Fannie Mae 10-K 2010
Documents found in this filing:
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2009
Commission File No.: 0-50231
Federal National Mortgage Association
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code:
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Variable Rate Non-Cumulative Preferred Stock, Series O, stated value $50 per share
(Title of class)
5.375% Non-Cumulative Convertible Series 2004-1 Preferred Stock, stated value $100,000 per share
(Title of class)
5.10% Non-Cumulative Preferred Stock, Series E, stated value $50 per share
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes þ No o
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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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 registrants 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):
(Do not check if a smaller reporting company)
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 30, 2009 (the last business day of the registrants most recently completed second fiscal quarter) was approximately $645 million.
As of January 31, 2010, there were 1,116,805,764 shares of common stock of the registrant outstanding.
We have been under conservatorship, with the Federal Housing Finance Agency (FHFA) acting as conservator, since September 6, 2008. As conservator, FHFA succeeded to all rights, titles, powers and privileges of the company, and of any shareholder, officer or director of the company with respect to the company and its assets. The conservator has since delegated specified authorities to our Board of Directors and has delegated to management the authority to conduct our day-to-day operations. We describe the rights and powers of the conservator, key provisions of our agreements with the U.S. Department of the Treasury (Treasury), and their impact on shareholders in Conservatorship and Treasury Agreements.
This report contains forward-looking statements, which are statements about matters that are not historical facts. Forward-looking statements often include words like expects, anticipates, intends, plans, believes, seeks, estimates, would, should, could, may, or similar words. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of factors including those discussed in Risk Factors and elsewhere in this report. Please review Forward-Looking Statements for more information on the forward-looking statements in this report.
We provide a glossary of terms in Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A)Glossary of Terms Used in This Report.
Fannie Mae is a government-sponsored enterprise that was chartered by Congress in 1938 to support liquidity, stability and affordability in the secondary mortgage market, where existing mortgage-related assets are purchased and sold. Our charter does not permit us to originate loans and lend money directly to consumers in the primary mortgage market. Our most significant activities include providing market liquidity by securitizing mortgage loans originated by lenders in the primary mortgage market into Fannie Mae mortgage-backed securities, which we refer to as Fannie Mae MBS, and purchasing mortgage loans and mortgage-related securities in the secondary market for our mortgage portfolio. We acquire funds to purchase mortgage-related assets for our mortgage portfolio by issuing a variety of debt securities in the domestic and international capital markets. We also make other investments that increase the supply of affordable housing. During 2009, we concentrated much of our efforts on preventing foreclosures and helping keep families in their homes, including through our role in the Obama Administrations initiatives to protect and stabilize the housing and mortgage markets. We describe our business activities below. We also provide information on the governments housing stability initiatives and our role in those initiatives.
As a federally chartered corporation, we are subject to extensive regulation, supervision and examination by FHFA, and regulation by other federal agencies, including Treasury, the Department of Housing and Urban Development (HUD), and the Securities and Exchange Commission (SEC).
Although we are a corporation chartered by the U.S. Congress, our conservator is a U.S. government agency, Treasury owns our senior preferred stock and a warrant to purchase 79.9% of our common stock, and Treasury has made a commitment under a senior preferred stock purchase agreement to provide us with funds under specified conditions to maintain a positive net worth, the U.S. government does not guarantee our securities or other obligations. Our common stock is listed on the New York Stock Exchange (NYSE) and traded under the symbol FNM. Our debt securities are actively traded in the over-the-counter market.
We have been under conservatorship, with FHFA acting as conservator, since September 6, 2008. As conservator, FHFA succeeded to all rights, titles, powers and privileges of the company, and of any shareholder, officer or director of the company with respect to the company and its assets. FHFA delegated specified authorities to our Board of Directors and has delegated to management the authority to conduct our day-to-day operations. The conservatorship has no specified termination date. There can be no assurance as to when or how the conservatorship will be terminated, whether we will continue to exist following
conservatorship, or what changes to our business structure will be made during or following the conservatorship.
Since our entry into conservatorship, we have entered into agreements with Treasury that include covenants that significantly restrict our business activities and provide for substantial U.S. government financial support. We provide additional information on the conservatorship, the provisions of our agreements with the Treasury, and its impact on our business below under Conservatorship and Treasury Agreements and Risk Factors.
RESIDENTIAL MORTGAGE MARKET
We conduct business in the U.S. residential mortgage market and the global securities market. In response to the financial crisis and severe economic recession that began in December 2007, accelerated in late 2008 and continued to deepen in 2009, the U.S. government took a number of extraordinary measures designed to provide fiscal stimulus, improve liquidity and protect and support the housing and financial markets. Examples of these measures include: (1) the Federal Reserves temporary program to purchase up to $1.25 trillion of GSE mortgage-backed securities by March 31, 2010, which is intended to provide support to mortgage lending and the housing market and to improve overall conditions in private credit markets; (2) the Administrations Making Home Affordable Program, which is intended to stabilize the housing market by providing assistance to homeowners and preventing foreclosures; and (3) the first-time and move-up homebuyer tax credits, enacted to help increase home sales and stabilize home prices.
Total U.S. residential mortgage debt outstanding, which includes $10.9 trillion of single-family mortgage debt outstanding, was estimated to be approximately $11.8 trillion as of September 30, 2009, the latest date for which information was available, according to the Federal Reserve. After increasing every quarter since record keeping began in 1952 until the second quarter of 2008, single-family mortgage debt outstanding has been steadily declining since then. We owned or guaranteed mortgage assets representing approximately 27.5% of total U.S. residential mortgage debt outstanding as of September 30, 2009.
We operate our business solely in the United States and its territories, and accordingly, we generate no revenue from and have no assets in geographic locations other than the United States and its territories.
The housing sector, while still fragile, began to show some signs of stabilization and improvement in the second half of 2009, due in part to the governments policy initiatives and programs to provide fiscal stimulus, improve liquidity and protect and support the housing and financial markets, and the U.S. economy began to emerge from the financial crisis and severe economic recession that began at the end of 2007. Home price declines began to moderate and deterioration in the labor market began to abate as payroll job losses diminished and weekly claims for unemployment fell steadily as 2009 progressed. Mortgage interest rates began to decline in late 2008 when the Federal Reserve announced that it would purchase $1.25 trillion of GSE mortgage-backed securities in an effort to lower rates, increase credit availability and bolster the housing market. Mortgage interest rates remained low throughout 2009, falling to record lows in the spring of 2009 and again in the fall.
The table below presents several key indicators related to the total U.S. residential mortgage market.
Housing and Mortgage Market Indicators(1)
Home prices, which rose slightly but consistently in the spring and summer, were relatively flat in the fourth quarter of 2009. On average, national home prices declined by approximately 2.2% in 2009. We estimate that home prices on a national basis have declined by approximately 16.4% from their peak in the third quarter of 2006. New home sales and housing starts remained sluggish throughout 2009. New home sales accounted for just 5.6% of total home sales in the fourth quarter of 2009, down from a peak of more than 19% at the beginning of 2005. Existing home sales rose throughout 2009, particularly during the third and fourth quarters of 2009, boosted by government support, including the first-time and move up homebuyer tax credit, as well as low mortgage interest rates and reduced home prices. The National Association of Realtors reported that existing home sales increased by 13.9% in the fourth quarter of 2009the highest level in nearly three years.
As a result of the increase in existing home sales, the number of unsold single-family homes in inventory began to drop in the fourth quarter of 2009. However, the supply of homes as measured by the inventory/sales ratio remains above long-term average levels. According to the National Association of Realtors, there was a 7.2 month average supply of existing unsold homes as of December 31, 2009, compared with a 9.4 month average supply as of June 30, 2009 and as of December 31, 2008. This national average inventory/sales ratio
masks significant regional variation as some regions, such as Florida, struggle with large inventory overhang while others, such as California, experience nearly depleted inventories.
An additional factor weighing on the market will be the elevated level of vacant properties, as reported by the Census Bureau. As of the fourth quarter of 2009, vacancy rates are above long-term average levels, with vacant and for-sale properties at an estimated 780,000 above the long-term average, vacant and for-rent properties at an estimated 1.2 million above the long-term average, and properties held off the market for other reasons at an estimated 500,000 above the long-term average. These vacant units held off the market, as well as about 5 million mortgages that are seriously delinquent (90 days or more past due or in the foreclosure process), represent a shadow inventory weighing on the market and its return to stability.
We estimate that total single-family mortgage originations increased by 25% in 2009 to $1.98 trillion, with a purchase share of 33% and a refinance share of 67%. However, the expected modest increase in mortgage rates will likely reduce the share of refinance loans to approximately 45% and, even accounting for the increase in home purchase loans, total single-family originations are expected to decline to about $1.3 trillion in 2010.
After increasing every quarter since record keeping began in 1952 until the second quarter of 2008, single-family mortgage debt outstanding has been steadily declining due to several factors including rising foreclosures, declining house prices, increasing loan-to-value ratios, increased cash sales, reduced household formation, and reduced home equity extraction. Total U.S. residential mortgage debt outstanding fell by approximately 3.1% in the third quarter of 2009 on an annualized basis, compared with a decrease of 1.6% in the second quarter of 2009 on an annualized basis. We anticipate another 1.7% decline in mortgage debt outstanding in 2010.
Despite signs of stabilization and improvement one out of seven borrowers was delinquent or in foreclosure during the fourth quarter of 2009, according to the Mortgage Bankers Association National Delinquency Survey. The housing market remains under pressure due to the high level of unemployment, which was the primary driver of the significant increase in mortgage delinquencies and defaults in 2009. At the start of the recession in December 2007, the unemployment rate was 5.0%, based on data from the U.S. Bureau of Labor Statistics. The unemployment rate rose to 7.7% by the start of 2009 and continued rising during the year, reaching a 26-year high of 10.1% in October 2009, and falling to 9.7% in January 2010. We expect the unemployment rate to decline modestly yet remain elevated throughout 2010.
The most comprehensive measure of the unemployment rate, which includes those working part-time who would rather work full-time (part-time workers for economic reasons) and those not looking for work but who want to work and are available for work (discouraged workers), was 17.3% in December 2009, close to the record high of 17.4% in October 2009.
Furthermore, the median time that unemployed workers are unemployed is at near record levels. Also, there are an increasing number of households that have exhausted their unemployment benefits. All of these factors place additional stress on the ability of homeowners to meet their mortgage and other consumer debt obligations.
The decline in house prices both nationally and regionally has left many homeowners with negative equity in their mortgages, which means their principal balance exceeds the current market value of their home. This provides an incentive for borrowers to walk away from their mortgage obligations and for the loans to become delinquent and proceed to foreclosure. According to First American CoreLogic, Inc. approximately 11 million, or 24%, of all residential properties with mortgages were in negative equity in the fourth quarter of 2009, which contributes to the current estimate of 5 million seriously delinquent loans based on the Mortgage Bankers Association National Delinquency Survey. This potential supply also weighs on the supply/demand balance putting downward pressure on both house prices and rents. See Risk Factors for a description of risks to our business associated with the weak economy and housing market.
Multifamily housing fundamentals remained stressed throughout 2009, primarily due to high unemployment. As a result of the high unemployment, it is also expected that new household formations will remain well below average, which in turn has negatively affected vacancy rates and rent levels. While apartment property
sales increased slightly during the second half of 2009 from the first half of 2009, we believe the increase in sales was likely due to sellers reducing sales prices. We believe that there is likely to be an increase in the supply of multifamily properties for sale in the near term because of the currently high number of distressed multifamily properties. In addition, we believe that exposure to refinancing risk may be higher for multifamily loans that are due to mature during the next several years.
Please read this Executive Summary together with our Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and our consolidated financial statements as of December 31, 2009 and related notes. This discussion contains forward-looking statements that are based upon managements current expectations and are subject to significant uncertainties and changes in circumstances. Please review Forward-Looking Statements for more information on the forward-looking statements in this report and Risk Factors for a discussion of factors that could cause our actual results to differ, perhaps materially, from our forward-looking statements. Please also see MD&AGlossary of Terms Used in This Report.
Our public mission is to support liquidity and stability in the secondary mortgage market and increase the supply of affordable housing. In connection with our public mission, FHFA, as our conservator, and the Obama Administration have given us an important role in addressing housing and mortgage market conditions. As we discuss below and elsewhere in Business, we are concentrating our efforts on keeping people in their homes and preventing foreclosures while continuing to support liquidity and stability in the secondary mortgage market.
Our Board of Directors and management consult with our conservator in establishing our strategic direction, taking into consideration our role in addressing housing and mortgage market conditions. FHFA has approved our business objectives. We face a variety of different, and potentially conflicting, objectives including:
We therefore regularly consult with and receive direction from our conservator on how to balance these objectives. Our pursuit of our mission creates conflicts in strategic and day-to-day decision-making that could hamper achievement of some or all of these objectives.
We currently are concentrating our efforts on minimizing our credit losses by using foreclosure alternatives to address delinquent mortgages, starting with alternatives, such as modifications, that permit people to stay in their homes. Where there is no available, lower-cost alternative, our goal is to move to foreclosure expeditiously. We also are continuing our significant role in the secondary mortgage market through our guaranty and capital markets businesses. These efforts are intended to support liquidity and affordability in the mortgage market, while we continue our foreclosure prevention activities. Currently, one of the principal ways in which we are working to minimize foreclosures and delinquent mortgages is through our participation in the Obama Administrations Making Home Affordable Program. If the Making Home Affordable Program is successful in reducing foreclosures and keeping borrowers in their homes, it may benefit the overall housing
market and help in reducing our long-term credit losses. We provide an update on our participation in the program below under the heading Homeowner Assistance Initiatives.
The ongoing adverse conditions in the housing and mortgage markets, along with the continuing credit deterioration throughout our mortgage credit book of business and the costs associated with our efforts pursuant to our mission, will increase the amount of funds that Treasury is required to provide to us. In turn, these factors make it exceedingly unlikely that we will be able to return to long-term profitability anytime in the foreseeable future. Further, there is significant uncertainty regarding the future of our business. In addition, our regulators, the Administration and Congress are considering options for the future state of Fannie Mae, Freddie Mac and the Federal Home Loan Bank system.
Our financial results for 2009 reflected the continued adverse impact of the weak economy and housing market, which has resulted in record mortgage delinquencies and contributed to our recording significant credit-related expenses and net losses during each quarter of the year. We recorded a net loss attributable to common stockholders, which includes dividends on senior preferred stock, of $74.4 billion and a diluted loss per share of $13.11 in 2009, compared with a net loss attributable to common stockholders of $59.8 billion and a diluted loss per share of $24.04 in 2008. The $14.7 billion increase in our net loss in 2009 from 2008 was primarily due to the increase in our credit-related expenses, which totaled $73.5 billion in 2009 and were more than double our credit-related expenses for 2008, and to our recognition of $5.5 billion in 2009 in other-than-temporary impairment losses on our federal low-income housing tax credit (LIHTC) investments. Our credit-related expenses and other-than-temporary impairment losses were partially offset by a lower level of fair value losses of $17.3 billion and a $5.7 billion increase in net interest income. In addition, we recorded a tax benefit of $985 million in 2009, compared with a tax expense of $13.7 billion in 2008 due to the carryback in 2009 of a portion of our current year tax loss to prior years and recognition of expense for a net deferred tax asset valuation allowance of $25.7 billion in 2009 as compared to $30.8 billion in 2008. The decrease in diluted loss per share from 2008 to 2009 is primarily due to the issuance of a common stock warrant to Treasury in September 2008 that resulted in a substantial increase in our weighted-average shares outstanding during 2009 over 2008.
For the fourth quarter of 2009, we recorded a net loss attributable to common stockholders of $16.3 billion and a diluted loss per share of $2.87, compared with a net loss attributable to common stockholders of $19.8 billion and a diluted loss per share of $3.47 for the third quarter of 2009. The $3.4 billion decrease in our net loss for the fourth quarter of 2009 from the third quarter of 2009 was driven principally by a lower level of credit-related expenses of $10.0 billion, which was offset by the recognition of $5.0 billion in the fourth quarter of 2009 in other-than-temporary impairment losses on our LIHTC investments.
Because of our significant net losses, we have not been able to maintain a positive net worth without government funding since September 30, 2008. We had a net worth deficit of $15.3 billion as of December 31, 2009, compared with a net worth deficit of $15.0 billion as of September 30, 2009, and $15.2 billion as of December 31, 2008. Our net worth deficit as of December 31, 2009 was negatively impacted by the recognition of our net loss of $72.0 billion and senior preferred stock dividends of $2.5 billion. These reductions in our net worth were offset by our receipt of $59.9 billion in funds from Treasury under the senior preferred stock purchase agreement, as well as from a reduction in unrealized losses on available-for-sale securities of $4.9 billion and the reversal of a portion of our deferred tax asset valuation allowance, in the amount of $3.0 billion, in connection with our April 1, 2009 adoption of the new accounting standard for assessing other-than-temporary impairments. We also reclassified $6.4 billion in unrealized losses on available-for-sale securities to other-than-temporary impairments, which were recognized as part of our net loss for 2009. Our net worth, which is the basis for determining the amount that Treasury has committed to provide us under the senior preferred stock purchase agreement, reflects the Total deficit reported in our consolidated balance sheets prepared in accordance with GAAP as of the end of each period.
We generally may request funds under Treasurys commitment on a quarterly basis in order to maintain a positive net worth. We had received an aggregate of $59.9 billion in funding from Treasury as of
December 31, 2009. In February of 2010, the Acting Director of FHFA submitted a request to Treasury on our behalf for an additional $15.3 billion to eliminate our net worth deficit as of December 31, 2009, and requested receipt of those funds on or before March 31, 2010. When Treasury provides the additional funds that have been requested, we will have received an aggregate of $75.2 billion from Treasury. The aggregate liquidation preference on the senior preferred stock will be $76.2 billion, which will require an annualized dividend of approximately $7.6 billion. This amount exceeds our reported annual net income for all but one of the last eight years, in most cases by a significant margin. Our senior preferred stock dividend obligation, combined with potentially substantial commitment fees payable to Treasury starting in 2011 (the amounts of which have not yet been determined) and our effective inability to pay down draws under the senior preferred stock purchase agreement, will have a significant adverse impact on our future financial position and net worth. See Risk Factors for more information on the risks to our business posed by our dividend obligations under the senior preferred stock purchase agreement.
In addition to our GAAP consolidated balance sheet, we provide a supplemental non-GAAP fair value balance sheet. While some assets and liabilities are reported at fair value on our GAAP consolidated balance sheet, we report all of our assets and liabilities at estimated fair value on our non-GAAP fair value balance sheet. We derive the fair value of our net assets, which is different from our GAAP net worth, from our supplemental non-GAAP fair value balance sheet. The fair value of our net assets increased by $6.4 billion in 2009, resulting in a deficit of $98.8 billion as of December 31, 2009, compared with a deficit of $90.4 billion as of September 30, 2009, and $105.2 billion as of December 31, 2008. The $8.4 billion decrease in the fair value of our net assets in the fourth quarter of 2009 was primarily due to a decrease in our net guaranty assets driven by an increase in the estimated fair value of our guaranty obligations. The $6.4 billion increase in the fair value of our net assets in 2009 was primarily due to $59.9 billion in funds received from Treasury under the senior preferred stock purchase agreement, offset by a decrease in the fair value of our net assets, excluding capital transactions, of $51.1 billion in 2009, primarily due to the adverse impact on our net guaranty assets from the continued weakness in the housing market and the increase in unemployment, which contributed to a significant increase in the fair value of our guaranty obligations. The Federal Reserves program to purchase mortgage-backed securities of Fannie Mae, Freddie Mac and Ginnie Mae and debt securities of Fannie Mae, Freddie Mac and the Federal Home Loan Banks had a positive impact on the fair value of our net assets. The significant purchasing of agency MBS and debt by the Federal Reserve in 2009 helped in narrowing the spreads between agency MBS and debt and Treasury yields to the levels exhibited prior to the financial crisis, which contributed to an increase in the fair value of our net assets. We describe in greater detail the differences between our GAAP balance sheet and supplemental non-GAAP balance sheet in MD&ASupplemental Non-GAAP InformationFair Value Balance Sheets.
Although there have been signs of stabilization in the housing market and economy, we expect that our credit-related expenses will remain high in the near term due in large part to the stress of high unemployment and underemployment on borrowers and the fact that many borrowers who owe more on their mortgages than their houses are worth are defaulting. As a result, we expect to continue to have losses and net worth deficits in 2010, which will require us to request additional funds from Treasury. Our ability to access funds from Treasury under the senior preferred stock purchase agreement is critical to keeping us solvent and avoiding the appointment of a receiver by FHFA under statutory mandatory receivership provisions. We provide additional detail on the terms of the senior preferred stock purchase agreement, as amended, and the conditions under which we may be placed into receivership in Conservatorship and Treasury Agreements.
Effective January 1, 2010, we adopted new accounting standards for transfers of financial assets and consolidation, which will have a major impact on the presentation of our consolidated financial statements. The new standards require that we consolidate the substantial majority of our MBS trusts and record the underlying assets (typically mortgage loans) and debt (typically bonds issued by the trusts in the form of Fannie Mae MBS certificates) of these trusts as assets and liabilities on our consolidated balance sheet. Please see MD&AOff-Balance Sheet Arrangements and Variable Interest EntitiesElimination of QSPEs and Changes in the Consolidation Model for Variable Interest Entities for a discussion of the impact of these new accounting standards on our accounting and financial statements.
We discuss below in this section a number of steps we have taken to minimize our credit losses from delinquent mortgages in our guaranty book of business. Under the heading Homeowner Assistance Initiatives below, we provide more detailed information on our work to expand refinance opportunities for borrowers and to help homeowners keep their homes, or at least avoid foreclosure.
In addition to our efforts, discussed below, to minimize credit losses on loans already in our book, during 2008 and early 2009 we made changes in our pricing and eligibility standards that helped to improve the risk profile of our new single-family business in 2009 and support sustainable homeownership. In 2009, we purchased or guaranteed an estimated $823.6 billion in new business, measured by unpaid principal balance. Compared to our 2008 acquisitions, the composition of our 2009 acquisitions experienced a decline in the average original loan-to-value (LTV) ratio from 72% to 67%, an increase in the average FICO credit score from 738 to 761, and a shift in product mix to more fully amortizing fixed-rate mortgage loans. The early performance of the single-family loans we acquired in 2009 appears stronger than loans acquired in any other year in the past decade. While this early performance is strong, we cannot yet predict how these loans will ultimately perform. Moreover, we expect the ultimate performance of these loans will be affected by macroeconomic trends, including unemployment, the economy, interest rates, and house prices. As of December 31, 2009, loans acquired in 2009 represented 23.6% of our total single family guaranty-book of business. We expect that these loans may have relatively slow prepayment speeds, and therefore may remain in our book of business for a relatively long time, due to the historically low interest rates available throughout 2009, which resulted in our 2009 acquisitions overall having an average interest rate of 4.9%. In addition to changes in our pricing and eligibility standards, our 2009 acquisitions reflect changes in the eligibility standards of mortgage insurers, which further reduced our acquisition of loans with higher LTV ratios. Also, the Federal Housing Administration (FHA) has become the lower-cost option, or in some cases the only option, for loans with higher LTV ratios, which further reduced our acquisition of these loans. Our 2009 acquisitions profile was further enhanced by a significant increase in our acquisition of refinanced loans, which generally have a stronger credit profile as the act of refinancing indicates the borrowers ability and desire to maintain homeownership. Whether our 2010 acquisitions exhibit the same credit profile as our 2009 acquisitions will depend on many factors, including our future pricing and eligibility standards, our future objectives, mortgage insurers eligibility standards, and future activity by our competitors, including FHA.
