This Information Statement describes the business and operations of the
Federal National Mortgage Association ("Fannie Mae" or the "Corporation") as of
March 31, 1999 and its financial condition as of December 31, 1998.
In connection with offerings of securities, Fannie Mae distributes Offering
Circulars, Prospectuses, or other offering documents that describe securities
offered, their selling arrangements and other information. Although typically
incorporated by reference into such selling documents, the Information Statement
does not offer any securities for sale. Any incorporation of this Information
Statement by reference includes all supplements hereto. You may obtain copies of
Fannie Mae's current Information Statement, any supplements thereto and other
available information from the office listed on page 2.
This Information Statement contains Fannie Mae's audited financial statements
for the year ended December 31, 1998. Fannie Mae updates its Information
Statement quarterly.
Fannie Mae is a federally chartered corporation. Its principal office is
located at 3900 Wisconsin Avenue, NW, Washington, DC 20016 (202/752-7000). Its
Internal Revenue Service employer identification number is 52-0883107.
Fannie Mae's securities are not required to be registered under the
Securities Act of 1933. At the close of business on February 28, 1999,
approximately 1,027 million shares of Fannie Mae's common stock (without par
value) were outstanding.
The delivery of this Information Statement at any time shall not
under any circumstances create an implication that there has been no change in
the affairs of Fannie Mae since the date hereof or that the information
contained herein is correct as of any time subsequent to its date.
Fannie Mae's Proxy Statement for the 1998 Annual Meeting of Shareholders is
incorporated by reference herein under "Management—Additional Information." Any
later proxy statement published by Fannie Mae prior to the publication of a new
Information Statement is incorporated herein by this reference. Fannie Mae will
supplement this Information Statement to reflect its quarterly financial results
and other events and information as Fannie Mae determines. References to the
"Information Statement" include any documents incorporated herein by reference
and any applicable amendments or supplements hereto. If Fannie Mae modifies or
updates information in the Information Statement in a later supplement or in a
document incorporated by reference in this Information Statement, the
information as modified or updated replaces the information initially reported
by Fannie Mae in this Information Statement.
Fannie Mae periodically makes available statistical information on its
mortgage purchase and mortgage-backed securities volumes as well as other
relevant information about Fannie Mae. You may obtain copies of this Information
Statement, any supplements relating hereto, as well as Fannie Mae's annual and
quarterly reports to stockholders, the Federal National Mortgage Association
Charter Act, Fannie Mae's bylaws and other information regarding Fannie Mae
without charge from the Office of Investor Relations, Fannie Mae, 3900 Wisconsin
Avenue, NW, Washington, DC 20016 (telephone: (202/752-7115)). This Information
Statement also is available from Fannie Mae by accessing the Corporation's World
Wide Web site at http://www.fannniemae.com. You may inspect reports and other
information concerning Fannie Mae at the offices of the New York Stock Exchange,
the Chicago Stock Exchange and the Pacific Stock Exchange. Fannie Mae does not
file reports or other information with the Securities and Exchange Commission.
General
Fannie Mae is a federally chartered and stockholder-owned corporation, and is
the largest investor in home mortgage loans in the United States. Fannie Mae was
established in 1938 as a United States government agency to provide supplemental
liquidity to the mortgage market, and was transformed into a stockholder-owned
and privately managed corporation by legislation enacted in 1968.
Fannie Mae provides funds to the mortgage market by purchasing mortgage loans
from lenders, thereby replenishing their funds for additional lending. Fannie
Mae acquires funds to purchase these loans by issuing debt securities to capital
market investors, many of whom ordinarily would not invest in mortgages. In this
manner, Fannie Mae is able to expand the total amount of funds available for
housing.
Fannie Mae also issues Mortgage-Backed Securities ("MBS"), receiving guaranty
fees for its guarantee of timely payment of principal and interest on MBS
certificates. Fannie Mae issues MBS primarily in exchange for pools of mortgage
loans from lenders. The issuance of MBS enables Fannie Mae to further its
statutory purpose of increasing the liquidity of residential mortgage loans.
In addition, Fannie Mae offers various services to lenders and others for a
fee. These services include issuing certain types of MBS and providing
technology services for originating and underwriting loans.
For information regarding Fannie Mae's mortgage loan, MBS and other
activities in 1998, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations."
In this document, both whole loans and participation interests in loans are
referred to as "loans," "mortgage loans" and "mortgages." (Fannie Mae purchases
participation interests that range from 50 to 99 percent.) The term "mortgage"
also is used to refer to the security instrument securing a loan rather than the
loan itself, and when so used also refers to a deed of trust. Mortgage loans
secured by four or fewer dwelling units are referred to as "single-family"
mortgage loans, and mortgage loans secured by more than four dwelling units are
referred to as "multifamily" mortgage loans.
Mortgage Loan Portfolio
Mortgage Loans Purchased
Fannie Mae purchases primarily single-family, conventional (i.e., not
federally insured or guaranteed), fixed- or adjustable-rate ("ARMs"), first
mortgage loans, but it also purchases other types of residential mortgage loans
for its loan portfolio, including mortgage loans insured by the Federal Housing
Administration ("FHA"), mortgage loans guaranteed by the Department of Veterans
Affairs ("VA"), mortgage loans guaranteed by the Rural Housing Service,
multifamily mortgage loans and second mortgage loans (i.e., loans secured by
second liens). The Corporation's purchases have a variety of maturities. Fannie
Mae's purchases of ARMs, fixed-rate loans with intermediate terms of 20 years or
less, and second mortgage loans are designed to provide a secondary market for a
variety of loans that may be attractive to homeowners.
The composition of Fannie Mae's loan portfolio at the end of each of the last
five years is shown in the table in "Portfolio Composition." The composition of
its purchases during the last three years is shown in "Management's Discussion
and Analysis of Financial Condition and Results of Operations— Balance Sheet
Analysis—Mortgage Portfolio." Of the single-family and multifamily mortgage
loans that the Corporation purchased in 1998, including mortgage-backed
securities, approximately 77 percent (measured by unpaid principal balance
("UPB")) were from investment banking companies, 8 percent were from mortgage
banking companies, 6 percent were from commercial and mutual savings banks, 4
percent were from savings and loan associations and 5 percent were from other
institutions. All of Fannie Mae's mortgage loan purchases from investment
banking companies were through purchases of mortgage-backed securities.
Principal Balance Limits. Maximum principal balance limits apply to
Fannie Mae's mortgage loan purchases. For 1998, Fannie Mae could not purchase
conventional mortgage loans on single-family dwellings if the loan's original
principal balance exceeded $227,150, except for loans secured by properties in
Alaska, Hawaii and the Virgin Islands. Higher principal balance limits apply to
loans secured by properties in those areas or secured by two- to four-family
dwelling units. The maximum principal balance limits applicable to conventional
mortgage loans secured by one- to four-family dwellings can be adjusted by
Fannie Mae annually based on the national average price of a single-family
dwelling as surveyed by the Federal Housing Finance Board. In January 1999,
Fannie Mae increased its maximum principal balance limit to $240,000.
Prior to last year, maximum principal balance limits also applied to Fannie
Mae's purchases of conventional multifamily mortgage loans. These limits were
removed by the VA-HUD fiscal year 1999 appropriations bill.
Mortgage loans insured by the FHA or guaranteed by the Rural Housing Service
are subject to statutory maximum amount limitations. Fannie Mae will not
purchase VA-guaranteed mortgage loans that have principal amounts in excess of
amounts that Fannie Mae specifies from time to time.
Fixed-Rate/Adjustable-Rate. Substantially all fixed-rate mortgage
loans purchased by Fannie Mae provide for level monthly installments of
principal and interest. Some of these loans (1 percent of the single-family
portfolio at December 31, 1998) have balloon payments due 5, 7 or 10 years after
origination, but with monthly payments based on longer (in many cases 30-year)
amortization schedules. Many of the 7-year balloon single-family mortgage loans
permit the borrower to refinance the balloon payment at maturity with a 23-year
fixed-rate mortgage loan if certain requirements are satisfied. Many of the
multifamily mortgage loans have balloon payments due 5, 7, 10 or 15 years after
origination, but with payments based on 25- or 30-year amortization schedules.
The interest rates on ARMs are determined by formulas providing for automatic
adjustment, up or down, at specified intervals in accordance with changes in
specified indices. Substantially all ARMs also provide for monthly installments
of principal and/or interest with the total amount of monthly installments
adjusted (up or down) after the interest rate on the loan is adjusted because of
changes in the applicable index. Fannie Mae currently purchases ARMs only if the
ARMs have a cap on the amount the interest rate may change over the life of the
loan. A substantial number of the ARMs purchased by the Corporation provide the
mortgagor with the option, at specified times or during specified periods of
time, to convert the ARM to a fixed-rate mortgage loan with payment of a small
fee.
Fannie Mae also purchases certain ARMs, called reverse mortgages, that
provide for monthly installments of principal to be paid to the borrower. Over
the life of the loan, interest and certain other fees accrue on the balance of
the payments made to the borrower. Fannie Mae currently purchases reverse
mortgages only if the reverse mortgages are subject to a cap on the amount the
interest rate may change over the life of the loan. Generally, the loan is due
when the borrower no longer occupies the property.
Maturity. Fannie Mae currently purchases conventional, single-family
fixed- and adjustable-rate mortgage loans with original maturities of up to 30
years and 40 years, respectively. Only a small portion of such ARMs purchased
have maturities of more than 30 years. The multifamily mortgage loans that
Fannie Mae currently purchases for its portfolio generally are conventional
fixed-rate loans that have maturities of up to 30 years.
Repayments
Substantially all of the single-family mortgage loans in Fannie Mae's
portfolio are prepayable by the borrower without penalty. Therefore, Fannie Mae
bears the risk that prepayments may increase when interest rates decline
significantly or as a result of other factors. Fannie Mae manages this risk as
described in "Management's Discussion and Analysis of Financial Condition and
Results of Operations—Risk Management—Interest Rate Risk Management." Most
multifamily loans in Fannie Mae's portfolio provide for a prepayment premium
that is calculated under a formula that is intended to protect Fannie Mae from
loss of yield on its investment in the mortgage loan being prepaid.
Portfolio Composition
The following table shows the composition of Fannie Mae's mortgage loan
portfolio and the weighted-average yield (net of servicing) on the mortgage loan
portfolio. The table includes mortgage loans that back MBS held in Fannie Mae's
mortgage loan portfolio.
| December 31, | |||||
|---|---|---|---|---|---|
|
| |||||
| 1998 | 1997 | 1996 | 1995 | 1994 | |
|
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| |
| Single-family: | |||||
| Government insured or guaranteed | $21,805 | $19,478 | $15,912 | $13,102 | $11,659 |
| Conventional: | |||||
| Long-term, fixed-rate | 297,106 | 211,541 | 177,070 | 140,466 | 109,079 |
| Intermediate-term, fixed-rate | 71,560 | 61,571 | 66,284 | 68,752 | 68,166 |
| Adjustable-rate | 11,873 | 11,373 | 12,783 | 15,108 | 16,718 |
| Second | 206 | 268 | 323 | 423 | 536 |
| Multifamily | 11,965 | 12,447 | 14,680 | 15,660 | 15,899 |
|
|
|
|
|
| |
| Total UPB | $414,515 | $316,678 | $287,052 | $253,511 | $222,057 |
|
|
|
|
|
| |
| Yield | 7.12% | 7.60% | 7.69% | 7.80% | 7.80% |
|
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|
| |
Commitments
Fannie Mae issues commitments to purchase, during the term of the commitment,
a specified dollar amount of mortgage loans. Fannie Mae purchases mortgage loans
through standard product commitments with posted yields and through negotiated
commitments.
Fannie Mae purchases most of its mortgage loans pursuant to mandatory
delivery portfolio commitments. Under such commitments, lenders are obligated to
sell loans to the Corporation at the commitment yield. Mandatory delivery
commitments are available for standard product and negotiated transactions. If a
lender is not able to deliver the mortgage loans required under a mandatory
delivery commitment during its term, the lender may buy back the commitment at
any time during the commitment term for a fee.
Fannie Mae issues master commitments to lenders to facilitate the delivery of
mortgages into MBS pools or portfolio. In order to deliver under a master
commitment, a lender must either deliver mortgages in exchange for MBS or enter
into a mandatory delivery portfolio commitment with the yield established upon
execution of the portfolio commitment.
Fannie Mae also issues to lenders negotiated standby commitments that commit
Fannie Mae to purchase a designated dollar amount of single-family mortgage
loans from the lenders if they convert their standby commitments to mandatory
delivery portfolio commitments. Standby commitments do not obligate the lenders
to sell the loans to Fannie Mae; they are obligated to do so only after such
commitments are converted to mandatory delivery portfolio commitments. The yield
on the mortgage loans is established at the time of the conversion in the case
of standby commitments. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations—Balance Sheet Analysis—Liquidity and Capital
Resources."
Underwriting Guidelines
Fannie Mae has established certain underwriting guidelines for purchases of
conventional mortgage loans to help reduce the risk of loss from mortgagor
defaults. These guidelines are designed to assess the creditworthiness of the
mortgagor, as well as the value of the mortgaged property relative to the amount
of the mortgage loan. Fannie Mae, in its discretion, accepts deviations from the
guidelines. Fannie Mae also reviews and changes its guidelines from time to
time. As part of its affordable housing initiatives, Fannie Mae continues to
introduce new underwriting criteria that could make the mortgage finance system
more accessible to minorities, low-and moderate-income families, underserved and
rural residents and people with special housing needs. In addition, Fannie Mae
is continuing its underwriting experiments involving alternative methods of
assessing the creditworthiness of potential borrowers, among other factors. See
"Affordable Housing Initiatives and Goals."
Fannie Mae generally relies on lender representations to ensure that the
mortgage loans it purchases conform to its underwriting guidelines. Fannie Mae
also performs quality control reviews of selected loans to monitor compliance
with the guidelines. In the event that a lender is found to have breached its
representations with respect to a loan's compliance with the guidelines, the
Corporation can demand that the lender repurchase the loan.
In each of the last three years, Fannie Mae enhanced Desktop Underwriter®,
its automated underwriting system, to assist lenders in meeting its underwriting
standards. Desktop Underwriter is designed to help lenders process mortgage
applications in a more efficient and accurate manner and to apply Fannie Mae's
underwriting criteria consistently and objectively, and in a more customized
manner, to all prospective borrowers. If Desktop Underwriter provides an
"approve" recommendation to a loan application, the Corporation waives certain
representations as long as the loan is originated in accordance with the
information that was submitted to Desktop Underwriter.
Fannie Mae generally requires that the UPB of each conventional single-family
first mortgage loan it purchases not be greater than 80 percent of the value of
the mortgaged property unless at least the excess over the 80 percent level is
insured by a mortgage insurance company acceptable to Fannie Mae. If mortgage
insurance is required initially, Fannie Mae requires it to be maintained as long
as the UPB is greater than 80 percent of the original value (or of the appraised
value as determined by a subsequent appraisal). Fannie Mae does not require
mortgage insurance on conventional single-family loans with LTV ratios greater
than 80 percent if the mortgage loan seller provides other acceptable credit
enhancement. Fannie Mae bears the risk that in some cases parties assuming
credit enhancement obligations may be unable to meet their contractual
obligations to the Corporation. Fannie Mae regularly monitors this risk and
follows specific criteria in evaluating and accepting credit enhancement
arrangements in order to minimize its exposure to credit loss.
Fannie Mae has required credit enhancement for a majority of the mortgage
loans in its multifamily loan portfolio. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations—Risk Management—Credit
Risk Management—Multifamily."
Servicing
Fannie Mae does not service mortgage loans, except for government-insured
multifamily loans, for which the primary servicing functions are performed by a
major servicing entity under a subservicing arrangement. However, Fannie Mae
generally manages and markets properties acquired through foreclosure. Fannie
Mae mortgage loans held in portfolio or backing MBS can be serviced only by a
servicer approved by the Corporation, and must be serviced subject to the
Corporation's guidelines. Lenders who sell single-family mortgage loans and
conventional multifamily loans to Fannie Mae often are such servicers. Servicing
includes the collection and remittance of principal and interest payments,
administration of escrow accounts, evaluation of transfers of ownership
interests, responding to requests for partial releases of security, granting of
easements, handling proceeds from casualty losses, negotiating problem loan
workouts and, if necessary, processing of foreclosures. In the case of
multifamily loans, servicing also includes performing property inspections,
evaluating the financial condition of owners, and administering various types of
agreements (including agreements regarding replacement reserves,
completion/repair, and operations and maintenance). Fannie Mae compensates
servicers by permitting them to retain a specified portion of each interest
payment on a serviced mortgage loan. Fannie Mae reserves the right to remove
servicing responsibility from a lender.
Mortgage-Backed Securities
MBS are mortgage pass-through trust certificates issued and guaranteed by
Fannie Mae that represent beneficial interests in pools of mortgage loans or
other MBS. Fannie Mae serves as trustee for each trust.
MBS are backed by loans from one of three sources: a single lender, multiple
lenders, or the Corporation's portfolio. Single-lender MBS generally are issued
through lender swap transactions in which a lender exchanges pools of mortgage
loans for MBS. Multiple-lender MBS allow several lenders to pool mortgage loans
together and, in return, receive MBS representing a proportionate share of a
larger pool (called Fannie Majors®). MBS may back other securities, including
Fannie Megas® ("Megas"), Stripped MBS ("SMBS"), real estate mortgage investment
conduit securities ("REMICs"), and other mortgage securities utilizing a
"grantor trust" structure.
MBS are not assets of Fannie Mae, except when acquired for investment
purposes, nor are MBS recorded as liabilities. The Corporation, however, is
liable under its guarantee to make timely payments to investors of principal and
interest on the mortgage loans in the pools, even if Fannie Mae has not received
payments of principal or interest on the mortgage loans in the underlying pools.
MBS enable the Corporation to further its statutory purpose of increasing the
liquidity of residential mortgage loans and create a source of guaranty fee
income to Fannie Mae without assuming any debt refinancing risk on the
underlying pooled mortgages. Because Fannie Mae guarantees the timely payment of
principal and interest, it assumes the ultimate credit risk of borrowers'
defaults on all mortgage loans underlying MBS, as well as for portfolio mortgage
loans. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations—Risk Management—Credit Risk Management."
Fannie Mae issues MBS backed by single-family or multifamily first or second
mortgage loans, with fixed or adjustable rates. Generally, the mortgage loans
are either conventional mortgage loans, or FHA-, VA- or Rural Housing
Service-guaranteed mortgage loans. The conventional mortgage loans are subject
to the maximum principal balance limits applicable to Fannie Mae's purchases as
described under "Mortgage Loan Portfolio—Mortgage Loans Purchased—Principal
Balance Limits." The mortgage loans also are subject to the same underwriting
guidelines as those for mortgage loans purchased for portfolio as described
under "Mortgage Loan Portfolio—Underwriting Guidelines." The substantial
majority of Fannie Mae's MBS outstanding represents beneficial interests in
conventional fixed-rate first mortgage loans on single-family dwellings.
Fannie Mae issues and guarantees several forms of MBS, including Fannie
Majors, that involve only a single class of certificates with each investor
receiving a portion of the payments of principal and interest on the underlying
mortgage loans equal to its undivided interest in the pool. With these standard
MBS, an investor has an undivided interest in a pool of underlying mortgage
loans that generally are provided either by one lender or by Fannie Mae out of
the Corporation's mortgage loan portfolio. Megas represent undivided interests
in a pool of MBS, REMIC tranches, or Government National Mortgage Association
("Ginnie Mae") guaranteed pass-through certificates ("Ginnie Mae certificates")
of the same type. In addition, Fannie Mae issues and guarantees MBS in the form
of single-class "grantor trust" securities representing an undivided interest in
a pool of MBS, Ginnie Mae certificates, other mortgage-backed securities, or
mortgage loans.
Fannie Mae also issues and guarantees MBS that involve more than one class of
certificates and, therefore, require special allocations of cash flows. SMBS are
issued in series, with one or more classes, each of which is entitled to
different cash flows and may represent (a) an undivided interest solely in the
principal payments, (b) an undivided interest solely in the interest payments or
(c) different percentage interests in principal and interest payments, to be
made on a pool of mortgage loans, MBS, REMICs, other SMBS and/or Ginnie Mae
certificates. REMICs represent beneficial interests in a trust having multiple
classes of certificates entitled to different cash flows from the underlying
mortgage loans, MBS, SMBS, Ginnie Mae certificates and/or certificates from
other REMICs. Pursuant to its guaranty of REMICs and SMBS, Fannie Mae is
obligated to make timely distribution of required installments of principal
and/or interest and, in the case of REMICs, to distribute the principal balance
in full by a specified date, whether or not sufficient funds are available in
the related REMIC trust (Fannie Mae has issued a limited amount of subordinated
REMIC classes that are not guaranteed by the Corporation).
Fannie Mae receives guaranty fees for a significant portion of its MBS
(principally its standard MBS and Fannie Majors). Such fees are paid monthly
until the underlying mortgage loans have been repaid or otherwise liquidated
from the pool (generally as a result of delinquency or prepayment). The
aggregate amount of guaranty fees received by Fannie Mae depends upon the amount
of MBS outstanding and on the guaranty fee rate. The amount of MBS outstanding
is influenced by the rates at which the underlying mortgage loans are repaid or
liquidated due to foreclosure, and by the rate at which Fannie Mae issues new
MBS. In general, when the level of interest rates declines significantly below
the interest rates on loans underlying MBS, the rate of prepayments is likely to
increase; conversely, when interest rates rise above the interest rates on loans
underlying MBS, the rate of prepayments is likely to slow down. In addition to
interest rate changes, the rate of principal prepayments is influenced by a
variety of economic, demographic and other factors. Fannie Mae also generally
receives one-time fees for swapping SMBS, REMICs, Megas, and grantor trust
securities for MBS, mortgage loans, Ginnie Mae certificates, SMBS, REMIC
certificates, or other mortgage-backed securities.
In many instances, the lender or lenders that originated the loans in an MBS
pool created from Fannie Mae's portfolio or the lender or lenders that exchanged
the loans for the MBS (in the case of a "swap" transaction) initially service
the loans. Fannie Mae, however, reserves the right to remove the servicing
responsibility from a lender at any time if it considers such removal to be in
the best interest of MBS certificate holders. In such event, Fannie Mae finds a
replacement lender that will service the loans. Generally, Fannie Mae ultimately
is responsible to MBS holders for the administration and servicing of mortgage
loans underlying MBS, including the collection and receipt of payments from
lenders, and the remittance of distributions and certain reports to holders of
MBS certificates.
Affordable Housing Initiatives and Goals
In 1994, Fannie Mae announced that, for the seven years from 1994 through the
year 2000, the Corporation would commit $1 trillion to help finance over 10
million homes for families and communities most in need (the "Trillion Dollar
Commitment"). As part of the Trillion Dollar Commitment announcement, Fannie Mae
laid out 11 initiatives targeting specific areas of the mortgage finance system
for improvement. (In early 1996, the Fannie Mae Foundation undertook three of
the initiatives.) By the end of 1998, Fannie Mae was able to report the
following progress with respect to each of the eleven initiatives (including
progress on the three Foundation initiatives that have been supported by the
Corporation): (i) established 33 Partnership Offices around the country
(initiative: Fannie Mae Partnership Offices); (ii) integrated research on credit
scoring and loan performance with Fannie Mae's automated underwriting, offering
lenders a tool that allows them to use the most flexible loan criteria to extend
full consideration for each borrower's unique credit profile (initiative:
Underwriting Flexibilities); (iii) issued $9.4 billion of total commitments to
specific underwriting experiments intended to lower barriers to homeownership
(initiative: Underwriting Experiments); (iv) addressed emerging markets with
products designed to meet home improvement renovation financing needs and
targeted those most in need with products designed for seniors, disabled people
and their families, and Native Americans (initiative: Innovations for Change);
(v) originated $40.3 billion in multifamily financing (initiative: Multifamily
Housing Finance); (vi) identified potential savings of approximately $800 per
mortgage related to the origination costs of mortgages through the use of Fannie
Mae technology (initiative: Technology to Reduce Costs); (vii) approved more
than $50 million of investments in community development financial institutions
and provided financing to more than 1.4 million minority borrowers (initiative:
Fighting Discrimination); (viii) together with 29 for-profit, nonprofit and
governmental organizations, created the American Homeowner Education and
Counseling Institute, an independent nonprofit organization committed to
increased professionalism in homeowner counseling and to identifying more
effective ways to finance home buyer education (initiative: HomePath
Initiative); (ix) exceeded its original commitment to increase giving to the
Fannie Mae Foundation (initiative: Increased Foundation Giving); (x) handled
over 6.6 million consumers' requests for homeownership information (initiative:
Opening Doors for Every American campaign—Fannie Mae Foundation initiative); and
(xi) provided nearly 1.7 million immigrants with home-buying information, using
multilingual media and community organizations supportive of immigrants
(initiative: New Americans Campaign—Fannie Mae Foundation initiative).
Under the Federal Housing Enterprises Financial Safety and Soundness Act of
1992 (the "1992 Act"), Fannie Mae has certain goals to promote affordable
housing for moderate-, low- and very low-income families and to serve the
housing needs of those in underserved areas. In 1998, Fannie Mae exceeded the
applicable goals. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations—Housing Goals."
Delinquencies and REO
When a mortgage loan for which Fannie Mae bears the default risk is
liquidated through foreclosure, the Corporation generally acquires the
underlying property (such real estate owned is called "REO") and holds it for
sale. The level of delinquencies and number of REO are affected by economic
conditions, loss mitigation efforts (which include contacting delinquent
borrowers to offer a preforeclosure sale, loan modification, or other options),
and a variety of other factors. Fannie Mae manages the risk of delinquencies and
REO as described in "Management's Discussion and Analysis of Financial Condition
and Results of Operations—Risk Management—Credit Risk Management."
Fee-Based Services
Fannie Mae offers certain services to lenders and other customers in return
for a fee. These include issuing REMICs, SMBS, Fannie Megas, and grantor trust
securities, technology services for originating and underwriting loans, and the
facilitation of securities transactions.
Fannie Mae receives fee income from dealers in exchange for creating and
issuing REMICs, SMBS, grantor trust securities, and Megas. In addition to
issuing these securities, Fannie Mae is responsible for all tax reporting and
administration costs associated with these securities.
Fannie Mae also receives fee income in return for providing technology
related services such as Desktop Underwriter, Desktop Originator®, Desktop
Trader®, and other on-line services. These services provide lenders the ability
to underwrite mortgage loans electronically, communicate with third-party
originators, access Fannie Mae loan pricing schedules, and enter into sale
commitments with the Corporation on a real-time basis.
Fannie Mae also simultaneously purchases and sells MBS and certain other
mortgage-related securities, such as Ginnie Mae certificates, with the intention
of earning a spread on such trades or as a service to customers. In addition,
Fannie Mae receives fee income through other activities, such as repurchase
transactions, and by providing other investment alternatives for customers.
