Fannie Mae 2005 Annual Report Download - page 47

to use other funds or funding sources to makes the required payments. The need to fund required payments
from alternative sources could have an adverse effect on our net income, depending on the amount involved
and when and whether we are able to regain possession of the amounts held by the depository institution.
Agreements with Dealers and Mortgage Originators and Investors. We enter into agreements with dealers
under which they commit to deliver pools of mortgages to us at an agreed-upon date and price. We commit to
sell Fannie Mae MBS based in part on these commitments. If a dealer defaults in its commitment obligation,
it could cause us to default in our obligation to deliver the Fannie Mae MBS on our commitment date or may
force us to replace the loans at a higher cost in order to meet our commitment. Similarly, we enter into
agreements with mortgage originators and mortgage investors to purchase or sell mortgage loans or mortgage-
related securities. If the originator or investor fails to deliver mortgage assets or pay the fee otherwise required
to fulfill its obligations under the agreement, we may be unable to sell or purchase equivalent mortgage loans
or mortgage-related securities or to purchase or sell them on equally favorable terms, which would decrease or
eliminate the profit or fees we expected to earn from the transaction.
Liquid Investment Portfolio Issuers. The primary credit exposure associated with investments held in our
liquid investment portfolio is that the issuers of these investments will not repay principal and interest in
accordance with the contractual terms. The failure of these issuers to make these payments could have a
material adverse effect on our business results.
Derivatives Counterparties. If a derivatives counterparty defaults on payments due to us, we may need to
enter into a replacement derivative contract with a different counterparty at a higher cost or we may be unable
to obtain a replacement contract. As of December 31, 2005, we had 21 interest rate and foreign currency
derivatives counterparties. Seven of these counterparties accounted for approximately 79% of the total
outstanding notional amount of our derivatives contracts, and each of these seven counterparties accounted for
between approximately 6% and 17% of the total outstanding notional amount. The insolvency of one of our
largest derivatives counterparties combined with an adverse move in the market before we are able to transfer
or replace the contracts could adversely affect our financial condition and results of operations. A discussion
of how we manage the credit risk posed by our derivatives transactions and a detailed description of our
derivatives credit exposure is contained in “Item 7—MD&A—Risk Management—Credit Risk
Management—Institutional Counterparty Credit Risk Management—Derivatives Counterparties.”
Our business faces significant operational risks and an operational failure could materially adversely affect
our business.
Shortcomings or failures in our internal processes, people or systems could have a material adverse effect on
our risk management, liquidity, financial condition and results of operations; disrupt our business; and result in
legislative or regulatory intervention, damage to our reputation and liability to customers. For example, our
business is dependent on our ability to manage and process, on a daily basis, a large number of transactions
across numerous and diverse markets. These transactions are subject to various legal and regulatory standards.
We rely on 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 beyond our
control, these employees or third parties could engage in improper or unauthorized actions, or these systems
could fail to operate properly. In the event of a breakdown in the operation of our or a third party’s systems,
or improper actions by employees or third parties, we could experience financial losses, business disruptions,
legal and regulatory sanctions, and reputational damage.
Because we use a process of delegated underwriting for the single-family mortgage loans we purchase and
securitize, we do not independently verify most borrower information that is provided to us. This exposes us
to mortgage fraud risk, which is the risk that one or more of the parties involved in a transaction (the
borrower, seller, broker, appraiser, title agent, lender or servicer) will misrepresent the facts about a mortgage
loan. We may experience financial losses and reputational damage as a result of mortgage fraud.
In addition, our operations rely on the secure processing, storage and transmission of a large volume of private
borrower information, such as names, residential addresses, social security numbers, credit rating data and
42