Fannie Mae 2004 Annual Report Download - page 23

securities include structured mortgage-related securities such as real estate mortgage investment conduits
(“REMICs”). The interest rates on the structured mortgage-related securities held in our portfolio may not be
the same as the interest rates on the underlying loans. For example, we may hold a floating rate REMIC
security with an interest rate that adjusts periodically based on changes in a specified market reference rate,
such as the London Inter-Bank Offered Rate (“LIBOR”); however, the REMIC may be backed by fixed-rate
mortgage loans. The REMIC securities we own primarily fall into two categories: agency REMICs, which are
generally Fannie Mae-issued REMICs, and non-agency REMICs issued by private-label issuers. For informa-
tion on the composition of our mortgage investment portfolio by product type, refer to Table 22 in “Item 7—
MD&A—Business Segment Results—Capital Markets Group—Mortgage Investments.”
While our Single-Family and HCD businesses are responsible for managing the credit risk associated with our
investments in 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 constraints, while
fulfilling our chartered liquidity function. We pursue these objectives by purchasing, selling and managing
mortgage assets based on market dynamics and our assessment of the economic attractiveness of specific
transactions at given points in time. This approach is an enhancement to our strategy prior to 2005, which
focused primarily on buying mortgage assets when anticipated returns met or exceeded our hurdle rates and
generally holding those assets to maturity. We now also consider asset sales in order to generate economic
value when supply and demand dynamics in our market result in attractive pricing for certain assets in our
portfolio.
The level of our purchases and sales of mortgage assets in any given period has been generally determined by
the rates of return that we expect to be able to earn on the equity capital underlying our investments. 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. When few opportunities exist to earn returns above our cost of
equity capital, we generally will be a less active purchaser, and may be a net seller, of mortgage loans and
mortgage-related securities. This investment strategy is consistent with our chartered liquidity function, as the
periods during which our purchase of mortgage assets is economically attractive to us generally have been
periods in which market demand for mortgage assets is low.
The difference, or spread, between the yield on mortgage assets available for purchase or sale and our
borrowing costs, after consideration of the net risks associated with the investment, is an important factor in
determining whether we are a net buyer or seller of mortgage assets. When the spread between the yield on
mortgage assets and our borrowing costs is wide, which is typically when demand for mortgage assets from
other investors is low, we will look for opportunities to add liquidity to the market primarily by purchasing
mortgage assets and issuing debt to investors to fund those purchases. When this spread is narrow, which is
typically when market demand for mortgage assets is high, we will look for opportunities to meet demand by
selling mortgage assets from our portfolio. Even in periods of high market demand for mortgage assets,
however, we expect to be an active purchaser of less liquid forms of mortgage loans and mortgage-related
securities. The amount of our purchases of these mortgage loans and mortgage-related securities may be less
than the amortization, prepayments and sales of mortgage loans we hold and, as a result, our investment
balances may decline during periods of high market demand.
We determine our total return by measuring the change in the fair value of our net assets attributable to
common stockholders, as adjusted for our capital transactions, such as dividend payments and share issuances
and repurchases. The fair value of our net assets will change from period to period as a result of changes in
the mix of our assets and liabilities and changes in interest rates, expected volatility and other market factors.
The fair value of our net assets is also subject to change due to inherent market fluctuations in the yields on
our mortgage assets relative to the yields on our debt securities. The fair value of our guaranty assets and
guaranty obligations will also fluctuate in the short term due to changes in interest rates. These fluctuations
are likely to produce volatility in the fair value of our net assets in the short-term that may not be
representative of our long-term performance.
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