Fannie Mae 2004 Annual Report Download

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
Commission File No.: 0-50231
Federal National Mortgage Association
(Exact name of registrant as specified in its charter)
Fannie Mae
Federally chartered corporation 52-0883107
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
3900 Wisconsin Avenue,
NW Washington, DC
(Address of principal executive offices)
20016
(Zip Code)
Registrant’s telephone number, including area code:
(202) 752-7000
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes nNo ¥
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the
Act. Yes nNo ¥
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes nNo ¥
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. n
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-
accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer ¥Accelerated filer nNon-accelerated filer n
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes nNo ¥
The aggregate market value of the common stock held by non-affiliates of the registrant computed by
reference to the price at which the common stock was last sold on June 30, 2006 (the last business day of the
registrant’s most recently completed second fiscal quarter) was approximately $46,790 million.
As of October 31, 2006, there were 975,052,687 shares of common stock of the registrant outstanding.

Table of contents

  • Page 1
    ...10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2004 Commission File No.: 0-50231 Federal National Mortgage Association (Exact name of registrant as specified in its charter) Fannie Mae Federally chartered corporation...

  • Page 2
    ... Results of Operations ...Organization of MD&A ...Executive Summary ...Restatement ...Critical Accounting Policies and Estimates ...Consolidated Results of Operations ...Business Segment Results...Supplemental Non-GAAP Information-Fair Value Balance Sheet ...Risk Management ...Liquidity and Capital...

  • Page 3
    ... Over Financial Reporting ...Report of Independent Registered Public Accounting Firm ...Item 9B. Other Information ... ... 198 198 199 204 211 213 213 213 220 233 237 239 PART III...Item 10. Directors and Executive Officers of the Registrant ...Item 11. Executive Compensation...Item 12. Security...

  • Page 4
    ... and Average Yield of Investments in Securities ...Non-GAAP Supplemental Consolidated Fair Value Balance Sheets ...Selected Market Information...Composition of Mortgage Credit Book of Business ...Risk Characteristics of Conventional Single-Family Mortgage Credit Book ...Risk Characteristics of...

  • Page 5
    ...45 46 47 48 Activity and Maturity Data for Risk Management Derivatives ...Interest Rate Sensitivity of Net Asset Fair Value ...Debt Activity ...Outstanding Short-Term Borrowings ...Fannie Mae Debt Credit Ratings ...Contractual Obligations ...Regulatory Capital Surplus/Deficit ...On- and Off-Balance...

  • Page 6
    ...corporation, and our business is self-sustaining and funded exclusively with private capital. Our common stock is listed on the New York Stock Exchange and traded under the symbol "FNM." Our debt securities are actively traded in the over-the-counter market. FINANCIAL RESTATEMENT, REGULATORY REVIEWS...

  • Page 7
    ... year ended December 31, 2003; and • a $1.2 billion net increase in earnings for the six months ended June 30, 2004. We previously estimated that errors in accounting for derivative instruments, including mortgage commitments, would result in a total of $10.8 billion in after-tax cumulative losses...

  • Page 8
    ... which we issued the consolidated financial statements that have been restated, including our Chief Financial Officer and Controller, and we hired a new General Counsel, Chief Risk Officer, Chief Audit Executive and Chief Compliance Officer. Our Board of Directors also appointed Stephen B. Ashley as...

  • Page 9
    ... these Fannie Mae MBS. We also issue some forms of mortgage-related securities for which we do not provide this guaranty. The mortgage market has experienced strong long-term growth. According to Federal Reserve estimates, total U.S. residential mortgage debt outstanding has increased each year from...

  • Page 10
    ... to slower home price growth, a sharp drop-off in home sales and declining refinance activity. While total U.S. residential mortgage debt outstanding as of June 30, 2006 was 12.3% higher than year-ago levels, the annualized growth rate in the second quarter of 2006 slowed to 9.6%. We expect that...

  • Page 11
    ... housing tax credit and other investments generate both tax credits and net operating losses that reduce our federal income tax liability. • Our Capital Markets group manages our investment activity in mortgage loans and mortgage-related securities, and has responsibility for managing our assets...

  • Page 12
    ...group works closely with Single-Family and HCD in making mortgage acquisition decisions. Our Capital Markets group works directly with our lender customers on structured Fannie Mae MBS transactions. • Portfolio Credit Risk Management. Our Single-Family and HCD business segments support our Capital...

  • Page 13
    ...GAAP. Business Segment Summary Financial Information For the Year Ended December 31, 2004 2003 2002 (Restated) (Restated) (Dollars in millions) Revenue(1): Single-Family Credit Guaranty ...$ 5,153 Housing and Community Development ...538 Capital Markets ...46,135 Total ...$51,826 Net income: Single...

  • Page 14
    ... agencies. Mortgage portfolio data is reported based on unpaid principal balance. Our Single-Family business manages the credit risk relating to the single-family mortgage loans and Fannie Mae MBS held in our portfolio that are backed by singlefamily mortgage loans. Our Capital Markets group manages...

  • Page 15
    ... guidelines. Guaranty Services Our Single-Family business provides guaranty services by assuming the credit risk of the single-family mortgage loans underlying our guaranteed Fannie Mae MBS held by third parties. Our Single-Family business also assumes the credit risk of the single-family mortgage...

  • Page 16
    ...-sized pool. • Single-Family Whole Loan Multi-Class Fannie Mae MBS are multi-class Fannie Mae MBS that are formed from single-family whole loans. Our Single-Family business works with our Capital Markets group in structuring these single-family whole loan multi-class Fannie Mae MBS. Single-family...

  • Page 17
    ... other agency issuers. Most of our single-class single-family Fannie Mae MBS are sold by lenders in the TBA market. Lenders use the TBA market both to purchase and sell Fannie Mae MBS. A TBA trade represents a forward contract for the purchase or sale of single-family mortgage-related securities to...

  • Page 18
    ... properties that qualify for federal low-income housing tax credits, making equity investments in other rental and for-sale housing, investing in acquisition, development and construction financing for single-family and multifamily housing developments, providing loans and credit support to public...

  • Page 19
    ... of its agencies. Mortgage portfolio data is reported based on unpaid principal balance. Our HCD business manages the credit risk relating to the multifamily mortgage loans and Fannie Mae MBS held in our portfolio that are backed by multifamily mortgage loans. Our Capital Markets group manages the...

  • Page 20
    ... cash flows. The fee and guaranty arrangements between HCD and Capital Markets are similar to the arrangements between Single-Family and Capital Markets. Our HCD business bears the credit risk of borrowers defaulting on their payments of principal and interest on the multifamily mortgage loans that...

  • Page 21
    ...we invest as a limited partner or as a non-managing member in a limited liability company, our exposure is generally limited to the amount of our investment. Most of our investments in for-sale housing involve the construction of entry-level homes that are generally eligible for conforming mortgages...

  • Page 22
    ... manage the interest rate risk inherent in our mortgage portfolio. Changes in the fair value of the derivative instruments we hold impact the net income reported by the Capital Markets group business segment. Our Capital Markets group also earns transaction fees for issuing structured Fannie Mae MBS...

  • Page 23
    ... mortgage loans and Fannie Mae MBS, our Capital Markets group is responsible for managing the credit risk of the non-Fannie Mae mortgage-related securities in our portfolio. Investment Activities and Objectives Our Capital Markets group seeks to maximize long-term total returns, subject to our risk...

  • Page 24
    ... regulatory housing goals requirements. Our Capital Markets group's purchase of goals-qualifying mortgage loans is a critical factor in our ability to meet our housing goals. Funding of Our Investments Our Capital Markets group funds its investments primarily through the issuance of debt securities...

  • Page 25
    ...programs, contribute to the favorable trading characteristics of our debt. As a result, we generally are able to borrow at lower interest rates than other corporate debt issuers. For information on the credit ratings of our long-term and short-term senior unsecured debt, qualifying subordinated debt...

  • Page 26
    ... do not provide a guaranty. Our Capital Markets group may work with our Single-Family or HCD businesses in structuring multi-class Fannie Mae MBS. Interest Rate Risk Management Our Capital Markets group is subject to the risks of changes in long-term earnings and net asset values that may occur due...

  • Page 27
    ... Federal Home Loan Banks, financial institutions, securities dealers, insurance companies, pension funds and other investors. Our market share of loans purchased for our investment portfolio or securitized into Fannie Mae MBS is affected by the amount of residential mortgage loans offered for sale...

  • Page 28
    ... share of new single-family mortgage-related securities issuance was 24.7%. Our estimates of market share are based on publicly available data and exclude previously securitized mortgages. We expect private-label issuers to continue to provide significant competition to our Single-Family business...

  • Page 29
    ... make available guidelines for the mortgage loans we purchase or securitize as well as for the sellers and servicers of these loans. • Loan-to-Value and Credit Enhancement Requirements. The Charter Act requires credit enhancement on any conventional single-family mortgage loan that we purchase or...

  • Page 30
    ... interests. In addition, our policies and guidelines have loan-to-value ratio requirements that depend upon a variety of factors, such as the borrower credit history, the loan purpose, the repayment terms and the number of dwelling units in the property securing the loan. Depending on these factors...

  • Page 31
    ... mortgage loan purchases, such as most purchases of non-conventional mortgage loans, equity investments (even if they facilitate low-income housing), mortgage loans secured by second homes and commitments to purchase or securitize mortgage loans at a later date. In addition to the three goals set...

  • Page 32
    ... On November 2, 2004, HUD published a final regulation amending its housing goals rule effective January 1, 2005. The regulation increased housing goal levels and also created the three new home purchase mortgage subgoals described above. The increased housing goal levels and new subgoal levels over...

  • Page 33
    ... units) providing purchase money for owner-occupied single-family housing in metropolitan areas. The source of this data is HUD's analysis of data we submitted to HUD. Some results differ from the results reported in our Annual Housing Activities Report for 2005. As shown in the table above, we...

  • Page 34
    ...'s May 2006 report, including actions relating to our corporate governance, Board of Directors, capital plans, internal controls, accounting practices, public disclosures, regulatory reporting, personnel and compensation practices. We also agreed not to increase our net mortgage assets above the...

  • Page 35
    ...-based capital requirement that is calculated as the amount of capital needed to withstand a severe ten-year stress period in which it is assumed that there would simultaneously be extreme movements in interest rates and severe credit losses. Moreover, to allow for management and operations risks...

  • Page 36
    ... ability of our Board of Directors to declare dividends, authorize repurchases of our preferred or common stock, or approve any other capital distributions in the following circumstances: • if a capital distribution would decrease our total capital below the risk-based capital requirement or our...

  • Page 37
    ... part-time employees, term employees and employees on leave. WHERE YOU CAN FIND ADDITIONAL INFORMATION We file reports, proxy statements and other information with the SEC. Our Web site address is www.fanniemae.com, and we make available free of charge through our Web site our annual reports on Form...

  • Page 38
    ...new policies and procedures to strengthen risk management practices relating to AD&C business by December 2006; • our expectation that, when we expect to earn returns greater than our cost of equity capital, we generally will be an active purchaser of mortgage loans and mortgage-related securities...

  • Page 39
    ... yield on these assets and our borrowing costs since year-end 2004; • our expectation that unrealized gains and losses on trading securities will fluctuate each period with changes in volumes, interest rates and market prices; • our expectation that tax credits and net operating losses resulting...

  • Page 40
    ... forward-looking statement as a result of new information, future events or otherwise. GLOSSARY OF TERMS USED IN THIS REPORT Terms used in this report have the following meanings, unless the context indicates otherwise. "Agency issuers" refers to the government-sponsored enterprises Fannie Mae and...

  • Page 41
    ...-family mortgage credit book of business" refers to the sum of the unpaid principal balance of: (1) the conventional single-family mortgage loans we hold in our investment portfolio; (2) the Fannie Mae MBS and non-Fannie Mae mortgage-related securities backed by conventional single-family mortgage...

