Fannie Mae 2005 Annual Report Download

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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2005
Commission File No.: 0-50231
Federal National Mortgage Association
(Exact name of registrant as specified in its charter)
Fannie Mae
Federally chartered corporation 52-0883107
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
3900 Wisconsin Avenue,
NW Washington, DC
(Address of principal executive offices)
20016
(Zip Code)
Registrant’s telephone number, including area code:
(202) 752-7000
Securities registered pursuant to Section 12(b) of the Act:
None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, without par value
(Title of class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes nNo ¥
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the
Act. Yes nNo ¥
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to such filing requirements for the
past 90 days. Yes nNo ¥
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. n
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-
accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act. (Check one):
Large accelerated filer ¥Accelerated filer nNon-accelerated filer n
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes nNo ¥
The aggregate market value of the common stock held by non-affiliates of the registrant computed by
reference to the price at which the common stock was last sold on June 30, 2006 (the last business day of the
registrant’s most recently completed second fiscal quarter) was approximately $46,790 million.
As of February 28, 2007, there were 973,046,601 shares of common stock of the registrant outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
None.

Table of contents

  • Page 1
    ... Washington, D.C. 20549 Form 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2005 Commission File No.: 0-50231 Federal National Mortgage Association (Exact name of registrant as specified in its charter) Fannie Mae...

  • Page 2
    ... of Financial Condition and Results of Operations ...Organization of MD&A ...Executive Summary ...Critical Accounting Policies and Estimates ...Consolidated Results of Operations ...Business Segment Results...Supplemental Non-GAAP Information-Fair Value Balance Sheet ...Risk Management ...Liquidity...

  • Page 3
    ... and Executive Officers of the Registrant ...Item 11. Executive Compensation...Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters ...Item 13. Certain Relationships and Related Transactions ...Item 14. Principal Accounting Fees and Services...

  • Page 4
    ...Properties ...Allowance for Loan Losses and Reserve for Guaranty Losses ...Credit Loss Exposure of Derivative Instruments ...Activity and Maturity Data for Risk Management Derivatives ...Interest Rate Sensitivity of Net Asset Fair Value ...Debt Activity ...Outstanding Short-Term Borrowings ...Fannie...

  • Page 5
    Table Description Page 37 38 39 40 41 42 43 Regulatory Capital Surplus ...On- and Off-Balance Sheet MBS and Other Guaranty Arrangements ...LIHTC Partnership Investments ...2005 Quarterly Condensed Consolidated Statements of Income ...2004 Quarterly Condensed Consolidated Statements of Income ......

  • Page 6
    ... our business is self-sustaining and funded exclusively with private capital. Our common stock is listed on the New York Stock Exchange, or NYSE, and traded under the symbol "FNM." Our debt securities are actively traded in the over-the-counter market. RECENT SIGNIFICANT EVENTS OFHEO Consent Order...

  • Page 7
    ...mortgage debt outstanding was estimated by the Federal Reserve to be approximately $10.9 trillion (including $10.2 trillion of single-family mortgages). Our mortgage credit book of business, which includes mortgage assets we hold in our investment portfolio, our Fannie Mae mortgage-backed securities...

  • Page 8
    ...investment portfolio; (3) Fannie Mae MBS held by third parties; and (4) credit enhancements that we provide on mortgage assets. Represents the estimated share of total U.S. residential mortgage debt outstanding on which we bear the interest rate risk. Calculated based on the unpaid principal balance...

  • Page 9
    ... 9% higher than year-ago levels, the annualized growth rate in the fourth quarter of 2006 slowed to 6.4%. We expect that growth in total U.S. residential mortgage debt outstanding will continue at a slower pace in 2007, as the housing market cools further and average home prices possibly decline...

  • Page 10
    ... investments in rental housing that qualify for federal low-income housing tax credits. Our HCD business has responsibility for managing our credit risk exposure relating to the multifamily Fannie Mae MBS held by third parties, as well as the multifamily mortgage loans and multifamily Fannie Mae MBS...

  • Page 11
    ...Mae MBS. Both our Single-Family and HCD businesses securitize mortgages that contribute to our housing goals. In addition, our Capital Markets group purchases mortgages for our mortgage portfolio that contribute to our housing goals. The table below displays the revenues, net income and total assets...

  • Page 12
    ... housing finance agencies. In our Single-Family business, mortgage lenders generally deliver mortgage loans to us in exchange for our Fannie Mae MBS. In a typical MBS transaction, we guaranty to each MBS trust that we will supplement amounts received by the MBS trust as required to permit timely...

  • Page 13
    ... guidelines. Guaranty Services Our Single-Family business provides guaranty services by assuming the credit risk of the single-family mortgage loans underlying our guaranteed Fannie Mae MBS held by third parties. Our Single-Family business also assumes the credit risk of the single-family mortgage...

  • Page 14
    ...formed from single-family whole loans. Our Single-Family business works with our Capital Markets group in structuring these single-family whole loan multi-class Fannie Mae MBS. Single-family whole loan multiclass Fannie Mae MBS divide the cash flows on the underlying loans and create several classes...

  • Page 15
    ... rates for mortgage loan applicants throughout the loan origination process. The TBA market lowers transaction costs, increases liquidity and facilitates efficient settlement of sales and purchases of mortgage-related securities. Credit Risk Management Our Single-Family business bears the credit...

  • Page 16
    ...lenders generally act as servicers on the loans they sell to us, and servicing transfers must be approved by us. We also work with DUS lenders to provide credit enhancement for taxable and tax-exempt bonds issued by entities such as housing finance authorities. DUS lenders generally share the credit...

  • Page 17
    ... of our Single-Family business by managing the quality of the mortgages we acquire for our portfolio or securitize into Fannie Mae MBS, diversifying our exposure to credit losses, continually assessing the level of credit risk that we bear, and actively managing problem loans and assets to mitigate...

  • Page 18
    ... Lending Group HCD's Community Lending Group supports the expansion of available housing by participating in specialized debt financing for a variety of customers and by acquiring mortgage loans. These activities include: • helping to meet the financing needs of single-family and multifamily home...

  • Page 19
    ...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...

  • Page 20
    ...of loans we held for a short time. 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...

  • Page 21
    ...highly-rated mortgage-related securities backed by mortgage loans that meet our regulatory housing goals requirements. Our Capital Markets group's purchase of goals-qualifying mortgage loans is a critical factor in our ability to meet our housing goals. Funding of Our Investments Our Capital Markets...

  • Page 22
    ... debt securities and the manner in which we conduct our financing programs, contribute to the favorable trading characteristics of our debt. As a result, we generally are able to borrow at lower interest rates than other corporate debt issuers. For information on the credit ratings of our long-term...

  • Page 23
    .... The types of Fannie Mae MBS that our Capital Markets group creates through portfolio securitizations include the same types as those created by our Single-Family and HCD businesses, as described in "Single-Family Credit Guaranty-Guaranty Services" and "Housing and Community Development-Multifamily...

  • Page 24
    ...Federal Home Loan Banks, financial institutions, securities dealers, insurance companies, pension funds and other investors. Our market share of loans purchased for our investment portfolio or securitized into Fannie Mae MBS is affected by the amount of residential mortgage loans offered for sale in...

  • Page 25
    ..., our estimated market share of new single-family mortgage-related securities issuance was 23.7%, compared to 23.5% in 2005, 29.2% in 2004 and 45.0% in 2003. Our estimates of market share are based on publicly available data and exclude previously securitized mortgages. We expect our Single-Family...

  • Page 26
    ... investment capital available for residential mortgage financing. In addition to our overall strategy being aligned with these purposes, all of our business activities must be permissible under the Charter Act. Our charter specifically authorizes us to "purchase, service, sell, lend on the security...

  • Page 27
    ... policies and guidelines have loan-to-value ratio requirements that depend upon a variety of factors, such as the borrower credit history, the loan purpose, the repayment terms and the number of dwelling units in the property securing the loan. Depending on these factors and the amount and type of...

  • Page 28
    ... by the number of loans (not dwelling units) providing purchase money for owner-occupied single-family housing in metropolitan areas. We also have a subgoal for multifamily special affordable housing that is expressed as a dollar amount. Each year, we are required to submit an annual report on our...

  • Page 29
    ... income and rent data. Actual results for 2003 reflect the impact of incentive points for small multifamily and owner-occupied rental housing, which were no longer available starting in 2004. Goals are expressed as a percentage of the total number of dwelling units financed by eligible mortgage loan...

  • Page 30
    ... executive officers. OFHEO also may use other informal supervisory procedures of the type that are generally used by federal bank regulatory agencies. OFHEO Consent Order In 2003, OFHEO commenced a special examination of our accounting policies and practices, internal controls, financial reporting...

  • Page 31
    ... percentages of our assets and our off-balance sheet obligations, such as outstanding guaranties. In addition, the 1992 Act capital requirements include a risk-based capital requirement that is calculated as the amount of capital needed to withstand a severe ten-year stress period characterized by...

  • Page 32
    ...to increase the level of our required capital; • changing the approval process for products and activities and expanding the extent of regulatory oversight of us and our officers, directors and employees; • changing the method for enforcing compliance with housing goals; and • authorizing, and...

  • Page 33
    ... lowering the cost of borrowing in the mortgage market and, as a result, expanding access to housing and increasing opportunities for homeownership. As Fannie Mae has testified before Congress, we continue to support legislation that would: • create a single independent, well-funded regulator that...

  • Page 34
    ... have represented an elevated level of market activity by historical standards in recent years; • our expectation that, 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, and that when...

  • Page 35
    ... normal market conditions, our selling activity will represent a modest portion of the total changes in the total portfolio for the year; • our expectation that tax credits and net operating losses resulting from our investments in LIHTC partnerships, which reduce our federal income tax liability...

  • Page 36
    ... levels and lack of home price appreciation; • our expectation that our short-term and long-term funding needs and uses of cash in 2007 and 2008 will remain generally consistent with our needs during 2005 and 2006; • our expectation that, over the long term, our funding needs and sources...

  • Page 37
    ... "new business acquisitions" refers to the sum in any given period of the unpaid principal balance of: (1) the mortgage loans and mortgage-related securities we purchase for our investment portfolio; and (2) the mortgage loans we securitize into Fannie Mae MBS that are acquired by third parties. It...

  • Page 38
    ... investment portfolio; (2) the Fannie Mae MBS and non-Fannie Mae mortgage-related securities backed by conventional single-family mortgage loans we hold in our investment portfolio; (3) Fannie Mae MBS backed by conventional singlefamily mortgage loans that are held by third parties; and (4) credit...

