Fannie Mae 2006 Annual Report Download - page 90

growth in the average single-family mortgage credit book of business, and an increase in the average effective
guaranty fee rate on the book. The average 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. 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 certificate holders, increased by
$62 million, or 12%, in 2006 from 2005 due to an increase in short-term interest rates during the year.
In 2006, losses on certain guaranty contracts increased by $308 million as compared to 2005. This loss is
determined and recorded at an individual MBS issuance level and our credit guaranty business is largely
priced on an overall contract basis where a single guaranty fee is established for all loans in a deal. The loans
in that deal may be included in a single MBS issuance or in multiple MBS issuances. These losses are
recorded on new credit guaranteed MBS issuances where our modeled expectation of returns is below what we
believe a market participant would require for such credit risk inclusive of a reasonable profit margin. The
increase in 2006 is attributable, in part, to our efforts to increase the amount of mortgage financing that we
make available to target populations and geographic areas in support of housing goals. As home price
appreciation slows, our modeled expectation of credit risk in such loans increases, resulting in higher losses.
Expenses increased by 76% in 2006 from 2005 due to an increase in the segment allocation of indirect
corporate expenses during the period mostly driven by an increase in costs associated with our restatement and
related matters, as well as an increase of $218 million of foreclosed property expense.
The provision for credit losses of $577 million in 2006, an increase of $123 million from 2005, was primarily
attributable to a $221 million addition to the allowance for credit losses in the fourth quarter reflecting
continued credit weakness in the Midwest region and a decline in home prices in some regions in the second
half of the year which has an impact on the number of loans that will default and the amount of the charge off
in the event of a default. The prior year provision for credit losses included the impact of Hurricane Katrina.
While the credit environment was strong in the first half of 2006, the fundamentals that drive low credit
losses, such as defaults and loss severity, began to weaken in the latter half of the year. This was evidenced by
the steady growth in acquired properties and higher foreclosed property expense due to declining property
values. Additionally, we recorded $201 million of foreclosed property expense in 2006, compared to gains of
$17 million in 2005, due to the weakening home prices, particularly concentrated in the Midwest. We expect
weakening home prices to continue to result in significantly higher credit losses in 2007.
Net income for the Single-Family business segment increased by $227 million or 9% in 2005 from 2004,
primarily due to a $578 million increase in net revenues during the period that was offset by a $129 million
increase in administrative expenses and $142 million increase in the provision for credit losses. Net revenues
increased in 2005 by 12% to $5.6 billion as a result of higher guaranty fee income and float income. Guaranty
fee income for 2005 increased slightly from 2004 as the average single-family mortgage credit book of
business increased 3%. The average effective guaranty fee rate remained essentially unchanged from year to
year. Float income increased by $282 million in 2005 due to an increase in short-term interest rates during the
year. Expenses increased by 13% in 2005 due to the increase in administrative expenses resulting from costs
associated with our restatement and related matters. The provision for credit losses increased by 46% to
$454 million in 2005, primarily attributable to our provision for credit losses related to Hurricane Katrina and
our implementation of SOP 03-3.
During the period 2004 to 2006, there was intense competition for the purchase of mortgage assets by a
growing number of mortgage investors through a variety of investment vehicles and structures. During these
years, affordability issues, combined with a variety of new mortgage products being introduced and accepted
by investors, encouraged consumers to take advantage of adjustable-rate mortgages, including nontraditional
products such as interest-only ARMs, negative-amortizing ARMs and a variety of other product and risk
combinations. The increased demand for floating-rate and subprime mortgage loans accelerated the growth of
competing securitization options in the form of private-label mortgage-related securities. The demand for these
products slowed in 2007.
Single-family mortgage originations in the primary mortgage market totaled $2.8 trillion, $3.0 trillion and
$2.8 trillion in 2006, 2005 and 2004, respectively. The $3.0 trillion in originations in 2005 represented the
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