  • Page 42
    ...-income housing tax credit limited partnerships or limited liability companies. For a description of these partnerships, refer to "Business Segments-Housing and Community Development-Community Investment Group" above. "Liquid assets" refers to our holdings of non-mortgage investments, cash and cash...

  • Page 43
    ... the potential market or credit loss that could result from such transaction. "OFHEO" refers to the Office of Federal Housing Enterprise Oversight, our safety and soundness regulator. "Option-adjusted spread" or "OAS" refers to the incremental expected return between a security, loan or derivative...

  • Page 44
    ... detailed definition of our statutory risk-based capital requirement. "Secondary mortgage market" refers to the financial market in which residential mortgages and mortgagerelated securities are bought and sold. "Single-family" mortgage loan refers to a mortgage loan secured by a property containing...

  • Page 45
    ... at that time, our Capital Markets group engaged in more active management of our portfolio through both purchases and sales of mortgage assets, with the dual goals of supporting our chartered purpose of providing liquidity to the secondary mortgage market and maximizing total returns. In addition...

  • Page 46
    ... state of our business. When this information becomes available to investors, it may result in an adverse effect on the trading price of our common stock. Risks Relating to Suspension and Delisting of Our Securities from the NYSE. The delay in filing our Annual Report on Form 10-K for the year ended...

  • Page 47
    ...time. These business activities expose us to market risk, which is the risk of loss from adverse changes in market conditions. Our most significant market risks are interest rate risk and option-adjusted spread risk. Interest rate risk is the risk of changes in our long-term earnings or in the value...

  • Page 48
    ... pools supporting our Fannie Mae MBS, paying taxes and insurance on the properties secured by the mortgage loans, monitoring and reporting loan delinquencies, and repurchasing any loans that are subsequently found to have not met our underwriting criteria. In that event, we could incur credit losses...

  • Page 49
    ... net interest income depends primarily on our ability to issue substantial amounts of debt frequently and at attractive rates. The issuance of short-term and long-term debt securities in the domestic and international capital markets is our primary source of funding for purchasing assets for our...

  • Page 50
    ...issue debt on acceptable terms, which could adversely affect our liquidity and our results of operations. Our borrowing costs and our broad access to the debt capital markets depends in large part on our high credit ratings. Our senior unsecured debt currently has the highest credit rating available...

  • Page 51
    ... new programs in response to these changes. These restrictions on our business operations may negatively affect our ability to compete successfully with other companies in the mortgage industry from time to time, which in turn may adversely affect our market share, our earnings and our financial...

  • Page 52
    ... and compete with our goal of maximizing total returns. In order to obtain business that contributes to our new housing goals and subgoals, we have made, and continue to make, significant adjustments to our mortgage loan sourcing and purchase strategies. These strategies include entering into some...

  • Page 53
    ... estimating the fair value of financial instruments; • amortizing cost basis adjustments on mortgage loans and mortgage-related securities held in our portfolio and underlying outstanding Fannie Mae MBS using the effective interest method; • determining our allowance for loan losses and reserve...

  • Page 54
    ... laws in connection with the setting of our guaranty fees and a proposed class action lawsuit alleging that we violated purported fiduciary duties with respect to certain escrow accounts for FHA-insured multifamily mortgage loans. We are unable at this time to estimate our potential liability in...

  • Page 55
    ...laws and state consumer protection laws in connection with the setting of our guaranty fees. In addition, we are a defendant in a proposed class action lawsuit alleging that we violated purported fiduciary duties with respect to certain escrow accounts for FHA-insured multifamily mortgage loans. 50

  • Page 56
    ..., see "Notes to Consolidated Financial Statements-Note 20, Commitments and Contingencies." RESTATEMENT-RELATED MATTERS Securities Class Action Lawsuits In Re Fannie Mae Securities Litigation Beginning on September 23, 2004, 13 separate complaints were filed by holders of our securities against us...

  • Page 57
    ... actions assert various federal and state securities law and common law claims against us and certain of our current and former officers and directors based upon essentially the same alleged conduct as that at issue in the consolidated shareholder class action, and also assert insider trading...

  • Page 58
    ... report and other additional details. We filed motions to dismiss the first amended complaint on October 20, 2006. ERISA Action In re Fannie Mae ERISA Litigation (formerly David Gwyer v. Fannie Mae) Three ERISA-based cases have been filed against us, our Board of Directors' Compensation Committee...

  • Page 59
    ... OFHEO's final report, including actions relating to our corporate governance, Board of Directors, capital plans, internal controls, accounting practices, public disclosures, regulatory reporting, personnel and compensation practices. We also agreed not to increase our net mortgage assets above the...

  • Page 60
    ... class action complaints filed by single-family borrowers that allege that we and Freddie Mac violated the Clayton and Sherman Acts and state antitrust and consumer protection statutes by agreeing to artificially fix, raise, maintain or stabilize the price of our and Freddie Mac's guaranty fees...

  • Page 61
    Plaintiffs have filed an amended complaint and a motion for class certification. A hearing on plaintiffs' motion for class certification was held on July 19, 2006, and the motion remains pending. We believe we have defenses to the claims in this lawsuit and intend to defend this lawsuit vigorously. ...

  • Page 62
    ...Capital Management-Capital Management-Capital Adequacy Requirements-Capital Restoration Plan and OFHEO-Directed Minimum Capital Requirement" for a description of our capital restoration plan. On December 6, 2006, the Board of Directors increased the quarterly common stock dividend to $0.40 per share...

  • Page 63
    ... on their holders. All options and shares of restricted stock and restricted stock units were granted to persons who were employees or members of the Board of Directors. During the year ended December 31, 2004, 236,521 restricted stock awards vested, as a result of which 155,679 shares of common...

  • Page 64
    ... with the restatement of our consolidated financial statements, because we did not have reliable financial data for years within the award cycles, the Compensation Committee and the Board decided to postpone the determination of the amount of the awards under the Performance Share Program for the...

  • Page 65
    ... Securities by the Issuer The following table shows shares of our common stock we repurchased during 2004, 2005 and the first three quarters of 2006. Total Number of Shares Purchased(1) Total Number of Average Shares Purchased as Part of Publicly Price Paid per Share Announced Program(2) (Shares...

  • Page 66
    ... of Fannie Mae shares from non-officer employees. Neither the General Repurchase Authority nor the Employee Stock Repurchase Program has a specified expiration date. Consists of the total number of shares that may yet be purchased under the General Repurchase Authority as of the end of the month...

  • Page 67
    ... information for 2001 and 2000 should not be relied upon. For the Year Ended December 31, 2004 2003 2002 (Restated) (Restated) (Dollars in millions, except per share amounts) Income Statement Data: Net interest income...Guaranty fee income ...Derivative fair value losses, net Other income (loss...

  • Page 68
    ...) 2001 (Restated) Balance Sheet Data: Investments in securities: Trading(4) ...Available-for-sale ...Mortgage loans: Loans held for sale ...Loans held for investment, net of allowance ...Total assets ...Short-term debt ...Long-term debt ...Total liabilities ...Preferred stock ...Total stockholders...

  • Page 69
    ... Fannie Mae MBS and other guaranties. Charge-offs, net of recoveries and foreclosed property expense (income), as a percentage of the average mortgage credit book of business. "Earnings" includes reported income before extraordinary gains (losses), net of tax effect and cumulative effect of change...

  • Page 70
    ...-owned corporation (NYSE: FNM) chartered by the U.S. Congress to support liquidity and stability in the secondary mortgage market. Our business includes three integrated business segments- Single-Family Credit Guaranty, Housing and Community Development and Capital Markets-that work together...

  • Page 71
    ... for the low-income housing tax credit and other investments generate both tax credits and net operating losses that reduce our federal income tax liability. In our Capital Markets group, our principal business is the purchase and sale of mortgage loans and mortgage-related assets through a full...

  • Page 72
    ... activities. Risk management at the business level is conducted in accordance with enterprise-wide corporate risk policies approved by our Board of Directors. Our Single-Family and HCD businesses have responsibility for managing the credit risk inherent in the mortgage loans and Fannie Mae MBS that...

  • Page 73
    ... new organizational risk structure that includes risk management personnel within each business unit. • We appointed a new Chief Audit Executive from outside the company, reporting directly to the Audit Committee of the Board of Directors. We have completed a comprehensive review of Internal Audit...

  • Page 74
    ...The financial performance discussed in this Annual Report on Form 10-K is based on our consolidated financial results for the year ended December 31, 2004 and our restated consolidated financial results for the years ended December 31, 2003 and 2002. Net income and diluted earnings per share totaled...

  • Page 75
    ... record financial instruments in our consolidated financial statements, we expect our earnings to vary, perhaps substantially, from period to period and result in volatility in our stockholders' equity and regulatory capital. For example, we purchase mortgage assets and use a combination of debt and...

  • Page 76
    ... of purchase premiums and discounts on securities and loans and on other deferred charges. On December 15, 2004, the SEC's Office of the Chief Accountant announced that it had advised us to (1) restate our financial statements filed with the SEC to eliminate the use of hedge accounting, and...

  • Page 77
    ... year ended December 31, 2003; and • a $1.2 billion net increase in earnings for the six months ended June 30, 2004. We previously estimated that errors in accounting for derivative instruments, including mortgage commitments, would result in a total of $10.8 billion in after-tax cumulative losses...

  • Page 78
    ... for which we filed a periodic report with the SEC. We have classified our restatement adjustments into the seven primary categories as set forth in the table below. These categories involve subjective judgments by management regarding classification of amounts and particular accounting errors that...

  • Page 79
    ...) Retained earnings, as previously reported ...Restatement adjustments for: Debt and derivatives ...Commitments ...Investments in securities ...MBS trust consolidation and sale accounting ...Financial guaranties and master servicing ...Amortization of cost basis adjustments ...Other adjustments...

  • Page 80
    ... number of financial instruments as derivatives; we incorrectly valued certain option-based and foreign exchange derivatives; and we incorrectly calculated interest expense by using inappropriate estimates in our amortization of debt cost basis adjustments. The restatement adjustments associated...

  • Page 81
    ... resulted in changes in the fair value gain or loss associated with these derivatives, which was recognized in the consolidated statements of income. We incorrectly calculated interest expense by using inappropriate estimates in our amortization of debt cost basis adjustments. We amortized discounts...

  • Page 82
    ... resulted in the removal of the fair value adjustments related to multifamily loan commitments and the reversal of the entire transition adjustment in the consolidated statement of income for the year ended December 31, 2003. Prior to July 1, 2003, the effective date of SFAS 149, we did not account...

  • Page 83
    ...we incorrectly valued securities and we incorrectly classified certain dollar roll repurchase transactions as short-term borrowings instead of purchases and sales of securities. The restatement adjustments associated with these errors resulted in a cumulative pre-tax decrease in retained earnings of...

  • Page 84
    ...total assets of $1.2 billion as of December 31, 2003. Additionally, for the six-month period ended June 30, 2004, we recorded a pre-tax increase in net income of $233 million, resulting from the reversal of historical impairment charges that were recorded in 2003 in the restated financial statements...

  • Page 85
    ... $26 million in "Investments losses, net" in the consolidated statements of income for the years ended December 31, 2003 and 2002, respectively, primarily due to reversing previously recorded asset sales. As a result of adopting FIN 46R, we consolidated certain MBS trusts created prior to February...

  • Page 86
    ...up-front cash receipts associated with our guaranties, known as buy-downs and risk-based pricing adjustments, pursuant to SFAS No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (an amendment of FASB Statements No. 13...

  • Page 87
    ... increase in "Guaranty fee income" in the consolidated statements of income for the year ended December 31, 2003. We did not record certain retained interests as guaranty assets and certain recourse obligations as guaranty obligations in connection with the transfer of loans to MBS trusts for which...

  • Page 88
    ... as an adjustment to interest income over the life of a loan or security by using the interest method and applying a constant effective yield ("level yield"). In calculating a level yield, we calculate amortization factors, based on prepayment and interest rate assumptions. Our method for estimating...