  • Page 39
    ... balance of outstanding Fannie Mae MBS held by third parties; and (3) up to 0.45% of other off-balance sheet obligations. "Mortgage assets," when referring to our assets, refers to both mortgage loans and mortgage-related securities we hold in our portfolio. "Mortgage credit book of business...

  • Page 40
    ... the potential market or credit loss that could result from such transaction. "OFHEO" refers to the Office of Federal Housing Enterprise Oversight, our safety and soundness regulator. "Option-adjusted spread" or "OAS" refers to the incremental expected return between a security, loan or derivative...

  • Page 41
    ...-related securities backed by single-family mortgage loans we hold in our investment portfolio; (3) Fannie Mae MBS backed by single-family mortgage loans that are held by third parties; and (4) credit enhancements that we provide on single-family mortgage assets. "Subprime mortgage" generally refers...

  • Page 42
    ... sell mortgage assets and accelerate our realization of spread income, with the dual goals of supporting our chartered purpose of providing liquidity to the secondary mortgage market and maximizing long-term total returns, subject to various constraints on our purchases and sales of mortgage assets...

  • Page 43
    ... requirement. In December 2006, the Board of Directors increased the common stock dividend to $0.40 per share and on May 1, 2007 increased the dividend to $0.50 per share. We are subject to credit risk relating to the mortgage loans that we purchase or that back our Fannie Mae MBS, and any resulting...

  • Page 44
    ... 31, 2005 and 2006. We also estimate that subprime loans represented approximately 2.2% of our single-family mortgage credit book of business as of December 31, 2006, of which approximately 0.2% consisted of subprime mortgage loans or structured Fannie Mae MBS backed by subprime mortgage loans and...

  • Page 45
    ... of short-term and long-term debt securities in the domestic and international capital markets is our primary source of funding for purchasing assets for our mortgage portfolio and repaying or refinancing our existing debt. Moreover, our primary source of revenue is the net interest income we...

  • Page 46
    ... costs necessary to replace the defaulting mortgage servicer. These events would result in a decrease in our net income. As of December 31, 2005, our ten largest single-family mortgage servicers serviced 72% of our single-family mortgage credit book of business, and Countrywide Financial Corporation...

  • Page 47
    ... the ability of our employees and our internal financial, accounting, cash management, data processing and other operating systems, as well as technological systems operated by third parties, to process these transactions and to manage our business. As a result of events that are wholly or partially...

  • Page 48
    ...events could result in significant financial losses, legal and regulatory sanctions, and reputational damage. A description of our risk management programs for mortgage fraud and information security is included in "Item 7-MD&A-Risk Management-Operational Risk Management." We have several key lender...

  • Page 49
    ... average total mortgage portfolios (including whole loans and securitized obligations, whether held in portfolio or sold in any form) to a fund to support affordable housing. Unlike the bill that passed the House in October 2005, the new bill would require annual contributions to the fund regardless...

  • Page 50
    ... Act data released in 2006 show that the share of the primary mortgage market serving low- and moderate-income borrowers declined in 2005, reducing our ability to purchase and securitize mortgage loans that meet the HUD subgoals. If our efforts to meet the new housing goals and subgoals in 2007...

  • Page 51
    ...the fair value of financial instruments; • amortizing cost basis adjustments on mortgage loans and mortgage-related securities held in our portfolio and underlying outstanding Fannie Mae MBS using the effective interest method; • determining our allowance for loan losses and reserve for guaranty...

  • Page 52
    ... will result in a higher level of credit losses, which in turn will adversely affect our earnings. In addition, housing price declines would reduce the fair value of our mortgage assets. Our business volume is affected by the rate of growth in total U.S. residential mortgage debt outstanding and...

  • Page 53
    ... this growth rate reduces the number of mortgage loans available for us to purchase or securitize, which in turn could lead to a reduction in our net interest income and guaranty fee income. Item 1B. Unresolved Staff Comments None. Item 2. Properties We own our principal office, which is located at...

  • Page 54
    ...information on these proceedings, see "Notes to Consolidated Financial Statements-Note 19, Commitments and Contingencies." RESTATEMENT-RELATED MATTERS Securities Class Action Lawsuits In re Fannie Mae Securities Litigation Beginning on September 23, 2004, 13 separate complaints were filed by holders...

  • Page 55
    ... officers and directors based upon essentially the same alleged conduct as that at issue in the consolidated shareholder class action, and also assert insider trading claims against certain former officers. Both cases seek compensatory and punitive damages, attorneys' fees, and other fees and costs...

  • Page 56
    ...an order naming Pirelli Armstrong Tire Corporation Retiree Medical Benefits Trust and Wayne County Employees' Retirement System as co-lead plaintiffs. A consolidated complaint was filed on September 26, 2005. The consolidated complaint named the following current and former officers and directors as...

  • Page 57
    ...'s final report, including actions relating to our corporate governance, Board of Directors, capital plans, internal controls, accounting practices, public disclosures, regulatory reporting, personnel and compensation practices. We also agreed not to increase our net mortgage portfolio assets above...

  • Page 58
    ...further proceedings are necessary. The parties have filed a request for an extension with the arbitrator. Antitrust Lawsuits In re G-Fees Antitrust Litigation Since January 18, 2005, we have been served with 11 proposed class action complaints filed by single-family borrowers that allege that we and...

  • Page 59
    ...class of multifamily borrowers whose mortgages are insured under Sections 221(d)(3), 236 and other sections of the National Housing Act and are held or serviced by us. The complaint identified as a class low- and moderate-income apartment building developers who maintained uninvested escrow accounts...

  • Page 60
    ... quarter of 2007. In January 2005, our Board of Directors reduced our quarterly common stock dividend rate by 50%, from $0.52 per share to $0.26 per share. We reduced our common stock dividend rate in order to increase our capital surplus, which was a component of our capital restoration plan. See...

  • Page 61
    ... outstanding totaled $128.4 million for the quarter ended March 31, 2007. See "Notes to Consolidated Financial Statements-Note 16, Preferred Stock" for detailed information on our preferred stock dividends. Securities Authorized for Issuance under Equity Compensation Plans The information required...

  • Page 62
    ... from employees in a limited number of instances relating to employees' financial hardship. Consists of 47,440 shares of common stock repurchased from employees pursuant to our publicly announced employee stock repurchase program. On May 9, 2006, we announced that the Board of Directors had...

  • Page 63
    ... be purchased under the Employee Stock Repurchase Program. Does not reflect the determination by our Board of Directors in February 2007 not to pay out certain shares expected to be issued under our plans. See "Notes to Consolidated Financial Statements-Note 12, Stock-Based Compensation Plans" for...

  • Page 64
    ...statements and related notes and with "Item 7-MD&A" included in this Annual Report on Form 10-K. As of December 31, 2005 2004 2003 2002 (Dollars in millions, except per share amounts) Income Statement Data: Net interest income ...Guaranty fee income ...Derivative fair value losses, net Other income...

  • Page 65
    ...) 2001 Balance Sheet Data: Investments in securities: Trading(4) ...Available-for-sale ...Mortgage loans: Loans held for sale ...Loans held for investment, net of allowance ...Total assets ...Short-term debt ...Long-term debt ...Total liabilities ...Preferred stock ...Total stockholders' equity...

  • Page 66
    ...to pay dividends on outstanding preferred stock using our effective income tax rate for the relevant periods. Fixed charges represent total interest expense and capitalized interest. Note: * Average balances for purposes of the ratio calculations are based on beginning and end of year balances. 61

  • Page 67
    ... of key terms used throughout this discussion. Our MD&A is organized as follows: • Executive Summary • Critical Accounting Policies and Estimates • Consolidated Results of Operations • Business Segment Results • Supplemental Non-GAAP Information-Fair Value Balance Sheet • Risk Management...

  • Page 68
    ... including the total amount of residential mortgage debt outstanding, the volume and composition of mortgage originations and the level of competition for mortgage assets generally among investors. The Federal Open Market Committee of the Federal Reserve increased the federal funds target rate by 25...

  • Page 69
    ... factors will support continued long-term demand for new capital to finance the substantial and sustained housing finance needs of American homebuyers. In the secondary mortgage market, competition for mortgage assets among a broad range of investors was intense in 2005, resulting in extremely...

  • Page 70
    ..., mortgage commitments and trading securities at fair value in our consolidated balance sheets and recognize changes in the fair value of those financial instruments in net income. • We record available-for-sale ("AFS") securities, retained interests and guaranty fee buy-ups at fair value in...

  • Page 71
    ...of management's actions as well as current market conditions, management uses this information to assess performance and gauge how much management is adding to the long-term value of the company. Single-Family Credit Guaranty Results Our Single-Family Credit Guaranty business generated net income of...

  • Page 72
    ... mortgage assets, selling highly valued assets on attractive economic terms. These sales contributed to our objectives of satisfying our capital requirement while supporting our primary liquidity function and, subject to various constraints, maximizing long-term total returns in our Capital Markets...

  • Page 73
    ...: Fannie Mae's Chief Business Officer is leading a company-wide effort to explore additional opportunities to serve mortgage lenders, housing agencies and organizations, investors, shareholders, the housing finance market and the company's affordable housing mission. • Reduce Cost: Management is...

  • Page 74
    ... rate yield curves, measures of volatility and prepayment rates. • If market data used to estimate fair value as described above is not available, we estimate fair value using internally developed models that employ techniques such as a discounted cash flow approach. These models include market...

  • Page 75
    ... consolidated balance sheets through earnings using the interest method by applying a constant effective yield. Cost basis adjustments include premiums, discounts and other adjustments to the original value of mortgage loans or mortgage-related securities that are generally incurred at the time of...

  • Page 76
    ... rates are a key assumption used in our prepayment models. Table 2 shows the estimated effect on our net interest income of the amortization of cost basis adjustments for our investments in loans and securities using the retrospective effective interest method applying a constant effective yield...

  • Page 77
    ... MBS trusts as required to permit timely payment of principal and interest on the related Fannie Mae MBS. We strive to mitigate our credit risk by, among other things, working with lender servicers, monitoring loan-to-value ratios and requiring mortgage insurance. See "Risk Management-Credit Risk...

  • Page 78
    ... drivers of expected losses for these VIEs. For those mortgage-backed investment trusts that we evaluate using quantitative analyses, we use internal models to generate Monte Carlo simulations of cash flows associated with the different credit, interest rate and housing price environments. Material...

  • Page 79
    ...to use the tax credits to offset taxable income. The projection of cash flows and probabilities related to these cash flows requires significant management judgment because of the inherent limitations that relate to the use of historical loss and cost overrun data for the projection of future events...

