10-Q 1 w74938e10vq.htm 10-Q e10vq
 
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 June 30, 2009
 
OR
     
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
    For the transition period from          to          
 
 
Commission File No.: 0-50231
 
 
Federal National Mortgage Association
(Exact name of registrant as specified in its charter)
 
 
Fannie Mae
 
 
     
Federally chartered corporation   52-0883107
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)
     
3900 Wisconsin Avenue, NW
Washington, DC
(Address of principal executive offices)
  20016
(Zip Code)
 
 
Registrant’s telephone number, including area code:
(202) 752-7000
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  þ Accelerated filer  o
Non-accelerated filer  o     (Do not check if a smaller reporting company) Smaller reporting company  o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
As of June 30, 2009, there were 1,112,020,933 shares of common stock of the registrant outstanding.
 


 

 
TABLE OF CONTENTS
 
                 
    1  
      Financial Statements     118  
        Condensed Consolidated Balance Sheets     118  
        Condensed Consolidated Statements of Operations     119  
        Condensed Consolidated Statements of Cash Flows     120  
        Condensed Consolidated Statements of Changes in Equity (Deficit)     121  
          Note 1— Organization and Conservatorship     122  
          Note 2— Summary of Significant Accounting Policies     124  
          Note 3— Consolidations     132  
          Note 4— Mortgage Loans     136  
          Note 5— Allowance for Loan Losses and Reserve for Guaranty Losses     139  
          Note 6— Investments in Securities     140  
          Note 7— Portfolio Securitizations     146  
          Note 8— Financial Guarantees and Master Servicing     151  
          Note 9— Acquired Property, Net     157  
          Note 10—Short-term Borrowings and Long-term Debt     158  
          Note 11—Derivative Instruments and Hedging Activities     160  
          Note 12—Income Taxes     166  
          Note 13—Loss Per Share     168  
          Note 14—Employee Retirement Benefits     169  
          Note 15—Segment Reporting     169  
          Note 16—Regulatory Capital Requirements     173  
          Note 17—Concentrations of Credit Risk     174  
          Note 18—Fair Value of Financial Instruments     176  
          Note 19—Commitments and Contingencies     192  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations     1  
        Introduction     1  
        Executive Summary     2  
        Legislative and Regulatory Matters     17  
        Critical Accounting Policies and Estimates     20  
        Consolidated Results of Operations     27  
        Business Segment Results     44  
        Consolidated Balance Sheet Analysis     50  
        Supplemental Non-GAAP Information—Fair Value Balance Sheets     61  
        Liquidity and Capital Management     66  
        Off-Balance Sheet Arrangements and Variable Interest Entities     79  
        Risk Management     81  
        Impact of Future Adoption of New Accounting Pronouncements     113  
        Forward-Looking Statements     113  
      Quantitative and Qualitative Disclosures About Market Risk     198  
      Controls and Procedures     198  


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    201  
      Legal Proceedings     201  
      Risk Factors     203  
      Unregistered Sales of Equity Securities and Use of Proceeds     214  
      Defaults Upon Senior Securities     216  
      Submission of Matters to a Vote of Security Holders     216  
      Other Information     216  
      Exhibits     216  