The performance of loans in our guaranty book of business deteriorated significantly during 2009 as a result of the sustained decline in home prices, the weakened economy, and the rise in unemployment and underemployment during the year. In order to minimize our credit losses, we believe we must (1) keep more borrowers current on their loan payments through outreach programs to identify and assist borrowers on the verge of delinquency; (2) prevent borrowers from defaulting on their loans through home retention strategies, including loan modifications, repayment plans and forbearances; (3) reduce the costs associated with foreclosures by promoting foreclosure alternatives, including preforeclosure sales and deeds-in-lieu of foreclosure; (4) move to foreclosure expeditiously where there is no available, lower-cost alternative; (5) expedite the sales of REO properties, or real-estate owned by Fannie Mae because we have obtained it through foreclosure or a deed-in-lieu of foreclosure, and transform stagnant properties into cash generating assets through rental and leasing programs; and (6) aggressively pursue collections on repurchase and compensation claims due from lenders and mortgage insurers. It will be through these strong asset management initiatives that we will achieve our stated goal of decreasing our credit losses and stabilizing markets. We are pursuing a reduction in our credit losses through the following key activities.
The actions we have taken to stabilize the housing market and minimize our credit losses have had and will continue to have, at least in the short term, a material adverse effect on our results of operations and financial condition, including our net worth. See MD&AConsolidated Results of OperationsFinancial Impact of the Making Home Affordable Program on Fannie Mae for information on our impairments and fair value losses on loans that entered trial modifications under HAMP during 2009. These actions have been undertaken with the goal of reducing our future credit losses below what they otherwise would have been. It is difficult to predict how effective these actions ultimately will be in reducing our credit losses and, in the future, it may be difficult to measure the impact our actions ultimately have on our credit losses.
The comparative credit performance data for the mortgage loans in our single-family guaranty book of business presented in Table 1 for each quarter of 2009 illustrates the continued deterioration in the credit quality of our overall single-family guaranty book of business and the financial impact of this deterioration. We also provide summarized data on our loan workout efforts to keep people in their homes and prevent foreclosures.
Table 1: Credit Statistics, Single-Family Guaranty Book of Business(1)
Table 1 does not include information about trial modifications under HAMP that have not yet become permanent modifications or repayment and forbearance plans that have been initiated but not completed. As of December 31, 2009, 291,053 of our loans were in trial modification periods under HAMP, as reported by servicers to the system of record for the program.
Our single-family serious delinquency rate of 5.38% as of December 31, 2009 was more than double the rate of 2.42% at the end of 2008. In addition, our seriously delinquent loan population aged significantly during 2009. The increase in delinquencies during 2009 was primarily driven by the duration and depth of the decline in home prices and the rise in unemployment and underemployment among borrowers. These factors adversely affected not only higher risk loan categories, but also loans traditionally considered to have a lower risk of default, such as loans with lower original LTV ratios and higher FICO credit scores, fixed-rate mortgages and loans past the peak default period of two to six years. Certain loan categories, however, continued to contribute disproportionately to the increase in our nonperforming loans and credit losses in 2009. These categories include: loans on properties in certain Midwest states, California, Florida, Arizona and Nevada; loans originated in 2006 and 2007; and loans related to higher-risk product types, such as Alt-A loans. The duration and depth of the decline in home prices and the rise in unemployment also contributed to the aging of our seriously delinquent loan population. In addition, our foreclosure prevention efforts have, by design, contributed to the rise in and aging of our delinquencies as we have delayed some foreclosure proceedings until the borrower has been sufficiently considered for a home retention solution.
The decline in home prices has made it more difficult for delinquent borrowers to sell their homes and resolve all their mortgage delinquencies. Approximately 14% of the loans in our guaranty book of business had mark-to-market LTV ratios of 100% or greater at the end of 2009, compared with approximately 12% at the end of 2008. As a result of the decline in home prices, our average credit loss severity, and average initial charge-off per default, increased during 2009.
The substantial increase in our loss reserves at December 31, 2009 compared with the prior year was driven by further deterioration of our credit book and reflects our estimate of the losses inherent in our guaranty book of business as of the end of each period. Higher provisions for credit losses, through which we maintain appropriate loss reserves, were the major driver of the $73.5 billion in credit-related expenses we recognized in 2009, compared with the $29.8 billion we recognized in 2008. Our loss reserve coverage to total nonperforming loans increased to 29.98% as of December 31, 2009, from 20.76% as of December 31, 2008.
We experienced a significant increase in our credit losses in 2009; however, the level of our credit losses was substantially lower than our credit-related expenses, due in part to the delays in foreclosures (that is, charge-offs) resulting from our home retention efforts, as well as new laws enacted in a number of states that lengthen the time required to complete a foreclosure. Our credit losses totaled $13.6 billion in 2009, compared with credit losses of $6.5 billion in 2008. Our credit-related expenses, which consist of our provision for credit losses and our foreclosed property expense, are included in our consolidated statement of operations. Our credit losses, by contrast, are not defined within GAAP and may not be calculated in the same manner as similarly titled measures reported by other companies. We measure our credit losses as our charge-offs, net of recoveries plus our foreclosed property expense, adjusted to eliminate the impact associated with our HomeSaver Advance loans and our acquisition of credit-impaired loans from MBS trusts, in the manner described in MD&AConsolidated Results of OperationsCredit-Related ExpensesCredit Loss Performance Metrics.
Although our combined loss reserves increased significantly in 2009 compared with 2008, we did not add to our combined loss reserves in the fourth quarter of 2009. The slight decline in our loss reserves as of December 31, 2009 compared with September 30, 2009 was due to a moderation in the pace at which loans transitioned to seriously delinquent status and an improvement in our loss severities due to stabilizing home prices as well as an increase in the number of loans acquired from our MBS trusts in order to complete workouts for the loans. To the extent that the acquisition cost of these loans exceeded the estimated fair value, we recorded a fair value loss charge-off against the Reserve for guaranty losses. Recognizing these fair value losses, which typically meet or exceed the actual credit losses we ultimately realize, has the effect of reducing the inherent losses that remain in our guaranty book of business, and consequently reduces our
combined loss reserves. With the adoption of new accounting standards on January 1, 2010, we will no longer recognize the acquisition of loans from the MBS trusts that we have consolidated as a purchase with an associated fair value loss for the difference between the fair value of the acquired loan and its acquisition cost, as these loans will already be reflected on our consolidated balance sheet.
Current market and economic conditions have adversely affected the liquidity and financial condition of many of our institutional counterparties, particularly mortgage insurers, which has significantly increased the risk to our business of defaults by these counterparties due to bankruptcy or receivership, lack of liquidity, insufficient capital, operational failure or other reasons. See MD&ARisk ManagementCredit Risk ManagementInstitutional Counterparty Credit Risk Management for more information about our institutional counterparty credit risk.
In 2009, as the weak economy, home price declines and rising unemployment led to a substantial increase in the population of distressed borrowers, we devoted significant resources to a variety of foreclosure prevention and refinance programs. These programs are consistent with our mission of keeping people in their homes and providing liquidity and affordability to the market.
Our homeowner assistance initiatives can be grouped broadly into three categories: (1) initiatives designed to increase the number of borrowers eligible for mortgage refinances; (2) home retention strategies, including loan modifications, repayment plans and forbearances, and HomeSaver Advance loans, which are described below; and (3) foreclosure alternatives, including preforeclosure sales and deeds-in-lieu of foreclosure. Our initiatives to increase the number of borrowers eligible to refinance their mortgages help borrowers obtain a monthly payment that is more affordable now and into the future or a more stable loan product, such as a fixed-rate mortgage loan in lieu of an adjustable-rate mortgage loan. Our home retention strategies and foreclosure alternatives are intended to help borrowers who have been affected by the challenging housing and economic environment stay in their homes or, for borrowers who are unable or unwilling to stay in their homes, avoid the pressure and stigma associated with a foreclosure. Additionally, sustainable home retention workouts and foreclosure alternative strategies are designed to lead to an overall reduction in our credit losses. Specifically, sustainable home retention workouts reduce defaults that would have otherwise occurred in our guaranty book, thereby reducing costly foreclosure losses. Foreclosure alternative strategies, while not avoiding a borrower default, reduce the severity of the loss that we suffer from the default.
During 2009, our homeowner assistance efforts were principally focused on the Making Home Affordable Program, including HAMP and HARP, details of which were first announced by the Obama Administration in March 2009. For more information on these programs, please see Making Home Affordable Program. In our instructions to the servicers who service our loans, we require that all problem loans first be evaluated under HAMP before being considered for other workout alternatives. If it is determined that a borrower in default is not eligible for modification under HAMP, our servicers are required to exhaust all other workout alternatives before proceeding to foreclosure.
We experienced a significant increase in our single-family refinancing volume in 2009 relative to 2008, primarily due to a sustained decline in mortgage rates to record or near-record lows. We acquired or guaranteed approximately 2,484,000 loans that were refinancings in 2009, a 60% increase over 2008. Our refinancing volume includes approximately 329,000 loans refinanced through our Refi Plus initiatives, which provide refinance solutions for eligible Fannie Mae loans, of which approximately 104,000 loans were refinanced under HARP. On average, borrowers who refinanced during 2009 through our Refi Plus initiatives reduced their monthly mortgage payments by $153. In addition, borrowers refinancing under HARP were able to benefit from lower levels of mortgage insurance and higher LTV ratios than what would have been allowed under our traditional standards.
In 2009, we completed home retention workouts for over 160,000 loans with an aggregate unpaid principal balance of $27.7 billion. On a loan count basis, this represented a 43% increase over home retention workouts completed in 2008. Loan modifications were the most significant driver of the increase in home retention workouts from 2008 to 2009 as we experienced a shift in our approach to workouts to address the increasing number of borrowers facing long-term, rather than short-term, financial hardships. Our loan modifications in 2009 targeted permanent changes to loan terms to further increase the likelihood of long-term home retention, in contrast to HomeSaver Advance Loans, which are unsecured personal loans in the amount of past due payments on a borrowers mortgage loan used to bring the mortgage loan current. We provided fewer HomeSaver Advance loans in 2009 than in 2008.
Not counting trial modifications under HAMP, in 2009 we completed approximately 99,000 loan modifications, an increase of 195% over 2008. Loan modifications represented 61% of home retention workouts completed in 2009 compared with 30% in 2008.
In 2009, the characteristics of our modifications changed notably, with 93% of modifications involving term extensions, interest rate reductions, or a combination of both, compared with 57% in 2008. As a result, approximately 58% of modifications completed in 2009 resulted in a reduction in initial monthly payments of greater than 20%, compared with 13% for modifications completed in 2008. This level of payment reduction should provide valuable assistance to borrowers in sustaining home ownership and, in turn, should help us reduce borrower defaults, which are costly for us.
Our modification statistics do not include HAMP trial modifications until they become permanent modifications. HAMP was our primary loan modification program in 2009; however, many of the trial modifications entered into during 2009 have not yet converted to a permanent modification solution due to the fact that the trial period is still underway or the trial period has been extended for servicers to obtain documents and perform final modification underwriting. A borrower receives payment relief during the HAMP trial period to the extent that the borrower pays according to the trial modification plan. While HAMP is the first home retention workout that servicers must consider for borrowers, we continued to complete modifications for those borrowers who did not qualify for HAMP, with the vast majority of our modifications in 2009 completed through our standard modification approaches. Including HAMP trials entered into during 2009, our HAMP efforts represented the vast majority of our total foreclosure prevention actions. As of December 31, 2009, 291,053 of our loans were in trial modification periods under HAMP, as reported by servicers to the system of record for the program. The number of our HAMP trials increased substantially in the third and fourth quarters of 2009, and we expect our permanent HAMP modifications to increase significantly as trial periods are completed and permanent modification offers are extended. However, it is difficult to predict how many trial modifications for our loans under HAMP will ultimately convert to permanent loan modifications.
If we are unable to provide a viable home retention option through HAMP or other programs, we may offer foreclosure alternatives, including preforeclosure sales and deeds-in-lieu of foreclosure. In 2009, our total volume of preforeclosure sales and deeds-in-lieu of foreclosures increased by 239% to approximately 40,000 in 2009 compared with approximately 12,000 in 2008. We have increasingly relied on foreclosure alternatives, primarily preforeclosure sales and deeds-in-lieu of foreclosure, as a growing number of borrowers have faced longer-term economic hardships that cannot be solved through a home retention solution.
In 2009, we purchased or guaranteed an estimated $823.6 billion in new business, measured by unpaid principal balance, which included financing for approximately 3,125,000 conventional single-family loans and approximately 372,000 multifamily units. The $823.6 billion in new single-family and multifamily business in 2009 consisted of $496.0 billion in Fannie Mae MBS acquired by third parties, and $327.6 billion in mortgage loans and mortgage-related securities that we purchased for our mortgage investment portfolio.
Our mortgage credit book of businesswhich consists of the mortgage loans and mortgage-related securities we hold in our investment portfolio, Fannie Mae MBS held by third parties and other credit enhancements that we provide on mortgage assetstotaled $3.2 trillion as of September 30, 2009, which represented approximately 27.5% of U.S. residential mortgage debt outstanding on September 30, 2009, the latest date for which the Federal Reserve has estimated U.S. residential mortgage debt outstanding. Our estimated market share of new single-family mortgage-related securities issuances was 38.9% in the fourth quarter of 2009 and 46.3% for the full year, making us the largest single issuer of mortgage-related securities in the secondary market in both periods. In comparison, our estimated market share of new single-family mortgage-related securities issuances was 44.0% in the third quarter of 2009, and 41.7% a year ago in the fourth quarter of 2008. Our estimated market share for 2009 of 46.3% includes $94.6 billion of whole loans held for investment in our mortgage portfolio that were securitized into Fannie Mae MBS in the second quarter, but retained in our mortgage portfolio and consolidated on our consolidated balance sheets. If we exclude these Fannie Mae MBS from the estimation of our market share, our estimated 2009 market share of new single-family mortgage-related securities issuances was 43.2%, still high enough to make us the largest single issuer of mortgage-related securities in the secondary market in 2009. Our market share remained high during 2009, primarily due to the dramatic curtailment of issuances of private-label securities since the end of 2007.
We remain a constant source of liquidity in the multifamily market and we have been successful with our goal of expanding our multifamily MBS business and broadening our multifamily investor base. Approximately 81% of our total multifamily production in 2009 was an MBS execution, compared with 17% in 2008.
In addition to purchasing and guaranteeing mortgage assets, we are taking a variety of other actions to provide liquidity to the mortgage market. These actions include whole loan conduit activities, early funding activities, dollar roll transactions, and REMICs and other structured securitizations, which we describe in Business SegmentsCapital Markets Group.
In response to the strong demand that we experienced for our debt securities during 2009, we issued a variety of non-callable and callable debt securities in a wide range of maturities to achieve cost-efficient funding and to strengthen our debt maturity profile. In particular, we issued a significant amount of long-term debt during this period, which we then used to repay maturing debt and prepay more expensive long-term debt. As a result, as of December 31, 2009, our outstanding short-term debt, based on its original contractual maturity, decreased as a percentage of our total outstanding debt to 26% from 38% as of December 31, 2008. In addition, the weighted-average interest rate on our long-term debt (excluding debt from consolidations) based on its original contractual maturity, decreased to 3.71% as of December 31, 2009 from 4.66% as of December 31, 2008.
We believe that our ready access to long-term debt funding during 2009 has been primarily due to the actions taken by the federal government to support us and the financial markets. Accordingly, we believe that continued federal government support of our business and the financial markets, as well as our status as a GSE, are essential to maintaining our access to debt funding. Changes or perceived changes in the governments support could increase our roll-over risk and materially adversely affect our ability to refinance our debt as it becomes due, which could have a material adverse impact on our liquidity, financial condition, results of operations and ability to continue as a going concern. Demand for our debt securities could decline in the future, as the Federal Reserve concludes its agency debt and MBS purchase programs during the first quarter of 2010, or for other reasons. Despite the expiration of the credit facility we had with Treasury and a Treasury MBS purchase program, as well as the scheduled expiration of the Federal Reserves program to purchase agency MBS and debt, as of the date of this filing, demand for our long-term debt securities continues to be strong.
See MD&ALiquidity and Capital ManagementLiquidity Management for more information on our debt funding activities and Risk Factors for a discussion of the risks to our business posed by our reliance on the issuance of debt securities to fund our operations.
Overall Housing and Mortgage Market Conditions. Although the financial markets have begun to recover, they remain weak on a historical basis. We expect this weakness in the real estate financial markets to continue in 2010. We expect home sales to slow somewhat in the coming months from the fourth quarter 2009 pace; however, the expanded homebuyer tax credit, combined with historically low mortgage rates, should support a strong sales pace through the first half of 2010 before slowing somewhat in the second half. We also expect home sales to start a longer term growth path by the end of 2010, if the labor market shows improvement. The continued deterioration in the performance of outstanding mortgages, however, will result in the foreclosure of troubled loans, which is likely to add to the excess housing inventory. If, as we expect, interest rates rise modestly, the pace at which the excess inventory is absorbed will decline.
We expect heightened default and severity rates to continue during 2010, and home prices, particularly in some geographic areas, may decline further. All of these conditions may worsen if the increase in the unemployment rate exceeds current expectations on either a national or regional basis. We continue to expect further increases in the level of foreclosures and single-family delinquency in 2010, as well as in the level of multifamily defaults and loss severity. We expect the decline in residential mortgage debt outstanding to continue through 2010, which would mark three consecutive annual declines. Approximately 80% of our single-family business in 2009 consisted of refinancings. We expect a decline in total originations as well as a potential shift of the market away from refinance activity during 2010, to have a significant adverse impact on our business volumes.
Home Price Declines: Home prices declined approximately 2.2% in 2009, following a decline of approximately 10% in 2008. We expect home prices to stabilize in 2010 and that the peak-to-trough home price decline on a national basis will range between 17% to 24%. These estimates are based on our home price index, which is calculated differently from the S&P/Case-Shiller U.S. National Home Price Index and therefore results in different percentages for comparable declines. These estimates also contain significant inherent uncertainty in the current market environment regarding a variety of critical assumptions we make when formulating these estimates, including: the effect of actions the federal government has taken and may take with respect to national economic recovery; the impact of the end of the Federal Reserves MBS purchase program; and the impact of those actions on home prices, unemployment and the general economic and interest rate environment. Because of these uncertainties, the actual home price decline we experience may differ significantly from these estimates. We also expect significant regional variation in home price declines.
Our 17% to 24% peak-to-trough home price decline estimate compares with an approximately 32% to 40% peak-to-trough decline using the S&P/Case-Shiller index method. Our estimates differ from the S&P/Case-Shiller index in two principal ways: (1) our estimates weight expectations for each individual property by number of properties, whereas the S&P/Case-Shiller index weights expectations of home price declines based on property value, causing declines in home prices on higher priced homes to have a greater effect on the overall result; and (2) our estimates do not include known sales of foreclosed homes because we believe that differing maintenance practices and the forced nature of the sales make foreclosed home prices less representative of market values, whereas the S&P/Case-Shiller index includes sales of foreclosed homes. The S&P/Case-Shiller comparison numbers shown above are calculated using our models and assumptions, but modified to use these two factors (weighting of expectations based on property value and the inclusion of foreclosed property sales). In addition to these differences, our estimates are based on our own internally available data combined with publicly available data, and are therefore based on data collected nationwide, whereas the S&P/Case-Shiller index is based only on publicly available data, which may be limited in certain geographic areas of the country. Our comparative calculations to the S&P/Case-Shiller index provided above are not modified to account for this data pool difference.
Credit-Related Expenses. Our credit-related expenses in 2009 were more than double our credit-related expenses in 2008. We expect that our credit-related expenses will remain high in 2010, as we believe that the level of our nonperforming loans will remain elevated for a period of time. Absent further significant economic deterioration, however, we anticipate that our credit-related expenses will be lower in 2010 than in 2009. Our expectation is based on several factors, including (1) the slow-down in the rate of increase in
average loss severities as home price declines have begun to moderate and stabilize in some regions, (2) our current expectation that, as 2010 progresses, credit deterioration will continue at a slower pace, coupled with an increase in the pace of foreclosures and problem loan workouts, and result in a slower rate of increase in delinquencies, and (3) our January 1, 2010 adoption of new accounting standards as a result of which we will no longer recognize the acquisition of loans from the MBS trusts that we have consolidated as a purchase with an associated fair value loss for the difference between the fair value of the acquired loan and its acquisition cost, as these loans will already be reflected on our consolidated balance sheet. As a result, we expect a reduction in our provision for credit losses.
Credit Losses. We expect that our credit losses will continue to increase during 2010 as a result of anticipated continued high unemployment and overall economic weakness, which will contribute to an expected increase in our charge-offs as we pursue foreclosure alternatives and foreclosures on seriously delinquent loans for which we are not able to provide a sustainable home retention workout solution.
Future Losses and Preferred Stock Dividends. We expect to continue to have losses on our guaranty book of business in response to the dual stresses of high unemployment and the extent and duration of the decline in home prices. Given our expectations regarding future losses and future draws from Treasury, we do not expect to earn profits in excess of our annual dividend obligation to Treasury for the indefinite future.
Uncertainty Regarding our Future Status and Long-Term Financial Sustainability. We expect that the actions we take to stabilize the housing market and minimize our credit losses will continue to have, in the short term at least, a material adverse effect on our results of operations and financial condition, including our net worth. Although Treasurys additional funds under the senior preferred stock purchase agreement permit us to remain solvent and avoid receivership, the resulting dividend payments are substantial and will increase as we request additional funds from Treasury under the senior preferred stock purchase agreement. As a result of these factors, along with current and expected market and economic conditions and the deterioration in our single-family and multifamily books of business, there is significant uncertainty as to our long-term financial sustainability. We expect that, for the indefinite future, the earnings of the company, if any, will not be sufficient to pay the dividends on the senior preferred stock. As a result, dividend payments will be effectively paid from funds drawn from the Treasury.
There is significant uncertainty in the current market environment, and any changes in the trends in macroeconomic factors that we currently anticipate, such as home prices and unemployment, may cause our future credit-related expenses, credit losses and credit loss ratio to vary significantly from our current expectations. In addition, there is uncertainty regarding the future of our business after the conservatorship is terminated, including whether we will continue in our current form, and we expect this uncertainty to continue. In announcing the December 24, 2009 amendments to the senior preferred stock purchase agreement and to Treasurys preferred stock purchase agreement with Freddie Mac, Treasury noted that the amendments should leave no uncertainty about the Treasurys commitment to support [Fannie Mae and Freddie Mac] as they continue to play a vital role in the housing market during this current crisis. On February 1, 2010, the Obama Administration stated in its fiscal year 2011 budget proposal that it was continuing to monitor the situation of Fannie Mae, Freddie Mac and the Federal Home Loan Banks (the GSEs) and would continue to provide updates on considerations for longer-term reform of Fannie Mae and Freddie Mac as appropriate. We cannot predict the prospects for the enactment, timing or content of legislative proposals regarding longer-term reform of the GSEs. Please see GSE Reform and Pending Legislation for a discussion of legislation being considered that could affect our business, including a list of possible reform options for the GSEs.
We support market liquidity by securitizing mortgage loans, which means we place loans in a trust and Fannie Mae MBS backed by the mortgage loans are then issued. We guarantee to the MBS trust that we will supplement amounts received by the MBS trust as required to permit timely payment of principal and interest on the trust certificates and, in return for this guaranty, we receive guaranty fees.
Below we discuss (1) two broad categories of securitization transactions: lender swaps and portfolio securitizations; (2) features of our MBS trusts; (3) circumstances under which we purchase loans from MBS trusts; and (4) single-class and multi-class Fannie Mae MBS.