  • Page 80
    ... in market conditions that result in periodic fluctuations in the estimated fair value of our derivative instruments, which we recognize in our consolidated statements of income as "Derivatives fair value losses, net." Although we use derivatives as economic hedges to help us manage interest rate...

  • Page 81
    ... rate swaps, is not reflected in net interest income. See "Derivatives Fair Value Losses, Net" for additional information. Table 4: Analysis of Net Interest Income and Yield 2005 Average(1) Balance Interest For the Year Ended December 31, 2004 2003 Average(1) Average(1) Yield Balance Interest Yield...

  • Page 82
    ... Interest income: Mortgage loans...Mortgage securities ...Non-mortgage securities ...Federal funds sold and securities purchased under agreements to resell ...Advances to lenders ...Total interest income ...Interest expense: Short-term debt ...Long-term debt...Federal funds purchased and securities...

  • Page 83
    ... curve was steep (i.e., short- and medium-term interest rates were low relative to long-term interest rates). As the yield curve flattened during 2005 and we replaced this debt to fund our existing fixed-rate mortgage investments, we experienced an increase in our funding costs. At the same time, we...

  • Page 84
    ... the share of originations of lower credit quality loans, loans with reduced documentation and loans to fund investor properties increased. At the same time, originations of traditional mortgages, such as conventional fixed-rate loans, which historically have represented the majority of our business...

  • Page 85
    ...in 2003. Mortgage interest rates were higher in 2005 and 2004 relative to 2003, which reduced the rate of prepayments thereby increasing the average expected life of the underlying assets of outstanding Fannie Mae MBS. As a result, amortization of the deferred guaranty obligations into income slowed...

  • Page 86
    ...-down in earnings and establish a new cost basis for the security. Decreases in mortgage interest rates cause the expected lives of these securities to shorten, which decreases the expected cash flows and fair value of the securities. Mortgage interest rates reached historic lows in mid-2003 before...

  • Page 87
    ... involve the transfer of mortgage loans or mortgage-related securities from our balance sheet to a trust to create Fannie Mae MBS (whether in the form of single-class Fannie Mae MBS, REMICs or other types of beneficial interests). We may retain an interest in the assets transferred to a trust in...

  • Page 88
    ... fair value with unrealized gains and losses recorded in earnings. We expect unrealized gains and losses on trading securities to fluctuate each period with changes in volumes, interest rates and market prices. Generally, increases in medium- and long-term interest rates result in losses on mortgage...

  • Page 89
    ... mortgage purchases that we are not able to accomplish solely through our issuance of debt securities. The following tables show the impact of derivatives on our consolidated statements of income and consolidated balance sheets. Table 8 provides an analysis of changes in the estimated fair value...

  • Page 90
    ... income, excluding mortgage commitments. (3) (4) (5) Amounts presented in Table 8 have the following effect on our consolidated financial statements: • Cash payments made to purchase options (purchased options premiums) increase the derivative asset recorded in the consolidated balance sheets...

  • Page 91
    ...decrease to the derivative asset recorded in the consolidated balance sheets. The corresponding offsetting amount is recorded as a component of derivatives fair value losses in the consolidated statements of income. • Changes in the estimated fair value of our derivatives that result in a gain are...

  • Page 92
    ... MBS options, forward starting debt, forward purchase and sale agreements, swap credit enhancements, mortgage insurance contracts and exchange-traded futures. The subsequent recognition in our consolidated statements of income associated with cost basis adjustments that we record upon the settlement...

  • Page 93
    ... fair value of derivatives recorded in our consolidated balance sheets and the related outstanding notional amount by derivative instrument type as of December 31, 2005 and 2004. We describe our risk management derivative activity in "Risk Management-Interest Rate Risk Management and Other Market...

  • Page 94
    ... change in interest rates. The effects of our investment strategy, including our interest rate risk management, are reflected in changes in the estimated fair value of our net assets over time. Debt Extinguishment Losses, Net We call debt securities in order to reduce future debt costs as a part of...

  • Page 95
    ... for credit losses as a result of our adoption of Statement of Position 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer ("SOP 03-3"). Under SOP 03-3, we are required to record loans we purchase from Fannie Mae MBS trusts due to default at fair value because these loans...

  • Page 96
    ...-Mortgage Credit Risk Management." Administrative Expenses Administrative expenses include costs incurred to run our daily operations, such as salaries and employee benefits, professional services, occupancy expense and technology expenses. Administrative expenses totaled $2.1 billion in 2005...

  • Page 97
    ... ability to use tax credits in any given year may be limited by the corporate alternative minimum tax rules, which ensure that corporations pay at least a minimum amount of federal income tax annually. For 2005, we were not able to use all the tax credits we received because our income tax liability...

  • Page 98
    .... Table 12: Business Segment Results Summary Increase (Decrease) For the Year Ended December 31, 2005 vs. 2004 2004 vs. 2003 2005 2004 2003 $ % $ % (Dollars in millions) Revenues:(1) Single-Family Credit Guaranty ...Housing and Community Development ...Capital Markets ...Total ...Net income: Single...

  • Page 99
    ... in guaranty fee income offset by lower fee and other income, and higher expenses. Guaranty fee income increased by 6% in 2004 from 2003, primarily due to growth in average single-family mortgage credit book of business in 2004. The average effective guaranty fee rate on single-family Fannie Mae MBS...

  • Page 100
    ... lenders reach and serve new, emerging and non-traditional markets by providing more flexible, low-cost mortgage options. We also continue to expand our mortgage options for borrowers with weaker credit histories. HCD Business Our Housing and Community Development business generated net income...

  • Page 101
    ... LIHTC investments. HCD further enables the expansion of affordable housing stock by participating in specialized debt financing, acquiring mortgage loans from a variety of new public and private partners, and increasing other community lending activities. Capital Markets Group Our Capital Markets...

  • Page 102
    ... cost of our short-term debt, which further reduced net interest income. Investment losses increased from $446 million in 2004 to $1.5 billion in 2005 due to higher other-than-temporary impairment on AFS securities and unrealized losses on trading securities as the fair value of our mortgage assets...

  • Page 103
    ...the yield curve flattened, as well as our focus on managing the size of our balance sheet to achieve our capital plan objectives. Portfolio purchases totaled $145.4 billion in 2005 compared with $258.5 billion in 2004, and included a much lower proportion of 30-year fixed-rate assets than historical...

  • Page 104
    ... of our balance sheet to maintain a 30% capital surplus. Portfolio purchases and sales during 2006 were consistent with the primary objectives of our business model-supporting liquidity in the secondary mortgage market and, subject to various constraints, maximizing long-term total returns from our...

  • Page 105
    ... (discounts) and cost basis adjustments, net ...Lower of cost or market adjustments on loans held for sale ...Allowance for loan losses for loans held for investment . . Total mortgage loans, net ...Mortgage-related securities: Fannie Mae single-class MBS ...Non-Fannie Mae single-class mortgage...

  • Page 106
    ... or have short-term maturities, such as commercial paper. As of December 31, 2005 and 2004, we had approximately $52.2 billion and $55.1 billion, respectively, in liquid assets, net of any cash and cash equivalents pledged as collateral. Our investments in non-mortgage securities, which account for...

  • Page 107
    ... Amortized Cost(1) Total Fair Value Fannie Mae singleclass MBS(2) ...$144,193 $143,742 Non-Fannie Mae single-class mortgage securities(2) ...Fannie Mae structured MBS(2) ...Non-Fannie Mae structured mortgage securities(2) ...Mortgage revenue bonds ...Other mortgage-related securities(3) ...Asset...

  • Page 108
    ...our net assets to become overvalued or undervalued relative to the level of risk and expected long-term fundamentals of our business. In addition, as discussed in "Critical Accounting Policies and Estimates-Fair Value of Financial Instruments," when quoted market prices or observable market data are...

  • Page 109
    ... loan losses ...362,479 Derivative assets at fair value ...5,803 Guaranty assets and buy-ups ...7,629 Total financial assets ...799,524 Other assets ...34,644 Total assets...$834,168 Liabilities: Federal funds purchased and securities sold under agreements to repurchase Short-term debt ...Long-term...

  • Page 110
    ... our adjusted deferred income taxes are a net asset in each year, the amounts are included in our non-GAAP fair value balance sheets as a component of other assets. Non-GAAP total assets represent the sum of the estimated fair value of (i) all financial instruments carried at fair value in our...

  • Page 111
    ... rate models used to measure OAS. We work to manage the OAS risk that exists at the time we purchase mortgage assets through our asset selection process. We use our proprietary models to evaluate mortgage assets on the basis of yield-to-maturity, option-adjusted yield spread, historical valuations...

  • Page 112
    ... basis for measuring both mortgage OAS and debt OAS. Table 18: Selected Market Information(1) As of December 31, 2005 2004 2003 Change 2005 2004 vs. 2004 vs. 2003 10-year U.S. Treasury note yield ...Implied volatility(2) ...30-year Fannie Mae MBS par coupon rate ...Lehman U.S. MBS Index OAS (in...

  • Page 113
    ...above, the 30-year Fannie Mae MBS par coupon rate and the 10-year U.S. Treasury note yield increased in 2005, which slowed the rate of expected prepayments and increased the fair value of our net guaranty assets. As also indicated in Table 18, mortgage OAS based on the Lehman U.S. MBS Index to LIBOR...

  • Page 114
    ... for the management of the day-to-day risks inherent in the activities of the business unit, and monitoring aggregate risks and compliance with risk policies at a corporate level. Our corporate risk framework is supported by a governance structure encompassing the Board of Directors, an independent...

  • Page 115
    ..., the level of risk by type of risk, performance relative to risk limits and any significant risk management issues. The Chief Risk Officer also reports to the Board of Directors annually on management's adherence to our corporate risk principles. Risk Management Committees At the end of 2006...

  • Page 116
    ... Executive reports directly and independently to the Audit Committee of the Board of Directors, and audit personnel are compensated on objectives set for the group by the Audit Committee rather than corporate financial results or goals. The Chief Audit Executive operates independently of management...

  • Page 117
    ... assets. Our mortgage credit book of business consists of both on- and off-balance sheet arrangements, including singlefamily and multifamily mortgage loans held in our portfolio; Fannie Mae MBS and non-Fannie Mae mortgage-related securities held in our portfolio; Fannie Mae MBS held by third- party...

  • Page 118
    ... Credit Book of Business As of December 31, 2005 Single-Family Multifamily Total Conventional(1) Government(2) Conventional(1) Government(2) Conventional(1) Government(2) (Dollars in millions) Mortgage portfolio:(3) Mortgage loans(4) ...Fannie Mae MBS(4) ...Agency mortgage-related securities...