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MD&A TABLE REFERENCE
 
             
Table
 
Description
  Page
 
1
  Credit Statistics, Single-Family Guaranty Book of Business     5  
2
  Level 3 Recurring Financial Assets at Fair Value     23  
3
  Summary of Condensed Consolidated Results of Operations and Performance Metrics     27  
4
  Analysis of Net Interest Income and Yield     29  
5
  Rate/Volume Analysis of Net Interest Income     30  
6
  Guaranty Fee Income and Average Effective Guaranty Fee Rate     32  
7
  Fair Value Gains (Losses), Net     34  
8
  Derivatives Fair Value Gains (Losses), Net     35  
9
  Credit-Related Expenses     37  
10
  Allowance for Loan Losses and Reserve for Guaranty Losses (Combined Loss Reserves)     38  
11
  Statistics on Acquired Loans from MBS Trusts Subject to SOP 03-3     40  
12
  Credit Loss Performance Metrics     41  
13
  Single-Family Credit Loss Sensitivity     43  
14
  Single-Family Business Results     45  
15
  HCD Business Results     47  
16
  Capital Markets Group Results     48  
17
  Mortgage Portfolio Activity     50  
18
  Mortgage Portfolio Composition     52  
19
  Trading and Available-for-Sale Investment Securities     54  
20
  Investments in Private-Label Mortgage-Related Securities, Excluding Wraps, and Mortgage Revenue Bonds     55  
21
  Analysis of Losses on Alt-A and Subprime Private-Label Mortgage-Related Securities, Excluding Wraps     57  
22
  Credit Statistics of Loans Underlying Alt-A and Subprime Private-Label Mortgage-Related Securities, Including Wraps     58  
23
  Changes in Risk Management Derivative Assets (Liabilities) at Fair Value, Net     60  
24
  Comparative Measures—GAAP Consolidated Balance Sheets and Non-GAAP Fair Value Balance Sheets     61  
25
  Supplemental Non-GAAP Consolidated Fair Value Balance Sheets     64  
26
  Change in Fair Value of Net Assets (Net of Tax Effect)     66  
27
  Debt Activity     68  
28
  Outstanding Short-Term Borrowings and Long-Term Debt     70  
29
  Maturity Profile of Outstanding Short-Term Debt     71  
30
  Maturity Profile of Outstanding Long-Term Debt     72  
31
  Cash and Other Investments Portfolio     75  
32
  Fannie Mae Credit Ratings     76  
33
  Regulatory Capital Measures     77  
34
  On- and Off-Balance Sheet MBS and Other Guaranty Arrangements     80  
35
  Composition of Mortgage Credit Book of Business     83  
36
  Risk Characteristics of Conventional Single-Family Business Volume and Mortgage Credit Book of Business     84  
37
  Exposure to Selected Mortgage Product Features     88  
38
  Delinquency Status of Conventional Single-Family Loans     89  


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PART I—FINANCIAL INFORMATION
 
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
We have been under conservatorship, with the Federal Housing Finance Agency (“FHFA”) acting as conservator, since September 6, 2008. As conservator, FHFA succeeded to all rights, titles, powers and privileges of the company, and of any shareholder, officer or director of the company with respect to the company and its assets. The conservator has since delegated specified authorities to our Board of Directors and has delegated to management the authority to conduct our day-to-day operations. We describe the rights and powers of the conservator, the provisions of our agreements with the U.S. Department of Treasury (“Treasury”), and changes to our business, liquidity, corporate structure, business strategies and objectives since conservatorship in our Annual Report on Form 10-K for the year ended December 31, 2008 (“2008 Form 10-K”) in “Part I—Item 1—Business” and in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2009 (“First Quarter 2009 Form 10-Q”) in “Part I—Item 2—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Executive Summary.”
 
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 contained in our 2008 Form 10-K. This discussion contains forward-looking statements that are based upon management’s current expectations and are subject to significant uncertainties and changes in circumstances. Our actual results may differ materially from those included in these forward-looking statements due to a variety of factors including, but not limited to, those described in this report in “Part II—Item 1A—Risk Factors” and in our 2008 Form 10-K in “Part I—Item 1A—Risk Factors.”
 
Please also refer to our 2008 Form 10-K in “Part I—Item 7—MD&A—Glossary of Terms Used in This Report” for an explanation of terms we use in this report.
 
INTRODUCTION
 
Fannie Mae is a government-sponsored enterprise (“GSE”) that was chartered by Congress in 1938. Fannie Mae has a public mission to support liquidity and stability in the secondary mortgage market, where existing mortgage loans are purchased and sold. We securitize mortgage loans originated by lenders in the primary mortgage market into mortgage-backed securities that we refer to as Fannie Mae MBS, which can then be bought and sold in the secondary mortgage market. We also participate in the secondary mortgage market by purchasing mortgage loans (often referred to as “whole loans”) and mortgage-related securities, including our own Fannie Mae MBS, for our mortgage portfolio. In addition, we make other investments that increase the supply of affordable housing. Under our charter, we may not lend money directly to consumers in the primary mortgage market. Although we are a corporation chartered by the U.S. Congress, and although our conservator is a U.S. government agency and Treasury owns our senior preferred stock and a warrant to purchase our common stock, the U.S. government does not guarantee, directly or indirectly, our securities or other obligations.


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EXECUTIVE SUMMARY
 
Our Mission
 
In connection with our public mission to support liquidity and stability in the secondary mortgage market, and in addition to the investments we undertake to increase the supply of affordable housing, FHFA, as our conservator, and the Obama Administration have given us an important role in addressing housing and mortgage market conditions. As we discuss below in “Our Business Objectives and Strategy,” “Homeowner Assistance Initiatives” and “Providing Mortgage Market Liquidity,” pursuant to our mission, we are concentrating our efforts on keeping people in their homes and preventing foreclosures while continuing to support liquidity and stability in the secondary mortgage market.
 
