Fannie Mae 2006 Annual Report Download

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2006
Annual Report

Table of contents

  • Page 1
    2006 Annual Report

  • Page 2
    T C Financial Highlights ...1 Letter to Shareholders ...2 Board of Directors ...7 Senior Management ...8 Form 10-K...9 Shareholder Information ...Inside Back Cover

  • Page 3
    ...balance of our total interest-earning assets during the period. 8 Guaranty fee income as a percentage of average outstanding Fannie Mae MBS and other guaranties. 9 Charge-offs, net of recoveries and foreclosed property expense (income), as a percentage of the average mortgage credit book of business...

  • Page 4
    ..., and affordable in 2006. financing to the market, Fannie Mae's • Our credit loss ratio - charge offs, single-family and multifamily credit Daniel H. Mudd net of recoveries and foreclosed guaranty businesses are now having President and Chief Executive Officer property expense (income), as a one...

  • Page 5
    ... $PNQMJBODFBOE Audit Committees of the Board. 0WFSQFSDFOUPGPVSTFOJPSPÄ‹DFSTBSFOFXUPUIF company or in new roles; the senior management team has rebuilt key departments, including Finance, Audit, Risk Management, Controller's and Legal, and has overhauled business strategies in each of...

  • Page 6
    ... creates and guarantees Fannie Mae Mortgage-Backed Securities (MBS), generated $2.6 billion in net income in 2005 and $2.0 billion in 2006. As the housing and mortgage markets began to weaken, the credit loss ratio - a key measure of risk - increased on this book of business from 1.9 basis points...

  • Page 7
    ... other business, we have adjusted our cost base and sought revenue and market share opportunities in light of the expectation of higher credit loss ratios during a period of home price declines. Members of Congress and other national leaders have proposed measures to expand Fannie Mae's stabilizing...

  • Page 8
    ... market we serve as borrowers refinance into longerterm fixed-rate mortgage loans - our specialty. • We expect further increases in the cost of our debt, which will cause a continued decline in net interest income in 2007. • We expect our credit losses to rise in 2007 given current market...

  • Page 9
    ...&YFDVUJWF0ċDFS Fannie Mae Washington, DC Joe K. Pickett Former Chairman and $IJFG&YFDVUJWF0ċDFS HomeSide International Inc. A mortgage banking company Montgomery, Alabama Leslie Rahl President and Founder Capital Market Risk Advisors, Inc. A financial advisory firm New York, New York John...

  • Page 10
    ... Senior Vice President Multifamily Kristy M. Williams Senior Vice President Single-Family Mortgage Business - NBC Mark Winer Senior Vice President Business Analysis and Decisions David S. Worley Senior Vice President Housing and Community Development Risk Management Fannie Mae 2006 Annual Report 8

  • Page 11
    ... 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, 2006 Commission File No.: 0-50231 Federal National Mortgage Association (Exact name of registrant as specified in its charter) Fannie Mae...

  • Page 12
    ... of MD&A ...Executive Summary ...Critical Accounting Policies and Estimates ...Consolidated Results of Operations ...Business Segment Results ...Consolidated Balance Sheet Analysis ...Supplemental Non-GAAP Information-Fair Value Balance Sheet ...Liquidity and Capital Management ...Off-Balance Sheet...

  • Page 13
    ... Corporate Governance ...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, and Director Independence ...Item 14. Principal Accountant Fees and Services...

  • Page 14
    ... Market Information ...Non-GAAP Estimated Fair Value of Net Assets (Net of Tax Effect)...Debt Activity ...Fannie Mae Debt Credit Ratings ...Contractual Obligations ...Regulatory Capital Surplus ...On-and Off-Balance Sheet MBS and Other Guaranty Arrangements...LIHTC Partnership Investments ...2006...

  • Page 15
    ... ...Single-Family Credit Loss Sensitivity ...Allowance for Loan Losses and Reserve for Guaranty Losses ...Credit Loss Exposure of Risk Management Derivative Instruments ...Activity and Maturity Data for Risk Management Derivatives ...Interest Rate Sensitivity of Fair Value of Net Assets ... 131...

  • Page 16
    ... us from reporting our financial results on a timely basis. On June 8, 2007, we announced that we plan to become a current filer by the end of February 2008 with the filing of our Annual Report on Form 10-K for the year ended December 31, 2007 ("2007 Form 10-K") with the SEC. At this time, we are...

  • Page 17
    ... trusts as required to permit timely payment of principal and interest on the Fannie Mae MBS. We also issue some forms of mortgage-related securities for which we do not provide this guaranty. The U.S. residential mortgage market has experienced strong long-term growth. According to Federal Reserve...

  • Page 18
    ...-related securities we hold in our 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...

  • Page 19
    ... rental housing that is eligible 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 managing and pricing the credit risk of the multifamily mortgage loans...

  • Page 20
    ... net operating losses that reduce our federal income tax liability. Other investments in rental and for-sale housing generate revenue from operations and the eventual sale of the assets. • Our Capital Markets group manages our investment activity in mortgage loans and mortgage-related securities...

  • Page 21
    ...-party investor. 2 1 We create Fannie Mae MBS backed by pools of mortgage loans and return the MBS to lenders. We assume credit risk, for which we receive guaranty fees. Lenders originate mortgage loans with borrowers. Borrowers $$ Mortgages Mortgages Mortgages Lenders Fannie Mae MBS Fannie...

  • Page 22
    ... is a forward, or delayed delivery, market for 30-year and 15-year fixed-rate single-family mortgage-related securities issued by us and other agency issuers. Most of our single-class, single-family Fannie Mae MBS are sold by lenders in the TBA market. Lenders use the TBA market both to purchase and...

  • Page 23
    ... limited partner or non-managing limited liability company member, with the fund manager acting as the general partner or managing member. We earn a return on our investments in LIHTC partnerships through reductions in our federal income tax liability that result from both our use of the tax credits...

  • Page 24
    ... by product type, refer to Table 12 in "Item 7-MD&A-Consolidated Balance Sheet Analysis." Investment Activities Our Capital Markets group seeks to maximize long-term total returns while fulfilling our chartered liquidity function. The Capital Markets group's purchases and sales of mortgage assets in...

  • Page 25
    ... only to satisfy our funding and risk management requirements, but also to access the capital markets in an orderly manner using debt securities designed to appeal to a wide range of investors. International investors, seeking many of the features offered in our debt programs for their U.S. dollar...

  • Page 26
    ... market risk we face and actively manage is interest rate risk-the risk of changes in our long-term earnings or in the value of our net assets due to changes in interest rates. • Operational Risk. Operational risk relates to the risk of loss resulting from inadequate or failed internal processes...

  • Page 27
    ... the Federal Home Loan Banks. We have been the largest issuer of mortgage-related securities in every year since 1990. Competition for the issuance of mortgage-related securities is intense and participants compete on the basis of the value of their products and services relative to the prices they...

  • Page 28
    ...U.S. Department of the Treasury may purchase obligations of Fannie Mae up to a maximum of $2.25 billion outstanding at any one time. We have not used this facility since our transition from government ownership in 1968. Neither the U.S. nor any of its agencies guarantees our debt or mortgage-related...

  • Page 29
    ... property. However, we are not exempt from the payment of federal corporate income taxes. • Other Limitations and Requirements. Under the Charter Act, we may not originate mortgage loans or advance funds to a mortgage seller on an interim basis, using mortgage loans as collateral, pending the sale...

  • Page 30
    ...conventional mortgage loans, equity investments (even if they facilitate low-income housing), mortgage loans secured by second homes and commitments to purchase or securitize mortgage loans at a later date. In November 2004, HUD published a final regulation amending its housing goals rule, effective...

  • Page 31
    ... Annual Housing Activities Reports for 2005 and 2004. Actual results reflect the impact of provisions that allow us to estimate the affordability of units with missing income and rent data. Goals are expressed as a percentage of the total number of dwelling units financed by eligible mortgage loan...

  • Page 32
    ... make changes and take actions in specified areas, including our accounting practices, capital levels and activities, corporate governance, Board of Directors, internal controls, public disclosures, regulatory reporting, personnel and compensation practices. In the OFHEO consent order, we agreed to...

  • Page 33
    ..., as determined in accordance with U.S. generally accepted accounting principles ("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 18

  • Page 34
    ... 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...

  • Page 35
    ...of risks that results from combining these product types with other features that may compound risk. In June 2007, the same financial regulatory agencies published the final "Statement on Subprime Mortgage Lending," which addresses risks relating to certain subprime mortgages. Together, the agencies...

  • Page 36
    ... in our financial results due to volatility in the fair value of our financial instruments; • our ability to manage credit risk successfully; • changes in our assumptions regarding interest rates, rates of growth of our business and spreads we expect to earn or required capital levels; 21

  • Page 37
    ...primarily the U.S. residential housing market; • borrower preferences for fixed-rate mortgages or ARMs; • investor preferences for mortgage loans and mortgage-backed securities rather than other instruments; • our estimates regarding our 2006 and 2007 business results and market share; • our...

  • Page 38
    COMPANY RISKS We are subject to credit risk relating to both the mortgage assets that we hold in our portfolio and the mortgage loans that back our Fannie Mae MBS, and any resulting delinquencies and credit losses could adversely affect our financial condition, liquidity and results of operations. ...

  • Page 39
    ...whether resulting from a decrease in the volume of mortgage loans available to us from lenders or from our inability to purchase loans as a result of the limit on the size of our portfolio, could reduce the liquidity of Fannie Mae MBS, which in turn could have an adverse effect on their market value...

  • Page 40
    ... our borrowing costs and the interest we earn on our mortgage assets. We make significant use of business and financial models to manage risk. We recognize that models are inherently imperfect predictors of actual results because they are based on the information we input based on data available...

  • Page 41
    ... affect our business. Regulation by OFHEO could adversely affect our results of operations and financial condition. OFHEO has broad authority to regulate our operations and management in order to ensure our financial safety and soundness. For example, to meet our capital plan requirements in 2005...