  • Page 119
    ... estimate incurred credit losses inherent in our mortgage credit book of business as of each balance sheet date and maintain a combined balance of allowance for loan losses and reserve for guaranty losses at a level we believe reflects these losses. Acquisition Policy and Standards Single-Family Our...

  • Page 120
    ... of actual loan performance to expected performance. Lenders generally represent and warrant compliance with our asset acquisition requirements when they sell mortgage loans to us or deliver mortgage loans in exchange for Fannie Mae MBS. We may require the lender to repurchase a loan or we...

  • Page 121
    ... of non-agency mortgage-related securities held in our portfolio as of December 31, 2006 were rated AAA/Aaa by Standard & Poor's and Moody's. Housing and Community Development Our HCD business is responsible for managing the credit risk on multifamily mortgage loans we purchase and on Fannie Mae MBS...

  • Page 122
    ... mortgage loans held in our portfolio and backing Fannie MBS (whether held in our portfolio or held by third parties). Table 21: Risk Characteristics of Conventional Single-Family Mortgage Credit Book Percent of Book of Business(1) As of December 31, 2005 2004 2003 Original loan-to-value ratio...

  • Page 123
    ... calculated based on unpaid principal balance of loans as of the end of each period. Excludes loans for which this information is not readily available. The methodology used to estimate the mark-to-market loan-to-value ratio was implemented in 2004. Long-term fixed-rate consists of mortgage loans...

  • Page 124
    ... fixed-rate ...Adjustable-rate: Interest-only ...Negative-amortizing ...Other ARMs ...Total adjustable-rate ...Total ...Number of property units: 1 unit ...2-4 units ...Total ...Property type: Single-family detached ...Condo/Co-op ...Total ...Occupancy type: Primary residence...Second/vacation home...

  • Page 125
    ...balance of the loan. The aggregate current or estimated mark-to-market LTV is based on the estimated current value of the property, calculated using an internal valuation model that estimates periodic changes in home value, and the unpaid principal balance of the loan as of the date of each reported...

  • Page 126
    ... Mae MBS. We believe the average credit score within our single-family mortgage credit book of business is a strong indicator of default risk. • Loan purpose. Loan purpose indicates how the borrower intends to use the funds from a mortgage loan. We designate the loan purpose as purchase, cash...

  • Page 127
    ... allow us to closely monitor credit risk and pricing dynamics across the full spectrum of mortgage product types. The percentage of our single-family mortgage credit book of business consisting of subprime mortgage loans or structured Fannie Mae MBS backed by subprime mortgage loans was not material...

  • Page 128
    ..., guidelines, credit enhancements or guaranty fees for future business. Housing and Community Development Diversification within our multifamily mortgage credit book of business and LIHTC equity investments business by geographic concentration, term-to-maturity, interest rate structure, borrower...

  • Page 129
    ... Mae MBS backed by non-Fannie Mae mortgage-related securities) and credit enhancements that we provide, where we have more detailed loan-level information. Credit Loss Management Single-Family We manage problem loans to mitigate credit losses. If a mortgage loan does not perform, we work closely...

  • Page 130
    ... the total number of loans in our conventional single-family mortgage credit book for the years ended December 31, 2005, 2004 and 2003, respectively. Housing and Community Development When a multifamily loan does not perform, we work closely with our loan servicers to minimize the severity of loss...

  • Page 131
    ... monthly payments. We calculate the single-family serious delinquency rate by dividing the number of seriously delinquent single-family loans by the total number of single-family loans outstanding. We include all of the conventional single-family loans that we own and that back Fannie Mae MBS...

  • Page 132
    ... single-family mortgage credit book of business had an estimated mark-to-market loan-to-value ratio greater than 80%. Over 76% of these loans were covered by credit enhancement. The remaining loans, which would have required credit enhancement at acquisition if the original loan-to-value ratios...

  • Page 133
    ... our credit risk management strategies. Credit-related losses include charge-offs plus foreclosed property expense (income). Credit losses for the years ended December 31, 2005, 2004 and 2003 are presented in Table 26. Table 26: Single-Family and Multifamily Credit Loss Performance 2005 SingleFamily...

  • Page 134
    ... this estimate are possible as we continue to monitor this issue. We use internally developed models to assess our sensitivity to credit losses based on current data on home values, borrower payment patterns, non-mortgage consumer credit history and management's economic outlook. We closely examine...

  • Page 135
    ... of our expected future credit losses to an immediate 5% decline in home values for first lien single-family whole loans we own or that back Fannie Mae MBS. After the initial shock, we estimate home price growth rates return to the rate projected by our credit pricing models. (2) The estimates in...

  • Page 136
    ... separate line items in the consolidated balance sheets. The provision for credit losses is reported in the consolidated statements of income. Table 29 summarizes changes in our allowance for loan losses and reserve for guaranty losses for the years ended December 31, 2005, 2004, 2003 and 2002. 131

  • Page 137
    ...-3 where the acquisition price exceeded the fair value of the acquired loan. Represents ratio of combined allowance and reserve balance by loan type to total mortgage credit book of business by loan type. Our combined allowance for loan losses and reserve for guaranty losses totaled $724 million as...

  • Page 138
    ... for loan losses and reserve for guaranty losses as a percentage of our total mortgage credit book of business has remained relatively stable, averaging between 0.02% and 0.03%. This trend reflects our historically low average default rates and loss severity on foreclosed properties, which we expect...

  • Page 139
    ... in collateral as of December 31, 2005 and 2004, respectively, to secure single-family recourse transactions. In addition, a portion of servicing fees on loans includes recourse to certain lenders, and the credit support for such lender recourse considers the value of the mortgage servicing assets...

  • Page 140
    ... result in our having to replace the mortgage pools at higher cost to meet a forward commitment to sell the MBS. Mortgage Originators and Investors We are routinely exposed to pre-settlement risk through the purchase, sale and financing of mortgage loans and mortgage-related securities with mortgage...

  • Page 141
    ... investments to high credit quality short- and medium-term instruments, such as commercial paper, asset-backed securities and corporate floating rate notes, which are broadly traded in the financial markets. Our non-mortgage securities, which account for the majority of our liquid assets, totaled...

  • Page 142
    ... any ratings based on Moody's scale. Includes MBS options, defined benefit mortgage insurance contracts, forward starting debt and swap credit enhancements accounted for as derivatives. Represents the exposure to credit loss on derivative instruments, which is estimated by calculating the cost, on...

  • Page 143
    ... using both internal and external pricing models, compare the exposure to counterparty limits, and determine whether additional collateral is required. We evaluate any additional exposure to a counterparty beyond our model tolerance level based on our corporate credit policy framework for managing...

  • Page 144
    ... The Capital Markets Investment Committee reports interest rate risk measures on a weekly basis. As discussed in "Supplemental Non-GAAP Information-Fair Value Balance Sheet," we do not attempt to actively manage or hedge the impact of changes in mortgage-to-debt OAS after we purchase mortgage assets...

  • Page 145
    ... As a substitute for notes and bonds that we issue in the debt markets. When we purchase mortgages, we fund the purchase with a combination of equity and debt. The debt we issue is a mix that typically consists of short- and long-term, non-callable debt and callable debt. The varied maturities and...

  • Page 146
    ... balance sheets and expected trends, the relative mix of our debt and derivative positions, and the interest rate environment. Table 31 presents our risk management derivative activity by type for the year ended December 31, 2005, along with the stated maturities of derivatives outstanding...

  • Page 147
    ... as of December 31, 2005. The key driver of this decline was the termination of derivatives in connection with the elimination of debt that was used to fund mortgage assets that we sold. During 2004, we decreased the outstanding notional balance of our risk management derivatives by $348.9 billion...

  • Page 148
    ... investments. We began including non-mortgage investments in our duration gap calculation in November 2005. These incremental assets are primarily short-term, liquid investments included in our liquid investment portfolio. Based on our historical experience, we expect that the guaranty fee income...

  • Page 149
    ... the SEC in a current report on Form 8-K. Our monthly duration gap, which is presented below for the period January 1, 2003 to December 31, 2005 reflects the estimate used contemporaneously by management as of the reported date to manage the interest rate risk of our portfolio. During 2006 and 2007...

  • Page 150
    ... securities is managed by the business. Includes net financial assets and financial liabilities reported in "Notes to Consolidated Financial Statements-Note 18, Fair Value of Financial Instruments" and additional market sensitive instruments that consist of master servicing assets, master servicing...

  • Page 151
    ... of our business continuity efforts, information security programs, fraud management and our corporate insurance program under this new operational risk oversight function. In 2007, we consolidated our SOX Finance Team as part of the operational risk oversight function, with accountability to both...

  • Page 152
    ... in skill sets, processes and other elements. The results of this assessment identified several deficiencies in our operational risk management structure that we have been working to remediate. For a description of the material weaknesses in our internal control over financial reporting relating to...

  • Page 153
    ...essential to our business. We actively manage our liquidity and capital position with the objective of preserving stable, reliable and cost-effective sources of cash to meet all of our current and future operating financial commitments and regulatory capital requirements. We obtain the funds we need...

  • Page 154
    ... secured borrowings pursuant to repurchase agreements or for sale; and • maintaining an investment portfolio of liquid non-mortgage assets that are readily marketable or have short-term maturities so that we can quickly and easily convert these assets into cash. Sources and Uses of Cash We manage...

  • Page 155
    ... the payment of federal income taxes; • losses incurred in connection with our Fannie Mae MBS guaranty obligations; and • the payment of dividends on our common and preferred stock. Debt Funding Because our primary source of cash is proceeds from the issuance of our debt securities, we depend on...

  • Page 156
    ... using month-end balances. Maximum outstanding represents the highest month-end outstanding balance during the year. For information regarding our outstanding long-term debt as of December 31, 2005 and 2004, refer to "Notes to Consolidated Financial Statements-Note 8, Short-term Borrowings and Long...

  • Page 157
    ...and long-term debt securities. Our short-term and long-term funding needs during 2007 and 2008 are generally expected to be consistent with our needs during 2005 and 2006, and with the uses of cash described above under "Sources and Uses of Cash." As described below under "Capital Management-Capital...

  • Page 158
    business day until our account balance was zero. Since July 2006, we have been required to fund interest and redemption payments on our debt and Fannie Mae MBS before the Federal Reserve Banks, acting as our fiscal agent, will execute the payments on our behalf. We compensate the Federal Reserve ...

  • Page 159
    ... are readily marketable or have short-term maturities. As of December 31, 2005 and 2004, we had approximately $52.2 billion and $55.1 billion, respectively, in liquid assets, net of any cash and cash equivalents pledged as collateral. Our investments in non-mortgage securities, which account for the...

