Fannie Mae 2005 Annual Report Download - page 88

Gains or losses on Fannie Mae portfolio securitizations in any given period are primarily affected by the level
of securitization activity, the carrying amount of the financial assets sold, and changes in interest rates and
prices from the time the financial assets are purchased until the completion of the securitization. We may
record losses on portfolio securitizations because we are required to recognize a liability for the fair value of
our guaranty obligation in determining the gain or loss on the sale. Cash proceeds from portfolio
securitizations totaled $55.0 billion, $12.3 billion and $7.2 billion in 2005, 2004 and 2003, respectively, and
we recognized net gains on these transactions of $259 million in 2005 and net losses of $34 million and
$13 million in 2004 and 2003, respectively.
Gains on Sale of Investment Securities, Net
Gains and losses on the sale of investment securities in any given period are primarily affected by the volume
of sales and changes in interest rates and prices from the time the securities are purchased until the time they
are sold. We recorded net gains of $225 million, $185 million and $87 million in 2005, 2004 and 2003,
respectively, primarily related to the sale of securities totaling $113.6 billion, $18.4 billion and $24.7 billion,
respectively.
We began to increase the level of sales from our mortgage portfolio beginning in the latter part of 2004.
Competition for mortgage assets during 2005 generally increased the number of economically attractive
opportunities to sell certain mortgage assets, resulting in a sizeable increase in portfolio sales during 2005.
These sales were aligned with our need to lower portfolio balances to achieve our capital plan objectives.
Unrealized Gains (Losses) on Trading Securities, Net
Trading securities are carried at 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-related securities classified as trading and decreases in interest rates result in gains. We recorded net
unrealized losses on trading securities of $415 million in 2005, net unrealized gains of $24 million in 2004
and net unrealized losses of $97 million in 2003. The increase in medium- and long-term interest rates during
2005 caused the fair value of our trading securities to decline, resulting in significant unrealized losses for the
year. We experienced unrealized gains on trading securities during 2004 due to the modest decrease in long-
term interest rates from the end of 2003 to the end of 2004. In 2003, an increase in interest rates in the second
half of the year resulted in unrealized losses for the year.
Derivatives Fair Value Losses, Net
We record all derivatives as either assets or liabilities in the consolidated balance sheets at estimated fair value
and recognize changes in fair value in our consolidated statements of income. Changes in the fair value of our
derivatives, including mortgage commitments, resulted in losses of $4.2 billion, $12.3 billion and $6.3 billion
in 2005, 2004 and 2003, respectively. Included in these derivatives fair value loss amounts are net contractual
interest expense accruals on interest rate swaps totaling $1.3 billion, $5.0 billion and $6.4 billion in 2005,
2004 and 2003, respectively, which we consider to be part of the cost of funding our mortgage investments.
Had we elected to fund our mortgage investments with long-term fixed-rate debt instead of a combination of
short-term variable-rate debt and interest rate swaps, the expense related to our interest rate swap accruals
would have been reflected as interest expense instead of as a component of our derivatives fair value losses.
To fully understand the derivatives fair value gains and losses recognized in our consolidated statements of
income, it is important to examine the gains and losses in the context of our overall interest rate risk
management objectives and strategy, including the economic objective in our use of various types of derivative
instruments, the factors that drive changes in the fair value of our derivatives, how these factors affect changes
in the fair value of other assets and liabilities, and the differences in accounting for our derivatives and other
financial instruments.
While we use debt instruments as the primary means to fund our mortgage investments and manage our
interest rate risk exposure, we supplement our issuance of debt with interest rate-related derivatives to manage
the prepayment and duration risk inherent in our mortgage investments. As an example, by combining a pay-
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