Our Business Objectives and Strategy
 
Our Board of Directors and management consult with our conservator in establishing our strategic direction, taking into consideration our role in addressing housing and mortgage market conditions, and FHFA has approved our business objectives.
 
We face a variety of different, and potentially conflicting, objectives, including:
 
  •  providing liquidity, stability and affordability in the mortgage market;
 
  •  immediately providing additional assistance to the mortgage market and to the struggling housing market;
 
  •  limiting the amount of the investment Treasury must make under our senior preferred stock purchase agreement with Treasury in order to eliminate a net worth deficit;
 
  •  returning to long-term profitability; and
 
  •  protecting the interests of the taxpayers.
 
We therefore regularly consult with and receive direction from our conservator on how to balance these objectives. Our pursuit of our mission creates conflicts in strategic and day-to-day decision-making that could hamper achievement of some or all of these objectives. Our financial results are likely to suffer, at least in the short term, as we expand our efforts to assist the mortgage market, thereby increasing the amount of funds that Treasury is required to provide to us and further limiting our ability to return to long-term profitability.
 
Pursuant to our mission, we currently are concentrating our efforts on keeping people in their homes and preventing foreclosures. We also are continuing our significant role in the secondary mortgage market through our guaranty business. These efforts are intended to support liquidity and affordability in the mortgage market, while we also work to implement foreclosure prevention programs. Currently, one of the principal ways in which we are pursuing these efforts is through our participation in the Obama Administration’s Making Home Affordable Program. We provide an update on our participation in the Making Home Affordable Program below.
 
Concentrating our efforts on keeping people in their homes and preventing foreclosures while continuing to be active in the secondary mortgage market, rather than concentrating solely on returning to long-term profitability, is likely to contribute, at least in the short term, to additional financial losses and declines in our net worth. Continuing deterioration in the housing and mortgage markets, along with the continuing deterioration in our book of business and the costs associated with these efforts pursuant to our mission, will increase the amount of funds that Treasury is required to provide to us. In turn, these factors put additional pressure on our ability to return to long-term profitability. If, however, the Making Home Affordable Program is successful in reducing foreclosures and keeping borrowers in their homes, it may benefit the overall housing market and help in reducing our long-term credit losses.


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Obama Administration Financial Regulatory Reform Plan
 
In June 2009, the Obama Administration announced a comprehensive financial regulatory reform plan. The Administration’s white paper describing the plan notes that “[w]e need to maintain the continued stability and strength of the GSEs during these difficult financial times.” Although the white paper does not include proposals for reform of Fannie Mae, Freddie Mac and the Federal Home Loan Bank system, the Administration has stated that it expects to provide its recommendations in February 2010. See “Legislative and Regulatory Matters—Obama Administration Financial Regulatory Reform Plan and Congressional Hearing” for more information, including a list of possible reform options for the GSEs outlined in the Administration’s white paper.
 
Housing and Mortgage Market and Economic Conditions
 
The U.S. residential mortgage market continued to deteriorate in the second quarter of 2009, which adversely affected our financial condition and results of operations. While housing activity, as measured by sales, stabilized in the second quarter of 2009, the number of mortgage delinquencies and mortgage foreclosures continued to increase.
 
We estimate that home prices on a national basis declined in the first quarter of 2009, but increased slightly in the second quarter of 2009, resulting in an estimated home price decline of 2.2% for the first half of 2009. Although the increase in home prices in the second quarter of 2009 was broad-based, with increases in approximately 75% of large metropolitan statistical areas, the second quarter typically is the highest growth quarter of the year because it is the peak home buying season. Accordingly, as described in “Outlook,” we believe that home prices will decline from current levels in the second half of 2009. We estimate that home prices on a national basis have declined by 16.1% from their peak in the third quarter of 2006. Our home price estimates are based on preliminary data and are subject to change as additional data become available.
 
The economic recession that began in December 2007 continued in the second quarter. The U.S. gross domestic product, or GDP, declined by 1.0% in the second quarter of 2009, compared with a decline of 6.4% in the first quarter of 2009. The U.S. has lost a net total of 6.46 million jobs since the start of the recession. The U.S. Bureau of Labor Statistics reported successive increases in the unemployment rate in each month of the second quarter, reaching 9.5% in June. High levels of unemployment and severe declines in home prices have contributed to a continued increase in residential mortgage delinquencies.
 
The number of single-family unsold homes in inventory increased in the second quarter of 2009 as compared to the first quarter, and the supply of homes as measured by the inventory/sales ratio remains high. In addition, we believe there are a considerable number of foreclosed homes that are not yet on the market, as well as a large number of seriously delinquent loans that will be foreclosed upon. These homes are likely to contribute to a significant increase in the market supply of single-family homes in the future.
 
