10-Q 1 w73633e10vq.htm 10-Q e10vq
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
     
     
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
     
    For the quarterly period ended March 31, 2009
OR
     
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
    For the transition period from          to          
 
Commission File No.: 0-50231
 
Federal National Mortgage Association
(Exact name of registrant as specified in its charter)
 
Fannie Mae
 
     
Federally chartered corporation
(State or other jurisdiction of
incorporation or organization)
  52-0883107
(I.R.S. Employer
Identification No.)
     
3900 Wisconsin Avenue, NW
Washington, DC
(Address of principal executive offices)
  20016
(Zip Code)
 
Registrant’s telephone number, including area code:
(202) 752-7000
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o  No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer þ Accelerated filer o
Non-accelerated filer o     (Do not check if a smaller reporting company) Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
As of March 31, 2009, there were 1,107,781,938 shares of common stock of the registrant outstanding.
 


Table of Contents

 
TABLE OF CONTENTS
 
                 
      1  
      Financial Statements     110  
        Condensed Consolidated Balance Sheets     111  
        Condensed Consolidated Statements of Operations     112  
        Condensed Consolidated Statements of Cash Flows     113  
        Condensed Consolidated Statements of Changes in Equity (Deficit)     114  
        Notes to Condensed Consolidated Financial Statements     115  
          Note 1—Organization and Conservatorship     115  
          Note 2—Summary of Significant Accounting Policies     116  
          Note 3—Consolidations     123  
          Note 4—Mortgage Loans     127  
          Note 5—Allowance for Loan Losses and Reserve for Guaranty Losses     130  
          Note 6—Investments in Securities     131  
          Note 7—Portfolio Securitizations     134  
          Note 8—Financial Guarantees and Master Servicing     139  
          Note 9—Acquired Property, Net     144  
          Note 10—Short-term Borrowings and Long-term Debt     145  
          Note 11—Derivative Instruments     147  
          Note 12—Income Taxes     152  
          Note 13—Loss Per Share     154  
          Note 14—Employee Retirement Benefits     155  
          Note 15—Segment Reporting     155  
          Note 16—Regulatory Capital Requirements     157  
          Note 17—Concentrations of Credit Risk     157  
          Note 18—Fair Value of Financial Instruments     159  
        Note 19—Commitments and Contingencies     171  
        Note 20—Subsequent Event     176  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations       1  
        Introduction       1  
        Executive Summary       2  
        Housing Goals      16  
        Critical Accounting Policies and Estimates      17  
        Consolidated Results of Operations      23  
        Business Segment Results      39  
        Consolidated Balance Sheet Analysis      43  
        Supplemental Non-GAAP Information — Fair Value Balance Sheets      59  
        Liquidity and Capital Management      64  
        Off-Balance Sheet Arrangements and Variable Interest Entities      76  
        Risk Management      78  
        Impact of Future Adoption of New Accounting Pronouncements     106  
        Forward-Looking Statements     106  
      Quantitative and Qualitative Disclosures About Market Risk     177  
      Controls and Procedures     177  


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    181  
      Legal Proceedings     181  
      Risk Factors     182  
      Unregistered Sales of Equity Securities and Use of Proceeds     191  
      Defaults Upon Senior Securities     193  
      Submission of Matters to a Vote of Security Holders     193  
      Other Information     193  
      Exhibits     193  
 Ex-4.21
 Ex-31.1
 Ex-31.2
 Ex-32.1
 Ex-32.2


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MD&A TABLE REFERENCE
 
             
Table
 
Description
  Page
 
  Credit Statistics, Single-Family Guaranty Book of Business     10  
  Housing Goals and Subgoals     17  
  Level 3 Recurring Financial Assets at Fair Value     20  
  Summary of Condensed Consolidated Results of Operations and Performance Metrics     24  
  Analysis of Net Interest Income and Yield     25  
  Rate/Volume Analysis of Net Interest Income     26  
  Guaranty Fee Income and Average Effective Guaranty Fee Rate     27  
  Investment Gains (Losses), Net     29  
  Fair Value Gains (Losses), Net     30  
  Derivatives Fair Value Gains (Losses), Net     30  
  Credit-Related Expenses     32  
  Allowance for Loan Losses and Reserve for Guaranty Losses (Combined Loss Reserves)     33  
  Statistics on Acquired Loans from MBS Trusts Subject to SOP 03-3     35  
  Credit Loss Performance Metrics     36  
  Single-Family Credit Loss Sensitivity     38  
  Single-Family Business Results     39  
  HCD Business Results     41  
  Capital Markets Group Results     42  
  Mortgage Portfolio Activity     44  
  Mortgage Portfolio Composition     45  
  Trading and Available-for-Sale Investment Securities     47  
  Investments in Private-Label Mortgage-Related Securities and Mortgage Revenue Bonds     48  
  Investments in Alt-A and Subprime Private-Label Mortgage-Related Securities, Excluding Wraps     49  
  Delinquency Status and Loss Severity Rates of Loans Underlying Alt-A and Subprime Private-Label Mortgage-Related Securities     50  
  Other-than-temporary Impairment Losses on Available-for-Sale Alt-A and Subprime Private-Label Mortgage-Related Securities     50  
  Hypothetical Performance Scenarios—Investments in Alt-A Private-Label Mortgage-Related Securities, Excluding Wraps     52  
  Hypothetical Performance Scenarios—Investments in Subprime Private-Label Mortgage-Related Securities, Excluding Wraps     54  
  Hypothetical Performance Scenarios—Alt-A and Subprime Private-Label Wraps     56  
  Changes in Risk Management Derivative Assets (Liabilities) at Fair Value, Net     58  
  Comparative Measures—GAAP Consolidated Balance Sheets and Non-GAAP Fair Value Balance Sheets     59  
  Supplemental Non-GAAP Consolidated Fair Value Balance Sheets     62  
  Change in Fair Value of Net Assets (Net of Tax Effect)     64  
  Debt Activity     65  
  Outstanding Short-Term Borrowings and Long-Term Debt     67  
  Maturity Profile of Outstanding Short-Term Debt     68  
  Maturity Profile of Outstanding Long-Term Debt     69  
  Cash and Other Investments Portfolio     71  


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Table
 
Description
  Page
 
  Fannie Mae Credit Ratings     73  
  Regulatory Capital Measures     74  
  On- and Off-Balance Sheet MBS and Other Guaranty Arrangements     77  
  Composition of Mortgage Credit Book of Business     79  
  Risk Characteristics of Conventional Single-Family Business Volume and Mortgage Credit Book of Business     81  
  Delinquency Status of Conventional Single-Family Loans     85  
  Serious Delinquency Rates     86  
  Nonperforming Single-Family and Multifamily Loans     88  
  Statistics on Conventional Single-Family Problem Loan Workouts     89  
  Re-performance Rates of Modified Conventional Single-Family Loans     90  
  Single-Family and Multifamily Foreclosed Properties     91  
  Mortgage Insurance Coverage     94  
  Activity and Maturity Data for Risk Management Derivatives     102  
  Fair Value Sensitivity of Net Portfolio to Changes in Level and Scope of Yield Curve     104  
  Duration Gap     105  
  Interest Rate Sensitivity of Financial Instruments     105  


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PART I—FINANCIAL INFORMATION
 
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
We have been under conservatorship, with the Federal Housing Finance Agency (“FHFA”) acting as conservator, since September 6, 2008. As conservator, FHFA succeeded to all rights, titles, powers and privileges of the company, and of any shareholder, officer or director of the company with respect to the company and its assets. The conservator has since delegated specified authorities to our Board of Directors and has delegated to management the authority to conduct our day-to-day operations. We describe the rights and powers of the conservator, the provisions of our agreements with the U.S. Department of Treasury (“Treasury”), and changes to our business, liquidity, corporate structure, business strategies and objectives since conservatorship in our Annual Report on Form 10-K for the year ended December 31, 2008 (“2008 Form 10-K”) in “Part I—Item 1—Business.”
 
You also should read this Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, in conjunction with our unaudited condensed consolidated financial statements and related notes, and the more detailed information contained in our 2008 Form 10-K. This discussion contains forward-looking statements that are based upon management’s current expectations and are subject to significant uncertainties and changes in circumstances. Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in this report in “Part II—Item 1A—Risk Factors” and in our 2008 Form 10-K in “Part I—Item 1A—Risk Factors.” Please also refer to our 2008 Form 10-K in “Part I—Item 7—MD&A—Glossary of Terms Used in This Report” for an explanation of terms we use in this report.
 
INTRODUCTION
 
Fannie Mae is a government-sponsored enterprise (“GSE”) that was chartered by Congress in 1938 to support liquidity and stability in the secondary mortgage market, where existing mortgage loans are purchased and sold. We securitize mortgage loans originated by lenders in the primary mortgage market into mortgage-backed securities that we refer to as Fannie Mae MBS, which can then be bought and sold in the secondary mortgage market. We also participate in the secondary mortgage market by purchasing mortgage loans (often referred to as “whole loans”) and mortgage-related securities, including our own Fannie Mae MBS, for our mortgage portfolio. In addition, we make other investments that increase the supply of affordable housing. Under our charter, we may not lend money directly to consumers in the primary mortgage market. Although we are a corporation chartered by the U.S. Congress, and although our conservator is a U.S. government agency and Treasury owns our senior preferred stock and a warrant to purchase our common stock, the U.S. government does not guarantee, directly or indirectly, our securities or other obligations.


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EXECUTIVE SUMMARY
 
Housing and Economic Conditions
 
Mortgage and Housing Market and Economic Conditions
 
The U.S. residential mortgage market continued to experience significant deterioration in the first quarter of 2009, which adversely affected our financial condition and results.
 
Virtually all fundamental measures of the housing market’s health worsened in the first quarter of 2009 compared with the fourth quarter of 2008. The market experienced declines in new and existing home sales, housing starts and home prices, as well as increases in mortgage delinquencies.
 
The recession that began in December 2007 continued to deepen in the first quarter. The U.S. gross domestic product, or GDP, for the fourth quarter of 2008 was revised downward to (6.3)% on an annualized basis, and declined further, although at a slower pace, by (6.1)% in the first quarter of 2009. The U.S. has lost a net total of over 5.1 million jobs since the start of the recession, and in the first quarter of 2009, the total number of Americans receiving unemployment benefits increased to the highest levels on record dating back to 1967. The U.S. Bureau of Labor Statistics reported successive increases in the unemployment rate in each month of the first quarter, reaching 8.5% in March. Unemployment rates in Florida, California, Arizona and Nevada rose to 9.7%, 11.2%, 7.8% and 10.4%, respectively, in March 2009.
 
High levels of unemployment, coupled with severe declines in home equity and household wealth, have contributed to a continued increase in residential mortgage delinquencies.
 
The actual number of unsold homes in inventory has begun to decline in recent months, but the supply of homes as measured by the inventory/sales ratio remains high since the pace of sales has slowed in recent months in response to rising unemployment. Although affordability measures have risen dramatically since home prices peaked and subsequently began falling, the limited availability of credit for many potential homebuyers and low consumer confidence have dampened purchase activity even at the decreasing price levels. Surveys of bank loan officers by the Federal Reserve showed lenders were still tightening credit standards in the first quarter.
 
While first quarter housing market indicators were worse than the fourth quarter, there were some tentative signs of improvement. On a seasonally adjusted basis, single-family housing starts, new home sales, and existing home sales were all higher in March than in January, though down from February.
 
Long-term mortgage rates declined to near-record lows in March, resulting in a wave of mortgage refinancing that drove an increase in mortgage originations overall—from approximately $363 billion in the fourth quarter of 2008 to approximately $511 billion in the first quarter of 2009. Approximately 73% of first quarter 2009 mortgage originations were refinancings, compared with 63% in the first quarter of 2008.
 
Multifamily housing fundamentals are under increasing stress that reflects broader unfavorable economic conditions, including higher unemployment and severely restricted capital. These conditions are negatively affecting multifamily property level cash flows, vacancy rates and rent levels. Property values are declining due to both the downward pressure on cash flows and the higher premium required by investors.
 
As of December 31, 2008, the latest date for which information was available, the amount of U.S. residential mortgage debt outstanding was estimated by the Federal Reserve to be approximately $11.9 trillion, including $11.0 trillion of single-family mortgages. Total U.S. residential mortgage debt outstanding decreased by 0.3% in 2008, compared with an increase of 7.0% in 2007 and 10.9% in 2006. Our mortgage credit book of business, which includes mortgage assets we hold in our investment portfolio, our Fannie Mae MBS held by third parties and credit enhancements that we provide on mortgage assets, was $3.1 trillion as of December 31, 2008, or approximately 26% of total U.S. residential mortgage debt outstanding. See “Part I—Item 1A—Risk Factors” of our 2008 Form 10-K for a description of the risks associated with the housing market downturn and continued home price declines.


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U.S. Government Actions to Stabilize the Markets and Support Economic Recovery
 
The U.S. government has taken a number of actions intended to strengthen market stability, improve the strength of financial institutions, enhance market liquidity, and provide support to homeowners, including the following actions, which were taken in 2009:
 
  •  On February 17, 2009, President Barack Obama signed into law the American Recovery and Reinvestment Act of 2009 (“2009 Stimulus Act”), a $787 billion economic stimulus package aimed at lifting the economy out of recession.
 
  •  On February 18, 2009, the Obama Administration announced the Homeowner Affordability and Stability Plan (“HASP”) as part of the Administration’s strategy to help reestablish confidence in the housing markets and to support a broader economic recovery. The Administration announced that key components of the plan are (1) providing access to low-cost refinancing for responsible homeowners suffering from falling home prices, (2) creating a $75 billion mortgage loan modification program to reach up to three to four million at-risk homeowners and (3) supporting low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac. On March 4, 2009, the Obama Administration announced new Treasury guidelines to enable servicers to begin modifications of eligible mortgages under the HASP. The refinancing and modification components of this program, the Making Home Affordable Program, are described in more detail below.
 
  •  On March 18, 2009, the Federal Reserve announced it would expand a program it first announced in November 2008 to purchase direct obligations of Fannie Mae, Freddie Mac, and the 12 Federal Home Loan Banks (“FHLBs”), and to purchase mortgage-backed securities guaranteed by Fannie Mae, Freddie Mac and the Government National Mortgage Association (“Ginnie Mae”). The expansion increased the amounts to be purchased in 2009 from up to $100 billion to up to $200 billion in direct obligations, and from up to $500 billion to up to $1.25 trillion in mortgage-backed securities. The Federal Reserve also announced that, to help improve conditions in private credit markets, it would purchase up to $300 billion of longer-term Treasury securities over the next six months. The Federal Reserve began purchasing our debt and MBS under this program in January 2009.
 
Our Business Objectives and Strategy
 
Our Board of Directors and management consult with FHFA, as our conservator, in establishing our strategic direction, and FHFA has approved our business objectives and strategy.
 
We face a variety of different, and potentially conflicting, objectives, including:
 
  •  providing liquidity, stability and affordability in the mortgage market;
 
  •  immediately providing additional assistance to the mortgage market and to the struggling housing market;
 
  •  limiting the amount of the investment Treasury must make under our senior preferred stock purchase agreement with Treasury in order to eliminate a net worth deficit;
 
  •  returning to long-term profitability; and
 
  •  protecting the interests of the taxpayers.
 
These objectives create conflicts in strategic and day-to-day decision-making that could lead to less than optimal outcomes for some or all of these objectives. For example, limiting the amount of funds Treasury must invest in us under the senior preferred stock purchase agreement in order to eliminate a net worth deficit could require us to constrain some of our business activities, including activities targeted at providing liquidity, stability and affordability to the mortgage market. Conversely, to the extent we expand our efforts to assist the mortgage market, our financial results are likely to suffer, at least in the short term, which will increase the amount of funds that Treasury is required to provide to us and further limit our ability to return to long-term profitability. We regularly consult with and receive direction from our conservator on how to balance our objectives.


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Accordingly, we currently are primarily focusing on the first two objectives listed above:
 
  •  providing liquidity, stability and affordability in the mortgage market; and
 
  •  immediately providing additional assistance to the mortgage market and to the struggling housing market.
 
We are concentrating our efforts on keeping people in their homes and preventing foreclosures. We also are continuing to be active in the secondary mortgage market through our guaranty business. The essence of this strategy is to support liquidity and affordability in the mortgage market, while creating and implementing successful foreclosure prevention approaches. Currently, one of the principal ways in which we are focusing on these objectives is through our participation in the government’s Making Home Affordable Program, which we describe in more detail below. Focusing on these objectives, rather than on returning to long-term profitability, is likely to contribute to further deterioration in both our results of operations and our net worth. Continuing deterioration in the housing and mortgage markets, along with the continuing deterioration in our guaranty book of business and the costs associated with the objectives on which we are focused, will increase the amount of funds that Treasury is required to provide to us. In turn, these factors put additional pressure on our ability to return to long-term profitability. If, however, the Making Home Affordable Program is successful in reducing foreclosures and keeping borrowers in their homes, it may benefit the overall housing market and help in reducing our long-term credit losses. We therefore consult regularly with our conservator on how to balance these two objectives against the competing objectives we face.
 
Summary of Our Financial Results for the First Quarter of 2009
 
Our financial results for the first quarter of 2009 were adversely affected by ongoing deterioration in the housing, mortgage, financial and credit markets.
 
We recorded a net loss of $23.2 billion and a diluted loss per share of $4.09 for the first quarter of 2009. In comparison, we recorded a net loss of $25.2 billion and a diluted loss per share of $4.47 for the fourth quarter of 2008, and a net loss of $2.2 billion and a diluted loss per share of $2.57 for the first quarter of 2008. Our results for the first quarter of 2009 were driven primarily by credit-related expenses of $20.9 billion, other-than-temporary impairment related to available-for-sale securities of $5.7 billion and fair value losses of $1.5 billion.
 
The $2.1 billion decrease in our net loss for the first quarter of 2009 from the fourth quarter of 2008 was driven principally by a $10.9 billion reduction in net fair value losses, which was partially offset by an $8.9 billion increase in credit-related expenses. The $21.0 billion increase in our net loss for the first quarter of 2009 compared to the loss we incurred in the first quarter of 2008 was driven principally by the significant increase in credit-related expenses.
 
Our credit-related expenses included a provision for credit losses of $20.3 billion, compared with a provision for credit losses of $11.0 billion in the fourth quarter of 2008. Our combined loss reserves, which reflect our best estimate of credit losses incurred in our guaranty book of business as of each balance sheet date, increased to $41.7 billion as of March 31, 2009, or 28.78% of our nonperforming loans, from $24.8 billion as of December 31, 2008, or 20.76% of our nonperforming loans. The substantial increase in our loss reserves primarily reflected further deterioration in the credit quality of both our single-family and multifamily guaranty book of business, evidenced by a significant increase in our nonperforming loans (loans for which we believe collectability of interest or principal is not reasonably assured) and seriously delinquent loans (single-family loans three months or more past due or in the foreclosure process or multifamily loans 60 days or more past due), as market conditions such as the severe economic downturn and rising unemployment continued to adversely affect the performance of our guaranty book of business. In addition, our average loss severities increased as a result of the continued decline in home prices during the first quarter of 2009. Because of the existing stress in the housing and credit markets, and the speed and extent to which these markets have deteriorated, our process for determining the adequacy of our loss reserves has become more complex and involves a greater degree of management judgment. The current state of the housing and mortgage markets is unprecedented in many respects, greatly reducing the usefulness of relying on our historical loan performance data in estimating our loss reserves. To address the limitations in these historical data, we made refinements to


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our loss estimation process during the first quarter of 2009. We provide additional information on our loss reserves, including refinements we made to our loss reserve process in response to the rapidly changing and unprecedented conditions in the housing and mortgage markets, in “Critical Accounting Policies and Estimates—Allowance for Loan Losses and Reserve for Guaranty Losses” and in “Consolidated Results of Operations—Credit Related Expenses.”
 
The other-than-temporary impairment on available-for-sale securities of $5.7 billion that we recognized in the first quarter of 2009 related to additional impairment losses on some of our Alt-A and subprime private-label securities that we had previously impaired, as well as impairment losses on other Alt-A and subprime securities, attributable to a continued deterioration in the credit quality of the loans underlying these securities and further declines in the expected cash flows.
 
Our mortgage credit book of business remained relatively unchanged at $3.1 trillion as of March 31, 2009, roughly the same level as at December 31, 2008, as high levels of refinancing activity led to high volumes of acquisitions and liquidations. Our estimated market share of new single-family mortgage-related securities issuances was 44.2% for the first quarter of 2009, compared with 41.7% for the fourth quarter of 2008.
 
We provide more detailed discussions of key factors affecting changes in our results of operations and financial condition in “Consolidated Results of Operations,” “Business Segment Results,” “Consolidated Balance Sheet Analysis,” “Supplemental Non-GAAP Information—Fair Value Balance Sheets,” and “Risk Management—Credit Risk Management—Mortgage Credit Risk Management—Mortgage Credit Book of Business.”
 
Homeowner Assistance and Foreclosure Prevention Initiatives
 
On March 4, 2009, the Obama Administration announced the details of its Making Home Affordable Program. The program includes a Home Affordable Refinance Program, which provides for the refinance of mortgage loans owned or guaranteed by us or Freddie Mac, and the Home Affordable Modification Program, which provides for the modification of mortgage loans owned or guaranteed by us or Freddie Mac, as well as other mortgage loans. On April 28, 2009, the Obama Administration announced the Second Lien Program, which provides participating servicers with alternatives for addressing second-lien loans when the servicers are modifying the associated first-lien mortgage loan under the Home Affordable Modification Program.
 
On March 4, 2009, we announced our participation in the Home Affordable Refinance and Home Affordable Modification Programs and released guidelines for Fannie Mae sellers and servicers in offering these two programs for Fannie Mae borrowers. These two programs are designed to significantly expand the number of borrowers who can refinance or modify their mortgages to achieve a monthly payment that is more affordable now and into the future. We also are serving as program administrator under the Home Affordable Modification Program and the Second Lien Program for loans we do not own or guarantee.
 
Key aspects of the Making Home Affordable Program are as follows.
 
Home Affordable Refinance Program
 
The Home Affordable Refinance Program is targeted at borrowers who have demonstrated an acceptable payment history on their mortgage loans but have been unable to refinance due to a decline in home prices or the unavailability of mortgage insurance. Loans under this program are available only if the new mortgage loan either reduces the monthly principal and interest payment for the borrower or provides a more stable loan product (such as movement from an adjustable-rate mortgage to a fixed-rate mortgage loan). Other eligibility requirements that must be met under this program include the following.
 
  •  We must own or guarantee the mortgage loan being refinanced.
 
  •  The unpaid principal balance on the mortgage loan may not exceed 105% of the current value of the property covered by the mortgage. In other words, the maximum loan-to-value, or LTV, ratio is 105%.
 
