Fannie Mae 2001 Annual Report Download - page 68

{ 66 } Fannie Mae 2001 Annual Report
where Fannie Mae will receive fixed interest payments and
make variable interest payments, effectively creating callable
debt that reprices at a lower interest rate.
Financial Statement Impact
Fannie Mae records changes in the fair value of derivatives
used as fair value hedges in the fee and other income
(expense) line item on the income statement along with
offsetting changes in the fair value of the hedged items
attributable to the risk being hedged. Fannie Mae’s fair value
hedges produced no hedge ineffectiveness during the year
ended December 31, 2001.
Fannie Mae only includes changes in the intrinsic value
of receive-fixed swaptions in its assessment of hedge
effectiveness. Fannie Mae excludes changes in the time
value of receive-fixed swaptions used as fair value hedges
from the assessment of hedge effectiveness and records
them in purchased options expense on the income statement.
For the year ended December 31, 2001, Fannie Mae
recorded pre-tax purchased options expense of $3 million
in the income statement for the change in time value of
these contracts.
Credit Risk Associated with Derivative Activities
The primary credit risk associated with Fannie Mae’s
derivative transactions is that a counterparty might default
on its payments to Fannie Mae, which could result in
Fannie Mae having to replace derivatives with a different
counterparty at a higher cost. Fannie Mae reduces credit
risk on derivatives by dealing only with experienced
counterparties of high credit quality, generally executing
master agreements that provide for netting of certain
amounts payable by each party, requiring that counterparties
post collateral if the value of Fannie Mae’s gain positions
exceeds an agreed-upon threshold, and diversifying these
derivative instruments across counterparties. Fannie Mae
regularly monitors the exposures on its derivative
instruments by valuing the positions via dealer quotes and
internal pricing models. The exposure to credit loss for
derivative instruments can be estimated by calculating the
cost, on a present value basis, to replace at current market
rates all those derivative instruments outstanding for which
Fannie Mae was in a gain position.
Fannie Mae’s exposure (taking into account master
agreements) was $766 million at December 31, 2001, and
$182 million at December 31, 2000. Fannie Mae expects
the credit exposure to fluctuate as interest rates change.
Fannie Mae mitigates this credit exposure by requiring
collateral from counterparties based on counterparty credit
ratings and the level of credit exposure. Fannie Mae
generally requires overcollateralization from counterparties
whose credit ratings have dropped below predetermined
levels. Fannie Mae held $656 million of collateral through
custodians for derivative instruments at December 31, 2001
and $70 million of collateral at December 31, 2000.
Fannie Mae’s exposure, net of collateral, was $110 million
at year-end 2001 and $112 million at year-end 2000.
The following table provides a summary of counterparty
credit ratings for the exposure on derivatives in a gain
position at December 31, 2001.
Years to Maturity1Maturity Exposure
Less than 1 to Over Distribution Collateral Net of
Dollars in millions 1 Year 5 Years 5 Years Netting2Exposure Held Collateral
Derivative Credit Loss Exposure:
Credit Rating
AAA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ — $ 136 $(136) $ — $ — $ —
AA . . . . . . . . . . . . . . . . . . . . . . . . .— 43 671 (528) 186 95 91
A . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . — 43 826 (289) 580 561 19
Total . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $ — $ 86 $1,633 $(953) $766 $656 $110
1
Represents the exposure to credit loss on derivative instruments, which is estimated by calculating the cost, on a present value basis, to replace all outstanding derivative contracts in a gain position. Reported on a
net-by-counterparty basis where a legal right of offset exists under an enforceable master settlement agreement. Derivative gains and losses with the same counterparty in the same maturity category are presented net
within the maturity category.
2
Represents impact of netting of derivatives in a gain position and derivatives in a loss position for the same counterparty across maturity categories.
At December 31, 2001, over 99 percent of the notional
amount of Fannie Mae’s outstanding derivative
transactions was with counterparties rated A or better by
Standard & Poor’s (73 percent with counterparties rated
AA or better). At December 31, 2001, eight counterparties
represented approximately 78 percent of the total notional
amount of outstanding derivative transactions, and each
had a credit rating of A or better (70 percent of this notional
amount was held by counterparties with a credit rating
of AA or better).
At December 31, 2001, 100 percent of Fannie Mae’s
exposure on derivatives in a gain position excluding collateral
held was with counterparties rated A or better by Standard &
Poor’s. 83 percent of Fannie Mae’s exposure, net of collateral,