasonably different estimates and assumptions could have a
material impact on our reported results of operations or
financial condition. These critical accounting policies and
estimates are as follows:
We evaluate our critical accounting estimates and judgments
required by our policies on an ongoing basis and update them as
necessary based on changing conditions. Management has discussed
each of these significant accounting policies, including the
related estimates and judgments, with the Audit Committee of the
Board of Directors.
Fair value is defined as the amount at which a financial
instrument could be exchanged in a current transaction between
willing, unrelated parties, other than in a forced or
liquidation sale. The use of fair value
to measure our financial instruments is fundamental to our
financial statements and is our most critical accounting
estimate because a substantial portion of our assets and
liabilities are recorded at estimated fair value and, in certain
circumstances, our valuation techniques involve a high degree of
management judgment. The principal assets and liabilities that
we record at fair value, and the manner in which changes in fair
value affect our earnings and stockholders’ equity, are
summarized below.
We use one of the following three practices for estimating fair
value, the selection of which is based on the availability and
reliability of relevant market data: (i) actual, observable
market prices or market prices obtained from multiple third
parties when available; (ii) market data and model-based
interpolations using standard models widely accepted within the
industry if market prices are not available; or
(iii) internally developed models that employ techniques
such as a discounted cash flow approach and that include
market-based assumptions, such as prepayment speeds and default
and severity rates, derived from internally developed models.
Price transparency tends to be limited in less liquid markets
where quoted market prices or observable market data may not be
available. We regularly refine and enhance our valuation
methodologies to correlate more closely to observable market
data. When observable market prices or data are not readily
available or do not exist, the estimation of fair value may
require significant management judgment and assumptions. See
“Part I—Item 1A—Risk Factors” for
a discussion of the risks and uncertainties related to our use
of valuation models.
In September 2006, the Financial Accounting Standards Board
(“FASB”) issued SFAS No. 157, Fair Value
Measurements (“SFAS 157”), which establishes
a framework for measuring fair value under GAAP. SFAS 157
provides a three-level fair value hierarchy for classifying the
source of information used in fair value measures and requires
increased disclosures about the sources and measurements of fair
value. In February 2007, the FASB issued SFAS No. 159,
The Fair Value Option for Financial Assets and Financial
Liabilities (“SFAS 159”). SFAS 159
permits companies to make a one-time election to report certain
financial instruments at fair value with the changes in fair
value included in earnings. SFAS 157 and SFAS 159 are
effective for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. We provide
additional information in “Notes to Consolidated Financial
Statements—Note 1, Summary of Significant Accounting
Policies” on the impact to our consolidated financial
statements from the January 1, 2008 adoption of each of
these accounting pronouncements.
The downturn in the housing market, along with the mortgage and
credit market disruption that began in the third quarter of
2007, resulted in a repricing of credit risk and a dislocation
of historical pricing relationships
between certain financial instruments. These conditions, which
triggered greater market volatility, wider credit spreads and a
lack of price transparency, have had widespread implications on
how companies measure the fair value of certain financial
instruments and a direct impact on the significant market-based
valuation adjustments recorded in our earnings that are
identified in “Executive Summary—Impact of Market
Conditions on Our Business” and include:
(1) Derivatives fair value losses, net; (2) Losses on
certain guaranty contracts; and
(3) SOP 03-3
fair value losses. We provide additional information below on
our accounting for these items and discuss the effect of these
market conditions on the valuation process, including the
judgments and uncertainties surrounding our estimates, the
extent to which we have adjusted our assumptions used to derive
these estimates and the basis for these adjustments, and the
impact that reasonably likely changes in either market
conditions or our estimates and assumptions may have on our
results.
Changes in the fair value of our derivatives, which we recognize
in our consolidated statements of operations in
“Derivatives fair value gains (losses), net,”
generally have produced the most significant volatility in our
earnings. Table 2 summarizes the estimated fair value of
derivative assets and liabilities recorded in our consolidated
balance sheets as of December 31, 2007 and 2006. We present
additional detail on the estimated fair value and the related
outstanding notional amount of our derivatives by derivative
instrument type in “Consolidated Balance Sheet
Analysis—Derivative Instruments.”
Our derivatives consist primarily of over-the-counter
(“OTC”) contracts and commitments to purchase and sell
mortgage assets. While exchange-traded derivatives can generally
be valued using observable market prices or market parameters,
OTC derivatives are generally valued using industry-standard
models or model-based interpolations that utilize market inputs
obtained from widely accepted third-party sources. The valuation
models that we use to derive the fair value of our OTC
derivatives require inputs such as the contractual terms, market
prices, yield curves, and measures of implied volatility. A
substantial majority of our OTC derivatives trade in liquid
markets, such as interest rate swaps and swaptions; in those
cases, model selection and inputs generally do not involve
significant judgments.
When internal pricing models are used to determine fair value,
we use recently executed comparable transactions and other
observable market data to validate the results of the model.