  • Page 42
    ... our senior unsecured debt. Our ratings are subject to revision or withdrawal at any time by the rating agencies. Any reduction in our credit ratings could increase our borrowing costs, limit our access to the capital markets and trigger additional collateral requirements in derivative contracts and...

  • Page 43
    ... relating to our accounting for certain 2006 securities sold under agreements to repurchase and certain 2006 securities purchased under agreements to resell, our financial reporting process, our information technology applications and infrastructure access controls, and our multifamily lender loss...

  • Page 44
    ... in closing transactions, our products and services, the liquidity of Fannie Mae MBS, our reputation and our pricing. We face competition in the secondary mortgage market from other GSEs and from large commercial banks, savings and loan institutions, securities dealers, investment funds, insurance...

  • Page 45
    ...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 46
    ... and consolidated ERISA-based class action, which could have a material adverse effect on our business, our results of operations and our cash flows. In addition, our current and former directors, officers and employees may be entitled to reimbursement for the costs and expenses of these lawsuits...

  • Page 47
    ... result in increased delinquencies or defaults on the mortgage assets we own or that back our guaranteed Fannie Mae MBS. In addition, home price declines would reduce the fair value of our mortgage assets. Further, a significant portion of mortgage loans made in recent years contain adjustable-rate...

  • Page 48
    ... capital markets, including sudden and unexpected changes in short-term or long-term interest rates, could decrease the fair value of our mortgage assets, derivatives positions and other investments, negatively affect our ability to issue debt at attractive rates, and reduce our net interest income...

  • Page 49
    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 of our securities against us, as well as certain of our former officers, in three federal district courts. The complaints ...

  • Page 50
    ... two related individual securities actions assert various federal and state securities law and common law claims against us and certain of our current and former officers and directors based upon essentially the same alleged conduct as that at issue in the consolidated shareholder class action, and...

  • Page 51
    ... added third-party defendants. We filed motions to dismiss the first amended complaint and on May 31, 2007, the court issued a Memorandum Opinion and Order dismissing plaintiffs' derivative lawsuit for failing to make a demand on the Board of Directors or to plead specific facts demonstrating that...

  • Page 52
    ... statements filed with the SEC to eliminate the use of hedge accounting, and (2) evaluate our accounting for the amortization of premiums and discounts, and restate our financial statements filed with the SEC if the amounts required for correction were material. The SEC's Office of the Chief...

  • Page 53
    ... that ended in each of 2004, 2005 and 2006; and Mr. Raines's entitlement to additional compensation of approximately $140,000. 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...

  • Page 54
    ... filed a motion to dismiss our complaint, which was denied on June 13, 2007. On June 13, 2007, the court granted KPMG's motion to consolidate this action with In re Fannie Mae Securities Litigation for pretrial purposes. See "Restatement-Related Matters-Securities Class Action Lawsuits-In re Fannie...

  • Page 55
    ... Island 02940. Common Stock Data The following table shows, for the periods indicated, the high and low sales prices per share of our common stock in the consolidated transaction reporting system as reported in the Bloomberg Financial Markets service, as well as the dividends per share declared in...

  • Page 56
    ...result, we do not file registration statements with the SEC with respect to offerings of our securities. Purchases of Equity Securities by the Issuer The following table shows shares of our common stock we repurchased from January 2006 through December 2006. Total Number of Shares Purchased(1) Total...

  • Page 57
    ...2006 in the open market pursuant to the General Repurchase Authority. See "Notes to Consolidated Financial Statements-Note 13, Stock-Based Compensation Plans," for information about shares issued, shares expected to be issued, and shares remaining available for grant under our employee benefit plans...

  • Page 58
    ... related notes and with "Item 7-MD&A" included in this Annual Report on Form 10-K. 2006 For the Year Ended December 31, 2005 2004 2003 (Dollars in millions, except per share amounts) 2002 Income Statement Data: Net interest income ...$ 6,752 Guaranty fee income ...4,174 Derivative fair value losses...

  • Page 59
    ...: Mortgage portfolio(6) ...Fannie Mae MBS held by third parties(7) ...Other guarantees(8) ...Mortgage credit book of business ...Ratios: Return on assets ratio ...Return on equity ratio(10)* ...Equity to assets ratio(11)* ...Dividend payout ratio(12)* ...Average effective guaranty fee rate (in basis...

  • Page 60
    ... required 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...

  • Page 61
    ...Page • Executive Summary ...• Critical Accounting Policies and Estimates ...• Consolidated Results of Operations ...• Business Segment Results ...• Consolidated Balance Sheet Analysis ...• Supplemental Non-GAAP Information-Fair Value Balance Sheet ...• Liquidity and Capital Management...

  • Page 62
    ... of ARM products as a means of increasing home price affordability for borrowers. As a result, for the first time in six years, residential mortgage debt outstanding grew at single-digit rates in 2006. During the first quarter of 2007, this growth rate declined to 6%, its lowest level in nearly...

  • Page 63
    ... and depressed home prices contributed to higher levels of unsold inventories during 2006 and into 2007. A number of subprime lenders exited the subprime market, and the federal financial regulatory agencies issued guidance tightening lending standards for nontraditional loans. As a result of these...

  • Page 64
    ...Accounting Policies-Fair Value of Financial Instruments." One of the major drivers of volatility in our financial performance measures, including GAAP net income, is the accounting treatment for derivatives used to manage interest rate risk in our mortgage portfolio. When we purchase mortgage assets...

  • Page 65
    ... effective guaranty fee rate is calculated as guaranty fee income as a percentage of the average single-family mortgage credit book of business and excludes losses on certain guaranty contracts. Our total issuance of single-family Fannie Mae MBS declined by approximately 5% to $476.1 billion in 2006...

  • Page 66
    ..., as measured by loan-to-value ratios, credit scores and other loan characteristics that reflect the effectiveness of our credit risk management strategy. At the end of 2006, we estimate that we held or guaranteed approximately 22% of U.S. single-family mortgage debt outstanding. We anticipate that...

  • Page 67
    ...-Capital Markets Group." Key 2006 Priorities We evaluated our performance in 2006 based not only on our financial results, but also in terms of key nonfinancial priorities for the year. We entered 2006 focused on building a fundamentally stronger and more sound company while managing our businesses...

  • Page 68
    ... file our 2006 and 2007 financial statements and remediation of the company's operational and control weaknesses. Becoming a current filer with effective internal controls is a top priority. • Operate in "Real Time": We have set a longer-term goal of reengineering the company's business operations...

  • Page 69
    ... of cost or market with changes in the fair value (not to exceed the cost basis of these loans) recognized in earnings; and • Retained interests in securitizations and guaranty fee buy-ups on Fannie Mae MBS: Recorded in the consolidated balance sheets at fair value with unrealized gains and losses...

  • Page 70
    ...in Table 18 of "Consolidated Balance Sheet Analysis-Derivative Instruments." Our derivatives consist primarily of over-thecounter ("OTC") contracts and commitments to purchase and sell mortgage assets. While exchange-traded derivatives can generally be valued using observable market prices or market...

  • Page 71
    ... Leases (an amendment of FASB Statements No. 13, 60, and 65 and rescission of FASB Statement No. 17) ("SFAS 91"), cost basis adjustments are amortized into interest income as an adjustment to the yield of the mortgage loan or mortgage-related security based on the contractual terms of the instrument...

  • Page 72
    ...near-term outcomes as of December 31, 2006 and 2005. Table 2: Amortization of Cost Basis Adjustments for Investments in Loans and Securities For the Year Ended December 31, 2006 2005 (Dollars in millions) Unamortized cost basis adjustments ...Reported net interest income ...Decrease in net interest...

  • Page 73
    ... future cash flows is a subjective process involving significant management judgment, primarily due to inherent uncertainties related to the interest rate and home price environment, as well as the actual credit performance of the mortgage loans and securities that are held by each investment trust...

  • Page 74
    ... inherent limitations that relate to the use of historical loss and cost overrun data for the projection of future events. Additionally, we apply similar assumptions and cash flow models to determine the VIE and primary beneficiary status of our other limited partnership investments. We are exempt...

  • Page 75
    ...an analysis of our net interest income and net interest yield for 2006, 2005 and 2004. As described below in "Derivatives Fair Value Losses, Net," we supplement our issuance of debt with interest rate-related derivatives to manage the prepayment and duration risk inherent in our mortgage investments...

  • Page 76
    ...4.05 Total interest-earning assets ...Interest-bearing liabilities: Short-term debt ...Long-term debt ...Federal funds purchased and securities sold under agreements to repurchase ...Total interest-bearing liabilities ...Impact of net non-interest bearing funding ...Net interest income/net interest...

  • Page 77
    ... Rate (Dollars in millions) 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...

  • Page 78
    ..., we may require that the lender pay an upfront fee to compensate us for assuming the additional credit risk. We refer to this payment as a risk-based pricing adjustment. We also may adjust the monthly contractual guaranty fee rate so that the pass-through coupon rates on Fannie Mae MBS are in more...

  • Page 79
    ... amounts and buy-up impairment. Losses on certain guaranty contracts are excluded from the average effective guaranty fee rate. Table 6 shows our guaranty fee income, including and excluding buy-up impairment, our average effective guaranty fee rate, and Fannie Mae MBS activity for 2006, 2005 and...

  • Page 80
    ... that home prices will continue to decline in 2007, as well as our continued investment in loans that support our housing goals, we expect these losses to more than double in 2007 from 2006. Fee and Other Income Fee and other income includes transaction fees, technology fees, multifamily fees and...

  • Page 81
    ... each year. Table 8: Investment Losses, Net For the Year Ended December 31, 2006 2005 2004 (Dollars in millions) Other-than-temporary impairment on AFS securities(1) ...Lower-of-cost-or-market adjustments on HFS loans...Gains (losses) on Fannie Mae portfolio securitizations, net ...Gains on sale of...

