Fannie Mae 2007 Annual Report Download - page 88

currency swaps, which are recognized in our consolidated statements of operations as a component of
“Derivatives fair value losses, net.” We seek to eliminate our exposure to fluctuations in foreign exchange
rates by entering into foreign currency swaps that effectively convert debt denominated in a foreign currency
to debt denominated in U.S. dollars. See “Consolidated Results of Operations—Derivatives Fair Value Losses,
Net.”
The $773 million decrease in fee and other income in 2006 from 2005 was primarily due to a foreign currency
exchange loss of $230 million in 2006, compared with a foreign currency exchange gain of $625 million in
2005. The $625 million foreign currency gain recorded in 2005 stemmed from a strengthening of the
U.S. dollar relative to the Japanese yen. In addition, we experienced a $140 million decrease in multifamily
fees due to a reduction in refinancing volumes, which were significantly higher in 2005 than in 2006. These
decreases were partially offset by a $241 million increase in other fee income primarily attributable to the
recognition of defeasance fees on consolidated multifamily loans.
Losses on Certain Guaranty Contracts
Losses on certain guaranty transactions totaled $1.4 billion, $439 million and $146 million in 2007, 2006 and
2005, respectively. As home price appreciation slowed in 2006 and home prices declined and credit conditions
deteriorated in 2007, the market’s expectation of future credit risk increased. This change in market conditions
increased the estimated risk premium or compensation that a market participant would require to assume our
guaranty obligations. As a result, the estimated fair value of our guaranty obligations related to MBS issuances
increased, contributing to a higher level of losses at inception on certain of our MBS issuances. Our losses on
certain guaranty contracts also were affected by the following during 2007 and 2006:
•Lender Flow Transaction Contracts: As the market risk premium increased during 2007 and 2006, we
experienced an increase in the losses related to some of our lender flow transaction contracts because we
had established our base guaranty fee pricing for a specified time period and could not increase our prices
to reflect the increased market risk. To address this in part, we have expanded our use of standard risk-
based pricing adjustments that apply to all deliveries of loans with certain risk characteristics.
•Affordability Mission—Housing Goals: Our efforts to increase the amount of mortgage financing that we
make available to target populations and geographic areas to support our housing goals and subgoals
contributed to an increase in losses on certain guaranty contracts in 2007 and in 2006, due to the higher
credit risk premium associated with these MBS issuances. In addition, certain contracts that support our
affordability mission are priced at a discounted rate.
•Contract-Level Pricing: We negotiate guaranty contracts with our customers based upon the overall
economics of the transaction; however, the accounting for our guaranty-related assets and liabilities is not
determined at the contract level for the substantial majority of our single-family guaranty transactions.
Instead, it is determined separately for each individual MBS issuance within a contract. Although we
determine losses at an individual MBS issuance level, we largely price our guaranty business on an
overall contract basis and establish a single price for all loans included in the contract. Accordingly, a
single guaranty transaction may result in some loan pools for which we recognize a loss immediately in
earnings and other loan pools for which we record deferred profits that are recognized as a component of
guaranty fee income over the life of the loans underlying the MBS issuance.
The losses recognized at inception of certain guaranty contracts will be accreted into earnings over time as a
component of guaranty fee income, as described in “Critical Accounting Policies and Estimates—Fair Value of
Financial Instruments—Fair Value of Guaranty Assets and Guaranty Obligations—Effect on Losses on Certain
Guaranty Contracts.” Our guaranty fee income includes $603 million, $329 million and $208 million in 2007,
2006 and 2005, respectively, of accretion of the guaranty obligation related to losses recognized at inception
on certain guaranty contracts.
Losses on certain guaranty contracts do not reflect our estimate of incurred credit losses in our guaranty book
of business. Instead, our estimate of the probable credit losses incurred in our guaranty book of business is
reflected in our combined allowance for loan losses and reserve for guaranty losses. Actual credit losses are
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