Fannie Mae 2002 Annual Report Download - page 113

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FANNIE MAE 2002 ANNUAL REPORT
Portfolio Investment Business: The Portfolio Investment
business has two principal components: a mortgage
investment portfolio and a liquid investment portfolio (LIP).
The mortgage investment portfolio purchases mortgage
loans, mortgage-related securities, and other investments
from lenders, securities dealers, and other market
participants. The LIP serves as an alternative source of funds
to meet our cash flow needs by investing in high quality,
short-term and medium-term investments that provide an
ongoing supply of funds that can be used as necessary for
liquidity or reinvestment, or readily marketable, high credit
quality securities that can be sold to raise cash. We fund the
purchase of the assets in our Portfolio Investment business
by issuing debt in the global capital markets. The Portfolio
Investment business generates profits by ensuring that the
interest income from the mortgages, MBS, mortgage-related
securities, and liquid investments we purchase is greater
than our borrowing costs. A primary measure of profitability
for the Portfolio Investment business is our net interest
margin. Our net interest margin reflects the difference
between taxable-equivalent income on our mortgage assets
and nonmortgage investments and our borrowing expense,
divided by average interest earning assets.
Our Portfolio Investment business focuses on managing
Fannie Mae’s interest rate risk. Interest rate risk is the risk
that changes in interest rates could change cash flows on
our mortgage assets and debt in a way that adversely affects
Fannie Mae’s earnings or long-term value.
Credit Guaranty Business: Our Credit Guaranty business
has primary responsibility for managing all of our mortgage
credit risk. Credit risk is the risk of loss to future earnings
and future cash flows that may result from the failure of
a borrower or counterparty to fulfill their contractual
obligation to Fannie Mae. The Credit Guaranty business
primarily generates income from guaranty fees for
guaranteeing the timely payment of scheduled principal
and interest on mortgage-related securities we guarantee
that are not owned by the Portfolio Investment business.
The primary source of income for the Credit Guaranty
business is the difference between the guaranty fees earned
and the costs of providing this service. Income is also
allocated to the Credit Guaranty business for the
following activities:
•Managing the credit risk on mortgage-related assets
held by the Portfolio Investment business
•Providing capital to the Portfolio Investment business
•Temporarily investing principal and interest payments
on loans underlying MBS prior to remittance
to investors
Our Credit Guaranty business manages Fannie Mae’s
mortgage credit risk by managing the profile and quality
of mortgages in the mortgage credit book of business, using
credit enhancements to reduce our losses, assessing the
sensitivity of credit losses to changes in economic conditions,
and aggressively managing problem assets to mitigate losses.
We assign actual direct revenues and expenses among
our two lines of business. We use estimates to apportion
overhead and other corporate items. For example, we allocate
administrative expenses as direct expenses for the line of
business. If we cannot allocate expenses to a particular
business, we base the allocation on revenues, profits, or
volumes as applicable. We allocate capital to the lines of
business through an assessment of the interest rate risk
and credit risk associated with each business.
Core Business Earnings: The difference between core
business earnings and reported net income relates to the
FAS 133 accounting treatment for purchased options. Core
business earnings does not exclude any other accounting
effects related to the application of FAS 133 or any other
non-FAS 133 related adjustments. The guaranty fee income
that we allocate to the Credit Guaranty business for
managing the credit risk on mortgage-related assets
held by the Portfolio Investment business is offset by
a corresponding guaranty fee expense allocation to the
Portfolio Investment business in our line of business results.
Thus, there is no reconciling adjustment between our total
line of business guaranty fee income and our reported
guaranty fee income. We allocate transaction fees received
for structuring and facilitating securities transactions for our
customers primarily to our Portfolio Investment business.
We allocate technology-related fees received for providing
Desktop Underwriter and other online services and fees
received for providing credit enhancement alternatives to
our customers primarily to our Credit Guaranty business.
The following table shows our line of business results for
the years ended December 31, 2002, 2001, and 2000, and
reconciles total core business earnings to reported
GAAP results.