Fannie Mae 2010 Annual Report Download - page 65

counterparties were to become insolvent or otherwise default on its obligations to us, it could harm our
business and financial results in a variety of ways.
An institutional counterparty may default in its obligations to us for a number of reasons, such as changes in
financial condition that affect its credit rating, a reduction in liquidity, operational failures or insolvency. A
number of our institutional counterparties are currently experiencing financial difficulties that may negatively
affect the ability of these counterparties to meet their obligations to us and the amount or quality of the
products or services they provide to us. Counterparty defaults or limitations on their ability to do business with
us could result in significant financial losses or hamper our ability to do business, which would adversely
affect our business, results of operations, financial condition, liquidity and net worth.
We routinely execute a high volume of transactions with counterparties in the financial services industry.
Many of the transactions we engage in with these counterparties expose us to credit risk relating to the
possibility of a default by our counterparties. In addition, to the extent these transactions are secured, our
credit risk may be exacerbated to the extent that the collateral we hold cannot be realized or can be liquidated
only at prices too low to recover the full amount of the loan or derivative exposure. We have exposure to these
financial institutions in the form of unsecured debt instruments and derivatives transactions. As a result, we
could incur losses relating to defaults under these instruments or relating to impairments to the carrying value
of our assets represented by these instruments. These losses could materially and adversely affect our business,
results of operations, financial condition, liquidity and net worth.
We depend on our ability to enter into derivatives transactions in order to manage the duration and
prepayment risk of our mortgage portfolio. If we lose access to our derivatives counterparties, it could
adversely affect our ability to manage these risks, which could have a material adverse effect on our business,
results of operations, financial condition, liquidity and net worth.
Deterioration in the credit quality of, or defaults by, one or more of our mortgage insurer counterparties
could result in nonpayment of claims under mortgage insurance policies, business disruptions and
increased concentration risk.
We rely heavily on mortgage insurers to provide insurance against borrower defaults on conventional single-
family mortgage loans with LTV ratios over 80% at the time of acquisition. The current weakened financial
condition of our mortgage insurer counterparties creates a significant risk that these counterparties will fail to
fulfill their obligations to reimburse us for claims under insurance policies. Since January 1, 2009, the insurer
financial strength ratings of all of our major mortgage insurer counterparties have been downgraded to reflect
their weakened financial condition, in some cases more than once. One of our mortgage insurer counterparties
ceased issuing commitments for new mortgage insurance in 2008, and, under an order received from its
regulator, is now paying all valid claims 60% in cash and 40% by the creation of a deferred payment
obligation, which may be paid in the future.
A number of our mortgage insurers publicly disclosed that they have exceeded or might exceed the state-
imposed risk-to-capital limits under which they operate and they might not have access to sufficient capital to
continue to write new business in accordance with state regulatory requirements. In addition, a number of our
mortgage insurers have received waivers from their regulators regarding state-imposed risk-to-capital limits.
However, these waivers are temporary. Some mortgage insurers have been exploring corporate restructurings,
intended to provide relief from risk-to-capital limits in certain states. A restructuring plan that would involve
contributing capital to a subsidiary would result in less liquidity available to its parent company to pay claims
on its existing book of business and an increased risk that its parent company will not pay its claims in full in
the future.
If mortgage insurers are not able to raise capital and exceed their risk-to-capital limits, they will likely be
forced into run-off or receivership unless they can secure a waiver from their state regulator. This would
increase the risk that they will fail to pay our claims under insurance policies, and could also cause the quality
and speed of their claims processing to deteriorate. If our assessment of one or more of our mortgage insurer
counterparty’s ability to fulfill its obligations to us worsens and our internal credit rating for the insurer is
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