Fannie Mae 2004 Annual Report Download - page 136

Key Elements of Changes in Estimated Fair Value of Net Assets (Non-GAAP)
Although we have not provided specific attribution of fair value changes for 2004, we consider the factors
described in the following paragraphs in evaluating changes in the estimated fair value of our net assets
because they are the principal drivers of these changes.
•Capital Transactions, Net. Capital transactions include our issuances of common and preferred stock,
our repurchases of stock and our payment of dividends. Cash we receive from the issuance of preferred
and common stock results in an increase in the fair value of our net assets, while repurchases of stock and
dividends we pay on our stock reduce the fair value of our net assets.
•Estimated Net Interest Income from OAS. OAS income represents the estimated net interest income
generated during the current period that is attributable to the market spread between the yields on our
mortgage-related assets and the yields on our debt during the period, calculated on an option-adjusted
basis.
•Guaranty Fees, Net. Guaranty fees, net, represent the net cash receipts during the reported period related
to our guaranty business, and are generally calculated as the difference between the contractual guaranty
fees we receive during the period and the expenses we incur during the period that are associated with our
guaranty business. Changes in guaranty fees, net, result from changes in portfolio size and composition,
changes in the credit quality of the underlying assets and changes in the market spreads for similar
instruments.
•Fee and Other Income and Other Expenses, Net. Fee and other income includes miscellaneous fees,
such as resecuritization transaction fees and technology-related fees. Other expenses primarily include
costs incurred during the period that are associated with the Capital Markets group.
•Return on Risk Positions. Our investment activities expose us to market risks, including duration and
convexity risks, yield curve risk, OAS risk and volatility risk. The return on risk positions represents the
estimated net increase or decrease in the fair value of our net assets resulting from net exposures related
to the market risks we actively manage. We actively manage, or hedge, interest rate risk related to our
mortgage investments in order to maintain our interest rate risk exposure within prescribed limits.
However, we do not actively manage certain other market risks. Specifically, we do not actively manage
the mortgage-to-debt OAS or interest rate risk related to our guaranty business, as discussed below.
Additional information about credit, market and operational risks and our strategies for managing these
types of risks is included in “Risk Management.”
•Mortgage-to-debt OAS. Funding mortgage investments with debt exposes us to mortgage-to-debt OAS
risk, which represents basis risk. Basis risk is the risk that interest rates in different market sectors will
not move in the same direction or amount at the same time. We generally hold our mortgage investments
to generate a spread over our debt on a long-term basis. The fair value of our assets and liabilities can be
significantly affected by periodic changes in the net OAS between the mortgage and agency debt sectors.
The fair value impact of changes in mortgage-to-debt OAS for a given period represents an estimate of
the net unrealized increase or decrease in the fair value of our net assets resulting from fluctuations during
the reported period in the net OAS between our mortgage assets and our outstanding debt securities.
When the mortgage-to-debt OAS on a given mortgage asset increases, or widens, the fair value of the
asset will typically decline relative to the debt.
We 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, option-
adjusted yield spread, historical valuations and embedded options. Our models also take into account risk
factors such as credit quality, price volatility and prepayment experience. We purchase mortgage assets
that appear economically attractive to us in the context of current market conditions and that fall within
our OAS targets. Although a widening of mortgage-to-debt OAS during a period generally results in
lower fair values during that period, it can provide us with better investment opportunities to purchase
mortgage assets because a wider OAS is indicative of higher expected returns. We generally purchase
mortgage assets when mortgage-to-debt OAS is relatively wide and restrict our purchase activity or sell
mortgage assets when mortgage-to-debt OAS is relatively narrow. We do not, however, attempt to actively
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