The National Association of Realtors reported in June 2009 that existing home sales increased in the second quarter of 2009 to roughly the same level they were in the fourth quarter of 2008. Although affordability measures have risen dramatically as home prices have declined from their peak, the limited availability of conventional financing for many potential homebuyers, low consumer confidence and adverse economic conditions have kept purchase activity at historically low levels. However, on a seasonally adjusted basis, single-family housing starts, new home sales, and existing home sales were all higher in June of this year than in March.
 
In addition, multifamily housing fundamentals are under increasing stress, reflecting broader unfavorable economic conditions, including higher unemployment and severely restricted capital. These conditions are negatively affecting multifamily property level cash flows, vacancy rates and rent levels. Property values are declining due to both the downward pressure on cash flows and the higher premium required by investors. In addition, as some multifamily loans begin reaching maturity during the next several years, some portion of those loans may be exposed to refinancing risk.
 
As of March 31, 2009, the latest date for which information was available, the amount of U.S. residential mortgage debt outstanding was estimated by the Federal Reserve to be approximately $11.9 trillion, including


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$11.0 trillion of single-family mortgages. Total U.S. residential mortgage debt outstanding decreased by 0.2% in the first quarter of 2009 on an annualized basis, compared with an increase of 2.7% in the first quarter of 2008. Our mortgage credit book of business, which consists of the mortgage loans and mortgage-related securities we hold in our investment portfolio, Fannie Mae MBS held by third parties and other credit enhancements that we provide on mortgage assets, was $3.1 trillion as of March 31, 2009, or approximately 26.3% of total U.S. residential mortgage debt outstanding. See “Part I—Item 1A—Risk Factors” of our 2008 Form 10-K for a description of risks to our business associated with the housing market downturn and continued home price declines.
 
Summary of Our Financial Results and Condition for the Second Quarter and First Six Months of 2009
 
Our financial results and condition for the second quarter and first six months of 2009 were adversely affected by the ongoing deterioration in the housing and mortgage markets, the economic recession and rising unemployment.
 
Consolidated Results of Operations
 
Quarterly Results
 
We recorded a net loss of $14.8 billion and a diluted loss per share of $2.67 for the second quarter of 2009. Our net loss was driven by significant credit-related expenses, which totaled $18.8 billion in the second quarter, and more than offset our net revenues of $5.6 billion generated from net interest income and guaranty fee income, and $823 million in fair value gains.
 
In comparison, we recorded a net loss of $23.2 billion and a diluted loss per share of $4.09 for the first quarter of 2009, which was primarily due to credit-related expenses of $20.9 billion, other-than-temporary impairment losses of $5.7 billion and fair value losses of $1.5 billion, which more than offset our net revenues of $5.2 billion. Our net loss of $2.3 billion and diluted loss per share of $2.54 for the second quarter of 2008 reflected credit-related expenses of $5.3 billion that more than offset our net revenues of $4.0 billion and $517 million in fair value gains.
 
The $8.4 billion decrease in our net loss for the second quarter of 2009 from the first quarter of 2009 was driven principally by: a substantial decrease in other-than-temporary impairment, a significant portion of which was attributable to a change in the accounting standard relating to the assessment of other-than-temporary impairment; a reduction in credit-related expenses; and a shift to fair value gains from fair value losses in the first quarter of 2009.
 
The $12.5 billion increase in our net loss for the second quarter of 2009 from the second quarter of 2008 was driven principally by a $13.4 billion increase in credit-related expenses that more than offset a $1.7 billion increase in net interest income.
 
Year-to-Date Results
 
We recorded a net loss attributable to Fannie Mae of $37.9 billion and a diluted loss per share of $6.76 for the first six months of 2009, driven primarily by credit-related expenses of $39.7 billion and other-than-temporary impairment of $6.4 billion that more than offset our net revenues of $10.8 billion. In comparison, we recorded a net loss attributable to Fannie Mae of $4.5 billion and a diluted loss per share of $5.11 for the first six months of 2008, driven primarily by $8.6 billion in credit-related expenses and $3.9 billion in fair value losses that more than offset our net revenues of $7.7 billion.
 
The $33.4 billion increase in our net loss for the first six months of 2009 from the first six months of 2008 was driven principally by a $31.1 billion increase in credit-related expenses, coupled with a $5.8 billion increase in other-than-temporary impairment, that more than offset a $3.2 billion increase in net interest income and a $3.2 billion decrease in fair value losses.