  • Page 160
    ... net premium and cost basis adjustments of approximately $10.7 billion. Excludes contractual interest on long-term debt from consolidations. Includes certain premises and equipment leases. Includes on- and off-balance sheet commitments to purchase loans and mortgage-related securities. Includes only...

  • Page 161
    ... to lenders and purchases of AFS securities and HFI loans. • We used net cash of $217.4 billion in financing activities in 2005, primarily for the net redemption of short-term and long-term debt. Cash Flows for the Year Ended December 31, 2004 During the year ended December 31, 2004, cash and cash...

  • Page 162
    ... and reserve for guaranty losses in connection with Fannie Mae MBS, less the specific loss allowance (that is, the allowance required on individuallyimpaired loans). Each quarter, OFHEO runs a detailed profile of our book of business through the stress test simulation model. The model generates cash...

  • Page 163
    ... dividend rate by 50% on January 18, 2005, from $0.52 per share of common stock to $0.26 per share of common stock; and • canceling our plans to build major new corporate facilities in Southwest Washington, DC and undertaking other cost-cutting efforts. Under our May 23, 2006 consent order...

  • Page 164
    ... to cover management and operations risk. Defined as the surplus of total capital over required risk-based capital expressed as a percentage of risk-based capital. Generally, the sum of (a) 1.25% of on-balance sheet assets; (b) 0.25% of the unpaid principal balance of outstanding Fannie Mae MBS held...

  • Page 165
    ... using long-term financial simulations and near-term market value shocks. We currently target a combined corporate economic capital requirement that is less than our regulatory capital requirements. To ensure compliance with each of our regulatory capital requirements, we maintain different levels...

  • Page 166
    ... our non-officer employees, who are employees below the level of vice president. Under the program, we may repurchase shares weekly at fair market value only during the 30-trading day period following our quarterly filings on Form 12b-25 with the SEC. Officers and members of our Board of Directors...

  • Page 167
    ... the market perceives our debt to have a higher relative credit risk. The sum of our total capital plus the outstanding balance of our qualifying subordinated debt exceeded the sum of (1) outstanding Fannie Mae MBS held by third parties times 0.45% and (2) total on-balance sheet assets times 4% by...

  • Page 168
    ...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...

  • Page 169
    ... 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...

  • Page 170
    ...as an affordable housing project over the entire 15-year period may result in the recapture of a portion of the tax credits. The LIHTC partnerships are generally organized by fund manager sponsors who seek out investments with third-party developers who in turn develop or rehabilitate the properties...

  • Page 171
    ... eliminates the alternative of applying the intrinsic value measurement provisions of APB 25 to stock compensation awards issued to employees. Rather, SFAS 123R requires measurement of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair...

  • Page 172
    ... first fiscal year that begins after September 15, 2006. We adopted SFAS 155 effective January 1, 2007 and elected fair value remeasurement for hybrid financial instruments that contain embedded derivatives that otherwise require bifurcation, which includes buy-ups and guaranty assets arising from...

  • Page 173
    ...the use of fair value in any new circumstances. Under SFAS 157, fair value refers to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants in the market in which the reporting entity transacts. This statement clarifies...

  • Page 174
    ... service costs and credits as an adjustment to AOCI, net of income tax. Additionally, it requires determination of benefit obligations and the fair values of a plan's assets at a company's year-end. SFAS 158 is effective as of the end of the fiscal year ending after December 15, 2006. We adopted...

  • Page 175
    ... Statements of Income For the Quarter Ended March 31, June 30, September 30, December 31, 2005 2005 2005 2005 (Dollars and shares in millions, except per share amounts) Net interest income ...Guaranty fee income ...Investment gains (losses), net ...Derivatives fair value losses, net . . Debt...

  • Page 176
    ... Statements of Income For the Quarter Ended March 31, June 30, September 30, December 31, 2004 2004 2004 2004 (Dollars and shares in millions, except per share amounts) Net interest income ...Guaranty fee income ...Investment gains (losses), net ...Derivatives fair value gains (losses), net . Debt...

  • Page 177
    ... Balance Sheets March 31, 2005 As of June 30, September 30, 2005 2005 (Dollars in millions) December 31, 2005 Assets: Cash and cash equivalents...Investments in securities: Trading, at fair value ...Available-for-sale, at fair value ...Total investments ...Mortgage loans: Loans held for sale...

  • Page 178
    ... loss, net of tax effect ...Net income ...(1) (2) Includes cost of capital charge. Includes intercompany guaranty fee income (expense) of $247 million allocated to Single-Family Credit Guaranty and HCD from Capital Markets for absorbing the credit risk on mortgage loans and Fannie Mae MBS...

  • Page 179
    ... cost of capital charge. Includes intercompany guaranty fee income (expense) of $243 million allocated to Single-Family Credit Guaranty and HCD from Capital Markets for absorbing the credit risk on mortgage loans and Fannie Mae MBS held in our portfolio. During the year ended December 31, 2005...

  • Page 180
    ... second quarter of 2005 saw a continued decrease in our average yield as compared to the second quarter of 2004 related to our declining portfolio balance, coupled with a significant rise in short-term interest rates which increased the cost of our short-term debt. Guaranty fee income increased to...

  • Page 181
    ... rate environment. Investment losses in the third quarter of 2005 totaled $169 million as compared to investment gains of $887 million in the third quarter of 2004. The third quarter of 2005 losses were primarily due to unrealized losses on trading securities as the fair value of our mortgage assets...

  • Page 182
    ... sales activity during the year. Furthermore, the shift in our mortgage portfolio composition to a higher share of adjustable rate loans and floating-rate securities continued to drive net interest income down. We recorded derivatives fair value losses of $267 million in the fourth quarter of 2005...

  • Page 183
    ... provision for federal income taxes includes taxes at the federal statutory rate of 35% adjusted for tax credits recognized for our LIHTC partnership investments and other tax credits. Consolidated Balance Sheets Our consolidated assets totaled $834.2 billion as of December 31, 2005, a decrease of...

  • Page 184
    ...Board of Directors and Executive Roles Enterprise-Wide Risk Oversight Internal Audit Human Resources Fraud Risk Management Program Whistleblower Program Accounting/Finance Staffing Levels Information Technology Policy Policies and Procedures Application of GAAP Financial Reporting Process: Financial...

  • Page 185
    ... include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as...

  • Page 186
    ... control over financial reporting. Internal control over financial reporting, as defined in rules promulgated under the Exchange Act, is a process designed by, or under the supervision of, our Chief Executive Officer and Chief Financial Officer and effected by our Board of Directors, management and...

  • Page 187
    ... a new material weakness related to multifamily lender loss sharing modifications. Because of the material weaknesses described below, management has concluded that our internal control over financial reporting was not effective as of December 31, 2005. Our independent registered public accounting...

  • Page 188
    ... for debt and derivatives; • our accounting for commitments; • our accounting for investments in securities; • our accounting for MBS trust consolidations and sale accounting; • our accounting for financial guaranties and master servicing; • our amortization of cost basis adjustments; and...

  • Page 189
    ... were calculated accurately according to the model specifications. Our loan loss allowance, amortization, guaranty and financial instrument valuation processes each used models. We also incorrectly valued our derivatives, mortgage loan and security commitments, security investments, guaranties and...

  • Page 190
    ... of cash balances and wire transfer activity. In addition, approvals were not consistent with approval policies and funds movements lacked verifications. Multifamily Lender Loss Sharing Modifications We identified a material weakness as of December 31, 2005 related to the design of our internal...

  • Page 191
    ... design of our finance, risk, audit, compliance, operations and technology functions. New organizational structures and frameworks for each of these areas were implemented in 2005. We also initiated a comprehensive plan to transform our corporate culture into one focused on service, open and honest...

  • Page 192
    ...and Corporate Governance Committee, Compensation Committee, Compliance Committee, Risk Policy and Capital Committee, and Housing and Community Finance Committee); • changing the composition of the Board by eliminating two of the three management Board seats; • adding six new Board members, three...

  • Page 193
    ... risk oversight reporting to the new Chief Risk Officer. In 2006, we also hired a senior officer responsible for market risk oversight, capital methodology and model review. We have developed and communicated corporate-wide risk policies and enhanced our business unit risk management processes. We...

  • Page 194
    ... corrected deficient policies and procedures documentation for processes relevant to internal control over financial reporting. As noted above, we have also completed a comprehensive corporate review of delegations of authority and developed and communicated a corporate-wide policy. Application of...

  • Page 195
    ... of fair value prices through comparisons with external market sources and analytical procedures. As discussed below, we continue to implement remedial actions to improve our pricing processes. Wire Transfer Controls We have redesigned our internal control over financial reporting related...

  • Page 196
    ..., and improving data sourcing processes. These process and system design changes should enable us to develop a sustainable, repeatable financial reporting process. We continue to implement additional analytics to facilitate a more thorough and timely review of the results of operations. • Journal...

  • Page 197
    ...the date of this filing, we have redesigned our process for pricing our financial instruments. The process includes supervisory review over data inputs, model outputs and computational accuracy. However, we continue to refine and enhance these processes. Multifamily Lender Loss Sharing Modifications...

  • Page 198
    ...a comprehensive set of financial accounting policies, a comprehensive and independent risk oversight function, an effective and independent Internal Audit function, a human resources function with clear enterprise-wide coordination, clearly communicated information technology policies and procedures...

  • Page 199
    ... that loss sharing amendments related to credit facilities with the multifamily lenders were appropriately recorded in the information systems. Due to the nature and extent of these weaknesses, annual and quarterly consolidated financial statements have not been filed timely since the quarter ended...

  • Page 200
    ...served as Chairman and Chief Executive Officer of Sibley Mortgage Corporation, a commercial, multifamily and single-family mortgage banking firm, and Sibley Real Estate Services, Inc. Mr. Ashley is a past President of the Mortgage Bankers Association of America and has over 40 years of experience in...

  • Page 201
    ... 2005, and as Vice Chairman and Chief Operating Officer from February 2000 to December 2004. Prior to his employment with Fannie Mae, Mr. Mudd was President and Chief Executive Officer of GE Capital, Japan, a diversified financial services company and a whollyowned subsidiary of the General Electric...

  • Page 202
    ... auditor and personally worked on our audit within that time; or • an immediate family member of the director is a current partner of our outside auditor, or is a current employee of our outside auditor participating in the firm's audit, assurance or tax compliance (but not tax planning) practice...

  • Page 203
    ... that is applicable to all officers and employees and a Code of Conduct and Conflict of Interests Policy for Members of the Board of Directors. Our Code of Conduct also serves as the code of ethics for our Chief Executive Officer and senior financial officers required by the Sarbanes-Oxley Act of...