Our securitization transactions primarily fall within two broad categories: lender swap transactions and portfolio securitizations.
Our most common type of securitization transaction is our 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 mortgage loans. A pool of mortgage loans is a group of mortgage loans with similar characteristics. After receiving the mortgage loans in a lender swap transaction, we place them in a trust that is established for the sole purpose of holding the mortgage loans separate and apart from our assets. 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 an undivided beneficial ownership interest in each of the mortgage 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.
In contrast to our lender swap securitizations, in which lenders deliver pools of mortgage loans to us that we immediately place in a trust for securitization, our portfolio securitization transactions involve creating and issuing Fannie Mae MBS using mortgage loans and mortgage-related securities that we hold in our mortgage portfolio. We currently securitize a majority of the single-family mortgage loans we purchase.
We serve as trustee for our MBS trusts, each of which is established for the sole purpose of holding mortgage loans separate and apart from our assets. Our MBS trusts hold either single-family or multifamily mortgage loans. Each trust operates in accordance with a trust agreement or a trust indenture. An MBS trust is also governed by an issue supplement documenting the formation of that MBS trust and the issuance of the related Fannie Mae MBS. The 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 January 2009, we established a new multifamily master trust agreement that governs our multifamily MBS trusts formed on or after February 1, 2009 and amended and restated our previous 2007 master trust agreement to (1) establish specific criteria for the segregation and maintenance by our mortgage loan servicers of collateral reserve accounts, (2) provide greater flexibility in dealing with defaulted mortgage loans held in an MBS trust, and (3) make changes to our multifamily MBS trusts to conform with our single-family MBS trusts.
In 2008, we established a new single-family master trust agreement that governs our single-family MBS trusts formed on or after January 1, 2009 and amended and restated our previous single-family master trust agreement, also effective January 1, 2009. These changes are intended to facilitate the workout process on mortgage loans included in trusts governed by these trust documents.
Under the terms of our MBS trust documents, we have the option or, in some instances, the obligation, to purchase mortgage loans that meet specific criteria from an MBS trust. Our acquisition cost for these loans is the unpaid principal balance of the loan plus accrued interest. We generally purchase from the MBS trust any loan that we intend to modify prior to the time that the modification becomes effective.
In deciding whether and when to purchase a loan from a single-family MBS trust, we consider a variety of factors, including: our legal ability or obligation to purchase loans under the terms of the trust documents; our
mission and public policy; our loss mitigation strategies and the exposure to credit losses we face under our guaranty; our cost of funds; the impact on our results of operations; relevant market yields; the accounting impact; the administrative costs associated with purchasing and holding the loans; 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. The weight we give to these factors changes depending on market circumstances and other factors.
With the adoption of new accounting standards on January 1, 2010, we will no longer recognize the acquisition of loans from the MBS trusts that we have consolidated as a purchase with an associated fair value loss for the difference between the fair value of the acquired loan and its acquisition cost, as these loans will already be reflected on our consolidated balance sheet. Currently, the cost of purchasing most delinquent loans from Fannie Mae MBS trusts and holding them in our portfolio is less than the cost of advancing delinquent payments to security holders. In light of these factors, on February 10, 2010, we announced that we expect to significantly increase our purchases of delinquent loans from single-family MBS trusts. We will begin purchasing these loans in March 2010. We expect to purchase a significant portion of the current delinquent population within a few months period subject to market, servicer capacity, and other constraints, including the limit on mortgage assets that we may own pursuant to the preferred stock purchase agreement described in Conservatorship and Treasury Agreements Treasury Agreements Covenants under Treasury Agreements. As of December 31, 2009, the total unpaid principal balance of all loans in single-family MBS trusts that were delinquent four or more months was approximately $127 billion. We will continue to review the economics of purchasing loans that are four or more months delinquent in the future and may reevaluate our delinquent loan purchase practices and alter them if circumstances warrant.
For our multifamily MBS trusts, we typically exercise our option to purchase a loan from the trust if the loan is delinquent, in whole or in part, as to four or more consecutive monthly payments.
Fannie Mae MBS trusts may be single-class or multi-class. Single-class MBS are MBS where the investors receive principal and interest payments in proportion to their percentage ownership of the MBS issuance. Multi-class MBS are MBS, including 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. 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. After these classes expire, cash flows received on the underlying mortgage assets are allocated to the remaining classes in accordance with the terms of the securities structures. As a result, each of the classes in a multi-class MBS may have a different coupon rate, average life, repayment sensitivity or final maturity. Structured Fannie Mae MBS are either multi-class MBS or single-class MBS that are resecuritizations of other single-class Fannie Mae MBS. In a resecuritization, pools of MBS are collected and securitized.
We have three business segments for management reporting purposes: Single-Family Credit Guaranty, Housing and Community Development, and Capital Markets. Our business segments engage in complementary business activities in pursuing our mission of providing liquidity, stability and affordability to the U.S. housing market. These activities are summarized in the table below and described in more detail following this table. We also summarize in the table below the key sources of revenue for each of our segments and the primary expenses. See MD&ABusiness Segment Results and Note 15, Segment Reporting for the financial results of each of our segments and a discussion and analysis of the financial performance of each segment.
Our Single-Family business works with our lender customers to provide funds to the mortgage market by securitizing single-family mortgage loans into Fannie Mae MBS. Our Single-Family business issues single-class Fannie Mae MBS from pools of loans delivered to us by mortgage lenders that are placed immediately in a trust. Unlike MBS securitization transactions engaged in by our Capital Markets group, our Single-Family business securitizations are not comprised of loans from our portfolio. Our Single-Family business also works with our Capital Markets group to facilitate the purchase of single-family mortgage loans for our mortgage portfolio. Our Single-Family business has primary responsibility for pricing and managing the credit risk on our single-family guaranty book of business, which consists of single-family mortgage loans underlying Fannie Mae MBS and single-family loans held in our mortgage portfolio.
A single-family loan is secured by a property with four or fewer residential units. Our Single-Family business and Capital Markets group securitize and purchase primarily conventional (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. We also securitize or purchase loans insured by FHA, loans guaranteed by the Department of Veterans Affairs (VA), and loans guaranteed by the Rural Development Housing and Community Facilities Program of the Department of Agriculture, manufactured housing loans, reverse mortgage loans, multifamily mortgage loans, subordinate lien mortgage loans (for example, loans secured by second liens) and other mortgage-related securities.
Revenues for our Single-Family business are derived primarily from guaranty fees received as compensation for assuming the credit risk on the mortgage loans underlying single-family Fannie Mae MBS. We also allocate guaranty fee revenues to the Single-Family business for assuming and managing the credit risk on the single-family mortgage loans held in our portfolio. The aggregate amount of single-family guaranty fees we receive or that are allocated to our Single-Family business in any period depends on the amount of single-family Fannie Mae MBS outstanding and loans held in our mortgage portfolio during the 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. Other factors affecting the amount of Fannie Mae MBS outstanding are the extent to which we purchase loans from our MBS trusts because of borrower defaults (with the amount of these purchases affected by the rate of borrower defaults on the loans and the extent of loan modification programs in which we engage) and the extent to which sellers and servicers repurchase loans from us upon our demand because there was a breach in the selling representations and warranties provided upon delivery of the loans. Our Single-Family business accounted for approximately 39% of our net revenues in 2009, compared with 54% in 2008 and 63% in 2007.
We describe the credit risk management process employed by our Single-Family business, including its key strategies in managing credit risk and key metrics used in measuring and evaluating our single-family credit risk in MD&ARisk ManagementCredit Risk Management.
Our Single-Family business securitizes single-family mortgage loans and issues single-class Fannie Mae MBS, which are described above in Mortgage SecuritizationsSingle-Class and Multi-Class Fannie Mae MBS, for our lender customers. Unlike MBS securitization transactions engaged in by our Capital Markets group, our Single-Family business engages solely in lender swap transactions, in which lenders deliver pools of mortgage loans to us in exchange for Fannie Mae MBS backed by these loans. We describe lender swap transactions, and how they differ from portfolio securitizations, in Mortgage SecuritizationsLender Swaps and Portfolio Securitizations.
Loans from our lender customers are delivered to us 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 lenders future delivery of individual loans to us over a specified time period. Our bulk business generally consists of transactions in which a set of loans are delivered to us in bulk, typically with guaranty fees and other contract terms negotiated individually for each transaction.
Generally, the servicing of the mortgage loans held in our mortgage portfolio or that back our Fannie Mae MBS is performed by mortgage servicers on our behalf. Typically, lenders who sell single-family mortgage loans to us service these loans for us. For loans we own or guarantee, the lender or servicer must obtain our approval before selling servicing rights to another servicer.
Our mortgage servicers typically collect and deliver principal and interest payments, administer escrow accounts, monitor and report delinquencies, perform default prevention activities, evaluate transfers of ownership interests, respond to requests for partial releases of security, and handle proceeds from casualty and condemnation losses. Our mortgage servicers are the primary point of contact for borrowers and perform a key role in the effective implementation of our homeownership assistance initiatives, negotiation of workouts of troubled loans, and loss mitigation activities. If necessary, mortgage servicers inspect and preserve properties and process foreclosures and bankruptcies. Because we delegate the servicing of our mortgage loans to mortgage servicers and do not have our own servicing function, our ability to actively manage troubled loans that we own or guarantee may be limited. For more information on the risks of our reliance on servicers, refer to Risk Factors and MD&ARisk ManagementCredit Risk ManagementInstitutional Counterparty Credit Risk Management.
We compensate servicers primarily by permitting them to retain a specified portion of each interest payment on a serviced mortgage loan as 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.
REO Management and Lender Repurchase Evaluations
In the event a loan defaults and we acquire a home through foreclosure or a deed-in-lieu of foreclosure, we focus on selling the home through a national network of real estate agents. Our primary objectives are both to minimize the severity of loss to Fannie Mae by maximizing sales prices and also to stabilize neighborhoodsto prevent empty homes from depressing home values. We also continue to seek non-traditional ways to sell properties, including by selling homes to cities, municipalities and other public entities, and by selling properties in bulk or through public auctions.
We also conduct post-purchase quality control file reviews to ensure that loans sold to and serviced for us meet our guidelines. If we discover violations through reviews, we issue repurchase demands to the seller and seek to collect on our repurchase claims.
Our HCD business works with our lender customers to provide funds to the mortgage market by securitizing multifamily mortgage loans into Fannie Mae MBS. Our HCD business also works with our Capital Markets group to facilitate the purchase of multifamily mortgage loans for our mortgage portfolio. 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 also makes LIHTC partnership, debt and equity investments to increase the supply of affordable housing. Our HCD business has primary responsibility for pricing and managing the credit risk on our multifamily guaranty book of business, which consists of multifamily mortgage loans underlying Fannie Mae MBS and multifamily loans held in our mortgage portfolio.
Revenues for our HCD business are derived from a variety of sources, including: (1) 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 and on other mortgage-related securities; (2) transaction fees associated with the multifamily business and (3) other bond credit enhancement related fees. HCDs investments in rental housing projects eligible for LIHTC and other investments generate both tax
credits and net operating losses that may 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 accounted for approximately 3% of our net revenues in 2009, compared with 3% in 2008 and 4% in 2007.
We describe the credit risk management process employed by our HCD business, including its key strategies in managing credit risk and key metrics used in measuring and evaluating our multifamily credit risk, in MD&ARisk ManagementCredit Risk ManagementMultifamily Mortgage Credit Risk Management.
Our HCD business generally creates multifamily Fannie Mae MBS and acquires multifamily mortgage assets in the same manner as our Single-Family business, as described above in Single-Family Credit Guaranty BusinessMortgage Securitizations and Acquisitions.
As with the servicing of single-family mortgages, multifamily mortgage servicing is typically performed by the lenders who sell the mortgages to us. In contrast to our single-family mortgage servicers, however, many of those lenders have agreed, as part of the multifamily delegated underwriting and servicing relationship we have with these lenders, to accept loss sharing under certain defined circumstances with respect to mortgages that they have sold to us and are servicing. Thus, multifamily loss sharing obligations are an integral part of our selling and servicing relationships with multifamily lenders. Consequently, transfers of multifamily servicing rights are infrequent and are carefully monitored by us to enforce our right to approve all servicing transfers. As a seller-servicer, the lender is also responsible for evaluating the financial condition of property owners, administering various types of agreements (including agreements regarding replacement reserves, completion or repair, and operations and maintenance), as well as conducting routine property inspections.
Our HCD business helps to expand the supply of affordable housing by investing in rental and for-sale housing projects. Historically, most of these investments have been LIHTC investments. Our HCD business also makes non-LIHTC debt and equity investments in rental and for-sale housing. These investments are consistent with our focus on serving communities and improving access to affordable housing. As described in Note 11, Income Taxes, we concluded that it is more likely than not that we would not generate sufficient taxable income in the foreseeable future to realize all of our deferred tax assets. Therefore, we currently do not recognize in our financial statements any tax benefits associated with tax credits and net operating losses. As a result of our tax position, we did not make any new LIHTC investments in 2009 other than pursuant to commitments existing prior to 2008. In addition, we limited other new investments during 2009 due to the unfavorable real estate market conditions.
Prior to September 30, 2009, we entered into a nonbinding letter of intent to transfer equity interests in our LIHTC investments to third-party investors at a price above carrying value. This transaction was subject to the Treasurys approval under the terms of our senior preferred stock purchase agreement. In November of 2009, Treasury notified FHFA and us that it did not consent to the proposed transaction. Treasury stated the proposed sale would result in a loss of aggregate tax revenues that would be greater than the savings to the federal government from a reduction in the capital contribution obligation of Treasury to Fannie Mae under the senior preferred stock purchase agreement. Treasury further stated that withholding approval of the proposed sale afforded more protection to the taxpayers than approval would have provided.
We have continued to explore options to sell or otherwise transfer our LIHTC investments for value consistent with our mission; however, to date, we have not been successful. On February 18, 2010, FHFA informed us, by letter, of its conclusion that any sale by us of our LIHTC assets would require Treasurys consent under the senior preferred stock purchase agreement, and that FHFA had presented other options for Treasury to consider, including allowing us to pay senior preferred stock dividends by waiving the right to claim future tax benefits of the LIHTC investments. FHFAs letter further informed us that, after further consultation with the
Treasury, we may not sell or transfer our LIHTC partnership interests and that FHFA sees no disposition options. Therefore, we no longer have both the intent and ability to sell or otherwise transfer our LIHTC investments for value. As a result, we recognized a loss of $5.0 billion during the fourth quarter of 2009 to reduce the carrying value of our LIHTC Partnership investments to zero in the consolidated financial statements. For additional information regarding our investments in LIHTC partnerships and their impact on our financial results, see MD&AConsolidated Results of OperationsLosses from Partnership Investments and MD&AOff-Balance Sheet Arrangements and Variable Interest Entities.
Our Capital Markets group manages our investment activity in mortgage-related assets and other interest-earning non-mortgage investments. We fund our investments primarily through proceeds we receive from the issuance of debt securities in the domestic and international capital markets. Our Capital Markets group has primary responsibility for managing the interest rate risk associated with our investments in mortgage assets.
The business model for our Capital Markets group continues to evolve. Our business activity is increasingly focused on making short-term use of our balance sheet rather than on long-term buy and hold strategies. As a result, our Capital Markets group increasingly works with lender customers to provide funds to the mortgage market through short-term financing and investing activities. Activities we are undertaking to provide liquidity to the mortgage market include the following:
Our Capital Markets group is engaged in issuing both single-class and multi-class Fannie Mae MBS through both portfolio securitizations and lender swap securitizations.
For more information about lender swaps and how they differ from portfolio securitizations, please see Mortgage SecuritizationsLender Swaps and Portfolio Securitizations. For a description of single-class Fannie Mae MBS, please see Mortgage SecuritizationsSingle-Class and Multi-Class Fannie Mae MBS.
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 hedging 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.
Although our Capital Markets groups business activities are increasingly focused on short-term financing and investing, revenue from our Capital Markets group is derived primarily from the difference, or spread, between the interest we earn on our mortgage and non-mortgage investments and the interest we incur on the debt we issue to fund these assets. Accordingly, our Capital Markets revenues are primarily derived from our asset portfolio, which is capped under our senior preferred stock purchase agreement with Treasury at a limit that decreases each year. See Conservatorship and Treasury AgreementsTreasury AgreementsCovenants under Treasury Agreements for more information on the decreasing limits on the amount of mortgage assets we are permitted to hold. Our Capital Markets group also earns fee and other income on various transactions we provide as a service to our customers, which we describe below. Our Capital Markets group accounted for approximately 58% of our net revenues in 2009, compared with 43% in 2008 and 33% in 2007.
We describe the interest rate risk management process employed by our Capital Markets group, including its key strategies in managing interest rate risk and key metrics used in measuring and evaluating our interest rate risk in MD&ARisk ManagementMarket Risk Management, Including Interest Rate Risk.
Our Capital Markets group seeks to increase the liquidity of the mortgage market by maintaining a presence as an active investor in mortgage loans and mortgage-related securities and, in particular, supports the liquidity and value of Fannie Mae MBS in a variety of market conditions.
Our Capital Markets group funds its investments primarily through the issuance of a variety of debt securities in a wide range of maturities in the domestic and international capital markets. The most active investors in our debt securities include commercial bank portfolios and trust departments, investment fund managers, insurance companies, pension funds, state and local governments, and central banks. The approved dealers for underwriting various types of Fannie Mae debt securities may differ by funding program. See MD&ALiquidity and Capital ManagementLiquidity Management for information on the composition of our outstanding debt and a discussion of our liquidity.
Our Capital Markets groups investment and financing activities are affected by market conditions and the target rates of return that we expect to earn on the equity capital underlying our investments. When we estimate that we can earn returns in excess of our targets, we generally will be an active purchaser of mortgage loans and mortgage-related securities. When potential returns are below our investment targets, we generally will be a less active purchaser, and may be a net seller, of mortgage assets. The Federal Reserve agency MBS purchase program, which we describe in Residential Mortgage MarketHousing and Mortgage Market and Economic Conditions, had a significant impact on our investment activity during 2009. Our investment activities also are subject to capital requirements, contractual limitations, and other regulatory constraints, to the extent described below under Conservatorship and Treasury Agreements and Our Charter and Regulation of Our Activities.
CONSERVATORSHIP AND TREASURY AGREEMENTS
On September 6, 2008, the Director of FHFA appointed FHFA as our conservator in accordance with the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, as amended by the Federal Housing Finance Regulatory Reform Act of 2008, or 2008 Reform Act (together, the GSE Act). The conservatorship is a statutory process designed to preserve and conserve our assets and property, and put the company in a sound and solvent condition. Below we summarize key powers held by the conservator under the GSE Act.
The conservatorship has no specified termination date. There can be no assurance as to when or how the conservatorship will be terminated, whether we will continue in our current form following conservatorship, or what changes to our business structure will be made during or following the conservatorship. For more information on the risks to our business relating to the conservatorship and uncertainties regarding the future of our business, see Risk Factors.
Upon its appointment, the conservator immediately succeeded to all rights, titles, powers and privileges of Fannie Mae, and of any shareholder, officer or director of Fannie Mae with respect to Fannie Mae and its assets, and succeeded to the title to the books, records and assets of any other legal custodian of Fannie Mae. The conservator has since delegated specified authorities to our Board of Directors, which are described in Directors, Executive Officers and Corporate GovernanceCorporate Governance, and has delegated to management the authority to conduct our day-to-day operations. The conservator may take any actions it determines are necessary and appropriate to carry on our business and preserve and conserve our assets and property. The conservators powers include the ability to transfer or sell our assets or liabilities, generally without any approval, assignment of rights or consent of any party. The GSE Act provides that mortgage loans and mortgage-related assets that have been transferred to a Fannie Mae MBS trust must be held for the beneficial owners of the Fannie Mae MBS and cannot be used to satisfy our general creditors.
Disaffirmance and Repudiation of Contracts
The conservator may disaffirm or repudiate contracts (subject to certain limitations for qualified financial contracts) that we entered into prior to its appointment as conservator if it determines, in its sole discretion, that performance of the contract is burdensome and that disaffirmation or repudiation of the contract promotes the orderly administration of our affairs. The GSE Act requires FHFA to exercise its right to disaffirm or repudiate most contracts within a reasonable period of time after its appointment as conservator, and specifies the liability of the conservator for disaffirming or repudiating a contract. As of February 26, 2010, the conservator has advised us that it has not disaffirmed or repudiated any contracts we entered into prior to its appointment as conservator.
We continue to enter into and enforce contracts with third parties. In addition, we remain liable for all of our obligations relating to our outstanding debt securities and Fannie Mae MBS. The conservator has advised us that it has no intention of repudiating any guaranty obligation relating to Fannie Mae MBS because it views repudiation as incompatible with the goals of the conservatorship.
Security Interests Protected; Exercise of Rights under Qualified Financial Contracts
Notwithstanding the conservators powers described above, the conservator must recognize legally enforceable or perfected security interests, except where such an interest is taken in contemplation of our insolvency or with the intent to hinder, delay or defraud us or our creditors. In addition, the GSE Act provides that no person will be stayed or prohibited from exercising specified rights in connection with qualified financial contracts, including termination or acceleration (other than solely by reason of, or incidental to, the appointment of the conservator), rights of offset, and rights under any security agreement or arrangement or other credit enhancement relating to such contract. The term qualified financial contract means any
securities contract, commodity contract, forward contract, repurchase agreement, swap agreement and any similar agreement that FHFA determines by regulation, resolution or order to be a qualified financial contract.
Avoidance of Fraudulent Transfers
The conservator may avoid, or refuse to recognize, a transfer of any property interest of Fannie Mae or of any of our debtors, and also may avoid any obligation incurred by Fannie Mae or by any debtor of Fannie Mae, if the transfer or obligation was made (1) within five years of September 6, 2008, and (2) with the intent to hinder, delay, or defraud Fannie Mae, FHFA, the conservator or, in the case of a transfer in connection with a qualified financial contract, our creditors. To the extent a transfer is avoided, the conservator may recover, for our benefit, the property or, by court order, the value of that property from the initial or subsequent transferee, unless the transfer was made for value and in good faith. These rights are superior to any rights of a trustee or any other party, other than a federal agency, under the U.S. bankruptcy code.
Upon our entry into conservatorship in September 2008, FHFA, as conservator, succeeded to the powers of our officers and directors. The conservator subsequently reconstituted our Board of Directors and delegated to our management and Board of Directors the authority to conduct our day-to-day operations, subject to the direction of the conservator. The conservator retains the authority to withdraw its delegations to the Board and to management at any time.
Our directors serve on behalf of the conservator and exercise their authority as directed by and with the approval, where required, of the conservator. Our directors do not have any duties to any person or entity except to the conservator. Accordingly, our directors are not obligated to consider the interests of the company, the holders of our equity or debt securities or the holders of Fannie Mae MBS unless specifically directed to do so by the conservator. In addition, the conservator directed the Board to consult with and obtain the approval of the conservator before taking action in specified areas, as described in Directors, Executive Officers and Corporate GovernanceCorporate GovernanceConservatorship and Delegation of Authority to Board of Directors.
The conservatorship has had the following adverse effects on our common and preferred shareholders:
On September 7, 2008, we, through FHFA, in its capacity as conservator, and Treasury entered into a senior preferred stock purchase agreement, which was subsequently amended on September 26, 2008, May 6, 2009 and December 24, 2009. Unless the context indicates otherwise, references in this report to the senior preferred stock purchase agreement refer to the agreement as amended through December 24, 2009. The terms
of the senior preferred stock purchase agreement, senior preferred stock and warrant will continue to apply to us even if we are released from the conservatorship. Please see Risk Factors for a description of the risks to our business relating to the Treasury agreements.
