10-Q 1 fanniemaeq30930201210q.htm 10-Q FannieMae Q3.09.30.2012 10Q

 

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 September 30, 2012
OR
¨
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
52-0883107
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
3900 Wisconsin Avenue, NW
Washington, DC
20016
(Zip Code)
(Address of principal executive offices)
 
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 ¨
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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No ¨
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.
Large accelerated filer ¨
Accelerated filer  þ
Non-accelerated filer  ¨
(Do not check if a smaller reporting company)
Smaller reporting company  ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No þ
As of September 30, 2012, there were 1,158,077,970 shares of common stock of the registrant outstanding.
 



TABLE OF CONTENTS


 
 
Page
PART I—Financial Information
1
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
 
 
 
 
 
 
 
 
 
 
Item 3.
Item 4.
PART II—Other Information
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.


i


MD&A TABLE REFERENCE
Table
Description
Page
1
Treasury Draws and Senior Preferred Stock Dividend Payments
4
2
Selected Credit Characteristics of Single-Family Conventional Loans Held, by Acquisition Period
6
3
Credit Statistics, Single-Family Guaranty Book of Business
8
4
Level 3 Recurring Financial Assets at Fair Value
18
5
Summary of Condensed Consolidated Results of Operations
19
6
Analysis of Net Interest Income and Yield
20
7
Rate/Volume Analysis of Changes in Net Interest Income
22
8
Impact of Nonaccrual Loans on Net Interest Income
23
9
Fair Value Losses, Net
24
10
Total Loss Reserves
25
11
Allowance for Loan Losses and Reserve for Guaranty Losses (Combined Loss Reserves)
26
12
Nonperforming Single-Family and Multifamily Loans
29
13
Credit Loss Performance Metrics
31
14
Single-Family Credit Loss Sensitivity
32
15
Single-Family Business Results
33
16
Multifamily Business Results
35
17
Capital Markets Group Results
37
18
Capital Markets Group’s Mortgage Portfolio Activity
39
19
Capital Markets Group’s Mortgage Portfolio Composition
40
20
Summary of Condensed Consolidated Balance Sheets
41
21
Summary of Mortgage-Related Securities at Fair Value
42
22
Analysis of Losses on Alt-A and Subprime Private-Label Mortgage-Related Securities
43
23
Credit Statistics of Loans Underlying Alt-A and Subprime Private-Label Mortgage-Related Securities (Including Wraps)
44
24
Comparative Measures—GAAP Change in Stockholders’ Equity (Deficit) and Non-GAAP Change in Fair Value of Net Assets (Net of Tax Effect)
45
25
Supplemental Non-GAAP Consolidated Fair Value Balance Sheets
47
26
Activity in Debt of Fannie Mae
50
27
Outstanding Short-Term Borrowings and Long-Term Debt
52
28
Maturity Profile of Outstanding Debt of Fannie Mae Maturing Within One Year
53
29
Maturity Profile of Outstanding Debt of Fannie Mae Maturing in More Than One Year
54
30
Cash and Other Investments Portfolio
54
31
Fannie Mae Credit Ratings
55
32
Composition of Mortgage Credit Book of Business
58
33
Risk Characteristics of Single-Family Conventional Business Volume and Guaranty Book of Business
60
34
Selected Credit Characteristics of Single-Family Conventional Loans Acquired under HARP and Refi Plus
63
35
Delinquency Status of Single-Family Conventional Loans
65
36
Single-Family Serious Delinquency Rates
66
37
Single-Family Conventional Serious Delinquency Rate Concentration Analysis
67
38
Statistics on Single-Family Loan Workouts
68
39
Percentage of Loan Modifications That Were Current or Paid Off at One and Two Years Post-Modification
69

ii


Table
Description
Page
40
Single-Family Foreclosed Properties
69
41
Single-Family Foreclosed Property Status
70
42
Multifamily Lender Risk-Sharing
71
43
Multifamily Guaranty Book of Business Key Risk Characteristics
72
44
Multifamily Concentration Analysis
72
45
Multifamily Foreclosed Properties
73
46
Repurchase Request Activity
75
47
Outstanding Repurchase Requests
76
48
Mortgage Insurance Coverage
77
49
Rescission Rates of Mortgage Insurance
79
50
Estimated Mortgage Insurance Benefit
79
51
Unpaid Principal Balance of Financial Guarantees
80
52
Interest Rate Sensitivity of Net Portfolio to Changes in Interest Rate Level and Slope of Yield Curve
83
53
Derivative Impact on Interest Rate Risk (50 Basis Points)
84



iii



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. Our directors do not have fiduciary duties to any person or entity except to the conservator and, accordingly, are not obligated to consider the interests of the company, the holders of our equity or debt securities or the holders of Fannie Mae MBS unless specifically directed to do so by the conservator. We describe the rights and powers of the conservator, key provisions of our agreements with the U.S. Department of the Treasury (“Treasury”), and their impact on shareholders in our Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Form 10-K”) in “Business—Conservatorship and Treasury Agreements” and in this report in “Executive Summary—Amendment to Senior Preferred Stock Purchase Agreement with Treasury.”
You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in conjunction with our unaudited condensed consolidated financial statements and related notes and the more detailed information in our 2011 Form 10-K.
This report contains forward-looking statements that are based on management’s current expectations and are subject to significant uncertainties and changes in circumstances. Please review “Forward-Looking Statements” for more information on the forward-looking statements in this report. Our actual results may differ materially from those reflected in these forward-looking statements due to a variety of factors including, but not limited to, those described in “Risk Factors” and elsewhere in this report and in “Risk Factors” in our 2011 Form 10-K.
You can find a “Glossary of Terms Used in This Report” in the “MD&A” of our 2011 Form 10-K.
INTRODUCTION
Fannie Mae is a government-sponsored enterprise (“GSE”) that was chartered by Congress in 1938. Our public mission is to support liquidity and stability in the secondary mortgage market, where existing mortgage-related assets are purchased and sold, and increase the supply of affordable housing. Our charter does not permit us to originate loans and lend money directly to consumers in the primary mortgage market. Our most significant activity is securitizing mortgage loans originated by lenders into Fannie Mae mortgage-backed securities that we guarantee, which we refer to as Fannie Mae MBS. We also purchase mortgage loans and mortgage-related securities for our mortgage portfolio. We use the term “acquire” in this report to refer to both our guarantees and our purchases of mortgage loans. We obtain funds to support our business activities by issuing a variety of debt securities in the domestic and international capital markets.
We are a corporation chartered by the U.S. Congress. Our conservator, FHFA, is a U.S. government agency. Treasury owns our senior preferred stock and a warrant to purchase 79.9% of our common stock. Moreover, Treasury has made a commitment under a senior preferred stock purchase agreement to provide us with funds under specified conditions and, after 2012, up to a maximum amount, to maintain a positive net worth. The U.S. government does not guarantee our securities or other obligations.
Our common stock is traded in the over-the-counter market and quoted on the OTC Bulletin Board under the symbol “FNMA.” Our debt securities are actively traded in the over-the-counter market.
EXECUTIVE SUMMARY
The actions we have been taking since 2009 to provide liquidity and support to the market, grow a strong new book of business and minimize losses on loans we acquired prior to 2009 are having a positive impact on our business and our performance:

1



Financial Results. We experienced significant improvement in our financial results for the third quarter and first nine months of 2012, as compared with the third quarter and first nine months of 2011, despite elevated levels of mortgage delinquencies and foreclosures compared with pre-housing crisis levels, as well as home prices that are significantly below their peak in 2006. As described below under “Summary of Our Financial Performance for the Third Quarter and First Nine Months of 2012,” we had a positive net worth for the third quarter, paid Treasury its quarterly dividend and were not required to draw funds from Treasury for the quarter under the senior preferred stock purchase agreement. We expect to report net income for 2012, which would be the first time we have reported annual net income since 2006.
Strong New Book of Business. Single-family loans we have acquired since the beginning of 2009 constituted 63% of our single-family guaranty book of business as of September 30, 2012, while the single-family loans we acquired prior to 2009 constituted 37% of our single-family book of business. We refer to the single-family loans we have acquired since the beginning of 2009 as our “new single-family book of business” and the single-family loans we acquired prior to 2009 as our “legacy book of business.” Our new single-family book of business includes loans that are refinancings of loans that were in our legacy book of business. We provide information regarding the higher loan-to-value (“LTV”) ratios of these loans in “Our Strong New Book of Business—Credit Risk Characteristics of Loans Acquired under Refi Plus and HARP.” As described below in “Our Strong New Book of Business,” we expect that our new single-family book of business will be profitable over its lifetime.
Credit Performance. Our single-family serious delinquency rate has declined each quarter since the first quarter of 2010, and was 3.41% as of September 30, 2012, compared with 4.00% as of September 30, 2011. See “Credit Performance” below for additional information about the credit performance of the mortgage loans in our single-family guaranty book of business.
Reducing Credit Losses and Helping Homeowners. We continued to execute on our strategies for reducing credit losses on our legacy book of business, which are described below under “Reducing Credit Losses on Our Legacy Book of Business.” As part of our strategy to reduce defaults, we provided approximately 69,200 workouts to help homeowners stay in their homes or otherwise avoid foreclosure in the third quarter of 2012.
Providing Liquidity and Support to the Mortgage Market. We continued to be a leading provider of liquidity to the mortgage market in the third quarter of 2012. As described below under “Providing Liquidity and Support to the Mortgage Market,” we remained the largest single issuer of mortgage-related securities in the secondary mortgage market in the third quarter of 2012 and remained a constant source of liquidity in the multifamily market.
Helping to Build a New Housing Finance System. We also continued our work during the third quarter of 2012 to help build a new housing finance system, including pursuing the three strategic goals identified by our conservator for the next phase of our conservatorship: build a new infrastructure for the secondary mortgage market; gradually contract our dominant presence in the marketplace while simplifying and shrinking our operations; and maintain foreclosure prevention activities and credit availability for new and refinanced mortgages. In March 2012, FHFA directed us to implement a set of corporate performance objectives and related targets and measures for 2012, referred to as the 2012 conservatorship scorecard, which provides the implementation roadmap for FHFA’s strategic plan. For more information on our strategic goals, see “Business—Executive Summary—Our Business Objectives and Strategy” in our 2011 Form 10-K. For a description of the objectives and targets included in FHFA’s 2012 conservatorship scorecard, see “Executive Compensation—Compensation Discussion and Analysis—2012 Executive Compensation Program—2012 Corporate Performance Objectives” in Amendment No. 1 on Form 10-K/A to our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K/A”).
Summary of Our Financial Performance for the Third Quarter and First Nine Months of 2012
We experienced significant improvement in our financial results for the third quarter and first nine months of 2012 compared with the third quarter and first nine months of 2011. Over the past nine months, home prices have increased and we have experienced further improvement in the performance of our book of business, such as lower serious delinquency rates. As a result, our loan loss reserves and our provision for credit losses have decreased for the third quarter and first nine months of 2012.

