Fannie Mae 2006 Annual Report Download - page 38

COMPANY RISKS
We are subject to credit risk relating to both the mortgage assets that we hold in our portfolio and the
mortgage loans that back our Fannie Mae MBS, and any resulting delinquencies and credit losses could
adversely affect our financial condition, liquidity and results of operations.
We are exposed to credit risk on our mortgage credit book of business because either we hold the mortgage
assets in our portfolio, which consists of mortgage loans, Fannie Mae MBS and non-Fannie Mae mortgage-
related securities, or we have issued a guaranty in connection with the creation of Fannie Mae MBS backed by
mortgage assets. Borrowers of mortgage loans that we own or that back our Fannie Mae MBS or non-Fannie
Mae mortgage-related securities may fail to make the required payments of principal and interest on those
loans, exposing us to the risk of credit losses. Factors that affect the level of our risk of credit losses include
the financial strength and credit profile of the borrower, the structure of the loan, the type and characteristics
of the property securing the loan, and local, regional and national economic conditions.
For example, loans that have unpaid principal balances that are high in relation to the value of the property,
which are commonly referred to as loans with high loan-to-value (“LTV”) ratios, generally tend to have a
higher risk of default and, if a default occurs, a greater risk that the amount of the gross loss will be high
compared to loans with lower LTV ratios. The LTV ratio of an outstanding mortgage loan changes as the
unpaid principal balance of the loan and the value of the property securing the loan change. Depending on the
structure of the loan, the unpaid principal balance of the loan may increase or decrease over time. Similarly,
depending on local, regional and national economic conditions, or the underlying supply and demand for
housing, the value of the property securing the loan may increase or decrease over time. As of December 31,
2006, approximately 10% of our conventional single-family mortgage credit book of business consisted of
loans with a mark-to-market estimated loan-to-value ratio greater than 80%.
The proportion of higher risk mortgage loans that were originated in the market between 2003 and mid-2006
increased significantly. As a result, our purchase and securitization of loans that pose a higher credit risk, such
as negative-amortizing adjustable-rate mortgages (“ARMs”), interest-only loans and subprime mortgage loans,
also increased, although to a lesser degree than many other institutions. In addition, we increased the
proportion of reduced documentation loans that we purchased to hold or to back our Fannie Mae MBS.
For example, negative-amortizing ARMs represented approximately 3% of our conventional single-family
business volume in both 2005 and 2006. Interest-only ARMs represented approximately 9% of our
conventional single-family business volume in both 2005 and 2006, and approximately 7% as of June 30,
2007. Negative-amortizing ARMs and interest-only ARMs together represented approximately 6% of our
conventional single-family mortgage credit book of business as of December 31, 2005, December 31, 2006,
and June 30, 2007.
We also estimate that approximately 12% and 11% of our single-family mortgage credit book of business as
of June 30, 2007 and December 31, 2006, respectively, consisted of Alt-A mortgage loans or structured Fannie
Mae MBS backed by Alt-A mortgage loans, and approximately 1% of our single-family mortgage credit book
of business consisted of private-label mortgage-related securities backed by Alt-A mortgage loans, including
resecuritizations, as of both June 30, 2007 and December 31, 2006. We estimate that subprime loans
represented approximately 2.2% of our single-family mortgage credit book of business as of both June 30,
2007 and December 31, 2006, of which approximately 0.2% consisted of subprime mortgage loans or
structured Fannie Mae MBS backed by subprime mortgage loans and approximately 2% consisted of private-
label mortgage-related securities backed by subprime mortgage loans, including resecuritizations.
We expect to experience increased delinquencies and credit losses in 2007 compared with 2006, and the
increase in our exposure to credit risk resulting from our purchase or securitization of loans with higher credit
risk may cause a further increase in the delinquencies and credit losses we experience. An increase in the
delinquencies and credit losses we experience is likely to reduce our earnings during that period and also
could adversely affect our financial condition.
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