We also entered into a lending agreement with Treasury in September 2008 under which we were allowed to request loans from Treasury until December 31, 2009. In this report, we refer to this agreement as the Treasury credit facility. On December 24, 2009, Treasury announced that the Treasury credit facility would terminate on December 31, 2009, in accordance with its terms. We did not request any loans or borrow any amounts under the Treasury credit facility prior to its termination on December 31, 2009.
Senior Preferred Stock Purchase Agreement and Related Issuance of Senior Preferred Stock and Common Stock Warrant
Senior Preferred Stock Purchase Agreement
Under the senior preferred stock purchase agreement, we issued to Treasury (1) one million shares of Variable Liquidation Preference Senior Preferred Stock, Series 2008-2, which we refer to as the senior preferred stock, with an initial liquidation preference equal to $1,000 per share (for an aggregate liquidation preference of $1.0 billion), and (2) a warrant to purchase, for a nominal price, shares of common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis at the time the warrant is exercised, which we refer to as the warrant. We did not receive any cash proceeds from Treasury at the time the senior preferred stock or the warrant was issued.
The senior preferred stock and warrant were issued to Treasury as an initial commitment fee in consideration of the commitment from Treasury to provide funds to us under the terms and conditions set forth in the senior preferred stock purchase agreement. The senior preferred stock purchase agreement provides that, on a quarterly basis, we generally may draw funds up to the amount, if any, by which our total liabilities exceed our total assets, as reflected on our consolidated balance sheet, prepared in accordance with generally accepted accounting principles (GAAP), for the applicable fiscal quarter (referred to as the deficiency amount). More specifically, the agreement provides that if the Director of FHFA determines he will be mandated by law to appoint a receiver for us, then FHFA, in its capacity as our conservator, may request that Treasury provide funds to us in an amount up to the deficiency amount (subject to the maximum amount that may be funded under the agreement). The senior preferred stock purchase agreement also provides that, if we have a deficiency amount as of the date of completion of the liquidation of our assets, FHFA (or our Chief Financial Officer if we are not under conservatorship), may request funds from Treasury in an amount up to the deficiency amount (subject to the maximum amount that may be funded under the agreement).
On December 24, 2009, Treasurys maximum funding commitment to us under the senior preferred stock purchase agreement was increased pursuant to an amendment to the agreement. The amendment provides that the cap on Treasurys funding commitment to us under the senior preferred stock purchase agreement will increase as necessary to accommodate any net worth deficits for calendar quarters in 2010 through 2012. For any net worth deficits after December 31, 2012, Treasurys remaining funding commitment will be $124.8 billion, less any positive net worth as of December 31, 2012. In announcing the December 24, 2009 amendments to the senior preferred stock purchase agreement and to Treasurys preferred stock purchase agreement with Freddie Mac, Treasury noted that the amendments should leave no uncertainty about the Treasurys commitment to support [Fannie Mae and Freddie Mac] as they continue to play a vital role in the housing market during this current crisis. The senior preferred stock purchase agreement provides that the deficiency amount will be calculated differently if we become subject to receivership or other liquidation process. We discuss our net worth deficits and FHFAs requests on our behalf for funds from Treasury in Executive SummarySummary of our Financial Performance for 2009.
Under the senior preferred stock purchase agreement, beginning on March 31, 2011, we are required to pay a quarterly commitment fee to Treasury. This quarterly commitment fee will accrue from January 1, 2011. The fee, in an amount to be mutually agreed upon by us and Treasury and to be determined with reference to the market value of Treasurys funding commitment as then in effect, will be determined on or before December 31, 2010, and will be reset every five years. Treasury may waive the quarterly commitment fee for
up to one year at a time, in its sole discretion, based on adverse conditions in the U.S. mortgage market. We may elect to pay the quarterly commitment fee in cash or add the amount of the fee to the liquidation preference of the senior preferred stock.
The senior preferred stock purchase agreement provides that the Treasurys funding commitment will terminate under any of the following circumstances: (1) the completion of our liquidation and fulfillment of Treasurys obligations under its funding commitment at that time, (2) the payment in full of, or reasonable provision for, all of our liabilities (whether or not contingent, including mortgage guaranty obligations), or (3) the funding by Treasury of the maximum amount that may be funded under the agreement. In addition, Treasury may terminate its funding commitment and declare the senior preferred stock purchase agreement null and void if a court vacates, modifies, amends, conditions, enjoins, stays or otherwise affects the appointment of the conservator or otherwise curtails the conservators powers. Treasury may not terminate its funding commitment under the agreement solely by reason of our being in conservatorship, receivership or other insolvency proceeding, or due to our financial condition or any adverse change in our financial condition.
The senior preferred stock purchase agreement provides that most provisions of the agreement may be waived or amended by mutual written agreement of the parties; however, no waiver or amendment of the agreement is permitted that would decrease Treasurys aggregate funding commitment or add conditions to Treasurys funding commitment if the waiver or amendment would adversely affect in any material respect the holders of our debt securities or guaranteed Fannie Mae MBS.
In the event of our default on payments with respect to our debt securities or guaranteed Fannie Mae MBS, if Treasury fails to perform its obligations under its funding commitment and if we and/or the conservator are not diligently pursuing remedies in respect of that failure, the holders of our debt securities or Fannie Mae MBS may file a claim in the United States Court of Federal Claims for relief requiring Treasury to fund to us the lesser of (1) the amount necessary to cure the payment defaults on our debt and Fannie Mae MBS and (2) the lesser of (a) the deficiency amount and (b) the maximum amount that may be funded under the agreement less the aggregate amount of funding previously provided under the commitment. Any payment that Treasury makes under those circumstances will be treated for all purposes as a draw under the senior preferred stock purchase agreement that will increase the liquidation preference of the senior preferred stock.
Senior Preferred Stock
Pursuant to the senior preferred stock purchase agreement, we issued one million shares of senior preferred stock to Treasury on September 8, 2008 with an aggregate initial liquidation preference of $1.0 billion. The stocks liquidation preference is subject to adjustment. Dividends that are not paid in cash for any dividend period will accrue and be added to the liquidation preference. Any amounts Treasury pays to us pursuant to its funding commitment under the senior preferred stock purchase agreement and any quarterly commitment fees that are not paid in cash to Treasury or waived by Treasury will also be added to the liquidation preference. Accordingly, the aggregate liquidation preference of the senior preferred stock was $60.9 billion as of December 31, 2009 and will increase to $76.2 billion as a result of FHFAs request on our behalf for funds to eliminate our net worth deficit as of December 31, 2009.
Treasury, as holder of the senior preferred stock, is entitled to receive, when, as and if declared by our Board of Directors, out of legally available funds, cumulative quarterly cash dividends at the annual rate of 10% per year on the then-current liquidation preference of the senior preferred stock. If at any time we fail to pay cash dividends in a timely manner, then immediately following such failure and for all dividend periods thereafter until the dividend period following the date on which we have paid in cash full cumulative dividends (including any unpaid dividends added to the liquidation preference), the dividend rate will be 12% per year.
The senior preferred stock ranks ahead of our common stock and all other outstanding series of our preferred stock, as well as any capital stock we issue in the future, as to both dividends and rights upon liquidation. The senior preferred stock provides that we may not, at any time, declare or pay dividends on, make distributions with respect to, or redeem, purchase or acquire, or make a liquidation payment with respect to, any common stock or other securities ranking junior to the senior preferred stock unless (1) full cumulative dividends on the
outstanding senior preferred stock (including any unpaid dividends added to the liquidation preference) have been declared and paid in cash, and (2) all amounts required to be paid with the net proceeds of any issuance of capital stock for cash (as described in the following paragraph) have been paid in cash. Shares of the senior preferred stock are not convertible. Shares of the senior preferred stock have no general or special voting rights, other than those set forth in the certificate of designation for the senior preferred stock or otherwise required by law. The consent of holders of at least two-thirds of all outstanding shares of senior preferred stock is generally required to amend the terms of the senior preferred stock or to create any class or series of stock that ranks prior to or on parity with the senior preferred stock.
We are not permitted to redeem the senior preferred stock prior to the termination of Treasurys funding commitment under the senior preferred stock purchase agreement. Moreover, we are not permitted to pay down the liquidation preference of the outstanding shares of senior preferred stock except to the extent of (1) accrued and unpaid dividends previously added to the liquidation preference and not previously paid down; and (2) quarterly commitment fees previously added to the liquidation preference and not previously paid down. In addition, if we issue any shares of capital stock for cash while the senior preferred stock is outstanding, the net proceeds of the issuance must be used to pay down the liquidation preference of the senior preferred stock; however, the liquidation preference of each share of senior preferred stock may not be paid down below $1,000 per share prior to the termination of Treasurys funding commitment. Following the termination of Treasurys funding commitment, we may pay down the liquidation preference of all outstanding shares of senior preferred stock at any time, in whole or in part.
Common Stock Warrant
Pursuant to the senior preferred stock purchase agreement, on September 7, 2008, we, through FHFA, in its capacity as conservator, issued a warrant to purchase common stock to Treasury. The warrant gives Treasury the right to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis on the date of exercise, for an exercise price of $0.00001 per share. The warrant may be exercised in whole or in part at any time on or before September 7, 2028.
The senior preferred stock purchase agreement and warrant contain covenants that significantly restrict our business activities and require the prior written consent of Treasury before we can take certain actions. These covenants prohibit us from:
In November 2009, Treasury withheld its consent under these covenants to our proposed transfer of LIHTC investments. Please see MD&AConsolidated Results of OperationsLosses from Partnership Investments for information on the resulting other-than-temporary impairment losses we recognized during the fourth quarter of 2009.
We also are subject to limits, which are described below, on the amount of mortgage assets that we may own and the total amount of our indebtedness. As a result, we can no longer obtain additional equity financing
(other than pursuant to the senior preferred stock purchase agreement) and we are limited in the amount and type of debt financing we may obtain.
Under the terms of the senior preferred stock purchase agreement, mortgage assets and indebtedness are calculated without giving effect to changes made after May 2009 to the accounting rules governing the transfer and servicing of financial assets and the extinguishment of liabilities or similar accounting standards. Accordingly, our adoption of new accounting policies regarding consolidation and transfers of financial assets will not affect these calculations.
The agreements with Treasury have materially limited the rights of our common and preferred shareholders (other than Treasury as holder of the senior preferred stock). The senior preferred stock purchase agreement and the senior preferred stock and warrant issued to Treasury pursuant to the agreement have had the following adverse effects on our common and preferred shareholders:
As described above and in Risk Factors, the Treasury agreements also impact our business in ways that affect our common and preferred shareholders.
GSE REFORM AND PENDING LEGISLATION
In June 2009, the Obama administration released a white paper on financial regulatory reform stating that Treasury and HUD would be developing recommendations on the future of the GSEs. The white paper noted that there were a number of options for the reform of Fannie Mae and Freddie Mac, including:
On February 1, 2010 the administration stated in its 2011 budget proposal that it continues to monitor the situation of the GSEs closely and will continue to provide updates on considerations for longer-term reform of Fannie Mae and Freddie Mac as appropriate. The same day, HUD Secretary Shaun Donovan indicated that the administration would release a statement on the GSEs in the very near future.
During 2009, Congress began to hold hearings on the future status of Fannie Mae and Freddie Mac, and at least one legislative proposal relating to the future status of the GSEs was offered. We expect hearings to continue in 2010 and additional proposals to be discussed. The Chairman of the House Financial Services Committee stated in January 2010, I believe this committee will be recommending abolishing Fannie Mae and Freddie Mac in their current form and coming up with a whole new system of housing finance. We cannot predict the prospects for the enactment, timing or content of legislative proposals regarding the future status of the GSEs. In sum, there continues to be uncertainty regarding the future of our company, including whether we will continue in our current form after the conservatorship is terminated.
On December 11, 2009, the House of Representatives passed legislation that would significantly alter the current regulatory framework applicable to the financial services industry, with enhanced regulation of financial firms and markets. The legislation includes proposals relating to the enhanced regulation of securitization markets, changes to existing capital and liquidity requirements for financial firms, additional regulation of the over-the-counter derivatives market, stronger consumer protection regulations, requirements for the retention of credit risk by securitizers and originators of mortgage loans, regulations on compensation practices, and changes in accounting standards. The Senate may consider its own financial reform legislation in 2010. If enacted, such legislation could directly and indirectly affect many aspects of our business and that of our business partners.
In June 2009, the House of Representatives passed a bill that, among other things, would impose upon Fannie Mae and Freddie Mac a duty to develop loan products and flexible underwriting guidelines to facilitate a secondary market for energy-efficient and location-efficient mortgages. The legislation would also allow Fannie Mae and Freddie Mac additional credit toward their housing goals for purchases of energy-efficient and
location-efficient mortgages. It is unclear what action the Senate will take on this legislation, or what impact it may have on our business if this legislation is enacted.
In addition, legislation has been enacted or is being considered in some jurisdictions that would enable lending for residential energy efficiency improvements, with loans repaid via the homeowners real property tax bill. This structure is designed to grant lenders of energy efficiency loans the equivalent of a tax lien, giving them priority over all other liens on the property, including previously recorded first lien mortgage loans. Consequently, the legislation could increase our credit losses, impact our business volumes and limit the size of loans we acquire where these laws are in effect.
In May 2009, the House of Representatives passed a bill that, among other things, would enhance consumer protections in mortgage loan transactions, impose new servicing standards and allow for assignee liability. Similar provisions were also included in the House-passed financial regulation reform bill. If enacted, the legislation would impact our business and the overall mortgage market. However, it is unclear when, or if, the Senate will consider comparable legislation.
In March 2009, the House of Representatives passed a housing bill that, among other things, includes provisions intended to stem the rate of foreclosures by allowing bankruptcy judges to modify the terms of mortgages on principal residences for borrowers in Chapter 13 bankruptcy. Specifically, the House bill would allow bankruptcy judges to adjust interest rates, extend repayment terms and lower the outstanding principal amount to the current estimated fair value of the underlying property. If enacted, this legislation could have an adverse impact on our business. The Senate passed a similar housing bill in May 2009 that did not include comparable bankruptcy-related provisions. It is unclear when, or if, the Senate will reconsider other alternative bankruptcy-related legislation.
We cannot predict whether any legislation will be enacted and, if legislation is enacted, the prospects for the timing and content of the legislation, or the impact that any enacted legislation could have on our company or our industry.
OUR CHARTER AND REGULATION OF OUR ACTIVITIES
We are a shareholder-owned corporation, originally established in 1938, organized and existing under the Federal National Mortgage Association Charter Act, as amended, 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:
It is from these sections of the Charter Act that we derive our mission of providing liquidity, increasing stability and promoting affordability in the residential mortgage market. 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: 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.
Since early 2008, a series of legislative acts have increased our high-cost area loan limits for loans originated during specific timeframes. The Economic Stimulus Act of 2008 and subsequent laws set specific higher high-cost area limits covering loans originated between July 1, 2007 and December 31, 2010 and employing a ceiling of 175% of our general loan limit (for example, $729,750 for a one-family residence, higher for two- to four-units and in high-cost states and territories).
No statutory limits apply to the maximum original principal balance of multifamily mortgage loans that we purchase or securitize. In addition, the Charter Act imposes no maximum original principal balance limits on loans we purchase or securitize that are insured by FHA or guaranteed by the VA, home improvement loans, or loans secured by manufactured housing.
Pursuant to our charter, at the discretion of the Secretary of the Treasury, Treasury may purchase our obligations up to a maximum of $2.25 billion outstanding at any one time. In addition, the 2008 Reform Act amended the Charter Act to give Treasury expanded temporary authority to purchase our obligations and other securities in unlimited amounts (up to the national debt limit). This expanded authority expired on December 31, 2009. On December 24, 2009, Treasury announced that its GSE mortgage-backed securities program would end on December 31, 2009, the expiration date of its expanded temporary authority under our charter. We describe Treasurys investment in our senior preferred stock and a common stock warrant pursuant to this authority above under Conservatorship and Treasury AgreementsTreasury Agreements.
The Charter Act has the following additional provisions.
As a federally chartered corporation, we are subject to Congressional legislation and oversight. As a company under conservatorship, our primary regulator has management authority over us in its role as our conservator. The GSE Act, as amended in 2008, establishes FHFA as an independent agency with general supervisory and regulatory authority over Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks (FHLBs). FHFA assumed the duties of our former regulators, OFHEO, the predecessor to FHFA, and HUD, with respect to safety and soundness and mission oversight of Fannie Mae and Freddie Mac. HUD remains our regulator with respect to fair lending matters. We reference OFHEO in this report with respect to actions taken by our safety and soundness regulator prior to the creation of FHFA on July 30, 2008. As applicable, we reference HUD in this section with respect to actions taken by our mission regulator prior to the creation of FHFA on July 30, 2008. Our regulators also include the SEC and Treasury.
The GSE Act provides FHFA with safety and soundness authority that is stronger than the authority that was available to OFHEO, and that is comparable to and in some respects broader than that of the federal banking agencies. Among other things, the legislation gives FHFA the authority to raise capital levels above statutory minimum levels, regulate the size and content of our portfolio, approve new mortgage products, and place the GSEs into conservatorship or receivership. In general, we remain subject to regulations, orders and determinations that existed prior to the enactment of the 2008 Reform Act until new ones are issued or made. Below are some key provisions of the GSE Act.
Capital. FHFA has broad authority to establish risk-based capital standards to ensure that we operate in a safe and sound manner and maintain sufficient capital and reserves. FHFA also has broad authority to increase the level of our required minimum capital and to establish capital or reserve requirements for specific products and activities, so as to ensure that we operate in a safe and sound manner. On October 9, 2008, FHFA announced that our capital requirements will not be binding during the conservatorship. We describe our capital requirements below under Capital Adequacy Requirements.
Portfolio. FHFA is required to establish standards governing our portfolio holdings, to ensure that they are backed by sufficient capital and consistent with our mission and safe and sound operations. FHFA is also required to monitor our portfolio and, in some circumstances, may require us to dispose of or acquire assets. On January 30, 2009, FHFA published an interim final rule adopting, as the standard for our portfolio
holdings, the portfolio cap established by the senior preferred stock purchase agreement described under Treasury AgreementsCovenants under Treasury Agreements, as it may be amended from time to time. The interim final rule is effective for as long as we remain subject to the terms and obligations of the senior preferred stock purchase agreement.
Products and Activities. The GSE Act requires that, with some exceptions, we must obtain FHFAs approval before initially offering a product and provide FHFA written notice before commencing a new activity. In July 2009, FHFA published an interim final rule implementing this provision. In a letter to Congress dated February 2, 2010, the Acting Director of FHFA announced that FHFA was instructing Fannie Mae and Freddie Mac not to submit requests for approval of new products under the interim final rule. The letter stated that permitting the Enterprises to engage in new products is inconsistent with the goals of conservatorship, and concluded, the Enterprises will be limited to continuing their existing core business activities and taking actions necessary to advance the goals of the conservatorship.
Conservatorship and Receivership. FHFA has authority to place us into conservatorship, based on certain specified grounds. Pursuant to this authority, FHFA placed us into conservatorship on September 6, 2008. FHFA also has authority to place us into receivership at the discretion of the Director of FHFA, based on certain specified grounds, at any time, including directly from conservatorship. Further, FHFA must place us into receivership if it determines that our liabilities have exceeded our assets for 60 days, or we have not been paying our debts as they become due for 60 days.
Affordable Housing Allocations. We are required to make annual allocations to fund government affordable housing programs, based on the dollar amount of our total new business purchases, at the rate of 4.2 basis points per dollar. FHFA must issue regulations prohibiting us from redirecting the cost of our allocations, through increased charges or fees, or decreased premiums, or in any other manner, to the originators of mortgages that we purchase or securitize. FHFA shall temporarily suspend our allocation upon finding that it is contributing or would contribute to our financial instability; is causing or would cause us to be classified as undercapitalized; or is preventing or would prevent us from successfully completing a capital restoration plan. On November 13, 2008, we received notice from FHFA that it was suspending our allocation until further notice.
Affordable Housing Goals and Duty to Serve. We discuss our affordable housing goals and our new duty to serve underserved markets below under Housing Goals and Subgoals and Duty to Serve Underserved Markets.
Executive Compensation. The GSE Act directs FHFA to prohibit us from providing unreasonable or non-comparable compensation to our executive officers. FHFA may at any time review the reasonableness and comparability of an executive officers compensation and may require us to withhold any payment to the officer during such review.
FHFA is also authorized to prohibit or limit certain golden parachute and indemnification payments to directors, officers, and certain other parties. In January 2009, FHFA issued final regulations relating to golden parachute payments, under which FHFA may limit golden parachute payments as defined, and that set forth factors to be considered by the Director of FHFA in acting upon his authority to limit these payments.
The GSE Act establishes capital adequacy requirements. The statutory capital framework incorporates two different quantitative assessments of capitala 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 GSE Act requires us to maintain sufficient capital to meet both of these requirements in order to be classified as adequately capitalized. On October 9, 2008, however, FHFA announced that our existing statutory and FHFA-directed regulatory capital requirements will not be binding during the conservatorship. FHFA has directed us, during the time we are under conservatorship, to focus on managing to a positive net worth, provided that it is not inconsistent with our mission objectives.
FHFA has advised us that, because we are under conservatorship, we will not be subject to corrective action requirements that would ordinarily result from our receiving a capital classification of undercapitalized.
Minimum Capital Requirement. Under the GSE Act, we must maintain an amount of core capital that equals or exceeds our minimum capital requirement. The GSE Act defines core capital 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. The GSE Act sets our statutory minimum capital requirement equal to the sum of:
FHFA retains authority under the GSE Act to raise the minimum capital requirement for any of our assets or activities, as necessary and appropriate to ensure our safe and sound operations. For information on the amounts of our core capital and our statutory minimum capital requirement as of December 31, 2009 and 2008, see MD&ALiquidity and Capital ManagementCapital ManagementRegulatory Capital.
Risk-Based Capital Requirement. The GSE Act requires FHFA to establish risk-based capital requirements for Fannie Mae and Freddie Mac, to ensure that we operate in a safe and sound manner. Existing risk-based capital regulation 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% premium to cover unspecified management and operations risks.
Our total capital base is used to meet our risk-based capital requirement. The GSE Act defines total capital 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, our regulator 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. FHFA has stated that it does not intend to report our risk-based capital level during the conservatorship.
Critical Capital Requirement. The GSE Act also establishes a critical capital requirement, which is the amount of core capital below which we would be classified as critically undercapitalized. Under the GSE Act, such classification is a discretionary ground for appointing a conservator or receiver. Our critical capital requirement is generally equal to the sum of:
FHFA has stated that it does not intend to report our critical capital level during the conservatorship.
On January 12, 2010, FHFA (1) directed us, for loans backing Fannie Mae MBS held by third parties, to continue reporting our minimum capital requirements based on 0.45% of the unpaid principal balance and critical capital based on 0.25% of the unpaid principal balance, notwithstanding our adoption effective January 1, 2010 of new accounting standards that resulted in our recording on our consolidated balance sheet substantially all of the loans backing these Fannie Mae MBS, and (2) issued a regulatory interpretation stating that our minimum capital requirements are not automatically affected by the new accounting standards.