  • Page 89
    ... investments restatement adjustments, we also recorded a decrease in federal income tax expense of $138 million for the year ended December 31, 2003 due to changes in the recognition and classification of related tax credits and net operating losses. • Classification of loans held for sale...

  • Page 90
    ... financial statements for the restatement period: • Accounting for reverse mortgages. We made errors in accounting for reverse mortgages. When computing interest income on reverse mortgages we did not use the expected life of the borrower and house price expectations in the interest income...

  • Page 91
    ...month period ended June 30, 2004 was primarily the result of accounting for partnership investments, classification of loans held for sale and the provision for credit losses. In addition to the consolidated financial statement errors discussed above, we incorrectly applied the treasury stock method...

  • Page 92
    ...MBS Trust Financial Amortization As Consolidation Guaranties Total of Cost Previously Debt and Investments and Sale and Master Restatement Basis Other Reported(a) Derivatives Commitments in Securities Accounting Servicing Adjustments Adjustments Adjustments (Dollars in millions) As Restated Assets...

  • Page 93
    ... Statements-Note 2, Summary of Significant Accounting Policies." Reflects the impact of MBS trust consolidation and sale accounting; the derecognition of HTM securities at amortized cost and recognition of AFS and trading securities at fair value; the reversal of the SFAS 149 transition adjustment...

  • Page 94
    ... MBS Trust Financial Amortization Consolidation Guaranties Total of Cost As Investments and Sale and Master Restatement As Basis Other Previously Debt and Servicing Adjustments Adjustments Adjustments Restated Reported(a) Derivatives Commitments in Securities Accounting (Dollars in millions) Assets...

  • Page 95
    ... 31, 2001. Table 4: Balance Sheet Impact of Restatement as of December 31, 2001 As Total Previously Restatement As (a) Reported Adjustments Restated (Dollars in millions) Assets: Investments in securities ...Mortgage loans ...Derivative assets at fair value Deferred tax assets ...Other assets...

  • Page 96
    ...(Loss) Income (Dollars in millions) Total Stockholders' Equity December 31, 2001 balance, as previously reported . Restatement adjustments for: Debt and derivatives ...Commitments ...Investments in securities ...MBS trust consolidation and sale accounting . Financial guaranties and master servicing...

  • Page 97
    ...of income. Table 6: Income Statement Impact of Restatement for the Year Ended December 31, 2003 Restatement Adjustments for: Financial MBS Trust Consolidation Guaranties Amortization Total As and Master of Cost Basis and Sale Other Investments Restatement As Previously Debt and Servicing Adjustments...

  • Page 98
    ...of income. Table 7: Income Statement Impact of Restatement for the Year Ended December 31, 2002 Restatement Adjustments for: MBS Trust Financial Total Consolidation Guaranties Amortization As Investments Restatement As and Sale Other and Master of Cost Basis Previously Debt and Servicing Adjustments...

  • Page 99
    ... from trading securities and HFS loans to be classified as operating cash flows. As previously discussed, we incorrectly recorded sales of mortgage loans to MBS trusts that did not meet the definition of a QSPE under SFAS 140, which resulted in a net overall increase in cash flows from investing...

  • Page 100
    ... these estimates could have a material impact on our financial condition or results of operations. These four accounting policies are: (i) the fair value of financial instruments; (ii) the amortization of cost basis adjustments using the effective interest method; (iii) the allowance for loan losses...

  • Page 101
    ...of volatility and prepayment rates. • If market data used to estimate fair value as described above is not available, we estimate fair value using internally developed models that employ techniques such as a discounted cash flow approach. These models include market-based assumptions that are also...

  • Page 102
    ... market value adjustment based on applicable federal income tax rate of 35%. Calculated based on an instantaneous change in volatility or interest rate. Amortization of Cost Basis Adjustments on Mortgage Loans and Mortgage-Related Securities We amortize cost basis adjustments on mortgage loans...

  • Page 103
    ...balance and purchase the mortgage assets at a discount, the discount increases the yield above the stated coupon amount. Cost basis adjustments are amortized into earnings as an adjustment to the yield of the mortgage loan or mortgage-related security based on the contractual terms of the instrument...

  • Page 104
    ... reserve for guaranty losses on Fannie Mae MBS are reviewed and approved on a quarterly basis by our Allowance for Loan Loss Oversight Committee, which is a committee chaired by the Chief Risk Officer and comprised of senior management from the Single-Family and HCD businesses, the Chief Risk Office...

  • Page 105
    ... risk, the two primary drivers of expected losses for these VIEs. For those mortgage-backed investment trusts that we evaluated using quantitative analyses, we used internal models to generate Monte Carlo simulations of cash flows associated with the different credit, interest rate and housing price...

  • Page 106
    ... Operations Variance For the Year Ended December 31, 2004 vs. 2003 2003 vs. 2002 2004 2003 2002 $ % $ % (Restated) (Restated) (Dollars in millions, except per share amounts) Net interest income ...Guaranty fee income ...Fee and other income ...Investment losses, net ...Derivatives fair value losses...

  • Page 107
    ... market conditions that result in periodic fluctuations in the estimated fair value of our derivative instruments, which we recognize in our consolidated statements of income as "Derivatives fair value losses, net." Although we use derivatives as economic hedges to help us manage interest rate risk...

  • Page 108
    ...interest-earning assets . . Interest-bearing liabilities: Short-term debt ...Long-term debt ...Federal funds purchased and securities sold under agreements to repurchase ...Total interest-bearing liabilities ...Impact of net non-interest bearing funding ...Taxable-equivalent adjustment on tax-exempt...

  • Page 109
    ...income: Mortgage loans ...Mortgage securities ...Non-mortgage securities ...Federal funds sold and securities purchased agreements to resell ...Advances to lenders ...Total interest income ...Interest expense: Short-term debt...Long-term debt ...Federal funds purchased and securities sold agreements...

  • Page 110
    ..., which increases our guaranty fee income. Prepayment rates also affect the estimated fair value of buy-ups. Faster than expected prepayment rates shorten the average expected life of the underlying assets of the related MBS trusts, which reduces the value of our buy-up assets and may trigger the...

  • Page 111
    ... Fannie Mae MBS reaching a record $1.2 trillion in 2003. Borrowers took advantage of historically low interest rates and refinanced into long-term fixed-rate mortgages, which represent the majority of our business volume. Increased market demand among depository institutions for investments in fixed...

  • Page 112
    .... Table 16: Investment Losses, Net For the Year Ended December 31, 2004 2003 2002 (Restated) (Restated) (Dollars in millions) Other-than-temporary impairment on available-for-sale securities(1) . Lower-of-cost-or-market adjustments on held for sale loans ...Gains (losses) on Fannie Mae portfolio...

  • Page 113
    ... and changes in the valuation allowance recognized in income. The fair value of held for sale mortgage loans will fluctuate from period to period based primarily on changes in mortgage interest rates. As interest rates decline, the fair value of fixed-rate mortgage loans will generally increase...

  • Page 114
    ... structured from 15-year and 30-year Fannie Mae MBS held in our portfolio. Sales of selected assets from our portfolio contributed to both the enhancement of economic value and the reduction of portfolio balances to achieve our capital plan objectives. Unrealized Gains (Losses) on Trading Securities...

  • Page 115
    ... statements of income, it is important to examine the gains and losses in the context of our overall interest rate risk management objectives and strategy, including the economic objective in our use of various types of derivative instruments, the factors that drive changes in the fair value...

  • Page 116
    ...) $(18,118) Total cash payments ...Income statement impact of recognized amounts: Periodic net contractual interest expense accruals on interest rate swaps . . Net change in fair value during the period ...Derivatives fair value losses, net(5) ...Ending derivative asset (liability) (2) ...$ 5,432...

  • Page 117
    ... value losses recognized in the consolidated statements of income, excluding mortgage commitments. Amounts presented in Table 17 have the following effect on our consolidated financial statements: • Cash payments made to purchase options (purchased options premiums) increase the derivative asset...

  • Page 118
    ...fair value losses, net ...$(12,256) 2004 As of December 31, 2003 2002 5-year swap rate: Beginning rate ...Change ...Ending rate...(1) 3.64% 0.38 4.02% 3.20% 0.44 3.64% 5.09% (1.89) 3.20% Includes MBS options, forward starting debt, forward purchase and sale agreements, swap credit enhancements...

  • Page 119
    ... in Table 17 and included in the derivatives fair value losses recognized in the consolidated statements of income. Had we elected to fund our mortgage investments with long-term fixedrate debt instead of a combination of short-term variable-rate debt and interest rate swaps, the expense related...

  • Page 120
    ... of rebalancing actions needed for a given change in interest rates. The effects of our investment strategy, including our interest rate risk management, are reflected in changes in the fair value of our net assets over time. Debt Extinguishment Losses, Net We call debt securities in order to reduce...

  • Page 121
    ... Federal Income Taxes" below. Provision for Credit Losses The provision for credit losses results from a detailed analysis estimating an appropriate allowance for loan losses for single-family and multifamily loans classified as held for investment in our mortgage portfolio and reserve for guaranty...

  • Page 122
    ... Management-Credit Risk Management-Mortgage Credit Risk Management- Allowance for Loan Losses and Reserve for Guaranty Losses" and "Critical Accounting Policies and Estimates-Allowance for Loan Losses and Reserve for Guaranty Losses." Other Non-interest Expense Foreclosed Property Expense (Income...

  • Page 123
    ... in our statutory rate and effective tax rate is primarily due to the tax benefits we receive from our investments in LIHTC partnerships that help in supporting our mission. As disclosed in "Notes to Consolidated Financial Statements-Note 11, Income Taxes," our effective tax rate would have been...

  • Page 124
    ...Table 20: Business Segment Results Summary Increase (Decrease) For the Year Ended December 31, 2004 vs. 2003 2003 vs. 2002 2004 2003 2002 $ % $ % (Restated) (Restated) (Dollars in millions) Revenue(1): Single-Family Credit Guaranty ...$ Housing and Community Development . . Capital Markets ...Total...

  • Page 125
    ...outstanding single-family Fannie Mae MBS in 2003; and (3) a 40% increase in the provision for credit losses in 2003 from 2002, primarily due to the increase in our single-family mortgage credit book of business in 2003 and an increase in the guaranty liability relating to mortgage-related securities...

  • Page 126
    traditional markets by providing more flexible, low-cost mortgage options. We also continue to expand our lending options for borrowers with weaker credit histories. HCD Business Our Housing and Community Development business generated net income of $337 million, $286 million and $184 million in ...

  • Page 127
    ... securities backed by manufactured housing loans and aircraft leases, and reduced losses from lower-of-cost-or-market adjustments on HFS loans, resulting from lower loan acquisition volumes and more stable interest rates in 2004. The $3.5 billion, or 200%, increase in the net income of our Capital...

  • Page 128
    ...for the years ended December 31, 2004, 2003 and 2002. Table 21: Mortgage Portfolio Activity(1) Purchases 2003 2002 (Restated) (Restated) Sales 2004 2003 2002 (Restated) (Restated) (Dollars in millions) Liquidations(2) 2003 2002 (Restated) (Restated) 2004 2004 Mortgage loans: Fixed-rate: Long-term...

  • Page 129
    ..., except in limited circumstances at OFHEO's discretion. Our portfolio purchases in 2005 were significantly lower than in 2004, due to both our assessment of the pricing for fixed-rate mortgage assets and our focus on managing our balance sheet size to achieve our capital plan objectives. Portfolio...

  • Page 130
    ... (discounts) and deferred price adjustments, net ...Lower of cost or market adjustments on loans held for sale ...Allowance for loan losses for loans held for investment...Total mortgage loans, net ...Mortgage-related securities: Fannie Mae single-class MBS...Non-Fannie Mae single-class mortgage...

