Fannie Mae 2004 Annual Report Download - page 110

offset by a reduction in our borrowing costs, as we redeemed callable debt and issued new debt at lower
interest rates.
Since year-end 2004, we have experienced a decrease in the volume of our interest-earning assets as well as in
the spread between the average yield on these assets and our borrowing costs, which we expect to result in a
reduction in our net interest income and net interest yield in 2005 and 2006.
Guaranty Fee Income
Guaranty fee income primarily consists of contractual guaranty fees related to Fannie Mae MBS held in our
portfolio and held by third-party investors, adjusted for the amortization of upfront fees and impairment of
guaranty assets, net of a proportionate reduction in the related guaranty obligation and deferred profit, and
impairment of buy-ups.
Guaranty fee income is primarily affected by the amount of outstanding Fannie Mae MBS and the
compensation we receive for providing our guaranty on Fannie Mae MBS. The amount of compensation we
receive and the form of payment varies depending on factors such as the risk profile of the securitized loans,
the level of credit risk we assume and the negotiated payment arrangement with the lender. Our payment
arrangements may be in the form of an upfront exchange of payments, an ongoing payment stream from the
cash flows of the MBS trusts, or a combination. We typically negotiate a contractual guaranty fee with the
lender and collect the fee on a monthly basis based on the contractual fee rate multiplied by the unpaid
principal balance of loans underlying a Fannie Mae MBS issuance. In lieu of charging a higher contractual fee
rate for loans with greater credit risk, we may require that the lender pay an upfront fee to compensate us for
assuming the additional credit risk. We refer to this payment as a risk-based pricing adjustment. We also may
adjust the monthly contractual guaranty fee rate so that the pass-through coupon rates on Fannie Mae MBS are
in more easily tradable increments of a whole or half percent by making an upfront payment to the lender
(“buy-up”) or receiving an upfront payment from the lender (“buy-down”).
As we receive monthly contractual payments for our guaranty obligation, we recognize guaranty fee income.
We defer upfront risk-based pricing adjustments and buy-down payments that we receive from lenders and
recognize these amounts as a component of guaranty fee income over the expected life of the underlying
assets of the related MBS trusts. We record buy-up payments we make to lenders as an asset and reduce the
recorded asset as cash flows are received over the expected life of the underlying assets of the related MBS
trusts. We assess buy-ups for other-than-temporary impairment and include any impairment recognized as a
component of guaranty fee income. The extent to which we amortize deferred payments into income depends
on the rate of expected prepayments, which is affected by interest rates. In general, as interest rates decrease,
expected prepayment rates increase, resulting in accelerated accretion into income of deferred fee amounts,
which increases our guaranty fee income. Prepayment rates also affect the estimated fair value of buy-ups.
Faster than expected prepayment rates shorten the average expected life of the underlying assets of the related
MBS trusts, which reduces the value of our buy-up assets and may trigger the recognition of other-than
temporary impairment.
The average effective guaranty fee rate reflects our average contractual guaranty fee rate adjusted for the
impact of amortization of deferred amounts and buy-up impairment. Table 15 shows our guaranty fee income,
including and excluding buy-up impairments, our average effective guaranty fee rate, and Fannie Mae MBS
activity for 2004, 2003 and 2002.
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