Fannie Mae 2010 Annual Report Download - page 187

Market Risk Management, Including Interest Rate Risk Management
We are subject to market risk, which includes interest rate risk, spread risk and liquidity risk. These risks arise
from our mortgage asset investments. Interest rate risk is the risk of loss in value or expected future earnings
that may result from changes to interest rates. Spread risk is the resulting impact of changes in the spread
between our mortgage assets and our debt and derivatives we use to hedge our position. Liquidity risk is the
risk that we will not be able to meet our funding obligations in a timely manner.
Interest Rate Risk Management
Our goal is to manage market risk to be neutral to the movements in interest rates and volatility, subject to
model constraints and prevailing market conditions. 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 market risk policy and limits that are
established by our Chief Market Risk Officer and our Chief Risk Officer and are subject to review and
approval by our Board of Directors. Our Capital Markets Group has primary responsibility for executing our
interest rate risk management strategy.
We have actively managed the interest rate risk of our “net portfolio,” which is defined below, through the
following techniques: (1) asset selection and structuring (that is, by identifying or structuring mortgage assets
with attractive prepayment and other risk characteristics); (2) issuing a broad range of both callable and non-
callable debt instruments; and (3) using LIBOR-based interest-rate derivatives. We 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. For mortgage assets in our portfolio that we intend to hold 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.”
We monitor current market conditions, including the interest rate environment, to assess the impact of these
conditions on individual positions and our overall interest rate risk profile. In addition to qualitative factors,
we use various quantitative risk metrics in determining the appropriate composition of our consolidated
balance sheet and relative mix of debt and derivatives positions in order to remain within pre-defined risk
tolerance levels that we consider acceptable. We regularly disclose two interest rate risk metrics that estimate
our overall interest rate exposure: (1) fair value sensitivity to changes in interest rate levels and the slope of
the yield curve and (2) duration gap.
The metrics used to measure our interest rate exposure are generated using internal models. Our internal
models, consistent with standard practice for models used in our industry, require numerous assumptions.
There are inherent limitations in any methodology used to estimate the exposure to changes in market interest
rates. The reliability of our prepayment estimates and interest rate risk metrics depends on the availability and
quality of historical data for each of the types of securities in our net portfolio. When market conditions
change rapidly and dramatically, as they did during the financial market crisis of late 2008, the assumptions of
our models may no longer accurately capture or reflect the changing conditions. On a continuous basis,
management makes judgments about the appropriateness of the risk assessments indicated by the models.
Sources of Interest Rate Risk Exposure
The primary source of our interest rate risk is the composition of our net portfolio. Our net portfolio consists
of our existing investments in mortgage assets, investments in non-mortgage securities, our outstanding debt
used to fund those assets and the derivatives used to supplement our debt instruments and manage interest rate
risk, and any fixed-price asset, liability or derivative commitments.
Our mortgage assets consist mainly of single-family fixed-rate mortgage loans that give borrowers the option
to prepay at any time before the scheduled maturity date or continue paying until the stated maturity. Given
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