2



Comprehensive Income (Loss)
Quarterly Results
We recognized comprehensive income of $2.6 billion in the third quarter of 2012, consisting of net income of $1.8 billion and other comprehensive income of $746 million. In comparison, we recognized a comprehensive loss of $5.3 billion in the third quarter of 2011, consisting of a net loss of $5.1 billion and other comprehensive loss of $197 million.
The significant improvement in our financial results for the third quarter of 2012 compared with the third quarter of 2011 was primarily due to a $2.1 billion decrease in our provision for credit losses and a $3.5 billion decrease in fair value losses. Our provision for credit losses declined from $4.2 billion in the third quarter of 2011 to $2.1 billion in the third quarter of 2012 primarily due to a decrease in our total loss reserves. This decrease was driven by an improvement in the profile of our single-family book of business resulting primarily from an increase in actual and expected home prices, including the sales prices of our real-estate owned (“REO”) properties throughout 2012. Home prices increased by 1.5% in the third quarter of 2012 compared with a 0.9% decline in the third quarter of 2011 and increased by 4.8% in the first nine months of 2012 compared with a 1.7% decrease in the first nine months of 2011. Higher home prices decrease the likelihood that loans will default and reduce the amount of credit loss on loans that do default. In addition, sales prices on dispositions of our REO properties improved in the third quarter of 2012 as a result of strong demand compared to both the second quarter of 2012 and the prior year. We received net proceeds from our REO sales equal to 61% of the loans’ unpaid principal balance in the third quarter of 2012, compared with 59% in the second quarter of 2012 and 54% in the third quarter of 2011. The increase in sales proceeds reduces the amount of credit loss at foreclosure and, accordingly, results in a lower provision for credit loss.
The positive impact of higher home prices and higher REO sales values on our provision for credit losses in the third quarter of 2012 was partially offset by a $3.5 billion increase in our provision for credit losses due to changes in our assumptions and data used in calculating our loss reserves. For additional information on the impact from changes in our assumptions used in calculating our loss reserves in the third quarter of 2012, see “Critical Accounting Policies and Estimates—Total Loss Reserves.”
In addition, our provision for credit losses in the third quarter of 2012 was negatively impacted by a change in our accounting for loans to certain borrowers who have received bankruptcy relief. This change led to an increase in the number of loans we classify as troubled debt restructurings (“TDRs”), resulting in an increase in our provision for credit losses of approximately $1.1 billion in the third quarter of 2012. For additional information on this accounting change, see “Consolidated Results of Operations—Credit-Related Expenses—Provision for Credit Losses.”
As discussed below in “Our Expectations Regarding Future Loss Reserves and Credit-Related Expenses,” due to the large size of our guaranty book of business, even small changes in home prices, economic conditions and other variables can result in significant volatility in the amount of credit-related expenses we recognize from period to period.
Fair value losses declined from $4.5 billion in the third quarter of 2011 to $1.0 billion in the third quarter of 2012. The decrease in fair value losses was primarily due to lower risk management derivative losses as swap rates declined significantly in the third quarter of 2011 compared with a more modest decline in swap rates in the third quarter of 2012. Derivative instruments are an integral part of how we manage interest rate risk and an inherent part of the cost of funding and hedging our mortgage investments. We expect high levels of period-to-period volatility in our results because our derivatives are recorded at fair value in our financial statements while some of the instruments they hedge are not recorded at fair value in our financial statements.
In addition, we recognized other comprehensive income of $746 million in the third quarter of 2012 compared with other comprehensive loss of $197 million in the third quarter of 2011. The other comprehensive income recognized in the third quarter of 2012 was driven by a decrease in unrealized losses on non-agency available-for-sale securities primarily due to narrowing of credit spreads.
Year-to-Date Results
Our comprehensive income for the first nine months of 2012 was $11.1 billion, consisting of net income of $9.7 billion and other comprehensive income of $1.4 billion. In comparison, we recognized a comprehensive loss of $14.5 billion in the first nine months of 2011, primarily related to our net loss of $14.4 billion.
The significant improvement in our financial results in the first nine months of 2012 compared with the first nine months of 2011 was primarily due to a $20.2 billion decrease in our provision for credit losses and a $2.7 billion decline in our fair value losses. Our provision for credit losses declined from $21.2 billion in the first nine months of 2011 to $1.0 billion in the first nine months of 2012 primarily due to an increase in actual and expected home prices in 2012. Fair value losses declined from $5.9 billion in the first nine months of 2011 to $3.2 billion in the first nine months of 2012 due to lower losses on our risk management derivatives.

3



See “Consolidated Results of Operations” for more information on our results.
Net Worth
Our net worth of $2.4 billion as of September 30, 2012 reflects our comprehensive income of $11.1 billion offset by our payment to Treasury of $8.7 billion in senior preferred stock dividends during the first nine months of 2012.
As a result of our positive net worth as of September 30, 2012, we are not requesting a draw from Treasury under the senior preferred stock purchase agreement. The aggregate liquidation preference on the senior preferred stock remains at $117.1 billion, which requires a dividend payment of $2.9 billion for the fourth quarter of 2012. As of September 30, 2012, we have paid an aggregate of $28.5 billion to Treasury in dividends on the senior preferred stock. As described in “Amendment to Senior Preferred Stock Purchase Agreement with Treasury” below, our dividend obligations to Treasury will change beginning in 2013.
Table 1 below displays our Treasury draws and senior preferred stock dividend payments to Treasury since entering conservatorship on September 6, 2008.
Table 1: Treasury Draws and Senior Preferred Stock Dividend Payments
 
2008
 
2009
 
2010
 
2011
 
2012
(first nine months)
 
Cumulative Total
 
 
(Dollars in billions)
 
Treasury draws(1)(2)
 
$
15.2

 
 
 
$
60.0

 
 
 
$
15.0

 
 
 
$
25.9

 
 
 
$

 
 
 
$
116.1

 
Senior preferred stock dividends(3)
 

 
 
 
2.5

 
 
 
7.7

 
 
 
9.6

 
 
 
8.7

 
 
 
28.5

 
Treasury draws less senior preferred stock dividends
 
$
15.2

 
 
 
$
57.5

 
 
 
$
7.3

 
 
 
$
16.3

 
 
 
$
(8.7
)
 
 
 
$
87.6

 
Cumulative percentage of senior preferred stock dividends to Treasury draws 
 
0.2

%
 
 
3.3

%
 
 
11.3

%
 
 
17.1

%
 
 
24.5

%
 
 
24.5

%
__________
(1) 
Represents the total draws received from Treasury based on our quarterly net worth deficits for the periods presented. Draw requests are funded in the quarter following each quarterly net worth deficit.
(2) 
Treasury draws do not include the initial $1.0 billion liquidation preference of the senior preferred stock, for which we did not receive any cash proceeds.
(3) 
Represents total quarterly cash dividends paid to Treasury during the periods presented based on an annual rate of 10% per year on the aggregate liquidation preference of the senior preferred stock.
Total Loss Reserves
Our total loss reserves consist of (1) our allowance for loan losses, (2) our allowance for accrued interest receivable, (3) our allowance for preforeclosure property taxes and insurance receivables, and (4) our reserve for guaranty losses. Our total loss reserves, which reflect our estimate of the probable losses we have incurred in our guaranty book of business, including concessions we granted borrowers upon modification of their loans, decreased to $66.9 billion as of September 30, 2012 from $68.0 billion as of June 30, 2012 and $76.9 billion as of December 31, 2011. Our total loss reserve coverage to total nonperforming loans was 26% as of September 30, 2012, compared with 28% as of June 30, 2012 and 31% as of December 31, 2011.
Our Expectations Regarding Future Loss Reserves and Credit-Related Expenses
We expect the trends of stabilizing home prices and declining single-family serious delinquency rates to continue, although we expect serious delinquency rates to decline at a slower pace than in recent periods. As a result of these trends, we believe that our total loss reserves peaked as of December 31, 2011 and will not increase above $76.9 billion in the foreseeable future. Accordingly, we expect that our credit-related expenses will be significantly lower in 2012 than in 2011.
Although we expect these positive trends to continue, the amount of credit-related expenses we recognize in future periods could vary significantly from period to period and may be affected by many different factors, such as those described below. Moreover, although we believe that our total loss reserves peaked as of December 31, 2011, we expect our loss reserves will remain significantly elevated relative to historical levels for an extended period because (1) we expect future defaults on loans that we acquired prior to 2009 and the resulting charge-offs will occur over a period of years and (2) a significant portion of our reserves represents concessions granted to borrowers upon modification of their loans and will remain in our reserves until the loans are fully repaid or default.

4



Our expectations regarding our future credit-related expenses and loss reserves are based on our current expectations and assumptions about many factors that are subject to change. Factors that could result in higher credit-related expenses and loss reserves than we currently expect include: a drop in actual or expected home prices; an increase in our serious delinquency rate; an increase in interest rates; an increase in unemployment rates; future legislative or regulatory requirements that have a significant impact on our business, such as a requirement that we implement a principal forgiveness program; future updates to our models relating to our loss reserves, including the assumptions used by these models; future changes to accounting policies relating to our loss reserves; significant changes in modification and foreclosure activity; changes in borrower behavior, such as an increasing number of underwater borrowers who strategically default on their mortgage loan; failures by our mortgage seller/servicers to fulfill their repurchase obligations in full; failures by our mortgage insurers to fulfill their obligations in full; natural or other disasters; and many other factors, including those discussed in “Outlook—Factors that Could Cause Actual Results to be Materially Different from Our Estimates and Expectations” in this report and in “Risk Factors” in both this report and in our 2011 Form 10-K. Due to the large size of our guaranty book of business, even small changes in these factors could have a significant impact on our financial results for a particular period.
We are currently assessing the financial impact on us from Hurricane Sandy. Our exposure to losses as a result of Hurricane Sandy arises primarily from our guaranty of principal and interest payments due to holders of Fannie Mae MBS secured by property in the affected areas, our portfolio holdings of mortgages and mortgage-related securities secured by property in the affected areas, and real estate that we own in the affected areas.
In addition, in April 2012, FHFA issued an Advisory Bulletin that could have an impact on the amount of our future credit-related expenses and loss reserves; however, we are still assessing the impact of the Advisory Bulletin. See “Legislative and Regulatory Developments—FHFA Advisory Bulletin Regarding Framework for Adversely Classifying Loans” in our quarterly report on Form 10-Q for the quarter ended June 30, 2012 (“Second Quarter 2012 Form 10-Q”) for additional information.
Our Strong New Book of Business
Credit Risk Profile of Loans in our New Book of Business Compared with our Legacy Book of Business
Since 2009, we have seen the effect of actions we took, beginning in 2008, to significantly strengthen our underwriting and eligibility standards and change our pricing to promote sustainable homeownership and stability in the housing market. While it is too early to know how the single-family loans we have acquired since January 1, 2009 will ultimately perform, given their strong credit risk profile and based on their performance so far, we expect that these loans, in the aggregate, will be profitable over their lifetime, by which we mean that we expect our fee income on these loans to exceed our credit losses and administrative costs for them. In contrast, we expect that the single-family loans we acquired from 2005 through 2008, in the aggregate, will not be profitable over their lifetime. Loans we have acquired since the beginning of 2009 constituted 63% of our single-family guaranty book of business as of September 30, 2012. Our 2005 through 2008 acquisitions, which are becoming a smaller percentage of our single-family guaranty book of business, constituted only 24% of our single-family guaranty book of business as of September 30, 2012.
The 63% of our single-family guaranty book of business that represents our new single-family book of business includes loans that are refinancings of existing Fannie Mae loans under our Refi PlusTM initiative. Refi Plus loans constituted 15% of our single-family guaranty book of business as of September 30, 2012. Refi Plus loans include loans that are refinancings under the Administration’s Home Affordable Refinance Program (“HARP”). Because HARP and Refi Plus are designed to expand refinancing opportunities for borrowers who may otherwise be unable to refinance their mortgage loans due to a decline in home values, many of the loans we acquire under HARP and some of the loans we acquire under Refi Plus have higher LTV ratios than we would otherwise permit, greater than 100% in some cases. The volume of loans with high LTV ratios that we acquired under Refi Plus and HARP increased in the third quarter of 2012. As a result, loans with LTV ratios greater than 100% constituted 11% of our acquisitions in the third quarter of 2012, compared with 3% in the third quarter of 2011, and the weighted average LTV ratio at origination of loans we acquired in the third quarter of 2012 increased to 77% from 71% in the third quarter of 2011.
Our expectations regarding the ultimate performance of our loans are based on numerous expectations and assumptions, including those relating to expected changes in regional and national home prices, borrower behavior, public policy and other macroeconomic factors. If future conditions are more unfavorable than our expectations, the loans we acquired since the beginning of 2009 could become unprofitable. For example, home prices are a key factor affecting the profitability we expect. When home prices decline, the LTV ratios on our loans increase, and both the probability of default and the estimated severity of loss increase. If home prices decline significantly from September 2012 levels, the loans we acquired since the beginning of 2009 could become unprofitable. See “Outlook—Home Prices” for our current expectations regarding changes in home prices. Also see “Outlook—Factors that Could Cause Actual Results to be Materially Different from Our Estimates

