Fannie Mae 2002 Annual Report Download - page 40

38 FANNIE MAE 2002 ANNUAL REPORT
Low mortgage rates boosted originations of fixed-rate
mortgages in the primary market to record levels in 2002.
However, during the first half of 2002, primary market
lenders retained a higher than traditional level of mortgage
loans in their own portfolios. The demand for mortgage
investments also increased among other secondary market
participants. We believe this occurrence was in response to
equity market volatility and the perceived safety of mortgage-
related investments in a period of significant uncertainty
about the impact of the economy on corporate
creditworthiness. In addition, the steep yield curve lowered
borrowing costs for banks and other primary market
participants, which made it more attractive to hold mortgage
investments. The increased competition for mortgages in
the first half of 2002 resulted in tighter spreads between
mortgage yields and our debt costs (mortgage-to-debt
spreads), which slowed our overall portfolio growth. Our
portfolio growth accelerated in the second half of the year
as a sharp drop in mortgage rates sparked a refinancing wave
that increased the supply of mortgages in the secondary
market and generated wider mortgage-to-debt spreads.
We substantially increased our mortgage commitments in
response to these more attractive spreads. We also
experienced higher portfolio growth in 2001 because of
attractive mortgage-to-debt spreads stemming from an
increased supply of mortgage assets in the secondary market
because of a reduction in intermediate-term rates that
boosted mortgage refinancings and originations.
The sharp decline in short-term interest rates relative to
long-term interest rates during 2001 resulted in a steeper
yield curve that persisted throughout 2002. Our net interest
margin in 2002 continued to benefit from actions taken
during 2001 in response to opportunities presented by the
unusually steep yield curve and low short-term interest rates.
The Portfolio Investment business was able to replace
significant amounts of called or maturing debt in 2001 with
lower cost, shorter-term debt more quickly than our
mortgage assets matured or prepaid. These actions
temporarily reduced our debt cost relative to asset yield and
elevated our net interest margin in 2001. Our net interest
margin remained elevated in 2002 as the unusually steep yield
curve and low interest rate environment persisted, and we
called or otherwise retired additional high-cost debt.
Primary investing activities for the Portfolio Investment
business include purchasing mortgage loans, mortgage-
related securities, and other investments from lenders,
securities dealers, investors, and other market participants.
The Portfolio Investment business also issues real estate
mortgage investment conduits (REMICs), Megas, and
Stripped MBS (SMBS) as a source of fee income. The
Portfolio Investment business maintains the LIP, which
consists of nonmortgage investments and serves as an
alternative source of liquidity and an investment vehicle for
our surplus capital. Our primary financing activities involve
issuing various debt securities to fund our mortgage
purchases and other business activities.
Mortgage Portfolio
Our mortgage portfolio includes whole loan mortgages,
mortgage-related securities, and other mortgage
investments, including other agency securities purchased
from lenders, securities dealers, investors, and other market
participants. We grew our net mortgage portfolio by
13 percent to $798 billion at December 31, 2002. In
comparison, we expanded our net mortgage portfolio by
16 percent in 2001. We grew our portfolio more selectively
and at a slower pace in 2002 in accordance with our
disciplined approach to growth because of tighter mortgage-
to-debt spreads during the first half of 2002. Table 8 shows
the distribution of Fannie Mae’s mortgage portfolio by
product type.