Since 1993, we have been subject to housing goals, which have been set as a percentage of the total number of dwelling units underlying our total mortgage purchases, and have been 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, in 2004, HUD established three home purchase subgoals that have been 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. Since 1995, we have also been required to meet a subgoal for multifamily special affordable housing that is expressed as a dollar amount. The 2008 Reform Act changed the structure of the housing goals and created a new duty for us and Freddie Mac to serve three underserved marketsmanufactured housing, affordable housing preservation, and rural housingbeginning in 2010. The new goals structure establishes three single-family conforming purchase money mortgage goals and one conforming mortgage refinance goal. The purchase money goals target low-income families, very low-income families, and families in low-income areas. The refinance goal targets low-income families. The 2008 Reform Act also established a separate multifamily goal targeting low-income families and authorized FHFA to establish additional requirements for housing affordable to very low-income families.
On February 17, 2010, FHFA announced its proposed rule implementing the new housing goals structure for 2010 and 2011. FHFA proposed benchmark goals for the purchase of single-family purchase money mortgages as follows: 27% of our purchases of mortgage loans backed by single-family, owner-occupied properties must be affordable to low-income families; 8% of our purchases of mortgage loans backed by single-family, owner-occupied properties must be affordable to very low-income families; and 13% of our purchases of mortgage loans backed by single-family, owner-occupied properties must be in low-income areas. In addition, 25% of our purchases of refinance mortgage loans backed by single-family, owner-occupied properties must be affordable to low-income families. FHFAs proposal specifies that our performance will be measured against both these benchmarks and actual goals-qualifying shares of the primary mortgage market. We will not have failed to meet a goal if we do not meet a benchmark but our performance meets the actual share of the market.
FHFA also proposed a new multifamily goal and subgoal. Our multifamily mortgage purchases must finance at least 237,000 units affordable to low-income families and 57,000 units affordable to very low-income families.
The proposed rule makes other changes to FHFAs housing goals regulations. The proposed rule excludes private-label mortgage-related securities and REMICs from counting toward meeting our housing goals, broadens our ability to count mortgage revenue bonds, extends our ability to count loan modifications under the Making Home Affordable Program, and permits us to count jumbo conforming mortgages toward meeting our housing goals.
The proposed rule states that FHFA does not intend for [Fannie Mae] to undertake uneconomic or high-risk activities in support of the [housing] goals. Further, the fact that the Enterprises are in conservatorship should not be a justification for withdrawing support from these market segments. Under FHFAs current and proposed regulations, we report our progress toward achieving our housing goals to FHFA on a quarterly basis, and we are required to submit a report to FHFA and Congress on our performance in meeting our housing goals on an annual basis. If our efforts to meet our goals prove to be insufficient and FHFA finds that our goals were feasible, we may become subject to a housing plan that could require us to take additional steps that could have an adverse effect on our financial condition. The housing plan must describe the actions we will take to meet the goal in the next calendar year and be approved by FHFA. The potential penalties for failure to comply with housing plan requirements are a cease-and-desist order and civil money penalties. To the extent that we purchase higher risk loans to meet our housing goals, these purchases could contribute to future credit losses.
With respect to the underserved markets, beginning in 2010 we are required to provide leadership to the market in developing loan products and flexible underwriting guidelines to facilitate a secondary market for
mortgages for very low-, low-, and moderate-income families. The 2008 Reform Act also gave FHFA the authority to set and enforce the housing goals and the duty to serve underserved markets. FHFA must promulgate regulations to implement the duty to serve underserved markets.
The 2008 Reform Act provided that the housing goals established for 2008 would remain in effect for 2009, except that FHFA was required to review the 2009 goals to determine their feasibility given market conditions and, after seeking public comment, FHFA would make appropriate adjustments to the 2009 goals. Pursuant to this requirement, in May 2009 FHFA published a proposed rule lowering our 2009 housing goals and home purchase subgoals from the 2008 levels. FHFA determined that, in light of market conditions, the previously established 2009 housing goals were not feasible unless adjusted. The adverse market conditions that FHFA took into consideration included tighter underwriting practices, the sharply increased standards of private mortgage insurers, the increased role of FHA in the marketplace, the collapse of the private-label mortgage-related securities market, increasing unemployment, multifamily market volatility and the prospect of a refinancing surge in 2009. These conditions contribute to fewer goals-qualifying mortgages available for purchase by us. The final 2009 housing goals FHFA adopted in August 2009 lowered our base goals from the levels proposed in May, adopted the home purchase subgoals as proposed, and increased our multifamily special affordable subgoal.
Our 2009 housing goals were at approximately the levels that existed in 2004 through 2006. FHFA also permitted loan modifications that we make in accordance with the Making Home Affordable Program to be treated as mortgage purchases and count towards the housing goals. Purchases of loans on single-family properties with a maximum original principal balance higher than the nationwide conforming loan limit (currently set at $417,000) are not counted toward our 2009 housing goals.
The following table presents FHFAs 2009 housing goals and subgoals and our performance against those goals and subgoals. We also present our performance against our housing goals and subgoals for 2008 and 2007. Performance results for 2009 have not yet been validated by FHFA.
Housing Goals and Subgoals Performance
We believe we met all of our 2009 housing goals except for our underserved areas goal and our increased multifamily special affordable housing subgoal. We have requested that FHFA determine, based on economic and market conditions and our financial condition, that the underserved areas goal and the increased multifamily special affordable housing subgoal were not feasible for 2009. If FHFA makes this
determination, there will be no enforcement action against us for failing to meet these goals. We will file our assessment of our performance against our housing goals with FHFA in mid-March, and FHFA will determine our final performance numbers.
We did not meet our low- and moderate-income housing and special affordable housing goals, or any of our home purchase subgoals, for 2008, given declining market conditions. In March 2009, FHFA notified us of its determination that achievement of these housing goals and subgoals was not feasible due to housing and economic conditions and our financial condition in 2008.
In 2007, we met each of our three housing goals and two of the four subgoals. However, we did not meet our low- and moderate-income housing and special affordable housing home purchase subgoals in 2007. In April 2008, HUD notified us of its determination that achievement of these subgoals was not feasible, primarily due to reduced housing affordability and turmoil in the mortgage market, which reduced the share of the conventional conforming primary home purchase market that would qualify for these subgoals.
See Risk Factors for a description of how changes we have made to our business strategies in order to meet our housing goals and subgoals have increased our credit losses and will adversely affect our results of operations.
During 2009, the Obama Administration introduced a comprehensive Financial Stability Plan to help protect and support the U.S. housing and mortgage markets and stabilize the financial markets. As part of this plan, in March 2009, the Administration announced details of Making Home Affordable, a program intended to provide assistance to homeowners and prevent foreclosures. Working with our conservator, we have devoted significant effort and resources to help distressed homeowners through initiatives that support the Making Home Affordable Program. Below we describe key aspects of the Making Home Affordable Program and our role in the program. For additional information about our activities under the program and its financial impact on us, please see Executive SummaryHomeowner Assistance Initiatives and MD&AConsolidated Results of OperationsFinancial Impact of the Making Home Affordable Program on Fannie Mae.
The Making Home Affordable Program includes a Home Affordable Refinance Program (HARP), under which we acquire or guarantee loans that are refinancings of mortgage loans we own or guarantee, and Freddie Mac does the same, and a Home Affordable Modification Program (HAMP), which provides for the modification of mortgage loans owned or guaranteed by us or Freddie Mac, as well as other mortgage loans. These two programs were designed to expand the number of borrowers who can refinance or modify their mortgages to achieve a monthly payment that is more affordable now and into the future or to obtain a more stable loan product, such as a fixed-rate mortgage loan in lieu of an adjustable-rate mortgage loan.
In March 2009, we announced our participation in the Making Home Affordable Program and released guidelines for Fannie Mae sellers and servicers in offering HARP and HAMP for Fannie Mae borrowers. We also serve as program administrator under HAMP for loans we do not own or guarantee.
In an effort to expand the benefits available through the Making Home Affordable Program to more borrowers, the government announced a number of updates to the program throughout 2009. Key elements of HARP and HAMP are described below.
HARP is targeted at borrowers who have demonstrated an acceptable payment history on their mortgage loans but may have been unable to refinance due to a decline in home prices or the unavailability of mortgage insurance. Loans under this program are available only if the new mortgage loan either reduces the monthly principal and interest payment for the borrower or provides a more stable loan product (such as movement from an adjustable-rate mortgage to a fixed-rate mortgage loan). Other eligibility requirements that must be met under this program include the following.
We made the program available for newly refinanced mortgage loans delivered to us on or after April 1, 2009. We make refinancings under HARP through our Refi Plus initiatives, which provide refinance solutions for eligible Fannie Mae loans. This program replaced the streamlined refinance options we previously offered.
HAMP is aimed at helping borrowers whose loan either is currently delinquent or is at imminent risk of default by modifying their mortgage loan to make their monthly payments more affordable. The goal is to modify a borrowers mortgage loan to target the borrowers monthly mortgage payment at 31% of the borrowers gross monthly income. The program is designed to provide a uniform, consistent structure for servicers to use in modifying mortgage loans to prevent foreclosures, including loans owned or guaranteed by Fannie Mae or Freddie Mac and other qualifying mortgage loans. We have advised our servicers that we require borrowers at risk of foreclosure who are not eligible for a loan refinance under HARP to be evaluated for eligibility under HAMP before any other workout alternative is considered. Borrowers ineligible for HAMP may be considered under other workout alternatives we provide, such as our recently introduced HomeSaver Forbearance initiative and repayment plans. We serve as the program administrator of HAMP for Treasury. The program includes the following features:
Incentive Payments to Servicers. For each Fannie Mae loan for which a modification is completed under HAMP, we pay the servicer (1) $1,000; (2) an additional $500 if the modified loan was current when it entered the trial period (that is, if the loan was current but a payment default was imminent); and (3) an annual pay for success fee of up to $1,000 if the modification reduces the borrowers monthly payment by 6% or more, payable for each of the first three years after the modification as long as the borrower is continuing to make the payments due under the modified loan.
Incentives to Borrowers. For a permanent modification under HAMP that reduces the borrowers monthly payment by 6% or more, we will provide the borrower an annual reduction in the outstanding principal balance of the modified loan of up to $1,000 for each of the first five years after the modification as long as the borrower is continuing to make the payments due under the modified loan.
Costs of Modifications. We bear all of the costs of modifying our loans under the program, including any additional amounts we are required to provide under our guarantees for loans owned by one of our MBS trusts during a trial payment period or any other mortgage-backed securities for which we have provided a guaranty.
HAMP expires on December 31, 2012.
Treasury has engaged us to serve as program administrator for loans modified under HAMP that are not owned or guaranteed by us. In April 2009, Treasury released guidance to servicers for adoption and implementation of HAMP for mortgage loans that are not owned or guaranteed by us or Freddie Mac. Freddie Mac maintains guidelines for modification under the program of loans it owns or guarantees.
Our principal activities as program administrator include the following:
In our capacity as program administrator for the program, we support over 100 servicers that have signed up to offer modifications on non-agency loans under the program. To help servicers ramp up their operations to modify loans under HAMP, we have provided information and resources through a Web site dedicated to servicers under the program. We have also communicated information about the program to servicers and helped servicers implement and integrate the program with new systems and processes. Our servicer support as program administrator includes dedicating Fannie Mae personnel to participating servicers to work closely with the servicers to help them implement the program. We also have established a servicer support call center, conducted weekly conference calls with the leadership of participating servicers, and provided training through live Web seminars, recorded tutorials, checklists and job aids on the program Web site.
To assist state and local housing finance agencies (HFAs) to continue to meet their mission of providing affordable financing for both single-family and multifamily housing, in October of 2009 we entered into a memorandum of understanding with Treasury, FHFA and Freddie Mac that established terms under which we, Freddie Mac and Treasury would provide assistance to HFAs. Pursuant to this HFA initiative, we, Freddie Mac and Treasury are providing assistance to the HFAs through two primary programs: a temporary credit and liquidity facilities program, which is intended to improve the HFAs access to liquidity for outstanding HFA bonds, and a new issue bond program, which is intended to support new lending by the HFAs. Pursuant to the temporary credit and liquidity facilities program, Treasury has purchased participation interests in temporary credit and liquidity facilities provided by us and Freddie Mac to the HFAs. These facilities create a credit and liquidity backstop for the HFAs. Pursuant to the new issue bond program, Treasury has purchased new securities issued by us and Freddie Mac backed by new housing bonds issued by the HFAs. Please see Certain Relationships and Related Transactions, and Director IndependenceTransactions with Related PersonsTransactions with TreasuryTreasury Housing Finance Agency Initiative for a more detailed discussion of the HFA initiative.
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, 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 2009, approximately 1,100 lenders delivered single-family 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 2009, our top five lender customers, in the aggregate, accounted for approximately 62% of our single-family business volume, compared with 66% in 2008. Two lender customers, Bank of America Corporation and Wells Fargo & Company, including their respective affiliates, each accounted for more than 20% of our single-family business volume for 2009.
Due to ongoing consolidation within the mortgage industry, as well as the number of mortgage lenders that have gone out of business since late 2006, we, as well as our competitors, seek business from a decreasing number of large mortgage lenders. To the extent we become more reliant on a smaller number of lender customers, our negotiating leverage with these customers decreases, which could diminish our ability to price our products and services optimally. In addition, many of our lender customers are experiencing financial and liquidity problems that may affect the volume of business they are able to generate. We discuss these and other risks that this customer concentration poses to our business in Risk Factors.
Historically, our competitors have included Freddie Mac, FHA, Ginnie Mae (which primarily guarantees securities backed by FHA-insured loans), the FHLBs, financial institutions, securities dealers, insurance companies, pension funds, investment funds and other investors. During 2008, almost all of our competitors, other than Freddie Mac, FHA, Ginnie Mae and the FHLBs, ceased their activities in the residential mortgage finance business, and we remained the largest single issuer of mortgage-related securities in the secondary market in 2009.
We compete to acquire mortgage assets in the secondary market both for our investment portfolio and for securitization into Fannie Mae MBS. We also compete for the issuance of mortgage-related securities to investors. Competition in these areas is affected by many factors, including the amount of residential mortgage
loans offered for sale in the secondary market by loan originators and other market participants, the nature of the residential mortgage loans offered for sale (for example, whether the loans represent refinancings), the current demand for mortgage assets from mortgage investors, the interest rate risk investors are willing to assume and the yields they will require as a result, and the credit risk and prices associated with available mortgage investments. Pursuant to its agency MBS purchase program, the Federal Reserve was an active and significant purchaser of our MBS during 2009, which was significant in supporting the liquidity of our MBS.
Competition to acquire mortgage assets is significantly affected by pricing and eligibility standards. In 2008 and 2009, changes in our pricing and eligibility standards and in the eligibility standards of the mortgage insurance companies reduced our acquisition of loans with higher LTV ratios and other high-risk features. In addition, FHA has become the lower-cost option, or in some cases the only option, for loans with higher LTV ratios.
Prior to the severe market downturn, 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 Ginnie Mae. The subsequent mortgage and credit market disruption led many investors to curtail their purchases of private-label mortgage-related securities. As a result, private-label mortgage-related securities issuances were significantly curtailed. Accordingly, our market share significantly increased during 2008 and remained high in 2009. Our estimated market share of new single-family mortgage-related securities issuances was 46.3% in 2009 and 45.4% in 2008, compared with 33.9% in 2007. Our estimated market share in 2009 of 46.3% includes $94.6 billion of whole loans held for investment in our mortgage portfolio that were securitized into Fannie Mae MBS in the second quarter, but retained in our mortgage portfolio and consolidated on our consolidated balance sheets. Excluding these Fannie Mae MBS from the estimate of our market share, our estimated 2009 market share of new single-family mortgage-related securities issuances was 43.2%.
During 2009, our primary competitors for the issuance of mortgage-related securities were Ginnie Mae (which primarily guarantees mortgage-related securities backed by FHA-insured loans) and Freddie Mac. Our estimated market share of new single-family mortgage-related securities issuances was approximately 38.9% in the fourth quarter of 2009, compared with approximately 41.7% in the fourth quarter of 2008 and 48.5% in the fourth quarter of 2007. In comparison, Ginnie Maes market share of new single-family mortgage-related securities issuances was approximately 34.5% in the fourth quarter of 2009, compared with approximately 37.8% in the fourth quarter of 2008 and 9.0% in the fourth quarter of 2007. Our estimates of market share exclude previously securitized mortgages and are based on publicly available data.
We also compete for low-cost debt funding with institutions that hold mortgage portfolios, including Freddie Mac and the FHLBs.
As of December 31, 2009, we employed approximately 6,000 personnel, including full-time and part-time employees, term employees and employees on leave.
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 SECs Web site, www.sec.gov. You may also request copies of any filing from us, at no cost, by calling the Fannie Mae Fixed-Income Securities Helpline at (800) 237-8627 or (202) 752-7115 or by writing to Fannie Mae, Attention: Fixed-Income Securities, 3900 Wisconsin Avenue, NW, Area 2H-3S, Washington, DC 20016.
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 SECs Web site is not incorporated into this annual report on Form 10-K.
This report includes statements that constitute forward-looking statements within the meaning of Section 21E of the Exchange Act. 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 expect, anticipate, intend, plan, believe, seek, estimate, forecast, project, would, should, could, may, prospects, or similar words.
Among the forward-looking statements in this report are statements relating to:
Forward-looking statements reflect our managements expectations or predictions of future conditions, events or results based on various assumptions and managements 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, but not limited to, the following: our ability to maintain a positive net worth; adverse effects from activities we undertake to support the mortgage market and help borrowers; the conservatorship and its effect on our business; the investment by Treasury and its effect on our business; future amendments and guidance by the FASB; changes in the structure and regulation of the financial services industry, including government efforts to bring about an economic recovery; our ability to access the debt capital markets; further disruptions in the housing, credit and stock markets; the level and volatility of interest rates and credit spreads; the adequacy of credit reserves; pending government investigations and litigation; changes in management; the accuracy of subjective estimates used in critical accounting policies; and those factors described in this report, including those factors described in Risk Factors.
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 Risk Factors. 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 Risks Relating to Our Business are specific to us and our business, while those described in Risks Relating to Our Industry relate to the industry in which we operate. Refer to MD&ARisk Management for a more detailed description of the primary risks to our business and how we seek to manage those risks.
Any of these factors could materially adversely affect our business, results of operations, financial condition, liquidity and net worth, and 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. However, these are not the only risks facing us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, results of operations, financial condition, liquidity and net worth.
RISKS RELATING TO OUR BUSINESS
The future of our company following termination of the conservatorship and the timing of the conservatorships end are uncertain.
We do not know when or how the conservatorship will be terminated or what changes to our business structure will be made during or following the termination of the conservatorship. We do not know whether we will continue to exist in the same or a similar form after conservatorship is terminated or whether the conservatorship will end in receivership or in some other manner. The Obama Administrations June 2009 white paper on financial regulatory reform stated that Treasury and HUD, in consultation with other government agencies, would engage in a wide-ranging initiative to develop recommendations on the future of the GSEs. On December 24, 2009, in announcing amendments to its senior preferred stock purchase agreements with Fannie Mae and Freddie Mac, Treasury announced that it expected to provide a preliminary report about longer term reform of the federal governments role in the housing market around the time President Obama released his fiscal 2011 budget. Treasury observed, Recent announcements on the tightening of underwriting standards by Fannie Mae, Freddie Mac, and FHA, demonstrate a commitment to prudent housing finance policy that enables a transition to an environment where the private market is able to provide a larger source of mortgage finance. In February 2010, the Administration stated that it continues to monitor the situation of the GSEs, and indicated that it would release a statement on the GSEs in the very near future. Since June 2009, Congressional committees and subcommittees have held hearings to discuss the present condition and future status of Fannie Mae and Freddie Mac and at least one legislative proposal addressing the future status of the GSEs has been offered. We cannot predict the prospects for the enactment, timing or content of legislative proposals regarding the future status of the GSEs. See BusinessGSE Reform and Pending Legislation for more information about the white papers mention of options for reform of the GSEs and Congressional hearings about our present condition and future status.
Accordingly, there continues to be uncertainty regarding the future of Fannie Mae, including whether we will continue to exist in our current form after conservatorship is terminated. The options for reform of the GSEs include options that would result in a substantial change to our business structure or in Fannie Maes liquidation or dissolution.
We expect FHFA to request additional funds from Treasury on our behalf to ensure we maintain a positive net worth and avoid mandatory receivership. The dividends and commitment fees we must pay or that accrue on Treasurys investments are substantial and are expected to increase, and we likely will not be able to fund them through net income.
FHFA must place us into receivership if the Director of FHFA makes a written determination that our assets are less than our obligations (which we refer to as a net worth deficit) or if we have not been paying our debts, in either case, for a period of 60 days. We have had a net worth deficit as of the end of each of the last five fiscal quarters, including as of December 31, 2009. Treasury provided us with funds under the senior preferred stock purchase agreement to cure the net worth deficits in prior periods before the end of the 60-day period, and we expect Treasury to do the same with respect to the December 31, 2009 deficit. When Treasury provides the additional $15.3 billion FHFA has already requested on our behalf, the aggregate liquidation preference on the senior preferred stock will be $76.2 billion, and will require an annualized dividend of $7.6 billion. The prospective $7.6 billion annual dividend obligation exceeds our reported annual net income for all but one of the last eight years. Our ability to maintain a positive net worth has been and continues to be adversely affected by market conditions. To the extent we have a negative net worth as of the end of future fiscal quarters, we expect that FHFA will request additional funds from Treasury under the senior preferred stock purchase agreement. Further funds from Treasury under the senior preferred stock purchase agreement will substantially increase the liquidation preference of and the dividends we owe on the senior preferred stock and, therefore, we may need additional funds from Treasury in order to meet our dividend obligation.
In addition, beginning in 2011, the senior preferred stock purchase agreement requires that we pay a quarterly commitment fee to Treasury, unless Treasury waives this fee. The quarterly commitment fee amounts have not yet been determined. The aggregate liquidation preference and dividend obligations will also increase by the
amount of any required dividend we fail to pay in cash and by any required quarterly commitment fee that we fail to pay. The substantial dividend obligations and potentially substantial quarterly commitment fees, coupled with our effective inability to pay down draws under the senior preferred stock purchase agreement, will continue to strain our financial resources and have an adverse impact on our results of operations, financial condition, liquidity and net worth, both in the short and long term.
Our regulator is authorized or required to place us into receivership under specified conditions, which would result in the liquidation of our assets. Amounts recovered from the liquidation may be insufficient to cover our obligations or liquidation preferences on our preferred stock, or provide any proceeds to common shareholders.
FHFA must place us into receivership if the Director of FHFA makes a written determination that our assets are less than our obligations or if we have not been paying our debts, in either case, for a period of 60 days. Because of the weak economy and conditions in the housing market, we will continue to need funding from Treasury to avoid a trigger of mandatory receivership. In addition, we could be put into receivership at the discretion of the Director of FHFA at any time for other reasons, including conditions that FHFA has already asserted existed at the time the Director of FHFA placed us into conservatorship. These conditions include: a substantial dissipation of assets or earnings due to unsafe or unsound practices; the existence of an unsafe or unsound condition to transact business; an inability to meet our obligations in the ordinary course of business; a weakening of our condition due to unsafe or unsound practices or conditions; critical undercapitalization; the likelihood of losses that will deplete substantially all of our capital; or by consent. A receivership would terminate the conservatorship. In addition to the powers FHFA has as conservator, the appointment of FHFA as our receiver would terminate all rights and claims that our shareholders and creditors may have against our assets or under our charter arising as a result of their status as shareholders or creditors, except for their right to payment, resolution or other satisfaction of their claims as permitted under the GSE Act. Unlike a conservatorship, the purpose of which is to conserve our assets and return us to a sound and solvent condition, the purpose of a receivership is to liquidate our assets and resolve claims against us.