5



and Expectations” in this report and “Risk Factors” in both this report and our 2011 Form 10-K for a discussion of factors that could cause our expectations regarding the performance of the loans in our new single-family book of business to change.
Table 2 below displays information regarding the credit characteristics of the loans in our single-family conventional guaranty book of business as of September 30, 2012 by acquisition period, which illustrates the improvement in the credit risk profile of loans we acquired beginning in 2009 compared with loans we acquired in 2005 through 2008.
Table 2: Selected Credit Characteristics of Single-Family Conventional Loans Held, by Acquisition Period
 
As of September 30, 2012 
 
 
% of  
 
  
 
 
 
 
 
 
 
 
Single-Family 
 
Current 
 
Current 
 
 
 
 
Conventional 
 
Estimated 
 
Mark-to-Market 
 
Serious  
 
Guaranty Book  
 
Mark-to-Market 
 
LTV Ratio 
 
Delinquency 
 
of Business(1)
 
LTV Ratio(1)
 
>100%(1)(2)
 
Rate(3)
Year of Acquisition:
 
 
 
 
 
 
 
 
 
 
 
New Single-Family Book of Business:
 
 
 
 
 
 
 
 
 
 
 
2012
21
%
 
73
%
 
8
%
 
0.02
%
2011
16
 
 
67
 
 
3
 
 
0.19
 
2010
14
 
 
69
 
 
4
 
 
0.49
 
2009
12
 
 
70
 
 
5
 
 
0.85
 
Total New Single-Family Book of Business
63
 
 
70
 
 
5
 
 
0.34
 
Legacy Book of Business:
 
 
 
 
 
 
 
 
 
 
 
2005-2008
24
 
 
99
 
 
42
 
 
9.62
 
2004 and prior
13
 
 
58
 
 
7
 
 
3.49
 
Total Single-Family Book of Business
100
%
 
76
%
 
14
%
 
3.41
%
__________
(1) 
Calculated based on the aggregate unpaid principal balance of single-family loans for each category divided by the aggregate unpaid principal balance of loans in our single-family conventional guaranty book of business as of September 30, 2012.
(2) 
The majority of loans in our new single-family book of business as of September 30, 2012 with mark-to-market LTV ratios over 100% were loans acquired under our Refi Plus initiative. See “Credit Risk Characteristics of Loans Acquired under Refi Plus and HARP” for more information on our recent acquisitions of loans with high LTV ratios.
(3) 
Some of the loans acquired in 2012 were originated so recently that they could not yet have become seriously delinquent. The serious delinquency rates for loans acquired in more recent years will be higher after the loans have aged, but we do not expect them to approach the levels of the September 30, 2012 serious delinquency rates of loans in our legacy book of business.
The single-family loans that we acquired in the first nine months of 2012 had a weighted average FICO® credit score at origination of 761 and an average original LTV ratio of 74%. Of the single-family loans we acquired in the first nine months of 2012, approximately 16% had an original LTV ratio greater than 90%, and approximately 1% had a FICO credit score at origination of less than 620. The average original LTV ratio of single-family loans we acquired in the first nine months of 2012, excluding HARP loans, was 69%, compared with 109% for HARP loans. See Table 2 in our 2011 Form 10-K for information regarding the credit risk profile of the single-family conventional loans we acquired during specified previous periods.
Credit Risk Characteristics of Loans Acquired under Refi Plus and HARP
Since 2009, our acquisitions have included a significant number of loans refinanced under HARP. We acquire HARP loans under Refi Plus, which provides expanded refinance opportunities for eligible Fannie Mae borrowers. HARP loans have LTV ratios at origination in excess of 80% and must be secured by the borrower’s primary residence. In addition, a HARP loan cannot (1) be an adjustable-rate mortgage loan, or ARM, if the initial fixed period is less than five years; (2) have an interest-only feature, which permits the payment of interest without a payment of principal; (3) be a balloon mortgage loan; or (4) have the potential for negative amortization. Under Refi Plus, we also acquire loans with LTV ratios at origination greater than 80% that do not meet the criteria for HARP because they are not secured by the borrower’s primary residence, as well as loans that have LTV ratios at origination of less than 80%. Many of the loans we acquire under HARP and some of the loans we acquire under Refi Plus have higher LTV ratios than we would otherwise permit. Some borrowers for these loans also have lower FICO credit scores than we would otherwise require.

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Loans we acquire under Refi Plus and HARP represent refinancings of loans that are already in our guaranty book of business. The credit risk associated with loans we acquire under Refi Plus and HARP essentially replaces the credit risk that we already held prior to the refinancing. Loans we acquire under Refi Plus and HARP have higher serious delinquency rates and may not perform as well as the other loans we have acquired since the beginning of 2009. However, we expect these loans will perform better than the loans they replace because Refi Plus and HARP loans should reduce the borrowers’ monthly payments and/or provide more stable terms than the borrowers’ old loans (for example, by refinancing into a mortgage with a fixed interest rate instead of an adjustable rate).
Loans we acquired under Refi Plus represented 24% of our new single-family book of business as of September 30, 2012 and had a serious delinquency rate of 0.60%, compared with a serious delinquency rate for our new single-family book of business overall of 0.34%. HARP loans, which are a subset of Refi Plus loans, represented 11% of our new single-family book of business as of September 30, 2012 and had a serious delinquency rate of 0.98%. See “Table 34: Selected Credit Characteristics of Single-Family Conventional Loans Acquired under HARP and Refi Plus” for more information on the serious delinquency rates and mark-to-market LTV ratios as of September 30, 2012 and the FICO credit scores at origination of loans in our new single-family book of business overall and of loans we acquired under Refi Plus and HARP.
The changes we implemented in the first half of 2012 to make the benefits of HARP available to more borrowers, combined with historically low interest rates in the third quarter, resulted in an increase in the volume of loans we acquired under HARP and Refi Plus in the third quarter of 2012, as compared with the first and second quarters of 2012. The approximately 164,000 loans we acquired under HARP in the third quarter of 2012 constituted 15% of our single-family acquisitions for the period, measured by unpaid principal balance, compared with 15% of single-family acquisitions in the second quarter of 2012 and 10% of single-family acquisitions in the first quarter of 2012. These loans were included in the approximately 312,000 loans we acquired under Refi Plus in the third quarter of 2012, which constituted 25% of our single-family acquisitions for the period, measured by unpaid principal balance, compared with 27% of single-family acquisitions in the second quarter of 2012 and 22% of single-family acquisitions in the first quarter of 2012.
As a result of changes to HARP, we expect that if interest rates remain low we will continue to acquire a high volume of refinancings under HARP until there is no longer a large population of borrowers with loans that have high LTV ratios who would benefit from refinancing. In particular, we expect to acquire many refinancings with LTV ratios greater than 125%, because borrowers were unable to refinance loans with LTV ratios greater than 125% in large numbers until changes to HARP were fully implemented in the second quarter of 2012. HARP is scheduled to end in December 2013.
Factors that May Affect the Credit Risk Profile and Performance of Loans in our New Book of Business in the Future
Whether the loans we acquire in the future will exhibit an overall credit profile similar to our more recent acquisitions will depend on a number of factors, including our future pricing and eligibility standards and those of mortgage insurers and the Federal Housing Administration (“FHA”), the percentage of loan originations representing refinancings, our future objectives, government policy, market and competitive conditions, and the volume and characteristics of loans we acquire under Refi Plus and HARP.
See “Business—Executive Summary—Our Strong New Book of Business and Expected Losses on Our Legacy Book of Business—Building a Strong New Single-Family Book of Business” in our 2011 Form 10-K for a more detailed discussion of the changes in the credit profile of our single-family acquisitions. In addition, see “MD&A—Risk Management—Credit Risk Management—Single-Family Mortgage Credit Risk Management” for more detail regarding the credit risk characteristics of our single-family guaranty book of business.
Credit Performance
Table 3 presents information for each of the last seven quarters about the credit performance of mortgage loans in our single-family guaranty book of business and our workouts. The term “workouts” refers to home retention solutions and foreclosure alternatives. The workout information in Table 3 does not reflect repayment plans and forbearances that have been initiated but not completed, nor does it reflect trial modifications that have not become permanent.

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Table 3: Credit Statistics, Single-Family Guaranty Book of Business(1)
  
2012
 
 
2011
 
  
Q3
YTD
 
 
Q3
 
 
Q2
 
 
Q1
 
 
Full
Year
 
 
Q4
 
 
Q3
 
 
Q2
 
 
Q1
 
  
(Dollars in millions)
 
As of the end of each period: 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Serious delinquency rate(2)
3.41

%
 
3.41

%
 
3.53

%
 
3.67

%
 
3.91

%
 
3.91

%
 
4.00

%
 
4.08

%
 
4.27

%
Seriously delinquent loan count
599,430

 
 
599,430

 
 
622,052

 
 
650,918

 
 
690,911

 
 
690,911

 
 
708,847

 
 
729,772

 
 
767,161

 
Nonperforming loans(3)
$
250,678

 
 
$
250,678

 
 
$
240,472

 
 
$
243,981

 
 
$
248,379

 
 
$
248,379

 
 
$
248,134

 
 
$
245,848

 
 
$
248,444

 
Foreclosed property inventory:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Number of properties(4)
107,225

 
 
107,225

 
 
109,266

 
 
114,157

 
 
118,528

 
 
118,528

 
 
122,616

 
 
135,719

 
 
153,224

 
Carrying value
$
9,302

 
 
$
9,302

 
 
$
9,421

 
 
$
9,721

 
 
$
9,692

 
 
$
9,692

 
 
$
11,039

 
 
$
12,480

 
 
$
14,086

 
Combined loss reserves(5)
$
63,100

 
 
$
63,100

 
 
$
63,365

 
 
$
69,633

 
 
$
71,512

 
 
$
71,512

 
 
$
70,741

 
 
$
68,887

 
 
$
66,240

 
Total loss reserves(6)
$
65,685

 
 
$
65,685

 
 
$
66,694

 
 
$
73,119

 
 
$
75,264

 
 
$
75,264

 
 
$
73,973

 
 
$
73,116

 
 
$
70,466

 
During the period: 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Foreclosed property (number of properties): 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Acquisitions(4)
133,367

 
 
41,884

 
 
43,783

 
 
47,700

 
 
199,696

 
 
47,256

 
 
45,194

 
 
53,697

 
 
53,549

 
Dispositions
(144,670
)
 
 
(43,925
)
 
 
(48,674
)
 
 
(52,071
)
 
 
(243,657
)
 
 
(51,344
)
 
 
(58,297
)
 
 
(71,202
)
 
 
(62,814
)
 
Credit-related expenses (income)(7)
$
1,500

 
 
$
2,130

 
 
$
(3,015
)
 
 
$
2,385

 
 
$
27,218

 
 
$
5,397

 
 
$
4,782

 
 
$
5,933

 
 
$
11,106

 
Credit losses(8)
$
12,218

 
 
$
3,485

 
 
$
3,778

 
 
$
4,955

 
 
$
18,346

 
 
