Fannie Mae 2006 Annual Report Download - page 80

Losses on Certain Guaranty Contracts
While our guaranty fees are subject to competitive pressure and we may enter into transactions with lower
expected economic returns than our typical transactions to achieve our housing goals or to maintain our
market share, we expect the vast majority of our MBS guaranty transactions to generate positive economic
returns over the lives of the related MBS. We negotiate guaranty contracts with our customers based upon our
view of the overall economics of the transaction; however, the accounting for our guaranty-related assets and
liabilities is not determined at the contract level. Instead, it is determined separately for each individual MBS
issuance. We recognize an immediate loss in earnings on new credit guaranteed Fannie Mae MBS issuances
where our modeled expectation of returns is below what we believe a market participant would require for that
credit risk inclusive of a reasonable profit margin. Although we determine losses at an individual MBS
issuance level, we largely price our credit guaranty business on an overall contract basis and establish a single
guaranty fee for all the loans included in the contract. Accordingly, a guaranty transaction may result in some
loan pools for which we recognize a loss immediately in earnings and other loan pools for which we record
deferred profits that are recognized as a component of guaranty fee income over the life of the loans
underlying the MBS issuance. We expect that we will subsequently recover the losses recognized at inception
on certain guaranty contracts in our consolidated statements of income over time in proportion to our receipt
of contractual guaranty fees on those guaranties.
The losses on guaranty transactions that we were required to recognize immediately in earnings totaled
$439 million, $146 million and $111 million in 2006, 2005 and 2004, respectively. The increase in these
losses in 2006 was driven primarily by the slowdown in home price appreciation in 2006, which resulted in an
increase in our modeled expectation of credit risk and higher initial losses on some of our guaranty pools. In
addition, our expanded efforts to increase the amount of mortgage financing that we make available to target
populations and geographic areas to support our housing goals contributed to the increase in losses during
2006. Because of the likelihood that home prices will continue to decline in 2007, as well as our continued
investment in loans that support our housing goals, we expect these losses to more than double in 2007
from 2006.
Fee and Other Income
Fee and other income includes transaction fees, technology fees, multifamily fees and foreign currency
exchange gains and losses. Transaction, technology and multifamily fees are largely driven by business
volume, while foreign currency exchange gains and losses are driven by fluctuations in exchange rates on our
foreign-denominated debt. Table 7 displays the components of fee and other income.
Table 7: Fee and Other Income
2006 2005 2004
For the Year Ended December 31,
(Dollars in millions)
Transaction fees ................................................ $124 $ 136 $152
Technology fees ................................................ 216 223 214
Multifamily fees ................................................ 292 432 244
Foreign currency exchange gains (losses) .............................. (230) 625 (304)
Other ........................................................ 457 110 98
Fee and other income . . . ....................................... $859 $1,526 $ 404
The $667 million decrease in fee and other income in 2006 from 2005 was primarily due to a foreign currency
exchange loss of $230 million in 2006, compared with a foreign currency exchange gain of $625 million in
2005. The $625 million foreign currency gain recorded in 2005 stemmed from a strengthening of the
U.S. dollar relative to the Japanese yen. In addition, we experienced a $140 million decrease in multifamily
fees due to a reduction in refinancing volumes, which were significantly higher in 2005 than in 2006 or 2004.
These decreases were partially offset by a $347 million increase in other fee income, of which $191 million
was due to the recognition of defeasance fees on consolidated multifamily loans and $111 million was due to
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