Fannie Mae 2004 Annual Report Download - page 190

Fannie Mae MBS Transactions and Other Financial Guaranties
As described in “Item 1—Business,” both our Single-Family Credit Guaranty business and our HCD business
generate revenue through guaranty fees earned in connection with the issuance of Fannie Mae MBS. In a
typical Fannie Mae MBS transaction, we receive mortgage loans or mortgage-related securities from lenders
and transfer the assets to a trust or special purpose entity. Upon creation of the trust, we deliver back
beneficial interests in the trust to investors in the form of Fannie Mae MBS. In holding Fannie Mae MBS
created from a pool of whole loans, an investor has securities that are generally more liquid than whole loans,
which provides the investor with greater financial flexibility. In particular, by holding readily marketable
Fannie Mae MBS, lenders increase their ability to replenish their funds for use in making additional loans.
We guarantee to each MBS trust that we will supplement mortgage loan collections as required to permit
timely payments of principal and interest on the related Fannie Mae MBS, irrespective of the cash flows
received from borrowers. In connection with our guaranties issued or modified on or after January 1, 2003, we
record in the consolidated balance sheets a guaranty obligation based on an estimate of our non-contingent
obligation to stand ready to perform under these guaranties. We also record in the consolidated balance 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 therefore is generally not reflected in the consolidated balance
sheets. Of the $1.9 trillion in total Fannie Mae MBS outstanding as of December 31, 2004, $344.4 billion was
held in our portfolio and $1.4 trillion was held by third-party investors. The $344.4 billion in Fannie Mae
MBS held in our portfolio is reflected in the consolidated balance sheets as “Investments in securities.” We
consolidate certain Fannie Mae MBS trusts depending on the significance of our interest in those MBS trusts.
Upon consolidation, we recognize the assets of the consolidated trust. As of December 31, 2004, we had
recognized $150.1 billion of assets as “Mortgage loans” in the consolidated balance sheets as a result of
consolidating MBS trusts. Accordingly, as of December 31, 2004, there was approximately $1.4 trillion in
outstanding and unconsolidated Fannie Mae MBS held by third parties, which is not included in the
consolidated balance sheets.
While our guaranties relating to Fannie Mae MBS represent the substantial majority of our guaranty activity,
we also provide other financial guaranties. Our HCD business provides credit enhancements primarily for
taxable and tax-exempt bonds issued by state and local governmental entities to finance multifamily housing
for low- and moderate-income families. Under these credit enhancement arrangements, we guarantee to the
trust that we will supplement proceeds as required to permit timely payment on the related bonds, which
improves the bond ratings and thereby results in lower-cost financing for multifamily housing. Our HCD
business generates revenue from the fees earned on these transactions. These transactions also contribute to
our housing goals and help us meet other mission-related objectives.
Our maximum potential exposure to credit losses relating to our outstanding and unconsolidated Fannie Mae
MBS held by third parties and our other financial guaranties is significantly higher than the carrying amount
of the guaranty obligations and reserve for guaranty losses that are reflected in the consolidated balance sheets.
In the case of outstanding and unconsolidated Fannie Mae MBS held by third parties, our maximum potential
exposure arising from these guaranties is primarily represented by the unpaid principal balance of the
mortgage loans underlying these Fannie Mae MBS, which was $1.4 trillion as of December 31, 2004. In the
case of our other financial guaranties, our maximum potential exposure is primarily represented by the unpaid
principal balance of the underlying bonds and loans, which was $14.8 billion as of December 31, 2004.
Based on our historical credit losses, which have averaged approximately 0.01% of our mortgage credit book
of business during the period 2002 to 2004, we do not believe that the maximum exposure on our Fannie Mae
MBS and other credit-related guaranties is representative of our actual credit exposure relating to these
guaranties. In the event that we were required to make payments under these guaranties, we would pursue
recovery of these payments by exercising our rights to the collateral backing the underlying loans or through
available credit enhancements (which includes all recourse with third parties and mortgage insurance).
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