  •  Mortgage insurance for the new mortgage loan is only required if the existing loan has an original LTV ratio greater than 80% and mortgage insurance is currently in force on the existing loan. In that case, mortgage insurance is required only up to the coverage level on the existing loan, which may be less than our standard coverage requirements. FHFA has provided guidance that permits us to implement this feature of the program in compliance with our charter requirements through June 2010.


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  •  Reverse mortgage loans, second lien mortgage loans and government mortgage loans (such as loans guaranteed or insured by the Federal Housing Administration, or FHA, the Department of Veterans Affairs or the Rural Development Housing and Community Facilities Program of the Department of Agriculture) do not qualify for refinancing under this program.
 
  •  The new mortgage loan cannot:
 
  º  be an adjustable rate mortgage loan, or ARM, if the initial period for which the interest rate is fixed is less than five years;
 
  º  have an interest-only feature that permits the payment of interest without a payment of principal;
 
  º  be a balloon mortgage loan; or
 
  º  have the potential for negative amortization.
 
We made the program available for newly refinanced mortgage loans delivered to us on or after April 1, 2009. The program replaced the streamlined refinance options we previously offered. If interest rates remain near record lows, we expect that the Home Affordable Refinance Program will bolster refinance volumes over time as major lenders adopt necessary system changes and consumer awareness continues to build.
 
Home Affordable Modification Program
 
The Home Affordable Modification Program is aimed at helping borrowers whose loan either is currently delinquent or is at imminent risk of default by modifying their mortgage loan to make their monthly payments more affordable. The program is designed to provide a uniform, consistent regime for servicers to use in modifying mortgage loans to prevent foreclosures, including loans owned or guaranteed by Fannie Mae and other qualifying mortgage loans. We expect borrowers at risk of foreclosure who are not eligible for a loan refinance under the Home Affordable Refinance Program to be evaluated for eligibility under the Home Affordable Modification Program before any other workout alternative is considered. Borrowers ineligible for the Home Affordable Modification Program may be considered under other workout alternatives we provide, such as HomeSaver Advancetm and our recently introduced HomeSaver Forbearance initiative. For modifications under the Home Affordable Modification Program of qualifying mortgage loans that are not owned or guaranteed by Fannie Mae, we serve as the program administrator for Treasury, as described further below.
 
The key elements of the Home Affordable Modification Program include the following.
 
  •  Status of Mortgage Loan.  The mortgage loan must be delinquent (and may be in foreclosure) or default must be imminent. All borrowers must attest to a financial hardship. Examples include: a reduction or loss of income; a change in household circumstances; an increase in the existing mortgage payment or other expenses; a lack of sufficient cash reserves; or excessive monthly debt obligations, with an overextension of obligations to creditors.
 
  •  Reduction of Mortgage Payments.  Under the Home Affordable Modification Program, the goal is to modify a borrower’s mortgage loan to target the borrower’s monthly mortgage payment, after adding accrued interest and third-party escrow and other advances to the principal balance, at 31% of the borrower’s gross monthly income.
 
  •  Modifications Permitted.  Servicers must apply the permitted modification terms available in the order listed below until the borrower’s new monthly mortgage payment achieves the target payment ratio of 31%:
 
  º  Reduction of Interest Rate.  Reduce the interest rate to as low as 2% for the first five years following modification, increasing by 1% per year thereafter generally until it reaches the market rate at the time of modification.
 
  º  Extension of Loan Term.  Extend the loan term to up to 40 years.


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  º  Deferral of Principal.  Defer payment of a portion of the principal of the loan until (1) the borrower sells the property, (2) the end of the loan term, or (3) the borrower pays off the loan, whichever occurs first.
 
  •  Limits on Risk Features in Modified Mortgage Loans.
 
  º  ARMs and Interest-Only Loans.  If a borrower has an adjustable-rate or interest-only loan, the loan will convert to a fixed interest rate, fully amortizing loan.
 
  º  Prohibition on Negative Amortization.  Negative amortization is prohibited following the effective date of the modification.
 
  •  Trial Period Required before Modification.  Borrowers must satisfy the terms of a trial modification plan for a trial payment period of three months (for a delinquent loan) or four months (for a loan for which default is imminent). The modification will become effective upon satisfactory completion of the trial period.
 
  •  Counseling.  Borrowers with a total monthly debt-to-income ratio equal to or greater than 55% following modification must agree to work with a HUD-approved housing counselor on a plan to reduce the ratio below 55%.
 
  •  Pre-Foreclosure Eligibility Evaluation.  Servicers have been directed not to refer a loan for foreclosure or proceed with a foreclosure sale until the borrower has been evaluated for a modification under the program and, if eligible, has been extended an offer to participate in the program.
 
  •  Incentive Payments to Servicers.  For each of our loans for which a modification is completed under the Home Affordable Modification Program, we will pay the servicer:
 
  º  a $1,000 incentive payment for each completed modification;
 
  º  an additional $500 incentive payment for any modified loan that was current when it entered the trial period (i.e., a loan for which default was imminent); and
 
  º  an annual “pay for success” fee of up to $1,000 for any modification that reduces a borrower’s monthly payment by 6% or more, payable for each of the first three years after the modification as long as the borrower is continuing to make the payments due under the modified loan.
 
  •  Incentives to Borrowers.  For a completed modification under the Home Affordable Modification Program that reduces the borrower’s monthly payment by 6% or more, we will provide the borrower an annual reduction in the outstanding principal balance of the modified loan of up to $1,000 for each of the first five years after the modification as long as the borrower is continuing to make the payments due under the modified loan.
 
  •  Costs of Modifications.  We bear all of the costs of modifying our loans under the Home Affordable Modification Program, including any additional amounts we are required to provide under our guarantees for loans owned by one of our MBS trusts during a trial payment period or any other mortgage-backed securities for which we have provided a guaranty.
 
The Home Affordable Modification Program expires on December 31, 2012.
 
Our Role as Program Administrator of the Home Affordable Modification Program and Second Lien Program
 
Treasury has engaged us to serve as program administrator for loans modified under the Home Affordable Modification Program that are not owned or guaranteed by us. In April 2009, we released guidance to servicers for adoption and implementation of the Home Affordable Modification Program for mortgage loans that are not owned or guaranteed by us or Freddie Mac. Freddie Mac maintains guidelines for modification under the program of loans it owns or guarantees. Freddie Mac bears the costs of loan modifications under the Home Affordable Modification Program for all loans owned or guaranteed by Freddie Mac, and Treasury bears the costs for loans other than Fannie Mae’s or Freddie Mac’s modified under the program. Treasury also generally will compensate investors (other than Fannie Mae or Freddie Mac) for 50% of the amount by which


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a payment is reduced due to the modification, subject to certain limits, and will pay an up-front incentive fee of $1,500 to such investors if the borrower was current on the loan before the trial period and the borrower’s monthly mortgage payment was reduced by 6% or more.
 
Our principal activities as program administrator include the following:
 
  •  Implementing the guidelines and policies within which the program will operate;
 
  •  Preparing the requisite forms, tools and training to facilitate efficient loan modifications by servicers;
 
  •  Creating and making available a process for servicers to report modification activity and program performance;
 
  •  Acting as paying agent to calculate and remit subsidies and compensation consistent with program guidelines;
 
  •  Acting as record-keeper for executed loan modifications and program administration;
 
  •  Coordinating with Treasury and other parties toward achievement of the program’s goals; and
 
  •  Performing other tasks as directed by Treasury from time to time.
 
Treasury also has engaged us to serve as program administrator of the Second Lien Program for loans that are not owned or guaranteed by us. Our principal activities as program administrator for the Second Lien Program are similar to those described above for the Home Affordable Modification Program.
 
Expected Impact of the Making Home Affordable Program
 
The actions we are taking and the initiatives we have introduced to assist homeowners and limit foreclosures, including those described above, are significantly different from our historical approach to delinquencies, defaults and problem loans. As a result, it will take time for us to assess and provide statistical information both on the relative success of these efforts and their effect on our results of operations and financial condition. Some of the initiatives we undertook prior to the Making Home Affordable Program have not achieved the results we expected. We will continue to work with our conservator as we move forward under the Making Home Affordable Program to help us best fulfill our objective of helping homeowners and the mortgage market. As we gain more experience under these programs, we may supplement them with other initiatives to help us assist more homeowners. We have included data relating to our borrower loss mitigation activities for the first quarter and prior periods in “Risk Management—Credit Risk Management—Mortgage Credit Risk Management.” Given the timing of implementation of the Making Home Affordable Program, these data do not include activities under the program.
 
The nature of the Making Home Affordable Program is unprecedented. As a result, it is difficult for us to predict the full extent of our activities under the program and how those will affect us, the response rates we will experience, or the costs that we will incur. We do expect modifications of loans to increase in 2009 as a result of the Home Affordable Modification Program, however, we cannot predict the degree of increase in part due to the complexity involved in the process from the time we identify a potential loan for modification to actually modifying the loan. The steps in the process, which are generally performed by servicers, include:
 
  •  Identifying loans within our portfolio and Fannie Mae MBS that are candidates for modification;
 
  •  Making contact with the borrower;
 
  •  Obtaining current financial information from the borrower;
 
  •  Evaluating whether Home Affordable Modification Program is a viable workout option;
 
  •  Structuring the terms of the modification;
 
  •  Communicating the terms to the borrower together with the legal documentation; and
 
  •  Receiving agreement of the borrower to the terms of the modification.


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We are working with servicers to effectively implement the program and reach borrowers who are eligible for a modification under the program. However, the need to complete the steps detailed above, including having multiple servicer contacts with the borrower, creates significant uncertainty in our ability to estimate the number of modifications we will accomplish. It is also uncertain whether the borrower and servicer incentives under the Home Affordable Modification Program will provide sufficient motivation for modifications.
 
We expect modifications under the Home Affordable Modification Program of loans we own or guarantee in particular to adversely affect our financial results and condition for several reasons, including:
 
  •  Fair value loss charge-offs under Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”), against the “Reserve for guaranty losses” at the time we acquire loans, which we must do prior to any modification of a loan held in a Fannie Mae MBS trust;
 
  •  Incentive and “pay for success” fees paid to our servicers for modification of loans we own or guarantee;
 
  •  Principal balance reductions on loans if certain borrowers perform on the loans following modification; and
 
  •  The effect of holding these modified loans in our mortgage portfolio, as the loans will provide a below market yield that may be lower than our cost of funds.
 
We also expect to incur additional operational expenses associated with the Making Home Affordable Program. Accordingly, the Making Home Affordable Program will likely have a material adverse effect on our business, results of operations and financial condition, including our net worth. If the program is successful in reducing foreclosures and keeping borrowers in their homes, however, it may benefit the overall housing market and help in reducing our long-term credit losses.
 
Providing Mortgage Market Liquidity and Other Market Support
 
Ongoing provision of liquidity to the mortgage markets.  During the first quarter of 2009, we purchased or guaranteed an estimated $175.4 billion in new business, measured by unpaid principal balance. These purchases and guarantees consisted primarily of single-family mortgage loans, providing financing for approximately 730,000 conventional single-family loans. Our purchase or guarantee of approximately $3.8 billion of new and existing multifamily loans during the first quarter of 2009 helped to finance approximately 87,000 multifamily units. The $175.4 billion in new business for the quarter consisted of $125.4 billion in Fannie Mae MBS that were acquired by third parties, and $50.0 billion in mortgage loans and mortgage-related securities we purchased for our mortgage investment portfolio. Our estimated market share of new single-family mortgage-related securities issuances was 44.2% for the first quarter of 2009, compared with 41.7% for the fourth quarter of 2008, making us the largest single provider of mortgage-related securities in the secondary market.
 
Suspension of foreclosures.  We maintained a suspension of foreclosures from November 26, 2008 through January 31, 2009, and from February 17, 2009 through March 6, 2009. We extended the suspension to allow us time to implement the Making Home Affordable Program.
 
Adoption of National Real Estate Owned Rental Policy.  In January 2009, we adopted our National Real Estate Owned Rental Policy, which is designed to allow qualified renters in Fannie Mae-owned foreclosed properties to stay in their homes. Under the policy, eligible renters are offered a new month-to-month lease with Fannie Mae or financial assistance for their transition to new housing should they choose to vacate the property.
 
Enhancing multifamily Fannie Mae MBS.  Our HCD business is proactively working with our DUS lenders and other parties to expand our Fannie Mae multifamily MBS product suite to increase third-party investor interest and provide liquidity and stability in the multifamily market. Third-party multifamily Fannie Mae MBS execution was 32% of total multifamily commitment volume during the first quarter of 2009, compared with 2% of total multifamily commitment volume during the first quarter of 2008.


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Increased flexibility to allow more loans to one borrower.  In February 2009, we modified our policies to allow investor and second home borrowers to own up to ten financed properties if they meet certain eligibility, underwriting and delivery requirements. We previously limited the number of properties to five.
 
HomeSaver Forbearance.  On March 4, 2009, we introduced HomeSaver Forbearance, which is a new loss mitigation option available for borrowers whose loan either is delinquent or is at imminent risk of default and who do not qualify for a modification under the Home Affordable Modification Program. We have directed servicers to offer forbearance if an eligible borrower has a willingness and ability to make reduced monthly payments of at least one-half of their contractual monthly payment amount. The forbearance period lasts for six months, during which time the servicer works with the borrower to identify a more permanent foreclosure prevention alternative. We have instructed servicers to identify such an alternative during the first three months of the forbearance period and implement the alternative by the end of the six-month period.
 
Increase in conforming loan limit for 2009.  In March 2009, we announced our requirements for the acquisition of high-balance mortgage loans during 2009 under temporary authority granted under the 2009 Stimulus Act. This authority set the conforming loan limit for a one-family residence in high cost areas at a maximum of $729,750 for 2009.
 
New multifamily trust documents.  In January 2009, we introduced new master trust agreements for multifamily Fannie Mae MBS. The new agreements, which include an amendment and restatement of a prior master trust agreement, are designed to increase flexibility in managing delinquent loans backing multifamily Fannie Mae MBS issued on or after February 1, 2009, without requiring a repurchase of the affected loans or a change to an investor’s cash flows.
 
Credit Overview
 
We continued to experience a deterioration in the credit performance of mortgage loans in our guaranty book of business during the first quarter of 2009, reflecting the ongoing impact of the adverse conditions in the housing market, as well as the deepening economic recession and rising unemployment. We expect these conditions to continue to adversely affect our credit results in 2009. Table 1 below presents information about the credit performance of mortgage loans in our single-family guaranty book of business for the year ended December 31, 2008 and for each subsequent quarter, illustrating the worsening trend in performance throughout 2008 and continuing in the first quarter of 2009.
 
Table 1:  Credit Statistics, Single-Family Guaranty Book of Business(1)
 
                                                         
    2009     2008     2007  
    Q1     Full Year     Q4     Q3     Q2     Q1     Full Year  
    (Dollars in millions)  
 
As of the end of each period:
                                                       
Serious delinquency rate(2)
    3.15 %     2.42 %     2.42 %     1.72 %     1.36 %     1.15 %     0.98 %
On-balance sheet nonperforming loans(3)
  $ 23,145     $ 20,484     $ 20,484     $ 14,148     $ 11,275     $ 10,947     $ 10,067  
Off-balance sheet nonperforming loans(4)
  $ 121,378     $ 98,428     $ 98,428     $ 49,318     $ 34,765     $ 23,983     $ 17,041  
Combined loss reserves(5)
  $ 41,082     $ 24,649     $ 24,649     $ 15,528     $ 8,866     $ 5,140     $ 3,318  
Foreclosed property inventory (number of properties)(6)
    62,371       63,538       63,538       67,519       54,173       43,167       33,729  
During the period:
                                                       
Loan modifications (number of loans)(7)
    12,418       33,249       6,276       5,262       10,190       11,521       26,421  
HomeSaver Advance problem loan workouts (number of loans)(8)
    20,424       70,943       25,783       27,267       16,742       1,151        
Foreclosed property acquisitions (number of properties)(9)
    25,374       94,652       20,998       29,583       23,963       20,108       49,121  
Single-family credit-related expenses(10)
  $ 20,330     $ 29,725     $ 11,917     $ 9,215     $ 5,339     $ 3,254     $ 5,003  
Single-family credit losses(11)
  $ 2,465     $ 6,467     $ 2,197     $ 2,164     $ 1,249     $ 857     $ 1,331  


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  (1) The single-family guaranty book of business consists of single-family mortgage loans held in our mortgage portfolio, single-family Fannie Mae MBS held in our mortgage portfolio, single-family Fannie Mae MBS held by third parties, and other credit enhancements that we provide on single-family mortgage assets. Excludes non-Fannie Mae mortgage-related securities held in our investment portfolio for which we do not provide a guarantee.
 
  (2) Calculated based on number of conventional single-family loans that are three or more consecutive months past due and loans that have been referred to foreclosure but not yet foreclosed upon divided by the number of loans in our conventional single-family guaranty book of business. We include all of the conventional single-family loans that we own and those that back Fannie Mae MBS in the calculation of the single-family serious delinquency rate.
 
  (3) Represents the total amount of nonaccrual loans, troubled debt restructurings, and first-lien loans associated with unsecured HomeSaver Advance loans inclusive of troubled debt restructurings and HomeSaver Advance first-lien loans on accrual status. A troubled debt restructuring is a modification to the contractual terms of a loan that results in a concession to a borrower experiencing financial difficulty. Prior to the fourth quarter of 2008, we generally classified loans as nonperforming when the payment of principal or interest on the loan was three months or more past due. In the fourth quarter of 2008, we began classifying loans as nonperforming at an earlier stage in the delinquency cycle, generally when the payment of principal or interest on the loan is two months or more past due.
 
  (4) Represents unpaid principal balance of nonperforming loans in our outstanding and unconsolidated Fannie Mae MBS held by third parties, including first-lien loans associated with unsecured HomeSaver Advance loans that are not seriously delinquent. Prior to the fourth quarter of 2008, we generally classified loans as nonperforming when the payment of principal or interest on the loan was three months or more past due. In the fourth quarter of 2008, we began classifying loans as nonperforming at an earlier stage in the delinquency cycle, generally when the payment of principal or interest on the loan is two months or more past due.
 
  (5) Consists of the allowance for loan losses for loans held for investment in our mortgage portfolio and reserve for guaranty losses related to loans backing Fannie Mae MBS and loans that we have guaranteed under long-term standby commitments.
 
  (6) Reflects the number of single-family foreclosed properties we held in inventory as of the end of each period. Includes deeds in lieu of foreclosure.
 
  (7) Modifications include troubled debt restructurings and other modifications to the contractual terms of the loan that do not result in concessions to the borrower. A troubled debt restructuring involves some economic concession to the borrower, and is the only form of modification in which we do not expect to collect the full original contractual principal and interest amount due under the loan, although other resolutions and modifications may result in our receiving the full amount due, or certain installments due, under the loan over a period of time that is longer than the period of time originally provided for under the loans.
 
  (8) Represents number of first-lien loans associated with unsecured HomeSaver Advance loans.
 
  (9) Includes deeds in lieu of foreclosure.
 
(10) Consists of the provision for credit losses and foreclosed property expense.
 
(11) Consists of (a) charge-offs, net of recoveries and (b) foreclosed property expense; adjusted to exclude the impact of SOP 03-3 and HomeSaver Advance fair value losses for the reporting period. Interest forgone on single-family nonperforming loans in our mortgage portfolio is not reflected in our credit losses total. In addition, other-than-temporary impairment losses resulting from deterioration in the credit quality of our mortgage-related securities and accretion of interest income on single-family loans subject to Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”), are excluded from credit losses. Please see “Consolidated Results of Operations—Credit-Related Expenses—Provision Attributable to SOP 03-3 and HomeSaver Advance Fair Value Losses” for a discussion of SOP 03-3.
 
Our entire guaranty book of business, including loans with lower risk characteristics, has begun to experience increases in delinquency and default rates as a result of the sharp rise in unemployment, the continued decline in home prices, the prolonged downturn in the economy, and the resulting increase in mark-to-market LTV ratios. In addition, certain loan types have continued to contribute disproportionately to the increases in serious delinquencies and credit losses we reported for the first quarter of 2009. These include loans on properties in California, Florida, Arizona and Nevada; loans originated in 2006 and 2007; and loans in higher-risk categories such as Alt-A loans and interest-only loans.
 
“Alt-A loans” generally refers to mortgage loans that can be underwritten with reduced or alternative documentation than that required for a full documentation mortgage loan but may also include other alternative product features. In reporting our credit exposure, we classify mortgage loans as Alt-A if the lenders that deliver the mortgage loans to us have classified the loans as Alt-A based on documentation or other product features. We have classified loans as nonperforming, and placed them on nonaccrual status, when we believe collectability of interest or principal on the loan is not reasonably assured.


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Net Worth and Fair Value Deficit
 
Net Worth and Fair Value Deficit Amounts
 
Under the senior preferred stock purchase agreement that was entered into between us and Treasury in September 2008 and amended in May 2009, Treasury committed to provide us funds of up to $200 billion, on a quarterly basis, in the amount, if any, by which our total liabilities exceed our total assets at the end of the applicable fiscal quarter. This net worth deficit equals the total deficit that we report in our condensed consolidated balance sheets, and is calculated by subtracting our total liabilities from our total assets, each as shown on our condensed consolidated balance sheets prepared in accordance with generally accepted accounting principles (“GAAP”) for that fiscal quarter. We describe the amended terms of the agreement in more detail below in “Amendment to Senior Preferred Stock Purchase Agreement” and we describe the terms of the agreement prior to its May 2009 amendment, most of which continue to apply, in our 2008 Form 10-K in “Part I—Item 1—Business—Conservatorship, Treasury Agreements, Our Charter and Regulation of Our Activities—Treasury Agreements.”
 
Our net worth as of March 31, 2009 was negative and is presented in our condensed consolidated GAAP balance sheets as a total deficit of $18.9 billion as of March 31, 2009, which is an increase of $3.8 billion over our total deficit of $15.2 billion as of December 31, 2008. The increase in our net worth deficit was primarily attributable to the net loss we recorded during the first quarter of 2009, partially offset by the $15.2 billion we received from Treasury.
 
Our fair value deficit as of March 31, 2009, which is reflected in our supplemental non-GAAP fair value balance sheet, was $110.3 billion, an increase of $5.2 billion over our fair value deficit of $105.2 billion as of December 31, 2008. The amount that Treasury committed to provide us under the senior preferred stock purchase agreement is determined based on our GAAP balance sheet, not our non-GAAP fair value balance sheet. There are significant differences between our GAAP balance sheet and our non-GAAP fair value balance sheet, which we describe in greater detail in “Supplemental Non-GAAP Information—Fair Value Balance Sheets.”
 
