Fannie Mae 2005 Annual Report Download - page 162

OFHEO-directed minimum capital requirement. We are subject to continuous examination by OFHEO to
ensure that we meet these capital adequacy requirements on an ongoing basis.
Statutory Minimum Capital Requirement
OFHEO’s ratio-based minimum capital standard ties our capital requirements to the size of our book of
business. For purposes of the minimum capital requirement, we are in compliance if our core capital equals or
exceeds our minimum capital requirement. Core capital is defined by statute as the sum of the stated value of
outstanding common stock (common stock less treasury stock), the stated value of outstanding non-cumulative
perpetual preferred stock, paid-in capital and retained earnings, as determined in accordance with GAAP. Our
minimum capital requirement is generally equal to the sum of:
• 2.50% of on-balance sheet assets;
• 0.45% of the unpaid principal balance of outstanding Fannie Mae MBS held by third parties; and
• up to 0.45% of other off-balance sheet obligations.
Each quarter, OFHEO publishes our standing relative to the statutory minimum capital requirement and,
commencing for the quarter ended September 30, 2005, the OFHEO-directed minimum capital requirement as
part of its capital classification announcement. For a description of the amounts by which our core capital
exceeded or was less than our statutory minimum capital requirement as of December 31, 2005 and 2004, see
Table 37 under “Capital Classification Measures” below.
Statutory Risk-Based Capital Requirement
OFHEO’s risk-based capital standard ties our capital requirements to the risk in our book of business, as
measured by a stress test model. The stress test simulates our financial performance over a ten-year period of
severe economic conditions characterized by both extreme interest rate movements and high mortgage default
rates. Simulation results indicate the amount of capital required to survive this prolonged period of economic
stress absent new business or active risk management action. In addition to this model-based amount, the risk-
based capital requirement also includes an additional 30% surcharge to cover unspecified management and
operations risks.
Our total capital base is used to meet our risk-based capital requirement. Total capital is defined by statute as
the sum of core capital plus the total allowance for loan losses and reserve for guaranty losses in connection
with Fannie Mae MBS, less the specific loss allowance (that is, the allowance required on individually-
impaired loans). Each quarter, OFHEO runs a detailed profile of our book of business through the stress test
simulation model. The model generates cash flows and financial statements to evaluate our risk and measure
our capital adequacy during the ten-year stress horizon. As part of its quarterly capital classification
announcement, OFHEO makes these stress test results publicly available. For a description of the amounts by
which our total capital exceeded our statutory risk-based capital requirement as of December 31, 2005 and
2004, see Table 37 under “Capital Classification Measures” below.
Capital Restoration Plan and OFHEO-Directed Minimum Capital Requirement
OFHEO concluded in its September 2004 interim report on its special examination that we had misapplied
GAAP relating to hedge accounting and the amortization of purchase premiums and discounts on securities
and loans and on other deferred charges. The SEC’s Office of the Chief Accountant affirmed OFHEO’s
conclusion and, on December 15, 2004, advised us that we should restate our financial statements filed with
the SEC to eliminate the use of hedge accounting in order to be consistent with GAAP. At that time, we
estimated that the disallowed hedge accounting treatments resulted in a $9 billion cumulative reduction in our
core capital as of September 30, 2004. As a result, on December 21, 2004, OFHEO classified us as
significantly undercapitalized as of September 30, 2004 and directed us to submit a capital restoration plan
that would provide for compliance with our statutory minimum capital requirement plus a surplus of 30% over
the statutory minimum capital requirement. Pursuant to OFHEO’s directive, we submitted a capital restoration
plan which indicated our intention to achieve a 30% capital surplus over our minimum capital requirement by
September 30, 2005. The capital restoration plan was accepted by OFHEO on February 17, 2005.
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