  • Page 131
    ...) Total Amortized Cost(1) Total Fair Value One Year or Less Fair Amortized Cost(1) Value After Ten Years Amortized Fair Cost(1) Value Fannie Mae single-class MBS(2) Non-Fannie Mae single-class mortgage securities(2) ...Fannie Mae structured MBS(2) . Non-Fannie Mae structured mortgage securities...

  • Page 132
    ...level of risk and expected long-term fundamentals of our business. In addition, as discussed in "Critical Accounting Policies and Estimates-Fair Value of Financial Instruments," when quoted market prices or observable market data are not available, we rely on internally developed models that require...

  • Page 133
    ... Value Adjustment(1) Fair Value (Restated) (Restated) (Restated) (Dollars in millions) Assets: Cash and cash equivalents . . $ 3,701 Federal funds sold and securities purchased under agreements to resell ...3,930 Trading securities ...35,287 Available-for-sale securities ...532,095 Mortgage loans...

  • Page 134
    ... assets and liabilities, consisting of prepaid expenses and deferred charges such as deferred debt issuance costs, have no fair value. We adjust the GAAP-basis deferred taxes for purposes of each of our non-GAAP supplemental consolidated fair value balance sheets to include estimated income taxes...

  • Page 135
    .... Table 25: Selected Market Information(1) As of December 31, 2004 2003 Change 10-year U.S. Treasury Note Yield ...Implied volatility(2) ...30-year Fannie Mae MBS par coupon rate ...Lehman U.S. MBS Index OAS (in basis points) over U.S. Treasury yield curve . . Lehman U.S. Agency Debt Index...

  • Page 136
    ...work to manage the OAS risk that exists at the time we purchase mortgage assets through our asset selection process. We use models to evaluate mortgage assets on the basis of yield-to-maturity, optionadjusted yield spread, historical valuations and embedded options. Our models also take into account...

  • Page 137
    ... market risk we face and actively manage is interest rate risk-the risk of changes in our long-term earnings or in the value of our net assets due to changes in interest rates. • Operational Risk. Operational risk relates to the risk of loss resulting from inadequate or failed internal processes...

  • Page 138
    ... and report on credit, market, liquidity and operational risk; and (ii) establish and communicate risk management controls throughout the company; • overseeing compliance with all enterprise-wide risk management policies; • overseeing the Chief Risk Office; and • reviewing the sufficiency...

  • Page 139
    ..., and policies and procedures. The Chief Audit Executive reports directly and independently to the Audit Committee of the Board of Directors, and audit personnel are compensated on objectives set for the group by the Audit Committee rather than corporate financial results or goals. Internal Audit...

  • Page 140
    ...single-family mortgage credit book of business include the borrower's financial strength and credit profile; the type of mortgage; the characteristics of the property securing the mortgage; and economic conditions, such as changes in home prices. Factors that affect credit risk on a multifamily loan...

  • Page 141
    ...book of business ... As of December 31, 2003 Single-Family Multifamily Total Conventional(1) Government(2) Conventional(1) Government(2) Conventional(1) Government(2) (Restated) (Dollars in millions) Mortgage portfolio:(3) Mortgage loans(4) ...Fannie Mae MBS(4) ...Agency mortgage-related securities...

  • Page 142
    ... losses. Acquisition Policy and Standards Single-Family Our Single-Family business is responsible for pricing and managing credit risk relating to the portion of our single-family mortgage credit book of business consisting of whole single-family mortgage loans and Fannie Mae MBS backed by single...

  • Page 143
    ... single-family mortgage credit book of business consists of nonFannie Mae mortgage-related securities backed by single-family mortgage loans and credit enhancements that we provide on single-family mortgage assets. Our Capital Markets business is responsible for pricing and managing credit risk...

  • Page 144
    ... our credit risk. We continually review the credit quality of our single-family mortgage credit book of business with a focus on a variety of mortgage loan risk factors that include loan-to-value ratios, loan product type, property type, occupancy type, credit score, loan purpose, property location...

  • Page 145
    ... in our portfolio and backing Fannie MBS (whether held in our portfolio or held by third parties). Table 27: Risk Characteristics of Conventional Single-Family Mortgage Credit Book Percent of Book of Business(1) As of December 31, 2004 2003 2002 Original loan-to-value ratio: Ͻ= 60.00 ...60.01% to...

  • Page 146
    Percent of Book of Business(1) As of December 31, 2004 2003 2002 Number of property units: 1 unit ...2-4 units ...Total ...Property type: Single-family homes ...Condo/Co-op ...Total ...Occupancy type: Primary residence...Second/vacation home ...Investor ...Total ...Credit score: Ͻ 620...620 to Ͻ ...

  • Page 147
    ... calculated based on unpaid principal balance of loans as of the end of each period. The methodology used to estimate the mark-to-market loan-to-value ratio was implemented in 2004. Long-term fixed-rate consists of mortgage loans with contractual maturities greater than 15 years. Intermediate-term...

  • Page 148
    ... of Business Volume(1) For the Year Ended December 31, 2004 2003 2002 Adjustable-rate: Interest-only ...Negative-amortizing ...Other ARMs ...Total adjustable-rate ...Total ...Number of property units: 1 unit ...2-4 units ...Total ...Property type: Single-family detached ...Condo/Co-op ...Total...

  • Page 149
    ... than traditional mortgage loans. We consider the risk of default in determining our guaranty fee and purchase price. • Number of units. We classify mortgages secured by housing with four or fewer living units as singlefamily. Mortgages on one-unit properties tend to have lower credit risk than...

  • Page 150
    ... mark-to-market loan-to-value ratio was an estimated 54%. The weighted average credit score was 721 as of September 30, 2006. The most notable change in the overall risk profile of our single-family mortgage credit book of business since the end of 2004 has been in product types. As a result of the...

  • Page 151
    ... changes in risk or return profiles and to provide the basis for revising policies, standards, guidelines, credit enhancements or guaranty fees for future business. Housing and Community Development Diversification within our multifamily mortgage credit book of business and LIHTC equity investments...

  • Page 152
    ..., updated borrower credit data, current property values and mortgage product characteristics to evaluate the risk of each loan. Most of the lenders that service loans we buy or that back Fannie Mae MBS use Risk Profiler or a similar default prediction model. We require our single-family servicers to...

  • Page 153
    ... of the years ended December 31, 2004, 2003 and 2002, represents approximately 0.2% of the total number of loans in our conventional single-family mortgage credit book. Housing and Community Development When a multifamily loan does not perform, we work closely with our loan servicers to minimize...

  • Page 154
    ... plan are classified as seriously delinquent until the borrower has missed fewer than three consecutive monthly payments. We calculate the single-family serious delinquency rate by dividing the number of seriously delinquent single-family loans by the total number of single-family loans outstanding...

  • Page 155
    ... 2006 and the possibility of modest home price declines in 2007, we expect that serious delinquencies may trend upward. As of September 30, 2006, approximately 8% of our conventional single-family mortgage credit book had an estimated mark-to-market loan-to-value ratio greater than 80%. Over 80% of...

  • Page 156
    ... of our credit risk management strategies. Credit-related losses include charge-offs plus foreclosed property expense (income). Credit losses for the years ended December 31, 2004, 2003 and 2002 are presented in Table 32. Table 32: Single-Family and Multifamily Credit Loss Performance 2004...

  • Page 157
    ... ten-year period. We then calculate the present value of credit losses assuming an immediate 5% decline in the value of singlefamily properties securing mortgage loans we own or that back Fannie Mae MBS. Following this decline, we assume home prices will follow a statistically derived long-term path...

  • Page 158
    ...own or that back Fannie Mae MBS. After the initial shock, we estimate home price growth rates return to the rate projected by our credit pricing models. The estimates in the preceding paragraphs are based on approximately 90% and 92% of our total single-family mortgage credit book of business as of...

  • Page 159
    ... and 2002, respectively. Includes decrease in reserve for guaranty losses and increase in allowance for loan losses due to the purchase of delinquent loans from MBS pools. Represents ratio of combined allowance and reserve balance by loan type to mortgage credit book of business by loan type. 154

  • Page 160
    ... exposure to institutional counterparty risk exists with our lending partners and servicers, mortgage insurers, dealers who distribute our debt securities or who commit to sell mortgage pools or loans, issuers of investments included in our liquid investment portfolio, and derivatives counterparties...

  • Page 161
    ... Our multifamily recourse obligations generally were partially or fully secured by reserves held in custodial accounts, insurance policies, letters of credit from investment grade counterparties rated A or better, or investment agreements. Mortgage Servicers The primary risk associated with mortgage...

  • Page 162
    ... investments to high credit quality short- and medium-term instruments, such as commercial paper, asset-backed securities and corporate floating rate notes, which are broadly traded in the financial markets. Our non-mortgage securities, which account for the majority of our liquid assets, totaled...

  • Page 163
    ...& Poor's rating for any ratings based on Moody's scale. Includes MBS options, mortgage insurance contracts and swap credit enhancements accounted for as derivatives. Represents the exposure to credit loss on derivative instruments, which is estimated by calculating the cost, on a present value basis...

  • Page 164
    ... of our mortgage assets are intermediateterm or long-term fixed-rate loans that borrowers have the option to pay at any time before the scheduled maturity date or continue paying until the stated maturity. An inverse relationship exists between changes in interest rates and the value of fixed-rate...

  • Page 165
    ...limits. The Capital Markets Investment Committee develops and monitors near-term strategies that comply with our risk objectives and policies. The Capital Markets Investment Committee reports interest rate risk measures on a weekly basis. As discussed in "Supplemental Non-GAAP Information-Fair Value...

  • Page 166
    ...offset the fixed-rate interest payments on the long-term debt. The combination of the receive-fixed swaption and 10-year non-callable note serves as a substitute for callable debt. (2) To achieve risk management objectives not obtainable with debt market securities. We sometimes have risk management...

  • Page 167
    ... by type for the year ended December 31, 2004, along with the stated maturities of derivatives outstanding as of December 31, 2004. Table 37 does not include mortgage commitments that are accounted for as derivatives. We discuss our mortgage commitments in "Business Segment Results-Capital Markets...

  • Page 168
    ... the use of pay-fixed interest rate swaps. In addition, as our portfolio expanded, we purchased more caps and swaptions to help offset the increased prepayment option risk resulting from our new mortgage purchases. During 2004, we decreased the outstanding notional balance of our risk management...

  • Page 169
    ...will largely replace any guaranty fee income lost as a result of mortgage prepayments. Accordingly, we do not actively manage or hedge expected changes in the fair value of our guaranty business related to changes in interest rates. The fair values of our guaranty assets and guaranty obligations are...

  • Page 170
    ...much the portfolio's duration gap may change in different interest rate environments. Our primary strategy for managing convexity risk is to either issue callable debt or purchase option-based derivatives. Interest Rate Sensitivity of Net Asset Fair Value We perform various sensitivity analyses that...

  • Page 171
    ... to guaranty asset, guaranty obligations to reflect how the risk is managed by the business. Includes net financial assets and financial liabilities reported in "Notes to Consolidated Financial Statements-Note 19, Fair Value of Financial Instruments" and additional market sensitive instruments that...

  • Page 172
    ... discussed, we do not actively manage the interest rate risk of our guaranty business. These sensitivity analyses are limited in that they contemplate only certain movements in interest rates and are performed at a particular point in time based on the estimated fair values of our existing assets...

  • Page 173
    ... multi-year program to implement our new operational risk management framework. In November 2006, we submitted a detailed three-year plan on the design and implementation of this framework to OFHEO as required by our consent order with OFHEO. Our operational risk management framework is based on the...

  • Page 174
    ... capital markets. Liquidity Liquidity Risk Management Liquidity risk is the risk to our earnings and capital that would arise from an inability to meet our cash obligations in a timely manner. Because liquidity is essential to our business, we have adopted a comprehensive liquidity risk policy that...