  • Page 82
    ...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 during the year. • A net gain of $259 million in 2005 on Fannie Mae...

  • Page 83
    ... $71 million for 2006. The change in fair value of foreign currency swaps excluding this item resulted in a net gain of $176 million. Includes MBS options, forward starting debt, forward purchase and sale agreements, swap credit enhancements, mortgage insurance contracts and exchange-traded futures...

  • Page 84
    ... on our consolidated financial statements in "MD&A-Consolidated Balance Sheet Analysis-Derivative Instruments" and "MD&A-Risk Management-Interest Rate Risk Management and Other Market Risks." Debt Extinguishment Gains (Losses), Net We call debt securities in order to reduce future debt costs as...

  • Page 85
    ...accounting in "Off-Balance Sheet Arrangements and Variable Interest Entities-LIHTC Partnership Interests." Losses from partnership investments, net totaled $865 million, $849 million and $702 million in 2006, 2005 and 2004, respectively. These increased losses were primarily the result of continuing...

  • Page 86
    ... include this amount in the line item "Restatement and related regulatory expenses" for business segment reporting purposes. The increases in administrative expenses in 2006 and in 2005 were primarily due to costs associated with our efforts to return to timely financial reporting. In addition, we...

  • Page 87
    ...the fair value, if any, increases our provision for credit losses because it is recorded as a charge to "Reserve for guarantee losses" in the consolidated balance sheet. Based on the likelihood that home prices will continue to decline during 2007, we expect the level of foreclosures and the related...

  • Page 88
    ... in the timing of the recognition of derivatives fair value gains and losses for financial statement and income tax purposes. We have not recorded a valuation allowance against our net deferred tax asset as we anticipate it is more likely than not that the results of future operations will generate...

  • Page 89
    ... 1-Business-Business Segments." Table 11: Business Segment Summary Financial Information For the Year Ended December 31, 2006 2005 2004 (Dollars in millions) Net revenues:(1) Single-Family Credit Guaranty ...Housing and Community Development ...Capital Markets ...Total ...Net income: Single-Family...

  • Page 90
    ... fee income as a percentage of the average single-family mortgage credit book of business and excludes losses on certain guaranty contracts. Float income, the interest income that we earn on cash flows from the date of the remittance by servicers to us until the date of distribution by us to MBS...

  • Page 91
    ... revenues for our HCD business are guaranty fee income and fee and other income. Expenses primarily include administrative expenses, credit-related expenses and our share of net operating losses associated with LIHTC investments that are offset by the related tax benefits from these investments. Net...

  • Page 92
    ... and $2.1 billion in 2006, 2005 and 2004, respectively. The primary sources of net revenues for our Capital Markets group include net interest income and fee and other income. Derivatives fair value losses, investment gains and losses, and debt extinguishment gains and losses also have a significant...

  • Page 93
    ... attractively compensated for the risk assumed. We will continue to seek out these beneficial opportunities in the future. Changes to Business Segment Reporting in 2007 During 2007, we began to develop new metrics based on fair value changes, inclusive of fee income and costs incurred, and may use...

  • Page 94
    ...Total single-family ...Multifamily: Government insured or guaranteed Conventional: Long-term, fixed-rate...Intermediate-term, fixed-rate(3) . Adjustable-rate ... Total conventional multifamily ...Total multifamily ...Total mortgage loans ...Unamortized premiums and other cost basis adjustments, net...

  • Page 95
    ...-class mortgage securities. Fannie Mae structured MBS ...Non-Fannie Mae structured mortgage securities . . Mortgage revenue bonds ...Other mortgage-related securities ...Market value adjustments ...Other-than-temporary impairments ...Unamortized premiums (discounts) and other cost adjustments, net...

  • Page 96
    ...of 30-year fixed-rate assets relative to historical norms. As indicated above in Table 13, portfolio purchases were significantly lower in 2006 and 2005 than in 2004, due to narrowing mortgage-to-debt spreads, as well as our focus on managing the size of our balance sheet to achieve our capital plan...

  • Page 97
    ... fair value in our consolidated balance sheets, are presented below as of December 31, 2006, 2005 and 2004. Table 14: Non-Mortgage Investments 2006 As of December 31, 2005 2004 (Dollars in millions) Non-mortgage-related securities: Asset-backed securities ...Corporate debt securities ...Commercial...

  • Page 98
    ... of premiums, discounts and other cost basis adjustments) by amortized cost balances as of year-end. Debt Instruments Table 16 shows the amount of our outstanding short-term borrowings and long-term debt as of December 31, 2006 and 2005. Table 16: Outstanding Debt(1) December 31, 2006 December 31...

  • Page 99
    ... Interest Rate(1) 2006 Average During the Year Weighted Average (2) Interest Rate(1) Outstanding (Dollars in millions) Maximum Outstanding(3) Federal funds purchased and securities sold under agreements to repurchase ...Fixed-rate short-term debt: Discount notes ...Foreign exchange discount notes...

  • Page 100
    ... the year has been calculated using month-end balances. Maximum outstanding represents the highest month-end outstanding balance during the year. Derivative Instruments While we use debt instruments as the primary means to fund our mortgage investments and manage our interest rate risk exposure...

  • Page 101
    ... net fair value losses on our derivatives due to the effect of the passage of time on the fair value of our purchased options. Table 18 presents, by derivative instrument type, the estimated fair value of derivatives recorded in our condensed consolidated balance sheets and the related outstanding...

  • Page 102
    ... debt and the fair value of mortgage insurance contracts that are accounted for as derivatives. These mortgage insurance contracts have payment provisions that are not based on a notional amount. Table 19 provides an analysis of items affecting the estimated fair value of the net derivative asset...

  • Page 103
    ... in the fair value of our mortgage investments are offset by changes in the fair value of our debt and derivatives. SUPPLEMENTAL NON-GAAP INFORMATION-FAIR VALUE BALANCE SHEET Because our assets and liabilities consist predominately of financial instruments, we routinely use fair value measures to...

  • Page 104
    ...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 105
    ... ...32,375 Total assets ...$843,936 Liabilities: Federal funds purchased and securities sold under agreements to repurchase ...$ 700 Short-term debt ...165,810 Long-term debt ...601,236 Derivative liabilities at fair value ...1,184 Guaranty obligations ...11,145 Total financial liabilities ...780...

  • Page 106
    ... the carrying value and estimated fair value amounts of total mortgage loans in Note 19. In our GAAP consolidated balance sheets, we report the guaranty assets associated with our outstanding Fannie Mae MBS and other guaranties as a separate line item and include buy-ups, master servicing assets and...

  • Page 107
    ...we purchase mortgage assets or the interest rate risk related to our guaranty business. Additional information about credit, market and operational risks and our strategies for managing these types of risks is included in "Risk Management." • Mortgage-to-debt OAS. Funding mortgage investments with...

  • Page 108
    ... fair value of our net guaranty assets related to changes in interest rates. Table 22: Selected Market Information(1) As of December 31, 2006 2005 2004 Change 2006 2005 vs. 2005 vs. 2004 10-year U.S. Treasury note yield...4.70% Implied volatility(2) ...15.7% 30-year Fannie Mae MBS par coupon rate...

  • Page 109
    ...properties. House price appreciation reported above reflects the annual average HPI of the reported year compared with the annual average HPI of the prior year. Changes in Non-GAAP Estimated Fair Value of Net Assets The effects of our investment strategy, including our interest rate risk management...

  • Page 110
    ... price appreciation during the year. 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. Capital Markets Business Activities Mortgage OAS based...

  • Page 111
    ... of unsecured debt securities. We issue debt on a regular basis in significant amounts in the capital markets and have a diversified funding base of domestic and international investors. Purchasers of our debt securities include fund managers, commercial banks, pension funds, insurance companies...

  • Page 112
    ...the 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 113
    ... Payments Due by Period as of December 31, 2006 Less than 1 to 3 3 to 5 More than Total 1 Year Years Years 5 Years (Dollars in millions) Long-term debt obligations(1) ...Contractual interest on long-term debt obligations(2) ...Operating lease obligations(3) ...Purchase obligations: Mortgage...

  • Page 114
    ... without penalty. Excludes risk management derivative transactions that may require cash settlement in future periods and our obligations to stand ready to perform under our guaranties relating to Fannie Mae MBS and other financial guaranties, because the amount and timing of payments under these...

  • Page 115
    ... long-term stockholder value. Our economic capital framework relies upon both stress test and value-at-risk analyses that measure capital solvency using long-term financial simulations and near-term market value shocks. We currently target a combined corporate economic capital requirement that...

  • Page 116
    ... earnings. Core capital excludes AOCI. Generally, the sum of (a) 2.50% of on-balance sheet assets; (b) 0.45% of the unpaid principal balance of outstanding Fannie Mae MBS held by third parties; and (c) up to 0.45% of other off-balance sheet obligations, which may be adjusted by the Director of OFHEO...

  • Page 117
    ...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 30trading day period following our quarterly filings on Form 12b-25 with the SEC. Officers and members of our Board of Directors are...

  • Page 118
    ... 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 (1) outstanding Fannie Mae MBS held by third parties times 0.45% and (2) total on-balance sheet assets times 4%, which...

  • Page 119
    ... Single-Family business and our HCD business generate revenues through guaranty fees earned in connection with the issuance of Fannie Mae MBS. In connection with our guaranties issued or modified on or after January 1, 2003, we record in the consolidated balance sheets a guaranty obligation based on...

  • Page 120
    ... 31, 2006 and 2005, respectively. Based on our historical credit losses, which represent less than 0.03% of our mortgage credit book of business for each year from 2004 to 2006, we do not believe that the maximum exposure on our Fannie Mae MBS and other credit-related guaranties is representative...