$
4,548

 
 
$
4,384

 
 
$
3,810

 
 
$
5,604

 
REO net sales prices to UPB(9)
59

%
 
61

%
 
59

%
 
56

%
 
54

%
 
55

%
 
54

%
 
54

%
 
53

%
Loan workout activity (number of loans): 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Home retention loan workouts(10)
142,697

 
 
45,936

 
 
41,226

 
 
55,535

 
 
248,658

 
 
60,453

 
 
68,227

 
 
59,019

 
 
60,959

 
Short sales and deeds-in-lieu of foreclosure
69,548

 
 
23,322

 
 
24,013

 
 
22,213

 
 
79,833

 
 
22,231

 
 
19,306

 
 
21,176

 
 
17,120

 
Total loan workouts
212,245

 
 
69,258

 
 
65,239

 
 
77,748

 
 
328,491

 
 
82,684

 
 
87,533

 
 
80,195

 
 
78,079

 
Loan workouts as a percentage of delinquent loans in our guaranty book of business(11)
25.72

%
 
25.18

%
 
24.14

%
 
28.85

%
 
27.05

%
 
27.24

%
 
28.39

%
 
25.71

%
 
25.01

%
__________
(1) 
Our single-family guaranty book of business consists of (a) single-family mortgage loans held in our mortgage portfolio, (b) single-family mortgage loans underlying Fannie Mae MBS, and (c) other credit enhancements that we provide on single-family mortgage assets, such as long-term standby commitments. It excludes non-Fannie Mae mortgage-related securities held in our mortgage portfolio for which we do not provide a guaranty.
(2) 
Calculated based on the number of single-family conventional loans that are 90 days or more past due and loans that have been referred to foreclosure but not yet foreclosed upon, divided by the number of loans in our single-family conventional guaranty book of business. We include all of the single-family conventional 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 nonperforming loans including troubled debt restructurings. A troubled debt restructuring is a restructuring of a mortgage loan in which a concession is granted to a borrower experiencing financial difficulty. We generally classify loans as nonperforming when the payment of principal or interest on the loan is 60 days or more past due. As of September 30, 2012, we classified $12.7 billion of loans on accrual status as TDRs where certain borrowers have received bankruptcy relief.
(4) 
Includes held for use properties, which are reported in our condensed consolidated balance sheets as a component of “Other assets” and acquisitions through deeds-in-lieu of foreclosure.

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(5) 
Consists of the allowance for loan losses for loans recognized in our condensed consolidated balance sheets and the reserve for guaranty losses related to both single-family loans backing Fannie Mae MBS that we do not consolidate in our condensed consolidated balance sheets and single-family loans that we have guaranteed under long-term standby commitments. For additional information on the change in our loss reserves see “Consolidated Results of Operations—Credit-Related Expenses—Provision for Credit Losses.”
(6) 
Consists of (a) the combined loss reserves, (b) allowance for accrued interest receivable, and (c) allowance for preforeclosure property taxes and insurance receivables.
(7) 
Consists of (a) the provision for credit losses and (b) foreclosed property (income) expense.
(8) 
Consists of (a) charge-offs, net of recoveries and (b) foreclosed property (income) expense, adjusted to exclude the impact of fair value losses resulting from credit-impaired loans acquired from MBS trusts.
(9) 
Calculated as the amount of sale proceeds received on disposition of REO properties during the respective quarterly period, excluding those subject to repurchase requests made to our seller/servicers divided by the aggregate UPB of the related loans at the time of foreclosure. Net sales price represents the contract sale price less selling costs for the property and other charges paid by the seller at closing.
(10) 
Consists of (a) modifications, which do not include trial modifications or repayment plans or forbearances that have been initiated but not completed and (b) repayment plans and forbearances completed. See “Table 38: Statistics on Single-Family Loan Workouts” in “Risk Management—Credit Risk Management—Single-Family Mortgage Credit Risk Management—Problem Loan Management—Loan Workout Metrics” for additional information on our various types of loan workouts.
(11) 
Calculated based on annualized problem loan workouts during the period as a percentage of delinquent loans in our single-family guaranty book of business as of the end of the period.
Our single-family serious delinquency rate has decreased each quarter since the first quarter of 2010. The decrease in our serious delinquency rate is primarily the result of home retention solutions, foreclosure alternatives and completed foreclosures, as well as our acquisition of loans with stronger credit profiles since the beginning of 2009.
Although our single-family serious delinquency rate has decreased significantly since the first quarter of 2010, our serious delinquency rate and the period of time that loans remain seriously delinquent has been negatively affected in recent periods by the increase in the average number of days it is taking to complete a foreclosure. As described in “Business—Executive Summary—Reducing Credit Losses on Our Legacy Book of Business—Managing Timelines for Workouts and Foreclosures” in our 2011 Form 10-K, high levels of foreclosures, continuing issues in the servicer foreclosure process and changing legislative, regulatory and judicial requirements have lengthened the time it takes to foreclose on a mortgage loan in many states. We expect serious delinquency rates will continue to be affected in the future by home price changes, changes in other macroeconomic conditions, the length of the foreclosure process and the volume of loan modifications. We expect the number of our single-family loans that are seriously delinquent to remain well above pre-2008 levels for years. In addition, we anticipate that it will take a significant amount of time before our REO inventory is reduced to pre-2008 levels.
We provide additional information on our credit-related expenses in “Consolidated Results of Operations—Credit-Related Expenses” and on the credit performance of mortgage loans in our single-family book of business and our loan workouts in “Risk Management—Credit Risk Management—Single-Family Mortgage Credit Risk Management.”
Reducing Credit Losses on Our Legacy Book of Business
To reduce the credit losses we ultimately incur on our legacy book of business, we have been focusing our efforts on the following strategies:
Helping underwater and other eligible Fannie Mae borrowers with high LTV ratio loans refinance to more sustainable loans, including loans that significantly reduce their monthly payments, through HARP and our Refi Plus initiative;
Reducing defaults by offering borrowers solutions that can significantly reduce their monthly payments and enable them to stay in their homes (“home retention solutions”);
Pursuing “foreclosure alternatives,” which help borrowers avoid foreclosure and reduce the severity of the losses we incur overall;
Efficiently managing timelines for home retention solutions, foreclosure alternatives and foreclosures;
Improving servicing standards and servicers’ execution and consistency;
Managing our REO inventory to minimize costs and maximize sales proceeds; and
Pursuing contractual remedies from lenders, servicers and providers of credit enhancement.

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See “Business—Executive Summary—Reducing Credit Losses on our Legacy Book of Business” in our 2011 Form 10-K, as well as “Risk Management—Credit Risk Management—Single-Family Mortgage Credit Risk Management” in both this report and our 2011 Form 10-K, for more information on the strategies and actions we are taking to minimize our credit losses.
Providing Liquidity and Support to the Mortgage Market
Our Liquidity and Support Activities
We provide liquidity and support to the U.S. mortgage market in a number of important ways:
We serve as a stable source of liquidity for purchases of homes and financing of multifamily rental housing, as well as for refinancing existing mortgages. We provided approximately $3.0 trillion in liquidity to the mortgage market from January 1, 2009 through September 30, 2012 through our purchases and guarantees of loans, which enabled borrowers to complete 8.9 million mortgage refinancings and 2.5 million home purchases, and provided financing for 1.5 million units of multifamily housing.
We have strengthened our underwriting and eligibility standards to support sustainable homeownership. As a result, our new single-family book of business has a strong credit risk profile. Our support enables borrowers to have access to a variety of conforming mortgage products, including long-term, fixed-rate mortgages, such as the prepayable 30-year fixed-rate mortgage that protects homeowners from interest rate swings.
We helped 1.2 million homeowners stay in their homes or otherwise avoid foreclosure from January 1, 2009 through September 30, 2012, which helped to support neighborhoods, home prices and the housing market.
We helped borrowers refinance loans through Refi Plus. From April 1, 2009, the date we began accepting delivery of Refi Plus loans, through September 30, 2012, we have acquired approximately 2.5 million loans refinanced under our Refi Plus initiative. Refinancings delivered to us through Refi Plus in the third quarter of 2012 reduced borrowers’ monthly mortgage payments by an average of $221. Some borrowers’ monthly payments increased as they took advantage of the ability to refinance through Refi Plus to reduce the term of their loan, to switch from an adjustable-rate mortgage to a fixed-rate mortgage or to switch from an interest-only mortgage to a fully amortizing mortgage.
We support affordability in the multifamily rental market. Over 85% of the multifamily units we financed from 2009 through 2011 were affordable to families earning at or below the median income in their area.
In addition to purchasing and guaranteeing loans, we provide funds to the mortgage market through short-term financing and other activities. These activities are described in more detail in our 2011 Form 10-K in “Business—Business Segments—Capital Markets.”
2012 Acquisitions and Market Share
In the first nine months of 2012, we purchased or guaranteed approximately $668 billion in loans, measured by unpaid principal balance, which includes $35.9 billion in delinquent loans we purchased from our single-family MBS trusts. These activities enabled our lender customers to finance approximately 2.8 million single-family conventional loans and loans for approximately 371,000 units in multifamily properties during the first nine months of 2012.
We remained the largest single issuer of mortgage-related securities in the secondary market during the third quarter of 2012, with an estimated market share of new single-family mortgage-related securities issuances of 52%. Our estimated market share of new single-family mortgage-related securities issuances was 46% in the second quarter of 2012 and 43% in the third quarter of 2011. The volume of our loan acquisitions in the first nine months of 2012 was greater than the volume of our loan acquisitions for all of 2011, due to the implementation of changes to HARP and lower interest rates in 2012.
We remained a constant source of liquidity in the multifamily market. We owned or guaranteed approximately 22% of the outstanding debt on multifamily properties as of June 30, 2012 (the latest date for which information was available).
Amendment to Senior Preferred Stock Purchase Agreement with Treasury
On August 17, 2012, we, through FHFA acting on our behalf in its capacity as our conservator, and Treasury entered into an amendment to the senior preferred stock purchase agreement between us and Treasury. We describe the terms of this agreement and the related senior preferred stock, prior to the amendment described below, in our 2011 Form 10-K under the heading “Business—Conservatorship and Treasury Agreements—Treasury Agreements.” Unless the context indicates otherwise, references in this report to the senior preferred stock purchase agreement refer to the agreement as amended on August 17, 2012.