  • Page 204
    ... Annual Report on Form 10-K for the year ended 2005, we are filing our annual consolidated financial statements for 2005 and related certifications by our Chief Executive Officer and Chief Financial Officer required by the Sarbanes-Oxley Act of 2002. Executive Sessions Our non-management directors...

  • Page 205
    ... joined Fannie Mae in 2000 as Vice President for Fair Lending. Stephen M. Swad, 45, is beginning service as our Executive Vice President and Chief Financial Officer Designate on the date we file this annual report. We expect Mr. Swad initially to serve as Chief Financial Officer Designate and...

  • Page 206
    ...table. Information Form 8-K Filing Date Item Number and/or Heading Compensation arrangements for our Chief Financial Officer Table showing 2006 salaries for certain executive officers 2006 corporate performance goals and award targets for cash bonus awards for executive officers and other employees...

  • Page 207
    ...January 21, 2005 Form 8-K. "Other Annual Compensation" in 2005 includes $25,240 for tax counseling and financial planning services for Mr. Mudd and $27,752 for legal advice for Mr. Mudd in connection with entering into his employment agreement, and a gross-up for taxable income on insurance coverage...

  • Page 208
    ...an executive officer in 2005. (6) (7) Aggregated Option Exercises in Last Fiscal Year and Fiscal Year-End Option Values The following table shows the aggregate number of shares underlying options exercised in 2005 and the value as of December 31, 2005 of outstanding in-the-money options, whether...

  • Page 209
    ... under the Fannie Mae supplemental pension plans are not subject to deductions for social security benefits. The following table shows the estimated annual benefits that would have been payable under the Retirement Plan and, if applicable, the supplemental pension plans to an employee who did...

  • Page 210
    ... adopted the Executive Pension Plan to supplement the benefits payable to key officers under the Retirement Plan. The Compensation Committee selects the participants in the Executive Pension Plan. Active participants in the Executive Pension Plan are Executive Vice Presidents. The Board of Directors...

  • Page 211
    ... quarter of the fiscal year received a pro rata payout of their annual cash incentive award target for that year, adjusted for corporate performance. Consistent with the terms of our stock compensation plans, the vesting of options scheduled to vest within 12 months of termination was accelerated...

  • Page 212
    ... our capital restoration plan, we must obtain the approval of OFHEO prior to providing Mr. Mudd with any non-salary compensation awards. • Life Insurance. During the employment term, Mr. Mudd is eligible to receive life insurance benefits in accordance with our life insurance policies and programs...

  • Page 213
    ... restricted stock. • Termination due to death. In the event of Mr. Mudd's death during the employment term, his estate or beneficiary, as applicable, would be entitled to his accrued but unpaid base salary, all amounts payable (but unpaid) under the annual incentive plan for any year ended on...

  • Page 214
    ...participate in Fannie Mae's Executive Pension Plan and other compensation and benefits programs that are available to Fannie Mae executive vice presidents generally. Under the annual incentive plan, Mr. Swad's bonus target award for 2007 has been set at 210% of his base salary. Mr. Swad's 2007 bonus...

  • Page 215
    ...Fannie Mae employee, and the Director's Charitable Award Program. Cash Compensation Our non-management directors, with the exception of the non-executive Chairman of our Board, are paid a retainer at an annual rate of $35,000, plus $1,500 for attending each Board or Board committee meeting in person...

  • Page 216
    ... following the annual meeting of stockholders at the fair market value on the date of grant. A non-management director appointed or elected as a mid-term replacement receives a nonqualified stock option to purchase at the fair market value on the date of grant a pro rata number of shares equal to...

  • Page 217
    ... programs are structured so that a significant portion of the compensation paid to officers is in the form of common stock or rights to acquire common stock. Our employees also have the opportunity to own Fannie Mae common stock through bonus stock opportunities and our Employee Stock Ownership Plan...

  • Page 218
    ...These requirements and guidelines are contained in our Corporate Governance Guidelines. Stock Ownership Guidelines for Non-Management Members of the Board: • Each non-management director is expected to own Fannie Mae common stock with a value equal to at least five times the director's annual cash...

  • Page 219
    ... Beneficial Ownership(1) Stock Options Exercisable or Other Shares Common Stock Total Obtainable Within 60 Days Beneficially Owned Common Stock (2) of March 31, 2007 Excluding Stock Options Beneficially Owned Bridget Macaskill(9) ...Director Daniel Mudd(10) ...President and Chief Executive Officer...

  • Page 220
    ...Inc. beneficially owns 62,341,565 shares of our common stock, with shared voting and dispositive power for all such shares. This information is based solely on information contained in a Schedule 13G/A filed with the SEC on February 13, 2007 by AXA, its subsidiary AXA Financial, Inc., and a group of...

  • Page 221
    ... retirement plan and employee stock ownership plan. The Enterprise Systems Operations division does not report, nor has it ever reported, to Mr. Levin. Rebecca Senhauser, the wife of William Senhauser, our Chief Compliance Officer, is a Senior Vice President in our Housing and Community Development...

  • Page 222
    ... Foundation's operations, as well as other forms of support, including the services of Fannie Mae employees, to support the Foundation's orderly wind-down and termination and to support certain Foundation programs after April 2007. Our President and CEO, Daniel Mudd, is the Chairman of the Board of...

  • Page 223
    ... the year ended December 31, 2004. The following table sets forth the estimated or actual fees for services provided by our independent registered public accounting firm Deloitte & Touche for the 2005 and 2004 audits. During 2004, KPMG reviewed our interim financial statements for the quarters ended...

  • Page 224
    ..., Financial Statement Schedules Documents filed as part of this report Consolidated Financial Statements Report of Independent Registered Public Accounting Firm ...Consolidated Balance Sheets as of December 31, 2005 and 2004 ...Consolidated Statements of Income for the years ended December 31, 2005...

  • Page 225
    ... do or cause to be done by virtue hereof. Federal National Mortgage Association By /s/ DANIEL H. MUDD Daniel H. Mudd President and Chief Executive Officer Date: May 2, 2007 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following...

  • Page 226
    Signature Title Date /s/ LESLIE RAHL Leslie Rahl GREG C. SMITH Greg C. Smith Director May 2, 2007 /s/ Director May 2, 2007 /s/ H. PATRICK SWYGERT H. Patrick Swygert /s/ JOHN K. WULFF John K. Wulff Director May 2, 2007 Director May 2, 2007 221

  • Page 227
    ... Mae's Quarterly Report on Form 10-Q for the quarter ended September 30, 2003.) 4.10 Certificate of Designation of Terms of Fannie Mae Non-Cumulative Convertible Preferred Stock, Series 2004-1 (Incorporated by reference to Exhibit 4.1 to Fannie Mae's Current Report on Form 8-K, filed January 4, 2005...

  • Page 228
    ... "Executive Compensation Information" in Item 11 of Fannie Mae's Annual Report on Form 10-K for the year ended December 31, 2005.) Form of Indemnification Agreement for Non-Management Directors of Fannie Mae (Incorporated by reference to Exhibit 10.7 to Fannie Mae's registration statement on Form 10...

  • Page 229
    ... Report on Form 8-K, filed September 8, 2005.) Statement re: computation of ratios of earnings to fixed charges Statement re: computation of ratios of earnings to combined fixed charges and preferred stock dividends Certification of Chief Executive Officer pursuant to Securities Exchange Act Rule...

  • Page 230
    ... FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm...Consolidated Balance Sheets as of December 31, 2005 and 2004 ...Consolidated Statements of Income for the years ended December 31, 2005, 2004 and 2003...Consolidated Statements of Cash Flows for the years ended...

  • Page 231
    ... REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Fannie Mae: We have audited the accompanying consolidated balance sheets of Fannie Mae and consolidated entities (the "Company") as of December 31, 2005 and 2004, and the related consolidated statements of income, cash...

  • Page 232
    ... funds purchased and securities sold under agreements to repurchase ...Short-term debt ...Long-term debt ...Derivative liabilities at fair value ...Reserve for guaranty losses (includes $71 and $113 as of December 31, 2005 and 2004, respectively, related to Fannie Mae MBS included in Investments...

  • Page 233
    ...,156 Mortgage loans ...20,688 Total interest income ...44,844 Interest expense: Short-term debt ...Long-term debt ...Total interest expense ...Net interest income ...Guaranty fee income (includes imputed interest of $803, $833 respectively) ...Investment losses, net ...Derivatives fair value losses...

  • Page 234
    ... of tax effect ...Derivatives fair value adjustments ...Purchases of loans held for sale ...Proceeds from repayments of loans held for sale...Proceeds from sales of loans held for sale ...Net decrease in trading securities, excluding non-cash transfers ...Net change in: Guaranty assets ...Guaranty...

  • Page 235
    ...) ...Net cash flow hedging losses (net of tax of $2) ...Minimum pension liability (net of tax of $1) ...Total comprehensive income ...Common stock dividends ($1.04 per share) Preferred stock dividends ...Treasury stock issued for stock options and ...benefit plans . Balance as of December 31, 2005...

  • Page 236
    ... mortgage assets we own and the cost of the debt we issue in the global capital markets to fund these assets. Use of Estimates The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") requires management...

  • Page 237
    ... the securitization of mortgage assets in which we have the unilateral ability to liquidate the trust, those SPEs that do not meet the qualifying special purpose entity ("QSPE") criteria, our Low-Income Housing Tax Credit ("LIHTC") partnerships, other partnerships that provide tax benefits and other...

  • Page 238
    ... Portfolio Securitizations Portfolio securitizations involve the transfer of mortgage loans or mortgage-related securities from the consolidated balance sheets to a trust (an SPE) to create Fannie Mae MBS, real estate mortgage investment conduits ("REMICs") or other types of beneficial interests. We...

  • Page 239
    ...statements of cash flows, cash flows from derivatives that do not contain financing elements, mortgage loans held for sale, trading securities and guaranty fees, including buy-up and buy-down payments, are included as operating activities. Federal funds sold and securities purchased under agreements...

  • Page 240
    ... Guaranties, insurance contracts or other credit enhancements are considered contractually attached if they are part of and trade with the security upon transfer of the security to a third party. When we either decide to sell a security in an unrealized loss position and do not expect the fair value...

  • Page 241
    ... of an HFS loan's cost over its fair value is recognized as a valuation allowance, with changes in the valuation allowance recognized as "Investment losses, net" in the consolidated statements of income. Purchase premiums, discounts and/or other loan basis adjustments on HFS loans are deferred upon...

  • Page 242
    ... statements of income. Credit losses related to groups of similar single-family and multifamily loans held for investment that are not individually impaired, or those that are collateral for Fannie Mae MBS, are recognized when (i) available information as of each balance sheet date indicates...