Competition
Fannie Mae competes, within the limits prescribed by its Charter Act, for the
purchase of mortgage loans for portfolio and the issuance of mortgage-backed
securities in the secondary mortgage market. For single-family products, Fannie
Mae competes primarily with the Federal Home Loan Mortgage Corporation ("Freddie
Mac"), another government-sponsored enterprise also regulated by the Department
of Housing and Urban Development ("HUD") and the Office of Federal Housing
Enterprise Oversight ("OFHEO") with a mission and authority that is virtually
identical to that of Fannie Mae. Fannie Mae competes to a lesser extent with
savings and loan associations, savings banks, commercial banks, other
government-sponsored entities, and other companies that purchase for their own
portfolio or pool single-family mortgage loans for sale to investors as whole
loans or mortgage-backed securities. A number of Federal Home Loan Banks
("FHLBs") are participating in a pilot program, which was expanded in 1998, for
the financing and servicing of single-family mortgage loans. Given the pace of
the pilot's development, the FHLBs are not currently significant competitors.
Fannie Mae competes with the FHA insurance program, a HUD program, for the
business of guaranteeing the credit performance of mortgage loans and, due to
the eligibility of such FHA-insured loans for securitization by Ginnie Mae, with
Ginnie Mae as well.
In 1999, Fannie Mae is limited to purchasing and guaranteeing the credit
performance of mortgage loans with a maximum principal balance of $240,000 (or
more depending upon geographical area and number of dwelling units). The fiscal
year 1999 federal budget increased the maximum principal balance for loans
eligible for the FHA insurance program to 48 percent from 38 percent of Fannie
Mae's loan limits. The loan limit for FHA-insured loans in high cost areas was
increased from 75 percent, and now can be as high as 87 percent of Fannie Mae's
limits. The higher FHA limits may result in increased competition for Fannie
Mae's guaranty business. (For additional information on the maximum principal
balances for loans purchased by the Corporation, see "Mortgage Loan
Portfolio—Mortgage Loans Purchased—Principal Balance Limits.")
In the case of multifamily products, Fannie Mae generally competes with
government housing programs, with insurance companies, and with the same kinds
of entities as in the case of single-family products. Competition for
multifamily mortgage loans is intense from certain entities typically sponsored
by investment banks which purchase such loans and pool them for sale to
investors in the commercial mortgage-backed securities market. Such entities are
referred to as "conduits," and their role in the multifamily mortgage market
increased significantly in 1997. In 1998, conduits continued to be a strong
source of competition, but with the disruption in the fixed-income capital
market in the latter part of the year, they became less of a factor due to
decreased loan originations. However, Fannie Mae expects that they will provide
increased competition as market conditions stabilize. Prior to 1999, under the
Charter Act, maximum principal balance limits also applied to Fannie Mae's
purchase of conventional multifamily mortgage loans. The fiscal year 1999
federal budget removed the limitations on the size of multifamily mortgage loans
that Fannie Mae has authority to purchase. Notwithstanding the change, Fannie
Mae currently intends to continue to comply with prior limitations in most
cases.
Fannie Mae's market share of loans purchased for cash or swapped for MBS is
affected by the volume of mortgage loans offered for sale in the secondary
market by loan originators and other market participants and the amount
purchased by other market participants that compete with the Corporation.
Fannie Mae competes primarily on the basis of price, products, structures,
and services offered. Competition based on advances in technology-related and
other fee-based services continues to increase, as do the types and nature of
the products offered by Fannie Mae, Freddie Mac, and other market participants.
Competition is particularly intense for multifamily mortgage loans eligible
for government subsidies, which have low-income rent and occupancy restrictions.
As a prerequisite to expansion or merger plans, commercial banks must fund such
loans to meet certain obligations under the Community Reinvestment Act, and they
often are willing to do so at or below their own cost of funds. Fannie Mae
competes for these same investment opportunities to meet its housing goals.
Competition also is a consideration in connection with the issuance of Fannie
Mae's debt securities. Fannie Mae competes with Freddie Mac, the FHLB system,
the Student Loan Marketing Association, and other government-sponsored entities
for funds raised through the issuance of unsecured debt in the "agency" debt
market. Increases in the issuance of unsecured debt by other
government-sponsored entities generally, and in the issuance of callable debt in
particular, may have an adverse effect on the issuance of Fannie Mae's unsecured
debt, or result in the issuance of such debt at higher interest rates than would
otherwise be the case. In addition, the availability and cost of funds raised
through the issuance of certain types of unsecured debt may be adversely
affected by regulatory initiatives that tend to reduce investments by certain
depository institutions in unsecured debt with greater than normal volatility or
interest-rate sensitivity.
Under the 1992 Act, the Secretary of HUD must approve any new Fannie Mae or
Freddie Mac program that is significantly different from those approved or
engaged in prior to that Act's enactment. The ability of Fannie Mae and Freddie
Mac to compete with other competitors possibly could be affected by this
requirement. See "Government Regulation and Charter Act."
Facilities
Fannie Mae owns its principal office, which is located at 3900 Wisconsin
Avenue, NW, Washington, DC, an office at 3939 Wisconsin Avenue, NW, Washington,
DC, and two facilities in Herndon, Virginia. These owned facilities total
620,000 square feet. In addition, Fannie Mae leases approximately 379,000 square
feet of office space at 4000 Wisconsin Avenue, NW, which is adjacent to the
Corporation's principal office, and approximately 64,000 square feet of office
space at 2115 Wisconsin Avenue, NW. The present lease for 4000 Wisconsin Avenue
expires in 2003, but the Corporation has options to extend the lease for up to
15 additional years, in 5-year increments. The lease for 2115 Wisconsin expires
in 2002. Fannie Mae also maintains regional offices in leased premises in
Pasadena, California; Atlanta, Georgia; Chicago, Illinois; Philadelphia,
Pennsylvania; and Dallas, Texas. The regional offices negotiate mortgage loan
and MBS business with lenders, assist in supervising the servicing of the
Corporation's mortgage loan portfolio by lenders, assist in supervising or
managing the handling and disposition of REO, and provide training to the staffs
of lenders. In addition to the regional offices, Fannie Mae has opened 33
"Fannie Mae Partnership Offices" to date in leased premises around the country
which will work with cities, rural areas and other underserved communities.
Fannie Mae also plans to establish 11 additional Partnership Offices in 1999.
There currently are Fannie Mae Partnership Offices in Birmingham, Alabama;
Phoenix, Arizona; Los Angeles, California; Denver, Colorado; Hartford,
Connecticut; Washington, D.C.; Miami, Florida; Orlando, Florida; Atlanta,
Georgia; Chicago, Illinois; Des Moines, Iowa; Kansas City, Kansas; New Orleans,
Louisiana; Baltimore, Maryland; Boston, Massachusetts; Detroit, Michigan; St.
Paul, Minnesota; Jackson, Mississippi; St. Louis, Missouri; Lincoln, Nebraska;
Las Vegas, Nevada; Albuquerque, New Mexico; Buffalo, New York; New York, New
York; Charlotte, North Carolina; Oklahoma City, Oklahoma; Cleveland, Ohio;
Columbus, Ohio; Portland, Oregon; Houston, Texas; San Antonio, Texas (two
offices, one of which is responsible for border region issues); and Seattle,
Washington.
Employees
At December 31, 1998, Fannie Mae employed approximately 3,800 full-time
personnel.
Fannie Mae is a federally chartered and stockholder-owned corporation
organized and existing under the Charter Act (12 U.S.C. § 1716 et seq.)
whose purpose is to (1) provide stability in the secondary market for
residential mortgages, (2) respond appropriately to the private capital market,
(3) provide ongoing assistance to the secondary market for residential mortgages
(including activities relating to mortgages on housing for low- and
moderate-income families involving a reasonable economic return that may be less
than the return earned on other activities) by increasing the liquidity of
mortgage investments and improving the distribution of investment capital
available for residential mortgage financing and (4) promote access to mortgage
credit throughout the nation (including central cities, rural areas and
underserved areas) by increasing the liquidity of mortgage investments and
improving the distribution of investment capital available for residential
mortgage financing.
Fannie Mae originally was incorporated in 1938 pursuant to Title III of the
National Housing Act as a wholly owned government corporation and in 1954, under
a revised Title III called the Federal National Mortgage Association Charter
Act, became a mixed-ownership corporate instrumentality of the United States.
From 1950 to 1968, it operated in the Housing and Home Finance Agency, which was
succeeded by HUD. Pursuant to amendments to the Charter Act enacted in the
Housing and Urban Development Act of 1968 (the "1968 Act"), the then Federal
National Mortgage Association was divided into two separate institutions, the
present Corporation and the Government National Mortgage Association, a wholly
owned corporate instrumentality of the United States within HUD, which carried
on certain special financing assistance and management and liquidation
functions. Under the 1968 Act, Fannie Mae was constituted as a federally
chartered corporation and the entire equity interest in Fannie Mae became
stockholder-owned.
Although the 1968 Act eliminated all federal ownership interest in Fannie
Mae, it did not terminate government regulation of the Corporation. Under the
Charter Act, approval of the Secretary of the Treasury is required for Fannie
Mae's issuance of its debt obligations and MBS. In addition, the 1992 Act
established OFHEO, an independent office within HUD under the management of a
Director (the "Director") who is responsible for ensuring that the Corporation
is adequately capitalized and operating safely in accordance with the 1992 Act.
The 1992 Act established minimum capital, risk-based capital, and critical
capital requirements for Fannie Mae and required the Director to establish, by
regulation, a risk-based capital test to be used to determine the amount of
total capital the Corporation must have to exceed the risk-based capital level
from time to time. OFHEO issued a final rule (the "Rule") in 1996 related to the
minimum capital levels for Fannie Mae and Freddie Mac that sets forth how
minimum capital requirements for both entities are to be calculated, reported,
and classified on a quarterly basis. The Rule, which finalized an original
proposal dated June 1995, formalized the interim capital standards applied by
OFHEO, with which Fannie Mae has been in compliance since their inception. See
also "Management's Discussion and Analysis of Financial Condition and Results of
Operations—Balance Sheet Analysis—Regulatory Capital Requirements."
In 1996, OFHEO also released for comment part one ("Part I") of the proposed
regulations to establish the risk-based capital test. Part I specifies that
"benchmark loss experience" will be combined with other yet to be determined
assumptions and applied each quarter to Fannie Mae's book of business to
establish credit losses under the risk-based capital standard for the
Corporation. Part I also specifies the house price index that OFHEO will use in
connection with the risk-based capital standard. Fannie Mae submitted comments
to OFHEO in October 1996 stating that several aspects of the initial proposal
require adjustments or amendment, because it does not accurately capture Fannie
Mae's credit history and derives credit loss rates that are significantly worse
than any reasonable representation of Fannie Mae's and Freddie Mac's loss
experience. On March 26, 1999, after inter-agency review and comment on a
proposed second part of the risk-based capital regulation ("Part II"), OFHEO
sent Part II to Congress for review. Shortly after the 15-day period for
Congressional review, OFHEO is expected to publish Part II for public review and
comment over at least a 120-day period. Part II will specify, among other
matters, remaining aspects of the test and how the test will be used to
determine Fannie Mae's and Freddie Mac's risk-based capital requirements. The
summary accompanying Part II noted that if Part II had been in effect as of June
30, 1997, Fannie Mae's required risk-based capital would have been $17.73
billion, as compared with $14.05 billion in actual capital at that time. OFHEO
also noted that there were a variety of means, such as hedging, that Fannie Mae
could have used to reduce required risk-based capital to the level of its actual
capital. Fannie Mae has not yet thoroughly reviewed Part II but expects to
comment extensively on the proposal, which could change before it is finally
issued. The 1992 Act provides that the final regulations will be enforceable one
year after issuance. Management is confident that Fannie Mae will be able to
meet any reasonable final test.
If Fannie Mae fails to meet one or more of the capital standards under the
1992 Act, the Director is required to take certain remedial measures and may
take others, depending on the standards the Corporation fails to meet. The
Director's enforcement powers include the power to impose temporary and final
cease-and-desist orders and civil penalties on the Corporation and on directors
or executive officers of the Corporation. If the Director determines that Fannie
Mae is engaging in conduct not approved by the Director that could result in a
rapid depletion of core capital or that the value of the property subject to
mortgages held or securitized by the Corporation has decreased significantly,
the Director is authorized to treat the Corporation as not meeting one of the
capital standards that it otherwise meets. In addition, Fannie Mae is required
to submit a capital restoration plan if it fails to meet any of the capital
standards. If the Director does not approve the plan or determines that Fannie
Mae has failed to make reasonable efforts to comply with the plan, then the
Director may treat the Corporation as not meeting one of the capital standards
that it otherwise meets. Also, if Fannie Mae fails to meet or is treated by the
Director as not meeting one of the capital standards and the Director has
reasonable cause to believe that the Corporation or any executive officer or
director of the Corporation is engaging in or about to engage in any conduct
that threatens to result in a significant depletion of the Corporation's core
capital, then the Director is authorized to commence proceedings pursuant to
which, after a hearing, the Director could issue a cease and desist order
prohibiting such conduct. The Director could issue such an order without a
hearing, which would be effective until completion of the cease-and-desist
proceedings, if the Director determined that the conduct in question was likely
to cause a significant depletion of core capital. Prior approval of the Director
is required for Fannie Mae to pay a dividend if the dividend would decrease the
Corporation's capital below risk-based capital or minimum capital levels
established under the 1992 Act. See "Common Stock." The Director is authorized
to levy, pursuant to annual Congressional appropriations, annual assessments on
Fannie Mae and Freddie Mac to cover reasonable expenses of OFHEO.
The 1992 Act also gives the Director the authority to conduct on-site
examinations of Fannie Mae for purposes of ensuring the Corporation's financial
safety and soundness. In addition, Fannie Mae is required to submit annual and
quarterly reports of the financial condition and operations of the Corporation
to the Director. Moreover, the Charter Act, as amended by the 1992 Act,
authorizes the General Accounting Office to audit the programs, activities,
receipts, expenditures and financial transactions of the Corporation. Fannie Mae
also is required to submit an annual report to the House and Senate Banking
Committees and the Secretary of HUD regarding the Corporation's performance in
meeting housing goals relating to the purchase of mortgages on housing for low-
and moderate-income families, mortgages on rental and owner-occupied housing for
low-income families in low-income areas or for very-low-income families, and
mortgages on housing located in rural or other underserved areas.
Under the 1992 Act, the Secretary of HUD retains general regulatory authority
to promulgate rules and regulations to carry out the purposes of the Charter
Act, excluding authority over matters granted exclusively to the Director in the
1992 Act. The Secretary of HUD also must approve any new conventional mortgage
program that is significantly different from those approved or engaged in prior
to the 1992 Act. The Secretary is required to approve any new program unless it
is not authorized by the Charter Act of the Corporation or the Secretary finds
that it is not in the public interest. However, until one year after the final
regulations establishing the risk-based capital test are in effect, the
Secretary must disapprove a new program if the Director determines that the
program would risk significant deterioration of the financial condition of
Fannie Mae. The Secretary has adopted regulations related to the program
approval requirement.
Thirteen members of Fannie Mae's eighteen-member Board of Directors are
elected by the holders of the Corporation's common stock, and the remaining five
members are appointed by the President of the United States. The appointed
directors must include one person from the home building industry, one person
from the mortgage lending industry, and one person from the real estate
industry. Under the 1992 Act, one appointed director also must be from an
organization that has represented consumer or community interests for not less
than two years or a person who has demonstrated a career commitment to the
provision of housing for low-income households. Any member of the Board of
Directors that is appointed by the President of the United States may be removed
by the President for good cause.
In addition to placing Fannie Mae under federal regulation, the Charter Act
also grants to the Corporation certain privileges. For instance, securities
issued by Fannie Mae are deemed to be "exempt securities" under laws
administered by the Securities and Exchange Commission ("SEC") to the same
extent as securities that are obligations of, or guaranteed as to principal and
interest by, the United States. Registration statements with respect to Fannie
Mae's securities are not filed with the SEC. The Corporation also is not
required to file periodic reports with the SEC.
The Secretary of the Treasury of the United States has discretionary
authority to purchase obligations of Fannie Mae up to a maximum of $2.25 billion
outstanding at any one time. This facility has not been used since Fannie Mae's
transition from government ownership in 1968. Neither the United States nor any
agency thereof is obligated to finance Fannie Mae's operations or to assist the
Corporation in any other manner.
Fannie Mae is exempt from all taxation by any state or by any county,
municipality, or local taxing authority except for real property taxes. Fannie
Mae is not exempt from payment of federal corporate income taxes. Also, Fannie
Mae may conduct its business without regard to any qualifications or similar
statute in any state of the United States or the District of Columbia.
The Federal Reserve Banks are authorized to act as depositaries, custodians,
and fiscal agents for Fannie Mae, for its own account, or as fiduciary.
In the ordinary course of business, Fannie Mae is involved in legal
proceedings that arise in connection with properties acquired by the
Corporation, either through foreclosure on properties securing delinquent
mortgage loans owned by the Corporation or by receiving deeds to such properties
in lieu of foreclosure. For example, claims related to possible tort liability
and compliance with applicable environmental requirements arise from time to
time, primarily in the case of single-family REO.
Fannie Mae is a party to legal proceedings from time to time arising from its
relationships with its seller/servicers. Disputes with lenders concerning their
loan origination or servicing obligations to Fannie Mae, or disputes concerning
termination by Fannie Mae (for any of a variety of reasons) of a lender's
authority to do business with the Corporation as a seller and/or servicer, can
result in litigation. Also, loan servicing issues have resulted from time to
time in claims against Fannie Mae brought as putative class actions for
borrowers.
Fannie Mae also is a party to legal proceedings from time to time arising
from other aspects of its business and administrative policies.
Claims and proceedings of all types are subject to many uncertain factors
that generally cannot be predicted with assurance. However, in the case of the
legal proceedings and claims that are currently pending against Fannie Mae,
management believes that their outcome will not have a material adverse effect
on the Corporation's financial condition or results of operations.
Section 303(a) of the Charter Act provides that Fannie Mae shall have common
stock, without par value. The common stock is vested with all voting rights.
Each share of common stock is entitled to one vote at all elections of directors
and on all other matters presented for common stockholder vote. The holders of
the common stock elect thirteen directors, and the President of the United
States appoints the remaining five directors. The Charter Act, Fannie Mae's
governing instrument, cannot be amended by the stockholders, but only by an Act
of Congress.
Fannie Mae also is authorized by the Charter Act to have preferred stock on
such terms and conditions as the Board of Directors of the Corporation may
prescribe. No common stockholder approval is required to issue preferred stock.
Fannie Mae issued $1 billion of non-cumulative preferred stock in 1996 and $150
million in 1998 that is redeemable at the Corporation's option beginning in 2001
and 1999, respectively. Holders of these preferred stock issues are entitled to
receive noncumulative, quarterly dividends when, and if, declared by Fannie
Mae's Board of Directors. Payment of dividends on preferred stock is not
mandatory, but has priority over payment of dividends on common stock. After the
specified period, preferred stock is redeemable at its stated value at the
option of Fannie Mae. See "Notes to Financial Statements—Note 12" for additional
information on preferred stock.
The Charter Act contains no limitation on the amount of stock that may be
issued, except that if Fannie Mae fails to meet certain minimum capital
standards, the Director could require that the Director approve the
Corporation's issuance of stock or securities convertible into stock. At
February 28, 1999, there were outstanding approximately 1,027 million shares of
common stock, which were held by approximately 25,000 stockholders of record.
Based on the number of requests for proxies and quarterly reports, Fannie Mae
estimates that on February 28, 1999 there were approximately 340,000 additional
stockholders who held shares through banks, brokers and nominees.
Holders of the common stock are entitled to receive cash dividends if, as,
and when declared by the Board of Directors. However, certain provisions of the
1992 Act may operate to restrict the ability of the Board of Directors to
declare dividends in certain circumstances. The 1992 Act established risk-based
capital, minimum capital and critical capital requirements for Fannie Mae, and
required the Director of OFHEO to establish, by regulation, a risk-based capital
test to be used to determine the amount of total capital Fannie Mae must have to
exceed the risk-based capital level from time to time. As discussed in
"Government Regulation and Charter Act," the Director of OFHEO publicly released
Part I of the proposed risk-based capital regulations in 1996, and it is
expected that Part II of the proposed risk-based capital regulations will be
published for public review and comment shortly. Until one year after the final
regulations establishing the risk-based capital test are in effect, a dividend
may be paid without the prior approval of the Director of OHFEO if Fannie Mae
meets the minimum capital level established under the 1992 Act and the dividend
payment would not decrease the Corporation's base capital below such level. See
"Government Regulation and Charter Act."
One year after final regulations establishing the risk-based capital test
take effect, a dividend may be paid without the prior approval of the Director
if Fannie Mae meets both the risk-based capital and minimum capital levels and
the dividend payment would not decrease the Corporation's total capital below
the risk-based capital level or its core capital below the minimum capital
level. If Fannie Mae meets either the risk-based capital standard or the minimum
capital standard, it may make a dividend payment without obtaining the approval
of the Director only if the dividend payment would not cause Fannie Mae to fail
to meet another capital standard. At any time when Fannie Mae does not meet the
risk-based capital standard but meets the minimum capital standard, Fannie Mae
is prohibited from making a dividend payment that would cause the Corporation to
fail to meet the minimum capital standard. If Fannie Mae meets neither the
risk-based capital standard nor the minimum capital standard but does meet the
critical capital standard established under the 1992 Act, it may make a dividend
payment only if the Corporation would not fail to meet the critical capital
standard as a result of such payment and the Director approves the payment after
finding that it satisfies certain statutory conditions. The Director has the
authority to require Fannie Mae to submit a report to the Director regarding any
capital distribution (including any dividend) declared by Fannie Mae before the
Corporation makes the distribution. See "Government Regulation and Charter Act"
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations—Balance Sheet Analysis—Regulatory Capital Requirements" regarding the
capital standards applicable to Fannie Mae.
The payment of dividends on common stock also is subject to the payment of
dividends on any preferred stock outstanding. Accordingly, no cash dividend may
be declared or paid or set apart for payment on common stock unless cash
dividends have been declared and paid or set apart (or ordered to be set apart)
on preferred stock outstanding for the then-current dividend period.
Dividends on common stock have been declared and paid for each quarter during
Fannie Mae's two most recent fiscal years. See "Quarterly Results of Operations"
on pages 73-74 for quarterly dividends paid on common stock during 1998 and
1997.
In the event of liquidation of Fannie Mae, holders of common stock are
entitled to share ratably, in accordance with their holdings, in the remaining
assets of Fannie Mae after payment of all liabilities of the Corporation and
amounts payable to the holders of preferred stock.
The common stock has no conversion or pre-emptive rights or redemption or
sinking fund provisions. The outstanding shares of common stock are fully paid
and nonassessable. There is no prohibition against the purchase by Fannie Mae of
its own common stock, holding such common stock in its treasury, and reselling
such stock.
This description is summarized from the Charter Act, the 1992 Act, the bylaws
and certain resolutions of the Board of Directors and stockholders of Fannie
Mae. This description does not purport to be complete, and is qualified in its
entirety by reference to the Charter Act, the 1992 Act, the bylaws of Fannie
Mae, and such resolutions. Copies of the Charter Act, the bylaws of Fannie Mae,
and any applicable resolutions may be obtained from Fannie Mae.
Fannie Mae's common stock is publicly traded on the New York, Pacific and
Chicago stock exchanges and is identified by the ticker symbol "FNM." The
transfer agent and registrar for the common stock is First Chicago Trust Company
of New York, 525 Washington Boulevard, Jersey City, New Jersey 07310.
The following table shows, for the periods indicated, the high and low prices
per share of Fannie Mae's common stock on the New York Stock Exchange Composite
Transactions as reported in the Bloomberg Financial Markets service.
| 1998 | 1997 | |||
|---|---|---|---|---|
|
|
| |||
| Quarter | High | Low | High | Low |
|
|
|
|
|
|
| 1st | $66.38 | $56.06 | $43.75 | $36.13 |
| 2nd | 67.19 | 55.75 | 47.63 | 36.13 |
| 3rd | 68.31 | 55.56 | 49.44 | 41.13 |
| 4th | 76.19 | 49.56 | 57.31 | 44.69 |
The closing price of Fannie Mae's common stock on March 30, 1999, as so
reported, was $70.19.
From time to time, Fannie Mae may make forward-looking statements relating to
matters such as the Corporation's anticipated financial performance, business
prospects, future business plans, financial condition or other matters. For
example, "Management's Discussion and Analysis of Financial Condition and
Results of Operations" includes forward-looking statements, which are statements
therein that are not historical facts or explanations of historical data. The
words "believes," "anticipates," "expects," and similar expressions generally
identify forward-looking statements.
Forward-looking statements reflect management's expectations based on various
assumptions and management's estimates of trends and economic factors in the
markets in which Fannie Mae is active, as well as Fannie Mae's business plans.
As such, forward-looking statements are subject to risks and uncertainties, and
Fannie Mae's actual results may differ (possibly significantly) from those
indicated in such statements. Among the factors that may affect the performance,
development or results of Fannie Mae's business, and thereby cause actual
results to differ from management's expressed expectations, are the following:
Fannie Mae does not undertake to update any forward-looking statement herein
or that may be made from time to time on behalf of the Corporation.
The following selected financial data for the years 1994 through 1998 (which
data are not covered by the independent auditors' report) have been summarized
or derived from the audited financial statements and other financial
information. These data should be read in conjunction with the audited financial
statements and notes to the financial statements.
| Income Statement Data for the year ended December 31: | 1998 | 1997 | 1996 | 1995 | 1994 |
|---|---|---|---|---|---|
|
|
|
|
|
| |
| Interest income | $29,995 | $26,378 | $23,772 | $21,071 | $17,347 |
| Interest expense | (25,885) | (22,429) | (20,180) | (18,024) | (14,524) |
|
|
|
|
|
| |
| Net interest income | 4,110 | 3,949 | 3,592 | 3,047 | 2,823 |
| Guaranty fees | 1,229 | 1,274 | 1,196 | 1,086 | 1,083 |
| Fee and other income, net | 275 | 125 | 86 | 93 | 143 |
| Credit-related expenses | (261) | (375) | (409) | (335) | (378) |
| Administrative expenses | (708) | (636) | (560) | (546) | (525) |
| Special Contribution | — | — | — | (350) | — |
|
|
|
|
|
| |
| Income before
federal income taxes and
extraordinary item |
4,645 | 4,337 | 3,905 | 2,995 | 3,146 |
| Provision for federal income taxes | (1,201) | (1,269) | (1,151) | (840) | (1,005) |
|
|
|
|
|
| |
| Income before extraordinary item | 3,444 | 3,068 | 2,754 | 2,155 | 2,141 |
| Extraordinary
item—loss on early extinguishment
of debt, net of tax effect |
(26) | (12) | (29) | (11) | (9) |
|
|
|
|
|
| |
| Net income | $3,418 | $3,056 | $2,725 | $2,144 | $2,132 |
|
|
|
|
|
| |
| Preferred stock dividends | (66) | (65) | (42) | — | — |
|
|
|
|
|
| |
| Net income available to common shareholders | $3,352 | $2,991 | $2,683 | $2,144 | $2,132 |
|
|
|
|
|
| |
| Basic earnings per common share(1): | |||||
| Earnings before extraordinary item | $3.28 | $2.87 | $2.53 | $1.98 | $1.96 |
| Extraordinary item | (.02) | (.02) | (.03) | (.01) | (.01) |
|
|
|
|
|
| |
| Net earnings | $3.26 | $2.85 | $2.50 | $1.97 | $1.95 |
|
|
|
|
|
| |
| Diluted earnings per common share(1): | |||||
| Earnings before extraordinary item | $3.26 | $2.84 | $2.51 | $1.96 | $1.95 |
| Extraordinary item | (.03) | (.01) | (.03) | (.01) | (.01) |
|
|
|
|
|
| |
| Net earnings | $3.23 | $2.83 | $2.48 | $1.95 | $1.94 |
|
|
|
|
|
| |
| Cash dividends per common share | $.96 | $.84 | $.76 | $.68 | $.60 |
| Balance Sheet Data at December 31: | |||||
| Mortgage portfolio, net | $415,223 | $316,316 | $286,259 | $252,588 | $220,525 |
| Investments | 58,515 | 64,596 | 56,606 | 57,273 | 46,335 |
| Total assets | 485,014 | 391,673 | 351,041 | 316,550 | 272,508 |
| Borrowings: | |||||
| Due within one year | 205,413 | 175,400 | 159,900 | 146,153 | 112,602 |
| Due after one year | 254,878 | 194,374 | 171,370 | 153,021 | 144,628 |
| Total liabilities | 469,561 | 377,880 | 338,268 | 305,591 | 262,967 |
| Stockholders' equity | 15,453 | 13,793 | 12,773 | 10,959 | 9,541 |
| Capital(2) | 16,244 | 14,575 | 13,520 | 11,703 | 10,367 |
| Other Data for the year ended December 31: | |||||
| Average net interest margin | 1.03% | 1.17% | 1.18% | 1.16% | 1.24% |
| Return on average common equity | 25.2 | 24.6 | 24.1 | 20.9 | 24.3 |
| Dividend payout ratio | 29.5 | 29.4 | 30.4 | 34.6 | 30.8 |
| Average effective guaranty fee rate | .202 | .227 | .224 | .220 | .225 |
| Credit loss ratio | .027 | .041 | .053 | .050 | .057 |
| Ratio of earnings
to combined fixed charges
and preferred stock dividends(3) |
1.18:1 | 1.19:1 | 1.19:1 | 1.17:1 | 1.22:1 |
| Mortgage purchases | $188,448 | $70,465 | $68,618 | $56,598 | $62,389 |
| MBS issued | 326,148 | 149,429 | 149,869 | 110,456 | 130,622 |
| MBS outstanding at year-end(4) | 834,518 | 709,582 | 650,780 | 582,959 | 530,343 |
| Weighted-average
diluted common shares outstanding,
in millions |
1,037 | 1,056 | 1,080 | 1,098 | 1,098 |
(1) Earnings per common share amounts in 1996, 1995, and 1994 have been
restated to comply with Financial Accounting Standard No. 128, Earnings per
Share.