In the event of a liquidation of our assets, only after paying the secured and unsecured claims against the company (including repaying all outstanding debt obligations), the administrative expenses of the receiver and the liquidation preference of the senior preferred stock, would any liquidation proceeds be available to repay the liquidation preference on any other series of preferred stock. Finally, only after the liquidation preference on all series of preferred stock is repaid would any liquidation proceeds be available for distribution to the holders of our common stock. It is highly uncertain that there would be sufficient proceeds to repay the liquidation preference of any series of our preferred stock or to make any distribution to the holders of our common stock. To the extent we are placed into receivership and do not or cannot fulfill our guaranty to the holders of our Fannie Mae MBS, the MBS holders could become unsecured creditors of ours with respect to claims made under our guaranty.
We have experienced substantial deterioration in the credit performance of mortgage loans that we own or that back our guaranteed Fannie Mae MBS, which we expect to continue and result in additional credit-related expenses.
We are exposed to mortgage credit risk relating to the mortgage loans that we hold in our investment portfolio and the mortgage loans that back our guaranteed Fannie Mae MBS. When borrowers fail to make required payments of principal and interest on their mortgage loans, we are exposed to the risk of credit losses and credit-related expenses.
Conditions in the housing and financial markets worsened dramatically during 2008 and remained stressed in 2009 and early 2010, contributing to a deterioration in the credit performance of our book of business, including higher serious delinquency rates, default rates and average loan loss severity on the mortgage loans we hold or that back our guaranteed Fannie Mae MBS, as well as a substantial increase in our inventory of foreclosed properties. Increases in delinquencies, default rates and loss severity cause us to experience higher credit-related expenses. The credit performance of our book of business has also been negatively affected by the extent and duration of the decline in home prices and high unemployment. These deteriorating credit performance trends have been notable in certain of our higher risk loan categories, states and vintages. In
addition, home price declines, adverse market conditions, and continuing high levels of unemployment have also increasingly affected the credit performance of our broader book of business. Further, as social acceptability of defaulting on a mortgage increases, more borrowers may default on their mortgages because they owe more than their houses are worth. We present detailed information about the risk characteristics of our conventional single-family guaranty book of business in MD&ARisk ManagementCredit Risk ManagementMortgage Credit Risk Management, and we present detailed information on our 2009 credit-related expenses, credit losses and results of operations in MD&AConsolidated Results of Operations.
Adverse credit performance trends may continue, particularly if we experience further national and regional declines in home prices, weak economic conditions and high unemployment.
The credit losses we experience in future periods are likely to be larger, and perhaps substantially larger, than our current combined loss reserves. As a result, we likely will experience credit losses for which we have not yet provisioned.
In accordance with GAAP, our combined loss reserves, as reflected on our consolidated balance sheets, do not reflect our estimate of the future credit losses inherent in our existing guaranty book of business. Rather, they reflect only the probable losses that we believe we have already incurred as of the balance sheet date. Accordingly, although we believe that our credit losses will increase in the future due to the weak housing and mortgage markets, and possibly also, in the near term, due to the costs of our activities under various programs designed to keep borrowers in their homes, high unemployment and other negative trends, we are not permitted under GAAP to reflect these future trends in our loss reserve calculations. Because of these negative trends, there is significant uncertainty regarding the full extent of our future credit losses but they likely will exceed, perhaps substantially, our current combined loss reserves. The credit losses we experience in future periods will adversely affect our business, results of operations, financial condition, liquidity and net worth.
We expect to experience further losses and write-downs relating to our investment securities.
We experienced significant fair value losses and other-than-temporary impairment write-downs relating to our investment securities in 2008 and recorded significant other-than-temporary impairment write-downs of some of our available-for-sale securities in 2009. A substantial portion of these fair value losses and write-downs related to our investments in private-label mortgage-related securities backed by Alt-A and subprime mortgage loans and, in the case of fair value losses, our investments in commercial mortgage-backed securities (CMBS) due to the decline in home prices and the weak economy. We continue to expect to experience additional other-than-temporary impairment write-downs of our investments in private-label mortgage-related securities, including those that continue to be AAA-rated. See MD&AConsolidated Balance Sheet AnalysisMortgage-Related SecuritiesInvestments in Private-Label Mortgage-Related Securities for detailed information on our investments in private-label mortgage-related securities backed by Alt-A and subprime mortgage loans.
We also have incurred significant losses relating to the non-mortgage investment securities in our cash and other investments portfolio, primarily as a result of a substantial decline in the market value of these assets due to the financial market crisis. The fair value of the investment securities we hold may be further adversely affected by deterioration in the housing market and economy, including continued high unemployment, additional ratings downgrades or other events.
To the extent that the market for our securities remains illiquid, we are required to use a greater amount of management judgment to value the securities we own in our investment portfolio. Further, if we were to sell any of these securities, the price we ultimately would realize could be materially lower than the estimated fair value at which we carry these securities on our balance sheet.
Any of the above factors could require us to record additional write-downs in the value of our investment portfolio, which could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth.
Our business activities are significantly restricted by the conservatorship and the senior preferred stock purchase agreement.
We are currently under the control of our conservator, FHFA, and we do not know when or how the conservatorship will be terminated. Under the GSE Act, FHFA can direct us to enter into contracts or enter into contracts on our behalf. Further, FHFA, as conservator, generally has the power to transfer or sell any of our assets or liabilities and may do so without the approval, assignment or consent of any party. In addition, our directors do not have any duties to any person or entity except to the conservator. Accordingly, our directors are not obligated to consider the interests of the company, the holders of our equity or debt securities or the holders of Fannie Mae MBS in making or approving a decision unless specifically directed to do so by the conservator.
The conservator said in February 2010 that while we are in conservatorship, we will be limited to continuing our existing core business activities and taking actions necessary to advance the goals of the conservatorship.
The senior preferred stock purchase agreement with Treasury includes a number of covenants that significantly restrict our business activities. We cannot, without the prior written consent of Treasury: pay dividends (except on the senior preferred stock); sell, issue, purchase or redeem Fannie Mae equity securities; sell, transfer, lease or otherwise dispose of assets in specified situations; engage in transactions with affiliates other than on arms-length terms or in the ordinary course of business; issue subordinated debt; or incur indebtedness that would result in our aggregate indebtedness exceeding 120% of the amount of mortgage assets we are allowed to own. In deciding whether or not to consent to any request for approval it receives from us under the agreement, Treasury has the right to withhold its consent for any reason and is not required by the agreement to consider any particular factors, including whether or not management believes that the transaction would benefit the company. Pursuant to the senior preferred stock purchase agreement, the maximum allowable amount of mortgage assets we may own on December 31, 2010 is $810 billion. On December 31, 2011, and each December 31 thereafter, our mortgage assets may not exceed 90% of the maximum allowable amount that we were permitted to own as of December 31 of the immediately preceding calendar year. The maximum allowable amount is reduced annually until it reaches $250 billion. This limit on the amount of mortgage assets we are permitted to hold could constrain the amount of delinquent loans we purchase from single-family MBS trusts. Please see BusinessMortgage SecuritizationsPurchases of Loans from our MBS Trusts for more information about these planned purchases.
We discuss the powers of the conservator, the terms of the senior preferred stock purchase agreement, and their impact on us and shareholders in BusinessConservatorship and Treasury Agreements. These factors may adversely affect our business, results of operations, financial condition, liquidity and net worth.
The conservatorship and investment by Treasury have had, and will continue to have, a material adverse effect on our common and preferred shareholders.
No voting rights during conservatorship. The rights and powers of our shareholders are suspended during the conservatorship. The conservatorship has no specified termination date. During the conservatorship, our common shareholders do not have the ability to elect directors or to vote on other matters unless the conservator delegates this authority to them.
Dividends to common and preferred shareholders, other than to Treasury, have been eliminated. Under the terms of the senior preferred stock purchase agreement, dividends may not be paid to common or preferred shareholders (other than the senior preferred stock) without the consent of Treasury, regardless of whether we are in conservatorship.
Liquidation preference of senior preferred stock will increase, likely substantially. The senior preferred stock ranks prior to our common stock and all other series of our preferred stock, as well as any capital stock we issue in the future, as to both dividends and distributions upon liquidation. Accordingly, if we are liquidated, the senior preferred stock is entitled to its then-current liquidation preference, plus any accrued but unpaid dividends, before any distribution is made to the holders of our common stock or other preferred stock. As of December 31, 2009, the liquidation preference on the senior preferred stock was $60.9 billion; however, it will increase to $76.2 billion when Treasury provides the additional $15.3 billion FHFA has already requested on
our behalf. The liquidation preference could increase substantially as we draw on Treasurys funding commitment, if we do not pay dividends owed on the senior preferred stock or if we do not pay the quarterly commitment fee under the senior preferred stock purchase agreement. If we are liquidated, it is highly uncertain that there would be sufficient funds remaining after payment of amounts to our creditors and to Treasury as holder of the senior preferred stock to make any distribution to holders of our common stock and other preferred stock.
Exercise of the Treasury warrant would substantially dilute investment of current shareholders. If Treasury exercises its warrant to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis, the ownership interest in the company of our then existing common shareholders will be substantially diluted, and we would thereafter have a controlling shareholder.
No longer managed for the benefit of shareholders. Because we are in conservatorship, we are no longer managed with a strategy to maximize shareholder returns.
We do not know when or how the conservatorship will be terminated, and if or when the rights and powers of our shareholders, including the voting powers of our common shareholders, will be restored. Moreover, even if the conservatorship is terminated, by their terms, we remain subject to the senior preferred stock purchase agreement, senior preferred stock and warrant, which can only be cancelled or modified by mutual consent of Treasury and the conservator. For a description of additional restrictions on and risks to our shareholders, see BusinessConservatorship and Treasury Agreements.
Efforts we are required or asked to take by FHFA, other government agencies or Congress in pursuit of providing liquidity, stability and affordability to the mortgage market and providing assistance to struggling homeowners, or in pursuit of other goals, may adversely affect our business, results of operations, financial condition, liquidity and net worth.
Prior to the conservatorship, our business was managed with a strategy to maximize shareholder returns, while fulfilling our mission. In this time of economic uncertainty, our conservator has directed us to focus primarily on fulfilling our mission of providing liquidity, stability and affordability to the mortgage market and minimizing our credit losses from delinquent mortgages, and providing assistance to struggling homeowners to help them remain in their homes. As a result, we may continue to take a variety of actions designed to address this focus that could adversely affect our economic returns, possibly significantly, such as: reducing our guaranty fees and modifying loans to extend the maturity, lower the interest rate or defer or forgive principal owed by the borrower. These activities may have short- and long-term adverse effects on our business, results of operations, financial condition, liquidity and net worth. Other agencies of the U.S. government or Congress also may ask us to undertake significant efforts to support the housing and mortgage markets, as well as struggling homeowners. For example, under the Administrations Making Home Affordable Program, we are offering HAMP. We have incurred substantial costs in connection with the program, as we discuss in MD&AConsolidated Results of OperationsFinancial Impact of the Making Home Affordable Program on Fannie Mae.
During 2009, we were subject to housing goals that required that a specified portion of our mortgage purchases 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. Market conditions during 2009 resulted in the origination of fewer goals-qualifying mortgages, which negatively affected our ability to meet our goals. These conditions include: tighter underwriting and eligibility standards; the sharply increased standards of private mortgage insurers; high unemployment; the increased role of FHA in acquiring goals-qualifying mortgage loans; the collapse of the private-label mortgage-related securities market; multifamily market volatility; and the prospect of high levels of refinancings. These conditions are likely to continue in 2010. On February 17, 2010, the FHFA announced a proposed rule implementing the new housing goals structure for 2010 and 2011 as required by the 2008 Reform Act. The new housing goals structure establishes goals for the purchase of purchase money mortgages backed by single-family, owner-occupied properties affordable to low-income families, very low-income families, and families in low-income areas. The proposed rule also establishes goals for the purchase of
mortgages financing multifamily housing affordable to low-income families and very low-income families. We cannot predict the impact that market conditions during 2010 will have on our ability to meet the new goals.
Based on preliminary calculations, we believe we met all of our 2009 housing goals except for our underserved areas goal and our increased multifamily special affordable housing subgoal. We have requested that FHFA find, based on economic and market conditions and our financial condition, that the underserved areas goal and the increased multifamily special affordable housing subgoal were infeasible for 2009. If FHFA makes this finding, there will be no enforcement action against us for failing to meet these goals. If FHFA finds that the goals were feasible, we may become subject to a housing plan that could require us to take additional steps that could have an adverse effect on our financial condition. The potential penalties for failure to comply with housing plan requirements are a cease-and-desist order and civil money penalties. In addition, to the extent that we purchase higher risk loans in order to meet our housing goals, these purchases could contribute to further increases in our credit losses and credit-related expenses.
Limitations on our ability to access the debt capital markets could have a material adverse effect on our ability to fund our operations and generate net interest income.
Our ability to fund our business depends primarily on our ongoing access to the debt capital markets. Our level of net interest income depends on how much lower our cost of funds is compared to what we earn on our mortgage assets. Market concerns about matters such as the extent of government support for our business and the future of our business (including future profitability, future structure, regulatory actions and GSE status) could have a severe negative effect on our access to the unsecured debt markets, particularly for long-term debt. We believe that our ability in 2009 to issue debt of varying maturities at attractive pricing resulted from federal government support of us and the financial markets, including the prior availability of the Treasury credit facility and the Federal Reserves purchases of our debt and MBS. As a result, we believe that our status as a GSE and continued federal government support of our business and the financial markets are essential to maintaining our access to debt funding. Changes or perceived changes in the governments support of us or the markets could lead to an increase in our roll-over risk in future periods and have a material adverse effect on our ability to fund our operations. Although demand for our debt securities has continued to be strong as of the date of this filing, demand for our debt securities could decline, perhaps significantly, as the Federal Reserve concludes its agency debt and MBS purchase programs by March 31, 2010. On February 1, 2010, the Obama Administration stated in its fiscal year 2011 budget proposal that it was continuing to monitor the situation of the GSEs and would continue to provide updates on considerations for longer-term reform of Fannie Mae and Freddie Mac as appropriate. Please see MD&ALiquidity and Capital ManagementLiquidity ManagementDebt FundingDebt Funding Activity for a more complete discussion of actions taken by the federal government to support us and the financial markets. There can be no assurance that the government will continue to support us or that our current level of access to debt funding will continue.
In addition, future changes or disruptions in the financial markets could significantly change the amount, mix and cost of funds we obtain, as well as our liquidity position. If we are unable to issue both short- and long-term debt securities at attractive rates and in amounts sufficient to operate our business and meet our obligations, it likely would interfere with the operation of our business and have a material adverse effect on our liquidity, results of operations, financial condition and net worth.
Our liquidity contingency planning may not provide sufficient liquidity to operate our business and meet our obligations if we cannot access the unsecured debt markets.
We plan for alternative sources of liquidity that are designed to allow us to meet our cash obligations for 90 days without relying on the issuance of unsecured debt. We believe, however, that market conditions over the last two years have had an adverse impact on our ability to effectively plan for a liquidity crisis. During periods of adverse market conditions, our ability to repay maturing indebtedness and fund our operations could be significantly impaired. Our liquidity contingency planning during 2009 relied significantly on the Treasury credit facility, as well as our ability to pledge mortgage assets as collateral for secured borrowings and sell other assets. The Treasury credit facility expired on December 31, 2009, leaving secured borrowings and assets sales as our principal sources of alternative liquidity. Our ability to pledge or sell mortgage assets may
be impaired, or the assets may be reduced in value if other market participants are seeking to pledge or sell similar assets at the same time. We may be unable to find sufficient alternative sources of liquidity in the event our access to the unsecured debt markets is impaired. See MD&ALiquidity and Capital ManagementLiquidity ManagementLiquidity Contingency Planning for a discussion of our contingency plans if we become unable to issue unsecured debt.
A decrease in our credit ratings would likely have an adverse effect on our ability to issue debt on reasonable terms and trigger additional collateral requirements.
Our borrowing costs and our access to the debt capital markets depend in large part on the high credit ratings on our senior unsecured debt. Our ratings are subject to revision or withdrawal at any time by the rating agencies. Factors such as the amount of our net losses, deterioration in our financial condition, actions by governmental entities or others, and sustained declines in our long-term profitability could adversely affect our credit ratings. The reduction in our credit ratings would likely increase our borrowing costs, limit our access to the capital markets and trigger additional collateral requirements under our derivatives contracts and other borrowing arrangements. It may also reduce our earnings and materially adversely affect our liquidity, our ability to conduct our normal business operations, our financial condition and results of operations. Our credit ratings and ratings outlook are included in MD&ALiquidity and Capital ManagementLiquidity ManagementCredit Ratings.
Deterioration in the credit quality of, or defaults by, one or more of our institutional counterparties could result in financial losses, business disruption and decreased ability to manage risk.
We face the risk that one or more of our institutional counterparties may fail to fulfill their contractual obligations to us. The challenging mortgage and credit market conditions have adversely affected, and will likely continue to adversely affect, the liquidity and financial condition of our institutional counterparties. Our primary exposures to institutional counterparty risk are with: mortgage servicers that service the loans we hold in our mortgage portfolio or that back our Fannie Mae MBS; third-party providers of credit enhancement on the mortgage assets that we hold in our mortgage portfolio or that back our Fannie Mae MBS, including mortgage insurers, lenders with risk sharing arrangements, and financial guarantors; issuers of securities held in our cash and other investments portfolio; and derivatives counterparties.
We may have multiple exposures to one counterparty as many of our counterparties provide several types of services to us. For example, our lender customers or their affiliates also act as derivatives counterparties, mortgage servicers, custodial depository institutions or document custodians. 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.
An institutional counterparty may default in its obligations to us for a number of reasons, such as changes in financial condition that affect its credit rating, a reduction in liquidity, operational failures or insolvency. A number of our institutional counterparties are currently experiencing financial difficulties that 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. Counterparty defaults or limitations on their ability to do business with us could result in significant financial losses or hamper our ability to do business, which would adversely affect our business, results of operations, financial condition, liquidity and net worth.
We routinely execute a high volume of transactions with counterparties in the financial services industry. Many of these transactions expose us to credit risk relating to the possibility of a default by our counterparties. In addition, to the extent these transactions are secured, our credit risk may be exacerbated to the extent that the collateral held by us cannot be realized or is liquidated at prices not sufficient to recover the full amount of the loan or derivative exposure. We have exposure to these financial institutions in the form of unsecured debt instruments, derivatives transactions and equity investments. As a result, we could incur losses relating to defaults under these instruments or relating to impairments to the carrying value of our assets represented by these instruments. These losses could materially and adversely affect our business, results of operations, financial condition, liquidity and net worth.
We depend on our ability to enter into derivatives transactions in order to manage the duration and prepayment risk of our mortgage portfolio. If we lose access to our derivatives counterparties, it could adversely affect our ability to manage these risks, which could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth.
Deterioration in the credit quality of, or defaults by, one or more of our mortgage insurer counterparties could result in nonpayment of claims under mortgage insurance policies, business disruption and increased concentration risk.
We rely heavily on mortgage insurers to provide insurance against borrower defaults on conventional single-family mortgage loans with LTV ratios over 80% at the time of acquisition. The current weakened financial condition of our mortgage insurer counterparties creates a risk that these counterparties will fail to fulfill their obligations to reimburse us for claims under insurance policies. Since January 1, 2009, the insurer financial strength ratings of all of our major mortgage insurer counterparties have been downgraded to reflect their weakened financial condition, in some cases more than once. One of our mortgage insurer counterparties ceased issuing commitments for new mortgage insurance in 2008, and, under an order received from its regulator, is now paying all valid claims 60% in cash and 40% by the creation of a deferred payment obligation, which may be paid in the future.
A number of our mortgage insurers publicly disclosed that they might exceed the state-imposed risk-to-capital limits under which they operate and they might not have access to sufficient capital to continue to write new business in accordance with state regulatory requirements. Regulators in some states have been granted statutory relief to temporarily waive or raise risk-to-capital limits. However, we can not be certain that a regulator will grant such relief for a regulated entity. Some mortgage insurers have been exploring corporate restructurings, intended to provide relief from risk-to-capital limits in certain states. A restructuring plan that would involve contributing capital to a subsidiary would result in less liquidity available to its parent company to pay claims on its existing book of business, and an increased risk that its parent company will not pay its claims in full in the future.
In addition, many mortgage insurers have pursued and continue to explore capital raising options. If mortgage insurers are not able to raise capital and exceed their risk-to-capital limits, they will likely be forced into run-off or receivership unless they can secure a waiver from their state regulator. This would increase the risk that they will fail to pay our claims under insurance policies, and could also cause the quality and speed of their claims processing to deteriorate. If our assessment of one or more of our mortgage insurer counterpartys ability to fulfill its obligations to us worsens and our internal credit rating for the insurer is further downgraded, it could result in a significant increase in our loss reserves and a significant increase in the fair value of our guaranty obligations.
Many mortgage insurers have stopped insuring new mortgages with higher loan-to-value ratios or with lower borrower credit scores or on select property types, which has contributed to the reduction in our business volumes for high loan-to-value ratio loans. As our charter generally requires us to obtain credit enhancement on conventional single-family mortgage loans with loan-to-value ratios over 80% at the time of purchase, an inability to find suitable credit enhancement may inhibit our ability to pursue new business opportunities, meet our housing goals and otherwise support the housing and mortgage markets. For example, where mortgage insurance or other credit enhancement is not available, we may be hindered in our ability to refinance borrowers whose loans we do not own or guarantee into more affordable loans. In addition, access to fewer mortgage insurer counterparties will increase our concentration risk with the remaining mortgage insurers in the industry.
The loss of business volume from any one of our key lender customers could adversely affect our business and result in a decrease in our revenues.
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 most of our mortgage loans through mortgage purchase volume commitments that are negotiated annually or semiannually with lender customers and that establish a minimum level of mortgage volume that these customers will
deliver to us. We acquire a significant portion of our mortgage loans from several large mortgage lenders. During 2009, two of our customers each accounted for greater than 20% 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.
The mortgage industry has been consolidating and a decreasing number of large lenders originate most single-family mortgages. The loss of business from any one of our major lender customers could adversely affect our revenues and the liquidity of Fannie Mae MBS, which in turn could have an adverse effect on their market value. In addition, as we become more reliant on a smaller number of lender customers, our negotiating leverage with these customers decreases, which could diminish our ability to price our products optimally.
In addition, many of our lender customers are experiencing, or may experience in the future, financial and liquidity problems that may affect the volume of business they are able to generate. Many of our lender customers also have tightened their lending criteria, which has reduced their loan volume. 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 revenues. 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 reliance on third parties to service our mortgage loans may impede our efforts to keep people in their homes, as well as the re-performance rate of loans we modify.
Mortgage servicers, or their agents and contractors, typically are the primary point of contact for borrowers as we delegate servicing responsibilities to them. We rely on these mortgage servicers to identify and contact troubled borrowers as early as possible, to assess the situation and offer appropriate options for resolving the problem and to successfully implement a solution. The demands placed on experienced mortgage loan servicers to service delinquent loans have increased significantly across the industry, straining servicer capacity. The Making Home Affordable Program is also impacting servicer resources. To the extent that mortgage servicers are hampered by limited resources or other factors, they may not be successful in conducting their servicing activities in a manner that fully accomplishes our objectives within the timeframe we desire. Further, our servicers have advised us that they have not been able to reach many of the borrowers who may need help with their mortgage loans even when repeated efforts have been made to contact the borrower.
For these reasons, our ability to actively manage the troubled loans that we own or guarantee, and to implement our homeownership assistance and foreclosure prevention efforts quickly and effectively, may be limited by our reliance on our mortgage servicers.