  • Page 243
    ... observable data about a borrower's ability to pay, including reviews of current borrower financial information, operating statements on the underlying collateral, historical payment experience, collateral values when appropriate, and other related credit documentation. Multifamily loans that...

  • Page 244
    ... on the fair value of the collateral, reduced by estimated disposal costs, on a discounted basis, and estimated proceeds from mortgage, flood, or hazard insurance or similar sources. Impairment recognized on individually impaired loans is part of our allowance for loan losses. Loans Purchased or...

  • Page 245
    .... Gains or losses on sales of foreclosed property are recognized through "Foreclosed property expense (income)" in the consolidated statements of income. Guaranty Accounting Our primary guaranty transactions result from mortgage loan securitizations in which we issue Fannie Mae MBS. The majority...

  • Page 246
    ... statements of income at inception of the guaranty fee contract. We recognize a liability for estimable and probable losses for the credit risk we assume on loans underlying Fannie Mae MBS based on management's estimate of probable losses incurred on those loans at each balance sheet date...

  • Page 247
    ... statements of income as "Guaranty fee income" on an accrual basis over the term of the unconsolidated Fannie Mae MBS. We recognized a contingent liability under SFAS 5 based on management's estimate of probable losses incurred on those loans at each balance sheet date. Upfront cash payments...

  • Page 248
    ..., which generally requires deferred fees and costs to be recognized as an adjustment to yield using the interest method over the contractual or estimated life of the loan or security. We amortize these cost basis adjustments into interest income for mortgage securities and loans held for investment...

  • Page 249
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) constant effective yield for deferred guaranty price adjustments based upon our estimate of the cash flows of the mortgage loans underlying the related Fannie Mae MBS, which includes an estimate of prepayments. For each reporting ...

  • Page 250
    ... calculation of gain or loss on the sale of assets. The fair values of the MSA and MSL are based on the present value of expected cash flows using management's best estimates of certain key assumptions, which include prepayment speeds, forward yield curves, adequate compensation, and discount rates...

  • Page 251
    ...balance sheets with unrealized gains and losses included in "Investment losses, net" in the consolidated statements of income. We apply trade date accounting to commitments to purchase or sell existing securities when these commitments settle within the period of time that is customary in the market...

  • Page 252
    ... to the settlement of a security commitment, must meet our standard underwriting guidelines for the purchase or guarantee of mortgage loans. Cash Collateral To the extent that we pledge cash collateral and give up control to a counterparty, we remove it from the consolidated balance sheets. We had...

  • Page 253
    ... dollars using foreign exchange spot rates at the balance sheet date and any associated gains or losses are reported in "Fee and other income" in the consolidated statements of income. Foreign currency gains and losses included in "Fee and other income" for the years ended December 31, 2005, 2004...

  • Page 254
    ... at fair value and recognized in "Salaries and employee benefits expense" in the consolidated statements of income over the required service period. Prior to adoption of SFAS 123, we applied the intrinsic value method of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued...

  • Page 255
    ... a discount rate in the actuarial valuation of our pension and postretirement benefit obligations. In determining the discount rate as of each balance sheet date, we consider the current yields on high-quality, corporate fixed-income debt instruments with maturities corresponding to the expected...

  • Page 256
    ... that market participants would use in their estimates of values. New Accounting Pronouncements SOP 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants...

  • Page 257
    ... of the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award. With respect to options, SFAS 123R requires that they be measured at fair value using an option-pricing model that takes into account the options' unique...

  • Page 258
    ... the MSRs for impairment as was originally required by SFAS 140. This option is available by class of servicing asset or liability. This statement also changes the calculation of the gain from the sale of financial assets by requiring that the fair value of servicing rights be considered part of the...

  • Page 259
    ... prior service costs and credits as an adjustment to accumulated other comprehensive income, net of income tax. Additionally, it requires determination of benefit obligations and the fair values of a plan's assets at a company's year-end. SFAS 158 is effective as of the end of the fiscal year ending...

  • Page 260
    ... by each trust. However, the substantial majority of outstanding Fannie Mae MBS is held by third parties and therefore is generally not reflected in the consolidated balance sheets. We have securitized mortgage loans since 1981. Refer to "Note 6, Portfolio Securitizations" for additional information...

  • Page 261
    ... the secondary mortgage market, our ownership percentage in any given mortgage-related security will vary over time. We consolidated $113.1 billion and $147.8 billion of assets from MBS trusts in the consolidated balance sheets as of December 31, 2005 and 2004, respectively. Third-party ownership in...

  • Page 262
    ... the unpaid principal amount outstanding, net of unamortized premiums and discounts, cost basis adjustments, and an allowance for loan losses. We report HFS loans at the lower of cost or market determined on a pooled basis, and record valuation changes in the consolidated statements of income. F-33

  • Page 263
    ... balance sheets. Refer to "Note 6, Portfolio Securitizations" for additional information on mortgage loans underlying our securities. As of December 31, 2005 2004 (Dollars in millions) Single-family:(1) Government insured or guaranteed . Conventional: Long-term fixed-rate...Intermediate-term fixed...

  • Page 264
    ...Loans Acquired in a Transfer If a borrower of a loan underlying a Fannie Mae MBS is three or more months past due, we have the right to purchase the loan out of the related MBS trust. Typically, we purchase these loans when the cost of advancing interest to the MBS trust at the security coupon rate...

  • Page 265
    ... for loan losses for loans in our mortgage portfolio and a reserve for guaranty losses related to loans backing Fannie Mae MBS. The allowance and reserve are calculated based on our estimate of incurred losses. Refer to "Note 1, Summary of Significant Accounting Policies" for additional information...

  • Page 266
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The following table displays changes in the allowance for loan losses and reserve for guaranty losses for the years ended December 31, 2005, 2004 and 2003. For the Year Ended December 31, 2005 2004 2003 (Dollars in millions) ...

  • Page 267
    ... changes in fair value recorded in "Investment losses, net" in the consolidated statements of income. Trading securities include Fannie Mae MBS of $14.6 billion and $34.4 billion and non-Fannie Mae single-class mortgage-related securities of $503 million and $937 million as of December 31, 2005 and...

  • Page 268
    ... Fair Unrealized Fair Unrealized Fair (1) Cost Gains Losses Value Losses Value Losses Value (Dollars in millions) Fannie Mae single-class MBS Non-Fannie Mae single-class mortgage-related securities . Fannie Mae structured MBS . Non-Fannie Mae structured mortgage-related securities . Mortgage...

  • Page 269
    ... Gross Fair Unrealized Fair Unrealized Fair Amortized Unrealized Unrealized Cost(1) Gains Losses Value Losses Value Losses Value (Dollars in millions) Fannie Mae single-class MBS Non-Fannie Mae single-class mortgage-related securities . Fannie Mae structured MBS . Non-Fannie Mae structured mortgage...

  • Page 270
    ...losses. Since the retained interest that results from our guaranty does not trade in active financial markets, we estimate its fair value by using internally developed models and market inputs for securities with similar characteristics. The key assumptions are discount rate, or yield, derived using...

  • Page 271
    ... key assumptions used in measuring the fair value of our retained interests at the time of portfolio securitization for the years ended December 31, 2005 and 2004. Fannie Mae Single-class MBS & Fannie Mae Megas REMICs & SMBS Guaranty Assets For the year ended December 31, 2005 Weighted-average life...

  • Page 272
    ...both prepayment speed assumptions and discount rates. Fannie Mae Single-class MBS & Fannie Mae Megas REMICs & SMBS Guaranty Assets As of December 31, 2005 Retained interest valuation at period end: Fair value (dollars in millions) ...Weighted-average life(1) ...Prepayment speed assumptions: Average...

  • Page 273
    ... Servicing Financial Guaranties We generate revenue by absorbing the credit risk of mortgage loans and mortgage-related securities backing our Fannie Mae MBS in exchange for a guaranty fee. We primarily issue single-class and multi-class Fannie Mae MBS and guarantee to the respective MBS trusts...

  • Page 274
    ... FINANCIAL STATEMENTS-(Continued) tax-exempt mortgage revenue bonds issued by state and local governmental entities to finance multifamily housing for low- and moderate-income families. Additionally, we issue long-term standby commitments that require us to purchase loans from lenders if the loans...

  • Page 275
    ... fair value of the guaranty obligation, net of deferred profit, associated with the Fannie Mae MBS included in "Investments in securities" was $118 million and $256 million as of December 31, 2005 and 2004, respectively. Master Servicing We do not perform the day-to-day servicing of mortgage loans...

  • Page 276
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 8. Short-term Borrowings and Long-term Debt We obtain the funds to finance our mortgage purchases and other business activities by selling debt securities in both the domestic and international capital markets. We issue a variety of ...

  • Page 277
    ... the use of foreign currency swaps for the purpose of funding our mortgage assets. Our other long-term debt includes callable and non-callable securities, which include all long-term nonbenchmark securities, such as zero-coupons, fixed and other long-term securities, and are generally negotiated...

  • Page 278
    ...instruments to manage the duration and prepayment risk of expected cash flows of the mortgage assets we own. Our outstanding debt as of December 31, 2005 included $173.4 billion of callable debt that could be redeemed in whole or in part at our option any time on or after a specified date. The table...

  • Page 279
    ... years ended December 31, 2005, 2004 and 2003, respectively, as a reduction of "Interest expense" in the consolidated statements of income. Risk Management Derivatives We issue various types of debt to finance the acquisition of mortgages and mortgage-related securities. We use interest rate swaps...

  • Page 280
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The following table displays the outstanding notional balances and fair value of our derivative instruments, excluding mortgage commitment derivatives, as of December 31, 2005 and 2004. As of December 31, 2005 Notional 2004 Fair Fair ...

  • Page 281
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 10. Income Taxes We operate as a government-sponsored enterprise. We are subject to federal income tax, but we are exempt from state and local income taxes. The following table displays the components of our provision for federal ...

  • Page 282
    ...tax assets: Debt and derivative instruments ...Net guaranty assets and obligations and related items . Cash fees and other upfront payments ...Allowance for loan losses and basis in REO properties Employee compensation and benefits ...Partnership and equity investments and related credits . Mortgage...

  • Page 283
    ... Stock Compensation Plan of 2003. Under these plans, we offer various stock-based compensation programs where we provide employees an opportunity to purchase Fannie Mae common stock or we periodically make stock awards to certain employees in the form of nonqualified stock options, performance share...