(2) Stockholders' equity plus general allowance for losses.
(3) "Earnings" consists of (i) income before federal income taxes and
extraordinary item and (ii) fixed charges. "Fixed charges" represents interest
expense. There was no preferred stock outstanding in 1995 and 1994.
(4) Includes $197 billion, $130 billion, $103 billion, $70 billion, and $44
billion of MBS in portfolio at December 31, 1998, 1997, 1996, 1995, and 1994,
respectively.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
This discussion highlights significant factors influencing Fannie Mae's
financial condition and results of operations. It should be read in conjunction
with the financial statements and related notes. This discussion (and other
sections of this Information Statement) includes certain forward-looking
statements based on management's estimates of trends and economic factors in
markets in which Fannie Mae is active, as well as the corporation's business
plans. In light of securities law developments, including the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, Fannie Mae
notes that such forward-looking statements are subject to risks and
uncertainties. Accordingly, the corporation's actual results may differ from
those set forth in such statements. Significant changes in economic conditions;
regulatory or legislative changes affecting Fannie Mae, its competitors, or the
markets in which it is active; or changes in other factors may cause future
results to vary from those expected by Fannie Mae. The "Forward-Looking
Information" section in Fannie Mae's Information Statement discusses certain
factors that may cause such differences to occur.
Overview
Fannie Mae extended its string of record earnings in 1998 to 12 years, with
diluted earnings per common share increasing to $3.23 per share, or 14 percent,
compared with $2.83 in 1997. Net income increased $362 million to $3.418 billion
in 1998, compared with $3.056 billion for 1997. Fannie Mae's 1998 double-digit
earnings growth was principally due to a record volume of mortgage purchases and
Fannie Mae mortgage-backed securities issues, increased fee and other income,
strengthened credit performance, and continued effective management of interest
rate risk. The 31 percent increase in the portfolio was the product of a number
of factors, including a sustained period of lower interest rates that resulted
in record mortgage originations, as well as wide mortgage-to-debt spreads that,
in part, stemmed from a period of exceptional market turbulence in the second
half of the year.
In 1998, Fannie Mae initiated a new funding product called Benchmark
Notes(SM). Benchmark Notes are large issues of noncallable debt securities
designed to provide liquidity and performance to investors while reducing Fannie
Mae's cost of debt. Benchmark Notes have served to consolidate much of Fannie
Mae's noncallable long-term debt issuances from a large number of small,
unscheduled issues to a smaller number of larger, regular, more liquid issues.
Fannie Mae anticipates that the liquidity of the Benchmark Notes, combined with
Fannie Mae's outstanding credit quality, will cause Benchmark Notes to be viewed
by many investors as a liquid investment alternative to U.S. Treasuries. During
1998, Fannie Mae issued $42 billion of Benchmark Notes.
Fannie Mae's credit risk management continued to excel during 1998. The
decline in credit-related expenses was a result of the combined beneficial
effects of an improved housing market, particularly in California; a significant
degree of risk sharing on higher-risk loans; and continued success in loss
mitigation activities. The credit loss ratio—credit losses as a percentage of
the average unpaid principal balance of total mortgages in portfolio and Fannie
Mae MBS outstanding—declined to .027 percent in 1998 from .041 percent in 1997.
Fannie Mae's core capital grew 12 percent, to $15.5 billion at December 31,
1998. Fannie Mae also repurchased $1.1 billion of common stock during the year.
Core capital exceeded applicable regulatory capital standards by $131 million at
December 31, 1998.
The remainder of Management's Discussion and Analysis includes detailed
information on Fannie Mae's results of operations, risk management, balance
sheet analysis, mortgage-backed securities, and housing goals, as well as a new
accounting standard.
Results of Operations
Net Interest Income
Net interest income increased $161 million to $4.110 billion in 1998,
compared with $3.949 billion in 1997. The 4 percent increase was a result of a
$53 billion, or 18 percent, increase in the average mortgage portfolio balance,
which was partially offset by a 14 basis point decrease in the average net
interest margin. The decline in the average net interest margin stemmed from an
increase in the refinancing of high-coupon mortgages; the recording, during the
fourth quarter of 1998, of additional amortization of premiums on mortgages held
in portfolio ; an increase in tax-advantaged investments, which generally have
lower investment yields; and the repurchase of common shares. The additional
amortization recorded in the fourth quarter reflects management's estimate of
the effects of the decline in interest rates and the high level of 1998
refinancing activity on the unamortized premium and discount balances associated
with the net mortgage portfolio. The repurchase of common shares reduces the net
interest margin, as such share repurchases are funded through the issuance of
debt, but has a positive effect on earnings per common share. For 1999,
management expects that net interest income will increase due to continued
growth in the average net mortgage portfolio and a more stable net interest
margin.
Net interest income excludes interest receivable on nonperforming loans.
Conventional single-family and multifamily loans are classified as nonperforming
and previously accrued interest is removed from income when the collection of
interest payments is deemed less than probable.
Guaranty Fee Income
Guaranty fees compensate Fannie Mae for its guarantee of the timely payment
of principal and interest to MBS investors and for the assumption of credit risk
on loans underlying MBS. Guaranty fees on Fannie Mae MBS held in portfolio are
included in interest income. Guaranty fee income decreased 4 percent, or $45
million, from $1.274 billion in 1997 to $1.229 billion in 1998. The decrease in
guaranty fee income primarily resulted from a decrease of .025 percentage points
in the average effective guaranty fee rate, which was partially offset by a $48
billion, or 9 percent, increase in average net MBS outstanding. The decline in
the average effective guaranty fee rate was due to several factors, including
recording additional amortization of prepaid or deferred guaranty fees in the
fourth quarter of 1998, reflecting management's estimate of the effects of the
decline in interest rates and refinance activity on such fees; growth in the
number of loans swapped for MBS for which the default risk is shared by a third
party; and competitive pricing in the market. For 1999, management expects that
guaranty fee income will increase as a result of continued growth in average net
MBS outstanding.
The table below presents guaranty fee income as a percentage of the average
balance of MBS outstanding, net of MBS held in portfolio, in 1998, 1997, and
1996.
| 1998 | 1997 | 1996 | |
|---|---|---|---|
|
|
|
| |
| (Dollars in millions) | |||
| Guaranty fee income | $1,229 | $1,274 | $1,196 |
| Average balance of net MBS outstanding | 609,513 | 561,079 | 534,553 |
| Effective guaranty fee rate | .202% | .227% | .224% |
Additional information on Fannie Mae's MBS and guaranty fees is presented
under "Mortgage-Backed Securities" below.
Fee and Other Income
Fee and other income is composed of multifamily fees, structured transaction
fees, and technology fees, as well as other miscellaneous items, and is net of
operating losses from certain tax-advantaged investments. Fee and other income
increased 120 percent, or $150 million, to $275 million in 1998, compared with
$125 million in 1997. The increase was primarily due to increases in technology
fees, multifamily fees, and other fees. The increase in technology fees was
driven by record usage of Fannie Mae's Desktop Underwriter® and Desktop
Originator® systems. Additional information on structured transactions is
presented under "Mortgage-Backed Securities." For 1999, management expects that
fee and other income will be somewhat lower than in 1998.
Credit-Related Expenses
Credit-related expenses, which include the provision for losses and
foreclosed property expenses, decreased $114 million to $261 million in 1998,
compared with $375 million in 1997. The credit loss ratio fell to 2.7 basis
points in 1998 from 4.1 basis points in 1997. The decrease in credit-related
expenses was driven by a significant reduction in the provision for losses as
compared with 1997. In 1998, Fannie Mae recorded a negative loss provision of
$50 million, compared with a $100 million loss provision recorded in 1997.
Contributing to the decrease in credit-related expenses was a reduction in the
number of foreclosed properties. A stronger national housing market (especially
in California), a significant degree of risk sharing on higher-risk loans, and
continued loss mitigation efforts contributed to the reduction in the provision
for losses and the number of foreclosed properties.
Management anticipates that credit-related expenses will continue to decline
in 1999 in spite of continued growth in the mortgage portfolio and MBS
outstanding. In 1999, Fannie Mae expects to continue to benefit from a healthy
national housing market and the Corporation's loss mitigation efforts.
Administrative Expenses
Administrative expenses grew 11 percent to $708 million in 1998, compared
with $636 million in 1997. The ratio of Fannie Mae's administrative expenses to
the average net mortgage portfolio plus average net MBS outstanding was .074
percent in both 1998 and 1997. The ratio of administrative expenses to revenues
(net interest income, guaranty fees, and fee and other income) was 12.6 percent
in 1998 and 11.9 percent in 1997. The increase in administrative expenses
resulted primarily from higher technology equipment costs and compensation
costs, which included efforts to make Fannie Mae's computer systems Year 2000
compliant and the effect of a higher common share price on certain Fannie Mae
stock-based compensation plans. Compensation expense was $453 million in 1998,
compared with $394 million in 1997. Additional information concerning the Year
2000 issue is presented under "Risk Management."
Income Taxes
The provision for federal income taxes, net of the tax benefit from
extraordinary losses, was $1.187 billion in 1998, compared with $1.262 billion
in 1997. The effective federal income tax rate was 26 percent in 1998, compared
with 29 percent in 1997. The reduction in federal income tax expense and the
effective federal income tax rate for 1998 reflect the recording of additional
low-income housing tax credits in the fourth quarter of 1998. The additional tax
credits were a result of the Corporation using improved systems and information
to refine the timing of the recognition of the tax benefits associated with
investments qualifying for low-income housing tax credits. Management expects
the effective federal income tax rate to increase slightly in 1999.
Extraordinary Loss
Extraordinary loss is recognized when debt or certain interest rate swaps are
repurchased or called. The repurchase and call of debt and the call of certain
interest rate swaps are part of Fannie Mae's interest rate risk management
strategy, and are designed to favorably affect Fannie Mae's future cost of
funds. For 1998, as a result of these transactions, Fannie Mae recognized net
extraordinary losses of $40 million ($26 million after tax), compared with $19
million ($12 million after tax) in 1997.
During 1998, the amount of long-term debt called or repurchased plus the
notional amount of interest rate swaps called totaled $77 billion, with a
weighted-average cost of 6.71 percent. The comparable amount in 1997 was $31
billion, with a weighted-average cost of 7.22 percent.
Risk Management
Fannie Mae is subject to three major areas of risk: interest rate risk,
credit risk, and operational risk. Active management of these risks is an
essential part of Fannie Mae's operations and a key determinant of its ability
to maintain steady earnings growth. The following discussion highlights Fannie
Mae's various strategies to diversify and mitigate these three risks.
Interest Rate Risk Management
Fannie Mae is exposed to interest rate risk because changes in interest rates
may affect mortgage portfolio cash flows in a way that will adversely impact
earnings or long-term value. Fannie Mae's management of interest rate risk
involves analyses and actions that position the corporation to meet its
objective of consistent earnings growth in a wide range of interest rate
environments. Fannie Mae's interest rate risk is concentrated primarily in the
mortgage portfolio, where exposure to changes in interest rates is managed to
achieve stable earnings growth and an acceptable return on equity over time.
Central elements of Fannie Mae's approach to managing interest rate risk
include: (1) investing in assets and issuing liabilities that perform similarly
in different interest rate environments, (2) assessing the sensitivity of
portfolio profitability and risk to changes in interest rates, and (3) taking
rebalancing actions in the context of a well-defined risk management process.
The first element of interest rate risk management is the funding of mortgage
assets with liabilities that have similar durations or average cash flow
patterns through time. To achieve the desired liability durations, Fannie Mae
issues debt across a broad spectrum of maturities. Because the durations of
mortgage assets change as interest rates change, callable debt with similar
duration characteristics is frequently issued. The duration of callable debt,
like that of a mortgage asset, shortens when interest rates decrease and
lengthens when interest rates increase. Fannie Mae also utilizes
off-balance-sheet derivative financial instruments, including interest rate
swaps and other derivative instruments with embedded interest rate options, to
achieve its desired liability structure and to better match the prepayment risk
of the mortgage portfolio. A high degree of diversification of the interest rate
option characteristics embedded in the assets and liabilities of the portfolio
also serves to reduce interest rate risk.
Because the assets and the liabilities in Fannie Mae's mortgage portfolio are
not perfectly matched, the portfolio's projected performance changes with
movements in interest rates. Accordingly, the second element of interest rate
risk management involves regularly assessing the portfolio's risk using a
diverse set of analyses and measures, including net interest income simulations,
duration gap analysis, portfolio value analysis, and stress testing. Portfolio
net interest income is projected for a wide range of interest rate environments,
including specific rising and falling interest rate paths, and interest rate
simulations based on historical interest rate volatility. These analyses
generally include assumptions about new business activity to provide a more
realistic assessment of possible portfolio performance. Duration gap and
portfolio value analyses are used to provide information on the interest rate
sensitivity of the existing portfolio only (assuming no new business.) The
portfolio duration gap—the difference between the durations of portfolio assets
and liabilities—summarizes for management the extent to which asset and
liability estimated cash flows are matched, on average, through time.
Management regularly monitors the portfolio's duration gap under
current market conditions and for a series of hypothetical interest rate
scenarios. In addition, management tracks the portfolio's long-term value and
potential changes in value for a broad range of potential interest rate
scenarios. Information about interest rate risk is also obtained by means of
financial performance simulations in which highly stressful interest rate
scenarios are assumed.
Management monitors interest rate risk not only by using a diverse set of
risk measures, but also by evaluating the sensitivity of those measures to
changes in assumptions about future business conditions and financial market
relationships. Fannie Mae's practice of employing a variety of risk measures and
assumptions proved especially useful during the high level of financial market
volatility experienced in 1998. Risk measures and assumptions are regularly
reevaluated, and modeling tools are enhanced as management believes appropriate.
The third element of Fannie Mae's interest rate risk management is a
framework that facilitates the communication and attainment of corporate
objectives. The Board of Directors oversees interest rate risk management
through the adoption of corporate goals and objectives and the review of regular
reports on performance relative to these. Senior management is responsible for
ensuring that the appropriate long-term strategies are in place to achieve the
goals and objectives. Short-term strategies are formulated in weekly meetings of
senior mortgage portfolio management, based on recent financial market
information and the portfolio's standing relative to long-term objectives.
Management establishes reference points for the key performance measures that
are used to signal material changes in risk and to assist in determining whether
adjustments in portfolio strategy are required to achieve long-term objectives.
These measures and reference points are reported regularly to the Board of
Directors. Comparing the performance measures with the reference points helps
management make decisions about the necessity or desirability of portfolio
rebalancing.
Fannie Mae's performance in 1998 is evidence of management's ability to meet
its interest rate risk objectives. During the year, long-term interest rates
dropped to their lowest levels in over 30 years. In the quarter ending September
30, 1998, interest rates dropped by the largest amount in any three-month period
in nine years. Consequently, the mortgage portfolio's duration gap moved
somewhat outside Fannie Mae's established reference points and reached its
lowest point in early October. Portfolio rebalancing and the subsequent rise in
long-term interest rates resulted in the duration gap returning to a level
within management's target reference range by year-end.
At December 31, 1998, the duration gap of Fannie Mae's mortgage portfolio was
a negative three months. A negative duration gap results when the duration of
mortgage assets is shorter than the duration of the related liabilities, and
generally indicates that the existing portfolio's long-term earnings stream is
more vulnerable to a declining interest rate environment. At the end of 1998,
the projected net interest income of the mortgage portfolio over the next one to
two years was also somewhat more exposed to declining interest rates than to
rising interest rates. Actual portfolio net interest income performance may
differ from projections because of specific interest rate movements, changing
business conditions, and management actions.
Interest Rate Sensitivity of Net Asset Value
Another indicator of the interest rate exposure of Fannie Mae's existing
business is the sensitivity of the fair value of net assets (net asset value) to
changes in interest rates. The following table presents Fannie Mae's estimated
net asset value as of December 31, 1998, and two projections of the value 12
months later assuming hypothetical changes in interest rates over the 12-month
period. These interest rate movements represent the most extreme changes in
rates that would be expected over this period within a 95 percent confidence
interval, based on historical interest rate volatility. The interest rate
changes include an increase in long-term U.S. Treasury yields of approximately
175 basis points and a decrease of approximately 125 basis points from December
31, 1998 levels.
| Percentage of | ||
|---|---|---|
| Net | December 31, 1998 | |
| Asset Value | Net Asset Value | |
|
|
| |
| (Dollars in billions) | ||
| December 31, 1998 | $14.9 | — |
| Assuming a 175 basis point increase | 15.5 | 104% |
| Assuming a 125 basis point decrease | 13.0 | 87 |
The net asset value of Fannie Mae as of December 31, 1998, as presented in
the above table, is the same as that disclosed in Note 15 to the Financial
Statements, "Disclosures of Fair Value of Financial Instruments," and includes
the values of all portfolio business, as well as the guaranty fee business. The
projected net asset values were derived in a manner consistent with the
estimation procedures used in determining the December 31, 1998 net asset value.
As the table indicates, the net asset value of Fannie Mae's existing book of
business is projected to increase if interest rates were to rise 175 basis
points over the next year, and decline if interest rates were to fall 125 basis
points over the next year. These sensitivities reflect the generally greater
exposure of the company's existing book of business to declining interest rates
at the end of 1998.
These fair value estimates represent valuations for the company's existing
business only, and do not take into account the value of the company as a going
concern, which would include the value of future business opportunities. For
example, in a declining interest rate environment, the projected faster runoff
of the company's guaranty fee business would lower the net asset value of the
company's existing business. In the same environment, however, it is likely that
new business opportunities would result in faster growth of the total guaranty
fee book outstanding. Similarly, in a declining rate environment there are
likely to be increased opportunities for portfolio growth and wider portfolio
purchase spreads.
Additional information on interest rate risk management is presented under
"Balance Sheet Analysis—Financing Activities."
Credit Risk Management
Fannie Mae's primary exposure to credit risk results from the possibility
that it will not recover amounts due from borrowers. Management's overall
objective in managing credit risk is to minimize losses by applying prudent
underwriting guidelines and loan servicing requirements. Furthermore, Fannie Mae
and its servicers use analytical models to apply credit risk analysis throughout
the life of a loan.
Fannie Mae is also subject to the credit risk that counterparties to its
transactions may be unable to meet their contractual obligations. Additional
information on this credit risk exposure is presented under "Balance Sheet
Analysis—Financing Activities" and in the Notes to Financial Statements,
"Off-Balance-Sheet Credit Risk" and "Concentrations of Credit Risk." The
discussion that follows addresses the major elements of credit risk management
as they pertain to conventional single-family and multifamily mortgage loans.
Single-Family
Fannie Mae manages its single-family mortgage credit risk by focusing on two
phases: loan underwriting and loan servicing. If these are not managed
effectively, the likelihood of credit loss increases.
In the first phase, loan underwriting, the corporation manages credit risk
through its efforts to develop sound underwriting policies and to ensure that
loans sold to Fannie Mae meet the corporation's credit quality criteria.
Desktop Underwriter, Fannie Mae's automated underwriting model, was designed
to help lenders process mortgage applications more efficiently, accurately, and
consistently. It provides benefits to lenders, borrowers, and Fannie Mae by
consistently and objectively applying the corporation's underwriting standards
to all prospective borrowers, as well as customizing Fannie Mae's underwriting
standards to a loan's unique combination of credit risk factors. Use of Desktop
Underwriter significantly increased in 1998. Desktop Underwriter was used by
nearly 800 lenders and was processing, on average, 22 percent of the loans that
were delivered to Fannie Mae in 1998 versus 9 percent in 1997. By December 1998,
26 percent of loans delivered to Fannie Mae were processed through Desktop
Underwriter. Management expects Desktop Underwriter usage to continue to
increase in 1999.
In the second phase of credit risk management, loan servicing, Fannie Mae
manages the risk of credit loss by requiring its servicers to follow guidelines
for servicing a loan owned or securitized by Fannie Mae. The guidelines help
ensure that loans are serviced consistently and efficiently.
An important element in loan servicing is the servicer's responsibility to
carry out loss mitigation activities. A major component of loss mitigation is
early intervention in a delinquency. To help keep borrowers in their homes or
reduce the costs incurred when a loan goes through the foreclosure process,
borrowers are contacted early in the delinquency to determine whether their
delinquency might be resolved through a repayment plan, temporary forbearance,
or modification of terms. If repayment plans, forbearance, or modification are
not appropriate, the loan servicer may attempt to arrange a preforeclosure sale.
The benefits of a preforeclosure sale include avoidance of the costs of
foreclosure and a tendency for the property to sell at a better price because
the home is usually occupied. If a preforeclosure sale is not possible, Fannie
Mae's goal is to handle the foreclosure process expeditiously in order to
minimize the amount of time the Corporation retains a nonearning asset.
In 1998, Fannie Mae expanded on two initiatives introduced in 1997 that it
believes will contribute to reducing future credit losses. The first initiative,
Risk Profiler™, is a default prediction model that assists servicers in loss
mitigation activities. Risk Profiler predicts the likelihood that a loan will go
into default by using updated borrower credit data, current property values, and
loan characteristics, all of which are strong predictors of credit risk.
Currently, servicers are using Risk Profiler to evaluate more than seven million
loans on a quarterly basis, which represents approximately 75 percent of the
loans in Fannie Mae's book of business. Servicers have been able to integrate
the results from Risk Profiler into their loss mitigation activities to
prioritize their efforts on the high-risk loans if they become delinquent. As a
result of servicers using Risk Profiler, in 1998 Fannie Mae experienced an
increase in the number of loan workouts as compared with 1997, and management
expects this trend to continue as the use of Risk Profiler expands.
The second initiative involves placing Fannie Mae employees, or servicing
consultants, on-site with certain servicers to facilitate loss mitigation
efforts. The servicing consultants work with servicers to improve the default
management process and increase the number of loss mitigation workouts. At the
end of 1998, Fannie Mae had servicing consultants working on-site periodically
with nearly all of its major servicers. Servicing consultants also provide
value-added benefits to the servicer, including working with the servicer to
improve operational processes and implement best practices. As a result of this
initiative, Fannie Mae has experienced an increased flow of information between
itself and its servicers, which has led to greater efficiencies in the
servicers' loss mitigation activities, a strengthened relationship between
Fannie Mae and its servicers, and a reduction in credit losses.
Desktop Underwriter and Risk Profiler are part of Fannie Mae's strategy to
increase homeownership opportunities by providing a broad array of desktop
products that enable lenders to process and manage all of their business more
efficiently. Management expects to continue investing in research and technology
to provide lenders and Fannie Mae with additional quantitative information for
evaluating and managing credit risk while expanding homeownership opportunities.
In addition to Fannie Mae's continuing loss mitigation efforts, a much
stronger California economy, a healthy national housing market, and the
increased payments from mortgage insurance were key factors in the continued
improvement of credit performance in 1998. To illustrate the company's
improvement in California, at December 31, 1998, 20 percent of Fannie Mae's
total book of business was located in California, while 35 percent of Fannie
Mae's properties acquired due to foreclosure during the year were from
California. The comparable amounts in 1997 were 20 percent and 45 percent,
respectively. Moreover, 40 percent of total credit-related losses came from
California loans in 1998, compared with 61 percent in 1997. The improved
California economy has contributed to reductions in the number of foreclosures
and serious delinquencies, while strong home price appreciation has resulted in
a lower loss per case experienced on foreclosures.
As shown in the table below, single-family credit-related losses declined by
28 percent, or $96 million, in 1998, compared with 1997. The decrease in
credit-related losses was attributable to net recoveries experienced in 1998
compared with net charge-offs experienced in 1997, slightly offset by an
increase in foreclosed property expenses. The average loss per foreclosed
property decreased to $9,400 in 1998 from $12,800 in 1997, and single-family
foreclosed property acquisitions decreased to 20,703 in 1998, compared with
22,222 in 1997.
| Year Ended December 31, | |||
|---|---|---|---|
|
| |||
| 1998 | 1997 | 1996 | |
|
|
|
| |
| (Dollars in millions) | |||
| (Recoveries) Charge-offs, net | $(57) | $66 | $191 |
| Foreclosed property expenses | 306 | 279 | 216 |
|
|
|
| |
| Credit-related losses | $249 | $345 | $407 |
|
|
|
| |
| Credit loss ratio | .027% | .042% | .053% |
With the improvement in the California economy and a healthy national housing
market, Fannie Mae expects to continue to experience a reduction in its total
credit-related losses in 1999.
Fannie Mae's single-family credit loss ratio declined to .027 percent in
1998, compared with .042 percent in 1997. Management expects the 1999 credit
loss ratio to be somewhat lower than the 1998 level.
The total number of single-family properties owned by Fannie Mae at December
31, 1998, was 8,576, compared with 9,481 at December 31, 1997. These properties
had net carrying amounts of $730 million and $735 million at December 31, 1998
and 1997, respectively.