  • Page 121
    ...-Note 8, Financial Guaranties and Master Servicing" and "Notes to Consolidated Financial Statements-Note 18, Concentrations of Credit Risk." For information on the revenues and expenses associated with our SingleFamily and HCD businesses, refer to "Business Segment Results." LIHTC Partnership...

  • Page 122
    ... our off-balance sheet transactions, see "Notes to Consolidated Financial Statements-Note 18, Concentrations of Credit Risk." 2006 QUARTERLY REVIEW We provide certain selected unaudited quarterly financial statement information for the years ended December 31, 2006 and 2005 in "Notes to Consolidated...

  • Page 123
    ...securities ...Mortgage loans ...Total interest income ...Interest expense: Short-term debt ...Long-term debt ...Total interest expense ...Net interest income ...Guaranty fee income ...Losses on certain guaranty contracts ...Investment gains (losses), net ...Derivatives fair value gains (losses), net...

  • Page 124
    ...: Investments in securities ...Mortgage loans ...Total interest income ...Interest expense: Short-term debt ...Long-term debt ...Total interest expense ...Net interest income ...Guaranty fee income ...Losses on certain guaranty contracts(1) ...Investment gains (losses), net ...Derivatives fair value...

  • Page 125
    ..., 2006 Assets: Cash and cash equivalents ...Fed funds sold and securities purchased under agreements resell ...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...

  • Page 126
    ...March 31, 2006 Single-Family Capital Credit Guaranty HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) . . Losses on certain guaranty contracts Investment gains (losses), net ...Derivatives fair value gains, net ...Debt extinguishment gains...

  • Page 127
    ...31, 2006 Single-Family Capital Credit Guaranty HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) ...Losses on certain guaranty contracts . Investment gains, net ...Derivatives fair value losses, net...Debt extinguishment gains, net...Losses...

  • Page 128
    ... the federal statutory rate of 35% adjusted for tax credits recognized for our equity investments in affordable housing projects and tax benefits resulting from our holdings of tax-exempt investments. Second Quarter Ended June 30, 2006 versus Second Quarter Ended June 30, 2005 We recorded net income...

  • Page 129
    ... in mortgage rates reduces the rate of expected mortgage loan prepayments thereby increasing the average expected life of the guaranty assets and slowing the rate of amortization of deferred fees. Net investment losses totaled $633 million for the second quarter of 2006 as compared to net investment...

  • Page 130
    ... statutory rate of 35% adjusted for tax credits recognized for our equity investments in affordable housing projects and tax benefits resulting from our holdings of tax-exempt investments. Fourth Quarter Ended December 31, 2006 versus Fourth Quarter Ended December 31, 2005 We recorded net income of...

  • Page 131
    ... the fair value of open derivative positions as of December 31, 2006 resulting from a small decline in interest rates. The net losses in 2005 were due to a decrease in fair value of open derivative positions as of December 31, 2005 and net interest costs on interest rate swaps. Fee and other income...

  • Page 132
    ... housing projects and tax benefits resulting from our holdings of tax-exempt investments. RISK MANAGEMENT As discussed in "Item 1-Business-Risk Management," our businesses expose us to the following four major categories of risks that often overlap: credit risk, market risk, operational risk...

  • Page 133
    ...oversight of our risk management activities. In 2006 and 2007, we centralized oversight of our business continuity efforts, information security programs, corporate insurance program and SOX Finance Team under our Operational Risk Oversight function within the Chief Risk Office to further strengthen...

  • Page 134
    ... creation of Fannie Mae MBS backed by mortgage assets. Our mortgage credit book of business consists of the following on-and off-balance sheet arrangements: • single-family and multifamily mortgage loans held in our portfolio; • Fannie Mae MBS and non-Fannie Mae mortgage-related securities held...

  • Page 135
    ... credit risk on loans in our single-family mortgage credit book of business include the borrower's financial strength and credit profile; the type of mortgage; the value and characteristics of the property securing the mortgage; and economic conditions, such as changes in employment and home prices...

  • Page 136
    ...and housing-related municipal revenue bonds. Our Capital Markets group prices and manages credit risk related to this specific portion of our conventional singlefamily mortgage credit book of business. We may not have access to detailed loan-level data on these particular mortgage-related assets and...

  • Page 137
    ...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 We use proprietary models and analytical tools to price and...

  • Page 138
    ... single-family mortgage credit book of business with credit enhancement has not changed significantly since the end of 2006. Housing and Community Development Our HCD business is responsible for pricing and managing the credit risk on multifamily mortgage loans we purchase and on Fannie Mae MBS...

  • Page 139
    ... a loss in the event of default are typically lower as the LTV ratio decreases. • Product type. Certain loan product types have features that may result in increased risk. Intermediateterm, fixed-rate mortgages generally exhibit the lowest default rates, followed by long-term, fixed-rate mortgages...

  • Page 140
    Table 35: Risk Characteristics of Conventional Single-Family Business Volume and Mortgage Credit Book of Business(1) Percent of Business Volume(2) For the Year Ended December 31, 2006 2005 2004 Percent of Book of Business(3) As of December 31, 2006 2005 2004 Original LTV ratio:(4) Ͻ= 60% ...60.01%...

  • Page 141
    Percent of Business Volume(2) For the Year Ended December 31, 2006 2005 2004 Percent of Book of Business(3) As of December 31, 2006 2005 2004 Occupancy type: Primary residence ...Second/vacation home ...Investor ...Total ...FICO credit score: Ͻ 620 ...620 to Ͻ 660 . . 660 to Ͻ 700 . . 700 to Ͻ...

  • Page 142
    ... 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 period. Excludes loans for which this information is not readily available. Long-term fixed-rate...

  • Page 143
    ... originated by lenders specializing in this type of business, using processes unique to subprime loans. Based on data published by National Mortgage News and our internal economic analysis of the mortgage market, subprime mortgage loan originations have increased sharply in recent years, rising to...

  • Page 144
    ... loss. Our loan management strategy begins with payment collection and work-out guidelines designed to minimize the number of borrowers who fall behind on their obligations and to help borrowers who are delinquent from falling further behind on their payments. We require our single-family servicers...

  • Page 145
    ... and 0.18% of our total multifamily mortgage credit book of business as of the end of each respective period. Our risk exposure related to our LIHTC investments is limited to the amount of our investment and the possible recapture of the tax benefits we have received from the partnership. When a non...

  • Page 146
    ...(3) Reported based on unpaid principal balance of loans, where we have detailed loan-level information. Calculated based on number of loans for single-family and unpaid principal balance for multifamily. We include all of the conventional single-family loans that we own and that back Fannie Mae MBS...

  • Page 147
    ... loan level assessment. We continue to accrue interest on nonperforming loans that are federally insured or guaranteed by the U.S. government. Table 38 provides statistics on nonperforming single-family and multifamily loans as of the end of each year of the five-year period ending December 31, 2006...

  • Page 148
    ...our consolidated balance sheets as a component of "Acquired property, net." Estimated based on the total number of properties acquired through foreclosure as a percentage of the total number of loans in our conventional single-family mortgage credit book as of the end of each respective year. While...

  • Page 149
    ... estimated losses related to both single-family and multifamily properties affected by Hurricane Katrina. 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...

  • Page 150
    ... foreclosed properties. Calculations based on approximately 92% of our total singlefamily mortgage credit book of business as of December 31, 2006 and 2005. The mortgage loans and mortgage-related securities that are included in these estimates consist of single-family single-class Fannie Mae MBS...

  • Page 151
    ... 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 $859 million as of December 31, 2006...

  • Page 152
    ...rated internally. In addition, we require some lenders to pledge collateral to secure their recourse obligations. We held $112 million and $61 million in collateral as of December 31, 2006 and 2005, respectively, to secure single-family recourse transactions. In addition, a portion of servicing fees...

  • Page 153
    ... their servicing obligations. Mortgage servicers collect mortgage and escrow payments from borrowers, pay taxes and insurance costs from escrow accounts, monitor and report delinquencies, and perform other required activities on our behalf. A servicing contract breach could result in credit losses...

  • Page 154
    ... such as master netting agreements. Derivatives in a gain position are reported in the consolidated balance sheet as "Derivative assets at fair value." Table 43 presents our assessment of our credit loss exposure by counterparty credit rating on outstanding risk management derivative contracts as of...

  • Page 155
    ... 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 a present value basis, to replace all outstanding contracts...

  • Page 156
    ... this risk by restricting these 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. Approximately 99% and 98% of our non-mortgage securities as...

  • Page 157
    ... our investments in mortgage loans and securities, the debt issued to fund those assets, and the derivatives we use to manage interest rate risk. These assets and liabilities have a variety of risk profiles and sensitivities. We employ an integrated interest rate risk management strategy that...

  • Page 158
    ...the composition of our consolidated balance sheets and relative mix of our debt and derivative positions, the interest rate environment and expected trends. Table 44 presents, by derivative instrument type, our risk management derivative activity for the years ended December 31, 2006 and 2005, along...

  • Page 159
    ... 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. Since December 31, 2006, the outstanding notional balance of our risk management derivatives has increased by $40.6 billion to $786.0 billion as...

  • Page 160
    ... to interest rate level and slope shock, (ii) duration gap and (iii) net asset fair value sensitivity. Fair Value Sensitivity to Changes in Level and Slope of Yield Curve In July 2007, we disclosed in our Monthly Summary Report, which is submitted to the SEC in a Current Report on Form 8-K and made...

  • Page 161
    ...GAAP Information-Fair Value Balance Sheet." Table 45: Interest Rate Sensitivity of Fair Value of Net Assets As of December 31, 2006(6) Effect on Estimated Fair Value Ϫ 50 Basis Points +100 Basis Points Estimated Fair Value $ % $ % (Dollars in millions) Carrying Value Trading financial instruments...

  • Page 162
    ... "Guaranty assets and guaranty obligations, net" to reflect how the risk of these securities is managed by the business. Includes net financial assets and financial liabilities reported in "Notes to Consolidated Financial Statements-Note 19, Fair Value of Financial Instruments" and additional market...

