Fannie Mae 2001 Annual Report Download - page 66

Holders of preferred stock are entitled to receive
noncumulative, quarterly dividends when, and if, declared by
Fannie Mae’s Board of Directors. Payment of dividends on
preferred stock is not mandatory, but has priority over
payment of dividends on common stock. After the specified
period, preferred stock is redeemable at its stated value at
the option of Fannie Mae. All outstanding preferred stock
is nonvoting.
13. Derivative Instruments and
Hedging Activities
Fannie Mae issues various types of debt to finance the
acquisition of mortgages. Fannie Mae typically uses
derivative instruments, such as interest rate swaps, swaptions,
interest rate caps, deferred rate-setting agreements, and
foreign currency swaps, to hedge against the impact of
interest rate movements on its debt costs to preserve its
mortgage-to-debt interest spreads. Fannie Mae does not
engage in trading or other speculative use of derivative
instruments.
Swaps provide for the exchange of fixed and variable interest
payments based on contractual notional principal amounts.
These may include callable swaps, which give counterparties
or Fannie Mae the right to terminate interest rate swaps
before their stated maturities, and foreign currency swaps,
in which Fannie Mae and counterparties exchange payments
in different types of currencies. Basis swaps provide for the
exchange of variable payments that have maturities similar to
hedged debt, but the payments are based on different interest
rate indices. Swaptions give Fannie Mae the option to enter
into swaps at a future date, thereby mirroring the economic
effect of callable debt. Interest rate caps provide ceilings on
the interest rates of variable-rate debt.
Fannie Mae formally documents all relationships between
hedging instruments and the hedged items, including the
risk-management objective and strategy for undertaking
various hedge transactions. Fannie Mae links all derivatives
to specific assets and liabilities on the balance sheet or to
specific forecasted transactions and designates them as cash
flow or fair value hedges. Fannie Mae also formally assesses,
both at the hedge’s inception and on an ongoing basis,
whether the derivatives that are used in hedging transactions
are highly effective in offsetting changes in the cash flows or
fair values of the hedged items.
The following table reflects the hedge classification of the
notional balances of derivatives by type that were held by
Fannie Mae at December 31, 2001.
2001
Fair Value Cash Flow
Dollars in millions Hedges Hedges Total
Interest rate swaps:
Pay-fixed . . . . . . . . . . . . . . . . . . . $ 7,063 $206,617 $213,680
Receive-fixed & basis . . . . . . . . 10,989 75,134 86,123
Interest rate caps. . . . . . . . . . . . . . . . —75,893 75,893
Swaptions:
Pay-fixed . . . . . . . . . . . . . . . . . . . —69,650 69,650
Receive-fixed . . . . . . . . . . . . . . . 74,400 — 74,400
Other1. . . . . . . . . . . . . . . . . . . . . . . . 8,843 4,550 13,393
Total . . . . . . . . . . . . . . . . . . . . . . . . . . $101,295 $431,844 $533,139
1Includes foreign currency swaps, forward starting swaps, and asset swaps.
Fannie Mae discontinues hedge accounting prospectively
when (1) it determines that the derivative is no longer
effective in offsetting changes in the cash flows or fair value
of a hedged item; (2) the derivative expires or is sold,
terminated, or exercised; (3) the derivative is dedesignated
as a hedge instrument because it is unlikely that a forecasted
transaction will occur; or (4) it determines that designation of
the derivative as a hedge instrument is no longer appropriate.
Cash Flow Hedges
Objectives and Context
Fannie Mae employs cash flow hedges to lock in the interest
spread on purchased assets by hedging existing variable-rate
debt and forecasted issuances of debt through its Benchmark
Program. The issuance of short-term Discount Notes and
variable-rate long-term debt during periods of rising interest
rates can result in a mismatch of cash flows relative to
fixed-rate mortgage assets. Management minimizes the
risk of mismatched cash flows by converting variable-rate
interest expense to fixed-rate interest expense to lock-in
Fannie Mae’s funding costs.
Risk Management Strategies and Policies
To meet these objectives, Fannie Mae enters into interest
rate swaps, swaptions, and caps to hedge the variability of
cash flows resulting from changes in interest rates.
Fannie Mae enters into pay-fixed interest rate swaps to hedge
the interest rate risk associated with issuing debt after
committing to purchase assets.
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