Fannie Mae 2005 Annual Report Download - page 86

Other-than-Temporary Impairment on Available-for-Sale Securities
We periodically evaluate AFS securities for other-than-temporary impairment. Other-than-temporary impair-
ment occurs when we determine that it is probable we will be unable to collect all of the contractual principal
and interest payments of a security or if we do not have the ability and intent to hold the security until it
recovers to its carrying amount. We consider many factors in assessing other-than-temporary impairment,
including the severity and duration of the impairment, recent events specific to the issuer and/or the industry
to which the issuer belongs, external credit ratings and recent downgrades, as well as our ability and intent to
hold such securities until recovery. When we either decide to sell a security in an unrealized loss position and
do not expect the fair value of the security to fully recover prior to the expected time of sale or determine that
a security in an unrealized loss position may be sold in future periods prior to recovery of the impairment, we
identify the security as other-than-temporarily impaired in the period that the decision to sell or determination
that the security may be sold is made. For all other securities in an unrealized loss position resulting primarily
from increases in interest rates, we have the positive intent and ability to hold such securities until the earlier
of full recovery or maturity. We provide additional detail on our assessment of other-than-temporary
impairment in “Notes to Consolidated Financial Statements—Note 1, Summary of Significant Accounting
Policies.”
We recognized other-than-temporary impairment on AFS securities totaling $1.2 billion, $389 million and
$733 million in 2005, 2004 and 2003, respectively, primarily related to our investments in mortgage-related
securities held in our portfolio, interest-only securities, manufactured housing securities, and other non-
mortgage investment securities. These impairment amounts are reflected in the results of our Capital Markets
group and detailed below.
Other-than-temporary impairment on mortgage-related securities held in our portfolio totaled $1.2 billion,
$285 million and $23 million in 2005, 2004 and 2003, respectively. The rising interest rate environment in
2005 caused an overall decline in the fair value of our mortgage-related securities below the carrying value.
We generally view changes in the fair value of our mortgage-related securities caused by movements in
interest rates to be temporary. The $1.2 billion in other-than-temporary impairment that we recognized in 2005
related to securities totaling approximately $72.7 billion that we wrote down to fair value because we sold
these securities before the interest rate impairments recovered. Of the $72.7 billion in securities for which we
recorded other-than-temporary impairment in 2005, we sold $46.2 billion in 2005, $12.8 billion in 2006 and
$13.7 billion in the first quarter of 2007. We did not recognize other-than-temporary impairment on the
remaining mortgage-related securities in our portfolio that were in unrealized loss positions during 2005
because we have the intent and ability to hold these securities until the interest rate impairments recover. The
continued upward trend in interest rates during 2006 caused a further decline in the fair value of our
mortgage-related securities, which is likely to result in our recognition of material other-than-temporary
impairment charges in 2006 for impaired securities that we sold prior to recovery of the impairment.
The other-than-temporary impairment on mortgage-related securities recognized in 2004 primarily related to
certain securities with unrealized losses as of December 31, 2004 that we identified for possible sale in 2005
to comply with OFHEO’s directive that we achieve a 30% surplus over our statutory minimum capital
requirement by September 30, 2005.
We are required to write down the cost basis of our investments in interest-only securities to fair value when
there is both a decline in fair value below the carrying amount and an adverse change in expected cash flows.
We then recognize the write-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
beginning to increase during the second half of 2003 and 2004. While mortgage interest rates generally
trended up in 2004 and 2005, they were somewhat volatile with periodic declines over the course of each year.
We recognized other-than-temporary impairment of $19 million, $49 million and $78 million on mortgage-
related interest-only securities in 2005, 2004 and 2003, respectively. The upward trend in interest rates in 2005
and 2004 resulted in lower impairment amounts during those years relative to 2003 when interest rates fell to
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