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The August 2012 amendment revised the terms of the senior preferred stock purchase agreement and the related senior preferred stock in the following ways:
Dividends. Beginning in 2013, the method for calculating the amount of dividends we are required to pay Treasury on the senior preferred stock will change. The current method, which will remain in effect through December 31, 2012, is to apply an annual dividend rate of 10% to the aggregate liquidation preference of the senior preferred stock. Effective January 1, 2013, the amount of dividends payable on the senior preferred stock for a dividend period will be determined based on our net worth as of the end of the immediately preceding fiscal quarter. Our net worth as defined by the agreement is the amount, if any, by which our total assets (excluding Treasury’s funding commitment and any unfunded amounts related to the commitment) exceed our total liabilities (excluding any obligation in respect of capital stock), in each case as reflected on our balance sheet prepared in accordance with generally accepted accounting principles (“GAAP”). For each dividend period from January 1, 2013 through and including December 31, 2017, the dividend amount will be the amount, if any, by which our net worth as of the end of the immediately preceding fiscal quarter exceeds an applicable capital reserve amount. The capital reserve amount will be $3.0 billion during 2013 and will be reduced by $600 million each year until it reaches zero on January 1, 2018. For each dividend period beginning in 2018, the dividend amount will be the entire amount of our net worth, if any, as of the end of the immediately preceding fiscal quarter.
As a result of these revised dividend payment provisions, beginning in 2013, when we have quarterly earnings that result in a net worth greater than the applicable capital reserve amount, we will pay dividends to Treasury in the next quarter; but if our net worth does not exceed the applicable capital reserve amount as of the end of a quarter, then we will not be required to accrue or pay any dividends in the next quarter. See “Risk Factors” for a discussion of the risks relating to our dividend obligations to Treasury on the senior preferred stock.
Periodic Commitment Fee. Effective January 1, 2013, the periodic commitment fee provided for under the agreement is suspended, as long as the changes to the dividend payment provisions referenced above remain in effect. Although we had been scheduled to begin paying this commitment fee to Treasury beginning in 2011, Treasury waived the commitment fee for each quarter of 2011 and 2012 due to the continued fragility of the U.S. mortgage market and Treasury’s belief that the imposition of the fee would not generate increased compensation for taxpayers.
Transfer of Assets Covenant. The transfer of assets covenant contained in the agreement was amended to allow the company to dispose of assets and properties at fair market value, in one transaction or a series of related transactions, without requiring the prior written consent of Treasury, if such assets have a fair market value individually or in the aggregate of less than $250 million, regardless of whether or not the transaction is in the ordinary course of business.
Mortgage Assets Covenant. The mortgage assets covenant contained in the agreement was amended to: (1) reduce the maximum allowable amount of mortgage assets we may own as of December 31, 2012 from $656.1 billion to $650 billion; and (2) require that, on December 31 of each year following December 31, 2012, we reduce our mortgage assets to 85% of the maximum allowable amount that we were permitted to own as of December 31 of the immediately preceding calendar year (rather than 90% as previously provided by the agreement), until the amount of our mortgage assets reaches $250 billion. This amendment to the mortgage assets covenant accelerates the reduction of our mortgage asset portfolio. As a result of this amendment, our mortgage asset cap will decrease to $250 billion by 2018, rather than by 2022.
Annual Risk Management Plan Covenant. A new covenant was added requiring that we provide an annual risk management plan to Treasury not later than December 15 of each year we remain in conservatorship, beginning not later than December 15, 2012. Each annual risk management plan is required to set out our strategy for reducing our risk profile and to describe the actions we will take to reduce the financial and operational risk associated with each of our business segments. Each plan delivered after December 15, 2012 must include an assessment of our performance against the planned actions described in the prior year’s plan.
In addition to the above-described amendments, the August 2012 amendment also required that we amend or replace the existing certificate of designation for the senior preferred stock to reflect the revised dividend payment provisions described above. In accordance with this requirement, on September 27, 2012, FHFA, acting on our behalf as our conservator, issued an amended and restated certificate of designation reflecting the revised terms.
In its August 17, 2012 announcement regarding the modifications to the senior preferred stock purchase agreement, Treasury stated that the modifications will help achieve several important objectives, including:

11



making sure that every dollar of earnings that Fannie Mae and Freddie Mac generate will be used to benefit taxpayers for their investment in those firms;
ending the circular practice of Treasury advancing funds to the GSEs simply to pay dividends back to Treasury;
acting upon the commitment made in the Administration’s 2011 White Paper that the GSEs will be wound down and will not be allowed to retain profits, rebuild capital, and return to the market in their prior form;
supporting the continued flow of mortgage credit by providing borrowers, market participants, and taxpayers with additional confidence in the ability of the GSEs to meet their commitments while operating under conservatorship; and
providing greater market certainty regarding the financial strength of the GSEs.
Housing and Mortgage Market and Economic Conditions
Economic growth accelerated in the third quarter of 2012 compared with the second quarter of 2012. The inflation-adjusted U.S. gross domestic product, or GDP, rose by 2.0% on an annualized basis in the third quarter of 2012, according to the Bureau of Economic Analysis advance estimate, compared with an increase of 1.3% in the second quarter of 2012. Growth in employment improved during the third quarter of 2012, as the overall economy gained an estimated 521,000 jobs, compared with 200,000 jobs in the second quarter, according to the U.S. Bureau of Labor Statistics. Over the past 12 months ending in September 2012, the economy created 1.9 million non-farm jobs. The unemployment rate was 7.8% in September 2012 compared with 8.2% in June 2012. In October 2012, non-farm payrolls strengthened, rising by 171,000 during the month, but the unemployment rate rose to 7.9%.
Housing activity improved during the third quarter of 2012. Total existing home sales averaged 4.7 million units annualized in the third quarter of 2012, a 3.2% increase from the second quarter of 2012, according to data available through October 2012 from the National Association of REALTORS®. Sales of foreclosed homes and preforeclosure, or “short,” sales (together, “distressed sales”) accounted for 24% of existing home sales in September 2012, compared with 25% in June 2012 and 30% in September 2011. New single-family home sales strengthened during the quarter, averaging an annualized rate of 377,000 units, a 4.0% increase from the prior quarter.
The overall mortgage market serious delinquency rate, which has trended down since peaking in the fourth quarter of 2009, remained high at 7.3% as of June 30, 2012, according to the Mortgage Bankers Association National Delinquency Survey. According to the National Association of REALTORS® October 2012 Existing Home Sales Report, the months’ supply of existing unsold homes was 5.9 months as of September 30, 2012, compared with 6.5 months as of June 30, 2012 and 8.1 months as of September 30, 2011. While the high level of seriously delinquent mortgage loans has resulted in a high level of foreclosures, new home building has remained at a low level, which has brought the previously elevated level of housing supply down to a more market-balanced position over the past year. However, properties that are vacant and held off the market, combined with a portion of properties backing seriously delinquent mortgages not currently listed for sale, represent an elevated level of shadow inventory that could potentially put downward pressure on home prices.
After declining by an estimated 23.7% from their peak in the third quarter of 2006 to the first quarter of 2012, we estimate that home prices on a national basis increased by 3.5% in the second quarter of 2012 and by 1.5% in the third quarter of 2012. Our home price estimates are based on preliminary data and are subject to change as additional data become available. The decline in home prices over the past several years has left many homeowners with “negative equity” in their homes, which means their principal mortgage balance exceeds the current market value of their home. This increases the likelihood that borrowers will walk away from their mortgage obligations and that the loans will become delinquent and proceed to foreclosure. According to CoreLogic, approximately 11 million, or 22%, of all residential properties with mortgages were in a negative equity position at the end of the second quarter of 2012, the most recent date for which information is available. This potential supply also weighs on the supply/demand balance putting downward pressure on home prices. See “Risk Factors” in our 2011 Form 10-K for a description of risks to our business associated with the weak economy and housing market.
During the third quarter of 2012, the multifamily sector continued to experience growth in rental demand, but at a slightly slower rate. Preliminary third-party data suggest that the national vacancy rate for professionally managed, institutional investment-type apartment properties declined to an estimated 5.50% as of September 30, 2012, compared with an estimated 5.75% as of June 30, 2012 and an estimated 6.50% as of September 30, 2011. In addition, preliminary third-party data suggest that asking rents experienced a modest increase in the third quarter of 2012, rising by an estimated 0.75% on a national basis. As indicated by data from Axiometrics, multifamily concession rates, the rental discount rate as a percentage of asking rents, continued its declining trend during the third quarter of 2012, declining to less than -2.0%, compared with -2.3% as of June 30, 2012 and -3.0% as of September 30, 2011. Estimated positive net absorption, or the net change in the number of occupied rental units after deducting new supply added, remained positive during the third quarter of 2012,

12



although it slowed to approximately 23,000 units, according to preliminary data from Reis, Inc., compared with more than 31,000 units during the second quarter of 2012 and more than 36,000 units during the first quarter of 2012.
Multifamily construction starts rose to an annualized rate of 260,000 units as of September 30, 2012, compared with 219,000 units as of September 30, 2011, based on data from the Census Bureau. We believe that the overall national rental market’s supply will remain fairly stable over the longer term, based on expected construction completions, annualized obsolescence and anticipated household formation trends; however, there is a potential for over-supply in a limited number of local areas over the next 24 months.
Outlook
Credit-Related Expenses and Financial Results. We expect that our credit-related expenses for 2012 will be significantly lower than for 2011. As a result, we expect to report net income for 2012, which would be the first time we have reported annual net income since 2006. There is significant uncertainty in the current market environment, however, and any changes in the trends in macroeconomic factors that we currently anticipate, such as home prices and unemployment, may cause our future credit-related expenses and overall financial results to vary significantly from our current expectations. We further describe our outlook for credit-related expenses, including factors that could result in higher credit-related expenses than we currently expect, in “Summary of Our Financial Performance for the Third Quarter and First Nine Months of 2012—Our Expectations Regarding Future Loss Reserves and Credit-Related Expenses.”
Credit Losses. Our credit losses, which include our charge-offs, net of recoveries, reflect our realization of losses on our loans. We realize losses on loans, through our charge-offs, when foreclosure sales are completed or when we accept short sales or deeds-in-lieu of foreclosure. We expect our credit losses to remain high in 2012 relative to pre-housing crisis levels. To the extent delays in foreclosures continue in 2012, our realization of some credit losses will be delayed. See “Consolidated Results of Operations—Credit-Related Expenses—Credit Loss Performance Metrics” for more information regarding our credit losses.
Overall Market Conditions. We expect mortgage loan delinquencies and foreclosures to continue to decline slowly while remaining at levels significantly higher than pre-housing crisis levels for the remainder of 2012 and through 2013. We expect that single-family default and severity rates will remain high for the remainder of 2012 compared to pre-housing crisis levels, but will be lower in 2012 overall than in 2011 overall. Despite multifamily sector improvement at the national level, we expect multifamily foreclosures in 2012 to remain generally commensurate with 2011 levels as certain local markets and properties continue to exhibit weak fundamentals. Conditions may worsen if the unemployment rate increases on either a national or regional basis.
As a result of the changes to HARP implemented this year and historically low interest rates, we acquired more refinancings in the first nine months of 2012 than we acquired in all of 2011. We expect that if interest rates remain low we will continue to acquire a high volume of refinancings under HARP until there is no longer a large population of borrowers with loans that have high LTV ratios who would benefit from refinancing. In particular, we expect to acquire many refinancings with LTV ratios greater than 125%, because borrowers were unable to refinance loans with LTV ratios greater than 125% in large numbers until changes to HARP were fully implemented in the second quarter of 2012. For a description of the changes to HARP, see “Business—Making Home Affordable Program—Changes to the Home Affordable Refinance Program” in our 2011 Form 10-K.
We estimate that total originations in the U.S. single-family mortgage market in 2012 will increase from 2011 levels by approximately 20% from an estimated $1.5 trillion to an estimated $1.8 trillion, and that the amount of originations in the U.S. single-family mortgage market that are refinancings will increase from approximately $980 billion in 2011 to approximately $1.3 trillion in 2012. Refinancings comprised approximately 79% of our single-family business volume in the first nine months of 2012, compared with approximately 76% for all of 2011.
Home Prices. After declining by an estimated 23.7% from their peak in the third quarter of 2006 to the first quarter of 2012, we estimate that home prices on a national basis increased by 3.5% in the second quarter of 2012 and by 1.5% in the third quarter of 2012. Although we believe home prices may decline again through early 2013, we expect that, if current market trends continue, home prices will not decline on a national basis below their first quarter 2012 levels. Future home price changes may be very different from our estimates as a result of significant inherent uncertainty in the current market environment, including uncertainty about the effect of actions the federal government has taken and may take with respect to tax policies, spending cuts, mortgage finance programs and policies, and housing finance reform; the management of the Federal Reserve’s MBS holdings; the impact of those actions on and changes generally in unemployment and the general economic and interest rate environment; and the impact on the U.S. economy of the European debt crisis. Because of these uncertainties, the actual home price changes we experience may differ significantly from these estimates. We also expect significant regional variation in home price changes and the timing of home price stabilization. Our estimates of home price