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Credit Overview
 
Table 1 below presents information about the credit performance of mortgage loans in our single-family guaranty book of business for each quarter of 2008 and the first two quarters of 2009, illustrating the worsening trend in performance throughout 2008 and continuing in the first half of 2009.
 
Table 1:  Credit Statistics, Single-Family Guaranty Book of Business(1)
 
                                                                 
    2009     2008  
    Q2 YTD     Q2     Q1     Full Year     Q4     Q3     Q2     Q1  
    (Dollars in millions)  
 
As of the end of each period:
                                                               
Serious delinquency rate(2)
    3.94 %     3.94 %     3.15 %     2.42 %     2.42 %     1.72 %     1.36 %     1.15 %
On-balance sheet nonperforming loans(3)
  $ 26,300     $ 26,300     $ 23,145     $ 20,484     $ 20,484     $ 14,148     $ 11,275     $ 10,947  
Off-balance sheet nonperforming loans(4)
  $ 144,183     $ 144,183     $ 121,378     $ 98,428     $ 98,428     $ 49,318     $ 34,765     $ 23,983  
Combined loss reserves(5)
  $ 54,152     $ 54,152     $ 41,082     $ 24,649     $ 24,649     $ 15,528     $ 8,866     $ 5,140  
Foreclosed property inventory (number of properties)(6)
    62,615       62,615       62,371       63,538       63,538       67,519       54,173       43,167  
During the period:
                                                               
Loan modifications (number of loans)(7)
    29,130       16,684       12,446       33,388       6,313       5,291       10,229       11,555  
HomeSaver Advance problem loan workouts (number of loans)(8)
    32,093       11,662       20,431       70,967       25,788       27,278       16,749       1,152  
Foreclosed property acquisitions (number of properties)(9)
    57,469       32,095       25,374       94,652       20,998       29,583       23,963       20,108  
Single-family credit-related expenses (10)
  $ 38,721     $ 18,391     $ 20,330     $ 29,725     $ 11,917     $ 9,215     $ 5,339     $ 3,254  
Single-family credit losses(11)
  $ 5,766     $ 3,301     $ 2,465     $ 6,467     $ 2,197     $ 2,164     $ 1,249     $ 857  
 
 
  (1) The single-family guaranty book of business consists of single-family mortgage loans held in our mortgage portfolio, single-family Fannie Mae MBS held in our mortgage portfolio, single-family Fannie Mae MBS held by third parties, and other credit enhancements that we provide on single-family mortgage assets. It excludes non-Fannie Mae mortgage-related securities held in our investment portfolio for which we do not provide a guaranty.
 
  (2) Calculated based on number of conventional single-family loans that are three or more months past due and loans that have been referred to foreclosure but not yet foreclosed upon, divided by the number of loans in our conventional single-family guaranty book of business. We include all of the conventional single-family loans that we own and those that back Fannie Mae MBS in the calculation of the single-family serious delinquency rate.
 
  (3) Represents the total amount of nonaccrual loans, troubled debt restructurings, and first-lien loans associated with unsecured HomeSaver Advance loans including troubled debt restructurings and HomeSaver Advance first-lien loans on accrual status. A troubled debt restructuring is a restructuring of a mortgage loan in which a concession is granted to a borrower experiencing financial difficulty. Prior to the fourth quarter of 2008, we generally classified loans as nonperforming when the payment of principal or interest on the loan was three months or more past due. In the fourth quarter of 2008, we began classifying loans as nonperforming at an earlier stage in the delinquency cycle, generally when the payment of principal or interest on the loan is two months or more past due.
 
  (4) Represents unpaid principal balance of nonperforming loans in our outstanding and unconsolidated Fannie Mae MBS held by third parties, including first-lien loans associated with unsecured HomeSaver Advance loans that are not seriously delinquent. Prior to the fourth quarter of 2008, we generally classified loans as nonperforming when the payment of principal or interest on the loan was three months or more past due. In the fourth quarter of 2008, we began classifying loans as nonperforming at an earlier stage in the delinquency cycle, generally when the payment of principal or interest on the loan is two months or more past due. Loans have been classified as nonperforming according to the classification standard in effect at the time the loan became a nonperforming loan, and prior periods have not been revised to reflect changes in classification.
 
  (5) Consists of the allowance for loan losses for loans held for investment in our mortgage portfolio and reserve for guaranty losses related to both loans backing Fannie Mae MBS and loans that we have guaranteed under long-term standby commitments.


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  (6) Reflects the number of single-family foreclosed properties we held in inventory as of the end of each period. Includes properties we acquired through deeds in lieu of foreclosure.
 