  • Page 175
    ... our Internal Audit department; • maintaining unencumbered mortgage assets that are available as collateral for secured borrowings pursuant to repurchase agreements or for sale; and • maintaining an investment portfolio of liquid non-mortgage assets that are readily marketable or have short-term...

  • Page 176
    ... under derivative instruments; • administrative expenses; • the payment of federal income taxes; • losses incurred in connection with our Fannie Mae MBS guaranty obligations; and • the payment of dividends on our common and preferred stock. Debt Funding Because our primary source of cash is...

  • Page 177
    ... Rate(1) Outstanding(2) Interest Rate(1) Outstanding(3) (Restated) (Dollars in millions) Federal funds purchased and securities sold under agreements to repurchase ...Fixed short-term debt U.S. discount notes ...Foreign exchange discount notes ...Other fixed short-term debt Floating short-term debt...

  • Page 178
    ... in significant amounts in the capital markets and have a diversified funding base of domestic and international investors. Purchasers of our debt securities include fund managers, commercial banks, pension funds, insurance companies, foreign central banks, state and local governments, and retail...

  • Page 179
    ... the business day until our account balance was zero. Under the revised policy, we are now required to fund interest and redemption payments on our debt and Fannie Mae MBS before the Federal Reserve Banks, acting as our fiscal agent, will execute the payments on our behalf. We compensate the Federal...

  • Page 180
    ... are readily marketable or have short-term maturities. As of December 31, 2004 and 2003, we had approximately $55.1 billion and $67.1 billion, respectively, in liquid assets, net of any cash and cash equivalents pledged as collateral. Our investments in non-mortgage securities, which account for the...

  • Page 181
    ...services, and agreements. Excludes arrangements that may be cancelled without penalty. Excludes risk management derivative transactions that may require cash settlement in future periods and our obligations to stand ready to perform under our guaranties relating to Fannie Mae MBS and other financial...

  • Page 182
    ... in managing capital is to maximize long-term stockholder value through the pursuit of business opportunities that provide attractive returns while maintaining capital at levels sufficient to ensure compliance with both regulatory and internal capital requirements. Capital Adequacy Requirements We...

  • Page 183
    ...profile of our book of business through the stress test simulation model. The model generates cash flows and financial statements to evaluate our risk and measure our capital adequacy during the ten-year stress horizon. Our total capital base is used to meet our risk-based capital requirement. Total...

  • Page 184
    ... dividend rate by 50% on January 18, 2005, from $0.52 per share of common stock to $0.26 per share of common stock; and • canceling our plans to build major new corporate facilities in Southwest Washington, DC and undertaking other cost-cutting efforts. Under our May 23, 2006 consent order...

  • Page 185
    ... to cover management and operations risk. Defined as the surplus of total capital over required risk-based capital expressed as a percentage of risk-based capital. Generally, the sum of (a) 1.25% of on-balance sheet assets; (b) 0.25% of the unpaid principal balance of outstanding Fannie Mae MBS held...

  • Page 186
    ... ability of our Board of Directors to pay dividends, repurchase our preferred or common stock, or make any other capital distributions in the following circumstances: • if a capital distribution would decrease our total capital below the risk-based capital requirement or our core capital below the...

  • Page 187
    ...our non-officer employees, who are employees below the level of vice president. Under the program, we may repurchase shares weekly at fair market value only during the 30trading day period following our quarterly filings on Form 12b-25 with the SEC. Officers and members of our Board of Directors are...

  • Page 188
    ... Fannie Mae MBS held by third parties times 0.45% and (2) total on-balance sheet assets times 4%. We must also take reasonable steps to maintain sufficient outstanding subordinated debt to promote liquidity and reliable market quotes on market values. We also agreed to provide periodic public...

  • Page 189
    ... we return to timely financial reporting. In May 2006, $1.6 billion of our qualifying subordinated debt matured. As of the date of this filing, we have $11.0 billion in outstanding qualifying subordinated debt. Dividends In January 2005, our Board of Directors reduced our quarterly dividend rate by...

  • Page 190
    ... sheets a reserve for guaranty losses based on an estimate of our incurred credit losses on all of our guaranties, irrespective of the issuance date. While we hold some Fannie Mae MBS in our mortgage portfolio, the substantial majority of outstanding Fannie Mae MBS is held by third parties and...

  • Page 191
    ... partnerships in order to increase the supply of affordable housing in the United States and to serve communities in need. In addition, our investments in LIHTC partnerships generate both tax credits and net operating losses that reduce our federal income tax liability. The tax benefits associated...

  • Page 192
    ...the effective yield method of accounting, as appropriate. In each case, we record in the consolidated financial statements our share of the income and losses of the partnerships, as well as our share of the tax credits and tax benefits of the partnerships. Our share of the operating losses generated...

  • Page 193
    ... of APB 25 to stock compensation awards issued to employees. Rather, SFAS 123R requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. With respect to options, SFAS 123R requires that they be...

  • Page 194
    ... earnings or (ii) continue recognizing periodic amortization expense and assess the MSRs for impairment as was originally required by SFAS 140. This option is available by class of servicing asset or liability. This statement also changes the calculation of the gain from the sale of financial assets...

  • Page 195
    ... AOCI. Additionally, it requires determination of benefit obligations and the fair values of a plan's assets at a company's year-end and recognition of actuarial gains and losses, and prior service costs and credits, as a component of AOCI. For employers with publicly-traded securities, SFAS 158 is...

  • Page 196
    ... December 31, Reported(1) Restated Reported(1) Restated 2004 2004 (Dollars and shares in millions, except per share amounts) Net interest income ...Guaranty fee income ...Investment gains (losses), net ...Derivatives fair value gains (losses), net Debt extinguishment gains (losses), net . Loss from...

  • Page 197
    ...257 698,743 Total investments ...Mortgage loans: Loans held for sale, at lower of cost or market ...Loans held for investment, at amortized cost ...Allowance for loan losses ...Total loans...Derivative assets at fair value Guaranty assets ...Deferred tax assets ...Other assets ... ... 6,655 236,054...

  • Page 198
    ... the credit risk on mortgage loans and Fannie Mae MBS held in our portfolio. For the Quarter Ended June 30, 2004 Single-Family Capital Credit Guaranty HCD Markets Total (Restated) (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) . . Investment gains (losses...

  • Page 199
    ... the credit risk on mortgage loans and Fannie Mae MBS held in our portfolio. For the Quarter Ended December 31, 2004 Single-Family Capital Credit Guaranty HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) ...Investment gains (losses), net...

  • Page 200
    ... net interest income, guaranty fee income, investment gains and tax benefit for the quarter. Net interest income totaled $5.1 billion for the quarter ended March 31, 2004. The average yield on our investment balance in the first quarter of 2004 was affected by purchases of lower-coupon mortgages and...

  • Page 201
    ...-rate and ARM products, which tend to earn lower initial yields than fixed-rate mortgage assets. Net interest income was also impacted by continued increases in short-term debt rates during the third quarter of 2004. Guaranty fee income increased to $1.1 billion for the quarter ended September...

  • Page 202
    ...about market risk is set forth on pages 159 through 167 of this Annual Report on Form 10-K under the caption "Item 7-MD&A-Risk Management-Interest Rate Risk Management and Other Market Risks." Item 8. Financial Statements and Supplementary Data Our consolidated financial statements and notes thereto...

  • Page 203
    ... rules of the SEC and the NYSE, since June 30, 2004. Our review of our accounting policies and practices in 2005 and 2006, and the restatement of our consolidated financial statements for the years ended December 31, 2003 and 2002, resulted in an inability to timely file our Annual Reports on Form...

  • Page 204
    ... included data validation and certification procedures from the source systems to the general ledger, pre- and post-closing analytics, model validation procedures for financial models supporting the consolidated financial statements, and independent third-party reviews of selected accounting systems...

  • Page 205
    ... accounting and auditing knowledge, experience and training to effectively execute an appropriate audit plan. In addition, the Internal Audit department did not functionally report to the Audit Committee of the Board of Directors, but reported to the Chief Financial Officer, which created inadequate...

  • Page 206
    ... our accounting for investments in securities; • our accounting for MBS trust consolidations and sale accounting; • our accounting for financial guaranties and master servicing; • our amortization of cost basis adjustments; and • other adjustments, including accounting for income taxes. 201

  • Page 207
    ...internal control over financial reporting relating to the general ledger and the periodic closing of the general ledger. Specifically, the design and operation of this control was inadequate for managing the addition or deletion of specific balance sheet or consolidated statements of income accounts...

  • Page 208
    ..., guaranty and financial instrument valuation processes each used models and, as discussed in "Item 7-MD&A-Restatement," we incorrectly valued our derivatives, mortgage loan and security commitments, security investments, guaranties and other instruments. Treasury and Trading Operations We...

  • Page 209
    ... Overview Management has evaluated, with the participation of our Chief Executive Officer and Chief Financial Officer, whether any changes in our internal control over financial reporting that occurred during the period from July 1, 2004 through the date of this filing (including the quarter ended...

  • Page 210
    ...this filing. We have made significant changes to our Board of Directors, our management team and our corporate structure since December 31, 2004 in order to establish and maintain a consistent and proper tone as to the importance of internal control over financial reporting. The Board and management...

  • Page 211
    ... other new members to the Audit Committee. In addition, the Board of Directors appointed a new Chief Executive Officer. • Enterprise-Wide Risk Oversight We have established an enterprise-wide risk organization with oversight of credit risk, market risk and operational risk, as well as model review...

  • Page 212
    ... date of this filing. We have enhanced our whistleblower program with a new corporate ethics line that offers full anonymity to callers, if desired, regular reporting of cases to the Chief Compliance Officer, and regular formal reporting of cases to the Compliance and Audit Committees of the Board...

  • Page 213
    ... and communication of information technology policies, corporate technology standards and detailed technology operating procedures throughout the company. • Policies and Procedures We have developed corporate-wide standards for policies and procedures for use throughout our business to support...

  • Page 214
    ... all of our general ledger accounts. Reconciliation completion, review and issue management is monitored each month to ensure compliance with our policies. We have also identified all other corporate data reconciliations for processes related to internal control over financial reporting. For those...

  • Page 215
    ...the Chief Risk Officer. Many of the models that resulted in errors in the past are no longer being used to generate financial data. As of the date of this filing, we have reviewed our most critical financial models pursuant to our new independent model review process. Treasury and Trading Operations...

  • Page 216
    ...wide fraud risk management program, a trusted whistleblower program, appropriate accounting/finance staffing levels, clearly communicated information technology policies and procedures, and adequate transactional policies and procedures. • Application of Accounting Principles Generally Accepted in...

  • Page 217
    ... in securities, trust consolidation and sale accounting, financial guaranties and master servicing, amortization of cost basis adjustments, and other items; the consolidated financial statements for the year ended December 31, 2004 and the quarter ended September 30, 2004 were not filed timely; and...

  • Page 218
    ...served as Chairman and Chief Executive Officer of Sibley Mortgage Corporation, a commercial, multifamily and single-family mortgage banking firm, and Sibley Real Estate Services, Inc. Mr. Ashley is a past President of the Mortgage Bankers Association of America and has over 40 years of experience in...

  • Page 219
    ... and Chief Executive Officer of HomeSide Lending from 1990 to 1999. Mr. Pickett is a past President of the Mortgage Bankers Association of America. Mr. Pickett has been a Fannie Mae director since May 1996. Leslie Rahl, 56, is the founder of and has been President of Capital Market Risk Advisors...

  • Page 220
    ... reviewed the independence of all current board members under the listing standards of the New York Stock Exchange, or NYSE, and the standards of independence adopted by the Board, as set forth in our Corporate Governance Guidelines and outlined below. It is the policy of our Board of Directors that...

  • Page 221
    ...outside auditor and personally worked on our audit within that time. • A director will not be considered independent if, within the preceding five years: • the director was employed by a company at a time when one of our current executive officers sat on that company's compensation committee; or...

