Fannie Mae 2006 Annual Report Download - page 88

Other Non-Interest Expenses
Other Expenses
Other expenses include credit enhancement expenses that relate to the amortization of the credit enhancement
asset we record at inception of certain guaranty contracts, costs associated with the purchase of additional
mortgage insurance to protect against credit losses, regulatory penalties and other miscellaneous expenses.
Other expenses totaled $395 million, $251 million and $607 million in 2006, 2005 and 2004, respectively.
The $144 million increase in other expenses in 2006 over 2005 was attributable to higher credit enhancement
expense, due in part to our acquisition of insurance coverage related to our increased purchase of
nontraditional mortgage products that we believe may present higher credit risk, such as Alt-A and subprime
loans. In addition, we dissolved an MBS trust in 2006 for which we had a remaining unamortized credit
enhancement asset as of the date of dissolution of $126 million. We were required to recognize this
unamortized amount as credit enhancement expense in 2006. The $356 million decrease in other expenses in
2005 from 2004 was attributable to the $400 million civil penalty that we accrued in 2004 and paid to the
U.S. Treasury in 2006 pursuant to our settlements with OFHEO and the SEC.
Provision for Federal Income Taxes
Our effective income tax rate, excluding the provision or benefit for taxes related to extraordinary amounts,
was reduced below the 35% statutory rate to 4%, 17% and 17% in 2006, 2005 and 2004, respectively. The
difference between the statutory rate and our effective tax rate is primarily due to the tax benefits we receive
from our investments in LIHTC partnerships that help to support our affordable housing mission. As disclosed
in “Notes to Consolidated Financial Statements—Note 11, Income Taxes,” our effective tax rate would have
been 29%, 30% and 32% in 2006, 2005 and 2004, respectively, if we had not received the tax benefits from
our investments in LIHTC partnerships.
The variance in our effective income tax rate over the past three years is primarily due to the combined effect
of fluctuations in our pre-tax income, which affects the relative tax benefit of tax-exempt income and tax
credits, and an increase in the actual dollar amount of tax credits.
The extent to which we are able to use all of the tax credits generated by existing or future investments in
housing tax credit partnerships to reduce our federal income tax liability will depend on the amount of our
future federal income tax liability, which we cannot predict with certainty. In addition, our ability to use tax
credits in any given year may be limited by the corporate alternative minimum tax rules, which ensure that
corporations pay at least a minimum amount of federal income tax annually. We were not able to use all the
tax credits we received for 2006 and 2005 in the year the credits were generated because our income tax
liability, after applying all such credits, would have been reduced below the minimum tax amount. We were
able to apply a portion of the 2005 unused credits to reduce our income tax liability for 2004 and expect to
use the remainder for 2006. We expect to use the remaining credits generated in 2006 in future years, to the
extent permissible. Because we plan to continue investing in LIHTC partnerships, we expect tax credits related
to these investments to grow in the future, which is likely to significantly reduce our effective tax rate below
the 35% statutory rate assuming we are able to use all of the tax credits generated. If we are limited in our use
of the tax credits related to these investments and we conclude that the economic return from selling the
investment is likely to be greater than the benefit we would receive from continuing to hold these investments,
we may also sell certain LIHTC investments, as we did in 2007.
We recorded a net deferred tax asset of $8.5 billion and $7.7 billion as of December 31, 2006 and 2005,
respectively, arising principally from differences in the timing of the recognition of derivatives fair value gains
and losses for financial statement and income tax purposes. We have not recorded a valuation allowance
against our net deferred tax asset as we anticipate it is more likely than not that the results of future operations
will generate sufficient taxable income to allow us to realize the entire tax benefit.
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