Our adoption of new accounting standards relating to the elimination of QSPEs could have a material adverse effect on our ability to issue financial reports in a timely manner.
Effective January 1, 2010, we adopted new accounting standards for transfers of financial assets and consolidation, which will result in our recording on our consolidated balance sheet substantially all of the loans held in our MBS trusts. Implementation of these standards required us to make major operational and system changes. These changes, which involved the efforts of hundreds of our employees and contractors, have had a substantial impact on our overall internal control environment. The adoption of these accounting standards requires that we consolidate onto our balance sheet the assets and liabilities of the substantial majority of our MBS trusts, which will significantly increase the amount of our assets and liabilities. We initially recorded the assets and liabilities of the substantial majority of our existing outstanding MBS trusts that we were required to consolidate effective January 1, 2010 based on the unpaid principal balance as of that date. The unpaid principal balance amounts we consolidated related to MBS trusts increased both our total assets and total liabilities by approximately $2.4 trillion effective January 1, 2010. In addition, the number of loans on our balance sheet increased as a result of this consolidation to approximately 18 million as of January 1, 2010, from approximately two million as of December 31, 2009. Because of the magnitude and complexity of the operational and system changes that we have made, there is a risk that unexpected
developments could preclude us from implementing all of the necessary system changes and internal control processes by the time we file our results for the first quarter of 2010. Failure to make these changes could have a material adverse impact on us, including on our ability to produce financial reports on a timely basis. In addition, making the necessary operational and system changes in a compressed time frame has diverted resources from our other business requirements and corporate initiatives, which could have a material adverse impact on our operations.
Material weaknesses in our internal control over financial reporting could result in errors in our reported results or disclosures that are not complete or accurate.
Management has determined that, as of the date of this filing, we have ineffective disclosure controls and procedures and two material weaknesses in our internal control over financial reporting. In addition, our independent registered public accounting firm, Deloitte & Touche LLP, has expressed an adverse opinion on our internal control over financial reporting because of the material weaknesses. Our ineffective disclosure controls and procedures and material weaknesses could result in errors in our reported results or disclosures that are not complete or accurate, which could have a material adverse effect on our business and operations.
One of the material weaknesses relates specifically to the impact of the conservatorship on our disclosure controls and procedures. Because we are under the control of FHFA, some of the information that we may need to meet our disclosure obligations may be solely within the knowledge of FHFA. As our conservator, FHFA has the power to take actions without our knowledge that could be material to our shareholders and other stakeholders, and could significantly affect our financial performance or our continued existence as an ongoing business. Because FHFA currently functions as both our regulator and our conservator, there are inherent structural limitations on our ability to design, implement, test or operate effective disclosure controls and procedures relating to information within FHFAs knowledge. As a result, we have not been able to update our disclosure controls and procedures in a manner that adequately ensures the accumulation and communication to management of information known to FHFA that is needed to meet our disclosure obligations under the federal securities laws, including disclosures affecting our financial statements. Given the structural nature of this material weakness, it is likely that we will not remediate this weakness while we are under conservatorship. See Controls and Procedures for further discussion of managements conclusions on our disclosure controls and procedures and internal control over financial reporting.
Operational control weaknesses could materially adversely affect our business, cause financial losses and harm our reputation.
Shortcomings or failures in our internal processes, people or systems could have a material adverse effect on our risk management, liquidity, financial statement reliability, financial condition and results of operations; disrupt our business; and result in legislative or regulatory intervention, liability to customers, and financial losses or damage to our reputation, including as a result of our inadvertent dissemination of confidential or inaccurate information. For example, our business is dependent on our ability to manage and process, on a daily basis, an extremely large number of transactions across numerous and diverse markets and in an environment in which we must make frequent changes to our core processes in response to changing external conditions. These transactions are subject to various legal and regulatory standards. We rely upon business processes that are highly dependent on people, technology and the use of numerous complex systems and models to manage our business and produce books and records upon which our financial statements are prepared. We experienced a number of operational incidents in 2009 related to inadequately designed or failed execution of internal processes or systems. For example, in July and August 2009, we publicly identified errors in certain information reported about our MBS trusts and published corrected data relating to these errors.
We are implementing our operational risk management framework to support the identification, assessment, mitigation and control, and reporting and monitoring of operational risk. We have made a number of changes in our structure, business focus and operations during the past year, as well as changes to our risk management processes, to keep pace with changing external conditions. These changes, in turn, have necessitated modifications to or development of new business models, processes, systems, policies, standards and controls. The steps we have taken and are taking to enhance our technology and operational controls and organizational
structure may not be effective to manage these risks and may create additional operational risk as we execute these enhancements.
In addition, we have experienced substantial changes in management, employees and our business structure and practices since the conservatorship began. These changes could increase our operational risk and result in business interruptions and financial losses. In addition, due to events that are wholly or partially beyond our control, 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.
Management turnover may impair our ability to manage our business effectively.
Since August 2008, we have had a total of three Chief Executive Officers, three Chief Financial Officers, three Chief Risk Officers, two General Counsels and an interim General Counsel, two Executive Vice Presidents leading our Single Family business, two Executive Vice Presidents leading our Capital Markets group, and two Chief Technology Officers, as well as significant departures by various other members of senior management. Our Chief Risk Officer, General Counsel and Chief Technology Officer were new to Fannie Mae in 2009. Integration of new management and further turnover in key management positions could harm our ability to manage our business effectively and ultimately adversely affect our financial performance.
Limitations and restrictions on employee compensation have adversely affected, and may in the future adversely affect, our ability to recruit and retain well-qualified employees. Changes in public policy or opinion also may affect our ability to hire and retain qualified employees. If we lose a significant number of employees and are not able to quickly recruit and train new employees, it could negatively affect customer relationships and goodwill, and could have a material adverse effect on our ability to do business and our results of operations. In addition, the success of our business strategy depends on the continuing service of our employees.
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 managements 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 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 MD&ACritical 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 of the above factors, 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.
Failure of our models to produce reliable results may adversely affect our ability to manage risk and make effective business decisions.
We make significant use of business and financial models to measure and monitor our risk exposures and to manage our business. For example, we use models to measure and monitor our exposures to interest rate, credit and market risks, and to forecast credit losses. The information provided by these models is used in making business decisions relating to strategies, initiatives, transactions, pricing and products.
Models are inherently imperfect predictors of actual results because they are based on historical data available to us and our assumptions about factors such as future loan demand, prepayment speeds, default rates, severity rates, home price trends and other factors that may overstate or understate future experience. Our models could produce unreliable results for a number of reasons, including limitations on historical data to predict results due to unprecedented events or circumstances, invalid or incorrect assumptions underlying the models, the need for manual adjustments in response to rapid changes in economic conditions, incorrect coding of the models, incorrect data being used by the models or inappropriate application of a model to products or events outside of the models intended use. In particular, models are less dependable when the economic environment is outside of historical experience, as has been the case recently.
In addition, we continually receive new economic and mortgage market data, such as housing starts and sales and home price changes. Our critical accounting estimates, such as our loss reserves and other-than-temporary impairment, are subject to change, often significantly, due to the nature and magnitude of changes in market conditions. However, there is generally a lag between the availability of this market information and the preparation of our financial statements. When market conditions change quickly and in unforeseen ways, there is an increased risk that the assumptions and inputs reflected in our models are not representative of current market conditions.
The dramatic changes in the housing, credit and capital markets have required frequent adjustments to our models and the application of greater management judgment in the interpretation and adjustment of the results produced by our models.
Actions we may take to assist the mortgage market may also require adjustments to our models and the application of greater management judgment. This application of greater management judgment reflects the need to take into account updated information while continuing to maintain controlled processes for model updates, including model development, testing, independent validation and implementation. As a result of the time and resources, including technical and staffing resources, that are required to perform these processes effectively, it may not be possible to replace existing models quickly enough to ensure that they will always properly account for the impacts of recent information and actions. The application of management judgment to interpret or adjust modeled results, particularly in the current environment in which many events are unprecedented and therefore there is no relevant historical data, also may produce unreliable information.
If our models fail to produce reliable results on an ongoing basis, we may not make appropriate risk management decisions, including decisions affecting loan purchases, management of credit losses and risk, guaranty fee pricing, asset and liability management and the management of our net worth, and any of those decisions could adversely affect our business, results of operations, liquidity, net worth and financial condition. Furthermore, any strategies we employ to attempt to manage the risks associated with our use of models may not be effective.
Changes in option-adjusted spreads or interest rates, or our inability to manage interest rate risk successfully, could adversely affect our net interest income and increase interest rate risk.
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 adverse changes in the fair value of financial instruments resulting from changes in market conditions. Our most significant market risks are interest rate risk and option-adjusted spread risk. We describe these risks in more detail in MD&ARisk ManagementMarket Risk Management, Including Interest Rate Risk Management. Changes in interest rates affect both the value of our mortgage assets and prepayment rates on our mortgage loans.
Changes in interest rates could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth. Our ability to manage interest rate risk depends on our ability to issue debt
instruments with a range of maturities and other features, including call features, at attractive rates and to engage in derivatives transactions. We must exercise judgment in selecting the amount, type and mix of debt and derivatives instruments that will most effectively manage our interest rate risk. The amount, type and mix of financial instruments that are available to us may not offset possible future changes in the spread between our borrowing costs and the interest we earn on our mortgage assets.
Our business is subject to laws and regulations that restrict our activities and operations, which may prohibit us from undertaking activities that management believes would benefit our business and limits our ability to diversify our business.
As a federally chartered corporation, we are subject to the limitations imposed by the Charter Act, extensive regulation, supervision and examination by FHFA, and regulation by other federal agencies, including Treasury, HUD and the SEC. As a company under conservatorship, our primary regulator has management authority over us in its role as our conservator. 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. For example, the GSE Act requires that, with some exceptions, we must obtain FHFAs approval before initially offering a product. In a February 2, 2010 letter to Congress, the Acting Director of FHFA announced that FHFA was instructing Fannie Mae and Freddie Mac not to submit requests for approval of new products under FHFAs rule implementing the GSE Act provision, stating that permitting [Fannie Mae and Freddie Mac] to engage in new products is inconsistent with the goals of conservatorship, and concluding that Fannie Mae and Freddie Mac will be limited to continuing their existing core business activities and taking actions necessary to advance the goals of the conservatorship.
The Charter Act 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. The deteriorating conditions in the U.S. housing market over the past approximately two years has therefore had a significant adverse effect on our results of operations, financial condition and net worth, which is likely to continue.
We could be required to pay substantial judgments, settlements or other penalties as a result of pending government investigations and civil litigation.
We are subject to investigations by the Department of Justice and the SEC, and are a party to a number of lawsuits. 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 investigations and lawsuits, which could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth. In addition, responding to requests for information in these investigations and lawsuits may divert significant internal resources away from managing our business. More information regarding these investigations and lawsuits is included in Legal Proceedings and Note 20, Commitments and Contingencies.
If our common stock trades below one dollar per share, or our conservator determines that our securities should not continue to be listed on a national securities exchange, our common and preferred stock could be delisted from the NYSE, which likely would result in a significant decline in trading volume and liquidity, and possibly a decline in price, of our securities.
The average closing price of our common stock for the 30 consecutive trading days ended February 24, 2010 was $1.03 per share. Under NYSE rules, we would not meet the NYSEs standards for continued listing of our common stock if the average closing price of our common stock were less than one dollar per share during a consecutive 30 trading-day period. If we receive notice from the NYSE that we have failed to satisfy this requirement, and the average price of our common stock does not subsequently rise above one dollar for a period of 30 consecutive trading days within a specified period, the NYSE rules provide that the NYSE will initiate suspension and delisting procedures unless we present a plan to the NYSE to cure this deficiency.
If we were to receive notice from the NYSE that we failed to satisfy the average minimum closing price requirement for our common stock, our conservator would be involved in any decision made on whether or not we submit a plan to the NYSE to cure this deficiency. Our conservator could decline to permit any such submission, which would result in the NYSE initiating suspension and delisting procedures. Our conservator would be involved in any decision regarding the continued listing of our common and preferred stock on the NYSE. For example, our conservator could direct us to voluntarily delist our common and preferred stock from the NYSE.
If our common and preferred stock were to be delisted from the NYSE, it likely would result in a significant decline in the trading volume and liquidity of both our common stock and the classes of our preferred stock listed on the NYSE. As a result, it could become more difficult for our shareholders to sell their shares at prices comparable to those in effect prior to delisting, or at all.
Mortgage fraud could result in significant financial losses and harm to our reputation.
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. As a result, 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 have experienced financial losses resulting from mortgage fraud, including institutional fraud perpetrated by counterparties. In the future, we may experience additional financial losses and reputational damage as a result of mortgage fraud.
A continuing, or broader, decline in U.S. home prices or activity in the U.S. housing market would likely cause higher credit losses and credit-related expenses, and lower business volumes.
We expect weakness in the real estate financial markets to continue into 2010. The continued deterioration in the performance of outstanding mortgages will result in the foreclosure of some troubled loans, which is likely to add to excess inventory. We also expect heightened default and severity rates to continue during this period, and home prices, particularly in some geographic areas, may decline further. Any resulting increase in delinquencies or defaults, or in severity, will result in a higher level of credit losses and credit-related expenses, which in turn will reduce our earnings and adversely affect our net worth and 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. The rate of growth in total U.S. residential mortgage debt outstanding has declined substantially in response to the reduced activity in the housing market and declines in home prices, and we expect single-family mortgage debt outstanding to decrease by 1.7% in 2010. A decline in the rate of growth in mortgage debt outstanding reduces the unpaid principal balance of mortgage loans available for us to purchase or securitize, which in turn could reduce our net interest income and guaranty fee income. Even if we are able to increase our share of the secondary mortgage market, it may not be sufficient to make up for the decline in the rate of growth in mortgage originations, which could adversely affect our results of operations and financial condition.
Structural and regulatory changes in the financial services industry may negatively impact our business.
The financial services industry is undergoing significant structural changes. In light of current conditions in the financial markets and economy, regulators and legislatures have increased their focus on the regulation of the financial services industry. The Obama Administration issued a white paper in June 2009 that proposes significantly altering the current regulatory framework applicable to the financial services industry, with enhanced and more comprehensive regulation of financial firms and markets. That announcement was followed by proposed legislation submitted to Congress by the Department of the Treasury. The proposed legislation included proposals relating to the promotion of robust supervision and regulation of financial firms, stronger consumer protection regulations, the enhanced regulation of securitization markets, changes to existing capital and liquidity requirements for financial firms, additional regulation of the over-the-counter
derivatives market, regulations on compensation practices and changes in accounting standards. The House Financial Services Committee and the Agriculture Committee conducted hearings during 2009, and the House passed the Wall Street Reform and Consumer Protection Act in December 2009. While not identical to the Treasury proposal, the House bill was broadly similar to that proposal. In November 2009, Senator Christopher Dodd introduced the Restoring American Financial Stability Act of 2009, which covered many of the same areas as the House bill but contained many significant differences. If one of these bills is implemented, it may directly and indirectly affect many aspects of our business. Additionally, implementation of such a bill will result in increased supervision and more comprehensive regulation of our counterparties in this industry, which may have a significant impact on our counterparty credit risk.
On February 1, 2010, the Obama Administration stated in its fiscal year 2011 budget proposal that it was continuing to monitor the situation of the GSEs and would continue to provide updates on considerations for longer-term reform of Fannie Mae and Freddie Mac as appropriate.
We are unable to predict whether these proposals will be implemented or in what form, or whether any additional or similar changes to statutes or regulations (and their interpretation or implementation) will occur in the future. Actions by regulators of the financial services industry, including actions related to limits on executive compensation, impact the retention and recruitment of management. In addition, the actions of Treasury, the FDIC, the Federal Reserve and international central banking authorities directly impact financial institutions cost of funds for lending, capital raising and investment activities, which could increase our borrowing costs or make borrowing more difficult for us. Changes in monetary policy are beyond our control and difficult to anticipate.
The financial market crisis has also resulted in mergers of some of our most significant institutional counterparties. Consolidation of the financial services industry has increased and may continue to increase our concentration risk to counterparties in this industry, and we are and may become more reliant on a smaller number of institutional counterparties, which both increases our risk exposure to any individual counterparty and decreases our negotiating leverage with these counterparties.
The structural changes in the financial services industry and any legislative or regulatory changes could affect us in substantial and unforeseeable ways and could have a material adverse effect on our business, results of operations, financial condition, liquidity and net worth. In particular, these changes could affect our ability to issue debt and may reduce our customer base.
The occurrence of a major natural or other disaster in the United States could increase our delinquency rates and credit losses or disrupt our business operation.
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 business, results of operations, financial condition, liquidity and net worth.
The contingency plans and facilities that we have in place may be insufficient to prevent an adverse effect on our ability to conduct business, which could lead to financial losses. 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 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.
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 429,000 square feet of office space, including a conference center, at 4000 Wisconsin Avenue, NW, which is adjacent to our principal office. The present lease term for the office space at 4000 Wisconsin Avenue expires in April 2013 and we have one additional 5-year renewal option remaining under the original lease. The lease term for the conference center at 4000 Wisconsin Avenue expires in April 2018. We also lease an additional approximately 229,000 square feet of office space at two locations in Washington, DC and Virginia. We maintain approximately 612,000 square feet of office space in leased premises in Pasadena, California; Irvine, California; Atlanta, Georgia; Chicago, Illinois; Philadelphia, Pennsylvania; and two facilities in Dallas, Texas.
This item describes our material legal proceedings. We describe additional material legal proceedings in Note 20, Commitments and Contingencies in the section titled Litigation and Regulatory Matters, which is incorporated herein by reference. In addition to the matters specifically described or incorporated by reference 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 legal claims when losses associated with the claims become probable and the amounts can reasonably be estimated. The actual costs of resolving legal claims may be substantially higher or lower than the amounts reserved for those claims. 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. We presently cannot determine the ultimate resolution of the matters described or incorporated by reference below. We have recorded a reserve for legal claims related to those matters for which we were able to determine a loss was both probable and reasonably estimable. If certain of these matters are determined against us, it could have a material adverse effect on our results of operations, liquidity and financial condition, including our net worth.
Four shareholder derivative cases, filed at various times between June 2007 and June 2008, naming certain of our current and former directors and officers as defendants, and Fannie Mae as a nominal defendant, are currently pending in the U.S. District Court for the District of Columbia: Kellmer v. Raines, et al. (filed June 29, 2007); Middleton v. Raines, et al. (filed July 6, 2007); Arthur v. Mudd, et al. (filed November 26, 2007); and Agnes v. Raines, et al. (filed June 25, 2008). Three of the cases (Kellmer, Middleton, and Agnes) rely on factual allegations that Fannie Maes accounting statements were inconsistent with the GAAP requirements relating to hedge accounting and the amortization of premiums and discounts. Two of the cases (Arthur and Agnes) rely on factual allegations that defendants wrongfully failed to disclose our exposure to the subprime mortgage crisis and that the Board improperly authorized the company to buy back $100 million in shares while the stock price was artificially inflated. Plaintiffs seek, on behalf of Fannie Mae, various forms of monetary and non-monetary relief, including unspecified money damages (including restitution, legal fees and expenses, disgorgement and punitive damages); corporate governance changes; an accounting; and attaching, impounding or imposing a constructive trust on the individual defendants assets. Pursuant to a June 25, 2009 order, FHFA, as our conservator, substituted itself for shareholder plaintiffs in all of these actions. Plaintiffs Kellmer and Agnes are in the process of appealing the substitution order. FHFA has moved for voluntary dismissal without prejudice (or, alternatively, for a stay of proceedings) of all four derivative cases. Certain former officer defendants have also moved to dismiss the Kellmer, Middleton, and Agnes actions.
On January 25, 2010, we received a request for documents and information from the Financial Crisis Inquiry Commission in connection with its statutory mandate to examine the causes, domestic and global, of the current financial crisis in the United States. We are cooperating with this inquiry.
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 43078, 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.
Our payment of dividends is subject to the following restrictions:
Restrictions Relating to Conservatorship. Our conservator announced on September 7, 2008 that we would not pay any dividends on the common stock or on any series of preferred stock, other than the senior preferred stock.
Restrictions Under Senior Preferred Stock Purchase Agreement. The senior preferred stock purchase agreement prohibits us from declaring or paying any dividends on Fannie Mae equity securities without the prior written consent of Treasury.
Statutory Restrictions. Under the GSE Act, FHFA has authority to prohibit capital distributions, including payment of dividends, if we fail to meet our capital requirements. If FHFA classifies us as significantly undercapitalized, approval of the Director of FHFA is required for any dividend payment. Under the GSE Act, we are not permitted to make a capital distribution if, after making the distribution, we would be undercapitalized, except the Director of FHFA may permit us to repurchase shares if the repurchase is made in connection with the issuance of additional shares or obligations in at least an equivalent amount and will reduce our financial obligations or otherwise improve our financial condition.
Restrictions Relating to Subordinated Debt. During any period in which we defer payment of interest on qualifying subordinated debt, we may not declare or pay dividends on, or redeem, purchase or acquire, our common stock or preferred stock.
Restrictions Relating to Preferred Stock. Payment of dividends on our common stock is also subject to the prior payment of dividends on our preferred stock and our senior preferred stock. Payment of dividends on all outstanding preferred stock, other than the senior preferred stock, is also subject to the prior payment of dividends on the senior preferred stock.
See MD&ALiquidity and Capital Management for information on dividends declared and paid to Treasury on the senior preferred stock.
As of January 31, 2010, we had approximately 19,000 registered holders of record of our common stock, including holders of our restricted stock. In addition, as of January 31, 2010, Treasury held a warrant giving it the right to purchase shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis on the date of exercise.
We previously provided stock compensation to employees and members of the Board of Directors under the Fannie Mae Stock Compensation Plan of 1993 and the Fannie Mae Stock Compensation Plan of 2003 (the Stock Compensation Plans).
Information about sales and issuances of our unregistered securities during the first three quarters of 2009, which were made pursuant to these Stock Compensation Plans, was provided in our quarterly reports on Form 10-Q for the quarters ended March 31, 2009, June 30, 2009 and September 30, 2009 filed with the SEC on May 8, 2009, August 6, 2009 and November 5, 2009, respectively.
During the quarter ended December 31, 2009, 3,358,526 shares of common stock were issued upon conversion of 2,179,730 shares of 8.75% Non-Cumulative Mandatory Convertible Preferred Stock, Series 2008-1, at the option of the holders pursuant to the terms of the preferred stock. All series of preferred stock, other than the senior preferred stock, were issued prior to September 7, 2008.
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, except that, under the GSE Act, our equity securities are not treated as exempted securities for purposes of Section 12, 13, 14 or 16 of the Exchange Act. As a result, our securities offerings are exempt from SEC registration requirements and we do not file registration statements or prospectuses with the SEC under the Securities Act with respect to our securities offerings.
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 in 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 Maes securities offerings are exempted from SEC registration requirements, except that, under the GSE Act, our equity securities are not treated as exempted securities for purposes of Section 12, 13, 14 or 16 of the Exchange Act. As a result, we are not required to and do not file registration statements or prospectuses with the SEC under the Securities Act 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 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 Maes 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 address solely for your information. Information appearing on our Web site is not incorporated into this annual report on Form 10-K.
Purchases of Equity Securities by the Issuer
The following table shows shares of our common stock we repurchased during the fourth quarter of 2009.
The selected consolidated financial data presented below is summarized from our results of operations for the five-year period ended December 31, 2009, as well as selected consolidated balance sheet data as of the end of each year within this five-year period. Certain prior period amounts have been reclassified to conform to the current period presentation. This data should be reviewed in conjunction with the audited consolidated financial statements and related notes and with the MD&A included in this annual report on Form 10-K.