  (7) Modifications are granted for borrowers experiencing financial difficulty and include troubled debt restructurings as well as other modifications to the terms of the loan. A troubled debt restructuring of a mortgage loan is a restructuring in which a concession is granted to the borrower. It is the only form of modification in which we agree to accept less than the full original contractual principal and interest amount due under the loan, although other resolutions and modifications may result in our receiving the full amount due, or certain installments due, under the loan over a period of time that is longer than the period of time originally provided for under the terms of the loans.
 
  (8) Represents number of first-lien loans associated with unsecured HomeSaver Advance loans.
 
  (9) Includes deeds in lieu of foreclosure.
 
(10) Consists of the provision for credit losses and foreclosed property expense.
 
(11) Consists of (a) charge-offs, net of recoveries and (b) foreclosed property expense; adjusted to exclude the impact of SOP 03-3 and HomeSaver Advance fair value losses for the reporting period. Interest forgone on single-family nonperforming loans in our mortgage portfolio is not reflected in our credit losses total. In addition, we exclude other-than-temporary impairment losses resulting from deterioration in the credit quality of our mortgage-related securities and accretion of interest income on single-family loans subject to Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”), from credit losses. See “Consolidated Results of Operations—Credit-Related Expenses—Provision Attributable to SOP 03-3 and HomeSaver Advance Fair Value Losses” for a discussion of SOP 03-3.
 
As shown in Table 1 above, we continued to experience deterioration in the credit performance of mortgage loans in our guaranty book of business throughout the second quarter of 2009, reflecting the ongoing impact of the adverse conditions in the housing market, as well as the economic recession and rising unemployment. See “Housing and Mortgage Market and Economic Conditions” above for more detailed information regarding these conditions. We expect these conditions to continue to adversely affect our credit results in 2009 and into 2010.
 
We increased our single-family loss reserves to $54.2 billion as of June 30, 2009, or 31.76% of the amount of our single-family nonperforming loans, from $41.1 billion as of March 31, 2009, or 28.43% of the amount of our nonperforming loans, and $24.6 billion as of December 31, 2008, or 20.73% of the amount of our nonperforming loans. The increase in our loss reserves in the second quarter and first six months of 2009 reflected the continued deterioration in the overall credit performance of loans in our guaranty book of business, as evidenced by the significant increase in delinquent, seriously delinquent and nonperforming loans. In addition, our average loss severity, or average initial charge-off per default, increased as a result of the decline in home prices during the first half of 2009. We recorded a lower provision for credit losses in the second quarter of 2009 than in the first quarter of 2009, however, due to a slower rate of increase in both our estimated default rate and average loss severity as compared with the prior quarter.
 
We are experiencing increases in delinquency and default rates for our entire guaranty book of business, including on loans with fewer risk layers. Risk layering is the combination of risk characteristics that could increase the likelihood of default, such as higher loan-to-value ratios, lower FICO credit scores, higher debt-to-income ratios and adjustable-rate mortgages. This general deterioration in our guaranty book of business is a result of the stress on a broader segment of borrowers due to the rise in unemployment and the decline in home prices. Certain loan categories continue to contribute disproportionately to the increase in nonperforming loans and credit losses for the second quarter and first six months of 2009. These categories include: loans on properties in the Midwest, California, Florida, Arizona and Nevada; loans originated in 2006 and 2007; and loans related to higher-risk product types, such as Alt-A loans. The term “Alt-A loans” generally refers to mortgage loans that can be underwritten with reduced or alternative documentation than that required for a full documentation mortgage loan but may also include other alternative product features. In reporting our credit exposure, we classify mortgage loans as Alt-A if the lenders that delivered the mortgage loans to us classified the loans as Alt-A based on documentation or other product features. See “Risk Management—Credit Risk Management—Mortgage Credit Risk Management—Mortgage Credit Book of Business” for more detailed information on the risk profile and the performance of the loans in our mortgage credit book of business.
 
Current market and economic conditions have also adversely affected the liquidity and financial condition of many of our institutional counterparties, particularly mortgage insurers and mortgage servicers, which has


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significantly increased the risk to our business of defaults by these counterparties due to bankruptcy or receivership, lack of liquidity, insufficient capital, operational failure or other reasons. See “Risk Management—Credit Risk Management—Institutional Counterparty Credit Risk Management” for more information about our institutional counterparty credit risk.
 
