Fannie Mae 2004 Annual Report Download - page 162

We were the beneficiary of primary mortgage insurance coverage on $285.4 billion of single-family loans in
portfolio or underlying Fannie Mae MBS as of December 31, 2004, which represented approximately 13% of
our single-family mortgage credit book of business, compared with $308.8 billion, or approximately 15%, of
our single-family mortgage credit book of business as of December 31, 2003. Seven mortgage insurance
companies, all rated AA (or its equivalent) or higher by Standard & Poor’s, Moody’s or Fitch, provided
approximately 99% of the total coverage as of both December 31, 2004 and 2003.
Debt Security and Mortgage Dealers
The primary credit risk associated with dealers who commit to place our debt securities is that they will fail to
honor their contracts to take delivery of the debt, which could result in delayed issuance of the debt through
another dealer. The primary credit risk associated with dealers who make forward commitments to deliver
mortgage pools to us is that they may fail to deliver the agreed-upon loans to us at the agreed-upon date,
which could result in our having to replace the mortgage pools at higher cost to meet a forward commitment
to sell the MBS.
Mortgage Originators and Investors
We are routinely exposed to pre-settlement risk through the purchase, sale and financing of mortgage loans
and mortgage-related securities with mortgage originators and mortgage investors. The risk is the possibility
that the market moves against us at the same time the counterparty is unable or unwilling to either deliver
mortgage assets or pay a pair-off fee. On average, the time between trade and settlement is about 35 days. We
manage this risk by determining position limits with these counterparties, based upon our assessment of their
creditworthiness, and we monitor and manage these exposures. Based upon this assessment, we may, in some
cases, require counterparties to post collateral.
Liquid Investment Portfolio
The primary credit exposure associated with investments held in our liquid investment portfolio is that issuers
will not repay principal and interest in accordance with the contractual terms. We believe the risk of default is
low because we restrict these investments to high credit quality short- and medium-term instruments, such as
commercial paper, asset-backed securities and corporate floating rate notes, which are broadly traded in the
financial markets. Our non-mortgage securities, which account for the majority of our liquid assets, totaled
$43.9 billion and $46.8 billion as of December 31, 2004 and 2003, respectively. Approximately 93% and 88%
of our non-mortgage securities as of December 31, 2004 and 2003, respectively, had a credit rating of A (or
its equivalent) or higher, based on the lowest of Standard & Poor’s, Moody’s or Fitch ratings. We monitor the
fair value of these securities and regularly evaluate any impairment to assess whether the impairment is
required to be recognized in earnings because it is considered other than temporary.
Derivatives Counterparties
The primary credit exposure that we have on a derivative transaction is that a counterparty will default on
payments due, which could result in us having to acquire a replacement derivative from a different
counterparty at a higher cost. Our derivative credit exposure relates principally to interest rate and foreign
currency derivative contracts. Typically, we manage this exposure by contracting with experienced counter-
parties that are rated A (or its equivalent) or better. These counterparties consist of large banks, broker-dealers
and other financial institutions that have a significant presence in the derivatives market, most of which are
based in the United States. As an additional precaution, we have a conservative collateral management policy
with provisions for requiring collateral on aggregate gain positions with each interest rate and foreign currency
derivative counterparty. Also, we enter into master agreements that provide for netting of amounts due to us
and amounts due to counterparties under those agreements. We monitor credit exposure on these derivative
contracts daily and make collateral calls daily based on the results of our internal models and dealer quotes.
To date, we have never experienced a loss on a derivative transaction due to credit default by a counterparty.
Counterparties use the notional amounts of derivative instruments as the basis from which to calculate
contractual cash flows to be exchanged. However, the notional amount is significantly greater than the
potential market or credit loss that could result from such transactions and therefore does not represent our
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