  • Page 222
    ... Annual Report on Form 10-K for the year ended 2004, we are filing our annual consolidated financial statements for 2004 and related certifications by our Chief Executive Officer and Chief Financial Officer required by the Sarbanes-Oxley Act of 2002. Executive Sessions Our non-management directors...

  • Page 223
    ...director of Comcast Corporation, Fannie Mae Foundation, Corporation for Supportive Housing, Maret School and Communities In School. He is a member of the Executive Leadership Council and the Real Estate Round Table. Robert T. Blakely, 64, has been Executive Vice President and Chief Financial Officer...

  • Page 224
    ... as Senior Vice President-e-commerce from July 1999 to July 2000. Prior to this, Mr. Williams served in various roles in the Single-Family and Corporate Information Systems divisions of the company. Mr. Williams joined Fannie Mae in 1991. Under our bylaws, each executive officer holds office until...

  • Page 225
    ... table shows summary compensation information for the covered executives for 2004, 2003 and 2002. Annual Compensation Other Annual Salary Bonus Compensation 3) (2) Name and Principal Position(1) Year Long Term Compensation Awards Payouts Restricted Securities Stock Underlying LTIP Awards Options...

  • Page 226
    ... executive officer of Fannie Mae in December 2004, although under his employment agreement his retirement was not effective until June 2005. Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values The following table shows the aggregate number of shares underlying options...

  • Page 227
    ... to our officers based on the annual cash bonuses received by our officers. For purposes of determining benefits under the 2003 Supplemental Pension Plan, the amount of an officer's annual cash bonus taken into account is limited to 50% of the officer's salary. The benefits under the Fannie Mae...

  • Page 228
    ... Plan to supplement the benefits payable to key officers under the Retirement Plan. The Compensation Committee selects the participants in the Executive Pension Plan. Active participants in the Executive Pension Plan are Executive Vice Presidents. The Board of Directors sets their pension goal...

  • Page 229
    ... half years' salary. Participants terminated after the first quarter of the fiscal year receive a pro rata payout of their annual cash incentive award target for that year, adjusted for corporate performance. Consistent with the terms of our stock compensation plans, the vesting of options scheduled...

  • Page 230
    ... our capital restoration plan, we must obtain the approval of OFHEO prior to providing Mr. Mudd with any non-salary compensation awards. • Life Insurance. During the employment term, Mr. Mudd is eligible to receive life insurance benefits in accordance with our life insurance policies and programs...

  • Page 231
    ... restricted stock. • Termination due to death. In the event of Mr. Mudd's death during the employment term, his estate or beneficiary, as applicable, would be entitled to his accrued but unpaid base salary, all amounts payable (but unpaid) under the annual incentive plan for any year ended on...

  • Page 232
    ... his base salary for a period of 12 months from the date of termination and will continue to be covered by our life, medical, and long-term disability insurance plans for a 12-month period, or until re-employment that provides certain coverage for benefits, whichever occurs first. For the purpose of...

  • Page 233
    ... prices ranging from $69.43 to $78.315. Under our stock compensation plans, all options held at the time of retirement by any option holder who is at least 55 years old and who has at least 5 years of service with us remain exercisable until their initial expiration date, which is generally 10 years...

  • Page 234
    ... of Fannie Mae, May 2006. We described this agreement in a Form 8-K filed on July 7, 2006. Under the separation agreement, and in accordance with the terms of the severance program for management level employees, Ms. St. John will be entitled to receive the compensation and benefits described...

  • Page 235
    ...the required number of years of service at a reduced cost offered to such retirees. The separation agreement provides that Ms. St. John may not solicit or accept employment with or act in any way, directly or indirectly, to solicit or obtain employment or work for Freddie Mac, any one of the Federal...

  • Page 236
    ...stock she held. The remaining terms of Ms. Kappler's separation agreement were generally in accordance with the provisions of our severance program for management level employees discussed under "Employment Arrangements- Severance Program." Director Compensation Information Cash Compensation Our non...

  • Page 237
    ... following the annual meeting of stockholders at the fair market value on the date of grant. A non-management director appointed or elected as a mid-term replacement receives a nonqualified stock option to purchase at the fair market value on the date of grant a pro rata number of shares equal to...

  • Page 238
    ... table provides information as of December 31, 2004 with respect to shares of common stock that may be issued under our existing equity compensation plans. We have provided equity compensation plan information as of December 31, 2005 in a Form 8-K we are filing with the SEC today. Information...

  • Page 239
    ... Each Fannie Mae senior executive is required to hold shares of Fannie Mae common stock as a multiple of the executive's base salary, as follows: Job Level Multiple of Base Salary Chief Executive Officer Executive Vice President five times two times • Each senior executive has three years from...

  • Page 240
    ...by each person and the percentage owned. Holders of restricted stock have no investment power but have sole voting power over the shares and, accordingly, these shares are included in this table. Holders of shares through our Employee Stock Ownership Plan, or ESOP, generally have no investment power...

  • Page 241
    ...Fannie Mae common stock by each holder of more than 5% of our common stock as of December 31, 2005, or as otherwise noted, which is the most recent information provided. 5% Holders Common Stock Beneficially Owned (1) Percent of Class Capital Research and Management Company ...333 South Hope Street...

  • Page 242
    ... compensation and benefit plans that are generally available to our employees, including our employee stock purchase plan and employee stock ownership plan. Mr. Swygert's son left our employment in 2004. Barbara Spector, the sister of our Chief Business Officer, Mr. Levin, is a non-officer employee...

  • Page 243
    ...amended agreement, we pay Mr. Johnson an annual consulting fee of $300,000. Once we have filed our restated financial statements with the SEC, we will pay Mr. Johnson an annual fee in an amount equal to approximately $415,000 increased by the percentage increase in the consumer price index each year...

  • Page 244
    ... as excess personal liability insurance, financial planning assistance and an annual physical exam. We anticipate paying these benefits to Mr. Maxwell until such time as he no longer requests them. The following table sets forth our estimated costs of providing certain of these benefits. Office and...

  • Page 245
    ... & Touche audited these restated consolidated financial statements, as well as our consolidated financial statements for the year ended December 31, 2004. The following table sets forth the fees paid or accrued for services provided by our independent registered public accounting firm Deloitte...

  • Page 246
    ..., Financial Statement Schedules Documents filed as part of this report Consolidated Financial Statements Report of Independent Registered Public Accounting Firm ...F-2 Consolidated Balance Sheets as of December 31, 2004 and 2003 ...F-3 Consolidated Statements of Income for the years ended December...

  • Page 247
    ...by virtue hereof. Federal National Mortgage Association By: /s/ DANIEL H. MUDD Daniel H. Mudd President and Chief Executive Officer Date: December 6, 2006 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of...

  • Page 248
    Signature Title Date /s/ THOMAS P. GERRITY Thomas P. Gerrity Director December 6, 2006 /s/ KAREN N. HORN, PHD. Karen N. Horn, PhD. /s/ BRIDGET A. MACASKILL Bridget A. Macaskill /s/ JOE K. PICKETT Joe K. Pickett LESLIE RAHL Leslie Rahl GREG C. SMITH Greg C. Smith Director December 6, 2006 ...

  • Page 249
    ... Exhibit 10.1 to Fannie Mae's Current Report on Form 8-K, filed September 23, 2004.) Employment Agreement between Fannie Mae and Daniel H. Mudd, as amended on June 30, 2004†(Incorporated by reference to Exhibit 10.2 to Fannie Mae's Quarterly Report on Form 10-Q for the quarter ended June 30, 2004...

  • Page 250
    ... Compensation Information" under Item 11 of Fannie Mae's Annual Report on Form 10-K for the year ended December 31, 2004.) Form of Indemnification Agreement for Non-Management Directors of Fannie Mae (Incorporated by reference to Exhibit 10.7 to Fannie Mae's registration statement on Form 10, filed...

  • Page 251
    ...between Officer of Federal Housing Enterprise Oversight (OFHEO) and Fannie Mae, including Consent Order (Incorporated by reference to Exhibit 10.1 to Fannie Mae's Current Report on Form 8-K, filed May 30, 2006.) Consent of Defendant Fannie Mae with Securities and Exchange Commission (SEC), dated May...

  • Page 252
    ... FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm...Consolidated Balance Sheets as of December 31, 2004 and 2003 ...Consolidated Statements of Income for the years ended December 31, 2004, 2003 and 2002...Consolidated Statements of Cash Flows for the years ended...

  • Page 253
    ... respects, the financial position of Fannie Mae as of December 31, 2004 and 2003, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America...

  • Page 254
    ... payable ...Federal funds purchased and securities sold under agreements to repurchase...Short-term debt ...Long-term debt ...Derivative liabilities at fair value ...Reserve for guaranty losses (includes $113 and $83 as of December 31, 2004 and 2003, respectively, related to Fannie Mae MBS included...

  • Page 255
    ... share amounts) For the Year Ended December 31, 2004 2003 2002 (Restated) (Restated) Interest income: Investments in securities ...Mortgage loans ...Total interest income ...Interest expense: Short-term debt ...Long-term debt ...Total interest expense ...Net interest income ...Guaranty fee income...

  • Page 256
    ...Mortgage loans acquired by assuming debt ...Transfers of loans held for sale to loans held for investment ...Transfers from mortgage loans to acquired property, net...Issuance of common stock from treasury stock for stock option and benefit plans . See Notes to Consolidated Financial Statements...

  • Page 257
    ... losses on guaranty assets and guaranty fee buy-ups (net of tax of $83 million) ...Net cash flow hedging losses ...Minimum pension liability (net of tax of $1 million) ...Total comprehensive income (Restated) ...Common stock dividends ($1.32 per share in 2002) ...Preferred stock: Preferred dividends...

  • Page 258
    ... 1. Restatement of Previously Issued Financial Statements Overview As a result of an investigation by the Office of Federal Housing Enterprise Oversight ("OFHEO") and a review of our accounting practices by the staff of the Securities and Exchange Commission ("SEC"), we filed a Form 8-K with the SEC...

  • Page 259
    .... For the Year Ended December 31, 2003 2002 (Dollars in millions, except per share data) Net income available to common stockholders, as previously reported Restatement adjustments for: Debt and derivatives ...Commitments ...Investments in securities ...MBS trust consolidation and sale accounting...

  • Page 260
    ... MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) we incorrectly valued certain option-based and foreign exchange derivatives; and we incorrectly calculated interest expense by using inappropriate estimates in our amortization of debt cost basis adjustments. The restatement adjustments...

  • Page 261
    ... resulted in changes in the fair value gain or loss associated with these derivatives, which was recognized in the consolidated statements of income. We incorrectly calculated interest expense by using inappropriate estimates in our amortization of debt cost basis adjustments. We amortized discounts...

  • Page 262
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) to the acquired assets for the value of these derivatives as of their settlement date. These cost basis adjustments are amortized into interest income over the life of the acquired assets. The impact of this amortization is reflected ...

  • Page 263
    ... roll repurchase transactions as short-term borrowings instead of purchases and sales of securities. The restatement adjustments associated with these errors resulted in a pre-tax increase in net income of $148 million and a decrease of $90 million for the years ended December 31, 2003 and 2002...

  • Page 264
    ...-only securities and lower credit quality investments for impairment. The restatement adjustments associated with these errors resulted in a pre-tax decrease in net income of $480 million and $625 million and a decrease in total assets of $1.2 billion and $872 million for the years ended December...

  • Page 265
    ... $26 million in "Investments losses, net" in the consolidated statements of income for the years ended December 31, 2003 and 2002, respectively, primarily due to reversing previously recorded asset sales. As a result of adopting FIN 46R, we consolidated certain MBS trusts created prior to February...

  • Page 266
    ...up-front cash receipts associated with our guaranties, known as buy-downs and risk-based pricing adjustments, pursuant to SFAS No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (an amendment of FASB Statements No. 13...