Due to current trends in the housing and financial markets, we expect to have a net worth deficit in future periods, and therefore will be required to obtain additional funding from Treasury pursuant to the senior preferred stock purchase agreement.
 
Request for and Effect of Treasury Funding
 
Under the Federal Housing Finance Regulatory Reform Act (“Regulatory Reform Act”), FHFA must place us into receivership if the Director of FHFA makes a written determination that our assets are, and during the preceding 60 days have been, less than our obligations. FHFA has notified us that the measurement period for such a determination begins no earlier than the date of the SEC filing deadline for our quarterly and annual financial statements and continues for a period of 60 days after that date. FHFA also has advised us that, if we receive funds from Treasury during that 60-day period in order to eliminate our net worth deficit as of the prior period end in accordance with the senior preferred stock purchase agreement, the Director of FHFA will not make a mandatory receivership determination. On March 31, 2009, we received our first investment from Treasury under the senior preferred stock purchase agreement of $15.2 billion, which eliminated our net worth deficit as of December 31, 2008.
 
The Director of FHFA submitted a request to Treasury on May 6, 2009 for $19.0 billion on our behalf under the terms of the senior preferred stock purchase agreement to eliminate our net worth deficit as of March 31, 2009, and requested receipt of those funds on or prior to June 30, 2009.
 
When Treasury provides the additional funds that FHFA requested on our behalf, the aggregate liquidation preference of our senior preferred stock will total $35.2 billion and the annualized dividend on the senior preferred stock will be $3.5 billion, based on the 10% dividend rate. This dividend amount exceeds 50% of our reported annual net income in six of the past seven years, in most cases by a significant margin. If we do not make cash payments on time, the dividend rate increases to 12% annually, and the unpaid dividend is added to the liquidation preference, further increasing the amount of the annual dividends.


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Significance of Net Worth Deficit, Fair Value Deficit and Combined Loss Reserves
 
Our net worth deficit, which equals our total deficit reported on our consolidated GAAP balance sheet, includes the combined loss reserves of $41.7 billion that we recorded in our consolidated balance sheet as of March 31, 2009. Our non-GAAP fair value balance sheet presents all of our assets and liabilities at estimated fair value as of the balance sheet date. “Fair value” represents the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, which is also referred to as the “exit price.” In determining fair value, we use a variety of valuation techniques and processes. In general, fair value incorporates the market’s current view of the future, and that view is reflected in the current price of the asset or liability. However, future market conditions may be different from what the market has currently estimated and priced into these fair value measures. We describe our use of assumptions and management judgment and our valuation techniques and processes for determining fair value in more detail in “Supplemental Non-GAAP information—Fair Value Balance Sheets,” “Critical Accounting Policies and Estimates—Fair Value of Financial Instruments” and “Notes to Condensed Consolidated Financial Statements—Note 18, Fair Value of Financial Instruments.”
 
Neither our GAAP combined loss reserves nor our estimate of the fair value of our guaranty obligations, which we disclose in our consolidated non-GAAP fair value balance sheet, reflects our estimate of the future credit losses inherent in our existing guaranty book of business. Rather, our combined loss reserves reflect only probable losses that we believe we have already incurred as of the balance sheet date, while the fair value of our guaranty obligation is based not only on future expected credit losses over the life of the loans underlying our guarantees as of March 31, 2009, but also on the estimated profit that a market participant would require to assume that guaranty obligation. Because of the severe deterioration in the mortgage and credit markets, there is significant uncertainty regarding the full extent of future credit losses in the mortgage industry as a whole, as well as to any participant in the industry. Therefore, we are not currently providing guidance or other estimates of the credit losses that we will experience in the future.
 
Amendment to Senior Preferred Stock Purchase Agreement
 
Treasury and FHFA, acting on our behalf in its capacity as our conservator, entered into an amendment to the senior preferred stock purchase agreement between us and Treasury on May 6, 2009. Unless the context indicates otherwise, references in this report to the senior preferred stock purchase agreement refer to the agreement as amended on May 6, 2009. The May 6, 2009 amendment revised the terms of the senior preferred stock purchase agreement in the following ways:
 
  •  Treasury’s maximum funding commitment to us under the agreement was increased from $100 billion to $200 billion.
 
  •  The covenant limiting the amount of mortgage assets we can own on December 31, 2009 was increased from $850 billion to $900 billion. We continue to be required to reduce our mortgage assets, beginning on December 31, 2010 and each year thereafter, to 90% of the amount of our mortgage assets as of December 31 of the immediately preceding calendar year, until the amount of our mortgage assets reaches $250 billion.
 
  •  The covenant limiting the amount of our indebtedness was changed. Prior to the amendment, our debt cap was equal to 110% of our indebtedness as of June 30, 2008. As amended, our debt cap through December 30, 2010 equals $1,080 billion. Beginning December 31, 2010, and on December 31 of each year thereafter, our debt cap that will apply through December 31 of the following year will equal 120% of the amount of mortgage assets we are allowed to own on December 31 of the immediately preceding calendar year.
 
  º  We estimate that our indebtedness as of March 31, 2009 totaled $869.3 billion, which was approximately $22.7 billion below our estimated debt limit of $892.0 billion in effect at that time and approximately $210.7 billion below our revised debt limit.
 
  º  Our calculation of our indebtedness for purposes of complying with our debt cap, which has not been confirmed by Treasury, reflects the unpaid principal balance of our debt outstanding or, in the case of


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  long-term zero coupon bonds, the unpaid principal balance at maturity. Our calculation excludes debt basis adjustments and debt recorded from consolidations.
 
  •  The definition of indebtedness in the May 6, 2009 amendment was revised to clarify that it does not give effect to any change that may be made in respect of SFAS No. 140, Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125) (“SFAS 140”) or any similar accounting standard. The agreement continues to provide that, for purposes of evaluating our compliance with the limitation on the amount of mortgage assets we may own, the effect of changes in generally accepted accounting principles that occur subsequent to the date of the agreement and that require us to recognize additional mortgage assets on our balance sheet (for example, proposed amendments to SFAS 140), will not be considered.
 
  •  The limitation on entering into or changing compensation arrangements with our named executive officers (as defined by SEC rules) was broadened to apply to all of our executive officers (as defined by SEC rules). The agreement provides that we may not enter into any new compensation arrangements or increase amounts or benefits payable under existing compensation arrangements for these officers without the consent of the Director of FHFA, in consultation with the Secretary of the Treasury. As amended this requirement now applies to twelve of our current officers, instead of the five to whom it applied prior to the amendment. The executives who served as our executive officers as of February 26, 2009 are identified in “Part III—Item 10—Directors, Executive Officers and Corporate Governance” in our 2008 Form 10-K.
 
Liquidity
 
We fund our purchases of mortgage loans primarily from the proceeds from sales of our debt securities. In September 2008, Treasury made available to us two additional sources of funds: the Treasury credit facility and the senior preferred stock purchase agreement.
 
The dynamics of our funding program have improved significantly since late November 2008, including demand for our long-term and callable debt. As a result of our improved access to the long-term debt markets, we have decreased the portion of our total outstanding debt represented by short-term debt to 32% as of March 31, 2009 from 38% as of December 31, 2008, and the aggregate weighted-average maturity of our debt increased to 45 months as of March 31, 2009 from 42 months as of December 31, 2008.
 
We believe the improvement in our debt funding is due to actions taken by the federal government to support us and our debt securities, including the senior preferred stock purchase agreement entered into in September 2008, Treasury’s program announced in September 2008 to purchase MBS of the GSEs, the Treasury credit facility made available to us in September 2008 and the Federal Reserve’s program announced in November 2008 to purchase up to $100 billion in debt securities of Fannie Mae, Freddie Mac and the FHLBs and up to $500 billion in mortgage-backed securities of Fannie Mae, Freddie Mac and Ginnie Mae. On February 18, 2009, Treasury announced that it will continue to purchase Fannie Mae and Freddie Mac mortgage-backed securities to promote stability and liquidity in the marketplace. On March 18, 2009, the Federal Reserve announced that it intended to increase purchases of debt securities of Fannie Mae, Freddie Mac and the FHLBs and of Fannie Mae, Freddie Mac and Ginnie Mae mortgage-backed securities under its program to a total of up to $200 billion and $1.25 trillion, respectively.
 
There can be no assurance that the improvements in our access to the unsecured debt markets and in our ability to issue long-term and callable debt will continue. We believe the improvements stem from federal government support, such as the support described above, and, as a result, changes or perceived changes in the government’s support of us may have a material adverse affect on our ability to fund our operations. In particular, to the extent the market for our debt securities has improved due to the availability to us of the Treasury credit facility, we believe that the actual and perceived risk that we will be unable to refinance our debt as it becomes due is likely to increase substantially as we progress toward December 31, 2009, which is the date on which the Treasury credit facility terminates. Accordingly, we continue to have significant roll-over risk notwithstanding improved access to long-term funding, and this risk is likely to increase as we approach expiration of the Treasury credit facility. See “Liquidity and Capital Management—Liquidity


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Management—Debt Funding” for more information on our debt funding activities and “Part II—Item 1A—Risk Factors” of this report and “Part I—Item 1A—Risk Factors” of our 2008 Form 10-K for a discussion of the risks to our business posed by our reliance on the issuance of debt to fund our operations.
 
Outlook
 
We anticipate that adverse market dynamics and certain of our activities undertaken to stabilize and support the housing and mortgage markets will negatively affect our financial condition and performance through the remainder of 2009.
 
Overall Market Conditions.  We expect the current financial market crisis to continue through 2009. We expect further home price declines and rising default and severity rates, all of which may worsen if unemployment rates continue to increase and if the U.S. continues to experience a broad-based recession. We continue to expect the level of foreclosures and single-family delinquency rates to increase further in 2009, as well as the level of multifamily defaults and loss severities. We expect growth in residential mortgage debt outstanding to be flat in 2009.
 
Home Price Declines:  Following a decline of approximately 10% in 2008, we expect that home prices will decline another 7% to 12% on a national basis in 2009. We also continue to expect that we will experience a peak-to-trough home price decline of 20% to 30%. These estimates are based on our home price index, which is calculated differently from the S&P/Case-Schiller index and therefore results in lower percentages for comparable declines. These estimates also contain significant inherent uncertainty in the current market environment, due to historically unprecedented levels of uncertainty regarding a variety of critical assumptions we make when formulating these estimates, including: the effect of actions the federal government has taken and may take with respect to national economic recovery; the impact of those actions on home prices, unemployment and the general economic environment; and the rate of unemployment and/or wage decline. Because of these uncertainties, the actual home price decline we experience may differ significantly from these estimates. We also expect significant regional variation in home price decline percentages.
 
Our estimate of a 7% to 12% home price decline for 2009 compares with a home price decline of approximately 12% to 18% using the S&P/Case-Schiller index method, and our 20% to 30% peak-to- trough home price decline estimate compares with an approximately 33% to 46% peak-to-trough decline using the S&P/Case-Schiller index method. Our estimates differ from the S&P/Case-Schiller index in two principal ways: (1) our estimates weight expectations for each individual property by number of properties, whereas the S&P/Case-Schiller index weights expectations of home price declines based on property value, causing declines in home prices on higher priced homes to have a greater effect on the overall result; and (2) our estimates do not include sales of foreclosed homes because we believe that differing maintenance practices and the forced nature of the sales make foreclosed home prices less representative of market values, whereas the S&P/Case-Schiller index includes sales of foreclosed homes. The S&P/Case-Schiller comparison numbers shown above are calculated using our models and assumptions, but modified to use these two factors (weighting of expectations based on property value and the inclusion of foreclosed property sales). In addition to these differences, our estimates are based on our own internally available data combined with publicly available data, and are therefore based on data collected nationwide, whereas the S&P/Case-Schiller index is based only on publicly available data, which may be limited in certain geographic areas of the country. Our comparative calculations to the S&P/Case-Schiller index provided above are not modified to account for this data pool difference.
 
Credit Losses and Credit-Related Expenses.  We continue to expect our credit losses and our credit loss ratio (each of which excludes fair value losses under SOP 03-3 and our HomeSaver Advance product) in 2009 will exceed our credit losses and our credit loss ratio in 2008. We also expect a significant increase in our SOP 03-3 fair value losses as we increase the number of loans we repurchase from MBS trusts in order to modify them. In addition, if our book of business continues to be adversely affected by market and economic conditions or other factors, we expect our credit-related expenses to be higher in 2009 than they were in 2008, although we believe that our credit-related expenses for the first quarter of 2009 are not necessarily indicative of the expenses we will incur in subsequent quarters during 2009. Because of the current state of the market


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and a focus on keeping people in their homes and supporting liquidity and stability in the mortgage market, we are no longer providing guidance on expected changes in our combined loss reserves during 2009.
 
Expected Lack of Profitability for Foreseeable Future.  We expect to continue to have losses as our guaranty book of business continues to deteriorate and as we continue to incur ongoing costs in our efforts to keep people in homes and provide liquidity to the mortgage market. We expect that we will not operate profitably for the foreseeable future.
 
Uncertainty Regarding our Future Status and Long-Term Financial Sustainability:  We expect that we will experience adverse financial effects because of our strategy of concentrating our efforts on keeping people in their homes and preventing foreclosures, including our efforts under the Making Home Affordable Program, while remaining active in the secondary mortgage market. In addition, future activities that our regulators, other U.S. government agencies or Congress may request or require us to take to support the mortgage market and help borrowers may contribute to further deterioration in our results of operations and financial condition. Although Treasury’s additional funds under the senior preferred stock purchase agreement permit us to remain solvent and avoid receivership, the resulting dividend payments are substantial and will increase as we request additional funds from Treasury under the senior preferred stock purchase agreement. As a result of these factors, along with current and expected market and economic conditions and the deterioration in our single-family and multifamily books of business, there is significant uncertainty as to our long-term financial sustainability. We expect that for the foreseeable future the earnings of the company, if any, will not be sufficient to pay the dividends on the senior preferred stock. As a result, future dividend payments will be paid from equity drawn from the Treasury. Further, the conservatorship that we are under has no specified termination date, and the future structure of our business during and following termination of the conservatorship is uncertain.
 
HOUSING GOALS
 
Proposed 2009 Housing Goals
 
As described in our 2008 Form 10-K, the Regulatory Reform Act provides that the housing goals previously established by the Department of Housing and Urban Development for 2008 remain in effect for 2009; however, the Regulatory Reform Act also includes a requirement that the Director of FHFA review these goals to determine their feasibility for 2009 in light of current market conditions and, after seeking public comment, make appropriate adjustments to the goals consistent with these market conditions.
 
In April 2009, FHFA issued a proposed rule lowering our 2009 housing goals from the 2008 levels. FHFA determined that, in light of current market conditions, the previously established 2009 housing goals were not feasible unless adjusted. FHFA’s proposed adjustments would reduce our 2009 housing goals approximately to the levels that prevailed in 2004 through 2006. FHFA’s proposed rule would also permit loan modifications that we make in accordance with HASP to be treated as mortgage purchases and count towards the housing goals. In addition, the proposed rule would exclude from counting towards the 2009 housing goals any purchases of loans on one-to four-unit properties with a maximum original principal balance higher than the nationwide conforming loan limit (currently set at $417,000). The adverse market conditions that FHFA took into consideration in its determination that the existing 2009 goals were not feasible included tighter underwriting practices, the sharply increased standards of private mortgage insurers, the increased role of the FHA in the marketplace, the collapse of the private-label mortgage-related securities market, increasing unemployment, multifamily market volatility and the prospect of a refinancing surge in 2009. These conditions contribute to fewer goals-qualifying mortgages available for purchase by us. FHFA’s proposed rule notes that, even with these reductions, the proposed 2009 goals are generally at the upper end of FHFA’s market estimates for 2009.


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The following table sets forth FHFA’s proposed 2009 housing goals and subgoals, and for comparative purposes our 2008 housing goals and subgoals, and our performance against those goals and subgoals. The 2008 performance results have not yet been validated by FHFA.
 
Table 2:  Housing Goals and Subgoals
 
                         
    2009     2008  
    Proposed Goal     Result(1)     Goal  
 
Housing goals:(2)
                       
Low- and moderate-income housing
    51.0 %     53.6 %     56.0 %
Underserved areas
    37.0       39.4       39.0  
Special affordable housing
    23.0       26.0       27.0  
                         
Housing subgoals:
                       
Home purchase subgoals:(3)
                       
Low- and moderate-income housing
    40.0 %     38.9 %     47.0 %
Underserved areas
    30.0       30.4       34.0  
Special affordable housing
    14.0       13.6       18.0  
Multifamily special affordable housing subgoal ($ in billions)(4)
  $ 5.49     $ 13.42     $ 5.49  
 
 
(1) Results presented for 2008 were reported to FHFA in Fannie Mae’s Annual Housing Activities Report. They have not yet been validated by FHFA.
 
(2) Goals are expressed as a percentage of the total number of dwelling units financed by eligible mortgage loan purchases during the period.
 
(3) Home purchase subgoals measure our performance by the number of loans (not dwelling units) providing purchase money for owner-occupied single-family housing in metropolitan areas.
 
(4) The multifamily subgoal is measured by loan amount and expressed as a dollar amount.
 
Determination by FHFA Regarding 2008 Housing Goals Compliance
 
As described above and in our 2008 Form 10-K, we believe that we did not meet our two income-based housing goals (the low- and moderate-income housing goal and the special affordable housing goal) or any of our three home purchase subgoals for 2008. In March 2009, FHFA notified us of its determination that achievement of these housing goals and subgoals was not feasible due to housing and economic conditions and our financial condition in 2008. As a result, we will not be required to submit a housing plan for failure to meet these goals and subgoals pursuant to the Federal Housing Enterprises Safety and Soundness Act of 1992.
 
For additional background information on our housing goals and subgoals, refer to “Part I—Item 1—Business—Conservatorship, Treasury Agreements, Our Charter and Regulation of Our Activities—Regulation and Oversight of Our Activities—Housing Goals and Subgoals” of our 2008 Form 10-K.
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the condensed consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We describe our most significant accounting policies in “Notes to Consolidated Financial Statements—Note 2, Summary of Significant Accounting Policies” of our 2008 Form 10-K and in “Notes to Condensed Consolidated Financial Statements—Note 2, Summary of Significant Accounting Policies” of this report.
 
We have identified four of our accounting policies as critical because they involve significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different


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estimates and assumptions could have a material impact on our reported results of operations or financial condition. These critical accounting policies and estimates are as follows:
 
  •  Fair Value of Financial Instruments
 
  •  Other-than-temporary Impairment of Investment Securities
 
  •  Allowance for Loan Losses and Reserve for Guaranty Losses
 
  •  Deferred Tax Assets
 
We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as necessary based on changing conditions. We describe below significant changes in the judgments and assumptions we made during the first quarter of 2009 in applying our critical accounting policies and estimates. Management has discussed any changes in judgments and assumptions in applying our critical accounting policies with the Audit Committee of the Board of Directors. See “Part II—Item 7—MD&A—Critical Accounting Policies and Estimates” of our 2008 Form 10-K for additional information about our critical accounting policies and estimates.
 
Fair Value of Financial Instruments
 
The use of fair value to measure our financial instruments is fundamental to our financial statements and is a critical accounting estimate because we account for and record a substantial portion of our assets and liabilities at fair value. SFAS No. 157, Fair Value Measurements (“SFAS 157”), defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (also referred to as an exit price). SFAS 157 establishes a three-level fair value hierarchy for classifying financial instruments that is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Each asset or liability is assigned to a level based on the lowest level of any input that is significant to the fair value measurement. The three levels of the SFAS 157 fair value hierarchy are described below:
 
Level 1:  Quoted prices (unadjusted) in active markets for identical assets or liabilities.
 
  Level 2:   Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities.
 
Level 3:  Unobservable inputs.
 
In determining fair value, we use various valuation techniques. We disclose the carrying value and fair value of our financial assets and liabilities and describe the specific valuation techniques used to determine the fair value of these financial instruments in “Notes to Condensed Consolidated Financial Statements—Note 18, Fair Value of Financial Instruments.” The majority of our financial instruments carried at fair value fall within the level 2 category and are valued primarily utilizing inputs and assumptions that are observable in the marketplace, that can be derived from observable market data or that can be corroborated by recent trading activity of similar instruments with similar characteristics. For example, we generally request non-binding prices from at least four independent pricing services to estimate the fair value of our trading and available-for-sale investment securities at an individual security level. We use the average of these prices to determine the fair value. In the absence of such information or if we are not able to corroborate these prices by other available, relevant market information, we estimate their fair values based on single source quotations from brokers or dealers or by using internal calculations or discounted cash flow techniques that incorporate inputs, such as prepayment rates, discount rates and delinquency, default and cumulative loss expectations, that are implied by market prices for similar securities and collateral structure types. Because items classified as level 3 are valued using significant unobservable inputs, the process for determining the fair value of these items is generally more subjective and involves a high degree of management judgment and assumptions. These assumptions may have a significant effect on our estimates of fair value, and the use of different assumptions as well as changes in market conditions could have a material effect on our results of operations or financial condition.
 
In April 2009, the Financial Accounting Standards Board (“FASB”) issued two FASB Staff Positions (“FSPs”) to clarify the guidance on fair value measurement and to amend the recognition, measurement and presentation requirements of other-than-temporary impairments for debt securities. These FSPs consist of:


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(1) FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly and (2) FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. These FSPs are effective for interim and annual periods ending after June 15, 2009 with early adoption permitted. See “Notes to Condensed Consolidated Financial Statements—Note 2, Summary of Significant Accounting Policies” for additional information, including the expected impact of these recently issued pronouncements on our condensed consolidated financial statements.
 
Fair Value Hierarchy—Level 3 Assets and Liabilities
 
Our level 3 assets and liabilities consist primarily of financial instruments for which the fair value is estimated using valuation techniques that involve significant unobservable inputs because there is limited market activity and therefore little or no price transparency. We generally consider a market to be inactive if the following conditions exist: (1) there are few transactions for the financial instruments; (2) the prices in the market are not current; (3) the price quotes we receive vary significantly either over time or among independent pricing services or dealers; and (4) there is a limited availability of public market information.
 
Our level 3 financial instruments include certain mortgage- and asset-backed securities and residual interests, certain performing residential mortgage loans, nonperforming mortgage-related assets, our guaranty assets and buy-ups, our master servicing assets and certain highly structured, complex derivative instruments. We use the term “buy-ups” to refer to upfront payments that we make to lenders to adjust the monthly contractual guaranty fee rate so that the pass-through coupon rates on Fannie Mae MBS are in more easily tradable increments of a whole or half percent.
 
The following discussion identifies the types of financial assets and liabilities within each balance sheet category that are based on level 3 inputs and the valuation techniques we use to determine their fair values, including key inputs and assumptions.
 