  • Page 163
    ... by the Market Risk Committee and Board of Directors; periodic review and testing of our liquidity management controls by our Internal Audit department; maintaining unencumbered mortgage assets that are available as collateral for secured borrowings pursuant to repurchase agreements or for sale; and...

  • Page 164
    ... and under other agreements, including pledged collateral required to facilitate our trading activities. For further information on collateral pledged, see "Notes to Consolidated Financial Statements-Note 1, Summary of Significant Accounting Policies-Collateral ." Our liquid investment portfolio is...

  • Page 165
    ... 1, 2007 and elected fair value measurement for hybrid financial instruments that contain embedded derivatives that otherwise require bifurcation, which includes buy-ups and guaranty assets arising from portfolio securitization transactions. We also elected to classify investment securities that...

  • Page 166
    ... Assets and Financial Liabilities ("SFAS 159"). SFAS 159 permits companies to make a one-time election to report certain financial instruments at fair value with the changes in fair value included in earnings. SFAS 159 is effective for consolidated financial statements issued for fiscal years...

  • Page 167
    ...-family mortgage credit book of business" refers to the sum of the unpaid principal balance of: (1) the conventional single-family mortgage loans we hold in our investment portfolio; (2) the Fannie Mae MBS and non-Fannie Mae mortgage-related securities backed by conventional single-family mortgage...

  • Page 168
    ... guarantee to the related trusts that we will supplement amounts received by the MBS trust as required to permit timely payment of principal and interest on the related Fannie Mae MBS. We also issue some forms of mortgage-related securities for which we do not provide this guaranty. The term "Fannie...

  • Page 169
    ... 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" or "book of...

  • Page 170
    ... of our net mortgage assets is therefore the combination of these two spreads to swaps and is the option-adjusted spread between our assets and our funding and hedging instruments. "Outstanding Fannie Mae MBS" refers to the total unpaid principal balance of Fannie Mae MBS that is held by third-party...

  • Page 171
    ...into Fannie Mae MBS. "Single-family mortgage credit book of business" refers to the sum of the unpaid principal balance of: (1) the single-family mortgage loans we hold in our investment portfolio; (2) the Fannie Mae MBS and non-Fannie Mae mortgage-related securities backed by single-family mortgage...

  • Page 172
    ...of this Annual Report on Form 10-K under the caption "Item 7-MD&A-Risk Management-Interest Rate Risk Management and Other Market Risks." Item 8. Financial Statements and Supplementary Data Our consolidated financial statements and notes thereto are included elsewhere in this Annual Report on Form 10...

  • Page 173
    ... of December 31, 2006 Status as of the date of this Filing Control Environment: Accounting Policy Enterprise-Wide Risk Oversight Internal Audit Human Resources Information Technology Policy Policies and Procedures Application of GAAP Financial Reporting Process: Financial Statement Preparation and...

  • Page 174
    ..., 2004. Our review of our accounting policies and practices in 2005 and 2006, and the restatement of our consolidated financial statements for the years ended December 31, 2003 and 2002, has resulted in an inability to timely file our Annual Reports on Form 10-K for the years ended December 31, 2004...

  • Page 175
    ... systems, validation of results, disclosure review, and pre- and post-closing analytics. As a result, management believes that the consolidated financial statements included in this report fairly present in all material respects the company's financial position, results of operations and cash flows...

  • Page 176
    ... our internal control over financial reporting as of December 31, 2006 identified the continuation of material weaknesses in our application of GAAP, our financial reporting process, information technology applications and infrastructure access controls, pricing controls, and multifamily lender loss...

  • Page 177
    ... of our controls related to our pricing processes for securities. As a result, our accounting conclusions, including certain conclusions related to the fair value of our securities and unrealized gains and losses, could have been materially affected. Multifamily Lender Loss Sharing Modifications We...

  • Page 178
    ...operational risk oversight reporting to the new Chief Risk Officer. In September 2006, we also hired a senior officer responsible for market risk oversight, capital methodology and model review. We developed and communicated corporate-wide risk policies and enhanced our business unit risk management...

  • Page 179
    ... July 2006. The Chief Risk Officer reports independently to the Risk Policy and Capital Committee, and also reports directly to the Chief Executive Officer. • Internal Audit In July 2005, management and the Audit Committee of the Board appointed a new Chief Audit Executive from outside the company...

  • Page 180
    ... model review function under the Chief Risk Officer. As of December 31, 2006, we applied this process to our most critical financial models pursuant to our new independent model review process. Treasury and Trading Operations We redesigned our process for authorizing, approving, validating...

  • Page 181
    ... the date of this filing, we have redesigned our financial reporting processes and implemented technological changes which have resulted in generating the consolidated financial statements included in this Annual Report on Form 10-K. This redesigned process also includes requirements for appropriate...

  • Page 182
    ..., granting, revoking and reviewing access privileges on technology platforms that support applications that are material to our financial reporting process. Multifamily Lender Loss Sharing Modifications Although we have not yet remediated this material weakness, as of the date of this filing, we are...

  • Page 183
    ... REGISTERED PUBLIC ACCOUNTING FIRM To the Board of Directors and Stockholders of Fannie Mae Washington, DC We have audited management's assessment, included in the accompanying Management's Report on Internal Control over Financial Reporting, that Fannie Mae and consolidated entities (the "Company...

  • Page 184
    ... to the process related to the pricing process for securities. As a result, the Company's accounting conclusions, including certain conclusions related to the fair value of its securities and unrealized gains and losses, could have been materially affected. • Multifamily Lender Loan Loss Sharing...

  • Page 185
    ... and Company and Simon Property Group, Inc. and a director or trustee of all T. Rowe Price funds and trusts. She also serves as a vice-chairman of the U.S. Russia Investment Fund, a presidential appointment. Ms. Horn has been a Fannie Mae director since September 2006. Directors, Executive Officers...

  • Page 186
    ...Risk Advisors, Inc., a financial advisory firm specializing in risk management, hedge funds and capital market strategy, since 1994. Previously, Ms. Rahl spent 19 years at Citibank, including nine years as Vice President and Division Head, Derivatives Group-North America. She is currently a director...

  • Page 187
    ...We have a Code of Conduct that is applicable to all officers and employees and a Code of Conduct and Conflicts of Interest 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...

  • Page 188
    ...Executive Vice President and Chief Risk Officer since June 2006. Prior to joining Fannie Mae, Mr. Dallavecchia was with JP Morgan Chase, where he served as Head of Market Risk for Retail Financial Services, Chief Investment Office and Asset Wealth Management from April 2005 to May 2006 and as Market...

  • Page 189
    ...been Executive Vice President and Chief Information Officer since November 2006. Prior to joining Fannie Mae, Mr. Merchant was with Merrill Lynch & Co., where he served as Head of Technology from 2004 to 2006 and as Head of Global Business Technology for Merrill Lynch's Global Markets and Investment...

  • Page 190
    ...of our directors and officers filed all required reports and reported all transactions reportable during 2006, except that Julie St. John, our former Chief Information Officer, reported one transaction late. Item 11. Executive Compensation Compensation Discussion and Analysis This section discusses...

  • Page 191
    ... executives for 2006 consisted of salaries, cash incentive bonuses, long-term incentive awards, employee benefits and perquisites. We provided this compensation mix in order to maintain a competitive compensation program and to reinforce our corporate objectives. Salary was paid on a bi-weekly basis...

  • Page 192
    ... last 120 months of employment. Covered compensation under the plan is limited to 150% of base salary for our executive vice presidents and 200% of base salary for our chief executive officer. A named executive is not entitled to receive a pension benefit under the Executive Pension Plan until the...

  • Page 193
    ... the company by (a) building strong and productive relationships with regulators; (b) restating prior period financial statements; (c) managing capital surplus; and (d) building relationships with investors; • Business Results: Optimize the company's business model and generate shareholder value...

  • Page 194
    ...philosophy generally results in a greater portion of our named executives' compensation being stock-based than at companies in our comparator group. For 2006 performance, the Board and the Compensation Committee determined that, in light of Fannie Mae's not being a current filer, long-term incentive...

  • Page 195
    ... shares of Fannie Mae common stock with a value equal to five times his base salary. In addition, our chief executive officer's long-term incentive award for 2006 included a separate stock ownership requirement described above in footnote 2 to the "Compensation Paid or Granted for 2006" table. Our...

  • Page 196
    ... at Fiscal Year-End" table. The value of the shares is based on the closing price of our common stock of $68.75 on June 15, 2007, the date of the Board's determination. Mr. Blakely and Ms. Wilkinson did not receive awards under the performance share program because they joined Fannie Mae in 2006...

  • Page 197
    What is our compensation recoupment policy? Under our May 23, 2006 consent order with OFHEO, we have agreed that any new employment contracts with named executives will include an escrow of certain payments if OFHEO or any other agency has communicated allegations of misconduct concerning the named ...

  • Page 198
    ... grant date fair value of performance shares is calculated as the market value on date of grant, less the present value of expected dividends over the three-year performance period discounted at the risk-free rate, less the value of the three-times cap based on a Black-Scholes option pricing model...

  • Page 199
    .... For the assumptions used in calculating the value of these awards, see "Notes to Consolidated Financial Statements-Note 1, Summary of Significant Accounting Policies-Stock-Based Compensation." The reported amounts represent change in pension value. The table below shows more information about the...

  • Page 200
    ... awards listed in the table above reflect a grant date equal to the executive's starting date with Fannie Mae. The amounts shown are the target amounts established by our Board for 2006 performance under our Annual Incentive Plan. The amount paid to a named executive is based on Fannie Mae's and...

  • Page 201
    ... share program awards held by the named executives as of December 31, 2006. The market value of option and stock awards shown in the table below is based on a per share price of $59.39, which was the closing market price of our common stock on December 29, 2006. Stock Awards(2) Equity Incentive Plan...