  • Page 267
    ... or buy-ups for impairment in accordance with EITF 99-20 and SFAS 115, as appropriate. The restatement adjustments related to impairments resulted in a pre-tax decrease in net income of $869 million and $313 million and a decrease in total assets of $1.8 billion and $1.1 billion for the years ended...

  • Page 268
    ...," "Investments in Securities" and "MBS Trust Consolidation and Sale Accounting" sections above. The restatement adjustments relating to these amortization errors resulted in a pre-tax decrease in net income of $1.3 billion and a pre-tax increase in net income of $135 million for the years ended...

  • Page 269
    ... recalculated the allowance and reserve with updated information and supportable data, reviewed and documented any judgmental adjustments and appropriately applied estimates of recoveries from credit enhancements to the loan population. - We made errors in calculating loan charge-off amounts. These...

  • Page 270
    ... financial statements for the restatement period: • Accounting for reverse mortgages. We made errors in accounting for reverse mortgages. When computing interest income on reverse mortgages we did not use the expected life of the borrower and house price expectations in the interest income...

  • Page 271
    ... fair value of our guaranty assets and guaranty obligations, which affected the fair value of our whole loans. We also incorrectly calculated the fair value of our HTM securities and debt. For our guaranty obligations we did not appropriately consider an estimate of the return on capital required by...

  • Page 272
    ... to changes in the estimated fair values of mortgage revenue bonds and REMICs. For our debt, we did not appropriately exclude certain commission costs associated with the issuance of new debt securities in creating the yield curve we used for estimating fair value. Correcting this error resulted in...

  • Page 273
    ...Financial MBS Trust Guaranties Consolidation and Amortization Total As and Sale Investments Master of Cost Basis Other Restatement Previously Debt and Reported(a) Derivatives Commitments in Securities Accounting Servicing Adjustments Adjustments Adjustments (Dollars in millions) As Restated Assets...

  • Page 274
    ...MBS Trust Financial As Total Consolidation Guaranties Amortization Previously Debt and Investments Restatement and Sale Other and Master of Cost Basis (a) Reported Derivatives Commitments in Securities Accounting Servicing Adjustments Adjustments Adjustments (Dollars in millions) As Restated Assets...

  • Page 275
    ... consolidated balance sheet for all periods through and as of December 31, 2001. As Total Previously Restatement As (a) Reported Adjustments Restated (Dollars in millions) Assets: Investments in securities ...Mortgage loans ...Derivative assets at fair value Deferred tax assets ...Other assets...

  • Page 276
    ...(Loss) Income (Dollars in millions) Total Stockholders' Equity December 31, 2001 balance, as previously reported . Restatement adjustments for: Debt and derivatives ...Commitments ...Investments in securities ...MBS trust consolidation and sale accounting . Financial guaranties and master servicing...

  • Page 277
    ... and Servicing Adjustments Adjustments Adjustments Restated Reported(a) Derivatives Commitments in Securities Accounting (Dollars in millions, except per share data) Net interest income ...Guaranty fee income ...Investment losses, net ...Derivatives fair value losses, net Debt extinguishment losses...

  • Page 278
    ...of income. Restatement Adjustments for: MBS Trust Financial As Total Consolidation Guaranties Amortization Previously Debt and Investments Restatement As and Sale Other and Master of Cost Basis Reported(a) Derivatives Commitments in Securities Accounting Servicing Adjustments Adjustments Adjustments...

  • Page 279
    ... as operating cash flows. As previously discussed, we incorrectly recorded sales of mortgage loans to MBS trusts that did not meet the definition of a QSPE under SFAS 140, which resulted in a net overall increase in cash flows from investing activities. Regulatory Capital Impact The following table...

  • Page 280
    ...three business segments: Single-Family Credit Guaranty, Housing and Community Development ("HCD") and Capital Markets. Our Single-Family Credit Guaranty segment generates revenue primarily from the guaranty fees we charge to compensate us for assuming the credit risk on the mortgage loans underlying...

  • Page 281
    ...be identified through a qualitative analysis, we use internal cash flow models, which may include Monte Carlo simulations, to compute and allocate expected losses or residual returns to each variable interest holder. The allocation of expected cash flows is based upon the relative contractual rights...

  • Page 282
    ...mortgage loans held for sale, trading securities and guaranty fees, including buy-up and buy-down payments, are included as operating activities. Federal funds sold and securities purchased under agreements to resell are presented as investing activities, while federal funds purchased and securities...

  • Page 283
    ...market prices for similar securities that we adjust for directly observable or corroborated (i.e., information purchased from third-party service providers) market information. In the absence of observable or corroborated market data, we use internally developed estimates, incorporating market-based...

  • Page 284
    ... for sale are reported at the lower of cost or market and typically only include single-family loans, because we do not generally sell or securitize multifamily loans from our own portfolio. Any excess of an HFS loan's cost over its fair value is recognized as a valuation allowance, with changes in...

  • Page 285
    ... statements of income. Credit losses related to groups of similar single-family and multifamily loans held for investment that are not individually impaired, or those that are collateral for Fannie Mae MBS, are recognized when (i) available information as of each balance sheet date indicates...

  • Page 286
    ... of current borrower financial information, operating statements on the underlying collateral, historical payment experience, collateral values when appropriate, and other related credit documentation. Multifamily loans that are categorized into pools based on their relative credit risk ratings are...

  • Page 287
    ... or Exchange of Debt Instruments is within the Scope of FASB Statement No. 15. Impairment of a loan restructured in a TDR is based on the excess of the recorded investment in the loan over the present value of the expected future cash inflows discounted at the loan's original effective interest rate...

  • Page 288
    .... Gains or losses on sales of foreclosed property are recognized through "Foreclosed property expense (income)" in the consolidated statements of income. Guaranty Accounting Our primary guaranty transactions result from mortgage loan securitizations in which we issue Fannie Mae MBS. The majority...

  • Page 289
    ... statements of income at inception of the guaranty fee contract. We recognize a liability for estimable and probable losses for the credit risk we assume on loans underlying Fannie Mae MBS based on management's estimate of probable losses incurred on those loans at each balance sheet date...

  • Page 290
    ... Fannie Mae MBS as no new assets were retained and no new liabilities have been assumed upon the subsequent sale. Amortization of Cost Basis and Guaranty Price Adjustments Cost Basis Adjustments We account for cost basis adjustments, including premiums and discounts on mortgage loans and securities...

  • Page 291
    ... interest method using a constant effective yield to amortize all risk-based price adjustments and buy-downs in connection with our Fannie Mae MBS issued prior to January 1, 2003. We calculated the constant effective yield for deferred guaranty price adjustments based upon our estimate of the cash...

  • Page 292
    ... calculation of gain or loss on the sale of assets. The fair values of the MSA and MSL are based on the present value of expected cash flows using management's best estimates of certain key assumptions, which include prepayment speeds, forward yield curves, adequate compensation, and discount rates...

  • Page 293
    ... their fair value on the settlement date in the cost basis of the security or loan that we purchase. Regular-way securities trades provide for delivery of securities within the time generally established by regulations or conventions in the market in which the trade occurs and are exempt from SFAS...

  • Page 294
    ...with changes in fair value included in the consolidated statements of income. Collateral We enter into various transactions where we pledge and accept collateral, the most common of which are our derivative transactions. Required collateral levels vary depending on the credit risk rating and type of...

  • Page 295
    ... into U.S. dollars using foreign exchange spot rates at the balance sheet date and any associated gains or losses are reported in "Fee and other income" in the consolidated statements of income. The classification of interest expense as either short-term or long-term is based on the contractual...

  • Page 296
    ... the fair value method of accounting for stock-based awards granted on or after January 1, 2003. For such awards, compensation expense is measured at fair value and recognized in "Salaries and employee benefits expense" in the consolidated statements of income over the required service period. Prior...

  • Page 297
    ... value of the options granted under our stock-based compensation plans are estimated on the date of the grant using a Black-Scholes model with the following weighted average assumptions displayed in the table below. 2004 2003 2002 Risk-free rate ...Volatility ...Dividend ...Average expected life...

  • Page 298
    ... in our mortgage portfolio, reclassification of debentures, notes and bonds into short-term and long-term debt categories and federal funds sold and securities purchased under agreements to resell, advances to lenders and deferred tax assets were reclassified from other assets. New Accounting...

  • Page 299
    ... of APB 25 to stock compensation awards issued to employees. Rather, SFAS 123R requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. With respect to options, SFAS 123R requires that they be...

  • Page 300
    ... earnings or (ii) continue recognizing periodic amortization expense and assess the MSRs for impairment as was originally required by SFAS 140. This option is available by class of servicing asset or liability. This statement also changes the calculation of the gain from the sale of financial assets...

  • Page 301
    ... AOCI. Additionally, it requires determination of benefit obligations and the fair values of a plan's assets at a company's year-end and recognition of actuarial gains and losses, and prior service costs and credits, as a component of AOCI. For employers with publicly traded securities, SFAS 158 is...

  • Page 302
    ... of affordable housing in the United States and to serve communities in need. In addition, our investments in LIHTC partnerships generate both tax credits and net operating losses that reduce our federal income tax liability. Our LIHTC investments primarily represent limited partnership interests...

  • Page 303
    ... year ended December 31, 2004, we consolidated our investments in certain LIHTC funds that were structured as limited partnerships. The consolidated funds invest in LIHTC operating partnerships that did not require consolidation under the requirements of FIN 46R and are therefore accounted for using...

  • Page 304
    ... amount outstanding, net of unamortized premiums and discounts, deferred price adjustments, and an allowance for loan losses. HFS loans are reported at the lower of cost or market determined on a pooled basis, with valuation changes recorded in the consolidated statements of income. The table below...

  • Page 305
    ... $1,051 $ 63 $ 720 317 $1,037 $ 68 ... (2) (3) The discounted cash flows, collateral value or market price equals or exceeds the carrying value of the loan, and as such, no allowance is required. Amount includes single-family and multifamily loans restructured in a TDR of $833 million and $697...

  • Page 306
    ...to "Note 2, Summary of Significant Accounting Policies" for additional information regarding aggregation of loans by risk characteristics and our methodology used to estimate the allowance and the reserve. The following table displays changes in the allowance for loan losses and reserve for guaranty...

  • Page 307
    ... measured at fair value with changes in fair value recorded in "Investment losses, net" in the consolidated statements of income. Trading securities include Fannie Mae single-class MBS of $34.4 billion and $42.7 billion and non-Fannie Mae single-class mortgage-related securities of $937 million...

  • Page 308
    ... Months or Longer Gross Unrealized Fair Losses Value Total Amortized Cost(1) Gross Unrealized Gains Gross Unrealized Losses Fannie Mae single-class MBS Non-Fannie Mae single-class mortgage-related securities . Fannie Mae structured MBS. . Non-Fannie Mae structured mortgage-related securities...

  • Page 309
    ... securities(2) ...Fannie Mae structured MBS(2) ...Non-Fannie Mae structured mortgagerelated securities(2) . . Mortgage revenue bonds ...Other mortgage-related securities(3) ...Asset-backed securities(2) ...Corporate debt securities ...Municipal bonds...Other non-mortgagerelated securities ...Total...

  • Page 310
    ... the fair value of our retained interests at the time of portfolio securitization for the years ended December 31, 2004 and 2003. Single-class MBS & Megas REMICs & SMBS Guaranty Assets For the year ended December 31, 2004 Weighted-average life(1) ...Average 12-month CPR(2) ...Average discount rate...

  • Page 311
    ... changes in both prepayment speed assumptions and discount rates. Single-class MBS & Megas REMICs & SMBS Guaranty Assets As of December 31, 2004 Retained interest valuation at period end: Fair value (dollars in millions) ...Weighted-average life(1) ...Prepayment speed assumptions: Average 12-month...

  • Page 312
    ...Mae MBS, irrespective of the cash flows received from borrowers. We also provide credit enhancements on taxable or tax-exempt mortgage revenue bonds issued by state and local governmental entities to finance multifamily housing for low- and moderate- income families. Additionally, we issue long-term...