Consistent with market practice, we have individually negotiated
agreements with certain counterparties to exchange collateral
based on the level of fair values of the derivative contracts
they have executed. Through our derivatives collateral exchange
process, one party or both parties to a derivative contract
provides the other party with information about the fair value
of the derivative contract to calculate the amount of collateral
required. This sharing of fair value information provides
additional support of the recorded fair value for relevant OTC
derivative instruments. For more information regarding our
derivative counterparty risk management practices, see
“Risk Management—Credit Risk
Management—Institutional Counterparty Credit Risk
Management—Derivatives Counterparties.” In
circumstances where we cannot verify the model with market
transactions, it is possible that a different valuation model
could produce a materially different estimate of fair value. As
markets and products develop and the pricing for certain
derivative products becomes more transparent, we continue to
refine our valuation methodologies. We did not make any material
changes to the quantitative models used to value our derivatives
instruments for the years ended December 31, 2007, 2006 or
2005.
We disclose the sensitivity of the fair value of our derivative
assets and liabilities to changes in interest rates, a key
variable that affects the estimated fair value, in “Risk
Management—Interest Rate Risk Management and Other Market
Risks—Measuring Interest Rate Risk.”
Fair
Value of Guaranty Assets and Guaranty Obligations—Effect on
Losses on Certain Guaranty Contracts
When we issue Fannie Mae MBS, we record in our consolidated
balance sheets a guaranty asset that represents the present
value of cash flows expected to be received as compensation over
the life of the guaranty. As guarantor of our Fannie Mae MBS
issuances, we also recognize at inception of the guaranty the
fair value of our obligation to stand ready to perform over the
term of the guaranty. We record this amount in our consolidated
balance sheets as a component of “Guaranty
obligations.” The fair value of this obligation represents
management’s estimate, at the time we enter into the
guaranty contract, of the amount of compensation that we would
expect a third party of similar credit standing to require to
assume our guaranty obligation.
The fair value of our guaranty obligations consists of
compensation to cover estimated default costs, including
estimated unrecoverable principal and interest that will be
incurred over the life of the underlying mortgage loans backing
our Fannie Mae MBS, estimated foreclosure-related costs,
estimated administrative and other costs related to our
guaranty, and an estimated market rate of return, or profit,
that a market participant would require to assume the
obligation. As described in “Notes to Consolidated
Financial Statements—Note 1, Summary of Significant
Accounting Policies,” if the fair value at inception of the
guaranty obligation exceeds the fair value of the guaranty asset
and other consideration, we recognize a loss in “Losses on
certain guaranty contracts” in our consolidated statements
of operations. Subsequent to the inception of the guaranty, we
establish a “Reserve for guaranty losses” through a
recurring process by which the probable and estimable losses
incurred on homogeneous pools of loans underlying our MBS trusts
are recognized in accordance with SFAS No. 5, Accounting
for Contingencies (“SFAS No. 5”). Such future
probable and estimable losses incurred on loans underlying our
MBS may equal, exceed or be less than the expected losses
estimated as a component of the fair value of our guaranty
obligation at inception of the guaranty contract. We recognize
incurred losses in our consolidated statements of operations as
a part of our provision for credit losses and as foreclosed
property expense.
If all other things are equal, the SFAS 5 reserve for
guaranty losses is reduced at period end by virtue of the fact
that the purchased loan is no longer included in the population
for which the SFAS 5 reserve is determined. Therefore, if
the charge-off (which represents the
SOP 03-3
fair value loss) is greater than the decrease in the reserve
caused by removing the loan from the population subject to
SFAS 5, an incremental loss is recognized through the
current period provision for credit losses.
Following is an example to illustrate how losses recorded at
inception on certain guaranty contracts affect our earnings over
time. Assume that within one of our guaranty contracts, we have
an individual Fannie Mae MBS issuance for which the present
value of the guaranty fees we expect to receive over time based
on both a five-year contractual and expected life of the
fixed-rate loans underlying the MBS totals $100. Based on market
expectations, we estimate that a market participant would
require $120 to assume the risk associated with our guaranty of
the principal and interest due to investors in the MBS trust. To
simplify the accounting in our example, we assume that the
expected life of the underlying loans remains the same over the
five-year contractual period and the annual scheduled principal
and interest loan payments are equal over the five-year period.
Accounting Upon Initial Issuance of MBS:
Accounting in Each of Years 1 to 5:
As illustrated in the example, the $20 loss recognized at
inception of the guaranty contract will be accreted into
earnings over time as a component of guaranty fee income. For
additional information on our accounting for guaranty
transactions, which is more complex than the example presented,
refer to “Notes to Consolidated Financial
Statements—Note 1, Summary of Significant Accounting
Policies.”
When available, we base the fair value of the guaranty
obligations that we record when we issue Fannie Mae MBS on
market information obtained from spot transaction prices. In the
absence of spot transaction data, which is the case for the
substantial majority of our guaranties, we estimate the fair
value using internal models that project the future credit
performance of the loans underlying our guaranty obligations
under a variety of economic scenarios. Key inputs and
assumptions used in our models that affect the fair value of our
guaranty obligations are home price growth rates and an
estimated market rate of return.