  •  Trading and Available-for-Sale Investment Securities.  Our financial instruments within these asset categories that are classified as level 3 primarily consist of mortgage-related securities backed by Alt-A loans, subprime loans and manufactured housing loans and mortgage revenue bonds. We have relied on external pricing services to estimate the fair value of these securities and validated those results with our internally derived prices, which may incorporate spread, yield, or vintage and product matrices, and standard cash flow discounting techniques. The inputs we use in estimating these values are based on multiple factors, including market observations, relative value to other securities, and non-binding dealer quotations. When we are not able to corroborate vendor-based prices, we rely on management’s best estimate of fair value.
 
  •  Derivatives.  Our derivative financial instruments that are classified as level 3 primarily consist of a limited population of certain highly structured, complex interest rate risk management derivatives. Examples include certain swaps with embedded caps and floors that reference non-standard indices. We determine the fair value of these derivative instruments using indicative market prices obtained from independent third parties. If we obtain a price from a single source and we are not able to corroborate that price, the fair value measurement is classified as level 3.
 
  •  Guaranty Assets and Buy-ups.  We determine the fair value of our guaranty assets and buy-ups based on the present value of the estimated compensation we expect to receive for providing our guaranty. We generally estimate the fair value using proprietary internal models that calculate the present value of expected cash flows. Key model inputs and assumptions include prepayment speeds, forward yield curves and discount rates that are commensurate with the level of estimated risk.
 
  •  Guaranty Obligations.  The fair value of all guaranty obligations, measured subsequent to their initial recognition, reflects our estimate of a hypothetical transaction price that we would receive if we were to issue our guaranty to an unrelated party in a standalone arm’s-length transaction at the measurement date. We estimate the fair value of the guaranty obligations using internal valuation models that calculate the present value of expected cash flows based on management’s best estimate of certain key assumptions, such as default rates, severity rates and a required rate of return. During 2008, we further adjusted the model-generated values based on our current market pricing to arrive at our estimate of a hypothetical


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  transaction price for our existing guaranty obligations. Beginning in the first quarter of 2009, we concluded that the credit characteristics of the pools of loans upon which we were issuing new guarantees increasingly did not reflect the credit characteristics of our existing guaranteed pools; thus, current market prices for our new guarantees were not a relevant input to our estimate of the hypothetical transaction price for our existing guaranty obligations. Therefore, at March 31, 2009, we based our estimate of the fair value of our existing guaranty obligations solely upon our model without further adjustment.
 
Fair value measurements related to financial instruments that are reported at fair value in our condensed consolidated financial statements each period, such as our trading and available-for-sale securities and derivatives, are referred to as recurring fair value measurements. Fair value measurements related to financial instruments that are not reported at fair value each period, such as held-for-sale mortgage loans, are referred to as non-recurring fair value measurements.
 
Table 3 presents a comparison, by balance sheet category, of the amount of financial assets carried in our consolidated balance sheets at fair value on a recurring basis and classified as level 3 as of March 31, 2009 and December 31, 2008. The availability of observable market inputs to measure fair value varies based on changes in market conditions, such as liquidity. As a result, we expect the amount of financial instruments carried at fair value on a recurring basis and classified as level 3 to vary each period.
 
Table 3:  Level 3 Recurring Financial Assets at Fair Value
 
                 
    As of  
    March 31,
    December 31,
 
Balance Sheet Category
  2009     2008  
    (Dollars in millions)  
 
Trading securities
  $ 10,308     $ 12,765  
Available-for-sale securities
    40,412       47,837  
Derivatives assets
    331       362  
Guaranty assets and buy-ups
    1,179       1,083  
                 
Level 3 recurring assets
  $ 52,230     $ 62,047  
                 
Total assets
  $ 919,638     $ 912,404  
Total recurring assets measured at fair value
  $ 349,759     $ 359,246  
Level 3 recurring assets as a percentage of total assets
    6 %     7 %
Level 3 recurring assets as a percentage of total recurring assets measured at fair value
    15 %     17 %
Total recurring assets measured at fair value as a percentage of total assets
    38 %     39 %
 
Level 3 recurring assets totaled $52.2 billion, or 6% of our total assets, as of March 31, 2009, compared with $62.0 billion, or 7% of our total assets, as of December 31, 2008. The decrease in assets classified as level 3 during the first quarter of 2009 was principally the result of a net transfer of approximately $6.5 billion in assets to level 2 from level 3. The transferred assets consisted primarily of private-label mortgage-related securities backed by non-fixed rate Alt-A loans. The market for Alt-A securities continues to be relatively illiquid. However, during the first quarter of 2009, price transparency improved as a result of recent transactions, and we noted some convergence in prices obtained from third party vendors. As a result, we determined that it was appropriate to rely on level 2 inputs to value these securities.
 
Financial assets measured at fair value on a non-recurring basis and classified as level 3, which are not presented in the table above, include held-for-sale loans that are measured at lower of cost or fair value and that were written down to fair value during the period. Held-for-sale loans that were reported at fair value, rather than amortized cost, totaled $2.1 billion and $1.3 billion as of March 31, 2009 and December 31, 2008, respectively. In addition, certain other financial assets carried at amortized cost that have been written down to fair value during the period due to impairment are classified as non-recurring. The fair value of these level 3 non-recurring financial assets, which primarily consisted of certain guaranty assets, low income housing tax credit (“LIHTC”) partnership investments and acquired property, totaled $13.4 billion and $22.4 billion as of March 31, 2009 and December 31, 2008, respectively.
 
Our LIHTC investments trade in a market with limited observable transactions. There is decreased market demand for LIHTC investments because there are fewer tax benefits derived from these investments by traditional investors, as these investors are currently projecting much lower levels of future profits than in


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previous years. This decreased demand has reduced the value of these investments. We determine the fair value of our LIHTC investments using internal models that estimate the present value of the expected future tax benefits (tax credits and tax deductions for net operating losses) expected to be generated from the properties underlying these investments. Our estimates are based on assumptions that other market participants would use in valuing these investments. The key assumptions used in our models, which require significant management judgment, include discount rates and projections related to the amount and timing of tax benefits. We compare the model results to the limited number of observed market transactions and make adjustments to reflect differences between the risk profile of the observed market transactions and our LITHC investments.
 
Financial liabilities measured at fair value on a recurring basis and classified as level 3 consisted of long-term debt with a fair value of $867 million and $2.9 billion as of March 31, 2009 and December 31, 2008, respectively, and derivatives liabilities with a fair value of $23 million and $52 million as of March 31, 2009 and December 31, 2008, respectively.
 
Fair Value Control Processes
 
We have control processes that are designed to ensure that our fair value measurements are appropriate and reliable, that they are based on observable inputs wherever possible and that our valuation approaches are consistently applied and the assumptions used are reasonable. Our control processes consist of a framework that provides for a segregation of duties and oversight of our fair value methodologies and valuations and validation procedures.
 
Our Valuation Oversight Committee, which includes senior representation from business areas, our Enterprise Risk Office and our Finance Division, is responsible for reviewing and approving the valuation methodologies and pricing models used in our fair value measurements and any significant valuation adjustments, judgments, controls and results. Actual valuations are performed by personnel independent of our business units. Our Price Verification Group, which is an independent control group separate from the group that is responsible for obtaining the prices, also is responsible for performing monthly independent price verification. The Price Verification Group also performs independent reviews of the assumptions used in determining the fair value of products we hold that have material estimation risk because observable market-based inputs do not exist.
 
Our validation procedures are intended to ensure that the individual prices we receive are consistent with our observations of the marketplace and prices that are provided to us by pricing services or other dealers. We verify selected prices using a variety of methods, including comparing the prices to secondary pricing services, corroborating the prices by reference to other independent market data, such as non-binding broker or dealer quotations, relevant benchmark indices, and prices of similar instruments, checking prices for reasonableness based on variations from prices provided in previous periods, comparing prices to internally calculated expected prices and conducting relative value comparisons based on specific characteristics of securities. In addition, we compare our derivatives valuations to counterparty valuations as part of the collateral exchange process. We have formal discussions with the pricing services as part of our due diligence process in order to maintain a current understanding of the models and related assumptions and inputs that these vendors use in developing prices. The prices provided to us by independent pricing services reflect the existence of credit enhancements, including monoline insurance coverage, and the current lack of liquidity in the marketplace. If we determine that a price provided to us is outside established parameters, we will further examine the price, including having follow-up discussions with the specific pricing service or dealer. If we conclude that a price is not valid, we will adjust the price for various factors, such as liquidity, bid-ask spreads and credit considerations. These adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. All of these processes are executed before we use the prices in the financial statement process.
 
We continually refine our valuation methodologies as markets and products develop and the pricing for certain products becomes more or less transparent. While we believe our valuation methods are appropriate and consistent with those of other market participants, using different methodologies or assumptions to determine fair value could result in a materially different estimate of the fair value of some of our financial instruments.


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Allowance for Loan Losses and Reserve for Guaranty Losses
 
We maintain an allowance for loan losses for loans in our mortgage portfolio classified as held-for-investment. We maintain a reserve for guaranty losses for loans that back Fannie Mae MBS we guarantee and loans that we have guaranteed under long-term standby commitments. We report the allowance for loan losses and reserve for guaranty losses as separate line items in the consolidated balance sheets. These amounts, which we collectively refer to as our combined loss reserves, represent our best estimate of credit losses incurred in our guaranty book of business as of the balance sheet date.
 
We have an established process, using analytical tools, benchmarks and management judgment, to determine our loss reserves. Although our loss reserve process benefits from extensive historical loan performance data, this process is subject to risks and uncertainties, including a reliance on historical loss information that may not be representative of current conditions. It is our practice to continually monitor delinquency and default trends and make changes in our historically developed assumptions and estimates as necessary to better reflect the impact of present conditions, including current trends in borrower risk and/or general economic trends, changes in risk management practices, and changes in public policy and the regulatory environment.
 
Because of the current stress in the housing and credit markets, and the speed and extent to which these markets have deteriorated, our process for determining our loss reserves has become more complex and involves a greater degree of management judgment. As a result of the continued decline in home prices, more limited opportunities for refinancing due to the tightening of the credit markets and the sharp rise in unemployment, mortgage delinquencies have reached record levels. Our historical loan performance data indicates a pattern of default rates and credit losses that typically occur over time, which are strongly dependent on the age of a mortgage loan. However, we have witnessed significant changes in traditional loan performance and delinquency patterns, including an increase in early-stage delinquencies for certain loan categories and faster transitions to later stage delinquencies. We believe that recently announced government policies and our initiatives under these policies have partly contributed to these newly observed delinquency patterns. For example, our level of foreclosures and associated charge-offs were lower in the first quarter of 2009 than they otherwise would have been due to foreclosure delays resulting from our foreclosure suspension, our requirement that loan modification options be pursued with the borrower before proceeding to a foreclosure sale, and state-driven changes in foreclosure rules to slow and extend the foreclosure process. As a result, we determined that it was necessary to refine our loss reserve estimation process to reflect these newly observed delinquency patterns, as we describe in more detail below.
 
We historically have relied on internally developed default loss curves derived from observed default trends in our single-family guaranty book of business to determine our single-family loss reserve. These loss curves are shaped by the normal pattern of defaults, based on the age of the book, and informed by historical default trends and the performance of the loans in our book to date. We develop the loss curves by aggregating homogeneous loans into pools based on common underlying risk characteristics, such as origination year and seasoning, original LTV ratio and loan product type, to derive an overall estimate. We use these loss curve models to estimate, based on current events and conditions, the number of loans that will default (“default rate”) and how much of a loan’s balance will be lost in the event of default (“loss severity”). For the majority of our loan risk categories, our default rate estimates have traditionally been based on loss curves developed from available historical loan performance data dating back to 1980. However, we have recently used a shorter, more near-term default loss curve based on a one quarter “look-back” period to generate estimated default rates for loans originated in 2006 and 2007 and for Alt-A loans originated in 2005. More recently, we also have relied on a one-quarter look back period to develop loss severity estimates for all of our loan categories.
 
We experienced a substantial reduction in foreclosures and charge-offs during the periods November 26, 2008 through January 31, 2008 and February 17, 2009 through March 6, 2009 when our foreclosure suspension was in effect and a surge in foreclosures during the two-week period of February 1, 2009 through February 16, 2009. Since February 16, 2009, we have continued to observe a reduced level of foreclosures as our servicers, in keeping with our guidelines, evaluate borrowers for newly introduced workout options before proceeding to a foreclosure. Because of the distortion in defaults caused by these temporary events, we adjusted our loss curves to incorporate default estimates derived from an assessment of our most recently observed loan


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delinquencies and the related transition of loans through the various delinquency categories. We used this delinquency assessment and our most recent default information prior to the foreclosure suspension to estimate the number of defaults that we would have expected to occur during the first quarter of 2009 if the foreclosure moratorium had not been in effect. We then used these estimated defaults, rather than the actual number of defaults that occurred during the first quarter of 2009, to estimate our loss curves and derive the default rates used in determining our loss reserves. Consistent with our approach during the fourth quarter of 2008, we also made management adjustments to our model-generated results to capture incremental losses that may not be fully reflected in our models related to geographically concentrated areas that are experiencing severe stress as a result of significant home price declines and the sharp rise in unemployment rates.
 
We also made several enhancements to the models used in determining our multifamily loss reserves to reflect the impact of the deterioration in the credit performance of loans in our multifamily guaranty book of business resulting from current market conditions, including the severe economic downturn and lack of liquidity in the multifamily mortgage market. Our model enhancements involved weighting more heavily our recent loan performance experience to derive the key parameters used in calculating our expected default rates. We expect increased multifamily defaults and loss severities in 2009.
 
Our combined loss reserves increased by $17.0 billion during the first quarter of 2009 to $41.7 billion as of March 31, 2009, reflecting further deterioration in both our single-family and multifamily guaranty book of business, as evidenced by the significant increase in delinquent, seriously delinquent and nonperforming loans, as well as an increase in our average loss severities as a result of the continued decline in home prices during the first quarter of 2009. The incremental management adjustment to our loss reserves for geographic and unemployment stresses accounted for approximately $5.6 billion of our combined loss reserves of $41.7 billion as of March 31, 2009, compared with approximately $2.3 billion of our combined loss reserves of $24.8 billion as of December 31, 2008.
 
We provide additional information on our combined loss reserves and the impact of adjustments to our loss reserves on our condensed consolidated financial statements in “Consolidated Results of Operations—Credit-Related Expenses” and “Notes to Condensed Consolidated Financial Statements—Note 5, Allowance for Loan Losses and Reserve for Guaranty Losses.”
 
CONSOLIDATED RESULTS OF OPERATIONS
 
Our business generates revenues from three principal sources: net interest income; guaranty fee income; and fee and other income. Other significant factors affecting our results of operations include: fair value gains and losses; the timing and size of investment gains and losses; credit-related expenses; losses from partnership investments; administrative expenses and our effective tax rate. We expect high levels of period-to-period volatility in our results of operations and financial condition, principally due to changes in market conditions that result in periodic fluctuations in the estimated fair value of financial instruments that we mark-to-market through our earnings. These instruments include trading securities and derivatives. The estimated fair value of our trading securities and derivatives may fluctuate substantially from period to period because of changes in interest rates, credit spreads and expected interest rate volatility, as well as activity related to these financial instruments.
 
Table 4 presents a condensed summary of our consolidated results of operations for the three months ended March 31, 2009 and 2008 and selected performance metrics that we believe are useful in evaluating changes in our results between periods.


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Table 4:  Summary of Condensed Consolidated Results of Operations and Performance Metrics
 
                                 
    For the
       
    Three Months Ended
       
    March 31,     Variance  
    2009     2008     $     %  
    (Dollars in millions, except per share amounts)  
 
Net interest income
  $ 3,248     $ 1,690     $ 1,558       92 %
Guaranty fee income
    1,752       1,752              
Trust management income
    11       107       (96 )     (90 )
Fee and other income
    181       227       (46 )     (20 )
                                 
Net revenues
    5,192       3,776       1,416       38  
                                 
Investment losses, net
    (5,430 )     (111 )     (5,319 )     (4,792 )
Fair value losses, net(1)
    (1,460 )     (4,377 )     2,917       67  
Losses from partnership investments
    (357 )     (141 )     (216 )     (153 )
Administrative expenses
    (523 )     (512 )     (11 )     (2 )
Credit-related expenses(2)
    (20,872 )     (3,243 )     (17,629 )     (544 )
Other non-interest expenses(3)
    (358 )     (505 )     147       29  
                                 
Loss before federal income taxes and extraordinary losses
    (23,808 )     (5,113 )     (18,695 )     (366 )
Benefit for federal income taxes
    623       2,928       (2,305 )     (79 )
Extraordinary losses, net of tax effect
          (1 )     1       100  
                                 
Net loss
    (23,185 )     (2,186 )     (20,999 )     (961 )
Less: Net loss attributable to the noncontrolling interest
    17             17        
                                 
Net loss attributable to Fannie Mae
  $ (23,168 )   $ (2,186 )   $ (20,982 )     (960 )%
                                 
Diluted loss per common share
  $ (4.09 )   $ (2.57 )   $ (1.52 )     (59 )%
                                 
Performance metrics:
                               
Net interest yield(4)
    1.45 %     0.82 %                
Average effective guaranty fee rate (in basis points)(5)
    27.4 bp     29.5 bp                
Credit loss ratio (in basis points)(6)
    33.2       12.6                  
 
 
(1) Consists of the following: (a) derivatives fair value gains (losses), net; (b) trading securities gains (losses), net; (c) debt foreign exchange gains (losses), net; and (d) debt fair value gains (losses), net.
 
(2) Consists of provision for credit losses and foreclosed property expense.
 
(3) Consists of the following: (a) debt extinguishment gains (losses), net; and (b) other expenses.
 
(4) Calculated based on net interest income for the reporting period divided by the average balance of total interest-earning assets during the period, expressed as a percentage.
 
(5) Calculated based on guaranty fee income for the reporting period divided by average outstanding Fannie Mae MBS and other guarantees during the period, expressed in basis points.
 
(6) Calculated based on (a) charge-offs, net of recoveries; plus (b) foreclosed property expense; adjusted to exclude (c) the impact of SOP 03-3 and HomeSaver Advance fair value losses for the reporting period divided by the average guaranty book of business during the period, expressed in basis points.
 
The section below provides a comparative discussion of our condensed consolidated results of operations for the three months ended March 31, 2009 and 2008. Following this section, we provide a discussion of our business segment results. You should read this section together with our “Executive Summary” where we discuss trends and other factors that we expect will affect our future results of operations.
 
Net Interest Income
 
Net interest income represents the difference between interest income and interest expense and is a primary source of our revenue. Our net interest yield represents the difference between the yield on our interest-earning assets and the cost of our debt. We supplement our issuance of debt with interest rate-related derivatives to manage the prepayment and duration risk inherent in our mortgage investments. The effect of these derivatives, in particular the periodic net interest expense accruals on interest rate swaps, is not reflected in net interest income. See “Fair Value Gains (Losses), Net” for additional information.


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We expect net interest income and our net interest yield to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities. Table 5 presents an analysis of our net interest income and net interest yield for the first quarters of 2009 and 2008.
 
Table 5:  Analysis of Net Interest Income and Yield
 
                                                 
    For the Three Months Ended March 31,  
    2009     2008  
          Interest
    Average
          Interest
    Average
 
    Average
    Income/
    Rates
    Average
    Income/
    Rates
 
    Balance(1)     Expense     Earned/Paid     Balance(1)     Expense     Earned/Paid  
    (Dollars in millions)  
 
Interest-earning assets:
                                               
Mortgage loans(2)
  $ 431,918     $ 5,598       5.18 %   $ 410,318     $ 5,662       5.52 %
Mortgage securities
    346,923       4,620       5.33       315,795       4,144       5.25  
Non-mortgage securities(3)
    48,349       91       0.75       66,630       678       4.03  
Federal funds sold and securities purchased under agreements to resell
    64,203       104       0.65       36,233       393       4.29  
Advances to lenders
    4,256       23       2.16       4,229       65       6.08  
                                                 
Total interest-earning assets
  $ 895,649     $ 10,436       4.66 %   $ 833,205     $ 10,942       5.25 %
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
  $ 330,434     $ 1,107       1.34 %   $ 257,445     $ 2,558       3.93 %
Long-term debt
    554,806       6,081       4.38       545,549       6,691       4.91  
Federal funds purchased and securities sold under agreements to repurchase
    79                   448       3       2.65  
                                                 
Total interest-bearing liabilities
  $ 885,319     $ 7,188       3.25 %   $ 803,442     $ 9,252       4.59 %
                                                 
Impact of net non-interest bearing funding
  $ 10,330               0.04 %   $ 29,763               0.16 %
                                                 
Net interest income/net interest yield(4)
          $ 3,248       1.45 %           $ 1,690       0.82 %
                                                 
Selected benchmark interest rates at end of period:(5)
                                               
3-month LIBOR
                    1.19 %                     2.69 %
2-year swap interest rate
                    1.38                       2.45  
5-year swap interest rate
                    2.22                       3.31  
30-year Fannie Mae MBS par coupon rate
                    3.88                       5.25  
 
 
(1) We have calculated the average balances for mortgage loans based on the average of the amortized cost amounts as of the beginning of the year and as of the end of each month in the period. For all other categories, the average balances have been calculated based on a daily average.
 
(2) Average balance amounts include nonaccrual loans with an average balance totaling $18.4 billion and $8.2 billion for the three months ended March 31, 2009 and 2008, respectively. Interest income includes interest income on loans purchased from MBS trusts subject to SOP 03-3, which totaled $153 million and $145 million for the three months ended March 31, 2009 and 2008, respectively. These interest income amounts included accretion of $65 million and $35 million for the three months ended March 31, 2009 and 2008, respectively, relating to a portion of the fair value losses recorded upon the acquisition of loans subject to SOP 03-3.
 
(3) Includes cash equivalents.
 
(4) We compute net interest yield by dividing net interest income for the period by the average balance of our total interest-earning assets during the period.
 
(5) Data from British Bankers’ Association, Thomson Reuters Indices and Bloomberg.
 
Net interest income of $3.2 billion for the first quarter of 2009 reflected an increase of 92% over net interest income of $1.7 billion for the first quarter of 2008, driven by a 77% (63 basis point) expansion of our net interest yield to 1.45% and a 7% increase in our average interest-earning assets.
 
Table 6 presents the change in our net interest income between periods and the extent to which that variance is attributable to: (1) changes in the volume of our interest-earning assets and interest-bearing liabilities or (2) changes in the interest rates of these assets and liabilities.


