Fannie Mae 2002 Annual Report Download - page 118

116 FANNIE MAE 2002 ANNUAL REPORT
Financial Statement Impact
We record changes in the fair value of derivatives used as fair
value hedges in the “Fee and other income, net” line item on
the income statement along with offsetting changes in the
fair value of the hedged items attributable to the risk being
hedged. Our fair value hedges produced hedge
ineffectiveness totaling $.2 million of expense during the
year ended December 31, 2002. Our fair value hedges
produced no hedge ineffectiveness during the year ended
December 31, 2001.
We only include changes in the intrinsic value of swaptions
in our assessment of hedge effectiveness. We exclude changes
in the time value of receive-fixed swaptions used as fair value
hedges from the assessment of hedge effectiveness and record
them in the “Purchased options expense” line item on the
income statement. For the years ended December 31, 2002
and 2001, we recorded pre-tax purchased options expense of
$1.97 billion and $3 million, respectively, in the income
statement for the change in the time value of these contracts.
Foreign Currency Hedges
Fannie Mae uses derivatives to hedge foreign currency
exposure on debt issued in a foreign currency. Because all
of our assets are denominated in U.S. dollars, we enter into
currency swaps to effectively convert the foreign currency
debt into U.S. dollars. Our foreign denominated debt is not
material, representing .5 percent of total debt outstanding.
14. Financial Instruments with Off-Balance-Sheet
Risk
We are involved in financial instrument transactions that
create off-balance-sheet risk. We enter into these
transactions to fulfill our statutory purpose of meeting the
financing needs of the secondary residential mortgage
market and to reduce our own exposure to interest rate
fluctuations. These financial instruments include guaranteed
MBS and other mortgage-related securities, commitments
to purchase mortgage portfolio assets or to issue and
guarantee MBS, and credit enhancements. These
instruments involve elements of credit and interest rate risk
in excess of amounts recognized on the balance sheet to
varying degrees.
Guaranteed MBS and Mortgage-Related Securities
As guarantor of MBS, we are obligated to disburse scheduled
monthly installments of principal and interest at the
certificate rate plus the UPB of any foreclosed mortgage to
MBS investors whether or not they have been received. We
are paid a guaranty fee for assuming this credit risk. We also
are obligated to disburse unscheduled principal payments
received from borrowers on MBS. The borrower, lender, or
Fannie Mae may purchase credit enhancements, such as
mortgage insurance, to protect against the risk of loss from
borrower default. Occasionally, lenders may elect to remain
at risk for the loans underlying MBS through recourse
arrangements. Lenders that keep recourse retain the primary
default risk, in whole or in part, in exchange for a lower
guaranty fee. We may also enter into other credit
enhancement arrangements. Fannie Mae, however, bears
the ultimate risk of default on MBS. To a much more limited
extent, we guarantee the payment of principal and interest
on other mortgage-related securities.
At December 31, 2002, the maximum potential amount of
future principal payments we could be required to make
under our guarantee of MBS and other mortgage-related
securities was $1.029 trillion. We have recognized a liability
of $471 million at year-end 2002 for these guaranty
obligations based on our estimate of probable credit losses
in the loans underlying MBS and other mortgage-related
securities as of December 31, 2002.
In the event we were required to make the maximum amount
of future payments under the guarantees, we would first
pursue recovering these payments by proceeding against the
underlying collateral of the loans. If the value of the collateral
was less than the payments made under our guarantees, then
we would recover payments from third-party providers of
credit enhancements. In the event that the principal amount
of single-family loans exceeds the value of the underlying
properties, then we have credit enhancements with maximum
coverage totaling $66.1 billion in primary mortgage
insurance, $7.0 billion in pool insurance, and $31.5 billion
in full recourse to lenders on single-family loans. If the
collateral proceeds for multifamily loans were insufficient,
then we have credit enhancements totaling $4.2 billion in
recourse to multifamily lenders.
Commitments
We enter into master delivery commitments with lenders on
either a mandatory or an optional basis. Under a mandatory
master commitment, a lender must either deliver loans under
an MBS contract at a specified guaranty fee rate or enter into
a mandatory portfolio commitment with the yield established
upon executing the portfolio commitment.
We will also accept mandatory or lender-option delivery
commitments not issued pursuant to a master commitment.
These commitments may be for purchases for our mortgage
portfolio or for issuances of our MBS. The guaranty fee rate
on MBS lender-option commitments is specified in the
contract, while the yield for portfolio lender-option