  • Page 313
    ...for Loan Losses and Reserve for Guaranty Losses." These guaranties expose us to credit losses on the mortgage loans or, in the case of mortgage-related securities, the underlying mortgage loans of the related securities. The contractual terms of our guaranties range from 30 days to 30 years. However...

  • Page 314
    ...well the valuation allowance for any amount previously recorded as a LOCOM adjustment. 9. Short-term Borrowings and Long-term Debt We obtain the funds to finance our mortgage purchases and other business activities by selling debt securities in both the domestic and international capital markets. We...

  • Page 315
    ... Interest Rate(1) Outstanding (Restated) (Dollars in millions) Outstanding Federal funds purchased and securities sold under agreements to repurchase ...Fixed short-term debt: U.S. discount notes...Foreign exchange discount notes Other short-term debt ...Floating short-term debt ...Debt from...

  • Page 316
    ... through the use of cross currency interest rate swaps for the purpose of funding our mortgage assets. Our other long-term debt includes callable and non-callable securities, which include all long-term nonbenchmark securities, such as zero-coupons, fixed and other long-term securities, and are...

  • Page 317
    ... risk of expected cash flows of the mortgage assets we own. Our outstanding debt as of December 31, 2004 included $212.2 billion of callable debt that could be redeemed in whole or in part at our option any time on or after a specified date. The table below displays the amount of our long-term debt...

  • Page 318
    ... MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Although derivative instruments are critical to our interest rate risk management strategy, we did not apply hedge accounting to instruments entered into during the three-year period ended December 31, 2004. As such, all fair value changes...

  • Page 319
    ... Accrued interest...Total ...(1) (2) Represents the net of "Derivative assets at fair value "and "Derivative liabilities at fair value" for derivatives excluding mortgage commitment derivatives. Includes MBS options, swap credit enhancements and mortgage insurance contracts that are accounted for...

  • Page 320
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 11. Income Taxes We operate as a government-sponsored enterprise. We are subject to federal income tax, but we are exempt from state and local income taxes. The following table displays the components of our provision for federal ...

  • Page 321
    ..., 2004 2003 (Restated) (Dollars in millions) Deferred tax assets: Debt and derivative instruments ...Net guaranty assets and obligations and related items . . Cash fees and other upfront payments ...Allowance for loan losses and basis in REO properties . Employee compensation and benefits ...Other...

  • Page 322
    ...Stock-Based Compensation Plans The 1985 Employee Stock Purchase Plan (the "1985 Purchase Plan") provides employees an opportunity to purchase shares of Fannie Mae common stock at a discount to the fair market value of the stock during specified purchase periods. Our Board of Directors sets the terms...

  • Page 323
    ... shares, treasury shares or shares purchased on the open market. Stock-Based Compensation Programs Nonqualified Stock Options Under the 2003 Plan, we may grant stock options to eligible employees and non-management members of the Board of Directors. Generally, employees and non-management directors...

  • Page 324
    ...73 Total ...(1) Options in thousands. Employee Stock Purchase Program Plus Prior to 2003, the Board of Directors established offerings to eligible employees under the 1985 Purchase Plan. Beginning with the 2003 offering, the program was redesigned as a two-part program known as the Employee Stock...

  • Page 325
    ...longer than three years as long as the participant remains employed by Fannie Mae. Generally, dividend equivalents are earned on unpaid installments of completed cycles and are paid at the same time the shares are delivered to participants. The aggregate market value of performance shares awarded is...

  • Page 326
    ...from the Executive Pension Plan and whose salary exceeds the statutory compensation cap applicable to the qualified plan or whose benefit is limited by the statutory benefit cap. Similarly, the 2003 Supplemental Pension Plan provides additional benefits to our officers based on the annual cash bonus...

  • Page 327
    ...prior service costs and unrecognized gains or losses are included in the net periodic benefit costs in "Salaries and employee benefits expense" in the consolidated statements of income. Contributions to the qualified pension plan increase the plan assets while contributions to the unfunded plans are...

  • Page 328
    ...return on plan assets ...Employer contributions ...Plan participants' contributions ...Benefits paid ... Fair value of plan assets at end of year ...Reconciliation of Funded Status to Net Amount Recognized Funded status at end of period ...Unrecognized net actuarial loss...Unrecognized prior service...

  • Page 329
    ... to determine net periodic benefit costs Discount rate ...Average rate of increase in future compensation ...Expected long-term weighted average rate of return on plan assets ...Weighted average assumptions used to determine benefit obligation at year-end Discount rate ...Average rate of increase in...

  • Page 330
    ... FINANCIAL STATEMENTS-(Continued) In determining our net periodic benefit costs, we assess the discount rate to be used in the annual actuarial valuation of our pension and postretirement benefit obligations at year-end. We consider the current yields on high-quality, corporate fixed-income debt...

  • Page 331
    ... low market prices on the day preceding the contribution. Compensation cost is measured as the fair value of the shares or cash contributed to, or to be contributed to, the ESOP. We record these contributions as salaries and employee benefits expense in the consolidated statements of income. Expense...

  • Page 332
    ...manage business risk and each segment is based on the type of business activities it performs. These activities are discussed below. Single-Family Credit Guaranty. Our Single-Family Credit Guaranty segment works with our lender customers to securitize single-family mortgage loans into Fannie Mae MBS...

  • Page 333
    ... to our Single-Family Credit Guaranty business, neither the economic return nor the nature of the credit risk are similar to those of Single-Family Credit Guaranty. Capital Markets. Our Capital Markets segment manages our investment activity in mortgage loans and mortgage-related securities, and has...

  • Page 334
    ...the Year Ended December 31, 2004 Single-Family Capital Credit Guaranty HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense) . . Investment gains (losses), net ...Derivatives fair value losses, net ...Debt extinguishment losses, net ...Losses from...

  • Page 335
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) For the Year Ended December 31, 2003 Single-Family Capital Credit Guaranty HCD Markets Total (Restated) (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense) . . Investment gains (losses), net ......

  • Page 336
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) For the Year Ended December 31, 2002 Single-Family Capital Credit Guaranty HCD Markets Total (Restated) (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense) ...Investment gains (losses), net ......

  • Page 337
    ...Mae MBS held by third parties; and (iii) up to 0.25% of other off-balance sheet obligations, which may be adjusted by the Director of OFHEO under certain circumstances. OFHEO's risk-based capital standard ties our capital requirements to the risk in our book of business, as measured by a stress test...

  • Page 338
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) (6) (7) (8) Defined as the amount of total capital required to be held to absorb projected losses flowing from future adverse interest rate and credit risk conditions specified by statute (see 12 CFR 1750.13 for conditions), plus ...

  • Page 339
    ...: (i) outstanding Fannie Mae MBS held by third parties times 0.45%; and (ii) total on-balance sheet assets times 4%. We must also take reasonable steps to maintain sufficient outstanding subordinated debt to promote liquidity and reliable market quotes on market values. Every six months, commencing...

  • Page 340
    ... capital report to OFHEO as of December 31, 2005 ($727.75 billion), except under limited circumstances at the discretion of OFHEO. Net mortgage portfolio assets are defined as mortgage loans and securities net of mark-to-market adjustments for available-for-sale securities, allowance for loan losses...

  • Page 341
    ... property value underlying the loan. Geographic concentrations increase the exposure of our portfolio to changes in credit risk. Single-family borrowers are primarily affected by home price appreciation and low interest rates. The geographic dispersion of our Single-Family Credit Guaranty business...

  • Page 342
    ... our multifamily risk management activities, we perform detailed loss reviews that evaluate borrower and geographic concentrations, lender qualifications, counterparty risk, property performance and contract compliance. We generally require servicers to submit periodic property operating information...

  • Page 343
    ... could result in credit losses for us, and we could incur the cost of finding a replacement servicer, which could be substantial for loans that require a special servicer. Our ten largest single-family mortgage servicers serviced 71% and 69% of our single-family mortgage credit book of business as...

  • Page 344
    ...for any ratings based on Moody's scale. Includes MBS options, mortgage insurance contracts and swap credit enhancements accounted for as derivatives. Represents the exposure to credit loss on derivative instruments, which is estimated by calculating the cost, on a present value basis, to replace all...

  • Page 345
    ... prepayment rates. If market data needed to estimate fair value is not available, we estimate fair value using internally developed models that employ a discounted cash flow approach. These estimates are based on pertinent information available to us at the time of the applicable reporting periods...

  • Page 346
    ... Estimated Fair Estimated Fair Carrying Value Value Carrying Value Value (Restated) (Restated) (Dollars in millions) Assets: Cash and cash equivalents ...Federal funds sold and securities purchased under agreements to resell ...Trading securities ...Available-for-sale securities ...Mortgage loans...

  • Page 347
    ...Debt and Long-Term Debt-We estimate the fair value of our non-callable debt using the discounted cash flow approach based on the Fannie Mae yield curve with an adjustment to reflect fair values at the offer side of the market. We estimate the fair value of our callable bonds using an option adjusted...

  • Page 348
    ... on our business, financial condition and results of operations. However, excluding the SEC and OFHEO settlements described below, we are unable to reasonably estimate a range of possible losses at this time. Accordingly, we have not recorded a reserve for any litigation exposures discussed herein...

  • Page 349
    ... class action filed an amended consolidated complaint against us and former officers Franklin D. Raines, J. Timothy Howard and Leanne Spencer, that added purchasers of publicly traded call options and sellers of publicly traded put options to the putative class and sought to extend the end...

  • Page 350
    ... Paul Weiss report and other additional details. We filed motions to dismiss the first amended complaint on October 20, 2006. In Re Fannie Mae ERISA Litigation (formerly David Gwyer v. Fannie Mae) Three ERISA-based cases have been filed against us, our Board of Directors' Compensation Committee, and...

  • Page 351
    ... OFHEO's final report, including actions relating to our corporate governance, Board of Directors, capital plans, internal controls, accounting practices, public disclosures, regulatory reporting, personnel and compensation practices. We also agreed not to increase our net mortgage assets above the...

  • Page 352
    ... class action complaints filed by single-family borrowers that allege that we and Freddie Mac violated the Clayton and Sherman Acts and state antitrust and consumer protection statutes by agreeing to artificially fix, raise, maintain or stabilize the price of the companies' guaranty fees. Two...

  • Page 353
    ... dates through 2029, none of which are capital leases. Some of these leases provide for payment by the lessee of property taxes, insurance premiums, cost of maintenance and other costs. Rental expenses for operating leases were $38 million, $39 million and $35 million for the years ended December...

  • Page 354
    ...Reported(1) Restated 2004 2004 (Dollars in millions) Assets: Cash and cash equivalents ...Investments in securities: Trading, at fair value ...Available-for-sale, at fair value ...Held-to-maturity, at fair value ...Total investments ...Mortgage loans: Loans held for sale, at lower of cost or market...

  • Page 355
    ... the table, the condensed consolidated statements of income and earnings per share, for the quarters ended March 31, 2004 and June 30, 2004 have been restated from previously filed unaudited consolidated financial statements. For the Quarter Ended March 31, 2004 As Previously Reported(1) As Restated...

  • Page 356
    ... the credit risk on mortgage loans and Fannie Mae MBS held in our portfolio. For the Quarter Ended June 30, 2004 Single-Family Capital Credit Guaranty HCD Markets Total (Restated) (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) . . Investment gains (losses...

  • Page 357
    ... the credit risk on mortgage loans and Fannie Mae MBS held in our portfolio. For the Quarter Ended December 31, 2004 Single-Family Capital Credit Guaranty HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) ...Investment gains (losses), net...

  • Page 358
    ...of this employee stock repurchase program, we repurchased shares in a limited number of instances relating to financial hardship as well as reacquired common stock from employees as payment for the cost of option exercises and tax withholding. Final OFHEO Report and Settlements with OFHEO and SEC On...