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Table 6:  Rate/Volume Analysis of Net Interest Income
 
                         
    For the Three Months
 
    Ended March 31,
 
    2009 vs. 2008  
    Total
    Variance Due to:(1)  
    Variance     Volume     Rate  
    (Dollars in millions)  
 
Interest income:
                       
Mortgage loans
  $ (64 )   $ 290     $ (354 )
Mortgage securities
    476       414       62  
Non-mortgage securities(2)
    (587 )     (148 )     (439 )
Federal funds sold and securities purchased under agreements to resell
    (289 )     181       (470 )
Advances to lenders
    (42 )           (42 )
                         
Total interest income
    (506 )     737       (1,243 )
                         
Interest expense:
                       
Short-term debt
    (1,451 )     581       (2,032 )
Long-term debt
    (610 )     112       (722 )
Federal funds purchased and securities sold under agreements to repurchase
    (3 )     (1 )     (2 )
                         
Total interest expense
    (2,064 )     692       (2,756 )
                         
Net interest income
  $ 1,558     $ 45     $ 1,513  
                         
 
 
(1) Combined rate/volume variances are allocated to both rate and volume based on the relative size of each variance.
 
(2) Includes cash equivalents.
 
The 63 basis point increase in our net interest yield during the first quarter of 2009 was attributable to a 134 basis point reduction in the average cost of our debt to 3.25%, which more than offset the 59 basis point decline in the average yield on our interest-earning assets to 4.66%. The reduction in our borrowing costs was attributable to a decline in short-term borrowing rates and a shift in our funding mix to more short-term debt because of the reduced demand for our longer-term and callable debt securities during the second half of 2008. In addition, our net interest yield for the first quarter of 2008 reflected a benefit from the redemption of step-rate debt securities, which reduced the average cost of our debt. Because we paid off these securities prior to maturity, we reversed a portion of the interest expense that we had previously accrued.
 
Although we consider the periodic net contractual interest accruals on our interest rate swaps to be part of the cost of funding our mortgage investments, these amounts are not reflected in our net interest income and net interest yield. Instead, these amounts are included in our derivatives gains (losses) and reflected in our consolidated statements of operations as a component of “Fair value losses, net.” As shown in Table 10 below, we recorded net contractual interest expense on our interest rate swaps totaling $940 million and $26 million for the first quarter of 2009 and 2008, respectively. The economic effect of the interest accruals on our interest rate swaps increased our funding costs by approximately 42 basis points for the first quarter of 2009 and approximately 1 basis point for the first quarter of 2008.
 
The 7% increase in our average interest-earning assets was attributable to an increase in portfolio purchases during the second half of 2008, as mortgage-to-debt spreads reached historic highs, and a reduction in liquidations due to the disruption in the housing and credit markets. In the first quarter of 2009, we significantly reduced our purchases of agency MBS, largely due to the significant narrowing of spreads on agency MBS during the quarter in response to the Federal Reserve’s agency MBS purchase program, which was announced in November 2008 and expanded in March 2009 to include the purchase of up to $1.25 trillion of agency MBS by the end of 2009. The Federal Reserve currently is the primary purchaser of agency MBS.
 
Under the senior preferred stock purchase agreement, we are prohibited from issuing debt in amount greater than 120% of the amount of mortgage assets we are allowed to own. Through December 30, 2010, our debt cap equals $1,080 billion. Beginning December 31, 2010, and on December 31 of each year thereafter, our debt cap that will apply through December 31 of the following year will equal 120% of the amount of mortgage assets we are allowed to own on December 31 of the immediately preceding calendar year. We are permitted to increase our mortgage portfolio up to $900 billion through December 31, 2009. Beginning in


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2010, we are required to reduce our mortgage portfolio by 10% per year, until the amount of our mortgage assets reaches $250 billion. Although the debt and mortgage portfolio caps did not have a significant impact on our portfolio activities during the first quarter of 2009, these limits may have significant adverse impact on our future portfolio activities and net interest income. For additional information on our portfolio investment and funding activity, see “Consolidated Balance Sheet Analysis—Mortgage Investments” and “Liquidity and Capital Management—Liquidity Management—Debt Funding.” For a description of the amended terms of the senior preferred stock purchase agreement, see “Executive Summary—Amendment to Senior Preferred Stock Purchase Agreement” and see “Part I—Item 1—Business—Conservatorship, Treasury Agreements, Our Charter and Regulation of Our Activities—Treasury Agreements” of our 2008 Form 10-K for a description the terms of the agreement prior to its May 2009 amendment, most of which continue to apply.
 
Guaranty Fee Income
 
Guaranty fee income primarily consists of contractual guaranty fees related to both Fannie Mae MBS held in our portfolio and held by third-party investors, adjusted for the amortization of upfront fees over the estimated life of the loans underlying the MBS and impairment of guaranty assets, net of a proportionate reduction in the related guaranty obligation and deferred profit, and impairment of buy-ups. The average effective guaranty fee rate reflects our average contractual guaranty fee rate adjusted for the impact of amortization of upfront fees and buy-up impairment.
 
Table 7 shows the components of our guaranty fee income, our average effective guaranty fee rate and Fannie Mae MBS activity for the first quarters of 2009 and 2008.
 
Table 7:  Guaranty Fee Income and Average Effective Guaranty Fee Rate(1)
 
                                         
    For the Three Months Ended March 31,        
    2009     2008        
    Amount     Rate(2)     Amount     Rate(2)     %Change  
    (Dollars in millions)  
 
Guaranty fee income/average effective guaranty fee rate, excluding certain fair value adjustments and buy-up impairment
  $ 1,726       27.0  bp   $ 1,719       29.0  bp     %
Net change in fair value of buy-ups and certain guaranty assets
    46       0.7       62       1.0       (26 )
Buy-up impairment
    (20 )     (0.3 )     (29 )     (0.5 )     31  
                                         
Guaranty fee income/average effective guaranty fee rate
  $ 1,752       27.4  bp   $ 1,752       29.5  bp     %
                                         
Average outstanding Fannie Mae MBS and other guarantees(3)
  $ 2,559,424             $ 2,374,033               8 %
Fannie Mae MBS issues(4)
    154,320               168,592               (8 )
 
 
(1) Guaranty fee income includes the accretion of losses recognized at inception on certain guaranty contracts for periods prior to January 1, 2008.
 
(2) Presented in basis points and calculated based on guaranty fee income components divided by average outstanding Fannie Mae MBS and other guarantees for each respective period.
 
(3) Includes unpaid principal balance of other guarantees totaling $26.5 billion and $27.8 billion as of March 31, 2009 and December 31, 2008, respectively.
 
(4) Reflects unpaid principal balance of Fannie Mae MBS issued and guaranteed by us, including mortgage loans held in our portfolio that we securitized during the period and Fannie Mae MBS issued during the period that we acquired for our portfolio.
 
Our guaranty fee income in the first quarter of 2009 was at the same level as the first quarter of 2008. We experienced an 8% increase in average outstanding Fannie Mae MBS and other guarantees, which was offset by a 7% decrease in the average effective guaranty fee rate to 27.4 basis points from 29.5 basis points for the first quarter of 2008. We experienced an increase in our average outstanding Fannie Mae MBS and other guarantees as our MBS issuances exceeded liquidations throughout 2008 and in early 2009. Our market share


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of MBS issuances remained strong during 2008 and into 2009, reflecting the continuing shift in the composition of originations in the primary mortgage market to agency-conforming loans.
 
The decrease in our average effective guaranty fee rate for the first quarter of 2009 was attributable to the guaranty fee pricing changes we implemented during 2008 to address the current risks in the housing market. As result of these pricing changes, coupled with changes in our underwriting standards, we reduced or eliminated our acquisitions of higher risk, higher fee product categories, such as Alt-A, subprime, high LTV and low FICO score loans. As a result, we experienced a shift in the composition of our new business and overall guaranty book of business to a greater proportion of higher-quality, lower risk and lower guaranty fee mortgages. The average charged guaranty fee on our new single-family business for the first quarter of 2009 was 21.0 basis points, compared with 25.7 basis points for the first quarter of 2008. The average charged fee represents the average contractual fee rate for our single-family guaranty arrangements plus the recognition of any upfront cash payments ratably over an estimated average life. Beginning in 2009, we extended the estimated average life used in calculating the recognition of upfront cash payments for the purpose of determining our single-family new business average charged guaranty fee to reflect a longer expected duration because of the record low interest rate environment. This change did not have a material impact on the average charged guaranty fee on our new single-family business in the first quarter of 2009.
 
Our guaranty fee income includes an estimated $192 million and $297 million for the first quarter of 2009 and 2008, respectively, related to the accretion of deferred amounts on guaranty contracts where we recognized losses at the inception of the contract.
 
Trust Management Income
 
Trust management income consists of the fees we earn as master servicer, issuer and trustee for Fannie Mae MBS. We derive these fees from the interest earned on cash flows between the date of remittance of mortgage and other payments to us by servicers and the date of distribution of these payments to MBS certificateholders, which we refer to as float income. Trust management income decreased to $11 million for the first quarter of 2009, from $107 million for the first quarter of 2008. This decrease was attributable to the significant decline in short-term interest rates.
 
Fee and Other Income
 
Fee and other income consists of transaction fees, technology fees and multifamily fees. These fees are largely driven by our business volume. Fee and other income decreased to $181 million for the first quarter of 2009, from $227 million for the first quarter of 2008. The decrease was primarily attributable to lower multifamily fees due to slower multifamily loan prepayments during the first quarter of 2009 relative to the first quarter of 2008.
 
Investment Gains (Losses), Net
 
Investment gains and losses, net includes other-than-temporary impairment on available-for-sale securities; lower of cost or fair value adjustments on held-for-sale loans; gains and losses recognized on the securitization of loans or securities from our portfolio and from the sale of available-for-sale securities; and other investment losses. Investment gains and losses may fluctuate significantly from period to period depending upon our portfolio investment and securitization activities and changes in market and credit conditions that may result in other-than-temporary impairment. Table 8 details the components of investment gains and losses for the first quarters of 2009 and 2008.


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Table 8:  Investment Gains (Losses), Net
 
                 
    For the
 
    Three Months Ended
 
    March 31,  
    2009     2008  
    (Dollars in millions)  
 
Other-than-temporary impairment on available-for-sale securities(1)
  $ (5,653 )   $ (55 )
Lower of cost or fair value adjustments on held-for-sale loans
    (205 )     (71 )
Gains on Fannie Mae portfolio securitizations, net
    320       42  
Gains on sale of available-for-sale securities, net
    136       33  
Other investment losses, net
    (28 )     (60 )
                 
Investment losses, net
  $ (5,430 )   $ (111 )
                 
 
 
(1) Excludes other-than-temporary impairment on guaranty assets and buy-ups as these amounts are recognized as a component of guaranty fee income. Refer to Table 7: Guaranty Fee Income and Average Effective Guaranty Fee Rate.
 
The $5.3 billion increase in investment losses for the first quarter of 2009 over the first quarter of 2008 was primarily attributable to an increase in other-than-temporary impairment on available-for- sale securities. The other-than-temporary impairment of $5.7 billion that we recognized in the first quarter of 2009 included additional impairment losses on some of our Alt-A and subprime private-label securities that we had previously impaired, as well as impairment losses on other Alt-A and subprime securities, due to continued deterioration in the credit quality of the loans underlying these securities and further declines in the expected cash flows. See “Consolidated Balance Sheet Analysis—Trading and Available-for-Sale Investment Securities— Investments in Private-Label Mortgage-Related Securities” for additional information on the other-than-temporary impairment recognized on our investments in Alt-A and subprime private-label mortgage-related securities. See “Part II—Item 1A—Risk Factors” for a discussion of the risks associated with possible future write-downs of our investment securities.
 
Fair Value Gains (Losses), Net
 
Fair value gains and losses, net consists of (1) derivatives fair value gains and losses; (2) trading securities gains and losses; (3) foreign exchange gains and losses on our foreign-denominated debt; and (4) fair value gains and losses on certain debt securities carried at fair value. By presenting these items together in our consolidated results of operations, we are able to show the net impact of mark-to-market adjustments that generally result in offsetting gains and losses attributable to changes in interest rates.
 
We generally have expected that gains and losses on our agency MBS and commercial mortgage-backed securities backed by multifamily mortgage loans (“CMBS”) classified as trading securities, to the extent they are attributable to changes in interest rates, would offset a portion of the losses and gains on our derivatives because changes in the fair value of our trading securities typically moved inversely to changes in the fair value of our derivatives.
 
We seek to eliminate our exposure to fluctuations in foreign exchange rates by entering into foreign currency swaps that effectively convert debt denominated in a foreign currency to debt denominated in U.S. dollars. The foreign currency exchange gains and losses on our foreign-denominated debt are offset in part by corresponding losses and gains on foreign currency swaps.
 
Table 9 summarizes the components of fair value gains (losses), net for the first quarter of 2009 and 2008. The decrease in fair value losses in the first quarter of 2009 from the first quarter of 2008 was largely due to a decline in losses on our derivatives and net gains on our trading securities.


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Table 9:  Fair Value Gains (Losses), Net
 
                 
    For the
 
    Three Months Ended
 
    March 31,  
    2009     2008  
    (Dollars in millions)  
 
Derivatives fair value losses, net
  $ (1,706 )   $ (3,003 )
Trading securities gains (losses) net
    167       (1,227 )
                 
Fair value losses on derivatives and trading securities, net
    (1,539 )     (4,230 )
Debt foreign exchange gains (losses), net
    55       (157 )
Debt fair value gains, net
    24       10  
                 
Fair value losses, net
  $ (1,460 )   $ (4,377 )
                 
 
Derivatives Fair Value Gains (Losses), Net
 
Derivative instruments are an integral part of our management of interest rate risk. We supplement our issuance of debt with derivative instruments to further reduce duration and prepayment risks. Table 10 presents, by type of derivative instrument, the fair value gains and losses on our derivatives for the first quarters of 2009 and 2008. Table 10 also includes an analysis of the components of derivatives fair value gains and losses attributable to net contractual interest accruals on our interest rate swaps, the net change in the fair value of terminated derivative contracts through the date of termination and the net change in the fair value of outstanding derivative contracts. The 5-year swap interest rate, which is shown below in Table 10, is a key reference interest rate that affects the fair value of our derivatives.
 
Table 10:  Derivatives Fair Value Gains (Losses), Net
 
                 
    For the
 
    Three Months
 
    Ended
 
    March 31,  
    2009     2008  
    (Dollars in millions)  
 
Risk management derivatives:
               
Swaps:
               
Pay-fixed
  $ 3,314     $ (15,895 )
Receive-fixed
    (1,362 )     12,792  
Basis
    (23 )     5  
Foreign currency(1)
    (73 )     146  
Swaptions:
               
Pay-fixed
    (15 )     (189 )
Receive-fixed
    (3,238 )     273  
Interest rate caps
          (1 )
Other(2)
    29       64  
                 
Total risk management derivatives fair value losses, net
    (1,368 )     (2,805 )
Mortgage commitment derivatives fair value losses, net
    (338 )     (198 )
                 
Total derivatives fair value losses, net
  $ (1,706 )   $ (3,003 )
                 
Risk management derivatives fair value gains (losses) attributable to:
               
Net contractual interest income (expense) accruals on interest rate swaps
  $ (940 )   $ (26 )
Net change in fair value of terminated derivative contracts from end of prior year to date of termination
    2       204  
Net change in fair value of outstanding derivative contracts, including derivative contracts entered into during the period
    (430 )     (2,983 )
                 
Total risk management derivatives fair value losses, net(3)
  $ (1,368 )   $ (2,805 )
                 
 


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    2009     2008  
 
5-year swap interest rate:
               
As of January 1
    2.13 %     4.19 %
As of March 31
    2.22       3.31  
 
 
(1) Includes the effect of net contractual interest income accruals of approximately $6 million and interest expense accruals of approximately $3 million for the three months ended March 31, 2009 and 2008, respectively. The change in fair value of foreign currency swaps excluding this item resulted in a net loss of $79 million for the three months ended March 31, 2009 and a net gain of $149 million for the three months ended March 31, 2008.
 
(2) Includes MBS options, swap credit enhancements, mortgage insurance contracts and certain forward starting debt.
 
(3) Reflects net derivatives fair value losses, excluding mortgage commitments, recognized in the condensed consolidated statements of operations.
 
The derivatives fair value losses of $1.7 billion for the first quarter of 2009 were primarily attributable to fair value losses on our option-based derivatives due to the combined effect of a decrease in implied volatility and the time decay of these options.
 
The derivatives fair value losses of $3.0 billion for the first quarter of 2008 were driven by a decline in interest rates during the quarter. The 5-year swap interest rate fell by 88 basis points to 3.31% as of March 31, 2008, resulting in fair value losses on our pay-fixed swaps that exceeded the fair value gains on our receive-fixed swaps. We experienced partially offsetting fair value gains on our option-based derivatives due to an increase in implied volatility that more than offset the combined effect of the time decay of these options and the decrease in swap interest rates during the first quarter of 2008.
 
For additional information on our interest rate risk management strategy and our use of derivatives in managing our interest rate risk, see “Part II—Item 7—MD&A—Risk Management—Interest Rate Risk Management and Other Market Risks—Interest Rate Risk Management Strategies” of our 2008 Form 10-K. Also see “Consolidated Balance Sheet Analysis—Derivative Instruments” for a discussion of the effect of derivatives on our condensed consolidated balance sheets.
 
Trading Securities Gains (Losses), Net
 
We recorded net gains on trading securities of $167 million for the first quarter of 2009, compared with net losses of $1.2 billion for the first quarter of 2008. The gains on our trading securities during the first quarter of 2009 were attributable to the significant decline in mortgage interest rates and the narrowing of spreads on agency MBS during the quarter. These gains were partially offset by a continued decrease in the fair value of the private-label mortgage-related securities backed by Alt-A and subprime loans that we hold. The losses on our trading securities during the first quarter of 2008 were attributable to a significant widening of credit spreads during the quarter, particularly related to private-label mortgage-related securities backed by Alt-A and subprime loans and CMBS.
 
We provide additional information on our trading and available-for-sale securities in “Consolidated Balance Sheet Analysis—Trading and Available-for-Sale Investment Securities” and disclose the sensitivity of changes in the fair value of our trading securities to changes in interest rates in “Risk Management—Interest Rate Risk Management and Other Market Risks—Interest Rate Risk Metrics.”
 
Losses from Partnership Investments
 
Our partnership investments, which primarily include investments in LIHTC partnerships as well as investments in other affordable rental and for-sale housing partnerships, totaled approximately $8.9 billion as of March 31, 2009, compared with $9.3 billion as of December 31, 2008. Losses from partnership investments increased to $357 million for the first quarter of 2009, from $141 million for the first quarter of 2008. The increase in losses was largely due to the recognition of additional other-than-temporary impairment of $147 million in the first quarter of 2009 on a portion of our LIHTC and other affordable housing investments, reflecting the decline in value of these investments as result of the severe economic downturn. In addition, our

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partnership losses for the first quarter of 2008 were partially reduced by a gain on the sale of some of our LIHTC investments. We did not have any sales of LIHTC investments during the first quarter of 2009.
 
Administrative Expenses
 
Administrative expenses include ongoing operating costs, such as salaries and employee benefits, professional services, occupancy costs and technology expenses. Administrative expenses increased to $523 million for the first quarter of 2009, from $512 million for the first quarter of 2008. We took steps in the fourth quarter of 2008 and the first quarter of 2009 to realign our organization, personnel and resources to focus on our most critical priorities, which include providing liquidity to the mortgage market and preventing foreclosures. As part of this realignment, we reduced staffing levels in some areas of the company during the first quarter of 2009. This reduction in staff, however, was partially offset by an increase in employee and contractor staffing levels in other areas, particularly those divisions of the company that focus on our foreclosure-prevention efforts.
 
Credit-Related Expenses
 
Credit-related expenses included in our consolidated statements of operations consist of the provision for credit losses and foreclosed property expense. We detail the components of our credit-related expenses below in Table 11. The substantial increase in our credit-related expenses in the first quarter of 2009 from the first quarter of 2008 was largely due to the significant increase in our provision for credit losses, reflecting the deteriorating credit performance of the loans in our guaranty book of business given the current economic environment, including continued weakness in the housing market and rising unemployment.
 
Table 11:  Credit-Related Expenses
 
                 
    For the
 
    Three Months Ended
 
    March 31,  
    2009     2008  
    (Dollars in millions)  
 
Provision for credit losses attributable to guaranty book of business
  $ 18,809     $ 2,340  
Provision for credit losses attributable to SOP 03-3 and HomeSaver Advance fair value losses
    1,525       733  
                 
Total provision for credit losses(1)
    20,334       3,073  
Foreclosed property expense
    538       170  
                 
Credit-related expenses
  $ 20,872     $ 3,243  
                 
 
 
(1) Reflects total provision for credit losses reported in our condensed consolidated statements of operations and in Table 12 below under “Combined loss reserves.”
 
Provision for Credit Losses Attributable to Guaranty Book of Business
 
Our allowance for loan losses and reserve for guaranty losses, which we collectively refer to as our combined loss reserves, provide for probable credit losses inherent in our guaranty book of business as of each balance sheet date. We build our loss reserves through the provision for credit losses for losses that we believe have been incurred and will eventually be reflected over time in our charge-offs. When we determine that a loan is uncollectible, typically upon foreclosure, we record the charge-off against our loss reserves. We record recoveries of previously charged-off amounts as a credit to our loss reserves. Table 12, which summarizes changes in our loss reserves for the three months ended March 31, 2009 and 2008, details the provision for credit losses recognized in our condensed consolidated statements of operations each period and the charge-offs recorded against our combined loss reserves.


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Table 12:  Allowance for Loan Losses and Reserve for Guaranty Losses (Combined Loss Reserves)
 
                 
    For the
 
    Three Months
 
    Ended
 
    March 31,  
    2009     2008  
    (Dollars in millions)  
 
Changes in combined loss reserves:
               
Allowance for loan losses:
               
Beginning balance(1)
  $ 2,923     $ 698  
Provision for credit losses(2)
    2,509       544  
Charge-offs(3)
    (637 )     (279 )
Recoveries
    35       30  
                 
Ending balance(1)
  $ 4,830     $ 993  
                 
Reserve for guaranty losses:
               
Beginning balance
  $ 21,830     $ 2,693  
Provision for credit losses
    17,825       2,529  
Charge-offs(4)(5)
    (2,944 )     (1,037 )
Recoveries
    165       17  
                 
Ending balance
  $ 36,876     $ 4,202  
                 
Combined loss reserves:
               
Beginning balance
  $ 24,753     $ 3,391  
Provision for credit losses(2)
    20,334       3,073  
Charge-offs(3)(4)(5)
    (3,581 )     (1,316 )
Recoveries
    200       47  
                 
Ending balance(1)
  $ 41,706     $ 5,195  
                 
 
                 
    As of  
    March 31,
    December 31,
 
    2009     2008  
    (Dollars in millions)  
 
Combined loss reserves
  $ 41,706     $ 24,753  
Allocation of combined loss reserves:
               
Balance at end of each period attributable to:
               
Single-family
  $ 41,082     $ 24,649  
Multifamily
    624       104  
                 
Total
  $ 41,706     $ 24,753  
                 
Single-family and multifamily loss reserve ratios:(6)
               
Single-family loss reserves as a percentage of single-family guaranty book of business
    1.45 %     0.88 %
Multifamily loss reserves as a percentage of multifamily guaranty book of business
    0.36       0.06  
Combined loss reserves as a percentage of:
               
Total guaranty book of business
    1.38 %     0.83 %
Total nonperforming loans(7)
    28.78       20.76  
 
 
(1) Includes $197 million and $50 million as of March 31, 2009 and 2008, respectively, and $150 million as of December 31, 2008 for acquired loans subject to the application of SOP 03-3.
 