Our Managements Discussion and Analysis of Financial Condition and Results of Operations (MD&A) should be read in conjunction with our consolidated financial statements as of December 31, 2009 and related notes, and with BusinessExecutive Summary. This discussion contains forward-looking statements that are based upon managements current expectations and are subject to significant uncertainties and changes in circumstances. Please review BusinessForward-Looking Statements for more information on the forward-looking statements in this report and Risk Factors for a discussion of factors that could cause our actual results to differ, perhaps materially, from our forward-looking statements. Please also see MD&AGlossary of Terms Used in This Report.
The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. 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 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 any significant changes in judgments and assumptions in applying our critical accounting policies with the Audit Committee of the Board of Directors. We rely on a number of valuation and risk models as the basis for some of the amounts recorded in our financial statements. Many of these models involve significant assumptions and have limitations. See Risk Factors and Risk ManagementModel Risk Management for a discussion of the risk associated with the use of models.
The use of fair value to measure our assets and liabilities is fundamental to our financial statements and is a critical accounting estimate because we account for and record a substantial portion of our assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (also referred to as an exit price).
In April 2009, the Financial Accounting Standards Board (FASB) issued guidance on how to determine the fair value when the volume and level of activity for an asset or liability have significantly decreased. If there has been a significant decrease in the volume and level of activity for an asset or liability as compared to the normal level of market activity for the asset or liability, there is an increased likelihood that quoted prices or transactions for the instrument are not reflective of an orderly transaction and may therefore require significant adjustment to estimate fair value. We evaluate the existence of the following conditions in determining whether there is an inactive market for an asset or liability: (1) there are few transactions for the product category; (2) price quotes are not based on current market information; (3) the price quotes we receive vary significantly either over time or among independent pricing services or dealers; (4) price indices that were previously highly correlated are demonstrably uncorrelated; (5) there is a significant increase in implied
liquidity risk premiums, yields or performance indicators, such as delinquency rates or loss severities, for observed transactions or quoted prices when compared with our estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the financial instrument; (6) there is a wide bid-ask spread or significant increase in the bid-ask spread; (7) there is a significant decline or absence of a market for new issuances (in other words, a primary market) for the product or similar products; or (8) there is limited availability of public market information. Our adoption of this guidance did not result in a change in our valuation techniques for estimating fair value.
In determining fair value, we use various valuation techniques. We disclose the carrying value and fair value of our assets and liabilities and describe the valuation measurement techniques used to determine the fair value of these financial instruments in Note 19, Fair Value.
The fair value accounting rules provide a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Each asset or liability is assigned to a level based on the lowest level of any input that is significant to the fair value measurement. The three levels of the fair value hierarchy are described below:
The majority of the financial instruments that we report at fair value in our consolidated financial statements fall within the Level 2 category and are valued primarily utilizing inputs and assumptions that are observable in the marketplace, that can be derived from observable market data or that can be corroborated by recent trading activity of similar instruments with similar characteristics. For example, we generally request non-binding prices from at least four independent pricing services to estimate the fair value of our trading and available-for-sale securities at an individual security level. We use the average of these prices to determine the fair value.
In the absence of such information or if we are not able to corroborate these prices by other available, relevant market information, we estimate their fair values based on single source quotations from brokers or dealers or by using internal calculations or discounted cash flow techniques that incorporate inputs, such as prepayment rates, discount rates and delinquency, default and cumulative loss expectations, that are implied by market prices for similar securities and collateral structure types. Because this valuation technique relies on significant unobservable inputs, the fair value estimation is classified as Level 3. The process for determining fair value using unobservable inputs is generally more subjective and involves a high degree of management judgment and assumptions. These assumptions may have a significant effect on our estimates of fair value, and the use of different assumptions as well as changes in market conditions could have a material effect on our results of operations or financial condition.
The assets and liabilities that we have classified as Level 3 consist primarily of financial instruments for which there is limited market activity and therefore little or no price transparency. As a result, the valuation techniques that we use to estimate fair value involve significant unobservable inputs. Our Level 3 financial instruments consist of certain mortgage- and asset-backed securities and residual interests, certain mortgage loans, our guaranty assets and buy-ups, our master servicing assets and certain highly structured, complex derivative instruments.
Fair value measurements related to financial instruments that are reported at fair value in our consolidated financial statements each period, such as our trading and available-for-sale securities and derivatives, are referred to as recurring fair value measurements. The primary assets and liabilities reported at fair value on a recurring basis are trading and available-for-sale securities, derivatives, and guaranty assets and buy-ups.
Table 2 presents a comparison, by balance sheet category, of the amount of financial assets carried in our consolidated balance sheets at fair value on a recurring basis and classified as Level 3 as of December 31, 2009 and 2008. The availability of observable market inputs to measure fair value varies based on changes in market conditions, such as liquidity. As a result, we expect the amount of financial instruments carried at fair value on a recurring basis and classified as Level 3 to vary each period.
The decrease in assets classified as Level 3 during 2009 was principally the result of a net transfer of approximately $9.0 billion in assets to Level 2 from Level 3. The transferred assets consisted primarily of Fannie Mae guaranteed mortgage-related securities, which includes securities backed by jumbo conforming loans, and private-label mortgage-related securities backed by non-fixed rate Alt-A loans. During 2009, price transparency improved as a result of increased market activity and we noted some convergence in prices obtained from third-party vendors. As a result, we determined that our fair value estimates for these securities did not rely on significant unobservable inputs.
Assets measured at fair value on a non-recurring basis and classified as Level 3, which are not presented in the table above, include held-for-sale loans that are measured at the lower of cost or fair value and that were written down to fair value during the period. Held-for-sale loans that were reported at fair value, rather than amortized cost, totaled $3.6 billion during the year ended December 31, 2009 and $1.3 billion during the year ended December 31, 2008. In addition, certain other assets carried at amortized cost that have been written down to fair value during the period due to impairment are classified as non-recurring. The fair value of these Level 3 non-recurring financial assets, which consisted of held-for-investment loans, acquired property, guaranty assets, master servicing assets, and partnership investments, totaled $17.6 billion during the year ended December 31, 2009 and $22.4 billion during the year ended December 31, 2008.
Our LIHTC investments trade in a market with limited observable transactions. There is decreased market demand for LIHTC investments because there are fewer tax benefits derived from these investments by traditional investors, as these investors are currently projecting much lower levels of future profits than in previous years. This decreased demand has reduced the value of these investments. We determine the fair value of our LIHTC investments using internal models that estimate the present value of the expected future tax benefits (tax credits and tax deductions for net operating losses) expected to be generated from the properties underlying these investments. Our estimates are based on assumptions that other market participants would use in valuing these investments. The key assumptions used in our models, which require significant management judgment, include discount rates and projections related to the amount and timing of tax benefits. We compare our model results to independent third-party valuations to validate the reasonableness of our assumptions and valuation results. We also compare our model results to the limited number of observed market transactions and make adjustments to reflect differences between the risk profile of the observed market transactions and our LIHTC investments. For a discussion of other-than-temporary impairments
recognized on our LIHTC investments, see Off-Balance Sheet Arrangements and Variable Interest EntitiesPartnership Investment InterestsLIHTC Partnership Interests.
Financial liabilities measured at fair value on a recurring basis and classified as Level 3 consisted of long-term debt with a fair value of $601 million as of December 31, 2009 and $2.9 billion as of December 31, 2008, and derivatives liabilities with a fair value of $27 million as of December 31, 2009 and $52 million as of December 31, 2008.
We have control processes that are designed to ensure that our fair value measurements are appropriate and reliable, that they are based on observable inputs wherever possible and that our valuation approaches are consistently applied and the assumptions used are reasonable. Our control processes consist of a framework that provides for a segregation of duties and oversight of our fair value methodologies and valuations and validation procedures.
Our Valuation Oversight Committee, which includes senior representation from business areas, our Enterprise Risk Office and our Finance Division, is responsible for reviewing the valuation methodologies used in our fair value measurements and any significant valuation adjustments, judgments, controls and results. Actual valuations are performed by personnel independent of our business units. Our Price Verification Group, which is an independent control group separate from the group responsible for obtaining prices, is responsible for performing monthly independent price verification. The Price Verification Group also performs independent reviews of the assumptions used in determining the fair value of products we hold that have material estimation risk because observable market-based inputs do not exist.
Our validation procedures are intended to ensure that the individual prices we receive are consistent with our observations of the marketplace and prices that are provided to us by pricing services or other dealers. We verify selected prices using a variety of methods, including comparing the prices to secondary pricing services, corroborating the prices by reference to other independent market data, such as non-binding broker or dealer quotations, relevant benchmark indices, and prices of similar instruments, checking prices for reasonableness based on variations from prices provided in previous periods, comparing prices to internally calculated expected prices and conducting relative value comparisons based on specific characteristics of securities. In addition, we compare our derivatives valuations to counterparty valuations as part of the collateral exchange process. We have formal discussions with the pricing services as part of our due diligence process in order to maintain a current understanding of the models and related assumptions and inputs that these vendors use in developing prices. The prices provided to us by independent pricing services reflect the existence of credit enhancements, including monoline insurance coverage, and the current lack of liquidity in the marketplace. If we determine that a price provided to us is outside established parameters, we will further examine the price, including having follow-up discussions with the pricing service or dealer. If we conclude that a price is not valid, we will adjust the price for various factors, such as liquidity, bid-ask spreads and credit considerations. These adjustments are generally based on available market evidence. In the absence of such evidence, managements best estimate is used. All of these processes are executed before we use the prices in preparing our financial statements.
We continually refine our valuation methodologies as markets and products develop and the pricing for certain products becomes more or less transparent. While we believe our valuation methods are appropriate and consistent with those of other market participants, using different methodologies or assumptions to determine fair value could result in a materially different estimate of the fair value of some of our financial instruments.
The dislocation of historical pricing relationships between certain financial instruments persisted during 2009 due to the housing and financial market crisis, which continued in 2009. These conditions, which have resulted in greater market volatility, wider credit spreads and a lack of price transparency, have made the measurement of fair value more difficult and complex for some financial instruments, particularly for financial instruments for which there is no active market, such as our guaranty contracts and loans purchased with evidence of credit deterioration.
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. As described in Note 1, Summary of Significant Accounting Policies, we record this amount in our consolidated balance sheets as a component of Guaranty obligations. The fair value of our guaranty obligations consists of the following: (1) 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; (2) estimated foreclosure-related costs; (3) estimated administrative and other costs related to our guaranty; and (4) an estimated market risk premium, or profit, that a market participant would require to assume the obligation.
Effective January 1, 2008, as part of our implementation of the new accounting standard related to fair value measurements, we changed our approach to measuring the fair value of our guaranty obligations. Specifically, we adopted a measurement approach that is based upon an estimate of the compensation that we would require to issue the same guaranty in a standalone arms-length transaction with an unrelated party. For a guaranty issued in a lender swap transaction after 2007, we measure the fair value of the guaranty obligation at inception based on the fair value of the total compensation we expect to receive, which primarily consists of the guaranty fee, credit enhancements, buy-downs, risk-based price adjustments and our right to receive interest income during the float period in excess of the amount required to compensate us for master servicing. See Consolidated Results of OperationsGuaranty Fee Income for a description of buy-downs and risk-based price adjustments. Because the fair value of the guaranty obligation at inception for guaranty contracts issued after 2007 is equal to the fair value of the total compensation we expect to receive, we no longer recognize losses or record deferred profit at inception of our lender swap transactions, which represent the bulk of our guaranty transactions.
We also changed how we measure the fair value of our existing guaranty obligations to be consistent with our approach for measuring guaranty obligations at initial recognition. This change, which affects the fair value amounts disclosed in Supplemental Non-GAAP InformationFair Value Balance Sheets and in Note 19, Fair Value, does not affect the amounts recorded in our results of operations or consolidated balance sheets. The fair value of any guaranty obligation measured after its initial recognition represents our estimate of a hypothetical transaction price we would receive if we were to issue our guaranty to an unrelated party in a standalone arms-length transaction at the measurement date. We continue to use the models and inputs that we used prior to our adoption of the new accounting standard related to fair value measurements to estimate this fair value, which we calibrated to our current market pricing in 2008. Beginning in the first quarter of 2009, we concluded that the credit characteristics of the pools of loans upon which we were issuing new guarantees increasingly did not reflect the credit characteristics of our existing guaranteed pools; thus, current market prices for our new guarantees were not a relevant input to our estimate of the hypothetical transaction price for our existing guaranty obligations. Therefore, our estimate of the fair value of our existing guaranty obligations is based solely upon our model results, without further adjustment. The estimated fair value of our guaranty obligations as of each balance sheet date will always be greater than our estimate of future expected credit losses in our existing guaranty book of business as of that date because the fair value of our guaranty obligations includes an estimated market risk premium, or profit, that a market participant would require to assume our existing obligations.
Fair Value of Loans Purchased with Evidence of Credit Deterioration
We have the option to purchase delinquent loans underlying our Fannie Mae MBS under specified conditions, which we describe in BusinessMortgage SecuritizationsPurchases of Loans from our 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 as to 24 monthly payments of principal and interest and 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 under the terms of our guaranty arrangement. As described in Note 1, Summary of Significant Accounting Policies, when we acquire loans
with impaired credit, we record our net investment in these 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 an acquired credit-impaired loan fair value loss 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 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 credit-impaired loans on nonaccrual status and classify them as nonperforming when we believe collectability of interest or principal on the loan is not reasonably assured. If we subsequently determine that the collectability of principal and interest is reasonably assured, 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 fair value losses as discussed below.
To the extent that we have previously recognized an acquired credit-impaired loan fair value loss, our recorded investment in the loan is less than its acquisition cost. Under the accounting standard for acquired credit-impaired loans, the excess of the undiscounted contractual cash flows of the loan over the estimated cash flows we expect to collect at acquisition 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 the net interest income over the life of the loan. If estimated cash flows we expect to collect decrease subsequent to acquisition, we record impairment on the loan. If an acquired credit-impaired loan pays off in full, we recover the acquired credit-impaired loan fair value loss as a component of net interest income on the date of the payoff. If the loan is returned to accrual status, we recover the acquired credit-impaired loan 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 an acquired credit-impaired loan, which is 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 acquired credit-impaired loan 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 acquire a credit-impaired loan from an MBS trust; (b) we 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:
(c) We sell the REO property for $85.
As indicated in the example above, we would record the loan at the estimated fair value of $70 and record a credit-impaired loans 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. Assuming all other things were equal, this reserve for guaranty losses is reduced at period end because the purchased loan is no longer included in the population for which the reserve is determined. Therefore, if the charge-off for the credit-impaired loans fair value loss is greater than the decrease in the reserve caused by removing the loan from the population subject to accounting for contingencies, 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 credit-impaired loan 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 credit-impaired loan cures, which means it returns to accrual status, pays off or is resolved through a modification, long-term forbearance or a repayment plan, the credit-impaired loans 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 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. Refer to Fair Value Measurement in this section for a detailed discussion on the valuation process. These prices, which reflect the significant decline in the value of mortgage assets due to the deterioration in the housing and credit markets, have resulted in a substantial increase in the credit-impaired loans fair value loss we record when we purchase a delinquent loan from an MBS trust.
See Consolidated Results of OperationsCredit-Related Expenses for a discussion of our fair value losses on acquired credit-impaired loans.
We evaluate available-for-sale securities in an unrealized loss position as of the end of each quarter for other-than-temporary impairment. In April 2009, the FASB issued a new accounting standard that modified the model for assessing other-than-temporary impairment for investments in debt securities. Under this new standard, a debt security is evaluated for other-than-temporary impairment if its fair value is less than its amortized cost basis. We recognize other-than-temporary impairment in earnings if one of the following conditions exists: (1) our intent is to sell the security; (2) it is more likely than not that we will be required to sell the security before the impairment is recovered; or (3) we do not expect to recover our amortized cost basis. If, by contrast, we do not intend to sell the security and will not be required to sell prior to recovery of the amortized cost basis, we recognize only the credit component of other-than-temporary impairment in earnings. We record the noncredit component in other comprehensive income (OCI). The credit component is the difference between the securitys amortized cost basis and the present value of its expected future cash flows, while the noncredit component is the remaining difference between the securitys fair value and the present value of expected future cash flows. We adopted this new accounting standard effective April 1, 2009, which resulted in a cumulative-effect pre-tax reduction of $8.5 billion ($5.6 billion after tax) in our accumulated deficit as a result of our reclassifying to accumulated other comprehensive income (AOCI) the noncredit component of other-than-temporary impairment losses previously recognized in earnings. We also reversed $3.0 billion of our deferred tax asset valuation allowance that is related to some available-for-sale securities we hold, which reduced our accumulated deficit, because we continue to have the intent and ability to hold these securities to recovery.
As a result of our April 1, 2009 adoption of the new other-than-temporary impairment standard, we revised our approach for measuring and recognizing impairment losses on our investment securities. Our evaluation continues to require significant management judgment and consideration of various factors to determine if we will receive the amortized cost basis of our investment securities. These factors include: the severity and duration of the impairment; recent events specific to the issuer and/or industry to which the issuer belongs; the payment structure of the security; external credit ratings and the failure of the issuer to make scheduled interest or principal payments. We rely on expected future cash flow projections to determine if we will recover the amortized cost basis of our available-for-sale securities.
We provide more detailed information on our accounting for other-than-temporary impairment in Note 1, Summary of Significant Accounting Policies. Also refer to Consolidated Balance Sheet AnalysisTrading and Available-for-Sale Investment SecuritiesInvestments in Private-Label Mortgage-Related Securities for a discussion of other-than-temporary impairment recognized on our investments in Alt-A and subprime private-label securities. See Risk Factors for a discussion of the risks associated with possible future write-downs of our investment securities.
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 combined loss reserves, represent probable losses incurred in our guaranty book of business as of the balance sheet date. The allowance for loan losses is a valuation allowance that reflects an estimate of incurred credit losses related to our recorded investment in HFI loans. The reserve for guaranty losses is a liability account in our consolidated balance sheets that reflects an estimate of incurred credit losses related to our guaranty to each Fannie Mae MBS trust that we will supplement amounts received by the Fannie Mae MBS trust as required to permit timely payment of principal and interest on the related Fannie Mae MBS. As a result, the guaranty reserve considers not only the principal and interest due on the loan at the current balance sheet date, but also any additional interest payments due to the trust from the current balance sheet date up until the point of loan acquisition or foreclosure. We maintain separate loss reserves for single-family and multifamily loans. Our single-family and multifamily loss reserves consist of a specific loss reserve for individually impaired loans and a collective loss reserve for all other loans.
We have an established process, using analytical tools, benchmarks and management judgment, to determine our loss reserves. Although our loss reserve process benefits from extensive historical loan performance data, this process is subject to risks and uncertainties, including a reliance on historical loss information that may not be representative of current conditions. We continually monitor delinquency and default trends and make changes in our historically developed assumptions and estimates as necessary to better reflect the impact of present conditions, including current trends in borrower risk and/or general economic trends, changes in risk management practices, and changes in public policy and the regulatory environment. We also consider the recoveries that we will receive on mortgage insurance and other credit enhancements entered into contemporaneous with and in contemplation of a guaranty or loan purchase transaction, as such recoveries reduce the severity of the loss associated with defaulted loans. Because of the stress in the housing and credit markets, and the speed and extent of deterioration in these markets, our process for determining our loss reserves has become significantly more complex and involves a greater degree of management judgment than prior to this period of economic stress.
We establish a specific single-family loss reserve for individually impaired loans, which includes loans we restructure in a troubled debt restructuring, certain nonperforming loans in MBS trusts and acquired credit-impaired loans that have been further impaired subsequent to acquisition. The single-family loss reserve for individually impaired loans is a growing portion of the total single-family reserve and will continue to grow in conjunction with our modification efforts. We typically measure impairment based on the difference between our recorded investment in the loan and the present value of the estimated cash flows we expect to receive, which we calculate using the effective interest rate of the original loan or the effective interest rate at acquisition for credit-impaired loans. However, when foreclosure is probable, we measure impairment based on the difference between our recorded investment in the loan and the fair value of the underlying property, adjusted for the estimated discounted costs to sell the property and estimated insurance or other proceeds we expect to receive.
We establish a collective single-family loss reserve, which represents the majority of our total single-family loss reserve, for all other single-family loans in our single-family guaranty book of business using an econometric model that estimates the probability of default of loans to derive an overall loss reserve estimate given multiple factors such as: origination year, mark-to-market LTV ratio, delinquency status and loan product type. This model was implemented in the fourth quarter of 2009 to replace our previous model. Our previous model was used during 2008 and the first nine months of 2009 and was a loss curve-based model that was driven primarily by original LTV ratio, loan product type, the age of the mortgage loan and the performance to date of the vintage to which the loan belonged. The new model resulted in a decrease in our
single-family loss reserves as of December 31, 2009 of approximately $800 million relative to what the loss reserve would have been using the previous model.
We believe that the loss severity estimates used in determining our loss reserves reflect current available information on actual events and conditions as of each balance sheet date, including current home price and unemployment trends. Our loss severity estimates do not incorporate assumptions about future changes in home prices. We do, however, use a one-quarter look back period to develop our loss severity estimates for all loan categories. When using our previous model, we made adjustments to the period of default history used to estimate defaults for loans originated in 2006, 2007, and 2008, as well as some product types originated in 2005. Our new model, because it directly includes vintage effects in the estimation, does not require these adjustments.
Because the previous model was heavily dependent on changing default patterns, it was necessary to make adjustments to the loss curves to reflect the impacts of foreclosure moratoria and modification programs we implemented. Our new model directly uses delinquency status; therefore, it is no longer necessary to make these adjustments.
For the first three quarters of 2009, consistent with the approach we used as of December 31, 2008, we made adjustments to our model-generated results to capture incremental losses that may not have been fully reflected in our model related to geographically concentrated areas that are experiencing severe stress as a result of significant home price declines. These adjustments are no longer necessary because the new model captures the impact of mark-to-market LTV on default risk and captures the stress in those areas that have experienced significant home price declines. At the end of December 31, 2008 and the end of the first and second quarters of 2009, we also made adjustments to our model-generated results to capture incremental losses attributable to the sharp rise in unemployment during those quarters, which had not been fully captured in our prior model. We believe our new model incorporates the continuing high rate of unemployment.
We establish a specific multifamily loss reserve for multifamily loans that we determine are individually impaired. We use an internal credit-risk rating system and the delinquency status to evaluate the credit quality of our multifamily loans and to determine which loans we believe are impaired. Our risk-rating system assigns an internal rating through an assessment of the credit risk profile and repayment prospects of each loan, taking into consideration available operating statements and expected cash flows from the property, the estimated value of the property, the historical loan payment experience and current relevant market conditions that may impact credit quality. Because our multifamily loans are collateral-dependent, if we conclude that a multifamily loan is impaired, we measure the impairment based on the difference between our recorded investment in the loan and the fair value of the underlying property less the estimated discounted costs to sell the property. We generally obtain property appraisals from independent third-parties to determine the fair value of multifamily loans that we consider to be individually impaired. We also obtain property appraisals when we foreclose on a multifamily property.
The collective multifamily loss reserve for all other multifamily loans in our multifamily guaranty book of business is established using an internal model that applies loss factors to loans with similar risk ratings. Our loss factors are developed based on our historical data of default and loss severity experience. Management may also apply judgment to adjust the loss factors derived from our models, taking into consideration model imprecision and specifically known events, such as current credit conditions, that may affect the credit quality of our multifamily loan portfolio but are not yet reflected in our model-generated loss factors.
During the first and second quarters of 2009, we made several enhancements to the models used in determ