13



changes are based on our home price index, which is calculated differently from the S&P/Case-Shiller U.S. National Home Price Index and therefore results in different percentages for comparable changes. Our estimated 23.7% peak-to-trough decline in home prices on a national basis corresponds to a 34.7% decline according to the S&P/Case-Shiller U.S. National Home Price Index.
Uncertainty Regarding our Future Status. There is significant uncertainty regarding the future of our company, including how long the company will continue to be in its current form, the extent of our role in the market, what form we will have, and what ownership interest, if any, our current common and preferred stockholders will hold in us after the conservatorship is terminated. We expect this uncertainty to continue. In February 2011, Treasury and the Department of Housing and Urban Development (“HUD”) released a report to Congress on reforming America’s housing finance market. The report states that the Administration will work with FHFA to determine the best way to responsibly wind down both Fannie Mae and Freddie Mac. The report emphasizes the importance of providing the necessary financial support to Fannie Mae and Freddie Mac during the transition period. In February 2012, Treasury Secretary Geithner stated that the Administration intended to release new details around approaches to housing finance reform, including winding down Fannie Mae and Freddie Mac, and to work with congressional leaders to explore options for legislation, but that he does not expect housing finance reform legislation to be enacted in 2012.
We cannot predict the prospects for the enactment, timing or content of legislative proposals regarding long-term reform of the GSEs. See “Legislative and Regulatory Developments” in this report and “Business—Legislative and Regulatory Developments” in our 2011 Form 10-K for discussions of recent legislative reform of the financial services industry and proposals for GSE reform that could affect our business. See “Risk Factors” in our 2011 Form 10-K for a discussion of the risks to our business relating to the uncertain future of our company.
Treasury Draws and Dividend Payments. As a result of the revisions to the dividend payment provisions in our senior preferred stock purchase agreement with Treasury described in “Amendment to Senior Preferred Stock Purchase Agreement with Treasury,” beginning in 2013, if our net worth does not exceed the applicable capital reserve amount as of the end of a fiscal quarter, then no dividend amount will accrue or be payable for the applicable dividend period. Accordingly, beginning in 2013, we will no longer be required to draw additional funds from Treasury under the senior preferred stock purchase agreement in order to meet our dividend obligations to Treasury on the senior preferred stock. However, in some future periods we could have a net worth deficit and in such case we would be required to obtain additional funding from Treasury pursuant to the senior preferred stock purchase agreement. See “Risk Factors” for a discussion of the risks relating to our dividend obligation to Treasury on the senior preferred stock.
Factors that Could Cause Actual Results to be Materially Different from Our Estimates and Expectations. We present a number of estimates and expectations in this executive summary, including estimates and expectations regarding our future financial results, the profitability of single-family loans we have acquired, our credit losses, our loss reserves, our credit-related expenses, and our draws from and dividends to Treasury. These estimates and expectations are forward-looking statements based on our current assumptions regarding numerous factors, including future home prices and the future performance of our loans. Our future estimates of our performance, as well as the actual amounts, may differ materially from our current estimates and expectations as a result of: the timing and level of, as well as regional variation in, home price changes; changes in interest rates, unemployment rates and other macroeconomic variables; government policy; the length of time it takes to complete foreclosures; changes in GAAP; credit availability; borrower behavior; the volume of loans we modify; the effectiveness of our loss mitigation strategies, management of our REO inventory and pursuit of contractual remedies; whether our counterparties meet their obligations in full; changes in the fair value of our assets and liabilities; impairments of our assets; natural or other disasters; and many other factors, including those discussed in “Risk Factors,” “Forward-Looking Statements” and elsewhere in this report, and in “Risk Factors” in our 2011 Form 10-K. For example, if the economy were to enter a deep recession, we would expect actual outcomes to differ substantially from our current expectations.
LEGISLATIVE AND REGULATORY DEVELOPMENTS
The information in this section updates and supplements information regarding legislative and regulatory developments set forth in “Business—Legislative and Regulatory Developments” and “Business—Our Charter and Regulation of Our Activities” in our 2011 Form 10-K and in “MD&A—Legislative and Regulatory Developments” in both our quarterly report on Form 10-Q for the quarter ended March 31, 2012 (“First Quarter 2012 Form 10-Q”) and our Second Quarter 2012 Form 10-Q. Also see “Risk Factors” in this report and our 2011 Form 10-K for a discussion of risks relating to legislative and regulatory matters.

14



GSE Reform
Policymakers and others have focused significant attention in recent years on how to reform the nation’s housing finance system, including what role, if any, the GSEs should play. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), which was signed into law in July 2010, calls for enactment of meaningful structural reforms of Fannie Mae and Freddie Mac. The Dodd-Frank Act also required the Treasury Secretary to submit a report to Congress with recommendations for ending the conservatorships of Fannie Mae and Freddie Mac.
In February 2011, Treasury and HUD released their report to Congress on reforming America’s housing finance market. The report provides that the Administration will work with FHFA to determine the best way to responsibly reduce Fannie Mae’s and Freddie Mac’s role in the market and ultimately wind down both institutions.
The report identifies a number of policy steps that could be used to wind down Fannie Mae and Freddie Mac, reduce the government’s role in housing finance and help bring private capital back to the mortgage market. These steps include (1) increasing guaranty fees, (2) gradually increasing the level of required down payments so that any mortgages insured by Fannie Mae or Freddie Mac eventually have at least a 10% down payment, (3) reducing conforming loan limits to those established in the Federal Housing Finance Regulatory Reform Act of 2008 (the “2008 Reform Act”), (4) encouraging Fannie Mae and Freddie Mac to pursue additional credit loss protection and (5) reducing Fannie Mae’s and Freddie Mac’s portfolios, consistent with Treasury’s senior preferred stock purchase agreements with the companies.
In addition, the report outlines three potential options for a new long-term structure for the housing finance system following the wind-down of Fannie Mae and Freddie Mac. The first option would privatize housing finance almost entirely. The second option would add a government guaranty mechanism that could scale up during times of crisis. The third option would involve the government offering catastrophic reinsurance behind private mortgage guarantors. Each of these options assumes the continued presence of programs operated by FHA, the Department of Agriculture and the Veterans Administration to assist targeted groups of borrowers. The report does not state whether or how the existing infrastructure or human capital of Fannie Mae may be used in the establishment of such a reformed system. The report emphasizes the importance of proceeding with a careful transition plan and providing the necessary financial support to Fannie Mae and Freddie Mac during the transition period. A copy of the report can be found on the Housing Finance Reform section of Treasury’s Web site, www.Treasury.gov. We are providing Treasury’s Web site address solely for your information, and information appearing on Treasury’s Web site is not incorporated into this quarterly report on Form 10-Q.
In February 2012, Treasury Secretary Geithner stated that the Administration intended to release new details around approaches to housing finance reform, including winding down Fannie Mae and Freddie Mac, and to work with congressional leaders to explore options for legislation, but that he does not expect housing finance reform legislation to be enacted in 2012. As of the date of this filing, no further details have been released.
In the current congressional session, Congress has held hearings on the future status of Fannie Mae and Freddie Mac, and members of Congress have offered legislative proposals relating to the future status of the GSEs. We expect Congress to continue considering this issue in the next congressional session that begins in 2013. We expect additional hearings on GSE reform and additional legislation to be considered and proposals to be discussed, including proposals that could result in a substantial change to our business structure or that involve Fannie Mae’s liquidation or dissolution. Several bills have been introduced in the current congressional session that would place the GSEs into receivership after a period of time and either grant federal charters to new entities to engage in activities similar to those currently engaged in by the GSEs or leave secondary mortgage market activities to entities in the private sector. For example, legislation has been introduced in both the House of Representatives and the Senate that would require FHFA to make a determination within two years of enactment regarding whether the GSEs were financially viable and, if the GSEs were determined not to be financially viable, to place them into receivership. As drafted, these bills may, upon enactment, impair our ability to issue securities in the capital markets and therefore our ability to conduct our business, absent the federal government providing an explicit guarantee of our existing and future liabilities.
In addition to bills that seek to resolve the status of the GSEs, numerous bills have been introduced and considered in the current congressional session that could constrain the current operations of the GSEs or alter the existing authority that FHFA or Treasury has over the enterprises. For example, the Subcommittee on Capital Markets and Government Sponsored Enterprises of the House Financial Services Committee has approved bills that would or could:
suspend current compensation packages and apply a government pay scale for GSE employees;
require the GSEs to increase guaranty fees;
subject GSE loans to the risk retention standards in the Dodd-Frank Act;
require a quicker reduction of GSE portfolios than required under the senior preferred stock purchase agreement;

15



require Treasury to pre-approve all GSE debt issuances;
repeal the GSEs’ affordable housing goals;
provide additional authority to FHFA’s Inspector General;
prohibit FHFA from approving any new GSE products during conservatorship or receivership, with certain exceptions;
prevent Treasury from amending the senior preferred stock purchase agreement to reduce the dividend rate on our senior preferred stock;
abolish the Affordable Housing Trust Fund that the GSEs are required to fund except when such contributions have been temporarily suspended by FHFA;  
require FHFA to identify mission critical assets of the GSEs and require the GSEs to dispose of non-mission critical assets;
cap the maximum aggregate amount of funds Treasury or any other agency or entity of the federal government can provide to the GSEs subject to certain qualifications;
grant FHFA the authority to revoke the enterprises’ charters following receivership under certain circumstances; and
subject the GSEs to the Freedom of Information Act.
Of these bills that passed at a subcommittee level, the only one that has passed the full committee is the bill that would put GSE employees on a government pay scale. Unless these bills are enacted by the end of 2012, they would need to be reintroduced in the next congressional session that convenes in January 2013 in order to be considered again. We expect additional legislation relating to the GSEs to be introduced and considered by Congress. We cannot predict the prospects for the enactment, timing or content of legislative proposals concerning the future status of the GSEs, their regulation or operations.
In sum, there continues to be uncertainty regarding the future of our company, including how long the company will continue to exist in its current form, the extent of our role in the market, what form we will have, and what ownership interest, if any, our current common and preferred stockholders will hold in us after the conservatorship is terminated. See “Risk Factors” in our 2011 Form 10-K for a discussion of the risks to our business relating to the uncertain future of our company. Also see “Risk Factors” in this report for a discussion of how the uncertain future of our company may adversely affect our ability to retain and recruit well-qualified employees, including senior management.
The Dodd-Frank Act: Regulation of Swap Transactions
The Commodity Futures Trading Commission (the “CFTC”) and the SEC issued a joint final rule in May 2012 that, among other items, established the definitions of “swap dealer,” “security-based swap dealer,” “major swap participant” and “major security-based swap participant” under the Dodd-Frank Act. Institutions that meet one of these definitions are required to register with either the CFTC or the SEC, as applicable, and are subject to significant additional regulations. In addition, in August 2012, the CFTC and SEC issued a joint final rule that, among other items, defines “swap” and “security-based swap.”
We have reviewed these rules and determined that we are not a swap dealer, security-based swap dealer, major swap participant or major security-based swap participant for purposes of the Dodd-Frank Act. Accordingly, we do not need to register with the CFTC or the SEC. Although we do not need to register with the CFTC or the SEC, because we are a user of interest rate swaps, the Dodd-Frank Act requires us, among other items, to submit new swap transactions for clearing to a derivatives clearing organization. Additionally, the Federal Reserve Board, the Federal Deposit Insurance Corporation, FHFA, the Farm Credit Administration and the Office of the Comptroller of the Currency have proposed rules under the Dodd-Frank Act governing margin and capital requirements applicable to entities that are subject to their oversight. These proposed rules would require that, for all trades that have not been submitted to a derivatives clearing organization, we collect from our counterparties and provide to our counterparties collateral in excess of the amounts we have historically collected or provided.
Increase in Single-Family Guaranty Fee Pricing
In August 2012, FHFA directed us and Freddie Mac to increase our single-family guaranty fee prices by an average of 10 basis points. This increase was effective on November 1, 2012 for whole loan commitments and will be effective on December 1, 2012 for loans exchanged for Fannie Mae MBS. These changes to guaranty fee pricing represent a step toward encouraging greater participation in the mortgage market by private firms, which is one of the goals set forth in FHFA’s strategic plan for the next phase of Fannie Mae’s and Freddie Mac’s conservatorships.

