Fannie Mae 2012 Annual Report Download - page 64

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Due to the complexity of the critical accounting policies we have identified, our accounting methods relating to these policies
involve substantial use of models. Models are inherently imperfect predictors of actual results because they are based on
assumptions, including assumptions about future events. Our models may not include assumptions that reflect very positive
or very negative market conditions and, accordingly, our actual results could differ significantly from those generated by our
models. As a result of the above factors, the estimates that we use to prepare our financial statements, as well as our estimates
of our future results of operations, may be inaccurate, perhaps significantly.
Failure of our models to produce reliable results may adversely affect our ability to manage risk and make effective
business decisions.
We make significant use of quantitative models to measure and monitor our risk exposures and to manage our business. For
example, we use models to measure and monitor our exposures to interest rate, credit and market risks, and to forecast credit
losses. The information provided by these models is used in making business decisions relating to strategies, initiatives,
transactions, pricing and products.
Models are inherently imperfect predictors of actual results because they are based on historical data and assumptions
regarding factors such as future loan demand, borrower behavior, creditworthiness and home price trends. Other potential
sources of inaccurate or inappropriate model results include errors in computer code, bad data, misuse of data, or use of a
model for a purpose outside the scope of the model’s design. Modeling often assumes that historical data or experience can
be relied upon as a basis for forecasting future events, an assumption that may be especially tenuous in the face of
unprecedented events.
Given the challenges of predicting future behavior, management judgment is used at every stage of the modeling process,
from model design decisions regarding core underlying assumptions, to interpreting and applying final model output. To
control for these inherent imperfections, our primary models are vetted by an independent model risk oversight team within
our Enterprise Risk Division.
When market conditions change quickly and in unforeseen ways, there is an increased risk that the model assumptions and
data inputs for our models are not representative of the most recent market conditions. Under such circumstances, we must
rely on management judgment to make adjustments or overrides to our models. A formal model update is typically an
extensive process that involves basic research, testing, independent validation and production implementation. In a rapidly
changing environment, it may not be possible to update existing models quickly enough to properly account for the most
recently available data and events. Management adjustments to modeled results are applied within the confines of the
governance structure provided by a combination of our model risk oversight team and our business, finance, and risk
committees.
If our models fail to produce reliable results on an ongoing basis, we may not make appropriate risk management decisions,
including decisions affecting loan purchases, management of credit losses, guaranty fee pricing, asset and liability
management and the management of our net worth. Any of these decisions could adversely affect our businesses, results of
operations, liquidity, net worth and financial condition. Furthermore, strategies we employ to manage and govern the risks
associated with our use of models may not be effective or fully reliable.
Changes in interest rates or our loss of the ability to manage interest rate risk successfully could adversely affect our net
interest income and increase interest rate risk.
We fund our operations primarily through the issuance of debt and invest our funds primarily in mortgage-related assets that
permit mortgage borrowers to prepay their mortgages at any time. These business activities expose us to market risk, which is
the risk of adverse changes in the fair value of financial instruments resulting from changes in market conditions. Our most
significant market risks are interest rate risk and prepayment risk. We describe these risks in more detail in “MD&A—Risk
Management—Market Risk Management, Including Interest Rate Risk Management.” Changes in interest rates affect both
the value of our mortgage assets and prepayment rates on our mortgage loans.
Changes in interest rates could have a material adverse effect on our business, results of operations, financial condition,
liquidity and net worth. Our ability to manage interest rate risk depends on our ability to issue debt instruments with a range
of maturities and other features, including call provisions, at attractive rates and to engage in derivatives transactions. We
must exercise judgment in selecting the amount, type and mix of debt and derivatives instruments that will most effectively
manage our interest rate risk. The amount, type and mix of financial instruments that are available to us may not offset
possible future changes in the spread between our borrowing costs and the interest we earn on our mortgage assets.