The fair value of our guaranty obligations is highly sensitive
to changes in interest rates and the market’s perception of
future credit performance. When there is a market expectation of
a decline in home prices, which currently exists, the level of
perceived credit risk for a mortgage loan tends to increase
because the market anticipates a likelihood of higher credit
losses. Accordingly, the market requires a higher rate of
return. Incorporating these assumptions into our internal models
has resulted in significant increases in the estimated fair
value of our guaranty obligations on new Fannie Mae MBS
issuances and an increase in the losses recognized at inception
on certain guaranty contracts. We review the reasonableness of
the results of our models by comparing those results with
available market information; however, it is possible that
different assumptions and inputs could produce materially
different estimates of the fair value of our guaranty
obligations and losses on certain guaranty contracts,
particularly in the current market environment.
Based on our experience, we expect our actual future credit
losses to be significantly less than the fair value of our
guaranty obligations, as the fair value of our guaranty
obligations includes not only future expected credit losses but
also an estimated market rate of return that a market
participant would require to assume the obligation Our combined
allowance for loan losses and reserve for guaranty losses
reflects our estimate of the probable credit losses inherent in
our guaranty book of business. We discuss our credit-related
expenses and credit losses in “Consolidated Results of
Operations—Credit-Related Expenses.”
Fair
Value of Loans Purchased with Evidence of Credit
Deterioration—Effect on Credit-Related
Expenses
We have the option to purchase delinquent loans underlying our
Fannie Mae MBS trusts under specified conditions, which we
describe in “Item 1—Business—Business
Segments—Single-Family Credit Guaranty Business—MBS
Trusts—Optional and Required Purchases of Mortgage Loans
from Single-Family MBS Trusts.” The acquisition cost for
loans purchased from MBS trusts is the unpaid principal balance
of the loan plus accrued interest. We generally are required to
purchase the loan if it is delinquent 24 consecutive months or
at the time of foreclosure, if it is still in the MBS trust at
that time. As long as the loan or REO property remains in the
MBS trust, we continue to pay principal and interest to the MBS
trust.
As described in “Notes to Consolidated Financial
Statements—Note 1, Summary of Significant Accounting
Policies,” when we purchase loans that are within the scope
of
SOP 03-3,
we record our net investment in these seriously delinquent loans
at the lower of the acquisition cost of the loan or the
estimated fair value at
the date of purchase. To the extent the acquisition cost exceeds
the estimated fair value, we record a
SOP 03-3
fair value loss charge-off against the “Reserve for
guaranty losses” at the time we acquire the loan. We reduce
the “Guaranty obligation” (in proportion to the
“Guaranty asset”) as payments on the loans underlying
our MBS are received, including those resulting from the
purchase of seriously delinquent loans from MBS trusts, and
report the reduction as a component of “Guaranty fee
income.” These prepayments may cause an impairment of the
“Guaranty asset,” which results in a proportionate
reduction in the corresponding “Guaranty obligation”
and recognition of income. We place acquired loans that are
three months or more past due on nonaccrual status. If the loan
subsequently becomes less than three months past due, or we
subsequently modify the loan and determine through a financial
analysis that the borrower is able to make the modified
payments, we return the loan to accrual status. While the loan
is on nonaccrual status, we do not recognize income on the loan.
We apply any cash receipts towards the recovery of the interest
receivable at acquisition and to past due principal payments. We
may, however, subsequently recover a portion or the full amount
of these
SOP 03-3
fair value losses as discussed below.
To the extent that we have previously recognized an
SOP 03-3
fair value loss, our recorded investment in the loan is less
than the acquisition cost. Under
SOP 03-3,
the excess of the contractual cash flows of the loan over the
estimated cash flows we expect to collect represents a
nonaccretable difference that is not recognized in our earnings.
If the estimated cash flows we expect to collect exceed the
initial recorded investment in the loan, we accrete this excess
amount into our earnings as a component of interest income over
the life of the loan. If a seriously delinquent loan we purchase
pays off in full, we recover the
SOP 03-3
fair value loss as a component of interest income on the date of
the payoff. If the loan is returned to accrual status, we
recover the
SOP 03-3
fair value loss over the contractual life of the loan as a
component of net interest income (via an adjustment of the
effective yield of the loan). If we foreclose upon a loan
purchased from an MBS trust, we record a charge-off at
foreclosure based on the excess of our recorded investment in
the loan over the fair value of the collateral less estimated
selling costs. Any charge-off recorded at foreclosure for
SOP 03-3
loans recorded at fair value at acquisition would be lower than
it would have been if we had recorded the loan at its
acquisition cost. In some cases, the proceeds from the sale of
the collateral may exceed our recorded investment in the loan,
resulting in a gain.