  • Page 202
    ... (#) Unexercisable Name Award Type(1) Grant Date or Performance Period Option Exercise Price ($) Option Expiration Date Number of Shares or Units of Stock That Have Not Vested (#) Market Value of Shares or Units of Stock That Have Not Vested ($) PSP 1/1/2004 to 12/31/2006 Peter Niculescu...

  • Page 203
    ... in "Compensation Discussion and Analysis," the Board determined in June 2007 that our performance during this cycle did not meet the threshold performance level for the financial goal and was between the threshold and target performance levels for the qualitative goals. In accordance with SEC rules...

  • Page 204
    ... benefits are computed on a single life basis using a formula based on final average annual earnings and years of credited service. Participants are fully vested when they complete five years of credited service. Since 1989, provisions of the Internal Revenue Code of 1986, as amended, have limited...

  • Page 205
    ... compensation (excluding income or gain in connection with the exercise of stock options) earned for the relevant year, in an amount up to 150% of base salary for our executive vice presidents and 200% of base salary for Mr. Mudd. As a result, Mr. Mudd's maximum annual benefit under the Executive...

  • Page 206
    ... plans and, as a result, we have included values for Mr. Blakely under those plans rather than under our Executive Pension Plan. Pension Benefits for 2006 Name of Executive Plan Name Number of Years Credited Service (#)(1) Present Value of Accumulated Benefit ($)(2) ...Fannie Mae Retirement Plan...

  • Page 207
    ...rates of return, no further contributions can be made to the plan. The Career Deferred Compensation Plan is funded by a rabbi trust, a special type of trust the assets of which are subject to the claims of Fannie Mae's creditors. Deferred Performance Share Program Payments We have adopted guidelines...

  • Page 208
    ... agreements, plans and arrangements if our named executives' employment had terminated on December 29, 2006, taking into account each named executive's compensation and service levels as of that date and based on the closing price of our common stock on December 29, 2006. We are not obligated...

  • Page 209
    ... report to anyone other than the Chairman of the Board of Directors, (d) a requirement by Fannie Mae that Mr. Mudd relocate his office outside of the Washington, D.C. area, or (e) a breach by the company of any material obligation under the employment agreement. Failure to Extend means notification...

  • Page 210
    ... date of termination and will continue to be covered by our life, medical, and long-term disability insurance plans for a 12-month period, or until re-employment that provides certain coverage for benefits, whichever occurs first. For the purpose of this agreement, "cause" means a termination based...

  • Page 211
    ...cash severance payment of $750,000 and medical, long-term disability and life insurance coverage with premiums and a related gross-up payment we estimate would have cost us an aggregate of approximately $71,500. Severance Program On March 10, 2005, our Board of Directors approved a severance program...

  • Page 212
    ...-time, salaried employees, amounts for these benefits have not been included in the table above. The amount shown for Ms. St. John reflects our estimated cost of subsidizing her dental plan premiums for 18 months. Stock Compensation Plans, 2005 Performance Year Cash Awards and Annual Incentive Plan...

  • Page 213
    ... have vested exceed the closing price of our common stock on December 29, 2006. Mr. Blakely and Ms. Wilkinson have never been awarded Fannie Mae stock options. The reported amounts represent accelerated payment of cash awards made in early 2006 in connection with long-term incentive awards for the...

  • Page 214
    ...For the assumptions used in calculating the value of these awards, see "Notes to Consolidated Financial Statements-Note 1, Summary of Significant Accounting Policies- Stock-Based Compensation." Mr. Beresford, Ms. Gaines, Ms. Horn and Ms. Macaskill have never been awarded Fannie Mae stock options. As...

  • Page 215
    ... amount of time and effort necessary to fulfill the duties of non-executive Chairman of the Board, Mr. Ashley receives an annual fee of $500,000. Restricted Stock Awards We have a restricted stock award program for non-management directors established under the Fannie Mae Stock Compensation Plan of...

  • Page 216
    ...been held in 2005 or 2006. Stock Ownership Guidelines for Directors Under our Corporate Governance Guidelines, 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 retainer (currently, five times $35,000, or $175...

  • Page 217
    ... program awards that have been made to members of senior management for which a payout determination has been made but for which the shares were not paid out as of December 31, 2006. Outstanding awards, options and rights include grants under the Fannie Mae Stock Compensation Plan of 1993, the Stock...

  • Page 218
    ...Excluding Stock Options Beneficially Owned of June 30, 2007 Name and Position Stephen Ashley(3) ...Chairman of the Board of Directors Dennis Beresford(4) ...Director Robert Blakely(5) ...Executive Vice President and Chief Financial Officer Louis Freeh ...Director Brenda Gaines(6) ...Director Karen...

  • Page 219
    ...spouse and 650 shares of restricted stock. Mr. Smith's shares include 650 shares of restricted stock. Ms. St. John left Fannie Mae in December 2006. Information about Ms. St. John's holdings is based on an amended Form 4 filed by Ms. St. John on July 20, 2007 regarding her shares held as of December...

  • Page 220
    ... transaction. Our current written policies and procedures for review, approval or ratification of relationships or transactions with related persons are set forth in our: • Code of Conduct and Conflicts of Interest Policy for Members of the Board of Directors; • Board of Directors' delegation of...

  • Page 221
    ... and approve any investment, acquisition, financing or other transaction that Fannie Mae engages in directly with any current director or executive officer or any immediate family member or affiliate of a current director or executive officer. Our Code of Conduct for employees requires that we and...

  • Page 222
    ... provided services on an annual fixed-fee basis of $375,000. The fees we paid to The Duberstein Group in 2006 are included in the "2006 Non-Employee Director Compensation Table" in "Item 11-Executive Compensation-Director Compensation Information." Under our new agreement, we pay an annual fixed fee...

  • Page 223
    ...outplacement services under her separation agreement. Our employment relationship with and compensation of Mr. Levin's sister and Mr. Senhauser's wife have not required review and approval under any of our policies and procedures relating to transactions with related persons, other than the terms of...

  • Page 224
    ... no longer) a partner or employee of our outside auditor and personally worked on our audit within that time. • A director will not be considered independent if, within the preceding five years: • the director was employed by a company at a time when one of our current executive officers sat on...

  • Page 225
    ... Board and federal securities laws administered by the SEC. The following table sets forth the aggregate estimated or actual fees for professional services provided by Deloitte & Touche LLP, including fees for the 2006 and 2005 audits. Description of Fees For the Year Ended December 31, 2006...

  • Page 226
    ...Short-term Borrowings and Long-term Debt ...Note 10- Derivative Instruments ...Note 11- Income Taxes ...Note 12- Earnings Per Share ...Note 13- Stock-Based Compensation Plans ...Note 14- Employee Retirement Benefits ...Note 15- Segment Reporting ...Note 16- Regulatory Capital Requirements ...Note 17...

  • Page 227
    ... by virtue hereof. Federal National Mortgage Association /s/ DANIEL H. MUDD Daniel H. Mudd President and Chief Executive Officer Date: August 16, 2007 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the...

  • Page 228
    Signature Title Date /s/ BRIDGET A. MACASKILL Bridget A. Macaskill /s/ JOE K. PICKETT Joe K. Pickett LESLIE RAHL Leslie Rahl GREG C. SMITH Greg C. Smith Director August 16, 2007 Director August 16, 2007 /s/ Director August 16, 2007 /s/ Director August 16, 2007 /s/ H. PATRICK SWYGERT ...

  • Page 229
    ... 10, filed March 31, 2003.) 10.8 Description of Fannie Mae's Elective Deferred Compensation Plan II†(Incorporated by reference to "Nonqualified Deferred Compensation-Elective Deferred Compensation Plans" in Item 11 of Fannie Mae's Annual Report on Form 10-K for the year ended December 31, 2006...

  • Page 230
    ...Amendment to the Executive Pension Plan of the Federal National Mortgage Association, as amended and restated, effective March 1, 2007†(Incorporated by reference to Exhibit 10.20 to Fannie Mae's Annual Report on Form 10-K for the year ended December 31, 2005, filed May 2, 2007.) Fannie Mae Annual...

  • Page 231
    ... to Fannie Mae's Annual Report on Form 10-K for the year ended December 31, 2004, filed December 6, 2006.) Agreement between the Office of Federal Housing Enterprise Oversight (OFHEO) and Fannie Mae, September 27, 2004 (Incorporated by reference to Exhibit 10.1 to Fannie Mae's Current Report on Form...

  • Page 232
    ... FINANCIAL STATEMENTS Page Report of Independent Registered Public Accounting Firm...Consolidated Balance Sheets as of December 31, 2006 and 2005 ...Consolidated Statements of Income for the years ended December 31, 2006, 2005 and 2004...Consolidated Statements of Cash Flows for the years ended...

  • Page 233
    ... 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, 2006 and 2005, and the related consolidated statements of income, cash...

  • Page 234
    ... 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 $46 and $71 as of December 31, 2006 and 2005, respectively, related to Fannie Mae MBS included in Investments...

  • Page 235
    ...) ...Losses on certain guaranty contracts ...Investment losses, net ...Derivatives fair value losses, net ...Debt extinguishment gains (losses), net ...Losses from partnership investments ...Fee and other income ...Non-interest income (loss) ...Administrative expenses: Salaries and employee benefits...

  • Page 236
    ...-term debt ...Repurchase of common stock ...Proceeds from issuance of common and preferred stock...Payment of cash dividends on common and preferred stock ...Net change in federal funds purchased and securities sold under agreements to repurchase ...Excess tax benefits from stock-based compensation...

  • Page 237
    ...-for-sale securities (net of tax of $483) ...Reclassification adjustment for gains included in net income (net of tax of $9) ...Unrealized losses on guaranty assets and guaranty fee buy-ups (net of tax of $4) ...Net cash flow hedging losses (net of tax of $1) ...Minimum pension liability (net of tax...

