Fannie Mae 2008 Annual Report Download - page 126

Key factors affecting the results of our Capital Markets group for 2008 compared with 2007 included the
following.
• An increase in net interest income, primarily attributable to an expansion of our net interest yield driven
by a reduction in the average cost of our debt that more than offset a decline in the average yield on our
interest-earning assets. The decrease in the average cost of our debt was due to the decline in short-term
interest rates during 2008 and a shift in our funding mix to more short-term debt. The reversal of accrued
interest expense on step-rate debt that we paid off during the first quarter of 2008 also reduced the
average cost of our debt. The increase in our net interest income does not reflect the impact of a
significant increase in the net contractual interest expense on our interest rate swaps.
• A substantial increase in fair value losses, primarily attributable to significantly higher fair value losses on
our derivatives as a result of the considerable decline in swap interest rates during 2008. We also
experienced significant losses on our trading securities, primarily due to the continued widening of
spreads during the year, particularly on private-label mortgage-related securities backed by Alt-A and
subprime loans and CMBS. In addition, we recorded losses on some of the investments in corporate debt
securities in our cash and other investments portfolio due to the default or distressed financial condition
of the issuers of these securities.
• A significant increase in investment losses, attributable to other-than-temporary impairment on available-
for-sale securities totaling $7.0 billion in 2008, compared with $814 million in 2007. The impairment
losses were primarily associated with our investments in Alt-A and subprime private-label securities,
which have experienced extreme price declines and a significant reduction in the expected cash flows due
to markedly higher expected defaults and loss severities on the underlying mortgages.
• A non-cash charge during the third quarter of 2008 to establish a partial deferred tax asset valuation
allowance against our net deferred tax assets. As a result of the partial deferred tax valuation allowance,
we did not record tax benefits for the majority of the losses we incurred during 2008. The allocation of
this charge, which totaled $21.4 billion,to our Capital Markets group resulted in a provision for federal
income taxes of $8.5 billion for 2008, compared with a tax benefit of $1.1 billion for 2007.
Key factors affecting the results of our Capital Markets group for 2007 compared with 2006 included the
following.
• A significant reduction in net interest income during 2007, due to continued compression in our net
interest yield, largely attributable to the increase in our short-term and long-term debt costs as we
continued to replace, at higher interest rates, maturing debt that we had issued at lower interest rates
during the past few years.
• An increase in investment losses primarily due to increased losses on trading securities in 2007, reflecting
the decrease in the fair value of these securities due to wider credit spreads that more than offset the
favorable impact of a decrease in interest rates during the fourth quarter of 2007.
• An increase in derivatives fair value losses due to the significant decline in swap interest rates during the
second half of 2007. The 5-year swap interest rate fell by 131 basis points to 4.19% as of December 31,
2007 from 5.50% as of June 30, 2007.
• An effective tax rate of 45.6% for 2007, compared with an effective tax rate of 23.8% for 2006. The
variance in the effective tax rate and statutory rate was primarily due to fluctuations in our pre-tax income
and the relative benefit of tax-exempt income generated from our investments in mortgage revenue bonds.
CONSOLIDATED BALANCE SHEET ANALYSIS
We seek to structure the composition of our balance sheet and manage its size to ensure compliance with our
regulatory requirements, to provide adequate liquidity to meet our needs, to mitigate our interest rate and
credit risk exposure, and to maintain a positive net worth. The major asset components of our balance sheet
include our mortgage investments and our cash and other investments portfolio. We fund and manage the
interest rate risk on these investments through the issuance of debt securities and the use of derivatives. Our
debt securities and derivatives represent the major liability components of our consolidated balance sheet.
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