Following is an example of how
SOP 03-3
fair value losses, credit-related expenses and credit losses
related to loans underlying our guaranty contracts are recorded
in our consolidated financial statements. This example shows the
accounting and effect on our financial statements of the
following events: (a) we purchase a seriously delinquent
loan subject to
SOP 03-3
from an MBS trust; (b) we subsequently foreclose on this
mortgage loan; and (c) we sell the foreclosed property that
served as collateral for the loan. This example is based on the
following assumptions:
As indicated in the example above, we would record the loan at
the estimated fair value of $70 and record an
SOP 03-3
fair value loss of $30 as a charge-off to the reserve for
guaranty losses when we acquire the delinquent loan from the MBS
trust. We record a provision for credit losses each period to
adjust the reserve for guaranty losses to reflect the probable
credit losses incurred on loans remaining in MBS trusts.
Therefore, if the charge-off for the
SOP 03-3
fair value loss is greater than the decrease in the reserve
caused by removing the loan from the population subject to
SFAS 5, an incremental loss will be recognized through the
provision for credit losses in the period the loan is purchased.
We would record the REO property acquired through foreclosure at
the appraised fair value, net of estimated selling costs, of
$80. Although we recorded an initial
SOP 03-3
fair value loss of $30, the actual credit-related expense we
experience on this loan would be $15, which represents the
difference between the amount we paid for the loan and the
amount we received from the sale of the acquired REO property,
net of selling costs.
As described above, if a loan subject to
SOP 03-3
“cures,” which means it returns to accrual status,
pays off or is resolved through modification, long-term
forbearance or a repayment plan, the
SOP 03-3
fair value loss would be recovered over the life of the loan as
a component of net interest income through an adjustment of the
effective yield or upon full pay off of the loan. Conversely, if
a loan remains in an MBS trust, we would continue to provide for
incurred losses in our “Reserve for guaranty losses.”
Our estimate of the fair value of delinquent loans purchased
from MBS trusts is based upon an assessment of what a market
participant would pay for the loan at the date of acquisition.
Prior to July 2007, we estimated the initial fair value of these
loans using internal prepayment, interest rate and credit risk
models that incorporated market-based inputs of certain key
factors, such as default rates, loss severity and prepayment
speeds. Beginning in July 2007, the mortgage markets experienced
a number of significant events, including a dramatic widening of
credit spreads for mortgage securities backed by higher risk
loans, a large number of credit downgrades of higher risk
mortgage-related securities, and a severe reduction in market
liquidity for certain mortgage-related transactions. As a result
of this extreme disruption in the mortgage markets, we
57
concluded that our model-based estimates of fair value for
delinquent loans were no longer aligned with the market prices
for these loans. Therefore, we began obtaining indicative market
prices from large, experienced dealers and used an average of
these market prices to estimate the initial fair value of
delinquent loans purchased from MBS trusts. Because these prices
reflected significant declines in value due to the disruption in
the mortgage markets, we experienced a substantial increase in
the
SOP 03-3
fair value losses recorded upon the purchase of delinquent loans
from MBS trusts.
Other-than-temporary impairment occurs when the fair value of an
AFS security is below its amortized cost, and we determine that
it is probable we will be unable to collect all of the
contractual principal and interest payments of a security or we
do not have the ability and intent to hold the security until it
recovers to its amortized cost. We consider many factors that
may involve significant judgment in assessing
other-than-temporary impairment, including: the severity and
duration of the impairment; recent events specific to the issuer
and/or the
industry to which the issuer belongs; and external credit
ratings, as well as the probability that we will be able to
collect all of the contractual amounts due and our ability and
intent to hold the securities until recovery.
We generally view changes in the fair value of our AFS
securities caused by movements in interest rates to be
temporary. When we either decide to sell a security in an
unrealized loss position or determine that a security in an
unrealized loss position may be sold in future periods prior to
recovery of the impairment, we identify the security as
other-than-temporarily impaired in the period that we make the
decision to sell or determine that the security may be sold. For
all other securities in an unrealized loss position resulting
primarily from movements in interest rates, we have the positive
intent and ability to hold such securities until the earlier of
recovery of the unrealized loss amounts or maturity. For
securities in an unrealized loss position due to factors other
than movements in interest rates, such as the widening of credit
spreads, we consider whether it is probable that we will collect
all of the contractual cash flows. If we believe it is probable
that we will collect all of the contractual cash flows and we
have the ability and intent to hold the security until recovery,
we consider the impairment to be temporary. If we determine that
it is not probable that we will collect all of the contractual
cash flows or we do not have the ability and intent to hold the
security until recovery, we consider the impairment to be
other-than-temporary. We may subsequently recover
other-than-temporary impairment amounts we record on securities
if we collect all of the contractual principal and interest
payments due or if we sell the security at an amount greater
than its carrying value.
We maintain an allowance for loan losses for loans in our
mortgage portfolio classified as held-for-investment. We
maintain a reserve for guaranty losses for loans that back
Fannie Mae MBS we guarantee and loans that we have guaranteed
under long-term standby commitments. We report the allowance for
loan losses and reserve for guaranty losses as separate line
items in the consolidated balance sheets. These amounts, which
we collectively refer to as our loan loss reserves, represent
our estimate of probable credit losses inherent in our guaranty
book of business. We employ a systematic and consistently
applied methodology to determine our best estimate of incurred
credit losses and use the same methodology to determine both our
allowance for loan losses and reserve for guaranty losses, as
the relevant factors affecting credit risk are the same.