(2) Includes an increase in the allowance for loan losses for HomeSaver Advance first-lien loans held in MBS trusts that are consolidated on our balance sheets.
 
(3) Includes accrued interest of $247 million and $78 million for the three months ended March 31, 2009 and 2008, respectively.


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(4) Includes charges of $115 million and $5 million for the three months ended March 31, 2009 and 2008, respectively, related to unsecured HomeSaver Advance loans.
 
(5) Includes charges recorded at the date of acquisition totaling $1.4 billion and $728 million for the three months ended March 31, 2009 and 2008, respectively, for acquired loans subject to the application of SOP 03-3 where the acquisition cost exceeded the fair value of the acquired loan.
 
(6) Represents amount of loss reserves attributable to each loan type as a percentage of the guaranty book of business for each loan type.
 
(7) Loans are classified as nonperforming when we believe collectability of interest or principal on the loan is not reasonably assured, which typically occurs when payment of principal or interest on the loan is two months or more past due. Additionally, troubled debt restructurings and HomeSaver Advance first-lien loans are classified as nonperforming loans. See Table 45: Nonperforming Single-Family and Multifamily Loans for additional information on our nonperforming loans.
 
We have continued to build our combined loss reserves through provisions that have been well in excess of our charge-offs due to the general deterioration in the overall credit performance of loans in our guaranty book of business. This deterioration continues to be concentrated in certain states, certain higher risk loan categories and our 2006 and 2007 loan vintages. Our mortgage loans in the Midwest, which has experienced prolonged economic weakness, and California, Florida, Arizona and Nevada, which previously experienced rapid home price increases and continue to experience steep declines in home prices, have exhibited much higher delinquency rates and accounted for a disproportionate share of our foreclosures and charge-offs. Loans in our Alt-A book, particularly the 2006 and 2007 loan vintages, also have exhibited significantly higher delinquency rates and represented a disproportionate share of our foreclosures and charge-offs. We also are beginning to experience some deterioration in the credit performance of loans in our single-family guaranty book of business with lower risk characteristics, reflecting the adverse impact of the sharp rise in unemployment and the continued decline in home prices.
 
The provision for credit losses attributable to our guaranty book of business of $18.8 billion for the first quarter of 2009 exceeded net charge-offs of $1.9 billion and included an incremental build in our combined loss reserves of $16.9 billion for the quarter. In comparison, we recorded a provision for credit losses attributable to our guaranty book of business of $2.3 billion for the first quarter of 2008. Our increased provision levels were largely driven by a substantial increase in nonperforming single-family loans, higher delinquencies and an increase in the average loss severity, or initial charge-off per default. Our conventional single-family serious delinquency rate increased to 3.15% as of March 31, 2009, from 2.42% as of December 31, 2008 and 1.15% as of March 31, 2008. The average default rate and loss severity, excluding fair value losses related to SOP 03-3 and HomeSaver Advance loans, was 0.17% and 36%, respectively, for the first quarter of 2009, compared with 0.13% and 19%, respectively, for the first quarter of 2008.
 
As a result of our higher loss provisioning levels, we substantially increased our combined loss reserves in the first quarter of 2009, both in absolute terms and as a percentage of our total guaranty book of business, to $41.7 billion, or 1.38% of our total guaranty book of business, as of March 31, 2009, from $24.8 billion, or 0.83% of our total guaranty book of business, as of December 31, 2008. Our combined loss reserves as a percentage of our total nonperforming loans increased to 28.78% as of March 31, 2009, from 20.76% as of December 31, 2008.
 
We increased the portion of our combined loss reserves attributable to our multifamily guaranty book of business by $520 million during the first quarter of 2009, to $624 million, or 0.36% of our multifamily guaranty book of business, as of March 31, 2009, from $104 million, or 0.06% of our multifamily guaranty book of business, as of December 31, 2008. This increase reflects the stress on our multifamily guaranty book of business due to the severe economic downturn and lack of liquidity in the market, which has adversely affected multifamily property values, vacancy rates and rent levels, as well as the cash flows generated from these investments and refinancing options. These conditions have contributed to higher delinquency and default rates.
 
Provision for Credit Losses Attributable to SOP 03-3 and HomeSaver Advance Fair Value Losses
 
In our capacity as guarantor of our MBS trusts, we have the option under the trust agreements, to purchase specified mortgage loans from our MBS trusts. We generally are not permitted to complete a modification of a


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loan while the loan is held in the MBS trust. As a result, we must exercise our option to purchase any delinquent loan that we intend to modify from an MBS trust prior to the time that the modification becomes effective. The proportion of delinquent loans purchased from MBS trusts for the purpose of modification varies from period to period, driven primarily by factors such as changes in our loss mitigation efforts, as well as changes in interest rates and other market factors. See “Part I—Item 1—Business—Business Segments—Single-Family Credit Guaranty Business—MBS Trusts” of our 2008 10-K for additional information on the provisions in our MBS trusts agreements that govern the purchase of loans from our MBS trusts and the factors that we consider in determining whether to purchase delinquent loans from our MBS trusts.
 
“SOP 03-3” refers to the accounting guidance issued by the American Institute of Certified Public Accountants Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. This guidance is generally applicable to delinquent loans purchased from our MBS trusts and delinquent loans held in any MBS trust that we are required to consolidate, which we collectively refer to as “Acquired Loans from MBS Trusts Subject to SOP 03-3.” We record our net investment in these loans at the lower of the acquisition cost of the loan or the estimated fair value at the date of purchase or consolidation. To the extent the acquisition cost exceeds the estimated fair value, we record a SOP 03-3 fair value loss charge-off against the “Reserve for guaranty losses” at the time we acquire the loan.
 
We introduced HomeSaver Advance in the first quarter of 2008. HomeSaver Advance serves as a foreclosure prevention tool early in the delinquency cycle and does not conflict with our MBS trust requirements because it allows borrowers to cure their payment defaults without modifying their mortgage loan. HomeSaver Advance allows servicers to provide qualified borrowers with a 15-year unsecured personal loan in an amount equal to all past due payments relating to their mortgage loan, generally up to the lesser of $15,000 or 15% of the unpaid principal balance of the delinquent first lien loan. We record HomeSaver Advance loans at their estimated fair value at the date we purchase these loans from servicers, and, to the extent the acquisition cost exceeds the estimated fair value, we record a HomeSaver fair value loss charge-off against the “Reserve for guaranty losses” at the time we acquire the loan.
 
As indicated in Table 11 above, SOP 03-3 and HomeSaver Advance fair value losses increased to $1.5 billion in the first quarter of 2009, from $733 million in the first quarter of 2008, reflecting both an increase in the number of acquired delinquent loans and a decrease in the fair value of these loans.
 
Table 13 provides a quarterly comparison of the number of delinquent loans acquired from MBS trusts subject to SOP 03-3, the unpaid principal balance and accrued interest of these loans, and the average fair value based on indicative market prices. The decline in home prices and significant reduction in liquidity in the mortgage markets, along with the increase in mortgage credit risk, have resulted in continued downward pressure on the fair value of these loans.
 
Table 13:  Statistics on Acquired Loans from MBS Trusts Subject to SOP 03-3
 
                                         
    2009     2008  
    Q1     Q4     Q3     Q2     Q1  
    (Dollars in millions)  
 
Number of acquired loans from MBS trusts subject to SOP 03-3
    12,223       6,124       3,678       4,618       10,586  
Average indicative market price(1)
    45 %     50 %     53 %     53 %     60 %
Unpaid principal balance and accrued interest of loans acquired
  $ 2,561     $ 1,286     $ 744     $ 807     $ 1,704  
 
 
(1) Calculated based on the estimated fair value at the date of acquisition of delinquent loans subject to SOP 03-3 divided by the unpaid principal balance and accrued interest of these loans at the date of acquisition. The value of primary mortgage insurance is included as a component of the average market price. In the first quarter of 2009, we incorporated the average fair value of acquired multifamily loans subject to SOP 03-3 into the calculation of our average indicative market price. We have revised the previously reported prior period amounts to reflect this change.
 
During the fourth quarter of 2008, we began increasing the number of delinquent loans we purchased from MBS trusts in response to our efforts to take a more proactive approach to prevent foreclosures by addressing potential problem loans earlier and offering additional, more flexible workout alternatives. As a result of the increase in our loan modification volume that we are experiencing and expect to continue to experience during


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2009, particularly as more servicers participate in the Home Affordable Modification Program, we expect our acquisition of delinquent loans from MBS trusts to continue to increase during 2009. We also expect to continue to incur significant losses in 2009 in connection with the acquisition of delinquent loans and the modification of loans. We provide additional information on our loan workout activities in “Risk Management—Credit Risk Management—Mortgage Credit Risk Management—Problem Loan Management and Foreclosure Prevention.”
 
Credit Loss Performance Metrics
 
Management views our credit loss performance metrics, which include our historical credit losses and our credit loss ratio, as significant indicators of the effectiveness of our credit risk management strategies. Management uses these metrics together with other credit risk measures to assess the credit quality of our existing guaranty book of business, make determinations about our loss mitigation strategies, evaluate our historical credit loss performance and determine the level of our loss reserves. These metrics, however, are not defined terms within GAAP and may not be calculated in the same manner as similarly titled measures reported by other companies. Because management does not view changes in the fair value of our mortgage loans as credit losses, we exclude SOP 03-3 and HomeSaver Advance fair value losses from our credit loss performance metrics. However, we include in our credit loss performance metrics the impact of any credit losses we experience on loans subject to SOP 03-3 or first lien loans associated with HomeSaver Advance loans that ultimately result in foreclosure.
 
We believe that our credit loss performance metrics are useful to investors because they reflect how management evaluates our credit performance and the effectiveness of our credit risk management strategies and loss mitigation efforts. They also provide a consistent treatment of credit losses for on- and off-balance sheet loans. Moreover, by presenting credit losses with and without the effect of SOP 03-3 and HomeSaver Advance fair value losses, investors are able to evaluate our credit performance on a more consistent basis among periods.
 
Table 14 below details the components of our credit loss performance metrics, which exclude the effect of SOP 03-3 and HomeSaver Advance fair value losses, for the first quarters of 2009 and 2008.
 
Table 14:  Credit Loss Performance Metrics
 
                                 
    For the Three Months Ended
 
    March 31,  
    2009     2008  
    Amount     Ratio(1)     Amount     Ratio(1)  
    (Dollars in millions)  
 
Charge-offs, net of recoveries
  $ 3,381       45.2  bp   $ 1,269       18.2  bp
Foreclosed property expense
    538       7.2       170       2.5  
Less: SOP 03-3 and HomeSaver Advance fair value losses(2)
    (1,525 )     (20.4 )     (733 )     (10.5 )
Plus: Impact of SOP 03-3 on charge-offs and foreclosed property expense(3)
    89       1.2       169       2.4  
                                 
Credit losses(4)
  $ 2,483       33.2  bp   $ 875       12.6  bp
                                 
 
 
(1) Based on the annualized amount for each line item presented divided by the average guaranty book of business during the period.
 
(2) Represents the amount recorded as a loss when the acquisition cost of a delinquent loan purchased from an MBS trust that is subject to SOP 03-3 exceeds the fair value of the loan at acquisition. Also includes the difference between the unpaid principal balance of unsecured HomeSaver Advance loans at origination and the estimated fair value of these loans that we record in our consolidated balance sheets.
 
(3) For seriously delinquent loans purchased from MBS trusts that are recorded at a fair value amount at acquisition that is lower than the acquisition cost, any loss recorded at foreclosure is less than it would have been if we had recorded the loan at its acquisition cost instead of at fair value. Accordingly, we have added back to our credit losses the amount of charge-offs and foreclosed property expense that we would have recorded if we had calculated these amounts based on the purchase price.


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(4) Interest forgone on nonperforming loans in our mortgage portfolio, which is presented in Table 45, reduces our net interest income but is not reflected in our credit losses total. In addition, other-than-temporary impairment losses resulting from deterioration in the credit quality of our mortgage-related securities and accretion of interest income on loans subject to SOP 03-3 are excluded from credit losses.
 
Our credit loss ratio increased to 33.2 basis points in the first quarter of 2009, from 12.6 basis points in the first quarter of 2008. Our credit loss ratio including the effect of SOP 03-3 and HomeSaver Advance fair value losses would have been 52.4 basis points and 20.7 basis points for the first quarter of 2009 and 2008, respectively. The substantial increase in our credit losses in the first quarter of 2009 from the first quarter of 2008 reflected the adverse impact of the continued and dramatic national decline in home prices, as well as the severe economic downturn. These conditions have resulted in an increase in delinquencies across our entire guaranty book of business and higher default rates and loss severities, particularly for certain higher risk loan categories, loan vintages and loans within certain states that have had the greatest home price depreciation from their recent peaks.
 
Specific credit loss statistics related to loans within certain states that have had the greatest home price declines; loans within states in the Midwest; and certain higher risk loan categories and loan vintages include the following:
 
  •  California, Florida, Arizona and Nevada, which represented approximately 28% and 27% of our single-family conventional mortgage credit book of business as of March 31, 2009 and 2008, respectively, accounted for approximately 58% and 32% of our single-family credit losses for the first quarter of 2009 and 2008, respectively.
 
  •  Michigan and Ohio, two key states driving credit losses in the Midwest, represented approximately 6% of our single-family conventional mortgage credit book of business as of both March 31, 2009 and 2008, but accounted for approximately 9% and 29% of our single-family credit losses for the first quarter of 2009 and 2008, respectively.
 
  •  Certain higher risk loan categories, including Alt-A loans, interest-only loans, loans to borrowers with low credit scores and loans with high loan-to-value ratios, represented approximately 27% and 29% of our single-family conventional mortgage credit book of business as of March 31, 2009 and 2008, respectively, but accounted for approximately 65% and 66% of our single-family credit losses for the first quarter of 2009 and 2008, respectively. A significant portion of these higher risk loan categories were originated in 2006 and 2007 in states that have experienced the steepest declines in home prices, such as California, Florida, Arizona and Nevada.
 
The suspension of foreclosure sales on occupied single-family properties between the periods November 26, 2008 through January 31, 2009 and February 17, 2009 through March 6, 2009 reduced our foreclosure activity in the first quarter of 2009, which resulted in a reduction in our charge-offs and credit losses below what we believe we would have otherwise recorded in the first quarter of 2009 had the moratorium not been in place. We will record a charge-off upon foreclosure for loans subject to the foreclosure moratorium that we are not able to modify and that ultimately result in foreclosure. While the foreclosure moratorium affects the timing of when we incur a credit loss, it does not necessarily affect the credit-related expenses recognized in our consolidated statements of operations because we estimate probable losses inherent in our guaranty book of business as of each balance date in determining our loss reserves. See “Critical Accounting Policies and Estimates—Allowance for Loan Losses and Reserve for Guaranty Losses” for a discussion of changes we made in our loss reserve estimation process to address the impact of the foreclosure moratorium.
 
We provide more detailed credit performance information, including serious delinquency rates by geographic region, statistics on nonperforming loans and foreclosure activity, in “Risk Management—Credit Risk Management—Mortgage Credit Risk Management.”
 
Regulatory Hypothetical Stress Test Scenario
 
Under a September 2005 agreement with the Office of Federal Housing Enterprise Oversight (“OFHEO”), the predecessor to FHFA, we are required to disclose on a quarterly basis the present value of the change in future expected credit losses from our existing single-family guaranty book of business from an immediate 5%


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decline in single-family home prices for the entire United States. Although this agreement was suspended on March 18, 2009 by FHFA until further notice, we are continuing to provide this disclosure. For purposes of this calculation, we assume that, after the initial 5% shock, home price growth rates return to the average of the possible growth rate paths used in our internal credit pricing models. The sensitivity results represent the difference between future expected credit losses under our base case scenario, which is derived from our internal home price path forecast, and a scenario that assumes an instantaneous nationwide 5% decline in home prices.
 
Table 15 compares the credit loss sensitivities as of March 31, 2009 and December 31, 2008 for first lien single-family whole loans we own or that back Fannie Mae MBS, before and after consideration of projected credit risk sharing proceeds, such as private mortgage insurance claims and other credit enhancement.
 
Table 15:  Single-Family Credit Loss Sensitivity(1)
 
                 
    As of  
    March 31,
    December 31,
 
    2009     2008  
    (Dollars in millions)  
 
Gross single-family credit loss sensitivity
  $ 19,631     $ 13,232  
Less: Projected credit risk sharing proceeds
    (4,458 )     (3,478 )
                 
Net single-family credit loss sensitivity
  $ 15,173     $ 9,754  
                 
Outstanding single-family whole loans and Fannie Mae MBS
  $ 2,755,078     $ 2,724,253  
Single-family net credit loss sensitivity as a percentage of outstanding single-family whole loans and Fannie Mae MBS
    0.55 %     0.36 %
 
 
(1) Represents total economic credit losses, which consist of credit losses and forgone interest. Calculations are based on approximately 97% of our total single-family guaranty book of business as of both March 31, 2009 and December 31, 2008. The mortgage loans and mortgage-related securities that are included in these estimates consist of: (i) single-family Fannie Mae MBS (whether held in our mortgage portfolio or held by third parties), excluding certain whole loan Real Estate Mortgage Investment Conduits (“REMICs”) and private-label wraps; (ii) single-family mortgage loans, excluding mortgages secured only by second liens, subprime mortgages, manufactured housing chattel loans and reverse mortgages; and (iii) long-term standby commitments. We expect the inclusion in our estimates of the excluded products may impact the estimated sensitivities set forth in this table.
 
The increase in the projected credit loss sensitivities during the first quarter of 2009 reflected the continued decline in home prices and the current negative outlook for the housing and credit markets. Because these sensitivities represent hypothetical scenarios, they should be used with caution. Our regulatory stress test scenario is limited in that it assumes an instantaneous uniform 5% nationwide decline in home prices, which is not representative of the historical pattern of changes in home prices. Changes in home prices generally vary on a regional, as well as a local, basis. In addition, these stress test scenarios are calculated independently without considering changes in other interrelated assumptions, such as unemployment rates or other economic factors, which are likely to have a significant impact on our future expected credit losses.
 
Other Non-Interest Expenses
 
Other non-interest expenses consists of credit enhancement expenses, which reflect the amortization of the credit enhancement asset we record at the inception of guaranty contracts, costs associated with the purchase of additional mortgage insurance to protect against credit losses, net gains and losses on the extinguishment of debt, and other miscellaneous expenses. Other non-interest expenses decreased to $358 million for the first quarter of 2009, from $505 million for the first quarter of 2008. This decrease was largely due to a reduction in net losses recorded on the extinguishment of debt and a reduction in interest expense associated with unrecognized tax benefits related to certain unresolved tax positions.
 
Federal Income Taxes
 
We recorded a tax benefit for federal income taxes of $623 million for the first quarter of 2009, which represents the benefit of carrying back a portion of our expected current year tax loss, net of the reversal of


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the use of certain tax credits, to prior years. We were not able to recognize a net tax benefit associated with the majority of our pre-tax loss of $23.8 billion in the first quarter 2009, as there has been no change in the conclusion we reached in 2008 that it was more likely than not that we would not generate sufficient taxable income in the foreseeable future to realize our net deferred tax assets. As a result, we recorded an increase in our valuation allowance of $8.8 billion in our condensed consolidated statements of operations in the first quarter of 2009, which represented the tax effect associated with the majority of the pre-tax losses we recorded in the quarter. The valuation allowance recorded against our deferred tax assets totaled $39.6 billion as of March 31, 2009, resulting in a net deferred tax asset of $1.7 billion as of March 31, 2009, compared with a net deferred tax asset of $3.9 billion as of December 31, 2008. We discuss the factors that led us to record a partial valuation allowance against our net deferred tax assets in “Part II—Item 7—MD&A—Critical Accounting Policies and Estimates—Deferred Tax Assets” and “Notes to Consolidated Financial Statements—Note 12, Income Taxes” of our 2008 Form 10-K.
 
In comparison, we recorded a net tax benefit of $2.9 billion for the first quarter of 2008, due in part to the pre-tax loss for the period as well as the tax credits generated from our LIHTC partnership investments. Our effective income tax rate, excluding the provision or benefit for taxes related to extraordinary amounts, was 57% for the first quarter of 2008.
 
BUSINESS SEGMENT RESULTS
 
Results of our three business segments are intended to reflect each segment as if it were a stand-alone business. We describe the management reporting and allocation process used to generate our segment results in our 2008 Form 10-K in “Notes to Consolidated Financial Statements—Note 16, Segment Reporting.” We summarize our segment results for the first quarters of 2009 and 2008 in the tables below and provide a comparative discussion of these results. See “Notes to Condensed Consolidated Financial Statements—Note 15, Segment Reporting” of this report for additional information on our segment results.
 
Single-Family Business
 
Our Single-Family business recorded a net loss of $18.1 billion for the first quarter of 2009, compared with a net loss of $1.0 billion for the first quarter of 2008. Table 16 summarizes the financial results for our Single-Family business for the periods indicated. The primary source of revenue for our Single-Family business is guaranty fee income. Other sources of revenue include trust management income and other fee income, primarily related to technology fees. Expenses primarily include credit-related expenses and administrative expenses.
 
Table 16:  Single-Family Business Results
 
                                 
    For the
       
    Three Months Ended
       
    March 31,     Variance  
    2009     2008     $     %  
    (Dollars in millions)  
 
Statement of operations data:
                               
Guaranty fee income
  $ 1,966     $ 1,942     $ 24       1 %
Trust management income
    11       105       (94 )     (90 )
Other income(1)
    173       188       (15 )     (8 )
Credit-related expenses(2)
    (20,330 )     (3,254 )     (17,076 )     (525 )
Other expenses(3)
    (523 )     (533 )     10       2  
                                 
Loss before federal income taxes
    (18,703 )     (1,552 )     (17,151 )     (1,105 )
Benefit for federal income taxes
    645       544       101       19  
                                 
Net loss attributable to Fannie Mae
  $ (18,058 )   $ (1,008 )   $ (17,050 )     (1,691 )%
                                 
Other key performance data:
                               
Average single-family guaranty book of business(4)
  $ 2,819,459     $ 2,634,526     $ 184,933       7 %
 
(1) Consists of net interest income, investment gains and losses, and fee and other income.


