Fannie Mae 2004 Annual Report Download - page 22

• providing financing to designated communities to expand the affordable housing stock in those
communities as part of their community development efforts; and
• providing financing for single-family and multifamily housing to housing finance agencies, public housing
authorities and municipalities.
In August 2006, OFHEO advised us to suspend new AD&C business until we have finalized and implemented
specified policies and procedures required to strengthen risk management practices related to this business. We
expect to have finalized and substantially completed implementation of these policies and procedures by
December 2006. We will not engage in new AD&C business until OFHEO determines the finalized policies
and procedures are satisfactory.
Capital Markets
Our Capital Markets group manages our investment activity in mortgage loans, mortgage-related securities and
other liquid investments. We purchase mortgage loans and mortgage-related securities from mortgage lenders,
securities dealers, investors and other market participants. We also sell mortgage loans and mortgage-related
securities.
We fund our investments primarily through the proceeds from our issuance of debt securities in the domestic
and international capital markets. By using the proceeds of this debt funding to invest in mortgage loans and
mortgage-related securities, we directly and indirectly increase the amount of funding available to mortgage
lenders. By managing the structure of our debt obligations and through our use of derivatives, we strive to
substantially limit adverse changes in the net fair value of our investment portfolio that result from interest
rate changes.
Our Capital Markets group earns most of its income from the difference, or spread, between the interest we
earn on our mortgage portfolio and the interest we pay on the debt we issue to fund this portfolio, which is
referred to as our net interest yield. As described below, our Capital Markets group uses various debt and
derivative instruments to help 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, as described below under “Securitization Activities.”
Mortgage Investments
The amount of our net mortgage investments was $924.8 billion as of December 31, 2004 and $919.3 billion
as of December 31, 2003. As described in “Item 7—MD&A—Business Segment Results—Capital Markets
Group,” the amount of our mortgage investments has decreased since December 31, 2004. We estimate that
the amount of our net mortgage investments was $720.3 billion as of September 30, 2006. As described above
under “Financial Restatement, Regulatory Reviews and Other Significant Recent Events,” as part of our May
2006 consent order with OFHEO, we agreed not to increase the size of our net mortgage portfolio above
$727.75 billion, except in limited circumstances at OFHEO’s discretion. We will be subject to this limitation
on mortgage investment growth until the Director of OFHEO has determined that modification or expiration of
the limitation is appropriate in light of specified factors such as resolution of accounting and internal control
issues. For additional information on our capital requirements and regulations affecting the amount of our
mortgage investments, see “Our Charter and Regulation of Our Activities” and “Item 7—MD&A—Liquidity
and Capital Management—Capital Management.”
Our mortgage investments include both mortgage-related securities and mortgage loans. We purchase primarily
conventional single-family fixed-rate or adjustable-rate, first lien mortgage loans, or mortgage-related securities
backed by such loans. In addition, we purchase loans insured by the FHA, loans guaranteed by the Department
of Veterans Affairs (“VA”) or by the Rural Housing Service of the Department of Agriculture (“RHS”),
manufactured housing loans, multifamily mortgage loans, subordinate lien mortgage loans (e.g., loans secured
by second liens) and other mortgage-related securities. Most of these loans are prepayable at the option of the
borrower. Some of our investments in mortgage-related securities are effected in the TBA market, which is
described above under “Single-Family Credit Guaranty—TBA Market.” Our investments in mortgage-related
17