In evaluating expected future credit performance, management analyzes the
risk profile of the conventional single-family loans in Fannie Mae's mortgage
portfolio and underlying MBS. The loan-to-value ("LTV") ratio is an important
factor in credit performance because the amount of equity a borrower has in a
home has proven to be highly predictive of both the incidence and the severity
of default. Fannie Mae utilizes an increasing array of credit-risk-sharing
partnerships to manage credit risk. For instance, Fannie Mae offsets its
potential risk of loss by, among other strategies, requiring or purchasing
mortgage insurance, or structuring other credit protection on loans with LTV
ratios over 80 percent and certain loans with lower LTV ratios.
Fannie Mae experienced record volumes in 1998 as a result of the attractive
market conditions throughout much of the year. The lower interest rate
environment subjected a greater proportion of Fannie Mae's book of business to
refinancing, which in turn resulted in a large percentage of new business
consisting of refinanced fixed-rate mortgages. Refinanced loans typically have
higher credit quality because they usually involve loans with lower LTV ratios
and often convert higher-risk, adjustable-rate loans into lower-risk, fixed-rate
loans. Accordingly, management believes that the higher credit quality loans
added to Fannie Mae's portfolio in 1998 will contribute to improved credit
performance in the future.
Experience has shown that loan age is also a major factor affecting
delinquency rates and that the incidence of default for a group of mortgage
loans peaks in the third through fifth years after origination. Unless real
estate values decline significantly, loans outstanding after five years tend to
have lower default rates because borrowers have a history of being able to make
their payments and most likely have built up additional equity in their
properties. Between 1992 and 1994, Fannie Mae acquired a significant portion of
the loans in its portfolio and underlying MBS outstanding (30 percent of total
outstanding UPB at December 31, 1998). These loans are now largely past their
peak default years.
Product mix also influences potential future credit losses because the credit
risks associated with each product type vary. Adjustable-rate mortgages
generally have a higher incidence of default than long-term, fixed-rate
mortgages, while intermediate-term, fixed-rate mortgages tend to have a lower
incidence of default than long-term, fixed-rate mortgages.
The following table presents data, by percentage of UPB, on conventional
mortgage loans outstanding in the Corporation's own portfolio or underlying MBS
issued at December 31, 1998 and 1997 by product distribution, original LTV
ratio, and current LTV ratio. In addition, the table presents data by product
distribution and original LTV ratio for conventional loans purchased for the
corporation's portfolio or underlying MBS in the years 1998, 1997, and 1996.
Current LTV ratios are derived by adjusting the value of a property by the
estimated change in the price of the home since the mortgage was originated and
by comparing this adjusted value with the current UPB of the mortgage at
December 31, 1998 and 1997.
Distribution of Single-Family Loans
by Product Type
and Loan-to-Value Ratio
| Outstanding at | |||||
|---|---|---|---|---|---|
| December 31, | Percentage of Business Volumes | ||||
|
|
| ||||
| 1998 | 1997 | 1998 | 1997 | 1996 | |
|
|
|
|
|
| |
| Product: | |||||
| Long-term, fixed-rate | 69% | 64% | 77% | 72% | 70% |
| Intermediate-term, fixed-rate(1) | 24 | 26 | 19 | 17 | 22 |
| Adjustable-rate | 7 | 10 | 4 | 11 | 8 |
|
|
|
|
|
| |
| Total | 100% | 100% | 100% | 100% | 100% |
|
|
|
|
|
| |
| Original loan-to-value ratio: | |||||
| Greater than 90% | 12% | 13% | 10% | 16% | 16% |
| 81% to 90% | 15 | 17 | 12 | 17 | 18 |
| 71% to 80% | 40 | 38 | 43 | 40 | 38 |
| 61% to 70% | 15 | 14 | 16 | 13 | 13 |
| Less than 61% | 18 | 18 | 19 | 14 | 15 |
|
|
|
|
|
| |
| Total | 100% | 100% | 100% | 100% | 100% |
|
|
|
|
|
| |
| Average original loan-to-value ratio | 74% | 74% | 74% | 76% | 76% |
| Current loan-to-value ratio: | |||||
| Greater than 90% | 2% | 2% | |||
| 81% to 90% | 9 | 13 | |||
| 71% to 80% | 24 | 22 | |||
| 61% to 70% | 23 | 22 | |||
| Less than 61% | 42 | 41 | |||
|
|
|
||||
| Total | 100% | 100% | |||
|
|
|
||||
| Average current loan-to-value ratio | 61% | 62% | |||
| Average loan amount | $85,800 | $80,800 | $112,800 | $99,900 | $99,900 |
| (Maximum $227,150 in 1998) | |||||
(1) Contractual maturities of 20 years or less at purchase for portfolio
loans and 15 years or less at issue date for MBS issuances.
The following table summarizes conventional single-family serious delinquency
rates by region as of December 31, 1998, 1997, and 1996. Single-family serious
delinquency rates are based on the number of conventional loans in portfolio or
underlying MBS for which Fannie Mae has primary risk of loss and that are
delinquent 90 days or more or are in the process of foreclosure.
| December 31, | |||
|---|---|---|---|
|
| |||
| 1998 | 1997 | 1996 | |
|
|
|
| |
| Northeast | .83% | .89% | .87% |
| Southeast | .57 | .59 | .51 |
| Midwest | .41 | .40 | .33 |
| Southwest | .46 | .45 | .40 |
| West | .61 | .71 | .74 |
| Total | .58% | .62% | .58% |
Multifamily
There are two primary risks involved in the underwriting and management of
income-producing multifamily properties: (1) that underlying property cash flows
will be insufficient to service the debt over the life of the loan and (2) that
proceeds from the sale or refinancing of a property will be insufficient to
repay the loan at maturity.
Fannie Mae manages the credit risk on its multifamily loan portfolio in
several ways. First, the Corporation maintains rigorous loan-underwriting
guidelines coupled with extensive real estate due diligence examinations for
loan acquisitions. Because multifamily loans are primarily cash flow dependent
and much larger than single-family loans, management monitors the ongoing
performance of individual loans by requiring servicers to submit periodic
operating information and property condition reviews. This information, combined
with other loan risk characteristics, is used to evaluate the credit quality of
the portfolio, identify potential problem loans, and initiate appropriate loss
mitigation activities.
During the last two years, Fannie Mae has strengthened its credit risk
management of multifamily assets by creating a dedicated portfolio monitoring
team and expanding the quality control function. The activities of these groups
include detailed quarterly portfolio loss reviews, identification and monitoring
of borrower and geographic concentration risks, lender assessments, counterparty
risk analyses, and enhanced reviews of large transactions.
Fannie Mae also manages its credit risk exposure through various forms of
credit enhancement. For the majority of multifamily loans, Fannie Mae has shared
risk arrangements with lenders, full or partial recourse to lenders or third
parties for loan losses (which may be secured by letters of credit, investment
agreements, or pledged collateral), or government mortgage insurance. The
following table presents the risk profile, by UPB, of multifamily loans in the
Corporation's portfolio or underlying MBS at December 31, 1998, 1997, and 1996.
| December 31, | |||
|---|---|---|---|
|
| |||
| 1998 | 1997 | 1996 | |
|
|
|
| |
| Fannie Mae risk | 11% | 14% | 15% |
| Shared risk(1) | 52 | 48 | 44 |
| Recourse(2) | 37 | 38 | 41 |
|
|
|
| |
| Total | 100% | 100% | 100% |
|
|
|
| |
(1) Includes loans where the lender initially bears losses of up to 5 percent
of UPB and shares any remaining losses with Fannie Mae.
(2) Includes loans not included in "shared risk" that have government
mortgage insurance, or full or partial recourse to lenders or third parties.
As a result of strong underwriting standards and quality control processes,
continued improvements in the multifamily rental market, declining interest
rates, and continued emphasis on early loss mitigation efforts, the level of
serious delinquencies for multifamily loans has declined significantly over the
past several years.
Multifamily serious delinquencies at December 31, 1998, 1997, and 1996 were
.29 percent, .37 percent, and .68 percent, respectively. Multifamily serious
delinquencies are those loans for which Fannie Mae has primary risk of loss
(including those with shared risk) and that are delinquent two months or more.
Multifamily delinquency percentages are based on the UPB of such loans in
portfolio and underlying MBS.
Multifamily foreclosed property acquisitions where Fannie Mae has the primary
risk of loss totaled 12 properties and 28 properties during 1998 and 1997,
respectively. At December 31, 1998 and 1997, the corporation held 9 primary risk
foreclosed properties with an aggregate carrying value of $12 million and 14
such properties with an aggregate carrying value of $17 million, respectively.
Credit-related losses and the ratio of credit-related losses to average UPB
outstanding for multifamily loans in portfolio or underlying MBS are summarized
in the following table.
| Year Ended December 31, | |||
|---|---|---|---|
|
| |||
| 1998 | 1997 | 1996 | |
|
|
|
| |
| (Dollars in millions) | |||
| Charge-offs, net | $8 | $11 | $19 |
| Foreclosed property expense (income), net | 5 | (4) | (3) |
|
|
|
| |
| Credit-related losses | $13 | $7 | $16 |
|
|
|
| |
| Credit loss ratio | .036% | .020% | .054% |
In 1998, multifamily credit-related losses increased as a result of higher
foreclosed property expenses, primarily property preservation costs. Despite
increased business, credit-related losses have remained relatively low over the
past three years primarily because of aggressive management of delinquent
multifamily assets and a healthy multifamily rental market. Management
anticipates that these losses will increase somewhat in 1999.
Allowance for Losses
In evaluating the risk of loss on portfolio loans and MBS outstanding,
management considers current delinquency levels, historical loss experience,
current economic conditions, geographic concentrations, and other pertinent
factors. The allowance for losses is established by recording an expense for the
provision for losses. It is subsequently reduced through charge-offs on
foreclosed properties and is increased through recoveries on foreclosed
properties. Changes in the allowance for losses for the years 1994 through 1998
are presented in the following table.
| Total | |
|---|---|
|
| |
| (Dollars in millions) | |
| Balance, January 1, 1994 | $841 |
| Provision | 155 |
| Net foreclosure losses charged off | (169) |
|
| |
| Balance, December 31, 1994 | 827 |
| Provision | 140 |
| Net foreclosure losses charged off | (172) |
|
| |
| Balance, December 31, 1995 | 795 |
| Provision | 195 |
| Net foreclosure losses charged off | (210) |
| Balance, December 31, 1996 | 780 |
| Provision | 100 |
| Net foreclosure losses charged off | (77) |
|
| |
| Balance, December 31, 1997 | 803 |
|
| |
| Provision | (50) |
| Net recoveries | 49 |
|
| |
| Balance, December 31, 1998 | $802 |
|
|
Operational Risk Management
Operational risk is the risk of potential loss due to a breakdown in
established controls and procedures, examples of which include circumvention of
internal controls, fraud, human error, and systems malfunction or failure.
Fannie Mae has established extensive policies and procedures to decrease the
potential likelihood of such occurrences. Fannie Mae's Internal Audit Department
tests the adequacy of and adherence to internal controls and established
policies and procedures. Financial system data are regularly reconciled to
source documents to ensure the accuracy of financial system outputs.
Additionally, Fannie Mae has a comprehensive disaster recovery plan that is
designed to allow critical operations to be restored with minimal interruption
in the event of a natural disaster.
The use of financial forecast models is another potential operational risk.
To mitigate the risk associated with the use of financial models, Fannie Mae
regularly reconciles forecasted results to actual results and makes adjustments
to the models for differences affecting future periods.
The major operational risk faced by Fannie Mae is its Year 2000 system
compliance issue. Fannie Mae has been actively addressing the Year 2000 issues
that may result from computer programs that currently use two digits instead of
four digits to identify the year in a date field. If these issues are not
resolved, Fannie Mae's information technology ("IT") and non-IT systems (such as
facilities management systems) or those of its business partners may make
incorrect calculations or fail. Because this issue creates significant
operational risks, Fannie Mae has undertaken a major effort to identify and
modify its internal systems so that they are Year 2000 compliant. In addition,
Fannie Mae is coordinating with its business partners to assess whether their
systems will be operational in the Year 2000. However, due to the pervasive and
complex nature of the risks associated with Year 2000, there can be no assurance
that Fannie Mae will identify all the risks or undertake all actions necessary
to prevent a material adverse impact on the Corporation's business or results of
operations.
Risks Associated with the Year 2000
The business of Fannie Mae is highly dependent on the smooth interaction of
numerous internal and external (non-Fannie Mae) computer systems, and, as such,
the Year 2000 issue poses significant operational risks to Fannie Mae. Fannie
Mae is focusing on four types of Year 2000 risks: disruptions and/or
inaccuracies in decision support systems and business processing; disruptions
from third-party Year 2000 noncompliance; disruptions from Year 2000
noncompliance of funds and securities wiring and clearing systems, including the
Federal Reserve Bank; and disruptions in the telecommunications and utilities
industries and economic environment outside of Fannie Mae's control. These risks
may result in interruptions or delays in Fannie Mae's daily processing relating
to MBS issuance, mortgage purchases, financial reporting, calculation of
securities payments, and other matters. Such results could lead to loss of
revenue, loss of investor confidence, and possible litigation against the
Corporation. Fannie Mae cannot determine the likelihood or severity of such
events.
In addition, the level of economic and market activities may be temporarily
reduced as market participants assess the effectiveness of the global and
domestic markets' Year 2000 readiness in the period before and subsequent to the
Year 2000 date change. Such an event also could result in a reduction of Fannie
Mae's business activities. Fannie Mae cannot predict the likelihood of such a
reduction or estimate the impact such a reduction would have on its business.
Project Organization
Oversight of Fannie Mae's Year 2000 effort is structured in three tiers.
First, a core Year 2000 project team representing the technology and business
areas of Fannie Mae shares primary accountability for the overall Year 2000
effort. Second, a steering committee chaired by the President of Fannie Mae
meets monthly to review progress and resolve corporate-wide issues. Third,
Fannie Mae's Board of Directors interacts with the Year 2000 project team on a
regular basis to monitor project status.
Fannie Mae has developed a comprehensive approach to the Year 2000 issue that
includes preventative efforts and contingency planning to address the risks
discussed above. Fannie Mae has divided its Year 2000 project into three areas
of concentration: internal compliance, external compliance, and business
continuity planning. Internal compliance is designed to address the systems and
applications (internally developed and third-party vendor packages) used by
Fannie Mae employees. It also extends to Fannie Mae-developed applications that
are used by third parties. External compliance is designed to address Fannie Mae
applications with external interfaces and other electronic linkages between
Fannie Mae and its business partners. Business continuity planning includes
developing contingency plans for Fannie Mae's business operations.
Internal Compliance
Internal compliance involves four phases: (1) an inventory, assessment, and
planning phase; (2) a repair phase; (3) a validation phase; and (4) an
enterprise testing phase. Also included in internal compliance is
MORNET®/MORNETPlus® software compliance and facilities management readiness.
The inventory, assessment, and planning phase first identified existing
business applications and systems used internally (developed internally or
purchased from third-party vendors) and technology infrastructure components
that are sensitive to the date change. The second step in this phase assessed
the Year 2000 readiness of each identified application, system, or
infrastructure component. Finally, a timeline for necessary repair was planned.
Fannie Mae has completed the inventory, assessment, and planning phase.
The repair phase modified the code in an existing system or application that
is not Year 2000 compliant or, where necessary, replaced the existing system,
application, or infrastructure component with one that is designed to be Year
2000 compliant. The repair phase first addressed mission-critical systems
necessary for Fannie Mae to conduct its day-to-day operations and then proceeded
to non-mission-critical systems. Fannie Mae has completed the necessary repairs
on all identified mission-critical and non-mission-critical systems.
The validation phase tests systems and applications individually to ensure
that they are Year 2000 compliant. Fannie Mae's validation test environment is
designed to mirror its production environment and to test each system by
simulating key business events in the Year 2000. At December 31, 1998, Fannie
Mae completed 100 percent of the testing of all systems identified as mission
critical. Testing on identified non-mission-critical systems is expected to be
completed by the second quarter of 1999. At December 31, 1998, Fannie Mae
completed 90 percent of non-mission critical testing.
After the validation phase is completed for all systems, Fannie Mae will use
enterprise testing to further assess whether Fannie Mae will be able to operate
under normal business circumstances in the Year 2000. Fannie Mae expects to use
enterprise testing to simultaneously test both internal interfaces among Fannie
Mae's systems and external interfaces with certain of Fannie Mae's major
business partners using simulated Year 2000 business events. Fannie Mae expects
to begin enterprise testing in the second quarter of 1999 and to complete
enterprise testing early in the fourth quarter of 1999, followed by a suspension
of discretionary changes to Fannie Mae's production environment through January
2000.
Fannie Mae's internal compliance effort also involves efforts to make the
software provided to its customers Year 2000 ready. Most of Fannie Mae's lenders
use MORNET and MORNETPlus software applications to communicate with Fannie Mae.
Fannie Mae released 100 percent of its Year 2000-ready versions of these
applications to subscribers in 1998.
Fannie Mae's facilities, building security, and building control systems are
also likely to be affected by the Year 2000 date change. Providers of Fannie
Mae's facilities management services have been asked to submit Year 2000
certifications. Fannie Mae has received certifications from its facilities
management service providers and, on that basis, believes that Fannie Mae's
facilities, building security, and building control systems will be Year 2000
compliant by the second quarter of 1999.
External Compliance
External compliance focuses on business partners and, in particular, on those
with which Fannie Mae exchanges electronic information. These business partners
include lenders that sell loans to or service loans for Fannie Mae, securities
dealers, clearing agencies, securities depositories, data vendors, and the
Federal Reserve Bank. Fannie Mae's approach to the Year 2000 issue includes
measures intended to protect against the risk that its operations could be
materially affected by its business partners' failure to ensure Year 2000
readiness. These preventative measures include on-site assessments of major
lenders, evaluation of service providers, testing with the Federal Reserve Bank,
and participation in the Mortgage Bankers Association's ("MBA's") industry test.
Fannie Mae's Year 2000 project team has developed a methodology to evaluate
the Year 2000 readiness of its servicers. This includes on-site meetings with
each of Fannie Mae's top-tier servicers to determine their respective Year 2000
readiness. Fannie Mae has completed this assessment. Fannie Mae expects to
complete the assessment of the readiness of its smaller lenders by the second
quarter of 1999. Fannie Mae is one of the premier sponsors of the Year 2000
Inter-System Readiness Test sponsored by the MBA, which was developed to assist
servicers and other mortgage industry participants in evaluating their Year 2000
readiness. Fannie Mae has mandated that its servicers validate certain critical
business functions using the MBA test by March 31, 1999.
Fannie Mae's day-to-day operations are highly dependent on the smooth
interaction between Fannie Mae and its service providers. Fannie Mae's service
providers are involved in certain mission-critical activities, including the
securities clearing and depository functions. They also provide services related
to Fannie Mae's capital markets transactions. Accordingly, Fannie Mae's Year
2000 efforts include assessing the readiness of these service providers. Fannie
Mae is currently testing with its major external service providers, with the
degree of testing commensurate with the perceived level of business risk.
Fannie Mae's operations are also highly dependent on the Federal Reserve Bank
for handling book-entry securities and the wiring of funds and securities.
During 1998, Fannie Mae completed extensive testing with the Federal Reserve
Bank. Additionally, Fannie Mae established the Washington, DC, Year 2000
Usergroup, a forum for industry participants to share best practices regarding
Year 2000 awareness and readiness.
The steps outlined above are intended to evaluate Fannie Mae's external
business partners' Year 2000 readiness. However, Fannie Mae cannot predict the
Year 2000 compliance of these external entities. In the event that these
entities are not Year 2000 compliant, Fannie Mae's ability to purchase mortgage
loans and to issue, transfer, and make periodic payments on its debt, mortgage,
and other securities may be adversely affected.
Business Continuity Planning
The third area of concentration is business continuity planning. Fannie Mae
has completed its business continuity plan and will continue to refine it
throughout 1999. The business continuity plan identifies the most likely and
worst-case scenarios, prioritizes the risks associated with each scenario, and
addresses how Fannie Mae intends to handle such a scenario.
Fannie Mae's business continuity plan includes the addition of alternate
suppliers, including multiple telephone service providers, vendors, servicers,
and trading partners, as necessary, to permit business operations to continue
and to minimize possible disruptions if key business partners have significant
Year 2000 problems. Fannie Mae's plan also includes several measures designed to
ensure adequate liquidity in the event of Year 2000 problems affecting the
financial markets. Additional measures include backup systems, manual processes,
or changes in business practices. Fannie Mae expects to be prepared to move
functions from noncompliant partners to companies that are Year 2000 compliant,
if necessary. Fannie Mae intends to test key aspects of its business continuity
plan during 1999.
Costs
Fannie Mae's Year 2000 project is proceeding as scheduled and budgeted. The
estimated total cost to Fannie Mae is expected to be between $60 million and $65
million for the project, which began in early 1997 and runs through the year
2000. Approximately $38 million has been spent on the project from its inception
through December 31, 1998.
Balance Sheet Analysis
This section discusses Fannie Mae's mortgage portfolio and other investments
as well as related financing activities. A discussion of liquidity and capital
resources and regulatory capital requirements is also included.
Mortgage Portfolio
At December 31, 1998, the net mortgage portfolio totaled $415 billion,
compared with $316 billion at December 31, 1997. The increase in the net
mortgage portfolio was due primarily to the increased availability of mortgage
products in the secondary market resulting from the prolonged period of lower
interest rates; record fixed-rate mortgage originations; and wide
mortgage-to-debt spreads stemming from the period of exceptional market
turbulence in the fall of 1998. The volume of mortgage purchases in 1999 will
depend on financial and mortgage market conditions over the course of the year.
The yield on the net mortgage portfolio was 7.12 percent at December 31,
1998, compared with 7.60 percent at December 31, 1997. The yield on the net
mortgage portfolio averaged 7.38 percent in 1998, compared with 7.67 percent in
1997. The decline in both the ending yield and average yield for the year was
due largely to the lower interest rate environment that existed in 1998, which
resulted in the refinancing of many mortgages with high interest rates.
The following table summarizes mortgage purchases, sales, and repayments for
the years 1996 through 1998.
| Purchases | Sales | Repayments(1) | ||||||||
|---|---|---|---|---|---|---|---|---|---|---|
|
|
|
| ||||||||
| 1998 | 1997 | 1996 | 1998 | 1997 | 1996 | 1998 | 1997 | 1996 | ||
|
|
|
|
|
|
|
|
|
| ||
| (Dollars in millions) | ||||||||||
| Single-family: | ||||||||||
| Government insured
or guaranteed |
$6,016 | $5,539 | $4,461 | $— | $— | $— | $3,729 | $1,973 | $1,650 | |
| Conventional: | ||||||||||
| Long-term, fixed-rate | 147,615 | 55,925 | 54,021 | 1,383 | 563 | 105 | 60,718 | 20,995 | 17,554 | |
| Intermediate-term, fixed-rate |
28,703 | 6,001 | 8,139 | 1 | 26 | 44 | 18,713 | 10,688 | 10,564 | |
| Adjustable-rate | 3,507 | 1,977 | 706 | — | 476 | — | 2,965 | 2,807 | 2,789 | |
| Second | 22 | 29 | 17 | — | — | — | 84 | 84 | 117 | |
|
|
|
|
|
|
|
|
|
| ||
| Total single-family |
185,863 | 69,471 | 67,344 | 1,384 | 1,065 | 149 | 86,209 | 36,547 | 32,674 | |
| Multifamily | 2,585 | 994 | 1,274 | 409 | 23 | — | 2,658 | 3,204 | 2,254 | |
|
|
|
|
|
|
|
|
|
| ||
| Total | $188,448 | $70,465 | $68,618 | $1,793 | $1,088 | $149 | $88,867 | $39,751 | $34,928 | |
|
|
|
|
|
|
|
|
|
| ||
| Average net yield | 6.61% | 7.40% | 7.57% | 7.66% | 7.70% | 7.81% | ||||
| Repayments as a
percentage of average mortgage portfolio |
25.0% | 13.2% | 12.9% | |||||||
(1) Includes mortgage loan prepayments, scheduled amortization, and
foreclosures.
Investments
Fannie Mae maintains an investment portfolio consisting of high-quality,
short-term nonmortgage investments, such as federal funds, commercial paper,
repurchase agreements, asset-backed securities, and other investments. The
objectives of the investment portfolio are to serve as a source of liquidity and
to provide a return on the excess capital of Fannie Mae. As of December 31,
1998, the balance in Fannie Mae's investment portfolio was $59 billion, compared
with $65 billion at December 31, 1997. The decline in the investment portfolio
was a result of Fannie Mae utilizing its excess capital, during the period of
exceptional market turbulence in the fall of 1998, to significantly increase its
purchases of mortgage loans in support of the market. The weighted-average
interest rate earned on investment securities was 5.76 percent for 1998 and 5.82
percent for 1997.
Additional information on these investments is presented in Note 4 to the
Financial Statements, "Investments."
Financing Activities
The following table sets forth the amount and average cost of debt issued and
repaid in 1998, 1997, and 1996, and of debt outstanding at the end of each year.
The average cost of debt outstanding at December 31, 1998 was 6.10 percent,
compared with 6.46 percent at December 31, 1997. The average cost of debt
outstanding at December 31, 1998 declined because of lower interest rates during
1998 and the call and refunding of higher-cost debt. The weighted-average
maturity of effective long-term, fixed-rate debt outstanding at December 31,
1998 and 1997 was 68 months and 66 months, respectively.
Short-Term and Long-Term Debt Activity
| 1998 | 1997 | 1996 | |
|---|---|---|---|
|
|
|
| |
| (Dollars in millions) | |||
| Issued during the year: | |||
| Short-term(1): | |||
| Amount | $695,495 | $755,281 | $635,595 |
| Average cost | 5.42% | 5.53% | 5.36% |
| Long-term(1): | |||
| Amount | $147,430 | $86,325 | $80,302 |
| Average cost | 5.81% | 6.37% | 6.17% |
| Repaid during the year: | |||
| Short-term(1): | |||
| Amount | $657,308 | $738,552 | $636,768 |
| Average cost | 5.51% | 5.49% | 5.41% |
| Long-term(1): | |||
| Amount | $94,728 | $63,690 | $46,937 |
| Average cost | 6.40% | 6.65% | 6.93% |
| Outstanding at year-end: | |||
| Due within one year: | |||
| Net amount | $205,413 | $175,400 | $159,900 |
| Average cost(2) | 5.33% | 5.76% | 5.66% |
| Due after one year: | |||
| Net amount | $254,878 | $194,374 | $171,370 |
| Average cost(2) | 6.25% | 6.67% | 6.66% |
| Total debt: | |||
| Net amount | $460,291 | $369,774 | $331,270 |
| Average cost(2) | 6.10% | 6.46% | 6.49% |
(1) "Short-term" refers to the face amount of debt issued with an original
term of one year or less. "Long-term" is the face amount of debt issued with an
original term greater than one year.
(2) Average cost includes the amortization of premiums, discounts, issuance
costs, hedging results, and the effects of currency, debt and interest rate
swaps.
In 1998, Fannie Mae initiated a new funding product called Benchmark Notes.
Benchmark Notes are large issues of noncallable debt securities designed to
provide liquidity and performance to investors while reducing Fannie Mae's cost
of debt. Benchmark Notes have served to consolidate much of Fannie Mae's
long-term debt issuances from a large number of small, unscheduled issues to a
smaller number of larger, regular, more liquid issues. During 1998, Fannie Mae
issued $42 billion of Benchmark Notes with maturities ranging from 3 years to 10
years.