16



In addition to the fee increase described above, in September 2012, FHFA published a notice presenting an approach to adjust the guaranty fees that we and Freddie Mac charge on single-family mortgages in states where costs related to foreclosure practices are significantly higher than the national average. The approach outlined in FHFA’s notice would be to charge a one-time upfront payment of between 15 and 30 basis points on each loan acquired in the following five states that have significantly higher default-related costs than the national average: Connecticut, Florida, Illinois, New Jersey and New York. FHFA’s notice requests public input on this approach and potential future approaches to setting and adjusting state-level guaranty fees. FHFA’s notice indicates that, after reviewing public input and determining a final state-level guaranty fee pricing method, it expects to direct us and Freddie Mac to implement these pricing adjustments in 2013.
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 “Note 1, Summary of Significant Accounting Policies” in this report and in our 2011 Form 10-K.
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. Management has discussed any significant changes in judgments and assumptions in applying our critical accounting policies with the Audit Committee of our Board of Directors. We have identified three 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 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 Measurement
•    Total Loss Reserves
•    Other-Than-Temporary Impairment of Investment Securities
See “MD&A—Critical Accounting Policies and Estimates” in our 2011 Form 10-K for a detailed discussion of these critical accounting policies and estimates. We provide below information about our Level 3 assets and liabilities as of September 30, 2012 as compared with December 31, 2011. We also describe any significant changes in the judgments and assumptions we made during the first nine months of 2012 in applying our critical accounting policies and significant changes to critical estimates.
Fair Value Measurement
The use of fair value to measure our assets and liabilities is fundamental to our financial statements and our fair value measurement is a critical accounting estimate because we account for and record a portion of our assets and liabilities at fair value. In determining fair value, we use various valuation techniques. We describe the valuation techniques and inputs used to determine the fair value of our assets and liabilities and disclose their carrying value and fair value in “Note 12, Fair Value.”
Fair Value Hierarchy—Level 3 Assets and Liabilities
The assets and liabilities that we have classified as Level 3 consist primarily of financial instruments for which there is limited market activity and therefore little or no price transparency. As a result, the valuation techniques that we use to estimate the fair value of Level 3 instruments involve significant unobservable inputs, which generally are more subjective and involve a high degree of management judgment and assumptions. Our Level 3 assets and liabilities consist of certain mortgage-backed securities and residual interests, certain mortgage loans, certain acquired property, certain long-term debt arrangements and certain highly structured, complex derivative instruments.
Table 4 presents a comparison of the amount of financial assets carried in our condensed consolidated balance sheets at fair value on a recurring basis (“recurring assets”) that were classified as Level 3 as of September 30, 2012 and December 31, 2011. 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.

17



Table 4: Level 3 Recurring Financial Assets at Fair Value
 
As of
 
September 30, 2012
 
December 31, 2011
 
(Dollars in millions)
Trading securities
 
$
2,573

 
 
 
$
4,238

 
Available-for-sale securities
 
25,840

 
 
 
29,492

 
Mortgage loans
 
2,416

 
 
 
2,319

 
Other assets
 
197

 
 
 
238

 
Level 3 recurring assets
 
$
31,026

 
 
 
$
36,287

 
Total assets
 
$
3,226,250

 
 
 
$
3,211,484

 
Total recurring assets measured at fair value
 
$
120,617

 
 
 
$
156,552

 
Level 3 recurring assets as a percentage of total assets
 
1
%
 
 
 
1
%
 
Level 3 recurring assets as a percentage of total recurring assets measured
at fair value
 
26
%
 
 
 
23
%
 
Total recurring assets measured at fair value as a percentage of total assets
 
4
%
 
 
 
5
%
 
Assets measured at fair value on a nonrecurring basis and classified as Level 3, which are not presented in the table above, primarily include mortgage loans and acquired property. The fair value of Level 3 nonrecurring assets totaled $30.4 billion as of September 30, 2012.
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 $1.9 billion as of September 30, 2012 and $1.2 billion as of December 31, 2011, and other liabilities with a fair value of $167 million as of September 30, 2012 and $173 million as of December 31, 2011.
We updated our assumptions for prepayment speeds, severities and default rates during the third quarter of 2012, which resulted in an increase in the fair value of our loans of approximately $23 billion. These updates resulted in lower expectations of losses on certain loans, primarily performing loans with high LTV ratios.
Total Loss Reserves
Our total loss reserves consist of the following components:
Allowance for loan losses;
Allowance for accrued interest receivable;
Reserve for guaranty losses; and
Allowance for preforeclosure property tax and insurance receivable.
These components can be further divided into our single-family and multifamily loss reserves.
We continually monitor delinquency and default trends and periodically make changes in our historically developed assumptions to better reflect present conditions. In the third quarter of 2012, as described below, we enhanced our collective single-family loss reserve model and our model that calculates loss reserves for individually impaired loans. The combined impact from these changes resulted in an approximately $3.5 billion increase to our allowance for loan losses and provision for credit losses.
We enhanced our loan loss models for loans in our collective single-family loss reserve to reflect more recent experience of default expectations, including incorporating current credit bureau data, which provides additional information about the borrower’s ability to pay. The impact of this change had the most pronounced effect on loans with higher mark-to-market LTV ratios, where we have observed better than anticipated payment performance. The change resulted in an approximately $1.5 billion decrease to our allowance for loan losses and provision for credit losses.
We also enhanced our single-family loan loss models for individually impaired loans based on current observable trends of payment behavior on our modified loans to reflect slower prepayment and lower default expectations for these loans, which significantly extended the expected average life of our modified loans. Since a loan modification changes the contractual terms of a loan such that a concession is granted to the borrower, an extension of the average life of a modified loan increases the charge we record related to the concession. Therefore, while our expectations of credit loss decreased due to better performance of our modified loans, this decrease was more than offset by an increase in the present value of the concession granted to the borrower by the modification. The change resulted in an approximately $5.0 billion increase to our allowance for loan losses and provision for credit losses.

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Other-Than-Temporary Impairment of Investment Securities
We evaluate available-for-sale securities in an unrealized loss position as of the end of each quarter for other-than-temporary impairment. Our evaluation requires significant management judgment and consideration of various factors to determine if we will receive the amortized cost basis of our investment securities. We evaluate a debt security for other-than-temporary impairment using an econometric model that estimates the present value of cash flows given multiple factors. These factors include: the severity and duration of the impairment; recent events specific to the issuer and/or industry to which the issuer belongs; the payment structure of the security; external credit ratings and the failure of the issuer to make scheduled interest or principal payments. We rely on expected future cash flow projections to determine if we will recover the amortized cost basis of our available-for-sale securities.
In the second quarter of 2012, we updated our assumptions used to project cash flow estimates on our Alt-A and subprime private-label securities to incorporate observable market trends, which included extending the time it takes to liquidate loans underlying these securities and increasing severity rates for loans where the servicer stopped advancing payments. These updates resulted in lower net present value of cash flow projections on our Alt-A and subprime securities and increased our other-than-temporary impairment expense by approximately $500 million. We provide more detailed information on our accounting for other-than-temporary impairment in “Note 5, Investments in Securities.”
CONSOLIDATED RESULTS OF OPERATIONS
This section provides a discussion of our condensed consolidated results of operations for the periods indicated and should be read together with our condensed consolidated financial statements, including the accompanying notes.
Table 5 displays a summary of our condensed consolidated results of operations for the periods indicated.
Table 5: Summary of Condensed Consolidated Results of Operations
 
For the Three Months Ended
 
For the Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
Variance
 
2012
 
2011
 
Variance
 
(Dollars in millions)
Net interest income  
$
5,317

 
$
5,186

 
$
131

 
$
15,942

 
$
15,118

 
$
824

Fee and other income  
378

 
291

 
87

 
1,148

 
793

 
355

Net revenues  
$
5,695

 
$
5,477

 
$
218

 
$
17,090

 
$
15,911

 
$
1,179

Investment gains, net 
134

 
73

 
61

 
381

 
319

 
62

Net other-than-temporary impairments  
(38
)
 
(262
)
 
224

 
(701
)
 
(362
)
 
(339
)
Fair value losses, net 
(1,020
)
 
(4,525
)
 
3,505

 
(3,186
)
 
(5,870
)
 
2,684

Administrative expenses  
(588
)
 
(591
)
 
3

 
(1,719
)
 
(1,765
)
 
46

Credit-related expenses
 
 
 
 
 
 
 
 
 
 
 
Provision for credit losses 
(2,079
)
 
(4,151
)
 
2,072

 
(1,038
)
 
(21,242
)
 
20,204

Foreclosed property income (expense) 
48

 
(733
)
 
781

 
(221
)
 
(743
)
 
522

Total credit-related expenses 
(2,031
)
 
(4,884
)
 
2,853

 
(1,259
)
 
(21,985
)
 
20,726

Other non-interest expenses(1)
(339
)
 
(373
)
 
34

 
(956
)
 
(787
)
 
(169
)
Income (loss) before federal income taxes
1,813

 
(5,085
)
 
6,898

 
9,650

 
(14,539
)
 
24,189

Benefit for federal income taxes

 

 

 

 
91

 
(91
)
Net income (loss)
1,813

 
(5,085
)
 
6,898

 
9,650

 
(14,448
)
 
24,098

Less: Net loss (income) attributable to the noncontrolling interest
8

 

 
8

 
4

 
(1
)
 
5

Net income (loss) attributable to Fannie Mae
$
1,821

 
$
(5,085
)
 
$
6,906

 
$
9,654

 
$
(14,449
)
 
$
24,103

Total comprehensive income (loss) attributable to Fannie Mae
$
2,567

 
$
(5,282
)
 
$
7,849

 
$
11,090

 
$
(14,463
)
 
$
25,553

__________
(1) 
Consists of debt extinguishment losses, net and other expenses.


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Net Interest Income
Table 6 displays an analysis of our net interest income, average balances, and related yields earned on assets and incurred on liabilities for the periods indicated. For most components of the average balances, we use a daily weighted average of amortized cost. When daily average balance information is not available, such as for mortgage loans, we use monthly averages. Table 7 displays 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.
Table 6: Analysis of Net Interest Income and Yield

For the Three Months Ended September 30,

2012
 
2011
 
Average
Balance
 
Interest
Income/
Expense
 
 
Average
Rates
Earned/Paid
 
Average
Balance
 
Interest
Income/
Expense
 
 
Average
Rates
Earned/Paid
 
(Dollars in millions)
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans of Fannie Mae
$
366,836

 
$
3,536

 
 
3.86

%
 
$
386,067

 
$
3,701

 
 
3.83
%
Mortgage loans of consolidated trusts
2,627,408

 
27,057

 
 
4.12

 
 
2,598,264

 
30,633

 
 
4.72
 
Total mortgage loans
2,994,244

 
30,593

 
 
4.09

 
 
2,984,331

 
34,334

 
 
4.60
 
Mortgage-related securities
263,333

 
3,085

 
 
4.69

 
 
312,482

 
3,930

 
 
5.03
 
Elimination of Fannie Mae MBS held in portfolio
(171,205
)
 
(2,075
)
 
 
4.85

 
 
(199,691
)
 
(2,520
)
 