  • Page 238
    ... guaranteed single-family Fannie Mae mortgage-backed securities ("Fannie Mae MBS"). Our HCD segment generates revenue from a variety of sources, including guaranty fees the segment receives as compensation for assuming the credit risk on the mortgage loans underlying multifamily Fannie Mae MBS...

  • Page 239
    ... our net basis in the consolidated assets and liabilities to our investment in the VIE. 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...

  • Page 240
    ...the consolidated 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...

  • Page 241
    ... fair value in the consolidated balance sheets with unrealized gains and losses included in "Investment losses, net" in the consolidated statements of income. Realized gains and losses on AFS and trading securities are recognized when securities are sold; are calculated based upon the specific cost...

  • Page 242
    ...losses, net" in the consolidated statements of income. The fair value of the investment then becomes its new cost basis. We do not increase the investment's cost basis for subsequent recoveries in fair value. In periods after we recognize an other-than-temporary impairment on debt securities, we use...

  • Page 243
    ... the consolidated 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...

  • Page 244
    ...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 are categorized into pools based on their relative...

  • Page 245
    ... Scope of FASB Statement No. 15. Impairment of a loan restructured in a TDR is based on the excess of the recorded investment in the loan over the present value of the expected future cash inflows discounted at the loan's original effective interest rate. Loans modified that result in terms at least...

  • Page 246
    ... trusts to which we were not the transferor at the time of securitization, at their acquisition price. Concurrently, a portion of the "Reserve for guaranty losses" was reclassified into the "Allowance for loan losses" in the consolidated balance sheets. Acquired Property, Net "Acquired property, net...

  • Page 247
    ...fee for loans with greater credit risk, we may require that the lender pay an upfront fee to compensate us for assuming additional credit risk. We refer to this payment as a risk-based pricing adjustment. Risk-based pricing adjustments do not affect the pass-through coupon remitted to Fannie Mae MBS...

  • Page 248
    ... 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 received in the form of risk-based pricing adjustments or buy...

  • Page 249
    ...Investments in securities" in the consolidated balance sheets as well as the amount of our "Reserve for guaranty losses" and "Guaranty obligations" that relates to Fannie Mae MBS held as "Investments in securities." Upon subsequent sale of a Fannie Mae MBS, we continue to account for any outstanding...

  • Page 250
    ... cost basis adjustments, we aggregate similar mortgage loans or mortgage-related securities with similar prepayment characteristics. We consider Fannie Mae MBS to be aggregations of similar loans for the purpose of estimating prepayments. We aggregate individual mortgage loans based upon coupon rate...

  • Page 251
    ... 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 252
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) operations are accounted for using the cost method. These investments are included as "Other assets" in the consolidated balance sheets. We periodically review our investments to determine if a loss in value that is other-than-...

  • Page 253
    ... under early funding agreements with lenders, whereby we advance funds to lenders prior 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...

  • Page 254
    ... interest and basis adjustments of debt denominated in a foreign currency are re-measured into U.S. dollars using foreign exchange spot rates as of the balance sheet date and any associated gains or losses are reported in "Fee and other income" in the consolidated statements of income. Foreign...

  • Page 255
    ...in Income Taxes ("FIN 48"). Refer to New Accounting Pronouncements section of this note for impact to our consolidated financial statements. Stock-Based Compensation Effective January 1, 2006, we adopted SFAS No. 123 (Revised), Share-Based Payments ("SFAS 123R"), and the related FASB Staff Positions...

  • Page 256
    ... for new and modified stock-based compensation awards at fair value on the grant date and recognized compensation cost over the vesting period. However, under the prospective transition method, we continued to account for unmodified stock options that were outstanding as of December 31, 2002, using...

  • Page 257
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The fair value of options granted under our stock-based compensation plans (none in 2006) are estimated on the date of the grant using a Black-Scholes model with the following weighted average assumptions displayed in the table below....

  • Page 258
    ... "Guaranty fee income" in the consolidated statements of income as well as changes in the guaranty asset and obligation in the consolidated statements of cash flows have been reclassified as "Losses on certain guaranty contracts" to conform to current year presentation. New Accounting Pronouncements...

  • Page 259
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) SFAS No. 156, Accounting for Servicing of Financial Assets In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets, an amendment of FASB Statement No. 140 ("SFAS 156"). SFAS 156 modifies SFAS 140 by ...

  • 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
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The assets of these trusts may include mortgage-related securities and/or mortgage loans as collateral. The trusts created for Fannie Mega securities issue single-class securities while the trusts created for REMIC, grantor trust and ...

  • Page 262
    ... given mortgage-related security will vary over time. Thirdparty ownership in these consolidated MBS trusts is recorded as a component of either "Short-term debt" or "Long-term debt" in the consolidated balance sheets. We consolidate in our financial statements the assets and liabilities of limited...

  • Page 263
    ... principal amount outstanding, net of unamortized premiums and discounts, other 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-32

  • Page 264
    ...insured or guaranteed Conventional: Long-term fixed-rate ...Intermediate-term fixed-rate(3) . Adjustable-rate ... Total conventional multifamily ...Total multifamily ...Unamortized premiums, discounts and other cost basis adjustments, net ...Lower of cost or market adjustments on loans held for sale...

  • Page 265
    ... following table provides details on acquired loans accounted for in accordance with SOP 03-3 at their respective acquisition dates for the years ended December 31, 2006 and 2005. For the Year Ended December 31, 2006 2005 (Dollars in millions) Contractually required principal and interest payments...

  • Page 266
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Nonaccrual Loans We have single-family and multifamily loans in our portfolio, including those loans accounted for under SOP 03-3, that are subject to our nonaccrual policy. The following table displays information about nonaccrual ...

  • Page 267
    ... an allowance 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...

  • Page 268
    ...commitments related to mortgage-related securities that are accounted for as securities. Trading Securities Trading securities are recorded at fair value with subsequent changes in fair value recorded as "Investment losses, net" in the consolidated statements of income. The following table displays...

  • Page 269
    ...) Fannie Mae single-class MBS ...Non-Fannie Mae structured mortgagerelated securities ...Fannie Mae structured MBS...Non-Fannie Mae single-class mortgagerelated securities ...Mortgage revenue bonds ...Other mortgage-related securities(2) ...Asset-backed securities ...Corporate debt securities...

  • Page 270
    ...Fair Losses Value Fannie Mae single-class MBS...Non-Fannie Mae structured mortgagerelated securities ...Fannie Mae structured MBS ...Non-Fannie Mae single-class mortgage-related securities ...Mortgage revenue bonds ...Other mortgage-related securities(2) ...Asset-backed securities ...Corporate debt...

  • Page 271
    ... . Fannie Mae structured MBS(2) . . Non-Fannie Mae single-class mortgage-related securities(2) . Mortgage revenue bonds ...Other mortgage-related securities(3) ...Asset-backed securities(2) ...Corporate debt securities ...Commercial paper ...Other non-mortgage-related securities ... Total Fair Value...

  • Page 272
    ...as a 12-month constant prepayment rate ("CPR"). Our retained interests in Fannie Mae single-class MBS, Fannie Mae Megas, REMICs and SMBS are interests in securities with active markets. We primarily rely on third party prices to estimate the fair value of these retained interests. For the purpose of...

  • Page 273
    ... 31, 2006 and 2005 and a sensitivity analysis showing the impact of changes in both prepayment speed assumptions and discount rates. Fannie Mae Single-Class MBS & Fannie Mae Megas REMICs & SMBS Guaranty Assets As of December 31, 2006 Retained interest valuation at period end: Fair value (dollars...

  • Page 274
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) for the year ended December 31, 2004. These amounts are recognized as "Investment losses, net" in the consolidated statements of income. The following table displays cash flows on our securitization trusts related to portfolio ...

  • Page 275
    ... borrowers. We also provide credit enhancements on taxable or 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...

  • Page 276
    ... on these guaranties in "Reserve for guaranty losses" in the consolidated balance sheets, as discussed further in "Note 4, Allowance for Loan Losses and Reserve for Guaranty Losses." These guaranties expose us to credit losses on the mortgage loans or, in the case of mortgage-related securities, the...

  • Page 277
    ... risk on the underlying loans. We continue to recognize a guaranty obligation and a reserve for guaranty losses associated with these securities because we carry these securities in the consolidated financial statements as guaranteed Fannie Mae MBS. The fair value of the guaranty obligation, net...

  • Page 278
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 9. 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 279
    ...Total long-term debt(2) ...(1) (2) Includes discounts, premiums and other cost basis adjustments. Reported amounts include a net premium and cost basis adjustments of $11.9 billion and $10.7 billion as of December 31, 2006 and 2005, respectively. Our long-term debt includes a variety of debt types...

  • Page 280
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Additionally, we record a secured borrowing, to the extent of proceeds received, upon the transfer of financial assets from the consolidated balance sheets that does not qualify as a sale. Long-term debt from these transactions in the...

  • Page 281
    ... the basis for calculating actual payments or settlement amounts. Although derivative instruments are critical to our interest rate risk management strategy, we did not apply hedge accounting to instruments entered into during the three-year period ended December 31, 2006. As such, all fair value...

  • Page 282
    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, 2006 and 2005. As of December 31, 2006 Notional 2005 Fair Fair ...

  • Page 283
    ... related to extraordinary gains (losses). The following table displays the difference between our effective tax rates and the statutory federal tax rates for the years ended December 31, 2006, 2005 and 2004. For the Year Ended December 31, 2006 2005 2004 Statutory corporate tax rate ...Tax-exempt...

  • Page 284
    ... ...Net guaranty assets and obligations and related items ...Partnership and equity investments and related credits ...Mortgage and mortgage-related assets ...Allowance for loan losses and basis in acquired property, net . Employee compensation and benefits ...Cash fees and other upfront payments...

  • Page 285
    ... the 1985 Employee Stock Purchase Plan and the 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...