  • Page 284
    ... shares, treasury shares or shares purchased on the open market. Stock-Based Compensation Programs Nonqualified Stock Options Under the 2003 Plan, we may grant stock options to eligible employees and non-management members of the Board of Directors. Generally, employees and non-management directors...

  • Page 285
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Directors. The Board of Directors determined that we exceeded the target goal in December 2003 and the EPS Challenge options vested in January 2004. The following table displays nonqualified stock option activity for the years ended ...

  • Page 286
    ... Vice Presidents and above. Under the plans, the terms and conditions of the awards are established by the Compensation Committee for the 2003 Plan and by the non-management members of the Board of Directors for the 1993 Plan. Performance shares become actual awards of common stock if the goals set...

  • Page 287
    ... recorded compensation expense by $20 million resulting in a benefit of $20 million recorded as "Salaries and employee benefits expense" in the 2005 consolidated statement of income. A determination as to actual payment for this program will be made by the Board of Directors after reviewing the...

  • Page 288
    ... part-time employees regularly scheduled to work at least 1,000 hours per year are eligible to participate in the qualified defined benefit pension plan. We fund our qualified pension plan through employer contributions to a qualified irrevocable trust that is maintained for the sole benefit of plan...

  • Page 289
    ... net periodic benefit costs in "Salaries and employee benefits expense" in the consolidated statements of income. Contributions to the qualified pension plan increase the plan assets while contributions to the unfunded plans are made to fund current period benefit payments. We were not required to...

  • Page 290
    ... 47 121 - (7) $537 $ - - 2 - (2) $ - $ - - 4 1 (5) $ - Fair value of plan assets at end of year ...Reconciliation of Funded Status to Net Amount Recognized Funded status at end of period ...Unrecognized net actuarial loss...Unrecognized prior service cost (benefit) ...Unrecognized net transition...

  • Page 291
    ... periodic benefit costs, we assess the discount rate to be used in the annual actuarial valuation of our pension and postretirement benefit obligations at year-end. We consider the current yields on high-quality, corporate fixed-income debt instruments with maturities corresponding to the expected...

  • Page 292
    ... adjust our assumption accordingly. The expected long-term rate of return on plan assets for 2005 remained unchanged from the 2004 rate of 7.5% because of the stability of the investment market and our asset allocations. Changes in assumptions used in determining pension and postretirement benefit...

  • Page 293
    ... low market prices on the day preceding the contribution. Compensation cost is measured as the fair value of the shares or cash contributed to, or to be contributed to, the ESOP. We record these contributions as salaries and employee benefits expense in the consolidated statements of income. Expense...

  • Page 294
    ... to MBS certificate holders, commonly referred to as float income. The primary source of profit for the Single-Family Credit Guaranty segment is the difference between the guaranty fees earned and the costs of providing this service, including credit-related losses. Housing and Community Development...

  • Page 295
    ... investments in rental housing that qualify for federal low-income housing tax credits. Our HCD segment has responsibility for managing our credit risk exposure relating to the multifamily Fannie Mae MBS held by third parties, as well as the multifamily mortgage loans and multifamily Fannie Mae MBS...

  • Page 296
    ... MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The following table displays our segment results for the years ended December 31, 2005, 2004 and 2003. For the Year Ended December 31, 2005 Single-Family Capital Credit Guaranty HCD Markets Total (Dollars in millions) Net interest income...

  • Page 297
    ... losses, net of tax effect ...Net income ...(1) (2) Includes cost of capital charge. Includes intercompany guaranty fee revenue (expense) of $1.0 billion allocated to Single-Family Credit Guaranty and HCD from Capital Markets for absorbing the credit risk on mortgage loans and Fannie Mae MBS...

  • Page 298
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) For the Year Ended December 31, 2003 Single-Family Capital Credit Guaranty HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense) . . Investment gains (losses), net ...Derivatives ...

  • Page 299
    ... (see 12 CFR 1750.4 for existing adjustments made by the Director of OFHEO). The critical capital standard is generally equal to the sum of: (i) 1.25% of on-balance sheet assets; (ii) 0.25% of the unpaid principal balance of outstanding Fannie Mae MBS held by third parties; and (iii) up to 0.25% of...

  • Page 300
    ... to cover management and operations risk. Defined as the surplus of total capital over required risk-based capital expressed as a percentage of risk-based capital. Generally, the sum of (a) 1.25% of on-balance sheet assets; (b) 0.25% of the unpaid principal balance of outstanding Fannie Mae MBS held...

  • Page 301
    ... statistical rating organizations, in a quantity such that the sum of our total capital plus the outstanding balance of our qualifying subordinated debt equals or exceeds the sum of: (i) outstanding Fannie Mae MBS held by third parties times 0.45%; and (ii) total on-balance sheet assets times 4%. We...

  • Page 302
    ...; or other relevant information. We are in compliance with the OFHEO Consent Order as of the date of this filing. 16. Preferred Stock Annual Dividend Rate as of Stated December 31, Value 2005 per Share The following table displays preferred stock outstanding as of December 31, 2005 and 2004. Issue...

  • Page 303
    ... outstanding common stock into a smaller number of shares and issuances of any shares by reclassification of our common stock. No such events have occurred such that a change in conversion price would be required. Holders of preferred stock are entitled to receive non-cumulative, quarterly dividends...

  • Page 304
    ... manage credit risk and comply with legal requirements, we typically require primary mortgage insurance or other credit enhancements if the current LTV ratio (i.e., the ratio of the unpaid principal balance of a loan to the current value of the property that serves as collateral) of a single-family...

  • Page 305
    ... that we provide on single-family mortgage assets. Includes mortgage loans in our portfolio, credit enhancements and outstanding Fannie Mae MBS (excluding Fannie Mae MBS backed by non-Fannie Mae mortgage-related securities) where we have more detailed loan-level information, which constituted...

  • Page 306
    ... could result in credit losses for us, and we could incur the cost of finding a replacement servicer, which could be substantial for loans that require a special servicer. Our ten largest single-family mortgage servicers serviced 72% and 71% of our single-family mortgage credit book of business as...

  • Page 307
    ... any ratings based on Moody's scale. Includes MBS options, defined benefit mortgage insurance contracts, forward starting debt and swap credit enhancements accounted for as derivatives. Represents the exposure to credit loss on derivative instruments, which is estimated by calculating the cost, on...

  • Page 308
    ... prepayment rates. If market data needed to estimate fair value is not available, we estimate fair value using internally developed models that employ a discounted cash flow approach. These estimates are based on pertinent information available to us at the time of the applicable reporting periods...

  • Page 309
    ...Mortgage loans held for sale ...Mortgage loans held for investment, net of allowance for loan losses ...Derivative assets ...Guaranty assets and buy-ups...Total financial assets ...Liabilities: Federal funds purchased and securities sold under agreements to repurchase ...Short-term debt ...Long-term...

  • Page 310
    ... repurchase transactions. Short-Term Debt and Long-Term Debt-We estimate the fair value of our non-callable debt using the discounted cash flow approach based on the Fannie Mae yield curve with an adjustment to reflect fair values at the offer side of the market. We estimate the fair value of our...

  • Page 311
    ... reasonable legal fees and expenses incurred in connection with any investigation, claim, action, suit or proceeding, indemnified to the fullest extent permitted by applicable law, by reason of the fact that such person is or was serving as a director or officer of Fannie Mae. Until such time as an...

  • Page 312
    ... Securities Exchange Act of 1934, and SEC Rule 10b-5 promulgated thereunder, largely with respect to accounting statements that were inconsistent with the GAAP requirements relating to hedge accounting and the amortization of premiums and discounts. Plaintiffs contend that the alleged fraud resulted...

  • Page 313
    ...an order naming Pirelli Armstrong Tire Corporation Retiree Medical Benefits Trust and Wayne County Employees' Retirement System as co-lead plaintiffs. A consolidated complaint was filed on September 26, 2005. The consolidated complaint named the following current and former officers and directors as...

  • Page 314
    ...'s final report, including actions relating to our corporate governance, Board of Directors, capital plans, internal controls, accounting practices, public disclosures, regulatory reporting, personnel and compensation practices. We also agreed not to increase our net mortgage portfolio assets above...

  • Page 315
    ...The parties have filed a request for an extension with the arbitrator. In re G-Fees Antitrust Litigation Since January 18, 2005, we have been served with 11 proposed class action complaints filed by single-family borrowers that allege that we and Freddie Mac violated the Clayton and Sherman Acts and...

  • Page 316
    ...class of multifamily borrowers whose mortgages are insured under Sections 221(d)(3), 236 and other sections of the National Housing Act and are held or serviced by us. The complaint identified as a class low- and moderate-income apartment building developers who maintained uninvested escrow accounts...

  • Page 317
    ... 2005 Assets: Cash and cash equivalents ...Investments in securities: Trading, at fair value ...Available-for-sale, at fair value ...Total investments in securities ...Mortgage loans: Loans held for sale, at lower of cost or market Loans held for investment, at amortized cost . . Allowance for loan...

  • Page 318
    ... 31, 2005 2005 2005 2005 (Dollars and shares in millions, except per share amounts) Net interest income ...Guaranty fee income ...Investment gains (losses), net ...Derivatives fair value losses, net ...Debt extinguishment gains (losses), net Loss from partnership investments ...Fee and other income...

  • Page 319
    ... share amounts ) Net interest income ...Guaranty fee income ...Investment gains (losses), net ...Derivatives fair value gains (losses), net . Debt extinguishment gains (losses), net . Loss from partnership investments ...Fee and other income ...Administrative expenses ...Provision for credit losses...

  • Page 320
    ... mortgage loans and Fannie Mae MBS held in our portfolio. For the Quarter Ended June 30, 2005 Single-Family Capital Credit Guaranty HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) . . Investment gains, net ...Derivatives fair value losses...

  • Page 321
    ... losses, net of tax effect ...Net income ...(1) (2) Includes cost of capital charge. Includes intercompany guaranty fee revenue (expense) of $241 million allocated to Single-Family Credit Guaranty and HCD from Capital Markets for absorbing the credit risk on mortgage loans and Fannie Mae MBS...

  • Page 322
    ... losses, net of tax effect ...Net income ...(1) (2) Includes cost of capital charge. Includes intercompany guaranty fee revenue (expense) of $243 million allocated to Single-Family Credit Guaranty and HCD from Capital Markets for absorbing the credit risk on mortgage loans and Fannie Mae MBS...

  • Page 323
    ..., 2007, will result in a total common stock dividend of $0.50 per share for the second quarter of 2007. Redemption of Preferred Stock On February 28, 2007 and April 2, 2007, we redeemed all of the shares of our Variable Rate Non-Cumulative Preferred Stock, Series J, with an aggregate stated value of...

  • Page 324
    CA310