Consolidated Balance Sheet
 
Total assets of $911.4 billion as of June 30, 2009 decreased by $1.0 billion, or 0.1%, from December 31, 2008. Total liabilities of $922.0 billion decreased by $5.6 billion, or 0.6%, from December 31, 2008. Total Fannie Mae stockholders’ deficit decreased by $4.6 billion during the first six months of 2009, to a deficit of $10.7 billion as of June 30, 2009 from a deficit of $15.3 billion as of December 31, 2008. The decrease in total Fannie Mae stockholders’ deficit was attributable to the $34.2 billion in funds received from Treasury under the senior preferred stock purchase agreement, $5.9 billion in unrealized gains on available-for-sale securities and a $3.0 billion reduction in our accumulated deficit to reverse a portion of our deferred tax asset valuation allowance in conjunction with our April 1, 2009 adoption of the new accounting guidance for assessing other-than-temporary impairment, partially offset by our net loss attributable to Fannie Mae of $37.9 billion for the first six months of 2009.
 
Our mortgage credit book of business increased to $3.2 trillion as of June 30, 2009, from $3.1 trillion as of December 31, 2008 as our market share of mortgage-related securities issuance remained high and new business acquisitions outpaced liquidations. Our estimated market share of new single-family mortgage-related securities issuance was 53.5% for the second quarter of 2009, compared with 44.2% for the first quarter of 2009. As described in “Liquidity and Capital Management—Liquidity Contingency Planning—Unencumbered Mortgage Portfolio,” we securitized approximately $94.6 billion of whole loans held for investment in our mortgage portfolio into Fannie Mae MBS in the second quarter of 2009 in order to hold these assets in a more liquid form. These Fannie Mae MBS were retained in our mortgage portfolio and consolidated on our consolidated condensed balance sheets, rather than issued to third parties. Excluding these Fannie Mae MBS from both Fannie Mae and total market mortgage-related securities issuance volumes, our estimated market share of new single-family mortgage-related securities issuance was 44.5% for the second quarter of 2009. We did not issue Fannie Mae MBS backed by whole loans held for investment in our mortgage portfolio in the first quarter of 2009. Fannie Mae was the largest single issuer of mortgage-related securities in the secondary market in the second quarter of 2009.
 
We provide more detailed discussions of key factors affecting changes in our results of operations and financial condition in “Consolidated Results of Operations,” “Business Segment Results,” “Consolidated Balance Sheet Analysis,” “Supplemental Non-GAAP Information—Fair Value Balance Sheets,” and “Risk Management—Credit Risk Management—Mortgage Credit Risk Management—Mortgage Credit Book of Business.”
 
Net Worth Deficit
 
We had an estimated net worth deficit of $10.6 billion as of June 30, 2009, compared with a net worth deficit of $18.9 billion as of March 31, 2009 and $15.2 billion as of December 31, 2008. This net worth deficit equals the total deficit that we report in our condensed consolidated balance sheets, and is calculated by subtracting our total liabilities from our total assets, each as shown on our condensed consolidated balance sheets prepared in accordance with generally accepted accounting principles (“GAAP”) for that fiscal quarter.
 
Under the Federal Housing Finance Regulatory Reform Act (“Regulatory Reform Act”), FHFA must place us into receivership if the Director of FHFA makes a written determination that our assets are, and during the preceding 60 days have been, less than our obligations. FHFA has notified us that the measurement period for such a determination begins no earlier than the date of the SEC filing deadline for our quarterly and annual financial statements and continues for a period of 60 days after that date. FHFA also has advised us that, if we receive funds from Treasury during that 60-day period in order to eliminate our net worth deficit as of the prior period end in accordance with the senior preferred stock purchase agreement, the Director of FHFA will not make a mandatory receivership determination.


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Under the senior preferred stock purchase agreement that was entered into between us and Treasury in September 2008 and amended in May 2009, Treasury committed to provide us with funds of up to $200 billion under specified conditions. The agreement requires Treasury, upon the request of our conservator, to provide funds to us after any quarter in which we have a negative net worth (that is, our total liabilities exceed our total assets, as reflected on our GAAP balance sheet). The senior preferred stock purchase agreement does not terminate as of a particular time; however, we may no longer obtain new funds under the agreement once we have received a total of $200 billion under the agreement.
 
All references to the senior preferred stock purchase agreement in this report are to the agreement as amended in May 2009. We describe the terms of the May 2009 amendment to the senior preferred stock purchase agreement in our First Quarter 2009 Form 10-Q in “Part I—Item 2—MD&A—Executive Summary—Amendment to Senior Preferred Stock Purchase Agreement” and we describe the terms of the agreement prior to its May 2009 amendment, most of which continue to apply, in our 2008 Form 10-K in “Part I—Item 1—Business—Conservatorship, Treasury Agreements, Our Charter and Regulation of Our Activities—Treasury Agreements.”
 