To calculate the loan loss reserves for the single-family
guaranty book of business, we aggregate homogeneous loans into
pools based on common underlying characteristics or cohorts
based on similar risk characteristics, such as origination year
and seasoning, loan-to-value ratio and loan product type. We
calculate our loan loss reserves using internally developed
statistical loss curve models that estimate losses based on
consideration of a variety of factors affecting loan
collectability. To calculate loan loss reserves for the
multifamily mortgage credit book of business, we use loss curve
models, evaluate loans for impairment based on the risk profile
and review repayment prospects and collateral values underlying
individual loans. For a more detailed discussion of the
methodology used in developing our loan loss reserves, see
“Notes to Consolidated Financial
Statements—Note 1, Summary of Significant Accounting
Policies.”
Determining our loan loss reserves is complex and requires
judgment by management about the effect of matters that are
inherently uncertain. The key estimates and assumptions that
affect our loan loss reserves include: loss severity trends;
historical default experience; expected proceeds from credit
enhancements, such as primary mortgage insurance; collateral
valuation; and current economic trends and conditions. Although
our loss models include extensive historical loan performance
data, our loss reserve process is subject to risks and
uncertainties, including reliance on historical loss information
that may not represent current conditions. We regularly update
our loss forecast models to incorporate current loan performance
data, monitor the delinquency and default experience of our
homogenous loan pools, and adjust our underlying estimates and
assumptions as necessary to reflect our view of current economic
and market conditions.
The Chief Risk Office, through a designated Allowance for Loan
Losses Oversight Committee, reviews our loss reserve methodology
on a quarterly basis and evaluates the adequacy of our loss
reserves in the light of the factors described above. The
“Provision for credit losses” line item in our
consolidated statements of operations represents the amount
necessary to adjust the loan loss reserves each period to a
level that management believes reflects estimated incurred
losses as of the balance sheet date. We record amounts that we
deem uncollectible as a charge-off against the loss reserves and
record certain recoveries of previously charged
off-amounts
as an increase to the reserves. Changes in one or more of the
estimates or assumptions used to calculate the loan loss
reserves could have a material impact on the loan loss reserves
and provision for credit losses.
As the housing and mortgage markets deteriorated during 2007, we
adjusted certain key assumptions used to calculate our loss
reserves to reflect the rise in average loss severities, which
more than doubled from 2006, and default rates. Prior to the
fourth quarter of 2006, we derived loss severity factors using
available historical loss data for the most recent two-year
period. We derived our default rate factors based on loss curves
developed from available historical loan performance data dating
back to 1980. In the fourth quarter of 2006, we shortened our
loss severity period assumption to reflect losses based on the
previous year rather than a two-year period to reflect a trend
of higher loss severities. Given the significant increase in
loss severities during 2007 resulting from the decline in home
prices, in the fourth quarter of 2007 we further reduced the
loss severity period used in determining our loss reserves to
reflect average loss severity based on the previous quarter.
Additionally, for loans originated in 2006 and 2007, we
transitioned to a one-year default curve and subsequently to a
one-quarter default curve to reflect the increase in the
incidence of early payment defaults on these loans.
Statistically, the peak ages for mortgage loan defaults
generally have been from two to six years after origination.
However, our 2006 and 2007 loan vintages have exhibited a much
earlier and higher incidence of default. We provide additional
information on our loss reserves and the impact of adjustments
to our loss reserves on our provision for credit losses in
“Consolidated Results of Operations—Credit-Related
Expenses.”
The following discussion of our consolidated results of
operations is based on our results for the years ended
December 31, 2007, 2006 and 2005. Table 3 presents a
condensed summary of our consolidated results of operations for
these periods.
Table
3: Condensed Consolidated Results of
Operations
We recorded a net loss and a diluted loss per share of
$2.1 billion and $2.63, respectively, in 2007, compared
with net income and diluted earnings per share of
$4.1 billion and $3.65 in 2006, and $6.3 billion and
$6.01 in 2005. We expect high levels of period-to-period
volatility in our results of operations and financial condition
as part of our normal business activities. This volatility is
primarily due to changes in market conditions that result in
periodic fluctuations in the estimated fair value of financial
instruments that we mark-to-market through our earnings,
including trading securities and derivatives. The estimated fair
value of our trading securities and derivatives may fluctuate
substantially from period to period because of changes in
interest rates, credit spreads and expected interest rate
volatility, as well as activity related to these financial
instruments. Based on the current composition of our
derivatives, we generally expect to report decreases in the
aggregate fair value of our derivatives as interest rates
decrease.
