Fannie Mae 2004 Annual Report Download - page 48

due to the current competitive dynamics of the mortgage market, we have recently increased our purchase and
securitization of mortgage loans that pose a higher credit risk, such as negative-amortizing loans and interest-
only loans. We also have increased the proportion of reduced documentation loans that we purchase or that
back our Fannie Mae MBS.
For example, negative-amortizing adjustable-rate mortgages (“ARMs”) represented approximately 2% and 3%,
respectively, of our conventional single-family business volumes (which refers to both conventional single-
family mortgage loans we purchase for our mortgage portfolio and conventional single-family mortgage loans
we securitize into Fannie Mae MBS) in 2004 and 2005, and approximately 4% for the first nine months of
2006. Interest-only mortgage loans represented approximately 5% and 10%, respectively, of our conventional
single-family business volumes in 2004 and 2005, and approximately 15% for the first nine months of 2006.
We estimate that negative-amortizing ARMs and interest-only loans represented approximately 2% and 6%,
respectively, of our conventional single-family mortgage credit book of business as of September 30, 2006.
The increase in our exposure to credit risk resulting from the increase in these loans with higher credit risk
may cause us to experience increased delinquencies and credit losses in the future, which could adversely
affect our financial condition and results of operations. A discussion of how we manage mortgage credit risk
and a description of the risk characteristics of our mortgage credit book of business is included in “Item 7—
MD&A—Risk Management—Credit Risk Management—Mortgage Credit Risk Management.”
We depend on our institutional counterparties to provide services that are critical to our business, and our
financial condition and results of operations may be adversely affected by defaults by our institutional
counterparties.
We face the risk that our institutional counterparties may fail to fulfill their contractual obligations to us. Our
primary exposure to institutional counterparties risk is with our mortgage insurers, mortgage servicers, lender
customers, issuers of investments held in our liquid investment portfolio, dealers that commit to sell mortgage
pools or loans to us, and derivatives counterparties. The products or services that these counterparties provide
are critical to our business operations and a default by a counterparty with significant obligations to us could
adversely affect our financial condition and results of operations. A discussion of how we manage institutional
counterparty credit risk is included in “Item 7—MD&A—Risk Management—Credit Risk Management—
Institutional Counterparty Credit Risk Management.”
Mortgage Insurers. A mortgage insurer could fail to fulfill its obligation to reimburse us for claims under
our mortgage insurance policies, which would require us to bear the full loss of the borrower default on the
mortgage loans. As of December 31, 2004, we were the beneficiary of primary mortgage insurance coverage
on $285.4 billion of single-family loans held in our portfolio or underlying Fannie Mae MBS, which
represented approximately 13% of our single-family mortgage credit book of business.
Lender Risk-Sharing Agreements. We enter into risk-sharing agreements with some of our lender customers
that require them to reimburse us for losses under the loans that are the subject of those agreements. A
lender’s default in its obligation to reimburse us could decrease our net income.
Mortgage Servicers. One or more of our mortgage servicers could fail to fulfill its mortgage loan servicing
obligations, which include collecting payments from borrowers under the mortgage loans that we own or that
are part of the collateral 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
associated with loan delinquencies or penalties for late payment of taxes and insurance on the properties that
secure the mortgage loans serviced by that mortgage servicer. In addition, we likely would be forced to incur
the costs necessary to replace the defaulting mortgage servicer. These events would result in a decrease in our
net income. As of December 31, 2004, our ten largest single-family mortgage servicers serviced 71% of our
single-family mortgage credit book of business, and the largest single-family mortgage servicer serviced 21%
of the single-family mortgage credit book of business. Accordingly, the effect of a default by one of these
servicers could result in a more significant decrease in our net income than if our loans were serviced by a
more diverse group of servicers.
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