As described under "Risk Management—Interest Rate Risk Management," matching
the duration of mortgage assets with the duration of liabilities funding those
assets is accomplished through the use of varied debt maturities and embedded
option characteristics, as well as the use of off-balance-sheet financial
instruments, primarily interest rate swaps, caps, and swaptions.
The following table presents option-embedded debt instruments as a percentage
of mortgage purchases and the net mortgage portfolio. Option-embedded debt
instruments include derivative financial instruments.
| 1998 | 1997 | 1996 | |
|---|---|---|---|
|
|
|
| |
| (Dollars in billions) | |||
| Issued during the year | $113 | $36 | $44 |
| Percentage of total mortgage purchases | 60% | 51% | 64% |
| Outstanding at year-end | $174 | $139 | $130 |
| Percentage of total net mortgage portfolio | 42% | 44% | 45% |
The decline in the percentage of option-embedded debt instruments to 42
percent at December 31, 1998 from 44 percent at December 31, 1997 was primarily
attributable to the large amount of debt called in 1998.
Derivative financial instruments increase the flexibility of Fannie Mae's
funding alternatives by providing the specific cash flows or characteristics
that the portfolio requires but that might not be as readily available or
cost-effective if obtained in the standard debt market. Fannie Mae does not
speculate using derivatives and does not engage in derivatives trading. Fannie
Mae primarily uses four types of derivative instruments: (1) generic swaps,
which involve the exchange of fixed and variable interest payments based on
contractual notional principal amounts, and which may include callable swaps
(which give the counterparties or, in some cases, Fannie Mae the right to
terminate the interest rate swap agreement before its stated maturity); (2)
basis swaps, whereby the Corporation exchanges variable payments that have
maturities similar to the underlying debt but rates based on different indices;
(3) swaptions, which provide Fannie Mae with the option to enter into a swap at
a future date, thereby mirroring the economic effect of callable debt; and (4)
interest rate caps, which effectively cap the interest rate on a variable-rate
debt instrument in exchange for a premium.
The following table summarizes Fannie Mae's derivative activity for the years
ended December 31, 1998 and 1997, together with the expected maturities and
weighted-average interest rates to be received and paid on these derivative
instruments.
| Generic-Pay | Pay | ||||||
|---|---|---|---|---|---|---|---|
| Fixed/Receive Variable Swaps(1) | Variable/ | ||||||
|
|
Receive | ||||||
| Pay | Receive | Fixed | Basis | Caps and | |||
| Notional(2) | Rate(3) | Rate(3) | Swaps | Swaps | Swaptions | Total | |
|
|
|
|
|
|
|
| |
| (Dollars in millions) | |||||||
| Balance on January 1, 1997 | $100,111 | 6.73% | 5.59% | $15,624 | $40,078 | $— | $155,813 |
| Additions | 12,557 | 6.56 | 5.71 | 24,685 | 15,234 | — | 52,476 |
| Maturities | 15,955 | 6.36 | 5.69 | 10,656 | 32,929 | — | 59,540 |
|
|
|
|
|
|
|
| |
| Balance on December 31, 1997 | 96,713 | 6.77 | 5.82 | 29,653 | 22,383 | — | 148,749 |
| Additions | 23,725 | 5.31 | 5.28 | 20,448 | 10,931 | 27,165 | 82,269 |
| Maturities | 24,424 | 6.25 | 5.72 | 20,631 | 16,395 | — | 61,450 |
|
|
|
|
|
|
|
| |
| Balance on December 31, 1998 | $96,014 | 6.53% | 5.30% | $29,470 | $16,919 | $27,165 | $169,568 |
|
|
|
|
|
|
|
| |
| Future Maturities (4) 1999 | $5,450 | 6.64% | 4.89% | $16,325 | $15,120 | $250 | $37,145 |
| 2000 | 14,648 | 5.18 | 5.19 | 3,275 | 1,200 | 5,500 | 24,623 |
| 2001 | 9,800 | 6.22 | 5.28 | 2,892 | — | 4,750 | 17,442 |
| 2002 | 4,950 | 6.28 | 5.36 | 400 | 79 | 7,000 | 12,429 |
| 2003 | 4,376 | 5.96 | 5.35 | 1,000 | 200 | 7,365 | 12,941 |
| Thereafter | 56,790 | 6.98 | 5.36 | 5,578 | 320 | 2,300 | 64,988 |
|
|
|
|
|
|
|
| |
| $96,014 | 6.53% | 5.30% | $29,470 | $16,919 | $27,165 | $169,568 | |
|
|
|
|
|
|
|
| |
(1) Included in the notional amounts are callable swaps of $26 billion, and
$23 billion with weighted-average pay rates of 4.93 percent, and 6.58 percent,
and weighted-average receive rates of 5.44 percent, and 5.89 percent at December
31, 1998, and December 31, 1997, respectively.
(2) The notional value only indicates the amount on which swap payments are
being calculated and does not represent the amount at risk of loss.
(3) The weighted-average interest rate payable and receivable is as of the
date indicated. The interest rates of the swaps may be floating-rate, so these
rates may change as prevailing interest rates change.
(4) Based on stated maturities. Assumes that variable interest rates remain
constant at December 31, 1998 levels.
Fannie Mae's interest rate swaps had a weighted-average term of 68 months and
72 months at December 31, 1998 and 1997, respectively. Long-term debt
outstanding, including the effect of swaps but excluding effective variable-rate
debt (i.e., long-term debt that reprices within one year), totaled $352 billion
at December 31, 1998, and $294 billion at December 31, 1997. Interest rate swaps
effectively lengthened the final maturity of Fannie Mae's liabilities by 13
months at December 31, 1998, and 18 months at December 31, 1997.
The primary risk posed by Fannie Mae's derivative instruments is credit risk,
or the risk that a counterparty will fail to meet its contractual obligations on
a transaction, thereby causing Fannie Mae to have to replace the derivative
instrument at market prices. Fannie Mae manages this risk by dealing only with
experienced counterparties with high credit quality, diversifying its derivative
instruments across many counterparties, and entering into interest rate swaps
under master agreements that require counterparties to post collateral if Fannie
Mae is exposed to credit loss exceeding an agreed-upon threshold. In addition,
master agreements provide for netting of certain amounts payable by each party.
Fannie Mae regularly monitors the exposures on its derivative instruments by
determining the market value of positions via dealer quotes and internal pricing
models. Fannie Mae held $72 million of collateral for derivative instruments at
December 31, 1998.
Fannie Mae's off-balance-sheet exposure on derivative instruments (taking
into account master agreements that allow for netting of payments) was $46
million at December 31, 1998, compared with $26 million at December 31, 1997.
Fannie Mae also hedges against fluctuations in interest rates on planned debt
issuances using derivative instruments that simulate the short sale of U.S.
Treasury securities, through interest rate swaps, and through deferred
rate-setting agreements. Gains and losses on these instruments are deferred and
reflected as basis adjustments to the cost of the debt when issued. The hedging
of anticipated debt issuances enables Fannie Mae to maintain an orderly and
cost-effective debt issuance schedule and to make daily loan purchase
commitments without significantly increasing its interest rate risk exposure.
Additional information on interest rate swaps and other off-balance-sheet
financial instruments are presented in Notes 13 and 15 to the Financial
Statements, "Off-Balance-Sheet Credit Risk" and "Disclosures of Fair Value of
Financial Instruments."
Liquidity and Capital Resources
Fannie Mae's statutory mission requires that it provide ongoing assistance to
the secondary market for mortgage loans. Fannie Mae therefore must raise funds
continually to support its mortgage purchase activity. The capital markets
traditionally have treated Fannie Mae's obligations as "federal agency" debt. As
a result, even though the U.S. government does not guarantee Fannie Mae's debt,
Fannie Mae has had ready access to funding at relatively favorable spreads.
Fannie Mae's primary sources of cash are issuances of debt obligations,
mortgage loan repayments, interest income, and MBS guaranty fees. In addition,
at December 31, 1998, Fannie Mae had cash and cash equivalents and short-term
investments totaling $59 billion, compared with $67 billion at December 31,
1997. Primary uses of cash include the purchase of mortgages and other
securities, repayment of debt, interest payments, administrative expenses, and
taxes.
At December 31, 1998, Fannie Mae had mandatory delivery commitments and
lender-option commitments outstanding to purchase $11 billion and $2 billion of
mortgage loans, respectively, compared with $4 billion and $2 billion,
respectively, outstanding at December 31, 1997.
Fannie Mae's capital base (stockholders' equity plus general allowance for
losses) grew to $16.2 billion at December 31, 1998, compared with $14.6 billion
at the end of 1997. At year-end 1998, there were 1.025 billion shares of common
stock outstanding. In January 1999, the Board of Directors approved a quarterly
dividend rate for 1999 of $.27 per common share, and dividends of $.80125 per
Series A preferred share, $.81250 per Series B preferred share, $.80625 per
Series C preferred share, and $.65625 per Series D preferred share for the
period December 31, 1998, up to but excluding March 31, 1999. In 1998, the
quarterly dividend rate was $.24 per common share.
During the third quarter of 1998, Fannie Mae issued 3 million shares of 5.25
percent noncumulative preferred stock, Series D, with a stated value of $50 per
share. In addition, in October 1998, the Board of Directors authorized the
issuance of up to $850 million in preferred stock by January 1, 2001. During
1998, Fannie Mae continued implementing its capital restructuring program,
approved by the Board of Directors in December 1995, by repurchasing 17 million
shares of common stock. The shares were repurchased pursuant to the Board's
approval for the repurchase of up to an additional six percent of outstanding
common shares as of December 27, 1995 (adjusted for a stock split), to offset
the dilutive effect of common shares issued or expected to be issued in
conjunction with various stock compensation plans, and to use the $150 million
proceeds from the Series D preferred stock offering. In 1997, Fannie Mae
repurchased 31 million shares of common stock to offset the effect of shares
issued in conjunction with various stock compensation plans and toward the
aforementioned capital restructuring program.
Fannie Mae assesses the adequacy of its capital using an internally developed
stress test methodology. The stress test model calculates the amount of capital
required under different economic scenarios. By using this model, Fannie Mae can
estimate the amount of capital needed to carry out the company's mission during
times of economic distress. At December 31, 1998, Fannie Mae's capital was
sufficient under all tested scenarios. As discussed below, a regulatory capital
standard based on a stress test is being developed.
Regulatory Capital Requirements
Fannie Mae is subject to capital adequacy and risk-based standards
established by the 1992 Act. The capital adequacy standards require that Fannie
Mae's core capital equal or exceed a minimum capital standard and a critical
capital standard. The following table shows Fannie Mae's core capital compared
with the requirements.
| December 31, | ||
|---|---|---|
|
| ||
| 1998 | 1997 | |
|
|
| |
| (Dollars in millions) | ||
| Core capital(1) | $15,465 | $13,793 |
| Required minimum capital(2) | 15,334 | 12,703 |
| Required critical capital(3) | 7,863 | 6,528 |
| Excess of core capital over minimum capital | $131 | $1,090 |
(1) The sum of (a) the par value of outstanding common stock; (b) the par
value of outstanding noncumulative perpetual preferred stock; (c) paid-in
capital; and (d) retained earnings.
(2) The sum of (a) 2.50 percent of on-balance-sheet assets; (b) .45 percent
of outstanding MBS; and (c) .45 percent of other off- balance-sheet obligations,
except as adjusted by the Director of OFHEO.
(3) The sum of (a) 1.25 percent of on-balance-sheet assets; (b) .25 percent
of outstanding MBS; and (c) .25 percent of other off-balance-sheet obligations,
except as adjusted by the Director of OFHEO.
The Director of OFHEO also is developing a risk-based standard consistent
with the parameters specified in the 1992 Act. The risk-based standard includes
credit and interest rate risk components along with an additional amount of
required capital for management and operations risk. To meet that standard,
Fannie Mae must hold total capital equal to the amount necessary to meet the
combined occurrence of highly stressful credit and interest rate conditions over
a ten-year period, plus an additional 30 percent of this amount for management
and operations risk.
The Director of OFHEO publicly released Part I of the proposed risk-based
capital regulations in 1996. Part I creates benchmarks for credit testing and
specifies the housing price index that will be used in connection with this
standard. After interagency review and comment, OFHEO recently sent Part II of
the proposed risk-based capital regulations to Congress for review and comment.
After the Congressional review period, OFHEO is expected to publish Part II for
public review and comment. Part II will specify the remaining credit risk
criteria and the interest rate risk criteria. The 1992 Act provides that the
final regulations will be enforceable one year after issuance. Management is
confident that Fannie Mae will be able to meet any reasonable stress test. See
"Government Regulation and Charter Act."
Mortgage-Backed Securities
MBS outstanding grew to $835 billion at December 31, 1998, compared with $710
billion at December 31, 1997. MBS are backed by loans from a single lender, from
multiple lenders, or from Fannie Mae's mortgage loan portfolio. Single-lender
MBS are issued through lender swap transactions whereby a lender exchanges pools
of mortgage loans for MBS. Multiple-lender MBS allow several lenders to pool
mortgage loans and receive, in return, MBS (called Fannie Majors®) representing
a proportionate share of a larger pool. In some instances, Fannie Mae buys loans
and at the same time enters into a forward sale commitment. These loans are
designated as held for sale and sold from the portfolio as MBS.
MBS are not assets of Fannie Mae, except when acquired for investment
purposes, nor are they recorded as liabilities. However, Fannie Mae is liable
under its guarantee to make timely payment of principal and interest to
investors. The issuance of MBS creates guaranty fee income for Fannie Mae.
Sellers of pools of mortgage loans may retain or transfer to one or more third
parties the primary default risk on loans constituting the MBS pools, or they
may elect to transfer this credit risk to Fannie Mae. The guaranty fee paid by
the lender varies, depending on the risk profile of the loans securitized as
well as the level of credit risk assumed by Fannie Mae. Fannie Mae, however,
assumes the ultimate risk of loss on all MBS.
The table below summarizes MBS issued and outstanding for the years ended
December 31, 1998, 1997, and 1996. The increase in the total amount of MBS
issued compared with prior periods was due to several factors including a
sustained period of lower interest rates that resulted in record mortgage
originations and increased refinance activity. The increase in the percentage of
total MBS issued in the lender or shared risk category in 1998, compared with
1997, was primarily a result of increases in deals in which the default risk is
shared with a third party.
| Issued(1) | Outstanding(1) | |||||
|---|---|---|---|---|---|---|
|
|
| |||||
| Lender | Lender | |||||
| or | or | |||||
| Shared | Fannie Mae | Shared | Fannie Mae | |||
| Risk | Risk | Total | Risk(2) | Risk | Total(3) | |
|
|
|
|
|
|
| |
| (Dollars in millions) | ||||||
| 1998 | $90,694 | $235,454 | $326,148 | $160,223 | $674,295 | $834,518 |
| 1997 | 35,740 | 113,689 | 149,429 | 94,262 | 615,320 | 709,582 |
| 1996 | 13,389 | 136,480 | 149,869 | 70,642 | 580,138 | 650,780 |
(1) Based on primary default risk category. MBS outstanding includes MBS that
have been pooled to back Fannie Megas, SMBS, or REMICs.
(2) Included in lender risk are $123 billion, $57 billion, and $31 billion at
December 31, 1998, 1997, and 1996, respectively, on which the lender or a third
party had agreed to bear default risk limited to a certain portion or percentage
of the loans delivered and, in some cases, on which the lender had pledged
collateral to secure that obligation.
(3) Included are $197 billion, $130 billion, and $103 billion at December 31,
1998, 1997, and 1996, respectively, of MBS in Fannie Mae's portfolio.
Fannie Mae issues REMICs backed by MBS, SMBS, Ginnie Mae mortgage-backed
securities, other REMIC securities, or whole loans. REMICs provide an additional
source of fee income that does not subject the Corporation to added credit risk,
except for REMICs backed by whole loans. In 1998, REMIC issuances were $76
billion, compared with $75 billion in 1997. The outstanding balance of REMICs at
December 31, 1998 was $311 billion, compared with $329 billion at December 31,
1997.
Housing Goals
The 1992 Act gives the Secretary of HUD authority to establish low- and
moderate-income, underserved areas, and special affordable housing goals for
Fannie Mae. In December 1995, the Secretary of HUD issued final regulations
setting the housing goals for 1996 through 1999. Under the final regulation, the
Corporation's goal for 1997 through 1999 in low- and moderate-income housing is
42 percent of Fannie Mae's conventional mortgage business. The geographic goal
for 1997 through 1999, based on underserved census tracts in metropolitan
statistical areas and counties in rural areas, is 24 percent of Fannie Mae's
conventional mortgage business. The special affordable housing goal, which
serves very low-income families and low-income families in low-income areas, is
14 percent of Fannie Mae's single-family conventional mortgage business and
multifamily business for the years 1996 through 1999. Under this goal, Fannie
Mae also must include mortgage purchases of multifamily units totaling no less
than $1.3 billion (.8 percent of Fannie Mae's 1994 total dollar volume of such
mortgage purchases). All of these goals are measured as a percentage of dwelling
units financed.
Fannie Mae exceeded its low- and moderate-income housing goal in 1998 and
1997, with 44 percent and 45 percent, respectively, of its conventional mortgage
business counting toward this goal. In 1998, Fannie Mae exceeded its geographic
goal, with over 26 percent of its conventional mortgage business counting toward
this goal. Fannie Mae exceeded the 1997 geographic goal, with 29 percent of the
conventional mortgage business serving families in underserved areas. In
addition, in 1998 Fannie Mae exceeded its special affordable housing goal, with
over 15 percent of the conventional single-family and multifamily business
counting toward this goal and with $3.6 billion of multifamily business meeting
the $1.3 billion multifamily requirement. In 1997, Fannie Mae exceeded the
special affordable housing goal, with 19 percent of single-family and
multifamily business counting toward this goal and with special affordable
multifamily purchases of $3.2 billion.
Fannie Mae has built a solid foundation in affordable housing through
significant community outreach efforts, products directed at certain
disadvantaged groups, and the introduction of products with targeted
underwriting flexibilities, including an initiative to purchase loans with lower
down payments to help low-income households afford homes. In 1994, Fannie Mae
announced a commitment to increase outreach and access to mortgage credit under
our Trillion Dollar Commitment to serve 10 million households by the end of the
year 2000. Through the end of 1998, Fannie Mae has financed $700 billion under
this commitment, serving 8.3 million households. This targeted housing finance
serves families with incomes below the median for their areas, minorities and
new immigrants, families who live in central cities and distressed communities,
and people with special housing needs. With this announcement, Fannie Mae
pledged to provide the innovation and leadership necessary to transform the
housing finance industry into one without arbitrary barriers to individuals and
families who have been shut out of the dream of homeownership or have not had
ready access to decent, safe rental housing.
New Accounting Standard
In the second quarter of 1998, the Financial Accounting Standards Board
issued Financial Accounting Standard No. 133 ("FAS 133"), Accounting for
Derivative Instruments and Hedging Activities, which is effective for
Fannie Mae on January 1, 2000. FAS 133 requires that all derivatives be
recognized either as assets or liabilities on the balance sheet at fair value.
Subject to certain qualifying conditions, a derivative may be designated as
either a hedge of the fair value of a fixed-rate instrument (fair value hedge)
or as a hedge of the cash flows of a variable-rate instrument or anticipated
transaction (cash flow hedge). For a derivative qualifying as a fair value
hedge, fair value gains or losses would be reported in earnings along with
offsetting fair value gains or losses attributable to the risk being hedged. For
derivatives qualifying as a cash flow hedge, fair value gains or losses
associated with the risk being hedged would be reported in a separate component
of stockholders' equity (other comprehensive income) and then recognized in
earnings in the period(s) in which the hedged item affects income. For a
derivative instrument not qualifying as a hedge, fair value gains and losses
would be reported in earnings. Management currently is evaluating the impact
that this standard will have on its internal operations. If Fannie Mae continues
with its current business strategies, this standard will not have a significant
effect on net income, although it is likely to have a material effect on the
"other comprehensive income" component of stockholders' equity.
Comparison of 1997 with 1996
The following discussion and analysis provides a comparison of Fannie Mae's
results of operations for the years ended December 31, 1997 and 1996.
Results of Operations
Net income increased to $3.056 billion in 1997 from $2.725 billion in 1996,
and earnings per common share were $2.83, up from $2.48 in 1996.
Net interest income increased $357 million to $3.949 billion in 1997, as a
result of a $30 billion, or 11 percent, increase in the average mortgage
portfolio balance, which was partially offset by a 1 basis point decrease in the
average net interest margin.
Guaranty fee income increased $78 million to $1.274 billion in 1997, compared
with $1.196 billion in 1996. The increase in guaranty fee income resulted from a
$27 billion increase in average net Fannie Mae MBS outstanding coupled with an
increase of .3 basis points in the average effective guaranty fee rate.
Fee and other income increased $39 million to $125 million in 1997, compared
with $86 million in 1996. The 45 percent increase was due largely to increases
in income from structured transaction fees, multifamily fees, and special
transaction fees.
Credit-related expenses decreased $34 million to $375 million in 1997 from
$409 million in 1996. The decrease in credit-related expenses was driven by a
reduction in the provision for losses, reflecting a lower average loss per
foreclosed property in 1997. The lower average loss per foreclosed property
resulted from a stronger national housing market, increased payments from
mortgage insurance, and continued loss mitigation efforts.
Administrative expenses grew $76 million, or 14 percent, to $636 million in
1997, compared with $560 million in 1996. The increase in administrative
expenses resulted primarily from additional investments in systems development,
which included efforts to make Fannie Mae's computer systems Year 2000
compliant, expenses associated with restructuring the corporation's regional
offices, and the effect of a higher common share price on Fannie Mae's
stock-based compensation plans. Compensation expense was $394 million in 1997,
compared with $344 million in 1996.
The provision for federal income taxes, net of the tax benefit from
extraordinary losses, was $1.262 billion in 1997, compared with $1.135 billion
in 1996. The effective federal income tax rate was 29 percent for both periods.
During 1997, the amount of long-term debt called or repurchased and the
notional principal amount of interest rate swaps called was $31 billion, with a
weighted-average cost of 7.22 percent. The comparable amount in 1996 was $26
billion, with a weighted-average cost of 7.09 percent. As a result of repurchase
and call activity, Fannie Mae recognized net extraordinary losses of $19 million
($12 million after tax) in 1997, compared with $45 million ($29 million after
tax) in 1996. The repurchase or call of high-coupon debt favorably affects
Fannie Mae's future cost of funds.
FANNIE MAE
INDEX TO FINANCIAL
STATEMENTS
To the Board of Directors and Stockholders of Fannie Mae:
We have audited the accompanying balance sheets of Fannie Mae as of December
31, 1998 and 1997, and the related statements of income, changes in
stockholders' equity, and cash flows for each of the years in the three-year
period ended December 31, 1998. These financial statements are the
responsibility of Fannie Mae's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Fannie Mae as of December 31,
1998 and 1997, and the results of its operations and its cash flows for each of
the years in the three-year period ended December 31, 1998, in conformity with
generally accepted accounting principles.
We also have audited in accordance with generally accepted auditing standards
the supplemental fair value balance sheets of Fannie Mae as of December 31, 1998
and 1997, included in Note 15 to the financial statements. As described in Note
15, the supplemental fair value balance sheets have been prepared by management
to present relevant financial information that is not provided by the financial
statements and is not intended to be a presentation in conformity with generally
accepted accounting principles. In addition, the supplemental fair value balance
sheets do not purport to present the net realizable, liquidation, or market
value of Fannie Mae as a whole. Furthermore, amounts ultimately realized by
Fannie Mae from the disposal of assets may vary significantly from the fair
values presented. In our opinion, the supplemental fair value balance sheets
included in Note 15 present fairly, in all material respects, the information
set forth therein.
KPMG LLP
Washington, DC
January 13, 1999
| Year Ended December 31, | |||
|---|---|---|---|
|
| |||
| 1998 | 1997 | 1996 | |
|
|
|
| |
| (Dollars in millions, | |||
| except per common share amounts) | |||
| Interest income: | |||
| Mortgage portfolio | $25,676 | $22,716 | $20,560 |
| Investments and cash equivalents | 4,319 | 3,662 | 3,212 |
|
|
|
| |
| Total interest income | 29,995 | 26,378 | 23,772 |
|
|
|
| |
| Interest expense: | |||
| Short-term debt | 4,809 | 3,659 | 3,395 |
| Long-term debt | 21,076 | 18,770 | 16,785 |
|
|
|
| |
| Total interest expense | 25,885 | 22,429 | 20,180 |
|
|
|
| |
| Net interest income | 4,110 | 3,949 | 3,592 |
|
|
|
| |
| Other income: | |||
| Guaranty fees | 1,229 | 1,274 | 1,196 |
| Fee and other income, net | 275 | 125 | 86 |
|
|
|
| |
| Total other income | 1,504 | 1,399 | 1,282 |
|
|
|
| |
| Other expenses: | |||
| Provision for losses | (50) | 100 | 195 |
| Foreclosed property | 311 | 275 | 214 |
| Administrative | 708 | 636 | 560 |
|
|
|
| |
| Total other expenses | 969 | 1,011 | 969 |
|
|
|
| |
| Income before federal income taxes and extraordinary item | 4,645 | 4,337 | 3,905 |
| Provision for federal income taxes | 1,201 | 1,269 | 1,151 |
|
|
|
| |
| Income before extraordinary item | 3,444 | 3,068 | 2,754 |
| Extraordinary item—loss on early extinguishment of
debt (net of tax effect of $14 million in 1998, $7 million in 1997, and $16 million in 1996) |
26 | 12 | 29 |
|
|
|
| |
| Net income | $3,418 | $3,056 | $2,725 |
|
|
|
| |
| Preferred stock dividends | 66 | 65 | 42 |
|
|
|
| |
| Net income available to common stockholders | $3,352 | $2,991 | $2,683 |
|
|
|
| |
| Basic earnings per common share (1): | |||
| Earnings before extraordinary item | $3.28 | $2.87 | $2.53 |
| Extraordinary item | (.02) | (.02) | (.03) |
|
|
|
| |
| Net earnings | $3.26 | $2.85 | $2.50 |
|
|
|
| |
| Diluted earnings per common share (1): | |||
| Earnings before extraordinary item | $3.26 | $2.84 | $2.51 |
| Extraordinary item | (.03) | (.01) | (.03) |
|
|
|
| |
| Net earnings | $3.23 | $2.83 | $2.48 |
|
|
|
| |
| Cash dividends | $.96 | $.84 | $.76 |
| Weighted-average shares outstanding: | |||
| Basic | 1,029 | 1,049 | 1,071 |
| Diluted | 1,037 | 1,056 | 1,080 |
(1) Earnings per share amounts in 1996 have been restated to comply with
Financial Accounting Standard No. 128, Earnings per Share.