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(2) Consists of the provision for credit losses and foreclosed property expense.
 
(3) Consists of administrative expenses and other expenses.
 
(4) The single-family guaranty book of business consists of single-family mortgage loans held in our mortgage portfolio, single-family Fannie Mae MBS held in our mortgage portfolio, single-family Fannie Mae MBS held by third parties, and other credit enhancements that we provide on single-family mortgage assets. Excludes non-Fannie Mae mortgage-related securities held in our investment portfolio for which we do not provide a guarantee.
 
Key factors affecting the results of our Single-Family business for the first quarter of 2009 compared with the first quarter of 2008 included the following.
 
  •  A modest increase in guaranty fee income, primarily attributable to growth in the average single-family guaranty book of business, which was substantially offset by a decrease in the average effective single-family guaranty fee rate.
 
  —  Our average single-family guaranty book of business increased by 7%, as our MBS issuances exceeded our liquidations throughout 2008 and in early 2009. Our market share of MBS issuances remained strong during 2008 and into 2009, reflecting the continuing shift in the composition of originations in the primary mortgage market to agency-conforming loans. Our estimated market share of new single-family mortgage-related securities issuances, which is based on publicly available data and excludes previously securitized mortgages, remained high at approximately 44.2% for the first quarter of 2009, compared with 50.1% for the first quarter of 2008.
 
  —  The average effective single-family guaranty fee rate decreased by 5% to 27.9 basis points for the first quarter of 2009, from 29.5 basis points for the first quarter of 2008. This decrease was attributable to the guaranty fee pricing changes we implemented during 2008 to address the current risks in the housing market and a shift in the composition of our new business to a greater proportion of higher-quality, lower risk and lower guaranty fee mortgages. As a result of these changes, the average charged guaranty fee on new single-family business decreased to 21.0 basis points for the first quarter of 2009, from 25.7 basis points for the first quarter of 2008. The average charged fee represents the average contractual fee rate for our single-family guaranty arrangements plus the recognition of any upfront cash payments ratably over an estimated average life. Beginning in 2009, we extended the estimated average life used in calculating the recognition of upfront cash payments for the purpose of determining our single-family new business average charged guaranty fee to reflect a longer expected duration because of the record low interest rate environment. This change did not have a material impact on the average charged guaranty fee on our new single-family business in the first quarter of 2009.
 
  •  A substantial increase in credit-related expenses, reflecting a significantly higher incremental provision for credit losses as well as higher charge-offs due to worsening credit performance trends, including significant increases in delinquencies, defaults and loss severities, particularly in certain loan categories, states and vintages. We also experienced a significant increase in SOP 03-3 fair value losses during the first quarter of 2009, reflecting the increase in the number of delinquent loans we purchased from MBS trusts for loan modification as part of our increased efforts in preventing foreclosures and the decreases in the estimated fair value of these loans.
 
  •  A significant reduction in the relative tax benefits associated with our pre-tax losses. We recorded a tax benefit of $645 million on pre-tax losses of $18.7 billion for the first quarter of 2009, compared with a tax benefit of $544 million on pre-tax losses of $1.6 billion for the first quarter of 2008. We recorded a valuation allowance for the majority of the tax benefits associated with the pre-tax losses recognized in the first quarter of 2009 as there has been no change in the conclusion we reached in 2008 that it was more likely than not that we would not generate sufficient taxable income in the foreseeable future to realize all of the tax benefits generated from these losses.
 
HCD Business
 
Our HCD business recorded a net loss attributable to Fannie Mae of $1.0 billion for the first quarter of 2009, compared with net income of $150 million for the first quarter of 2008. Table 17 summarizes the financial results for our HCD business for the periods indicated. The primary sources of revenue for our HCD business are guaranty fee income and other income, consisting of transaction fees associated with our multifamily


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business and bond credit enhancement fees. Expenses primarily include administrative expenses, credit-related expenses and net operating losses associated with our partnership investments, the majority of which generate tax benefits that may reduce our federal income tax liability. However, we recorded a valuation allowance against a portion of the tax benefits generated by these investments in the first quarter of 2009 as there has been no change in the conclusion we reached in 2008 that it was more likely than not that we would not generate sufficient taxable income in the foreseeable future to realize our net deferred tax assets.
 
Table 17:   HCD Business Results
 
                                 
    For the
       
    Three Months Ended
       
    March 31,     Variance  
    2009     2008     $     %  
          (Dollars in millions)        
 
Statement of operations data:(1)
                               
Guaranty fee income
  $ 158     $ 148     $ 10       7 %
Other income(2)
    27       64       (37 )     (58 )
Losses on partnership investments
    (357 )     (141 )     (216 )     (153 )
Credit-related income (expenses)(3)
    (542 )     11       (553 )     (5,027 )
Other expenses(4)
    (169 )     (254 )     85       33  
                                 
Loss before federal income taxes
    (883 )     (172 )     (711 )     (413 )
Benefit (provision) for federal income taxes
    (168 )     322       (490 )     (152 )
                                 
Net loss
    (1,051 )     150       (1,201 )     (801 )%
Less: Net loss attributable to the noncontrolling interest
    17             17        
                                 
Net income (loss) attributable to Fannie Mae
  $ (1,034 )   $ 150     $ (1,184 )     (789 )%
                                 
Other key performance data:
                               
Average multifamily guaranty book of business(5)
  $ 174,329     $ 151,278     $ 23,051       15 %
 
 
(1) Certain prior period amounts have been reclassified to conform to the current period presentation.
 
(2) Consists of trust management income and fee and other income.
 
(3) Consists of the provision for credit losses and foreclosed property income.
 
(4) Consists of net interest expense, administrative expenses and other expenses.
 
(5) The multifamily guaranty book of business consists of multifamily mortgage loans held in our mortgage portfolio, multifamily Fannie Mae MBS held in our mortgage portfolio, multifamily Fannie Mae MBS held by third parties and other credit enhancements that we provide on multifamily mortgage assets. Excludes non-Fannie Mae mortgage-related securities held in our investment portfolio for which we do not provide a guarantee.
 
Key factors affecting the results of our HCD business for the first quarter of 2009 compared with the first quarter of 2008 included the following.
 
  •  A $553 million increase in credit-related expenses, as we increased our multifamily combined loss reserves by $520 million during the first quarter of 2009 to $624 million as of March 31, 2009. This increase reflects the stress on our multifamily guaranty book of business due to the severe economic downturn and lack of liquidity in the market, which has adversely affected multifamily property values, vacancy rates and rent levels, the cash flows generated from these investments and refinancing options.
 
  •  A $216 million increase in losses on partnership investments, largely due to the recognition of additional other-than-temporary impairment of $147 million on a portion of our LIHTC partnership investments and other affordable housing investments. In addition, our partnership losses for the first quarter of 2008 were partially reduced by a gain on the sale of some of our LIHTC investments.
 
  •  A provision for federal income taxes of $168 million for the first quarter of 2009, compared with a tax benefit of $322 million for the first quarter of 2008. The tax provision recognized in the first quarter of 2009 was attributable to the reversal of previously utilized tax credits because of our ability to carry back, for tax purposes, to prior years net operating losses expected to be generated in the current year. In addition, we recorded a valuation allowance for the majority of the tax benefits associated with the pre-tax losses and tax credits generated by our partnership investments in the first quarter of 2009 as there has


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  been no change in the conclusion we reached in 2008 that it was more likely than not that we would not generate sufficient taxable income in the foreseeable future to realize our net deferred tax assets.
 
Capital Markets Group
 
Our Capital Markets group recorded a net loss of $4.1 billion for the first quarter of 2009, compared with a net loss of $1.3 billion for the first quarter of 2008. Table 18 summarizes the financial results for our Capital Markets group for the periods indicated. The primary source of revenue for our Capital Markets group is net interest income. Expenses primarily consist of administrative expenses. Fair value gains and losses, investment gains and losses, and debt extinguishment gains and losses also have a significant impact on the financial performance of our Capital Markets group.
 
Table 18:   Capital Markets Group Results
 
                                 
    For the
       
    Three Months
       
    Ended
       
    March 31,     Variance  
    2009     2008     $     %  
          (Dollars in millions)        
 
Statement of operations data:
                               
Net interest income
  $ 3,295     $ 1,659     $ 1,636       99 %
Investment losses, net
    (5,503 )     (63 )     (5,440 )     (8,635 )
Fair value losses, net
    (1,460 )     (4,377 )     2,917       67  
Fee and other income, net
    69       63       6       10  
Other expenses(1)
    (623 )     (671 )     48       7  
                                 
Loss before federal income taxes
    (4,222 )     (3,389 )     (833 )     (25 )
Benefit for federal income taxes
    146       2,062       (1,916 )     (93 )
Extraordinary losses, net of tax effect
          (1 )     1       100  
                                 
Net loss attributable to Fannie Mae
  $ (4,076 )   $ (1,328 )   $ (2,748 )     (207 )%
                                 
 
 
(1) Consists of debt extinguishment losses, allocated guaranty fee expense, administrative expenses and other expenses.
 
Key factors affecting the results of our Capital Markets group for the first quarter of 2009 compared with the first quarter of 2008 included the following.
 
  •  An increase in net interest income, primarily attributable to an expansion of our net interest yield driven by a reduction in the average cost of our debt that more than offset a decline in the average yield on our interest-earning assets.
 
  —  The decrease in the average cost of our debt was due to the decline in short-term interest rates and the shift in our funding mix during the second half of 2008 to more short-term debt in response to reduced market demand for our longer-term and callable debt securities. Since November 2008, however, the demand for these securities has increased significantly, which has allowed us to issue more longer-term and callable debt securities and reduce the proportion of our short-term debt as a percentage of our total outstanding debt.
 
  —  Our net interest income does not include the effect of the periodic net contractual interest accruals on our interest rate swaps, which increased to an expense of $940 million in the first quarter of 2009, from an expense of $26 million in the first quarter of 2008. These amounts are included in derivatives gains (losses) and reflected in our consolidated statements of operations as a component of “Fair value losses, net.”
 
  •  A decrease in fair value losses, primarily attributable to a reduction in fair value losses on our derivatives and net gains on our trading securities.


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  —  We recorded derivatives fair value losses of $1.7 billion in the first quarter of 2009, compared with losses of $3.0 billion in the first quarter of 2008. The derivatives fair value losses of $1.7 billion in the first quarter of 2009 were primarily attributable to fair value losses on our option-based derivatives due to the combined effect of a decrease in implied volatility and the time decay of these options. The derivatives fair value losses of $3.0 billion in the first quarter of 2008 were attributable to net fair value losses on our interest rate swaps due to a considerable decline in the 5-year swap interest rate during the quarter.
 
  —  The gains on our trading securities during the first quarter of 2009 were attributable to the significant decrease in mortgage interest rates and the narrowing of spreads on agency MBS during the quarter. These gains were partially offset by a continued decrease in the fair value of our private-label mortgage-related securities backed by Alt-A and subprime loans.
 
  •  A significant increase in investment losses, attributable to other-than-temporary impairment on available-for-sale securities totaling $5.7 billion in the first quarter of 2009, compared with $55 million in the first quarter of 2008. The other-than-temporary impairment losses of $5.7 billion that we recognized in the first quarter of 2009 included additional impairment losses on some of our Alt-A and subprime private-label securities that we had previously impaired, as well as impairment losses on other Alt-A and subprime securities, attributable to continued deterioration in the credit quality of the loans underlying these securities and further declines in the expected cash flows.
 
  •  A significant reduction in the relative tax benefits associated with our pre-tax losses. We recorded a tax benefit of $146 million on pre-tax losses of $4.2 billion for the first quarter of 2009, compared with a tax benefit of $2.1 billion on pre-tax losses of $3.4 billion for the first quarter of 2008. We recorded a valuation allowance for the majority of the tax benefits associated with the pre-tax losses recognized in the first quarter of 2009 as there has been no change in the conclusion we reached in 2008 that it was more likely than not that we would not generate sufficient taxable income in the foreseeable future to realize all of the tax benefits generated from these losses.
 
CONSOLIDATED BALANCE SHEET ANALYSIS
 
Total assets of $919.6 billion as of March 31, 2009 increased by $7.2 billion, or 0.8%, from December 31, 2008. Total liabilities of $938.6 billion increased by $11.0 billion, or 1.2%, from December 31, 2008. Fannie Mae’s total deficit increased by $3.8 billion during the first quarter of 2009, to a deficit of $18.9 billion as of March 31, 2009. The increase in Fannie Mae’s total deficit was attributable to our net loss of $23.2 billion for the first quarter of 2009, which was partially offset by the $15.2 billion in funds received from Treasury under the senior preferred stock purchase agreement and a decrease in unrealized losses on available-for-sale securities. Following is a discussion of material changes in the major components of our assets and liabilities since December 31, 2008. See “Liquidity and Capital Management—Capital Management—Capital Activity,” for additional discussion of changes in Fannie Mae’s total deficit.
 
Mortgage Investments
 
Our mortgage investment activities may be constrained by our regulatory requirements, operational limitations, tax classifications and our intent to hold certain temporarily impaired securities until recovery in value, as well as risk parameters applied to the mortgage portfolio. In addition, the senior preferred stock purchase agreement with Treasury permits us to increase our mortgage portfolio temporarily up to a cap of $900 billion through December 31, 2009. Beginning in 2010, we are required to reduce the size of our mortgage portfolio by 10% per year, until the amount of our mortgage assets reaches $250 billion. We also are required to limit the amount of indebtedness that we can incur to 120% of the amount of mortgage assets we are allowed to own. Through December 30, 2010, our debt cap equals $1,080 billion. Beginning December 31, 2010, and on December 31 of each year thereafter, our debt cap that will apply through December 31 of the following year will equal 120% of the amount of mortgage assets we are allowed to own on December 31 of the immediately preceding calendar year.


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FHFA has encouraged us to acquire and hold increased amounts of mortgage loans and mortgage-related securities in our mortgage portfolio to provide additional liquidity to the mortgage market.
 
Table 19 summarizes our mortgage portfolio activity for the three months ended March 31, 2009 and 2008.
 
Table 19:  Mortgage Portfolio Activity(1)
 
                                         
    For the
             
    Three Months Ended
             
    March 31,     Variance        
    2009     2008     $     %        
          (Dollars in millions)              
 
Purchases(2)
  $ 49,587     $ 35,500     $ 14,087       40 %        
Sales
    24,092       13,529       10,563       78          
Liquidations(3)
    29,385       23,571       5,814       25          
 
 
(1) Excludes unamortized premiums, discounts and other cost basis adjustments.
 
(2) Excludes advances to lenders and mortgage-related securities acquired through the extinguishment of debt.
 
(3) Includes scheduled repayments, prepayments, foreclosures and lender repurchases.
 
Portfolio purchases and sales were greater in the first quarter of 2009, relative to the first quarter of 2008, due to increased mortgage originations, increased volume of loan deliveries to us, and increased securitizations from our portfolio. The increase in mortgage liquidations during the first quarter of 2009 reflected the surge in the volume of refinancings in March 2009, as mortgage interest rates fell to record lows.
 
As a result of the Federal Reserve’s agency MBS purchase program, which was announced in November 2008 and expanded in March 2009 to include the purchase of up to $1.25 trillion of agency MBS by the end of 2009, the Federal Reserve currently is the primary purchaser of our MBS. The Federal Reserve’s agency MBS purchase program has caused spreads on agency MBS to narrow. As a result, we significantly reduced our purchases of agency MBS during the first quarter of 2009.
 
Table 20 shows the composition of our mortgage portfolio by product type and the carrying value, which reflects the net impact of our purchases, sales and liquidations, as of March 31, 2009 and December 31, 2008. Our net mortgage portfolio totaled $760.4 billion as of March 31, 2009, reflecting a decrease of 1% from December 31, 2008.


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Table 20:  Mortgage Portfolio Composition(1)
 
                 
    As of  
    March 31,
    December 31,
 
    2009     2008  
    (Dollars in millions)  
 
Mortgage loans:(2) 
               
Single-family:
               
Government insured or guaranteed(3)(9)
  $ 48,167     $ 43,799  
Conventional:
               
Long-term, fixed-rate
    188,098       186,550  
Intermediate-term, fixed-rate(4)
    38,763       37,546  
Adjustable-rate
    42,167       44,157  
                 
Total conventional single-family
    269,028       268,253  
                 
Total single-family
    317,195       312,052  
                 
Multifamily:
               
Government insured or guaranteed(3)
    673       699  
Conventional:
               
Long-term, fixed-rate
    5,679       5,636  
Intermediate-term, fixed-rate(4)
    91,606       90,837  
Adjustable-rate
    21,216       20,269  
                 
Total conventional multifamily
    118,501       116,742  
                 
Total multifamily
    119,174       117,441  
                 
Total mortgage loans
    436,369       429,493  
                 
Unamortized premiums and other cost basis adjustments, net
    (2,015 )     (894 )
Lower of cost or market adjustments on loans held for sale
    (461 )     (264 )
Allowance for loan losses for loans held for investment
    (4,830 )     (2,923 )
                 
Total mortgage loans, net
    429,063       425,412  
                 
Mortgage-related securities:
               
Fannie Mae single-class MBS
    156,106       159,712  
Fannie Mae structured MBS
    66,918       69,238  
Non-Fannie Mae single-class mortgage securities
    25,783       26,976  
Non-Fannie Mae structured mortgage securities(5)
    86,311       88,467  
Mortgage revenue bonds
    15,285       15,447  
Other mortgage-related securities
    2,769       2,863  
                 
Total mortgage-related securities
    353,172       362,703  
                 
Market value adjustments(6)
    (9,638 )     (15,996 )
Other-than-temporary impairments, net of accretion
    (12,458 )     (7,349 )
Unamortized discounts and other cost basis adjustments, net(7)
    245       296  
                 
Total mortgage-related securities, net
    331,321       339,654  
                 
Mortgage portfolio, net(8)
  $ 760,384     $ 765,066  
                 
 
 
(1) Mortgage loans and mortgage-related securities are reported at unpaid principal balance.
 
(2) Mortgage loans include unpaid principal balances totaling $65.5 billion and $65.8 billion as of March 31, 2009 and December 31, 2008, respectively, related to mortgage-related securities that were consolidated under FASB Interpretation (“FIN”) No. 46R (revised December 2003), Consolidation of Variable Interest Entities (an interpretation of ARB No. 51) (“FIN 46R”), and mortgage-related securities created from securitization transactions that did not meet the sales criteria under SFAS No. 140, Accounting for Transfer and Servicing of Financial Assets and Extinguishments


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of Liabilities (a replacement of FASB Statement No. 125) (“SFAS 140”), which effectively resulted in mortgage-related securities being accounted for as loans.
 
(3) Refers to mortgage loans that are guaranteed or insured by the U.S. government or its agencies, such as the Department of Veterans Affairs, Federal Housing Administration or the Rural Development Housing and Community Facilities Program of the Department of Agriculture.
 
(4) Intermediate-term, fixed-rate consists of mortgage loans with contractual maturities at purchase equal to or less than 15 years.
 
(5) Includes private-label mortgage-related securities backed by subprime or Alt-A mortgage loans totaling $50.6 billion and $52.4 billion as of March 31, 2009 and December 31, 2008, respectively. Refer to “Trading and Available-for-Sale Investment Securities—Investments in Private-Label Mortgage-Related Securities—Investments in Alt-A and Subprime Private-Label Mortgage-Related Securities” for a description of our investments in subprime and Alt-A securities.
 
(6) Includes unrealized gains and losses on mortgage-related securities and securities commitments classified as trading and available for sale.
 
(7) Includes the impact of other-than-temporary impairments of cost basis adjustments.
 
(8) Includes consolidated mortgage-related assets acquired through the assumption of debt. Also includes $1.4 billion and $720 million as of March 31, 2009 and December 31, 2008, respectively, of mortgage loans and mortgage-related securities that we have pledged as collateral and that counterparties have the right to sell or repledge.
 
(9) Includes reverse mortgages with an outstanding unpaid principal balance of approximately $45.6 billion and $41.2 billion as of March 31, 2009 and December 31, 2008, respectively.
 
Cash and Other Investments Portfolio
 
Our cash and other investments portfolio consists of cash and cash equivalents, federal funds sold and securities purchased under agreements to resell and non-mortgage investment securities. Our cash and other investments portfolio totaled $92.4 billion as of March 31, 2009, compared with $93.0 billion as of December 31, 2008. See “Liquidity and Capital Management—Liquidity Management—Liquidity Contingency Plan—Cash and Other Investments Portfolio” for additional information on our cash and other investments portfolio.
 
Trading and Available-for-Sale Investment Securities
 
Our mortgage investment securities are classified in our condensed consolidated balance sheets as either trading or available for sale and reported at fair value. Table 21 shows the composition of our trading and available-for-sale securities at amortized cost and fair value as of March 31, 2009, which totaled $358.4 billion and $347.3 billion, respectively. We also disclose the gross unrealized gains and gross unrealized losses related to our available-for-sale securities as of March 31, 2009, and a stratification of the gross unrealized losses based on securities that have been in a continuous unrealized loss position for less than 12 months and for 12 months or longer.


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Table 21:  Trading and Available-for-Sale Investment Securities
 
                                                                 
    As of March 31, 2009  
                            Less Than 12
    12 Consecutive
 
                            Consecutive Months(2)     Months or Longer(2)  
          Gross
    Gross
    Total
    Gross
    Total
    Gross
    Total
 
    Amortized
    Unrealized
    Unrealized
    Fair
    Unrealized
    Fair
    Unrealized
    Fair
 
    Cost(1)     Gains     Losses     Value     Losses     Value     Losses     Value  
    (Dollars in millions)  
 
Trading:
                                                               
Fannie Mae single-class MBS
  $ 44,408     $     $     $ 46,747     $     $     $     $  
Fannie Mae structured MBS
    9,451                   9,507                          
Non-Fannie Mae single-class mortgage-related securities
    978                   1,022                          
Non-Fannie Mae structured mortgage-related securities
    19,547                   12,351                          
Mortgage revenue bonds
    795                   653                          
Asset-backed securities
    11,291                   10,270                          
Corporate debt securities
    4,166                   3,725                          
Other non-mortgage-related securities(3)
    2,003                   2,003                          
                                                                 
Total trading
  $ 92,639     $     $     $ 86,278     $     $     $     $  
                                                                 
Available for sale:
                                                               
Fannie Mae single-class MBS
  $ 111,348     $ 4,403     $ (11 )   $ 115,740     $ (10 )   $ 1,566     $ (1 )   $ 135  
Fannie Mae structured MBS
    57,211       2,331       (60 )     59,482       (17 )     2,059       (43 )     555  
Non-Fannie Mae single-class mortgage-related securities
    24,660       949       (8 )     25,601       (7 )     365       (1 )     90  
Non-Fannie Mae structured mortgage-related securities
    55,906       350       (11,125 )     45,131       (2,509 )     6,174       (8,616 )     20,100  
Mortgage revenue bonds
    14,468       41       (1,291 )     13,218       (175 )     3,406       (1,116 )     7,380  
Other mortgage-related securities
    2,186       50       (367 )     1,869       (278 )     1,048       (89 )     287  
                                                                 
Total available for sale
  $ 265,779     $ 8,124     $ (12,862 )   $ 261,041     $ (2,996 )   $ 14,618     $ (9,866 )   $ 28,547  
                                                                 
Total investments in securities
  $ 358,418     $ 8,124     $ (12,862 )   $ 347,319     $ (2,996 )   $ 14,618     $ (9,866 )   $ 28,547  
                                                                 
 
 
(1) Amortized cost includes unamortized premiums, discounts and other cost basis adjustments, as well as other-than-temporary impairment write downs.
 