  • Page 286
    ...31, 2006. Stock-Based Compensation Plans The 1985 Employee Stock Purchase Plan (the "1985 Purchase Plan") provides employees an opportunity to purchase shares of Fannie Mae common stock at a discount to the fair market value of the stock during specified purchase periods. Our Board of Directors sets...

  • Page 287
    ...-money options outstanding was $16 million, and the weighted-average remaining contractual term was 3.8 years and 3.6 years for options outstanding and exercisable, respectively. The total fair value of options vested in 2006 was $30 million. Employee Stock Purchase Program Plus The Employee Stock...

  • Page 288
    ... weighted-average grant date fair value of $71.83 in 2004. We recorded $24 million in compensation costs related to this program for the year ended December 31, 2004. There were no performance shares awarded in 2006 and 2005. On February 15, 2007, our Board of Directors determined that the remaining...

  • Page 289
    ...'s fair value at grant date for each grant, the fair value of restricted stock vested in 2006 was $68 million. The compensation expense related to restricted stock is based on the grant date fair value of our common stock. The following table displays restricted stock activity for the years ended...

  • Page 290
    ...from the Executive Pension Plan and whose salary exceeds the statutory compensation cap applicable to the qualified plan or whose benefit is limited by the statutory benefit cap. Similarly, the 2003 Supplemental Pension Plan provides additional benefits to our officers based on the annual cash bonus...

  • Page 291
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Net periodic benefit costs are determined on an actuarial basis and are included in "Salaries and employee benefits expense" in the consolidated statements of income. The following table displays components of our net periodic benefit...

  • Page 292
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The following table displays estimated pre-tax amounts in AOCI as of December 31, 2006 expected to be recognized as components of net periodic benefit cost in 2007. As of December 31, 2006 Pension Plans Other PostNonRetirement ...

  • Page 293
    ...- - 4 - (4) $ - $ - - 4 - (4) $ - Fair value of plan assets at end of year ...Reconciliation of Funded Status to Net Amount Recognized Over/Under funded status at end of period ...Unrecognized net actuarial loss ...Unrecognized prior service cost (benefit) ...Unrecognized net transition obligation...

  • Page 294
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Actuarial gains or losses reflect annual changes in the amount of either the benefit obligation or the fair value of plan assets that result from the difference between actual experience and projected amounts or from changes in ...

  • Page 295
    ... obligation increased 25 basis points, reflecting a corresponding rate increase in corporate-fixed income debt instruments during 2006. We also assess the long-term rate of return on plan assets for our qualified pension plan. The return on asset assumption reflects our expectations for plan-level...

  • Page 296
    ... 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 297
    ... service, including credit-related losses. Housing and Community Development. Our HCD segment helps to expand the supply of affordable and market-rate rental housing in the United States primarily by: (i) working with our lender customers to securitize multifamily mortgage loans into Fannie Mae MBS...

  • Page 298
    ... risk are similar to those of Single-Family. Capital Markets. Our Capital Markets segment manages our investment activity in mortgage loans and mortgage-related securities, and has responsibility for managing our assets and liabilities and our liquidity and capital positions. We fund mortgage loan...

  • Page 299
    ... the Year Ended December 31, 2006 Capital Single-Family HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) ...Losses on certain guaranty contracts . Investment gains (losses), net ...Derivatives fair value losses, net ...Debt extinguishment...

  • Page 300
    ... STATEMENTS-(Continued) For the Year Ended December 31, 2005 Capital Single-Family HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) ...Losses on certain guaranty contracts(3) Investment gains (losses), net ...Derivatives fair value losses...

  • Page 301
    ... STATEMENTS-(Continued) For the Year Ended December 31, 2004 Capital Single-Family HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) ...Losses on certain guaranty contracts(3) Investment gains (losses), net ...Derivatives fair value losses...

  • Page 302
    ... obligations, which may be adjusted by the Director of OFHEO under certain circumstances. OFHEO's risk-based capital standard also ties 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...

  • Page 303
    ... of statutory 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 by third parties; and (c) up to 0.25% of other off-balance sheet obligations, which may be adjusted by the Director of OFHEO...

  • Page 304
    ... 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 305
    ... assets that are reported to OFHEO for purposes of computing the portfolio limit are defined as the unpaid principal balance of our mortgage loans and mortgage-related securities, net of market valuation adjustments, allowance for loan losses, impairments and unamortized premiums and discounts...

  • Page 306
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) 17. Preferred Stock Annual Dividend Rate Stated as of Value December 31, 2006 per Share 50 50 50 50 50 50 50 50 50 50 50 50 5.250% 5.100 4.560(1) 4.590(2) 5.810 5.375 6.453(4) 5.396(5) 5.125 4.750 5.500 7.000(6) The following table ...

  • Page 307
    ... single-family mortgage loans held or securitized in Fannie Mae MBS as of December 31, 2006 and 2005, respectively, were located, no other significant concentrations existed in any state. No region or state experienced negative home price growth over this three-year period. To manage credit risk and...

  • Page 308
    ... our total conventional single-family mortgage credit book of business as of December 31, 2006 and 2005 respectively. Excludes non-Fannie Mae mortgage-related securities backed by single-family mortgage loans and credit enhancements that we provide on single-family mortgage assets. Includes mortgage...

  • Page 309
    ... their servicing obligations. Mortgage servicers collect mortgage and escrow payments from borrowers, pay taxes and insurance costs from escrow accounts, monitor and report delinquencies, and perform other required activities on our behalf. A servicing contract breach could result in credit losses...

  • Page 310
    ... have a collateral management policy with provisions for requiring collateral on interest rate and foreign currency derivative contracts in net gain positions based upon the counterparty's credit rating. The collateral includes cash, U.S. Treasury securities, agency debt and agency mortgage-related...

  • Page 311
    ... third parties. Pricing information we obtain from third parties is internally validated for reasonableness prior to use in the consolidated financial statements. When observable market prices are not readily available, we estimate the fair value using market data and model-based interpolation using...

  • Page 312
    ... Value Assets: Cash and cash equivalents(1) ...Federal funds sold and securities purchased under agreements to resell ...Trading securities ...Available-for-sale securities ...Mortgage loans held for sale ...Mortgage loans held for investment, net of allowance for loan losses...Advances to lenders...

  • Page 313
    ... balance sheets at the principal amount outstanding, net of unamortized premiums and discounts, cost basis adjustments and an allowance for loan losses. We determine the fair value of our mortgage loans based on comparisons to Fannie Mae MBS with similar characteristics. Specifically, we use...

  • Page 314
    ... bonds approximates market levels where we have executed secondary market transactions. For subordinated debt, we use third party prices. Guaranty Obligations-Our estimate of the fair value of the guaranty obligation is based on management's estimate of the amount that we would be required to pay...

  • Page 315
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) Restatement-Related Matters In re Fannie Mae Securities Litigation Beginning on September 23, 2004, 13 separate complaints were filed by holders of our securities against us, as well as certain of our former officers, in three federal...

  • Page 316
    ... two related individual securities actions assert various federal and state securities law and common law claims against us and certain of our current and former officers and directors based upon essentially the same alleged conduct as that at issue in the consolidated shareholder class action, and...

  • Page 317
    FANNIE MAE NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued) The plaintiffs filed an amended complaint on September 1, 2006. Among other things, the amended complaint added The Goldman Sachs Group, Inc., Goldman, Sachs & Co., Inc., Lehman Brothers, Inc., and Radian Insurance Inc. as defendants,...

  • Page 318
    ... statements filed with the SEC to eliminate the use of hedge accounting, and (2) evaluate our accounting for the amortization of premiums and discounts, and restate our financial statements filed with the SEC if the amounts required for correction were material. The SEC's Office of the Chief...

  • Page 319
    ...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 320
    ... and Purchase Obligations Certain premises and equipment are leased under agreements that expire at various dates through 2029, none of which are capital leases. Some of these leases provide for payment by the lessee of property taxes, insurance premiums, cost of maintenance and other costs. Rental...

  • Page 321
    ..., 2006 Assets: Cash and cash equivalents ...Fed funds sold and securities purchased under agreements resell ...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...

  • Page 322
    ...securities ...Mortgage loans ...Total interest income ...Interest expense: Short-term debt ...Long-term debt ...Total interest expense ...Net interest income ...Guaranty fee income ...Losses on certain guaranty contracts ...Investment gains (losses), net ...Derivatives fair value gains (losses), net...

  • Page 323
    ...: Investments in securities ...Mortgage loans ...Total interest income ...Interest expense: Short-term debt ...Long-term debt ...Total interest expense ...Net interest income ...Guaranty fee income ...Losses on certain guaranty contracts(1) ...Investment gains (losses), net ...Derivatives fair value...

  • Page 324
    ... 31, 2006 Capital Single-Family HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) ...Losses on certain guaranty contracts ...Investment gains (losses), net ...Derivatives fair value gains, net ...Debt extinguishment gains, net...Losses from...

  • Page 325
    ..., 2006 Capital Single-Family HCD Markets Total (Dollars in millions) Net interest income (expense)(1) ...Guaranty fee income (expense)(2) . . Losses on certain guaranty contracts Investment gains, net ...Derivatives fair value losses, net ...Debt extinguishment gains, net ...Losses from partnership...

  • Page 326
    ...stated value of $400 million, respectively. Sale of LIHTC Partnerships On March 16, 2007, we sold for cash a portfolio of investments in LIHTC partnerships reflecting approximately $676 million in future LIHTC tax credits and the release of future capital obligations relating to the investments. The...

  • Page 327
    ... Certifications by our Chief Executive Officer and Chief Financial Officer required by the Sarbanes-Oxley Act of 2002 have been filed with the SEC as exhibits to Fannie Mae's Annual Report on Form 10-K for the year ended December 31, 2006. Fannie Mae Resource Center Homeowners, home buyers, and the...

  • Page 328
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