FANNIE MAE
BALANCE SHEETS
| Assets | ||
| December 31, | ||
|---|---|---|
|
| ||
| 1998 | 1997 | |
|
|
| |
| (Dollars in millions) | ||
| Mortgage portfolio, net | $415,223 | $316,316 |
| Investments: | ||
| Held-to-maturity | 42,299 | 58,690 |
| Available-for-sale | 16,216 | 5,906 |
| Cash and cash equivalents | 743 | 2,205 |
| Accrued interest receivable | 3,453 | 2,864 |
| Acquired property and foreclosure claims, net | 827 | 919 |
| Other | 6,253 | 4,773 |
|
|
| |
| Total assets | $485,014 | $391,673 |
|
|
| |
| Liabilities and Stockholders' Equity | ||
| Liabilities: | ||
| Debentures, notes and bonds, net: | ||
| Due within one year | $205,413 | $175,400 |
| Due after one year | 254,878 | 194,374 |
|
|
| |
| Total | 460,291 | 369,774 |
| Accrued interest payable | 5,262 | 4,611 |
| Other | 4,008 | 3,495 |
|
|
| |
| Total liabilities | 469,561 | 377,880 |
|
|
| |
| Stockholders' Equity: | ||
| Preferred stock, $50 stated
value, 100 million
shares authorized— 23 million shares outstanding in 1998 and 20 million shares outstanding in 1997 |
1,150 | 1,000 |
| Common stock, $.525 stated
value, no maximum
authorization— 1,129 million shares outstanding |
593 | 593 |
| Additional paid-in capital | 1,533 | 1,495 |
| Retained earnings | 15,689 | 13,326 |
| Accumulated other comprehensive income | (13) | (1) |
|
|
| |
| 18,952 | 16,413 | |
| Less: Treasury stock, at
cost, 104 million shares in 1998 and
92 million shares in 1997 |
3,499 | 2,620 |
|
|
| |
| Total stockholders' equity | 15,453 | 13,793 |
|
|
| |
| Total liabilities and stockholders' equity | $485,014 | $391,673 |
|
|
| |
FANNIE MAE
STATEMENTS OF CHANGES IN
STOCKHOLDERS' EQUITY
| Number of | Accumulated | |||||||
|---|---|---|---|---|---|---|---|---|
| Common | Additional | Other | Total | |||||
| Shares | Preferred | Common | Paid-In | Retained | Comprehensive | Treasury | Stockholders' | |
| Outstanding | Stock | Stock | Capital | Earnings | Income | Stock | Equity | |
|
|
|
|
|
|
|
|
| |
| (Dollars and shares in millions) | ||||||||
| Balance, January 1, 1996 | 1,092 | $— | $593 | $1,389 | $9,348 | $— | $(371) | $10,959 |
| Comprehensive Income: | ||||||||
| Net income | — | — | — | — | 2,725 | — | — | 2,725 |
| Other comprehensive income: | ||||||||
| Unrealized
losses
on available-for-sale securities, net of tax effect |
— | — | — | — | — | (1) | — | (1) |
|
| ||||||||
| Total comprehensive income | 2,724 | |||||||
| Dividends | — | — | — | — | (858) | — | — | (858) |
| Shares repurchased | (48) | — | — | — | — | — | (1,536) | (1,536) |
| Preferred stock issued | — | 1,000 | — | (20) | — | — | — | 980 |
| Contribution to Foundation | 11 | — | — | 12 | — | — | 338 | 350 |
| Treasury stock issued for
stock options and benefit plans |
6 | — | — | 70 | — | — | 84 | 154 |
|
|
|
|
|
|
|
|
| |
| Balance, December 31, 1996 | 1,061 | 1,000 | 593 | 1,451 | 11,215 | (1) | (1,485) | 12,773 |
| Comprehensive Income: | ||||||||
| Net income | — | — | — | — | 3,056 | — | — | 3,056 |
| Other comprehensive income: | ||||||||
| Unrealized
losses
on available-for-sale securities, net of tax effect |
— | — | — | — | — | — | — | — |
|
| ||||||||
| Total comprehensive income | 3,056 | |||||||
| Dividends | — | — | — | — | (945) | — | — | (945) |
| Shares repurchased | (31) | — | — | — | — | — | (1,291) | (1,291) |
| Treasury stock issued for
stock options and benefit plans |
7 | — | — | 44 | — | — | 156 | 200 |
|
|
|
|
|
|
|
|
| |
| Balance, December 31, 1997 | 1,037 | 1,000 | 593 | 1,495 | 13,326 | (1) | (2,620) | 13,793 |
| Comprehensive Income: | ||||||||
| Net income | — | — | — | — | 3,418 | — | — | 3,418 |
| Other comprehensive income: | ||||||||
| Unrealized
losses
on available-for-sale securities, net of tax effect |
— | — | — | — | — | (12) | — | (12) |
|
| ||||||||
| Total comprehensive income | 3,406 | |||||||
| Dividends | — | — | — | — | (1,055) | — | — | (1,055) |
| Shares repurchased | (17) | — | — | — | — | — | (1,051) | (1,051) |
| Preferred stock issued | — | 150 | — | — | — | — | — | 150 |
| Treasury
stock issued for stock options and benefit plans |
5 | — | — | 38 | — | — | 172 | 210 |
|
|
|
|
|
|
|
|
| |
| Balance, December 31, 1998 | 1,025 | $1,150 | $593 | $1,533 | $15,689 | $(13) | $(3,499) | $15,453 |
|
|
|
|
|
|
|
|
| |
| Year Ended December 31, | |||
|---|---|---|---|
|
| |||
| 1998 | 1997 | 1996 | |
|
|
|
| |
| (Dollars in millions) | |||
| Cash flows from operating activities: | |||
| Net income | $3,418 | $3,056 | $2,725 |
| Adjustments to reconcile net income to net cash provided | |||
| by operating activities: | |||
| Discount amortization on short-term debt | 5,828 | 5,012 | 4,338 |
| Provision for losses | (50) | 100 | 195 |
| Loss on early extinguishment of debt | 40 | 19 | 45 |
| Other decreases, net | (1,540) | (1,691) | (830) |
|
|
|
| |
| Net cash provided by operating activities | 7,696 | 6,496 | 6,473 |
|
|
|
| |
| Cash flows from investing activities: | |||
| Purchases of mortgages | (189,721) | (70,768) | (68,471) |
| Proceeds from sales of mortgages | 1,824 | 1,082 | 102 |
| Mortgage principal repayments | 86,918 | 37,714 | 32,853 |
| Net proceeds from
disposition of
foreclosed properties |
2,890 | 3,085 | 2,448 |
| Net decrease (increase) in investments | 6,081 | (7,990) | 667 |
|
|
|
| |
| Net cash used in investing activities | (92,008) | (36,877) | (32,401) |
|
|
|
| |
| Cash flows from financing activities: | |||
| Proceeds from issuance of long-term debt | 149,034 | 86,079 | 79,189 |
| Payments to redeem long-term debt | (95,920) | (63,716) | (46,966) |
| Proceeds from issuance of short-term debt | 682,524 | 737,054 | 606,427 |
| Payments to redeem short-term debt | (650,961) | (725,584) | (610,876) |
| Net payments from stock activities | (1,827) | (2,097) | (1,314) |
|
|
|
| |
| Net cash provided by financing activities | 82,850 | 31,736 | 26,460 |
|
|
|
| |
| Net (decrease) increase in cash and cash equivalents | (1,462) | 1,355 | 532 |
| Cash and cash equivalents at beginning of year | 2,205 | 850 | 318 |
|
|
|
| |
| Cash and cash equivalents at end of year | $743 | $2,205 | $850 |
|
|
|
| |
| Supplemental disclosures of cash flow information: | |||
| Cash paid during the year for: | |||
| Interest | $24,415 | $21,622 | $19,526 |
| Income taxes | 555 | 1,240 | 1,053 |
1. Summary of Significant Accounting Policies
Fannie Mae is a federally chartered and stockholder-owned corporation
operating in the residential mortgage finance industry.
The accounting and reporting policies of Fannie Mae conform with generally
accepted accounting principles. Certain amounts in prior years' financial
statements have been reclassified to conform with the current presentation.
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Mortgage Portfolio
Mortgages and mortgage-backed securities that Fannie Mae has the ability and
positive intent to hold to maturity are classified as held-to-maturity and are
carried at their unpaid principal balances ("UPB") adjusted for unamortized
purchase discount or premium and deferred price adjustments. Mortgage loans held
for sale are carried at the lower of cost or fair value, with any unrealized
losses included in current period earnings. Mortgage-backed securities that
Fannie Mae intends to hold for an undetermined period, but not necessarily to
maturity, are classified as available-for-sale and are carried at fair value,
with any valuation adjustments reported as a component of other comprehensive
income, net of deferred taxes, in stockholders' equity.
Fannie Mae uses actual principal prepayment experience and estimates of
future principal prepayments in calculating the constant effective yield
necessary to apply the interest method in the amortization of deferred price
adjustments and purchase discount or premium. In evaluating prepayments, loans
are aggregated by similar characteristics (e.g., loan type, acquisition date,
and maturity). Factors used in determining estimates of future prepayments
include historical prepayment data and expected prepayment performance under
varying interest rate scenarios.
Interest income is not accrued on nonperforming loans. Conventional
single-family and multifamily loans are classified as nonperforming and
previously accrued interest is removed from income when the collection of
interest payments is deemed less than probable.
Investments
Nonmortgage investments are classified as either available-for-sale or
held-to-maturity. Investments that are classified as available-for-sale are
carried at fair value as of the balance sheet date, with any valuation
adjustments reported as a component of other comprehensive income, net of
deferred taxes, in stockholders' equity. Investments that are classified as
held-to-maturity are carried at historical cost, adjusted for unamortized
discount or premium. Interest income is recognized on an accrual basis unless
the collection of interest income is considered doubtful, in which case interest
income is recognized on a cash basis.
Guaranteed Mortgage-Backed Securities
Fannie Mae guarantees the timely payment of principal and interest on most
Fannie Mae Mortgage-Backed Securities ("MBS"). These securities represent
beneficial interests in pools of mortgages or other mortgage-backed securities
held in trust by Fannie Mae. The pools of mortgages or mortgage-backed
securities are not assets of Fannie Mae, except when acquired for investment
purposes, nor are the related outstanding securities liabilities; accordingly,
neither are reflected on the accompanying balance sheets. Fannie Mae receives
monthly guaranty fees for each MBS mortgage pool based on a percentage of the
pool's outstanding balance. Adjustments to the guaranty fee rate effected
through an upfront payment at securitization are deferred and amortized into
guaranty fee income over the estimated life of the underlying loans using the
interest method. For MBS pools held in Fannie Mae's portfolio, the guaranty fee
is reflected as interest income.
Allowance for Losses
The allowance for losses is based on an analysis of portfolio loans and MBS
outstanding and provides for known probable losses and losses inherent in the
mortgage portfolio and MBS. Management's analysis considers current delinquency
levels, historical loss experience, current economic conditions, geographic
conditions and concentrations, and other pertinent factors. The allowance for
losses is established by recording an expense for the provision for losses. It
is subsequently reduced through charge-offs on foreclosed properties and is
increased through recoveries on foreclosed properties. In management's
judgement, the allowance for losses is adequate to provide for expected losses.
Acquired Property
Foreclosed assets are carried at the lower of cost or fair value less
estimated costs to sell. Cost is defined as fair value at foreclosure and
represents the amount that a willing seller could reasonably expect from a
willing buyer in an arm's-length transaction. The difference between estimated
fair value of the collateral at foreclosure and the carrying amount of the
underlying loan is recorded as a charge-off against the allowance for losses.
Foreclosure, holding, and disposition costs are charged directly to earnings.
Hedging Instruments
Fannie Mae utilizes certain financial instruments, such as interest rate
swaps, swaptions, derivative instruments that simulate the short sale of
Treasury securities, interest rate caps, deferred rate-setting agreements, and
foreign currency swaps to achieve a specific financing or investment objective
at a desired cost or yield. Fannie Mae does not engage in trading or other
speculative use of these financial instruments. Specific criteria must be met
for financial instruments to qualify as a hedge on either an accrual or a
deferred basis. Financial instruments not qualifying as hedges are marked to
market through earnings. Financial instruments used to hedge the anticipated
issuance of debt must maintain a high correlation between the hedging instrument
and the item being hedged, both at inception and throughout the hedge period.
Interest rate swaps are contractual agreements between two parties for the
exchange of periodic payments, generally based on a notional principal amount
and agreed-upon fixed and variable rates. Fannie Mae has long-term interest rate
swap agreements with various parties to extend the effective maturity of certain
short-term debt obligations and to adjust the effective maturity of certain
long-term debt obligations. Fannie Mae also has interest rate swap agreements
that are linked to specific debt issues ("debt swaps") or specific investments
("asset swaps"). These swaps achieve a specific financing or investment
objective at a desired cost or yield. The costs and terms of the specific debt
issues and yield of these specific investments, as presented in the financial
statements, include the effects of these swaps. Interest rate swaps are
accounted for on an accrual basis with the net payable or receivable recognized
as an adjustment to interest income or expense on the related assets or
liabilities. Gains or losses on terminated interest rate swaps are deferred and
amortized over the shorter of the remaining life of the hedged items or the term
of the original swap. The fair value of the interest rate swap agreements and
changes in these fair values as a result of changes in market interest rates are
not recognized in the financial statements.
Swaptions are derivative instruments that provide Fannie Mae with the option
to enter into an interest rate swap at a future date, thereby mirroring the
economic effect of callable debt. Swaptions are used to hedge planned debt
issuances or existing debt instruments. The fair value of the swaptions and
changes in these fair values as a result of changes in market interest rates are
not recognized in the financial statements.
Derivative instruments that simulate short sales of Treasury securities are
used to hedge interest rate risk on planned debt issuances. Gains and losses
that result from the hedge positions are deferred and recognized as adjustments
to debt cost over the life of the hedged debt issuance.
An interest rate cap agreement is entered into with a counterparty to
effectively cap Fannie Mae's exposure on a variable-rate debt instrument in a
rising interest rate environment. In exchange for the premium paid for the cap,
the counterparty agrees to pay Fannie Mae an amount equal to any interest on the
debt in excess of the agreed-upon rate. Interest rate caps are used to hedge
planned debt issuances. The fair value of the interest rate caps and changes in
these fair values as a result of changes in market interest rates are not
recognized in the financial statements.
Fannie Mae enters into deferred rate-setting agreements when fixed-rate debt
is issued prior to the commitment for mortgages that the debt will support.
Under these agreements, Fannie Mae is able to set the effective interest rate on
the debt based on prevailing market conditions at one or more future dates. At
settlement of all or a portion of a deferred rate-setting agreement, Fannie Mae
pays or receives cash in an amount representing the present value of the
interest rate differential between the fixed-rate debt and the prevailing rate.
Gains and losses that result from the hedge position are deferred and recognized
as adjustments to debt cost over the life of the debt issuance.
Fannie Mae issues debt securities in which principal, interest, or both are
payable in a foreign currency or are determined by reference to an index that
includes one or more foreign currencies. Concurrently, Fannie Mae enters into
currency swaps that convert the proceeds of certain borrowings into dollars or
provide for scheduled exchanges of the currencies to insulate Fannie Mae against
foreign currency exchange risk. Foreign currency swaps are accounted for on an
accrual basis with the net differential received or paid under such swaps
recognized as an adjustment to interest income or expense on the related asset
or liability. Foreign currency borrowings and the related net receivables and
payables from currency swaps are translated at the market rates of exchange as
of the balance sheet date.
Cash and Cash Equivalents
Fannie Mae considers highly liquid investment instruments, generally with an
original maturity of three months or less, to be cash equivalents. Cash
equivalents are carried at cost, which approximates fair value.
Income Taxes
Deferred federal income tax assets and liabilities are established for
temporary differences between financial and taxable income and are measured
using the current marginal statutory tax rate. Investment and other tax credits
are generally recognized when recorded on the tax return.
Comprehensive Income
In 1998, Financial Accounting Standard No. 130 ("FAS 130"), Reporting
Comprehensive Income, became effective. FAS 130 requires reporting of
comprehensive income by its components and in total in the financial statements.
Comprehensive income is defined as the change in equity of a business
enterprise during a period from transactions and other events and circumstances
from nonowner sources. It includes all changes in equity during a period except
those resulting from investments by owners and distributions to owners.
Fannie Mae adopted the requirements of FAS 130 on January 1, 1998.
Presentation of prior year amounts have been restated to conform with the
requirements of FAS 130.
2. Mortgage Portfolio, Net
The mortgage portfolio consisted of the following at December 31, 1998 and
1997.
| 1998 | 1997 | |
|---|---|---|
|
|
| |
| (Dollars in millions) | ||
| Single-family mortgages: | ||
| Government insured or guaranteed | $21,805 | $19,478 |
| Conventional: | ||
| Long-term, fixed-rate | 297,106 | 211,541 |
| Intermediate-term, fixed-rate(1) | 71,560 | 61,571 |
| Adjustable-rate | 11,873 | 11,373 |
| Second | 206 | 268 |
|
|
| |
| 402,550 | 304,231 | |
|
|
| |
| Multifamily mortgages: | ||
| Government insured | 3,607 | 3,360 |
| Conventional | 8,358 | 9,087 |
|
|
| |
| 11,965 | 12,447 | |
|
|
| |
| Total unpaid principal balance | 414,515 | 316,678 |
| Less: | ||
| Unamortized
(premium) discount and deferred price
adjustments, net |
(919) | 86 |
| Allowance for losses | 211 | 276 |
|
|
| |
| Net mortgage portfolio | $415,223 | $316,316 |
|
|
| |
(1) Intermediate-term consists of portfolio loans with contractual maturities
at purchase equal to or less than 20 years and MBS held in portfolio with
maturities of 15 years or less at issue date.
Included in the mortgage portfolio are $260 billion and $157 billion of MBS
and other mortgage-related securities at December 31, 1998 and 1997,
respectively, with fair values of $264 billion and $163 billion, respectively.
MBS held in portfolio at December 31, 1998 and 1997 included $77 billion and $35
billion, respectively, of Real Estate Mortgage Investment Conduits ("REMICs")
and Stripped MBS ("SMBS"). REMICs and SMBS backed by MBS do not subject Fannie
Mae to added credit risk but generally have different interest rate risks than
MBS. At December 31, 1998, these securities had aggregate gross unrealized
losses of $444 million and gross unrealized gains of $1,122 million. At December
31, 1997, the aggregate gross unrealized losses and gains were $175 million and
$796 million, respectively.
Mortgage assets available for sale were $8.9 billion with unrealized gains of
$17 million at December 31, 1998 and $.6 billion with unrealized gains of $1
million at December 31, 1997.
The UPB of multifamily impaired loans at December 31, 1998 was $250 million,
of which $120 million had a specific loss allowance, compared with $351 million
and $161 million, respectively, at December 31, 1997. The average balance of
impaired loans during 1998 and 1997 was $310 million and $438 million,
respectively.
Nonperforming loans outstanding totaled $3.2 billion at the end of 1998,
compared with $2.6 billion at the end of 1997. If these nonperforming loans had
been fully performing, they would have contributed an additional $68 million to
net interest income in 1998 and $138 million in 1997.
3. Allowance for Losses
Changes in the allowance for the years 1996 through 1998 are summarized
below.
| Total | |
|---|---|
|
| |
| (Dollars in millions) | |
| Balance, January 1, 1996 | $795 |
| Provision | 195 |
| Net foreclosure losses charged off | (210) |
|
| |
| Balance, December 31, 1996 | 780 |
| Provision | 100 |
| Net foreclosure losses charged off | (77) |
|
| |
| Balance, December 31, 1997 | 803 |
| Provision | (50) |
| Net recoveries | 49 |
|
| |
| Balance, December 31, 1998 | $802 |
|
|
At December 31, 1998, $211 million of the allowance for losses is included in
the balance sheet under "Mortgage portfolio, net," which represents the
allocation for portfolio loan losses; $588 million is included in liabilities
under "Other" for estimated losses on MBS; and the remainder, or $3 million,
which relates to unrecoverable losses on Federal Housing Administration loans,
is included in "Acquired property and foreclosure claims, net." The
corresponding amounts at December 31, 1997 were $276 million, $523 million, and
$4 million, respectively. Included in the allowance for losses at December 31,
1998, are $10 million of specific allowances for impaired loans, compared with
$21 million at the end of 1997. During 1998, Fannie Mae established $3 million
of specific allowances for these loans, compared with $29 million in 1997.
4. Investments
Presented below are the amortized cost and fair value of nonmortgage
investments classified as held-to-maturity at December 31, 1998 and 1997.
| 1998 | 1997 | |||||||
|---|---|---|---|---|---|---|---|---|
|
|
| |||||||
| Gross | Gross | Gross | Gross | |||||
| Amortized | Unrealized | Unrealized | Fair | Amortized | Unrealized | Unrealized | Fair | |
| Cost | Gains | Losses | Value | Cost | Gains | Losses | Value | |
|
|
|
|
|
|
|
|
| |
| (Dollars in millions) | ||||||||
| Held-to-maturity | ||||||||
| investments: | ||||||||
| Asset-backed securities |
$12,188 | $15 | $— | $12,203 | $13,034 | $1 | $— | $13,035 |
| Eurodollar time deposits |
5,179 | — | — | 5,179 | 12,828 | 1 | — | 12,829 |
| Commercial paper | 5,155 | 5 | — | 5,160 | 11,745 | 4 | — | 11,749 |
| Repurchase agreements | 7,556 | — | — | 7,556 | 6,715 | — | — | 6,715 |
| Federal funds | 2,747 | — | — | 2,747 | 6,384 | — | — | 6,384 |
| Auction rate
preferred stock |
933 | — | — | 933 | 1,641 | — | — | 1,641 |
| Other | 8,541 | 22 | — | 8,563 | 6,343 | 6 | — | 6,349 |
|
|
|
|
|
|
|
|
| |
| Total | $42,299 | $42 | $— | $42,341 | $58,690 | $12 | $— | $58,702 |
|
|
|
|
|
|
|
|
| |
Presented below are the amortized cost and fair value of nonmortgage
investments classified as available-for-sale at December 31, 1998 and 1997.
| 1998 | 1997 | |||||||
|---|---|---|---|---|---|---|---|---|
|
|
| |||||||
| Gross | Gross | Gross | Gross | |||||
| Amortized | Unrealized | Unrealized | Fair | Amortized | Unrealized | Unrealized | Fair | |
| Cost | Gains | Losses | Value | Cost | Gains | Losses | Value | |
|
|
|
|
|
|
|
|
| |
| (Dollars in millions) | ||||||||
| Available-for-sale | ||||||||
| securities: | ||||||||
| Asset-backed securities |
$8,831 | $— | $26 | $8,805 | $3,607 | $— | $2 | $3,605 |
| Other | 7,415 | — | 4 | 7,411 | 2,301 | — | — | 2,301 |
|
|
|
|
|
|
|
|
| |
| Total | $16,246 | $— | $30 | $16,216 | $5,908 | $— | $2 | $5,906 |
|
|
|
|
|
|
|
|
| |
The following table shows the amortized cost, fair value, and yield of
nonmortgage investments at December 31, 1998 and 1997, by remaining maturity.
| 1998 | 1997 | |||||
|---|---|---|---|---|---|---|
|
|
| |||||
| Amortized | Fair | Amortized | Fair | |||
| Cost | Value | Yield | Cost | Value | Yield | |
|
|
|
|
|
|
| |
| (Dollars in millions) | ||||||
| Due within one year | $28,268 | $28,280 | 5.81% | $44,562 | $44,567 | 5.93% |
| Due after one year through
five years |
9,258 | 9,269 | 5.66 | 3,395 | 3,401 | 6.13 |
|
|
|
|
|
|
| |
| 37,526 | 37,549 | 5.77 | 47,957 | 47,968 | 5.95 | |
| Asset-backed securities(1) | 21,019 | 21,008 | 5.76 | 16,641 | 16,640 | 6.16 |
|
|
|
|
|
|
| |
| Total | $58,545 | $58,557 | 5.77% | $64,598 | $64,608 | 6.00% |
|
|
|
|
|
|
| |
(1) Contractual maturity of asset-backed securities is not a reliable
indicator of their expected life because borrowers have the right to repay their
obligations at any time.
5. Debentures, Notes, and Bonds, Net
Borrowings Due Within One Year
Borrowings due within one year at December 31, 1998 and 1997 are summarized
below. Amounts are net of unamortized discount and premium.
| 1998 | 1997 | |||||||||
|---|---|---|---|---|---|---|---|---|---|---|
|
|
| |||||||||
| Outstanding | Average | Outstanding | Average | |||||||
| at | Outstanding | Maximum | at | Outstanding | Maximum | |||||
| December 31, | During Year | Outstanding | December 31, | During Year | Outstanding | |||||
|
|
|
at Any |
|
|
at Any | |||||
| Amount | Cost(1) | Amount | Cost(1) | Month-End | Amount | Cost(1) | Amount | Cost(1) | Month-End | |
|
|
|
|
|
|
|
|
|
|
| |
| (Dollars in millions) | ||||||||||
| Short-term notes | $136,400 | 5.18% | $107,344 | 5.47% | $136,400 | $104,964 | 5.69% | $91,535 | 5.57% | $104,964 |
| Other short-term debt |
38,192 | 5.25 | 39,625 | 5.49 | 43,601 | 32,226 | 5.74 | 36,874 | 5.59 | 41,044 |
| Current portion of | ||||||||||
| borrowings due | ||||||||||
| after one year(2): | ||||||||||
| Debentures | 5,394 | 8.42 | 14,300 | 6.40 | ||||||
| Global debt | 2,986 | 5.30 | — | — | ||||||
| Medium-term notes |
22,171 | 5.67 | 23,629 | 5.68 | ||||||
| Other | 270 | 6.09 | 281 | 6.50 | ||||||
|
|
|
|
|
|||||||
| Total due
within one year |
$205,413 | 5.33% | $175,400 | 5.76% | ||||||
|
|
|
|
|
|||||||
(1) Represents weighted-average cost, which includes the amortization of
discounts, premiums, issuance costs, hedging results, and the effects of
currency swaps, debt swaps, swaptions and interest rate caps.
(2) Information on average amount and cost of debt outstanding during the
year and maximum amount outstanding at any month-end is not meaningful. See
"Borrowings Due After One Year" for additional information.
Borrowings Due After One Year
Borrowings due after one year consisted of the following at December 31, 1998
and 1997.
| 1998 | 1997 | |||||
|---|---|---|---|---|---|---|
|
|
| |||||
| Maturity | Amount | Average | Amount | Average | ||
| Date | Outstanding | Cost(1) | Outstanding | Cost(1) | ||
|
|
|
|
|
| ||
| (Dollars in millions) | ||||||
| Medium-term notes, net of $380
of discount for 1998 ($299 for 1997) |
1999-2028 | $165,993 | 6.21% | $135,453 | 6.48% | |
| Benchmark notes, net of $113
of discount for 1998 |
2001-2008 | 42,137 | 5.63 | — | — | |
| Other global debt, net of $495
of discount for 1998 ($28 for 1997) |
1999-2038 | 22,586 | 6.32 | 21,752 | 6.47 | |
| Debentures, net of $54 of
discount for 1998 ($99 for 1997) |
1999-2022 | 20,516 | 7.40 | 35,170 | 7.36 | |
| Zero coupon securities
and subordinated capital debentures, net of $13,687 of discount for 1998 ($12,612 for 1997) |
1999-2019 | 4,037 | 7.89 | 2,671 | 8.96 | |
| Long-term other, net of $43
of discount for 1998 ($47 for 1997) |
1999-2018 | 188 | 9.99 | 193 | 9.99 | |
|
|
|
|
| |||
| 255,457 | 6.25% | 195,239 | 6.67% | |||
| Adjustment for foreign currency | ||||||
| translation | (579) | (865) | ||||
|
|
|
|||||
| Total due after one year | $254,878 | $194,374 | ||||
|
|
|
|||||
(1) Represents weighted-average cost, which includes the amortization of
discounts, premiums, issuance costs, hedging results, and the effects of
currency and debt swaps.