Our business generates revenues from four principal sources: net
interest income, guaranty fee income, trust management income,
and fee and other income. Other significant factors affecting
our results of operations include losses on certain guaranty
contracts, the timing and size of investment gains and losses,
changes in the fair value of our derivatives, losses from
partnership investments, credit-related expenses and
administrative
expenses. We provide a comparative discussion of the effect of
our principal revenue sources and other listed items on our
consolidated results of operations for the three-year period
ended December 31, 2007 below. We also discuss other
significant items presented in our consolidated statements of
operations.
Net interest income, which is the difference between interest
income and interest expense, is a primary source of our revenue.
Interest income consists of interest on our interest-earning
assets, plus income from the accretion of discounts for assets
acquired at prices below the principal value, less expense from
the amortization of premiums for assets acquired at prices above
principal value. Interest expense consists of contractual
interest on our interest-bearing liabilities and accretion and
amortization of any cost basis adjustments, including premiums
and discounts, which arise in conjunction with the issuance of
our debt. The amount of interest income and interest expense
recognized in the consolidated statements of operations is
affected by our investment activity, debt activity, asset yields
and our cost of debt. We expect net interest income to fluctuate
based on changes in interest rates and changes in the amount and
composition of our interest-earning assets and interest-bearing
liabilities. Table 4 presents an analysis of our net interest
income and net interest yield for 2007, 2006 and 2005.
As described below in “Derivatives Fair Value Losses,
Net,” we supplement our issuance of debt with interest
rate-related derivatives to manage the prepayment and duration
risk inherent in our mortgage investments. The effect of these
derivatives, in particular the periodic net interest expense
accruals on interest rate swaps, is not reflected in net
interest income. See “Derivatives Fair Value Losses,
Net” for additional information.
Table
4: Analysis of Net Interest Income and
Yield
Table 5 presents the total variance, or change, in our net
interest income between periods and the extent to which that
variance is attributable to: (1) changes in the volume of
our interest-earning assets and interest-bearing liabilities or
(2) changes in the interest rates of these assets and
liabilities.
Table
5: Rate/Volume Analysis of Net Interest
Income
Net interest income of $4.6 billion for 2007 decreased 32%
from $6.8 billion in 2006, attributable to a 33%
(28 basis points) decline in our net interest yield to
0.57%, which was partially offset by a 2% increase in our
average interest-earning assets. We continued to experience
compression in our net interest yield during 2007, largely
attributable to the increase in our short-term and long-term
debt costs as we continued to replace, at higher interest rates,
maturing debt that we had issued at lower interest rates during
the past few years. The overall increase in the average cost of
our debt of 35 basis points more than offset a 5 basis
point increase in the average yield on our interest-earning
assets in 2007. In addition, as discussed below, in November
2006, we began separately reporting the fees we receive from the
interest earned on cash flows between the date of remittance of
mortgage and other payments to us by servicers and the date of
distribution of these payments to MBS certificateholders, which
we refer to as float income, as “Trust management
income.” We previously reported these amounts as a
component of “Interest income.” The reclassification
of these fees contributed to the decrease in our net interest
yield, resulting in a reduction of approximately 7 basis
points in 2007.
Net interest income of $6.8 billion for 2006 decreased by
41% from $11.5 billion in 2005, attributable to a 9%
decrease in our average interest-earning assets and a 35%
(46 basis points) decline in our net interest yield to
0.85%. The decrease in our average interest-earning assets was
due to a lower level of mortgage asset purchases relative to the
level of sales and liquidations during 2006. Sales, liquidations
and reduced purchases had the net effect of reducing our average
interest-earning assets and resulted in a decrease of 1% in the
balance of our net mortgage portfolio to $726.1 billion as
of December 31, 2006. Lower portfolio balances have the
effect of reducing the net interest income generated by our
portfolio. We experienced compression in our net interest margin
as the cost of our debt increased due to the interest rate
environment. As the Federal Reserve raised the short-term
Federal Funds target rate by 100 basis points to 5.25%, the
highest level since 2001, the yield curve remained
flat-to-inverted throughout 2006 and the cost of our short-term
debt rose significantly. The overall increase in the average
cost of our debt of 91 basis points more than offset a
39 basis point increase in the average yield on our
interest-earning assets in 2006.
As discussed below in “Derivatives Fair Value Losses,
Net,” we consider the net contractual interest accruals on
our interest rate swaps to be part of the cost of funding our
mortgage investments. However, we reflect these amounts in our
consolidated statements of operations as a component of
“Derivatives fair value losses, net.” Although we
experienced an increase in the average cost of our debt during
2007, we recorded net contractual interest income on our
interest rate swaps totaling $261 million. In comparison,
we recorded net contractual interest expense of
$111 million and $1.3 billion for 2006 and 2005,
respectively. The economic effect of the interest accruals on
our interest rate swaps, which is not reflected in the
comparative net interest yields presented above, resulted in a
reduction in our funding costs of approximately 3 basis
points for 2007 and an increase in our funding costs of
approximately 2 basis points and 15 basis points for
2006 and 2005, respectively.
