Fannie Mae 2008 Annual Report Download - page 204

cancel or replace the transaction. We manage this risk by determining position limits with these counterparties,
based upon our assessment of their creditworthiness, and monitoring and managing these exposures.
Debt Security and Mortgage Dealers
The credit risk associated with dealers that commit to place our debt securities is that they will fail to honor
their contracts to take delivery of the debt, which could result in delayed issuance of the debt through another
dealer. The primary credit risk associated with dealers who make forward commitments to deliver mortgage
pools to us is that they may fail to deliver the agreed-upon loans to us on the agreed-upon date, which could
result in our having to replace the mortgage pools at higher cost to meet a forward commitment to sell the
MBS. We manage these risks by establishing approval standards and limits on exposure and monitoring both
our exposure positions and changes in the credit quality of dealers.
Document Custodians
We use third-party document custodians to provide loan document certification and custody services for some
of the loans that we purchase and securitize. In many cases, our lender customers or their affiliates also serve
as document custodians for us. Our ownership rights to the mortgage loans that we own or that back our
Fannie Mae MBS could be challenged if a lender intentionally or negligently pledges or sells the loans that we
purchased or fails to obtain a release of prior liens on the loans that we purchased, which could result in
financial losses to us. When a lender or one of its affiliates acts as a document custodian for us, the risk that
our ownership interest in the loans may be adversely affected is increased, particularly in the event the lender
were to become insolvent. We mitigate these risks through legal and contractual arrangements with these
custodians that identify our ownership interest, as well as by establishing qualifying standards for document
custodians and requiring removal of the documents to our possession or to an independent third-party
document custodian if we have concerns about the solvency or competency of the document custodian.
Interest Rate Risk Management and Other Market Risks
Our most significant market risks are interest rate risk and spread risk, which primarily arise from our
mortgage asset investments. Our exposure to interest rate risk relates to the cash flow and/or market price
variability of our assets and liabilities attributable to movements in market interest rates. Our exposure to
spread risk relates to the possibility that interest rates in different market sectors, such as the mortgage and
debt markets, will not move in tandem.
Our overall goal is to manage interest rate risk by maintaining a close match between the duration of our
assets and liabilities. We employ an integrated interest rate risk management strategy that allows for informed
risk taking within pre-defined corporate risk limits. Decisions regarding our strategy in managing interest rate
risk are based upon our corporate interest rate risk policies and limits that are set by independent risk and
control groups and subject to periodic review. Our Enterprise Risk Office, in conjunction with our Capital
Markets group, has primary responsibility for executing our interest rate risk management strategy, measuring
and closely monitoring our interest rate exposure and ensuring compliance with established limits. FHFA
currently is reviewing our interest rate risk policies and limits; therefore, our existing policies and limits are
subject to change.
We historically have actively managed the interest rate risk of our “net portfolio,” which is defined below,
through the following techniques: (i) through asset selection and structuring (that is, by identifying or
structuring mortgage assets with attractive prepayment and other risk characteristics), (ii) by issuing a broad
range of both callable and non-callable debt instruments and (iii) by using LIBOR-based interest-rate
derivatives. We historically, however, have not actively managed or hedged our spread risk, or the impact of
changes in the spread between our mortgage assets and debt (referred to as mortgage-to-debt spreads) after we
purchase mortgage assets, other than through asset monitoring and disposition. Because we intend to hold the
majority of our mortgage assets to maturity to realize the contractual cash flows, we accept period-to-period
volatility in our financial performance attributable to changes in mortgage-to-debt spreads that occur after our
purchase of mortgage assets. For more information on the impact that changes in spreads have on the value of
the fair value of our net assets, see “Supplemental Non-GAAP Information—Fair Value Balance Sheets—
Primary Factors Driving Changes in Non-GAAP Fair Value of Net Assets.”
199