Debentures, notes, and bonds at December 31, 1998, included $135 billion of
callable debt, which generally is redeemable in whole or in part (and, in
certain cases, at a specified premium) at the option of Fannie Mae any time on
or after a specified date. At December 31, 1998, debentures, notes, and bonds
did not include any debt instruments that are subject to mandatory redemptions
tied to certain indices or rates after an initial nonredemption period.
The following table summarizes the amounts and call periods of callable debt,
the notional amount of callable swaps, and other option-embedded financial
instruments, excluding $9 billion of callable debt that was swapped to
variable-rate debt. Medium-term notes and subordinated capital debentures that
are redeemable at the Corporation's option are also included in the table.
| Year of | Amount | Average | |
|---|---|---|---|
| Call Date | Maturity | Outstanding | Cost |
|
|
|
|
|
| (Dollars in millions) | |||
| Callable Debt and Callable Swaps: | |||
| Currently callable | 1999-2008 | $563 | 5.46% |
| 1999 | 2000-2024 | 66,618 | 6.47 |
| 2000 | 2001-2026 | 37,056 | 6.25 |
| 2001 | 2003-2026 | 30,740 | 5.64 |
| 2002 | 2005-2027 | 5,900 | 6.88 |
| 2003 | 2006-2028 | 9,100 | 5.59 |
| 2004 and later | 2007-2012 | 826 | 6.88 |
|
|
| ||
| 150,803 | 6.21% | ||
| Other option-embedded
financial instruments |
23,220 | ||
|
|
|||
|
Total option-embedded
financial instruments |
$174,023 | ||
|
|
|||
Principal amounts at December 31, 1998 of total debt payable in the years
2000-2004, assuming callable debt is paid at maturity and assuming callable debt
is redeemed at the initial call date, were as follows:
| Assuming | ||
|---|---|---|
| Total Debt by | Callable Debt | |
| Year of | Redeemed at Initial | |
| Maturity(1) | Call Date(1) | |
|
|
| |
| (Dollars in millions) | ||
| 2000 | $38,540 | $64,634 |
| 2001 | 31,770 | 34,333 |
| 2002 | 24,754 | 20,177 |
| 2003 | 53,206 | 26,362 |
| 2004 | 9,487 | 3,504 |
(1) Excludes $9 billion of callable debt that was swapped to variable-rate
debt.
In 1998 and 1997, Fannie Mae repurchased or called $77 billion of debt and
swaps with an average cost of 6.71 percent and $31 billion with an average cost
of 7.22 percent, respectively. Fannie Mae recorded extraordinary losses of $40
million ($26 million after tax) in 1998 and $19 million ($12 million after tax)
in 1997 on the early extinguishment of debt.
Pursuant to Fannie Mae's Charter Act, approval of the Secretary of the
Treasury is required for Fannie Mae's issuance of its debt obligations.
6. Income Taxes
Components of the provision for federal income taxes for the years ended
December 31, 1998, 1997, and 1996, were as follows:
| 1998 | 1997 | 1996 | |
|---|---|---|---|
|
|
|
| |
| (Dollars in millions) | |||
| Current | $692 | $1,247 | $1,109 |
| Deferred | 509 | 22 | 42 |
|
|
|
| |
| 1,201 | 1,269 | 1,151 | |
| Tax benefit of extraordinary loss | (14) | (7) | (16) |
|
|
|
| |
| Net federal income tax provision | $1,187 | $1,262 | $1,135 |
|
|
|
| |
The tax effects of temporary differences that gave rise to significant
portions of the deferred tax assets and deferred tax liabilities at December 31,
1998 and 1997, consisted of the following:
| 1998 | 1997 | |
|---|---|---|
|
|
| |
| (Dollars in millions) | ||
| Deferred tax assets: | ||
| MBS guaranty and REMIC fees | $501 | $404 |
| Provision for losses | 331 | 339 |
| Other items, net | 76 | 55 |
|
|
| |
| Deferred tax assets | 908 | 798 |
|
|
| |
| Deferred tax liabilities: | ||
| Purchase discount and deferred fees | 420 | — |
| Debt-related expenses | 266 | 14 |
| Benefits from tax-advantaged investments | 93 | 171 |
| Other items, net | 16 | 9 |
|
|
| |
| Deferred tax liabilities | 795 | 194 |
|
|
| |
| Net deferred tax assets | $113 | $604 |
|
|
| |
Management anticipates that it is more likely than not that the results of
future operations will generate sufficient taxable income to realize the entire
balance of deferred tax assets.
Fannie Mae's effective tax rates differed from statutory federal rates for
the years ended December 31, 1998, 1997, and 1996, as follows:
| 1998 | 1997 | 1996 | |
|---|---|---|---|
|
|
|
| |
| Statutory corporate rate | 35% | 35% | 35% |
| Tax-exempt interest and dividends received deductions | (4) | (4) | (4) |
| Equity investments in affordable housing projects | (5) | (2) | (2) |
|
|
|
| |
| Effective rate | 26% | 29% | 29% |
|
|
|
|
Fannie Mae is exempt from state and local taxes, except for real estate
taxes.
7. Earnings per Common Share
The following table sets forth the computation of basic and diluted earnings
per common share:
| 1998 | 1997 | 1996 | ||||
|---|---|---|---|---|---|---|
|
|
|
| ||||
| Basic | Diluted | Basic | Diluted | Basic | Diluted | |
|
|
|
|
|
|
| |
| (Dollars and shares in millions, | ||||||
| except per common share amounts) | ||||||
| Net income before
extraordinary loss |
$3,444 | $3,444 | $3,068 | $3,068 | $2,754 | $2,754 |
| Less: Extraordinary loss | (26) | (26) | (12) | (12) | (29) | (29) |
| Preferred stock dividend | (66) | (66) | (65) | (65) | (42) | (42) |
|
|
|
|
|
|
| |
| Net income available to
common stockholders |
$3,352 | $3,352 | $2,991 | $2,991 | $2,683 | $2,683 |
|
|
|
|
|
|
| |
| Weighted average common shares | 1,029 | 1,029 | 1,049 | 1,049 | 1,071 | 1,071 |
| Dilutive potential
common shares(1) |
— | 8 | — | 7 | — | 9 |
|
|
|
|
|
|
| |
| Average number of common
shares outstanding used to calculate earnings per common share |
1,029 | 1,037 | 1,049 | 1,056 | 1,071 | 1,080 |
|
|
|
|
|
|
| |
| Earnings before extraordinary item | $3.28 | $3.26 | $2.87 | $2.84 | $2.53 | $2.51 |
| Net earnings | 3.26 | 3.23 | 2.85 | 2.83 | 2.50 | 2.48 |
(1) Dilutive potential common shares consist primarily of the dilutive effect
from employee stock options and other stock compensation plans.
For additional disclosures regarding Fannie Mae's stock compensation plans
and the outstanding preferred stock, see Notes 8 and 12, respectively.
8. Stock Compensation Plans
At December 31, 1998, Fannie Mae had five stock-based compensation plans,
which are described below. Financial Accounting Standard No. 123 ("FAS 123"),
Accounting for Stock-Based Compensation, gives companies the option of
either recording an expense for all stock compensation awards based on fair
value at grant date or continuing to follow Accounting Principles Board Opinion
No. 25 ("APB Opinion 25") with the additional requirement that they disclose, in
a footnote, pro forma net income and earnings per common share as if they had
adopted the expense recognition provisions of FAS 123. Fannie Mae elected to
apply APB Opinion 25 and related interpretations in accounting for its plans. As
a result, no compensation expense has been recognized for the nonqualified stock
options and Employee Stock Purchase Plan. Had compensation expense been
recognized for benefits under all five plans, based on their fair value at grant
date and consistent with FAS 123, Fannie Mae's net income and earnings per
common share would have been $3.312 billion and $3.19, $3.025 billion and $2.80,
and $2.701 billion and $2.46 for the years ended December 31, 1998, 1997, and
1996, respectively.
The fair value of benefits under Fannie Mae's stock-based plans was
determined using a Black-Scholes pricing model. The following table summarizes
the major assumptions used in the model.
| 1998 | 1997 | 1996 | |
|---|---|---|---|
|
|
|
| |
| Risk free rate (1) | 4.04 - 5.79% | 5.53 - 6.80% | 6.45 - 7.74% |
| Volatility | 25-30 | 23 - 25 | 21 - 22 |
| Forfeiture | 15 | 15 | 15 |
| Dividend(2) | $.96 | $.84 | $.76 |
| Expiration | 1 - 10yrs. | 1 - 10yrs. | 1 - 10yrs. |
(1) The closing yield on the comparable average life U.S. Treasury on the day
prior to grant.
(2) Dividend rate on common stock at date of grant. Dividend rate assumed to
remain constant over the option life.
Employee Stock Purchase Plan
Fannie Mae has an Employee Stock Purchase Plan that allows issuance of up to
36 million shares of common stock to qualified employees at a price equal to 85
percent of the fair market value on the grant date. In 1998, Fannie Mae granted
each qualified employee, excluding certain officers and other highly compensated
employees, the right to purchase in January 1999 up to 393 shares of common
stock. Under the 1998 offering, 1,336,278 common shares were purchased at $54.03
per share, compared with 1,883,197 common shares purchased at $33.73 per share
under the 1997 offering. The Board of Directors has approved a 1999 offering
under the plan, granting each qualified employee the right to purchase 348
common shares at $60.99 per share.
Employee Stock Ownership Plan
Fannie Mae has an Employee Stock Ownership Plan ("ESOP") for qualified
employees. Fannie Mae may contribute to the ESOP an amount based on defined
earnings goals, not to exceed 4 percent of the aggregate base salary for all
participants. The contribution is made in the subsequent year either in shares
of Fannie Mae common stock or in cash that is used to purchase such stock.
Performance Shares
Fannie Mae's Stock Compensation Plans authorize eligible employees to receive
performance awards, generally issued with an award period that can range from
three to five years. The performance awards become actual awards only if Fannie
Mae attains the goals set for the award period. At the end of such time, the
awards generally are payable in common stock, in three installments over a
two-year period. The outstanding contingent grants made for the 1999-2001, 1998-
2000, and 1997-1999 periods were 323,640 common shares, 366,712 common shares,
and 273,215 common shares, respectively.
Nonqualified Stock Options
Stock options may be granted to eligible employees and nonmanagement members
of the Board of Directors. The options generally do not become exercisable until
at least one year after the grant date and generally expire ten years from the
grant date. The purchase price of the common stock covered by each option is
equal to the fair value of the stock on the date the option is granted.
The following table summarizes stock option activity for the years 1996
through 1998:
| 1998 | 1997 | 1996 | ||||
|---|---|---|---|---|---|---|
|
|
|
| ||||
| Weighted-average | Weighted-average | Weighted-average | ||||
| Options | Exercise Price | Options | Exercise Price | Options | Exercise Price | |
|
|
|
|
|
|
| |
| (options in thousands) | ||||||
| Balance, January 1 | 22,777 | $27.15 | 23,910 | $22.24 | 24,249 | $18.90 |
| Granted | 3,381 | 67.63 | 3,373 | 50.16 | 3,418 | 38.67 |
| Exercised | (3,712) | 19.15 | (4,065) | 17.46 | (3,014) | 14.31 |
| Forfeited | (452) | 35.60 | (441) | 26.16 | (743) | 21.01 |
|
|
|
|
|
|
| |
| Balance, December 31 | 21,994 | $34.55 | 22,777 | $27.15 | 23,910 | $22.24 |
|
|
|
|
|
|
| |
| Options vested,
December 31 |
13,729 | $23.89 | 13,275 | $20.30 | 11,767 | $17.65 |
|
|
|
|
|
|
| |
The following table summarizes information about stock options outstanding at
December 31, 1998:
| Options Outstanding | Options Exercisable | ||||
|---|---|---|---|---|---|
|
|
| ||||
| Weighted-average | Number | ||||
| Range of | Number | Remaining | Weighted-average | of Options | Weighted-average |
| Exercise Prices | of Options | Contractual Life | Exercise Price | Exercisable | Exercise Price |
|
|
|
|
|
|
|
| (options in thousands) | |||||
| $8.00 - $23.97 | 8,853 | 5.0yrs. | $17.94 | 8,829 | $17.94 |
| 26.69 - 42.69 | 6,958 | 7.4 | 32.79 | 4,153 | 31.47 |
| 43.00 - 58.69 | 2,829 | 8.9 | 51.59 | 703 | 51.49 |
| 60.31 - 75.16 | 3,354 | 9.8 | 67.67 | 44 | 61.18 |
|
|
|
|
|
| |
| Total | 21,994 | 7.0yrs. | $34.55 | 13,729 | $23.89 |
|
|
|
|
|
| |
Restricted Stock
In 1998, 98,280 shares of restricted stock were awarded, issued, and placed
in escrow under the Stock Compensation Plans and Restricted Stock Plan for
Directors (66,240 shares in 1997); 100,600 shares were released as vesting of
participants occurred (138,968 shares in 1997).
9. Employee Retirement Benefits
Retirement Savings Plan
All regular employees of Fannie Mae scheduled to work 1,000 hours or more in
a calendar year are eligible to participate in the Corporation's Retirement
Savings Plan, which includes a 401(k) option. In 1998, employees could
contribute up to the lesser of 15 percent of their base salary or the current
annual dollar cap established and revised annually by the Internal Revenue
Service ("IRS"), with the Corporation matching such contributions up to 3
percent of base salary.
Postretirement Benefit Plans
All regular employees of Fannie Mae scheduled to work 1,000 hours or more in
a calendar year are covered by a noncontributory corporate retirement plan or by
the contributory Civil Service Retirement Law. Benefits payable under the
corporate plan are based on years of service and compensation using the average
pay during the 36 consecutive highest-paid months of the last 120 months of
employment. Fannie Mae's policy is to contribute an amount no less than the
minimum required employer contribution under the Employee Retirement Income
Security Act of 1974. Contributions to the corporate plan reflect benefits
attributed to employees' service to date and compensation expected to be paid in
the future. A $7 million contribution was made to the corporate plan in 1998.
Corporate plan assets consist primarily of listed stocks, fixed-income
securities, and other liquid assets.
At December 31, 1998 and 1997, the projected benefit obligations for services
rendered were $229 million and $185 million, respectively, while the plan assets
were $238 million and $190 million, respectively. The pension liability at
December 31, 1998 and 1997 was $38 million and $36 million, respectively, while
net periodic pension costs were $9 million and $8 million, respectively.
At December 31, 1998 and 1997, the weighted-average discount rates used in
determining the actuarial present value of the projected benefit obligation were
6.75 percent and 7.25 percent, respectively; the average rates of increase in
future compensation levels used in the calculation were 5.75 percent for both
1998 and 1997; and the expected long-term rates of return on assets were 9.00
percent and 9.25 percent, respectively. Fannie Mae uses the straight-line method
of amortization for prior service costs.
Fannie Mae also has an Executive Pension Plan and a Supplemental Pension
Plan, which supplement for key senior officers the benefits payable under the
retirement plan. Estimated benefits under the supplementary plans are accrued as
an expense over the period of employment. Accrued benefits under the Executive
Pension Plan generally are funded through a Rabbi trust.
Fannie Mae sponsors a Postretirement Health Care Plan that covers
substantially all full-time employees. The plan pays stated percentages of most
necessary medical expenses incurred by retirees, after subtracting payments by
Medicare or other providers and after a stated deductible has been met.
Participants become eligible for the subsidized benefits as follows: (1) for
employees hired prior to January 1, 1998, if they retire from Fannie Mae after
reaching age 55 with five or more years of service; or (2) for employees hired
January 1, 1998, or later, if they retire from Fannie Mae after reaching age 55
with ten or more years of service. Employees hired January 1, 1998 or later who
retire with less than 10 years of service may purchase coverage by paying the
full premium. The plan is contributory, with retiree contributions adjusted
annually. The expected cost of these postretirement benefits is charged to
expense during the years that employees render service. Cost-sharing percentages
are based on length of service with Fannie Mae, eligibility for and date of
retirement, and a defined dollar benefit cap. Fannie Mae does not fund this
plan.
Fannie Mae's accrued postretirement health care plan obligation for the years
ending December 31, 1998 , and 1997 was $32 million and $27 million,
respectively. The net postretirement health care costs were $8 million in 1998,
$6 million in 1997 and $7 million in 1996. In determining the net postretirement
health care cost for 1998, a 5.5 percent annual rate of increase in the per
capita cost of covered health care claims was assumed for 1998; the rate was
assumed to decrease gradually to 4.5 percent over four years and remain at that
level thereafter. The health care cost trend rate assumption has a significant
effect on the amounts reported. In determining the net postretirement health
care cost for 1997, a 6.25 percent annual rate of increase in the per capita
cost of covered health care claims was assumed for 1997; the rate was assumed to
decrease gradually to 4.75 percent over five years and remain at that level
thereafter. To illustrate, increasing the assumed health care cost trend rates
by one percentage point in each year would increase the accumulated
postretirement benefit obligation as of December 31, 1998 by $6 million and the
aggregate of the service and interest cost components of net postretirement
health care cost for the year by $1 million.
The weighted-average discount rates used in determining the health care cost
and the year-end accumulated postretirement benefit obligation were 6.75 percent
at December 31, 1998, and 7.25 percent at December 31, 1997.
10. Line of Business Reporting
Management analyzes corporate performance on the basis of two lines of
business: Portfolio Investment and Credit Guaranty.
The Portfolio Investment business includes the management of asset purchases
and funding activities for Fannie Mae's mortgage and nonmortgage investment
portfolios. Income is derived primarily from the difference, or spread, between
the yield on mortgage loans and nonmortgage investments, and the borrowing costs
related to those loans and investments.
The Credit Guaranty business involves guaranteeing the credit performance of
both single-family and multifamily mortgage loans for a fee. Guaranty fees for
MBS are based on a market rate of return for the credit risk assumed. For
mortgages held in portfolio, the Credit Guaranty business charges the Portfolio
Investment business a guaranty fee similar to what it would charge on an MBS.
These "notional" guaranty fees are classified as net interest income for the
Credit Guaranty business. Net interest income for the Credit Guaranty business
also includes interest on capital invested in guaranty activities and income
from temporary investment of principal and interest payments on guaranteed
mortgages prior to remittance to investors, and is net of interest charges paid
to the Portfolio Investment business for delinquent loans.
Fannie Mae assigns actual direct revenues and expenses among its lines of
business and uses estimates to apportion overhead and other corporate items. For
instance, administrative expenses are allocated on the basis of direct expenses
for the line of business or, where not assignable to a particular associated
business, are based on revenues, profits, or volumes, as applicable. Capital is
allocated to the separate businesses through an assessment of the interest rate
and credit risk associated with each business.
The following table sets forth Fannie Mae's financial performance by line of
business for the years ended December 31, 1998, 1997, and 1996.
| 1998(1) | 1997 | 1996 | |||||||
|---|---|---|---|---|---|---|---|---|---|
|
|
|
| |||||||
| Portfolio | Credit | Portfolio | Credit | Portfolio | Credit | ||||
| Investment | Guaranty | Total | Investment | Guaranty | Total | Investment | Guaranty | Total | |
|
|
|
|
|
|
|
|
|
| |
| (Dollars in millions) | |||||||||
| Net interest income | $3,460 | $650 | $4,110 | $3,483 | $466 | $3,949 | $3,191 | $401 | $3,592 |
| Guaranty fees | (823) | 2,052 | 1,229 | (746) | 2,020 | 1,274 | (712) | 1,908 | 1,196 |
| Fee and other income, net | 158 | 117 | 275 | 88 | 37 | 125 | 83 | 3 | 86 |
| Credit-related expenses | — | (261) | (261) | — | (375) | (375) | — | (409) | (409) |
| Administrative expenses | (184) | (524) | (708) | (174) | (462) | (636) | (160) | (400) | (560) |
| Federal income taxes | (707) | (494) | (1,201) | (745) | (524) | (1,269) | (679) | (472) | (1,151) |
| Extraordinary item— early extinguishment of debt |
(26) | — | (26) | (12) | — | (12) | (29) | — | (29) |
|
|
|
|
|
|
|
|
|
| |
| Net income | $1,878 | $1,540 | $3,418 | $1,894 | $1,162 | $3,056 | $1,694 | $1,031 | $2,725 |
|
|
|
|
|
|
|
|
|
| |
(1) Results include the recognition of additional non-recurring tax benefits
associated with investments qualifying for low-income housing tax credits, and
additional amortization of premiums or discounts and deferred or prepaid
guaranty fees that were recorded in the fourth quarter of 1998.
11. Dividend Restrictions
Fannie Mae's payment of dividends is subject to certain statutory
restrictions, including approval by the Director of the Office of Federal
Housing Enterprise Oversight of any dividend payment that would cause Fannie
Mae's capital to fall below specified capital levels.
Fannie Mae has exceeded the applicable capital standard since the adoption of
these restrictions in 1992 and, consequently, has been making dividend payments
without the need for Director approval.
Payment of dividends on common stock is also subject to payment of dividends
on preferred stock outstanding.
12. Preferred Stock
The following table presents the nonvoting preferred stock outstanding as of
December 31, 1998 and 1997.
| Shares Issued | Stated | Annual | |||
|---|---|---|---|---|---|
| and | Value | Dividend | Redeemable | ||
| Issue Date | Outstanding | Per Share | Rate | On or After | |
|
|
|
|
|
| |
| Series A | March 1, 1996 | 7,500,000 | $50 | 6.41% | March 1, 2001 |
| Series B | April 12, 1996 | 7,500,000 | 50 | 6.50 | April 12, 2001 |
| Series C | September 20, 1996 | 5,000,000 | 50 | 6.45 | September 20, 2001 |
| Series D | September 30, 1998 | 3,000,000 | 50 | 5.25 | September 30, 1999 |
|
|
|||||
| Total | 23,000,000 | ||||
|
|
|||||
Holders of preferred stock are entitled to receive noncumulative, quarterly
dividends when, and if, declared by Fannie Mae's Board of Directors. Payment of
dividends on preferred stock is not mandatory, but has priority over payment of
dividends on common stock. After the specified period, preferred stock is
redeemable at its stated value at the option of Fannie Mae.
13. Off-Balance-Sheet Credit Risk
Fannie Mae is a party to transactions involving financial instruments with
off-balance-sheet risk. Fannie Mae uses these instruments to fulfill its
statutory purpose of meeting the financing needs of the secondary mortgage
market and to reduce its own exposure to fluctuations in interest rates. These
financial instruments include MBS, commitments to purchase mortgages or to issue
and guarantee MBS, credit enhancements, and certain hedge instruments. These
instruments involve, to varying degrees, elements of credit and market risk in
excess of amounts recognized on the balance sheet.
Guaranteed Mortgage-Backed Securities
As issuer and guarantor of MBS, Fannie Mae is obligated to disburse scheduled
monthly installments of principal and interest (at the certificate rate) and the
full UPB of any foreclosed mortgage to MBS investors, whether or not any such
amounts have been received. Fannie Mae is also obligated to disburse unscheduled
principal payments received from borrowers.
Fannie Mae's credit risk is mitigated to the extent that sellers of pools of
mortgages elect to remain at risk for the loans sold to the corporation or other
credit enhancement was provided to protect against the risk of loss from
borrower default. Lenders have the option to retain the primary default risk, in
whole or in part, in exchange for a lower guaranty fee. Fannie Mae, however,
bears the ultimate risk of default.
Commitments
Fannie Mae enters into master delivery commitments with lenders on either a
mandatory or an optional basis. Under a mandatory master commitment, a lender
must either deliver loans under an MBS contract at a specified guaranty fee rate
or enter into a mandatory portfolio commitment with the yield established upon
executing the portfolio commitment.
Fannie Mae will also accept mandatory or lender-option delivery commitments
not issued pursuant to a master commitment. These commitments may be for
portfolio or MBS. The guaranty fee rate on MBS lender-option commitments is
specified in the contract, while the yield for portfolio lender-option
commitments is set at the date of conversion to a mandatory commitment.
The cost of funding future portfolio purchases generally is hedged upon
issuance of, or conversion to, a mandatory commitment. Therefore, the interest
rate risk relating to loans purchased pursuant to those commitments is largely
mitigated.
Hedge Instruments
Fannie Mae typically uses derivative instruments that simulate short sales of
Treasury securities, interest rate swaps, swaptions, interest rate caps, and
deferred rate-setting agreements to hedge against interest rate movements.
Changes in the value of these hedge instruments caused by fluctuations in
interest rates are expected to offset changes in the value of the items hedged.
Consequently, the primary risks associated with these hedging instruments are
that (1) changes in the value of the item hedged will not substantially offset
changes in the value of the hedge instrument, and (2) the counterparty to the
agreement will be unable or unwilling to meet the terms of the agreement.
Credit risk on derivative instruments that simulate short sales of Treasury
securities arises from the possible inability or unwillingness of the
counterparty to pay any difference between the agreed-upon price and the current
price for the referenced securities at settlement. This risk is reduced through
evaluation of the creditworthiness of counterparties and continuous monitoring
of hedge positions. The amount of deferrable net unrealized gains on open hedge
positions was $34 million at December 31, 1998, compared with $3 million of
unrealized losses at December 31, 1997. Total deferred gains and losses on
closed positions were $172 million and $473 million, respectively, at December
31, 1998, compared with $188 million and $231 million, respectively, at December
31, 1997.
Fannie Mae reduces counterparty risk on interest rate swaps, swaptions, and
interest rate caps by dealing only with experienced counterparties with high
credit quality, diversifying these derivative instruments across many
counterparties, and ensuring that these derivative instruments generally are
executed under master agreements that provide for netting of certain amounts
payable by each party. In addition, counterparties are obligated to post
collateral if Fannie Mae is exposed to credit loss on the related derivative
instruments exceeding an agreed-upon threshold. The amount of required
collateral is based on credit ratings and the level of credit exposure. Fannie
Mae generally requires overcollateralization from counterparties whose credit
ratings have dropped below predetermined levels. Fannie Mae regularly monitors
the exposures on its derivative instruments by valuing the positions via dealer
quotes and internal pricing models. At December 31, 1998, 93 percent of the
notional amount of Fannie Mae's outstanding interest rate swaps, swaptions, and
interest rate caps were with counterparties rated A or better (68 percent with
counterparties rated AA or better), and 100 percent of the notional amount of
outstanding swaps, swaptions, and interest rate caps were subject to collateral
arrangements. At December 31, 1998, six counterparties represented approximately
69 percent of the total notional amount of the outstanding interest rate swaps,
swaptions, and interest rate caps.
Counterparty risk on deferred rate-setting arrangements is limited to the
cash receivable, if any, due under the deferred rate-setting agreement. This
risk is reduced through evaluating the creditworthiness of counterparties.
Credit Enhancements
Fannie Mae provides credit enhancement and, in some cases, liquidity support
for certain financings involving taxable or tax-exempt housing bonds issued by
state and local governmental entities to finance multifamily housing for low-
and moderate-income families. In these transactions, Fannie Mae issues an MBS,
pledges an interest in certain mortgages it owns, or otherwise provides
contractual assurance of payment to a trustee for the bonds or another credit
party in the transaction. Fannie Mae's direct credit enhancement in a
multifamily housing bond transaction improves the rating on the bond, thus
resulting in lower-cost financing for multifamily housing.