(2) Reflects the gross unrealized losses and the related fair value of securities that are in a loss position as of March 31, 2009.
 
(3) Includes one certificate of deposit issued by BNP Paribas with a fair value of $2.0 billion, which exceeded 10% of our stockholders’ deficit as of March 31, 2009.
 
Gross unrealized losses on our available-for-sale securities decreased to $12.9 billion as of March 31, 2009, from $16.7 billion as of December 31, 2008. The decrease in gross unrealized losses was primarily attributable to the recognition of other-than-temporary impairment of $5.5 billion in the first quarter of 2009 on our Alt-A and subprime private-label securities. We had previously recognized other-than-temporary impairment on some of these securities. We discuss our process for assessing our available-for-sale investment securities for other-than-temporary impairment below.
 
Investments in Private-Label Mortgage-Related Securities
 
The non-Fannie Mae mortgage-related security categories presented in Table 21 above include agency mortgage-related securities issued or guaranteed by Freddie Mac or Ginnie Mae and private-label mortgage-related securities backed by Alt-A, subprime, multifamily, manufactured housing or other mortgage loans. We have no exposure to collateralized debt obligations, or CDOs. We classify private-label securities as Alt-A, subprime, multifamily or manufactured housing if the securities were labeled as such when issued. We also have invested in private-label Alt-A and subprime mortgage-related securities that we have resecuritized to include our guaranty (“wraps”). We report these wraps in Table 21 above as a component of Fannie Mae


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structured MBS. We generally focused our purchases of these securities on the highest-rated tranches available at the time of acquisition. Higher-rated tranches typically are supported by credit enhancements to reduce the exposure to losses. The credit enhancements on our private-label security investments generally are in the form of initial subordination provided by lower level tranches of these securities and prepayment proceeds within the trust. In addition, monoline financial guarantors have provided secondary guarantees on some of our holdings that are based on specific performance triggers. See “Risk Management—Credit Risk Management—Institutional Counterparty Credit Risk Management—Financial Guarantors” for information on our financial guarantor exposure and the counterparty risk associated with our financial guarantors.
 
The unpaid principal balance of private-label mortgage-related securities backed by Alt-A, subprime, multifamily, manufactured housing and other mortgage loans and mortgage revenue bonds held in our mortgage portfolio was $96.7 billion as of March 31, 2009, down from $98.9 billion as of December 31, 2008, primarily due to principal payments. Table 22 summarizes, by the underlying loan type, the composition of our investments in private-label securities and mortgage revenue bonds as of March 31, 2009 and the average credit enhancement. The average credit enhancement generally reflects the level of cumulative losses that must be incurred before we experience a loss of principal on the tranche of securities that we own. Table 22 also provides information on the credit ratings of our private-label securities as of April 28, 2009. The credit rating reflects the lowest rating reported by Standard & Poor’s (“Standard & Poor’s”), Moody’s Investors Service (“Moody’s”), Fitch Ratings (“Fitch”) or DBRS Limited, each of which is a nationally recognized statistical rating organization.
 
Table 22:  Investments in Private-Label Mortgage-Related Securities and Mortgage Revenue Bonds
 
                                                 
    As of March 31, 2009     As of April 28, 2009  
    Unpaid
    Average
                % Below
       
    Principal
    Credit
          % AA
    Investment
    Current %
 
    Balance     Enhancement(1)     % AAA(2)     to BBB-(2)     Grade(2)     Watchlist(3)  
                (Dollars in millions)              
 
Private-label mortgage-related securities backed by:
                                               
Alt-A mortgage loans:
                                               
Option ARM Alt-A mortgage loans
  $ 6,584       53 %     3 %     20 %     77 %     %
Other Alt-A mortgage loans
    20,488       14       32       21       47       5  
                                                 
Total Alt-A mortgage loans
    27,072       23       25       21       54       4  
Subprime mortgage loans(4)
    23,538       36       13       13       74        
                                                 
Total Alt-A and subprime loans
    50,610                                          
Multifamily mortgage loans (CMBS)
    25,792       30       100                   1  
Manufactured housing loans
    2,745       36       3       23       74        
Other mortgage loans
    2,275       6       93       3       4       4  
                                                 
Total private-label mortgage-related securities
    81,422                                          
Mortgage revenue bonds(5)
    15,284       35       38       59       3       17  
                                                 
Total
  $ 96,706                                          
                                                 
 
 
(1) Average credit enhancement percentage reflects both subordination and financial guarantees. Reflects the ratio of the current amount of the securities that will incur losses in a securitization structure before any losses are allocated to securities that we own. Percentage calculated based on the quotient of the total unpaid principal balance of all credit enhancement in the form of subordination or financial guarantee of the security divided by the total unpaid principal balance of all of the tranches of collateral pools from which credit support is drawn for the security that we own.
 
(2) Reflects credit ratings as of April 28, 2009, calculated based on unpaid principal balance as of March 31, 2009. Investment securities that have a credit rating below BBB- or its equivalent or that have not been rated are classified as below investment grade.
 
(3) Reflects percentage of investment securities, calculated based on unpaid principal balance as of March 31, 2009, that have been placed under review by either Standard & Poor’s, Moody’s, Fitch or DBRS, Limited.
 
(4) Excludes resecuritizations, or wraps, of private-label securities backed by subprime loans that we have guaranteed and hold in our mortgage portfolio. These wraps, which totaled $6.9 billion as of March 31, 2009, are presented in Table 28: Hypothetical Performance Scenarios—Alt-A and Subprime Private-Label Wraps.
 
(5) Reflects that 35% of the outstanding unpaid principal balance of our mortgage revenue bonds are guaranteed by third parties.


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Investments in Alt-A and Subprime Private-Label Mortgage-Related Securities
 
Table 23 presents the unpaid principal balance and estimated fair value of our investments in Alt-A and subprime private-label securities as of March 31, 2009 and December 31, 2008, and the gross unrealized losses on those securities classified as available for sale.
 
Table 23:  Investments in Alt-A and Subprime Private-Label Mortgage-Related Securities, Excluding Wraps
 
                                                 
    As of  
    March 31, 2009     December 31, 2008  
    Unpaid
          Gross
    Unpaid
          Gross
 
    Principal
    Fair
    Unrealized
    Principal
    Fair
    Unrealized
 
    Balance     Value     Losses     Balance     Value     Losses  
    (Dollars in millions)  
 
Alt-A private-label securities:
                                               
Trading
  $ 3,567     $ 1,232     $     $ 3,640     $ 1,476     $  
Available for sale
    23,505       13,742       (2,477 )     24,218       15,276       (4,307 )
                                                 
Total Alt-A private-label securities
    27,072       14,974       (2,477 )     27,858       16,752       (4,307 )
                                                 
Subprime private-label securities:(1)
                                               
Trading
    3,782       2,116             3,887       2,317        
Available for sale
    19,756       12,511       (2,863 )     20,664       14,318       (4,433 )
                                                 
Total subprime private-label securities
    23,538       14,627       (2,863 )     24,551       16,635       (4,433 )
                                                 
Total Alt-A and subprime private-label securities, excluding wraps
  $ 50,610     $ 29,601     $ (5,340 )   $ 52,409     $ 33,387     $ (8,740 )
                                                 
 
 
(1) Excludes resecuritizations, or wraps, of private-label securities backed by subprime loans that we have guaranteed and hold in our mortgage portfolio. These wraps, which totaled $6.9 billion and $7.3 billion as of March 31, 2009 and December 31, 2008, respectively, are presented in Table 28: Hypothetical Performance Scenarios—Alt-A and Subprime Private-Label Wraps.
 
The decrease in gross unrealized losses on our available-for-sale Alt-A and subprime private-label securities to $5.3 billion as of March 31, 2009, from $8.7 billion as of December 31, 2008 was primarily attributable to the recognition of other-than-temporary impairment of $5.5 billion in the first quarter of 2009. We recognized net fair value losses of $271 million and $1.0 billion for the first quarter of 2009 and 2008, respectively, on our investments in Alt-A and subprime private-label securities classified as trading during the respective quarters.
 
The substantial portion of our Alt-A and subprime private-label mortgage-related securities were rated AAA when we purchased these securities; however, many of these securities have suffered significant downgrades since we acquired them. As indicated in Table 22 above, approximately 54% and 74% of our Alt-A and subprime private-label mortgage-related securities, respectively, were rated below investment grade as of April 28, 2009. Approximately 25% and 13% of our Alt-A and subprime private-label mortgage-related securities, respectively, were rated AAA as of April 28, 2009. Although our portfolio of Alt-A and subprime private-label mortgage-related securities primarily consists of senior level tranches, we believe we are likely to incur losses on some securities that are currently rated AAA as a result of the significant and continued deterioration in home prices and the increasing delinquency, foreclosure and REO levels, particularly with regard to 2006 to 2007 loan vintages, which were originated in an environment of significant increases in home prices and relaxed underwriting criteria and eligibility standards. These conditions, which have had an adverse effect on the performance of the loans underlying our Alt-A and subprime private-label securities, have contributed to a sharp rise in expected defaults and loss severities and slower voluntary prepayment rates, particularly for the 2006 and 2007 loan vintages.
 
Table 24 presents a comparison, based on data provided by Intex Solutions, Inc. (“Intex”) and First American CoreLogic, LoanPerformance, where available, of the 60 days or more delinquency rates and average loss severities as of March 31, 2009, December 31, 2008, September 30, 2008 and June 30, 2008 of the Alt-A and subprime loans backing private-label securities that we own or guarantee.


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Table 24:   Delinquency Status and Loss Severity Rates of Loans Underlying Alt-A and Subprime Private-Label Mortgage-Related Securities
 
                                                                 
    As of  
    March 31, 2009     December 31, 2008     September 30, 2008     June 30, 2008  
          Average
          Average
          Average
          Average
 
    ³ 60 Days
    Loss
    ³ 60 Days
    Loss
    ³ 60 Days
    Loss
    ³ 60 Days
    Loss
 
Loan Categories
  Delinquent(1)     Severity(2)     Delinquent(1)     Severity(2)     Delinquent(1)     Severity(2)     Delinquent(1)     Severity(2)  
 
Option ARM Alt-A loans:
                                                               
2004 and prior
    26.05 %     41.93 %     22.97 %     37.67 %     18.88 %     38.52 %     15.95 %     32.37 %
2005
    32.18       55.14       26.48       50.34       21.65       46.84       17.35       42.77  
2006
    39.33       57.69       32.84       55.22       27.97       48.84       21.44       42.84  
2007
    31.77       53.24       24.16       51.00       17.17       44.60       10.79       32.99  
Other Alt-A loans:
                                                               
2004 and prior
    5.97       47.27       4.75       41.80       3.87       36.89       3.36       38.15  
2005
    15.18       53.90       12.18       49.59       10.27       45.30       8.78       41.12  
2006
    23.57       57.08       19.70       52.49       16.99       46.54       15.40       42.38  
2007
    31.34       63.33       26.05       54.96       21.55       47.71       17.55       39.21  
Subprime loans:
                                                               
2004 and prior
    22.09       71.47       21.09       65.56       20.71       63.27       21.51       61.00  
2005
    42.82       66.76       39.86       60.22       38.58       55.11       36.51       50.33  
2006
    47.82       68.18       44.60       62.30       40.19       55.97       36.13       50.36  
2007
    41.81       64.93       35.37       57.90       29.62       50.52       23.87       44.76  
 
 
(1) Delinquency data provided by Intex for Alt-A and subprime loans backing private-label securities that we own or guarantee. The Intex delinquency data reflects information from remittances for the last month each quarter. However, we have adjusted the Intex delinquency data for consistency purposes, where appropriate, to include in the delinquency rates all bankruptcies, foreclosures and real estate owned.
 
(2) Data obtained from First American CoreLogic, LoanPerformance and is based on most current data available as of each date. The average loss severities reported for March 31, 2009 include performance data for January 2009 and February 2009. We expect that the average loss severities as of March 31, 2009 will be higher than the amounts presented in Table 24 when the performance data for March 2009 is incorporated.
 
Other-Than-Temporary Impairment on Available-for-Sale Alt-A and Subprime Private-Label Securities
 
We recognized other-than-temporary impairment on our Alt-A and subprime private-label securities classified as available for sale totaling $5.5 billion in the first quarter of 2009, of which $2.9 billion related to Alt-A securities with an unpaid principal balance of $13.6 billion as of March 31, 2009, and $2.6 billion related to subprime securities with an unpaid principal balance of $9.7 billion as of March 31, 2009. Table 25 presents the cumulative other-than-temporary impairment losses recognized as of March 31, 2009 on our available-for-sale investments in Alt-A and subprime private-label securities.
 
Table 25:   Other-than-temporary Impairment Losses on Available-for-Sale Alt-A and Subprime Private-Label Mortgage-Related Securities
 
                                 
          For the Year Ended
    As of March 31,
 
    Q1     December 31,     2009  
    2009     2008     2007     Cumulative  
    (Dollars in millions)  
 
Other-than-temporary impairment on available-for-sale private-label mortgage-related securities backed by:
                               
Alt-A mortgage loans
  $ 2,928     $ 4,820     $     $ 7,748  
Subprime mortgage loans
    2,606       1,932       160       4,698  
                                 
Total
  $ 5,534     $ 6,752     $ 160     $ 12,446  
                                 


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The current market pricing of Alt-A and subprime securities has been adversely affected by the increasing level of defaults on the mortgages underlying these securities and the uncertainty as to the extent of further deterioration in the housing market. In addition, market participants are requiring a significant risk premium, which can be measured as a significant increase in the required yield on the investment, for taking on the increased uncertainty related to cash flows. Further, there continues to be less liquidity for these securities than was available prior to the onset of the housing and credit liquidity crises, which has also contributed to lower prices. For those securities that we have not impaired, we believe that the performance of the underlying collateral will still allow us to recover our initial investment, although at significantly lower yields than what is being required currently by new investors. We will accrete into interest income the portion of the amounts we expect to recover that exceeds the current carrying value of these securities over the remaining life of the securities. The amount accreted into earnings on our Alt-A and subprime securities for which we have recognized other-than-temporary impairment totaled $371 million and $24 million for the three months ended March 31, 2009 and 2008, respectively.
 
Hypothetical Performance Scenarios
 
Tables 26, 27 and 28 present additional information as of March 31, 2009 for our investments in Alt-A and subprime private-label mortgage-related securities, reported based on half-year vintages for securities we hold that were issued during the years 2005 to 2008. The securities within each reported half-year vintage are stratified by credit enhancement quartile. The 2006 and 2007 vintages of loans underlying these securities have experienced significantly higher delinquency rates than other vintages. Accordingly, the year of issuance or origination of the collateral underlying these securities is a significant factor in projecting expected cash flow performance and evaluating the ongoing credit performance. The credit enhancement quartiles presented range from the lowest level of credit enhancement to the highest. A higher level of credit enhancement generally reduces the exposure to loss.
 
We have disclosed for information purposes the net present value of projected losses (“NPV”) of our securities under four hypothetical scenarios, which assume specific cumulative constant default and loss severity rates against the loans underlying our Alt-A and subprime private-label securities. The projected loss results under these scenarios are calculated based on the projected cash flows from each security and include the following additional key assumptions: (i) discount rate, (ii) expected constant prepayment rates (“CPR”) and (iii) average life of the securities. These scenarios assume a discount rate based on the London Interbank Offered Rate (“LIBOR”) and constant default and loss severity rates experienced over a six-year period. We assume CPRs of 15% for our Alt-A securities and 10% to 15% for our subprime securities, which vary in each scenario based on the loan age. A CPR of 15% indicates that for each period, 15% of the remaining unpaid principal balance of the loans underlying the security will be paid off each year.
 
We also disclose the difference between the unpaid principal balance and the fair value for those securities that would be in a loss position under each hypothetical stress scenario. Assuming the actual default and loss severities associated with our Alt-A and subprime securities classified as available-for-sale approximate the default and severities presented in the hypothetical scenarios, we would expect that the other-than-temporary impairment that we may recognize on these securities would approximate the difference between the NPV of projected losses and the fair value.


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Table 26:   Hypothetical Performance Scenarios—Investments in Alt-A Private-Label Mortgage-Related Securities, Excluding Wraps*
 
                                                                                                 
    As of March 31, 2009  
    Unpaid Principal Balance                 Credit Enhancement Statistics     Hypothetical NPV Loss Scenarios(4)  
                                              Monoline
                         
          Available-
                                  Financial
                         
Vintage and
  Trading
    for-Sale
    Average
    Fair
    Average
          Minimum
    Guaranteed
    40d/60s
    50d/50s
    70d/60s
    70d/70s
 
CE Quartile(1)
  Securities     Securities     Price     Value     Current(2)     Original(2)     Current(2)     Amount(3)     NPV     NPV     NPV     NPV  
                                  (Dollars in millions)                                
 
Investments in Alt-A securities:(5)
                                                                                               
Option ARM Alt-A securities:
                                                                                               
2004 and prior
  $     $ 636     $ 38.02     $ 242       23 %     11 %     14 %   $     $ 21     $ 28     $ 147     $ 198  
                                                                                                 
2005-1(1)
          98       39.41       39       20       7       20             2       3       22       30  
2005-1(2)
          153       27.68       42       23       12       23             3       5       32       44  
2005-1(3)
          129       33.40       43       27       16       24             3       4       27       37  
2005-1(4)
          148       33.93       50       42       33       34                         21       33  
                                                                                                 
2005-1 subtotal
          528       33.01       174       29       18       20             8       12       102       144  
                                                                                                 
2005-2(1)
          228       35.60       81       33       28       31             2       5       45       63  
2005-2(2)
          228       42.46       97       35       32       35             6       8       47       66  
2005-2(3)
          344       39.78       137       48       42       44             1       1       44       69  
2005-2(4)
          316       37.79       119       100       100       100       316                          
                                                                                                 
2005-2 subtotal
          1,116       38.91       434       57       54       31       316       9       14       136       198  
                                                                                                 
2006-1(1)
          128       22.26       29       20       19       9             27       32       71       82  
2006-1(2)
          394       37.42       147       39       38       39             1       5       66       95  
2006-1(3)
          350       36.37       127       43       43       42                         47       72  
2006-1(4)
          401       26.19       105       88       88       47       308                   13       20  
                                                                                                 
2006-1 subtotal
          1,273       32.07       408       53       53       9       308       28       37       197       269  
                                                                                                 
2006-2(1)
                                                                       
2006-2(2)
          203       35.18       72       37       35       37                         32       47  
2006-2(3)
          92       38.37       35       40       40       40                         13       20  
2006-2(4)
          217       36.99       80       68       68       46       87                   17       26  
                                                                                                 
2006-2 subtotal
          512       36.52       187       51       50       37       87                   62       93  
                                                                                                 
2007-1(1)
    198             34.67       69       25       24       25             2       7       50       66  
2007-1(2)
    356             37.02       132       46       45       45                         44       69  
2007-1(3)
    254             36.64       93       48       47       48                         37       56  
2007-1(4)
    507             23.63       120       100       100       100       507                          
                                                                                                 
2007-1 subtotal
    1,315             31.43       414       64       64       25       507       2       7       131       191  
                                                                                                 
2007-2(1)
    286             31.21       89       33       32       25             3       8       62       84  
2007-2(2)
    210             42.00       88       47       47       47                         32       49  
2007-2(3)
    300             38.72       116       48       47       48                         44       68  
2007-2(4)
    408             20.31       83       100       100       100       408                          
                                                                                                 
2007-2 subtotal
    1,204             31.27       376       62       62       25       408       3       8       138       201  
                                                                                                 
Total option ARM Alt-A securities
  $ 2,519     $ 4,065     $ 33.95     $ 2,235       53 %     50 %     9 %   $ 1,626     $ 71     $ 106     $ 913     $ 1,294  
                                                                                                 
Trading securities with hypothetical NPV losses:(7)
                                                                                               
Fair value
                                                                  $ 247     $ 247     $ 587     $ 587  
UPB
                                                                    731       731       1,604       1,604  
                                                                                                 
Difference
                                                                  $ (484 )   $ (484 )   $ (1,017 )   $ (1,017 )
                                                                                                 
Available-for-sale securities with hypothetical NPV losses:(7)
                                                                                               
Fair value
                                                                  $ 664     $ 728     $ 1,232     $ 1,232  
UPB
                                                                    1,879       2,023       3,354       3,354  
                                                                                                 
Difference
                                                                  $ (1,215 )   $ (1,295 )   $ (2,122 )   $ (2,122 )
                                                                                                 
 


52


Table of Contents

                                                                                                 
    As of March 31, 2009  
    Unpaid Principal Balance                 Credit Enhancement Statistics     Hypothetical NPV Loss Scenarios(4)  
                                              Monoline
                         
          Available-
                                  Financial
                         
Vintage and
  Trading
    for-Sale
    Average
    Fair
    Average
          Minimum
    Guaranteed
    30d/60s
    30d/70s
    40d/60s
    40d/70s
 
CE Quartile(1)
  Securities     Securities     Price     Value     Current(2)     Original(2)     Current(2)     Amount(3)     NPV     NPV     NPV     NPV  
    (Dollars in millions)  
 
Investments in Alt-A securities:(5)
                                                                                               
Other Alt-A securities:
                                                                                               
2004 and prior
  $     $ 8,352     $ 76.21     $ 6,365       12 %     6 %     5 %   $ 24     $ 633     $ 865     $ 1,115     $ 1,452  
                                                                                                 
2005-1(1)
          352       65.84       232       9       5       6             30       41       52       67  
2005-1(2)
          354       65.58       232       13       7       12             19       31       44       61  
2005-1(3)
          423       64.42       273       14       10       13             22