 
5.05
 
Total mortgage-related securities, net
92,128

 
1,010

 
 
4.39

 
 
112,791

 
1,410

 
 
5.00
 
Non-mortgage securities(1)
42,922

 
13

 
 
0.12

 
 
72,333

 
24

 
 
0.13
 
Federal funds sold and securities purchased under agreements to resell or similar arrangements
40,565

 
19

 
 
0.18

 
 
27,217

 
7

 
 
0.10
 
Advances to lenders
7,178

 
34

 
 
1.85

 
 
3,417

 
19

 
 
2.18
 
Total interest-earning assets
$
3,177,037

 
$
31,669

 
 
3.99

%
 
$
3,200,089

 
$
35,794

 
 
4.47
%
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term debt(2)
$
93,186

 
$
37

 
 
0.16

%
 
$
181,495

 
$
63

 
 
0.14
%
Long-term debt
559,968

 
2,919

 
 
2.09

 
 
552,191

 
3,385

 
 
2.45
 
Total short-term and long-term funding debt
653,154

 
2,956

 
 
1.81

 
 
733,686

 
3,448

 
 
1.88
 
Debt securities of consolidated trusts
2,707,451

 
25,471

 
 
3.76

 
 
2,650,256

 
29,680

 
 
4.48
 
Elimination of Fannie Mae MBS held in portfolio
(171,205
)
 
(2,075
)
 
 
4.85

 
 
(199,691
)
 
(2,520
)
 
 
5.05
 
Total debt securities of consolidated trusts held by third parties
2,536,246

 
23,396

 
 
3.69

 
 
2,450,565

 
27,160

 
 
4.43
 
Total interest-bearing liabilities
$
3,189,400

 
$
26,352

 
 
3.30

%
 
$
3,184,251

 
$
30,608

 
 
3.84
%
Net interest income/net interest yield
 
 
$
5,317

 
 
0.67

%
 
 
 
$
5,186

 
 
0.65
%
Net interest income/net interest yield of consolidated trusts(3)
 
 
$
1,586

 
 
0.24

%
 
 
 
$
953

 
 
0.15
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

20



 
For the Nine Months Ended September 30,
 
2012
 
2011
 
Average
Balance
 
Interest
Income/
Expense
 
 
Average
Rates
Earned/Paid
 
Average
Balance
 
Interest
Income/
Expense
 
 
Average
Rates
Earned/Paid
 
(Dollars in millions)
 
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans of Fannie Mae
$
372,916

 
$
10,704

 
 
3.83

%
 
$
395,686

 
$
11,146
 
 
 
3.76
%
Mortgage loans of consolidated trusts
2,613,196

 
84,482

 
 
4.31

 
 
2,601,710

 
94,111
 
 
 
4.82
 
Total mortgage loans
2,986,112

 
95,186

 
 
4.25

 
 
2,997,396

 
105,257
 
 
 
4.68
 
Mortgage-related securities
275,456

 
9,809

 
 
4.75

 
 
321,979

 
12,204
 
 
 
5.05
 
Elimination of Fannie Mae MBS held in portfolio
(178,218
)
 
(6,558
)
 
 
4.91

 
 
(206,176
)
 
(7,956
)
 
 
5.15
 
Total mortgage-related securities, net
97,238

 
3,251

 
 
4.46

 
 
115,803

 
4,248
 
 
 
4.89
 
Non-mortgage securities(1)
55,391

 
56

 
 
0.13

 
 
76,266

 
99
 
 
 
0.17
 
Federal funds sold and securities purchased under agreements to resell or similar arrangements
33,349

 
42

 
 
0.17

 
 
20,980

 
20
 
 
 
0.13
 
Advances to lenders
5,959

 
89

 
 
1.96

 
 
3,548

 
59
 
 
 
2.19
 
Total interest-earning assets
$
3,178,049

 
$
98,624

 
 
4.14

%
 
$
3,213,993

 
$
109,683
 
 
 
4.55
%
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Short-term debt(2)
$
105,393

 
$
108

 
 
0.13

%
 
$
160,961

 
$
246
 
 
 
0.20
%
Long-term debt
569,112

 
9,101

 
 
2.13

 
 
591,126

 
11,383
 
 
 
2.57
 
Total short-term and long-term funding debt
674,505

 
9,209

 
 
1.82

 
 
752,087

 
11,629
 
 
 
2.06
 
Debt securities of consolidated trusts
2,685,408

 
80,031

 
 
3.97

 
 
2,652,057

 
90,892
 
 
 
4.57
 
Elimination of Fannie Mae MBS held in portfolio
(178,218
)
 
(6,558
)
 
 
4.91

 
 
(206,176
)
 
(7,956
)
 
 
5.15
 
Total debt securities of consolidated trusts held by third parties
2,507,190

 
73,473

 
 
3.91

 
 
2,445,881

 
82,936
 
 
 
4.52
 
Total interest-bearing liabilities
$
3,181,695

 
$
82,682

 
 
3.46

%
 
$
3,197,968

 
$
94,565
 
 
 
3.94
%
Net interest income/net interest yield
 
 
$
15,942

 
 
0.67

%
 
 
 
$
15,118
 
 
 
0.63
%
Net interest income/net interest yield of consolidated trusts(3)
 
 
$
4,451

 
 
0.23

%
 
 
 
$
3,219
 
 
 
0.16
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
As of September 30,
 
 
 
 
 
 
 
 
 
 
 
2012
 
2011
Selected benchmark interest rates(4)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
3-month LIBOR
 
 
 
 
 
 
 
 
 
 
0.36

%

 
 
0.37
%
2-year swap rate
 
 
 
 
 
 
 
 
 
 
0.37

 
 
 
0.58
 
5-year swap rate
 
 
 
 
 
 
 
 
 
 
0.76

 
 
 
1.26
 
30-year Fannie Mae MBS par coupon rate
 
 
 
 
 
 
 
 
 
 
1.84

 
 
 
2.96
 
__________
(1) 
Includes cash equivalents.
(2) 
Includes federal funds purchased and securities sold under agreements to repurchase.
(3) 
Net interest income of consolidated trusts represents interest income from mortgage loans of consolidated trusts less interest expense from debt securities of consolidated trusts. Net interest yield is calculated based on net interest income from consolidated trusts divided by average balance of mortgage loans of consolidated trusts.
(4) 
Data from British Bankers’ Association, Thomson Reuters Indices and Bloomberg L.P.

21



Table 7: Rate/Volume Analysis of Changes in Net Interest Income
  
For the Three Months Ended 
 
For the Nine Months Ended 
  
September 30, 2012 vs. 2011 
 
September 30, 2012 vs. 2011 
  
Total
 
Variance Due to:(1)
 
Total
 
Variance Due to:(1)
  
Variance
 
Volume
 
Rate
 
Variance
 
Volume
 
Rate
 
(Dollars in millions) 
Interest income:
 
 
 
 
 
 
 
 
 
 
 
Mortgage loans of Fannie Mae
$
(165
)
 
$
(185
)
 
$
20

 
$
(442
)
 
$
(651
)
 
$
209

Mortgage loans of consolidated trusts
(3,576
)
 
340

 
(3,916
)
 
(9,629
)
 
414

 
(10,043
)
Total mortgage loans
(3,741
)
 
155

 
(3,896
)
 
(10,071
)
 
(237
)
 
(9,834
)
Mortgage-related securities
(845
)
 
(589
)
 
(256
)
 
(2,395
)
 
(1,688
)
 
(707
)
Elimination of Fannie Mae MBS held in portfolio
445

 
348

 
97

 
1,398

 
1,042

 
356

Total mortgage-related securities, net
(400
)
 
(241
)
 
(159
)
 
(997
)
 
(646
)
 
(351
)
Non-mortgage securities(2) 
(11
)
 
(9
)
 
(2
)
 
(43
)
 
(24
)
 
(19
)
Federal funds sold and securities purchased under agreements to resell or similar arrangements
12

 
4

 
8

 
22

 
14

 
8

Advances to lenders
15

 
18

 
(3
)
 
30

 
37

 
(7
)
Total interest income
(4,125
)
 
(73
)
 
(4,052
)
 
(11,059
)
 
(856
)
 
(10,203
)
Interest expense:
 
 
 
 
 
 
 
 
 
 
 
Short-term debt (3) 
(26
)
 
(34
)
 
8

 
(138
)
 
(71
)
 
(67
)
Long-term debt
(466
)
 
47

 
(513
)
 
(2,282
)
 
(411
)
 
(1,871
)
Total short-term and long-term funding debt
(492
)
 
13

 
(505
)
 
(2,420
)
 
(482
)
 
(1,938
)
Debt securities of consolidated trusts
(4,209
)
 
628

 
(4,837
)
 
(10,861
)
 
1,130

 
(11,991
)
Elimination of Fannie Mae MBS held in portfolio
445

 
348

 
97

 
1,398

 
1,042

 
356

Total debt securities of consolidated trusts held by third parties
(3,764
)
 
976

 
(4,740
)
 
(9,463
)
 
2,172

 
(11,635
)
Total interest expense
(4,256
)
 
989

 
(5,245
)
 
(11,883
)
 
1,690

 
(13,573
)
Net interest income
$
131

 
$
(1,062
)
 
$
1,193

 
$
824

 
$
(2,546
)
 
$
3,370

__________
(1) 
Combined rate/volume variances are allocated to both rate and volume based on the relative size of each variance.
(2) 
Includes cash equivalents.
(3) 
Includes federal funds purchased and securities sold under agreements to repurchase.
Although our portfolio balance declined, net interest income increased in the third quarter and first nine months of 2012, compared with the third quarter and first nine months of 2011, primarily due to lower interest expense on funding debt, a reduction in the amount of interest income not recognized for nonaccrual mortgage loans and accelerated net amortization income on loans and debt of consolidated trusts. These factors were partially offset by lower interest income on Fannie Mae mortgage loans and securities. The primary drivers of these changes were:
lower interest expense on funding debt due to lower borrowing rates and lower funding needs, which allowed us to continue to replace higher-cost debt with lower-cost debt;
higher coupon interest income recognized on mortgage loans due to a reduction in the amount of interest income not recognized for nonaccrual mortgage loans. The balance of nonaccrual loans in our condensed consolidated balance sheet declined as we continued to complete a high number of loan workouts and foreclosures, and fewer loans became seriously delinquent;
accelerated net amortization income related to mortgage loans and debt of consolidated trusts driven by a high volume of prepayments due to declining interest rates;
lower interest income on Fannie Mae mortgage loans due to a decrease in average balance and new business acquisitions which continued to replace higher-yielding loans with loans issued at lower mortgage rates; and
lower interest income on mortgage securities due to lower interest rates and a decrease in the balance of our mortgage securities, as we continue to manage our portfolio requirements of the senior preferred stock purchase agreement.

22



Additionally, our net interest income and net interest yield were higher than they would have otherwise been because our debt funding needs were lower than would otherwise have been required because of the funds we have received from Treasury to date under the senior preferred stock purchase agreement and because dividends paid to Treasury are not recognized as interest expense.
Table 8 displays the interest income not recognized for loans on nonaccrual status and the resulting reduction in our net interest yield on total interest earning assets for the periods indicated.
Table 8: Impact of Nonaccrual Loans on Net Interest Income
 
 
For the Three Months Ended September 30,  
 
 
For the Nine Months Ended September 30,  
 
 
2012
 
 
2011
 
 
2012
 
 
2011
 
Interest Income not Recognized for Nonaccrual Loans(1)
 
Reduction in Net Interest Yield(2)
 
Interest Income not Recognized for Nonaccrual Loans(1)
 
Reduction in Net Interest Yield(2)
 
Interest Income not Recognized for Nonaccrual Loans(1)
 
Reducti