Guaranty fee income primarily consists of contractual guaranty
fees related to Fannie Mae MBS held in our portfolio and held by
third-party investors, adjusted for the amortization of upfront
fees and impairment of guaranty assets, net of a proportionate
reduction in the related guaranty obligation and deferred
profit, and impairment of
buy-ups.
Guaranty fee income is primarily affected by the amount of
outstanding Fannie Mae MBS and our other guaranties and the
compensation we receive for providing our guaranty on Fannie Mae
MBS and for providing other guaranties. The amount of
compensation we receive and the form of payment varies depending
on factors such as the risk profile of the securitized loans,
the level of credit risk we assume and the negotiated payment
arrangement with the lender. Our payment arrangements may be in
the form of an upfront payment, an ongoing payment stream from
the cash flows of the MBS trusts, or a combination. We typically
negotiate a contractual guaranty fee with the lender and collect
the fee on a monthly basis based on the contractual fee rate
multiplied by the unpaid principal balance of loans underlying a
Fannie Mae MBS issuance. In lieu of charging a higher
contractual fee rate for loans with greater credit risk, we may
require that the lender pay an upfront fee to compensate us for
assuming the additional credit risk. We refer to this payment as
a risk-based pricing adjustment. We also may adjust the monthly
contractual guaranty fee rate so that the pass-through coupon
rates on Fannie Mae MBS are in more easily tradable increments
of a whole or half percent by making an upfront payment to the
lender
(“buy-up”)
or receiving an upfront payment from the lender
(“buy-down”).
As we receive monthly contractual payments for our guaranty
obligation, we recognize guaranty fee income. We defer upfront
risk-based pricing adjustments and buy-down payments that we
receive from lenders and recognize these amounts as a component
of guaranty fee income over the expected life of the underlying
assets of the related MBS trusts. We record
buy-up
payments we make to lenders as an asset and reduce the recorded
asset as cash flows are received over the expected life of the
underlying assets of the related MBS trusts. We assess
buy-ups for
other-than-temporary impairment and include any impairment
recognized as a component of guaranty fee income. The extent to
which we amortize deferred payments into income depends on the
rate of expected prepayments, which is affected by interest
rates. In general, as interest rates decrease, expected
prepayment rates increase, resulting in accelerated accretion
into income of deferred fee amounts,
which increases our guaranty fee income. Prepayment rates also
affect the estimated fair value of
buy-ups.
Faster than expected prepayment rates shorten the average
expected life of the underlying assets of the related MBS
trusts, which reduces the value of our
buy-up
assets and may trigger the recognition of other-than-temporary
impairment.
The average effective guaranty fee rate reflects our average
contractual guaranty fee rate adjusted for the impact of
amortization of deferred amounts and
buy-up
impairment. Losses on certain guaranty contracts are excluded
from the average effective guaranty fee rate; however, the
accretion of these losses into income over time is included in
guaranty fee income. Table 6 shows the components of our
guaranty fee income, our average effective guaranty fee rate,
and Fannie Mae MBS activity for 2007, 2006 and 2005. Our
guaranty fee income includes $603 million,
$329 million and $208 million in 2007, 2006 and 2005,
respectively, of accretion of the guaranty obligation related to
losses recognized at inception on certain guaranty contracts.
Table
6: Analysis of Guaranty Fee Income and Average
Effective Guaranty Fee Rate
The 19% increase in guaranty fee income in 2007 from 2006 was
driven by a 12% increase in average outstanding Fannie Mae MBS
and other guaranties, and a 7% increase in the average effective
guaranty fee
rate to 23.7 basis points from 22.2 basis points.
Although mortgage origination volumes fell during 2007, our
market share of mortgage-related securities issuances increased
due to the shift in the product mix of mortgage originations
back to more traditional conforming products, such as
30-year
fixed-rate loans, which historically have accounted for the
majority of our new business volume, and reduced competition
from private-label issuers of mortgage-related securities. We
increased our guaranty fee pricing for some loan types during
2007 to reflect the higher risk premium resulting from the
overall market increase in mortgage credit risk. The increase in
our average effective guaranty fee rate was attributable to
these targeted pricing increases on new business and an increase
in the accretion of our guaranty obligation and deferred profit
into income, due in part to accretion related to losses on
certain guaranty contracts.
The 6% increase in guaranty fee income in 2006 from 2005 was
driven by a 7% increase in average outstanding Fannie Mae MBS
and other guaranties. While our MBS issuances decreased in 2006,
our outstanding Fannie Mae MBS increased primarily due to a
slower rate of liquidations. Our average effective guaranty fee
rate decreased slightly to 22.2 basis points in 2006 from
22.3 basis points in 2005.
We expect to generate higher guaranty fee income for 2008 as a
result of the market share gains we experienced in 2007, the
targeted guaranty pricing increases and the adverse market
delivery charge of 25 basis points for all loans delivered
to us, which is effective March 1, 2008.