Credit Exposure for Off-Balance-Sheet Financial
Instruments
The following table presents the contract or notional amount of derivative
instruments at December 31, 1998 and 1997.
| 1998 | 1997 | |
|---|---|---|
|
|
| |
| (Dollars in billions) | ||
| Contractual Amounts: | ||
| MBS outstanding(1) | $834.0 | $709.1 |
| MBS in portfolio | (197.4) | (130.4) |
|
|
| |
| Net MBS outstanding(1) | $636.6 | $578.7 |
|
|
| |
| Master commitments: | ||
| Mandatory | $31.7 | $38.2 |
| Optional | 56.1 | 45.9 |
| Portfolio commitments: | ||
| Mandatory | 11.1 | 3.6 |
| Optional | 1.6 | 1.6 |
| MBS commitments: | ||
| Optional | — | 0.1 |
| Notional Amounts(2): | ||
| Simulated short sales of Treasury securities | 3.6 | 1.6 |
| Interest rate swaps(3) | 95.8 | 96.1 |
| Debt swaps(4) | 46.6 | 52.7 |
| Asset swaps (5) | 0.4 | 1.0 |
| Interest rate caps | 14.5 | — |
| Swaptions | 12.7 | — |
| Credit enhancements | 6.6 | 7.3 |
| Other guarantees | 2.8 | 2.6 |
(1) Net of $588 million in allowance for losses in 1998 and $523 million in
1997. Includes $160.2 billion and $94.3 billion of MBS with lender or
third-party recourse at December 31, 1998 and 1997, respectively.
(2) Notional amounts do not necessarily represent the market or credit risk
of the derivative instrument positions.
(3) The weighted-average interest rate being received under these swaps was
5.32 percent and the weighted-average interest rate being paid was 6.53 percent
at December 31, 1998, compared with 5.85 percent and 6.79 percent, respectively,
at December 31, 1997.
(4) The weighted-average interest rate being received under these swaps was
5.48 percent and the weighted-average interest rate being paid was 5.18 percent
at December 31, 1998, compared with 5.94 percent and 5.65 percent, respectively,
at December 31, 1997.
(5) The weighted-average interest rate being received under these swaps was
5.86 percent and the weighted-average interest rate being paid was 5.32 percent
at December 31, 1998, compared with 6.03 percent and 6.27 percent, respectively,
at December 31, 1997.
Contract or notional amounts do not necessarily represent the market or
credit risk of the derivative instrument positions. The notional amounts of the
derivative instruments are used to calculate contractual cash flows to be
exchanged. In addition, any measurement of risk is meaningful only to the extent
that offsetting arrangements, such as master netting agreements and the value of
related collateral, are included.
Fannie Mae's exposure to credit loss for derivative instruments can be
estimated by calculating the cost, on a present value basis, to replace at
current market rates all those derivative instruments outstanding for which the
Corporation was in a gain position. Fannie Mae's net exposure (taking into
account master netting agreements) was $46 million at December 31, 1998, and $26
million at December 31, 1997. Fannie Mae expects the net credit exposure to
fluctuate as interest rates change.
14. Concentrations of Credit Risk
Concentrations of credit risk exist when a significant number of
counterparties (e.g., borrowers, lenders, and mortgage insurers) engage in
similar activities or are susceptible to similar changes in economic conditions
that could affect their ability to meet contractual obligations.
The following table presents UPB by primary default risk and the general
geographic distribution of properties underlying mortgages in the portfolio or
backing MBS outstanding at December 31, 1998 and 1997.
| Geographic Distribution | |||||||
|---|---|---|---|---|---|---|---|
|
| |||||||
| 1998 | Gross UPB | Northeast | Southeast | Midwest | Southwest | West | Total |
|
|
|
|
|
|
|
|
|
| (Dollars in millions) | |||||||
| Fannie Mae risk | $867,272 | 20% | 20% | 18% | 15% | 27% | 100% |
| Lender or shared risk | 184,386 | 15 | 19 | 21 | 16 | 29 | 100 |
|
|
|
|
|
|
|
| |
| Total | $1,051,658 | 19% | 20% | 19% | 15% | 27% | 100% |
|
|
|
|
|
|
|
| |
| Geographic Distribution | |||||||
|---|---|---|---|---|---|---|---|
|
| |||||||
| 1997 | Gross UPB | Northeast | Southeast | Midwest | Southwest | West | Total |
|
|
|
|
|
|
|
|
|
| (Dollars in millions) | |||||||
| Fannie Mae risk | $780,771 | 20% | 21% | 17% | 15% | 27% | 100% |
| Lender or shared risk | 115,045 | 16 | 18 | 18 | 14 | 34 | 100 |
|
|
|
|
|
|
|
| |
| Total | $895,816 | 20% | 20% | 17% | 15% | 28% | 100% |
|
|
|
|
|
|
|
| |
No significant concentration exists at the state level except for California,
where, at both December 31, 1998 and 1997, 20 percent of the gross UPB of
mortgages in portfolio and backing MBS were located.
To minimize credit risk, Fannie Mae requires primary mortgage insurance or
other credit protection if the loan-to-value ("LTV") ratio of a single-family
conventional mortgage loan (the UPB of the loan divided by the value of the
mortgaged property) is greater than 80 percent when the loan is delivered to
Fannie Mae.
Fannie Mae accepts conventional loans delivered with mortgage insurance from
15 insurance organizations. At December 31, 1998, $257 billion in current UPB of
single-family conventional mortgage loans in portfolio and underlying MBS
outstanding was covered by primary mortgage insurance at acquisition. Six
companies, all rated AA or higher, represented approximately 93 percent of that
insurance coverage. Fannie Mae monitors on a regular basis the performance and
financial strength of its mortgage insurers.
The following table presents the original LTV ratio distribution of
single-family loans in portfolio or backing MBS outstanding at December 31, 1998
and 1997.
| Loan-to-Value Ratio | ||||||||
|---|---|---|---|---|---|---|---|---|
|
| ||||||||
| 60% | Over | |||||||
| 1998 | Gross UPB | or less | 61-70% | 71-75% | 76-80% | 81-90% | 90% | Total |
|
|
|
|
|
|
|
|
|
|
| (Dollars in millions) | ||||||||
| Fannie Mae risk | $832,048 | 20% | 16% | 16% | 23% | 14% | 11% | 100% |
| Lender or shared risk | 149,165 | 6 | 8 | 12 | 33 | 22 | 19 | 100 |
|
|
|
|
|
|
|
|
| |
| Total | $981,213 | 18% | 15% | 15% | 25% | 15% | 12% | 100% |
|
|
|
|
|
|
|
|
| |
| Loan-to-Value Ratio | ||||||||
|---|---|---|---|---|---|---|---|---|
|
| ||||||||
| 60% | Over | |||||||
| 1997 | Gross UPB | or less | 61-70% | 71-75% | 76-80% | 81-90% | 90% | Total |
|
|
|
|
|
|
|
|
|
|
| (Dollars in millions) | ||||||||
| Fannie Mae risk | $752,654 | 19% | 15% | 15% | 23% | 16% | 12% | 100% |
| Lender or shared risk | 86,195 | 9 | 10 | 12 | 26 | 24 | 19 | 100 |
|
|
|
|
|
|
|
|
| |
| Total | $838,849 | 18% | 14% | 15% | 23% | 17% | 13% | 100% |
|
|
|
|
|
|
|
|
| |
The rate at which mortgage loans prepay tends to be sensitive to the level
and direction of prevailing market interest rates. In a declining interest rate
environment, higher-rate mortgage loans will pay off at a faster rate;
conversely, in an increasing interest rate environment, lower-rate mortgage
loans will prepay at a slower rate. The following table presents the
distribution by note rate of fixed-rate, single-family loans in the mortgage
portfolio or underlying MBS at December 31, 1998 and 1997.
| Fixed-Rate Loans by Note Rate(1) | ||||||
|---|---|---|---|---|---|---|
|
| ||||||
| 7.00% | 8.00% | 9.00% | 10.00% | |||
| Under | to | to | to | and | ||
| Gross UPB at December 31, | 7.00% | 7.99% | 8.99% | 9.99% | over | Total |
|
|
|
|
|
|
|
|
| (Dollars in billions) | ||||||
| 1998 | $201 | $484 | $155 | $30 | $14 | $884 |
| Percent of total | 23% | 55% | 17% | 3% | 2% | 100% |
| 1997 | $83 | $380 | $227 | $45 | $20 | $755 |
| Percent of total | 11% | 50% | 30% | 6% | 3% | 100% |
(1) Excludes housing revenue bonds and non-Fannie Mae securities.
15. Disclosures of Fair Value of Financial Instruments
The basic assumptions used and the estimates disclosed in the Fair Value
Balance Sheets represent management's best judgment of appropriate valuation
methods. These estimates are based on pertinent information available to
management as of December 31, 1998 and 1997. In certain cases, fair values are
not subject to precise quantification or verification and may change as economic
and market factors, and management's evaluation of those factors, change.
Although management uses its best judgment in estimating the fair value of
these financial instruments, there are inherent limitations in any estimation
technique. Therefore, these fair value estimates are not necessarily indicative
of the amounts that Fannie Mae would realize in a market transaction. The
accompanying Fair Value Balance Sheets do not represent an estimate of the
overall market value of the corporation as a going concern, which would take
into account future business opportunities.
| December 31, 1998 | December 31, 1997 | |||
|---|---|---|---|---|
|
|
| |||
| Cost | Fair Value | Cost | Fair Value | |
|
|
|
|
| |
| (Dollars in millions) | ||||
| Assets: | ||||
| Mortgage portfolio, net | $415,223 | $424,171 | $316,316 | $325,500 |
| Investments | 58,515 | 58,557 | 64,596 | 64,608 |
| Cash and cash equivalents | 743 | 743 | 2,205 | 2,205 |
| Other assets | 10,533 | 8,933 | 8,556 | 6,489 |
|
|
|
|
| |
| 485,014 | 492,404 | 391,673 | 398,802 | |
| Off-balance-sheet items: | ||||
| Guaranty fee income, net | — | 3,698 | — | 3,357 |
| Swaps in gain position, net | — | 32 | — | 4 |
| Other | — | 34 | — | — |
|
|
|
|
| |
| Total assets | $485,014 | $496,168 | $391,673 | $402,163 |
|
|
|
|
| |
| Liabilities and Net Assets | ||||
| Liabilities: | ||||
| Noncallable debt: | ||||
| Due within one year | $202,260 | $202,957 | $156,725 | $158,526 |
| Due after one year | 123,396 | 131,268 | 85,699 | 91,177 |
| Callable debt: | ||||
| Due within one year | 3,153 | 3,144 | 18,675 | 17,464 |
| Due after one year | 131,482 | 131,774 | 108,675 | 108,706 |
|
|
|
|
| |
| 460,291 | 469,143 | 369,774 | 375,873 | |
| Other liabilities | 9,270 | 7,844 | 8,106 | 7,137 |
| Off-balance-sheet items: | ||||
| Swaps in loss position, net | — | 4,296 | — | 3,168 |
| Other | — | — | — | 3 |
|
|
|
|
| |
| Total liabilities | 469,561 | 481,283 | 377,880 | 386,181 |
|
|
|
|
| |
| Net asset value, net of tax effect | $15,453 | $14,885 | $13,793 | $15,982 |
|
|
|
|
| |
Notes to Fair Value Balance Sheets
The following discussion summarizes the significant methodologies and
assumptions used in estimating the fair values presented in the accompanying
Fair Value Balance Sheets.
Mortgage Portfolio, Net
The fair value calculations of Fannie Mae's mortgage portfolio considered
such variables as interest rates, credit quality, and loan collateral. Because
an active market does not exist for a large portion of mortgage loans in the
portfolio, the portfolio's unsecuritized mortgages were aggregated into pools by
product type, coupon, and maturity and converted into notional MBS. A normal
guaranty fee that Fannie Mae's securitization business would charge for a pool
of loans with similar characteristics was subtracted from the weighted-average
interest rate less servicing fees. The method for estimating this guaranty fee
and the credit risk associated with the mortgage portfolio is described under
"Guaranty Fee Income, Net."
Fannie Mae then employed an option-adjusted spread ("OAS") approach to
estimate fair values for both notional MBS (the mortgage loan portfolio) and MBS
held in portfolio. The OAS represents the risk premium or incremental interest
spread over Treasury rates that is included in a security's yield to compensate
an investor for the uncertain effects of embedded prepayment options on
mortgages. The OAS was calculated using quoted market values for selected
benchmark securities and provided a generally applicable return measure that
considers the effect of prepayment risk and interest rate volatility.
Investments
Fair values of Fannie Mae's investment portfolio were based on actual quoted
prices or prices quoted for similar financial instruments.
Cash and Cash Equivalents
The carrying amount of cash and cash equivalents was used as a reasonable
estimate of their fair value.
Other Assets
Other assets include accrued interest receivable, net currency swap
receivables, and several other smaller asset categories. The fair value of other
assets, excluding currency swap receivables and certain deferred items that have
no fair value, approximates their carrying amount. Net currency swap receivables
are included in other assets at their fair value.
Guaranty Fee Income, Net
MBS are not assets owned by Fannie Mae, except when acquired for investment
purposes, nor are MBS recorded as liabilities of Fannie Mae. On MBS outstanding,
the Corporation receives a guaranty fee calculated on the outstanding principal
balance of the related mortgages. The guaranty fee represents a future income
stream for the Corporation. Under generally accepted accounting principles, this
guaranty fee is recognized as income over the life of the securities. The Fair
Value Balance Sheets reflect the present value of guaranty fees, net of
estimated future administrative costs and credit losses, and taking into account
estimated prepayments.
Fannie Mae estimates the credit loss exposure attached to the notional MBS,
MBS held in portfolio, and off-balance-sheet MBS where the Corporation has the
primary risk of default. Fannie Mae deducts estimated credit losses from the
projected guaranty fee cash flows to arrive at the fair value. Estimated credit
losses are calculated with an internal forecasting model based on actual
historical loss experience for the Corporation. The net guaranty fee cash flows
are then valued through an OAS method similar to that described under "Mortgage
Portfolio, Net."
Swap Obligations, Net
Fannie Mae enters into interest rate swaps, including callable swaps that in
general extend or adjust the effective maturity of certain debt obligations.
Under these swaps, Fannie Mae generally pays a fixed rate and receives a
floating rate based on a notional amount. Fannie Mae also enters into interest
rate swaps that are linked to specific bond investments ("asset swaps") or
specific debt issues ("debt swaps"). The fair value of interest rate swaps is
estimated based on either the expected cash flows or quoted market values of
these instruments. The effect of netting under master agreements is included in
determining swap obligations in a gain position or loss position.
In addition, Fannie Mae enters into swaptions and interest rate caps. Under a
swaption, Fannie Mae has the option to enter into a swap, as described above, at
a future date. Fannie Mae uses interest rate caps to effectively manage its
interest expense in a period of rising interest rates by entering into an
agreement whereby a counterparty makes payments to the Corporation for interest
rates above a specified rate. The fair values of these derivative instruments
are estimated based on either the expected cash flows or the quoted market
values of these instruments.
Noncallable and Callable Debt
The fair value of Fannie Mae's noncallable debt was estimated by using quotes
for selected debt securities of the Corporation with similar terms. Similar to
the valuation of the mortgage portfolio, the fair value of callable debt was
estimated with an OAS model.
Other Liabilities
Other liabilities include accrued interest payable, amounts payable to MBS
holders, estimated losses on MBS, net currency swap payables, and several other
smaller liability categories. The fair value of other liabilities, excluding
currency swap payables and certain deferred items that have no fair value,
approximates their carrying amount. Currency swap payables are included as a
component of other liabilities at their fair value. Credit loss exposure for MBS
is included as a component of the net MBS guaranty fee.
The fair value amount also includes the estimated effect on deferred income
taxes of providing for federal income taxes, at the statutory corporate tax rate
of 35 percent, for the difference between net assets at fair value and at cost.
The following unaudited results of operations include, in the opinion of
management, all adjustments necessary for a fair presentation of the results of
operations for such periods.
| 1998 Quarter Ended | ||||
|---|---|---|---|---|
|
| ||||
| December | September | June | March | |
|
|
|
|
| |
| (Dollars in millions, except per common share amounts) | ||||
| Interest income | $7,895 | $7,724 | $7,351 | $7,025 |
| Interest expense | 6,919 | 6,657 | 6,320 | 5,989 |
|
|
|
|
| |
| Net interest income | 976 | 1,067 | 1,031 | 1,036 |
| Guaranty fees | 261 | 324 | 323 | 321 |
| Fee and other income, net | 71 | 69 | 79 | 56 |
| Provision for losses | 20 | 15 | 10 | 5 |
| Foreclosed property expenses | (70) | (80) | (79) | (82) |
| Administrative expenses | (185) | (179) | (174) | (170) |
|
|
|
|
| |
| Income before federal income taxes
and extraordinary item |
1,073 | 1,216 | 1,190 | 1,166 |
| Provision for federal income taxes | (174) | (354) | (339) | (334) |
|
|
|
|
| |
| Income before extraordinary item | 899 | 862 | 851 | 832 |
| Extraordinary item—early extinguishment
of debt (net of tax effect) |
(10) | (5) | (3) | (8) |
|
|
|
|
| |
| Net income | $889 | $857 | $848 | $824 |
|
|
|
|
| |
| Preferred stock dividends | (18) | (16) | (16) | (16) |
|
|
|
|
| |
| Net income available to
common stockholders |
$871 | $841 | $832 | $808 |
|
|
|
|
| |
| Basic earnings per common share(1): | ||||
| Earnings before extraordinary item | $.86 | $.83 | $.81 | $.79 |
| Extraordinary item | (.01) | (.01) | — | (.01) |
|
|
|
|
| |
| Net earnings | $.85 | $.82 | $.81 | $.78 |
|
|
|
|
| |
| Diluted earnings per common share(1): | ||||
| Earnings before extraordinary item | $.85 | $.82 | $.80 | $.78 |
| Extraordinary item | (.01) | (.01) | — | (.01) |
|
|
|
|
| |
| Net earnings | $.84 | $.81 | $.80 | $.77 |
|
|
|
|
| |
| Cash dividends per common share | $.24 | $.24 | $.24 | $.24 |
(1) The total of the four quarters does not equal the amount for the year
because the amount for each period is calculated independently based on the
weighted-average number of common shares outstanding during the period.
| 1997 Quarter Ended | ||||
|---|---|---|---|---|
|
| ||||
| December | September | June | March | |
|
|
|
|
| |
| (Dollars in millions, except per common share amounts) | ||||
| Interest income | $6,884 | $6,651 | $6,514 | $6,329 |
| Interest expense | 5,848 | 5,658 | 5,544 | 5,379 |
|
|
|
|
| |
| Net interest income | 1,036 | 993 | 970 | 950 |
| Guaranty fees | 324 | 320 | 317 | 313 |
| Fee and other income, net | 29 | 33 | 33 | 30 |
| Provision for losses | — | (20) | (40) | (40) |
| Foreclosed property expenses | (77) | (71) | (61) | (66) |
| Administrative expenses | (167) | (159) | (159) | (151) |
|
|
|
|
| |
| Income before federal income taxes
and extraordinary item |
1,145 | 1,096 | 1,060 | 1,036 |
| Provision for federal income taxes | (339) | (319) | (309) | (302) |
|
|
|
|
| |
| Income before extraordinary item | 806 | 777 | 751 | 734 |
| Extraordinary item—early extinguishment
of debt (net of tax effect) |
(12) | (2) | 2 | — |
|
|
|
|
| |
| Net income | $794 | $775 | $753 | $734 |
|
|
|
|
| |
| Preferred stock dividends | (16) | (16) | (17) | (16) |
|
|
|
|
| |
| Net income available to
common stockholders |
$778 | $759 | $736 | $718 |
|
|
|
|
| |
| Basic earnings per common share(1): | ||||
| Earnings before extraordinary item | $.76 | $.73 | $.70 | $.68 |
| Extraordinary item | (.01) | — | — | — |
|
|
|
|
| |
| Net earnings | $.75 | $.73 | $.70 | $.68 |
|
|
|
|
| |
| Diluted earnings per common share(1): | ||||
| Earnings before extraordinary item | $.75 | $.72 | $.69 | $.67 |
| Extraordinary item | (.01) | — | — | — |
|
|
|
|
| |
| Net earnings | $.74 | $.72 | $.69 | $.67 |
|
|
|
|
| |
| Cash dividends per common share | $.21 | $.21 | $.21 | $.21 |
(1) The total of the four quarters does not equal the amount for the year
because the amount for each period is calculated independently based on the
weighted-average number of common shares outstanding during the period.
FANNIE MAE
NET INTEREST INCOME AND AVERAGE
BALANCES (Unaudited)
| 1998 | 1997 | 1996 | |
|---|---|---|---|
|
|
|
| |
| (Dollars in millions) | |||
| Interest income: | |||
| Mortgage portfolio | $25,676 | $22,716 | $20,560 |
| Investments and cash equivalents | 4,319 | 3,662 | 3,212 |
|
|
|
| |
| Total interest income | 29,995 | 26,378 | 23,772 |
|
|
|
| |
| Interest expense(1): | |||
| Short-term debt | 4,809 | 3,659 | 3,395 |
| Long-term debt | 21,076 | 18,770 | 16,785 |
|
|
|
| |
| Total interest expense | 25,885 | 22,429 | 20,180 |
|
|
|
| |
| Net interest income | 4,110 | 3,949 | 3,592 |
| Tax equivalent adjustment(2) | 304 | 283 | 247 |
|
|
|
| |
| Net interest income tax equivalent basis | $4,414 | $4,232 | $3,839 |
|
|
|
| |
| Average balances: | |||
| Interest-earning assets(3): | |||
| Mortgage portfolio, net | $352,169 | $298,698 | $268,629 |
| Investments and cash equivalents | 75,369 | 63,441 | 57,161 |
|
|
|
| |
| Total interest-earning assets | $427,538 | $362,139 | $325,790 |
|
|
|
| |
| Interest-bearing liabilities(1): | |||
| Short-term debt | $89,890 | $68,691 | $63,974 |
| Long-term debt | 319,638 | 277,129 | 246,733 |
|
|
|
| |
| Total interest-bearing liabilities | 409,528 | 345,820 | 310,707 |
| Interest-free funds | 18,010 | 16,319 | 15,083 |
|
|
|
| |
| Total interest-bearing liabilities and interest-free funds | $427,538 | $362,139 | $325,790 |
|
|
|
| |
| Average interest rates(2): | |||
| Interest-earning assets: | |||
| Mortgage portfolio, net | 7.38% | 7.67% | 7.71% |
| Investments and cash equivalents | 5.76 | 5.82 | 5.68 |
|
|
|
| |
| Total interest-earning assets | 7.09 | 7.34 | 7.36 |
|
|
|
| |
| Interest-bearing liabilities(1): | |||
| Short-term debt | 5.29 | 5.29 | 5.22 |
| Long-term debt | 6.60 | 6.77 | 6.82 |
|
|
|
| |
| Total interest-bearing liabilities | 6.31 | 6.48 | 6.49 |
|
|
|
| |
| Investment spread(4) | .78 | .86 | .87 |
| Interest-free return(5) | .25 | .31 | .31 |
|
|
|
| |
| Net interest margin(6) | 1.03% | 1.17% | 1.18% |
|
|
|
| |
(1) Classification of interest expense and interest-bearing liabilities as
short-term or long-term is based on effective maturity or repricing date, taking
into consideration the effect of derivative financial instruments.
(2) Reflects pro forma adjustments to permit comparison of yields on
tax-advantaged and taxable assets.
(3) Includes average balance of nonperforming loans of $2.6 billion in 1998
and $2.2 billion in 1997 and 1996.
(4) Consists primarily of the difference between the yield on
interest-earning assets, adjusted for tax benefits of nontaxable income, and the
effective cost of funds on interest-bearing liabilities.
(5) Consists primarily of the return on that portion of the investment
portfolio funded by equity and non-interest-bearing liabilities.
(6) Net interest income, on a tax equivalent basis, as a percentage of the
average investment portfolio.
FANNIE MAE
RATE/VOLUME ANALYSIS (Unaudited)
| Attributable to | |||
|---|---|---|---|
| changes in(1) | |||
| Increase |
| ||
| (Decrease) | Volume | Rate | |
|
|
|
| |
| (Dollars in millions) | |||
| 1998 vs. 1997 | |||
|
|
|||
| Interest income: | |||
| Mortgage portfolio | $2,960 | $3,930 | $(970) |
| Investments and cash equivalents | 657 | 684 | (27) |
|
|
|
| |
| Total interest income | 3,617 | 4,614 | (997) |
|
|
|
| |
| Interest expense(2): | |||
| Short-term debt | 1,150 | 1,134 | 16 |
| Long-term debt | 2,306 | 2,814 | (508) |
|
|
|
| |
| Total interest expense | 3,456 | 3,948 | (492) |
|
|
|
| |
| Net interest income | $161 | $666 | $(505) |
|
|
|
| |
| 1997 vs. 1996 | |||
|
|
|||
| Interest income: | |||
| Mortgage portfolio | $2,156 | $2,287 | $(131) |
| Investments and cash equivalents | 450 | 361 | 89 |
|
|
|
| |
| Total interest income | 2,606 | 2,648 | (42) |
|
|
|
| |
| Interest expense(2): | |||
| Short-term debt | 264 | 251 | 13 |
| Long-term debt | 1,985 | 2,059 | (74) |
|
|
|
| |
| Total interest expense | 2,249 | 2,310 | (61) |
|
|
|
| |
| Net interest income | $357 | $338 | $19 |
|
|
|
| |
(1) Combined rate/volume variances, a third element of the calculation, are
allocated to the rate and volume variances based on their relative size.
(2) Classification of interest expense and interest-bearing liabilities as
short-term or long-term is based on the effective maturity or repricing date,
taking into consideration the effect of derivative financial instruments.
Directors
The age and background, as of March 29, 1999, of each of the members of the
Board of Directors of Fannie Mae are as follows:
| First | |||
|---|---|---|---|
| Principal Occupation, | Became | Other | |
| Name and Age | Business Experience, and Residence | Director | Directorships(1) |
|
|
|
|
|
| Stephen B. Ashley, 59 | Chairman and Chief Executive Officer, The | 1995 | Exeter Fund, Inc.; The Gene- |
| Ashley Group, a group of commercial and | see Corporation; Hahn Auto- | ||
| multifamily real estate, brokerage and | motive Warehouse, Inc.; | ||
| investment companies, January 1997 to | Manning & Napiers Insurance | ||
| present; Chairman and Chief Executive | Fund, Inc. | ||
| Officer, Sibley Mortgage Corporation, a | |||
| mortgage banking company, 1985 to 1996; | |||
| Chairman and Chief Executive Officer, Sibley | |||
| Real Estate Services, Inc., a property | |||
| management company, 1985 to 1996; Livonia, | |||
| New York | |||
| Roger E. Birk, 68 | Former President and Chief Operating Officer | 1985 | Golden Bear Golf Inc.; Mutual |
| of the Corporation, November 1987 until his | of America Capital Corp.; | ||
| retirement in January 1992; Tequesta, Florida | Penske Corp.; WellPoint Health | ||
| Networks Inc. | |||
| Kenneth M. Duberstein, | Chairman and Chief Executive Officer, The Du- | 1998 | The Boeing Company; Cinergy |
| 54 | berstein Group, an independent strategic | Corporation; Global Vacation | |
| planning and consulting company, July 1989 to | Group; St. Paul Companies, | ||
| present; Chief of Staff to the President of | Inc. | ||