Trust management income consists of the fees we earn as master
servicer, issuer and trustee for Fannie Mae MBS. We derive these
fees from the interest earned on cash flows between the date of
remittance of mortgage and other payments to us by servicers and
the date of distribution of these payments to MBS
certificateholders, which we refer to as float income. Prior to
November 2006, funds received from servicers were maintained
with our corporate assets and reported as a component of
“Interest income” in our consolidated statements of
operations. In November 2006, we made operational changes to
segregate these funds from our corporate assets and began
separately reporting this compensation as “Trust management
income” in our consolidated statements of operations. Trust
management income separately reported in our consolidated
statements of operations totaled $588 million and
$111 million for 2007 and 2006, respectively.
Fee and other income consists of transaction fees, technology
fees, multifamily fees and foreign currency exchange gains and
losses. Transaction, technology and multifamily fees are largely
driven by business volume, while foreign currency exchange gains
and losses are driven by fluctuations in exchange rates on our
foreign-denominated debt. Table 7 displays the components of fee
and other income.
The $79 million increase in fee and other income in 2007
from 2006 was primarily due to a reduction in foreign currency
exchange losses on our foreign-denominated debt and an increase
in technology fees resulting from higher business volume. Our
foreign currency exchange losses decreased to $190 million
in 2007, from $230 million in 2006 largely due to a
decrease in the average amount of our outstanding
foreign-denominated debt. Our foreign currency exchange gains
(losses) are offset by corresponding net (losses) gains on
foreign
currency swaps, which are recognized in our consolidated
statements of operations as a component of “Derivatives
fair value losses, net.” We seek to eliminate our exposure
to fluctuations in foreign exchange rates by entering into
foreign currency swaps that effectively convert debt denominated
in a foreign currency to debt denominated in U.S. dollars.
See “Consolidated Results of Operations—Derivatives
Fair Value Losses, Net.”
The $773 million decrease in fee and other income in 2006
from 2005 was primarily due to a foreign currency exchange loss
of $230 million in 2006, compared with a foreign currency
exchange gain of $625 million in 2005. The
$625 million foreign currency gain recorded in 2005 stemmed
from a strengthening of the U.S. dollar relative to the
Japanese yen. In addition, we experienced a $140 million
decrease in multifamily fees due to a reduction in refinancing
volumes, which were significantly higher in 2005 than in 2006.
These decreases were partially offset by a $241 million
increase in other fee income primarily attributable to the
recognition of defeasance fees on consolidated multifamily loans.
Losses on certain guaranty transactions totaled
$1.4 billion, $439 million and $146 million in
2007, 2006 and 2005, respectively. As home price appreciation
slowed in 2006 and home prices declined and credit conditions
deteriorated in 2007, the market’s expectation of future
credit risk increased. This change in market conditions
increased the estimated risk premium or compensation that a
market participant would require to assume our guaranty
obligations. As a result, the estimated fair value of our
guaranty obligations related to MBS issuances increased,
contributing to a higher level of losses at inception on certain
of our MBS issuances. Our losses on certain guaranty contracts
also were affected by the following during 2007 and 2006:
The losses recognized at inception of certain guaranty contracts
will be accreted into earnings over time as a component of
guaranty fee income, as described in “Critical Accounting
Policies and Estimates—Fair Value of Financial
Instruments—Fair Value of Guaranty Assets and Guaranty
Obligations—Effect on Losses on Certain Guaranty
Contracts.” Our guaranty fee income includes
$603 million, $329 million and $208 million in
2007, 2006 and 2005, respectively, of accretion of the guaranty
obligation related to losses recognized at inception on certain
guaranty contracts.
Losses on certain guaranty contracts do not reflect our estimate
of incurred credit losses in our guaranty book of business.
Instead, our estimate of the probable credit losses incurred in
our guaranty book of business is reflected in our combined
allowance for loan losses and reserve for guaranty losses.
Actual credit losses are
recorded as charges against our loss reserves. See
“Credit-Related Expenses” below for a discussion of
our current year provision for credit losses and “Critical
Accounting Policies and Estimates” for illustrations of how
losses recorded at inception on certain guaranty contracts
affect our earnings over time and how credit-related expenses
and actual credit losses related to our guaranties are recorded
in our consolidated financial statements. We expect that the
substantial majority of our MBS guaranty transactions will
generate positive economic returns over the lives of the related
MBS because, based on our experience and modeled assessments, we
expect our guaranty fees to exceed our incurred credit losses.
Investment losses, net includes other-than-temporary impairment
on AFS securities, lower-of-cost-or-market adjustments on HFS
loans, gains and losses recognized on the securitization of
loans or securities from our portfolio and the sale of
AFS securities, gains and losses on trading securities, and
other investment losses. Investment gains and losses may
fluctuate significantly from period to period depending upon our
portfolio investment and securitization activities, changes in
market conditions that may result in fluctuations in the fair
value of trading securities, and other-than-temporary
impairment. We recorded investment losses of $1.2 billion,
$683 million and $1.3 billion in 2007, 2006 and 2005,
respectively. Table 8 details the components of investment gains
and losses for each year.
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