On March 31, 2009, we received $15.2 billion from Treasury under the senior preferred stock purchase agreement, which eliminated our net worth deficit as of December 31, 2008. We received an additional $19.0 billion from Treasury on June 30, 2009, which eliminated our net worth deficit as of March 31, 2009. The Director of FHFA submitted a request to Treasury on August 6, 2009 for an additional $10.7 billion on our behalf to eliminate our net worth deficit as of June 30, 2009, and requested receipt of those funds on or prior to September 30, 2009.
 
Upon receipt of these funds from Treasury, the aggregate liquidation preference of our senior preferred stock will total $45.9 billion and the annualized dividend on the senior preferred stock will be $4.6 billion, based on the 10% dividend rate. This dividend obligation exceeds our reported annual net income for four of the past seven years and will contribute to increasingly negative cash flows in future periods if we continue to pay the dividends on a quarterly basis. If we do not pay the dividend quarterly and in cash, the dividend rate would increase to 12% annually, and the unpaid dividend would accrue and be added to the liquidation preference of the senior preferred stock, further increasing the amount of the annual dividends.
 
Due to current trends in the housing and financial markets, we expect to have a net worth deficit in future periods, and therefore will be required to obtain additional funding from Treasury pursuant to the senior preferred stock purchase agreement. As a result, we are dependent on the continued support of Treasury in order to continue operating our business. Our ability to access funds from Treasury under the senior preferred stock purchase agreement is critical to keeping us solvent and avoiding the appointment of a receiver by FHFA under statutory mandatory receivership provisions.
 
Our senior preferred stock dividend obligation, combined with potentially substantial commitment fees payable to Treasury starting in 2010 (the amounts of which have not yet been determined) and our effective inability to pay down draws under the senior preferred stock purchase agreement, will have a significant adverse impact on our future financial position and net worth. See “Part II—Item 1A—Risk Factors” for more information on the risks to our business posed by our dividend obligations under the senior preferred stock purchase agreement.
 
Fair Value Deficit
 
Our fair value deficit as of June 30, 2009, which is reflected in our supplemental non-GAAP fair value balance sheet, was $102.0 billion, compared with a deficit of $110.3 billion as of March 31, 2009 and $105.2 billion as of December 31, 2008.
 
The fair value of our net assets, including capital transactions, increased by $3.1 billion during the first six months of 2009. Included in this increase was $34.2 billion of capital received from Treasury under the senior preferred stock purchase agreement. The fair value of our net assets, excluding capital transactions, decreased by $30.6 billion during the first six months of 2009. This decrease reflected the adverse impact on our net guaranty assets from the continued weakness in the housing market and increases in unemployment resulting


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from the economic recession, which contributed to a significant increase in the fair value of our guaranty obligations. We experienced a favorable impact on the fair value of our net assets attributable to an increase in the fair value of our net portfolio primarily due to changes in the net spread between our mortgage assets and our debt.
 
The amount that Treasury has committed to provide us under the senior preferred stock purchase agreement is determined based on our GAAP balance sheet, not our non-GAAP fair value balance sheet. There are significant differences between our GAAP balance sheet and our non-GAAP fair value balance sheet, which we describe in greater detail in “Supplemental Non-GAAP Information—Fair Value Balance Sheets.”
 
Significance of Net Worth Deficit, Fair Value Deficit and Combined Loss Reserves
 
Our net worth deficit, which equals our total deficit as reported on our consolidated GAAP balance sheet, includes the combined loss reserves of $55.1 billion that we recorded in our consolidated balance sheet as of June 30, 2009. Our non-GAAP fair value balance sheet presents all of our assets and liabilities at estimated fair value as of the balance sheet date. “Fair value” represents the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date, which is also referred to as the “exit price.” In determining fair value, we use a variety of valuation techniques and processes. In general, fair value incorporates the market’s current view of the future, and that view is reflected in the current price of the asset or liability. However, future market conditions may be different from what the market has currently estimated and priced into these fair value measures. We describe our use of assumptions and management judgment and our valuation techniques and processes for determining fair value in more detail in “Supplemental Non-GAAP information—Fair Value Balance Sheets,” “Critical Accounting Policies and Estimates—Fair Value of Financial Instruments” and “Notes to Condensed Consolidated Financial Statements—Note 18, Fair Value of Financial Instruments.”
 
Our combined GAAP loss reserves reflect probable losses that we believe we have already incurred as of the balance sheet date. In contrast, the fair value of our guaranty obligation is based not only on future expected credit losses over the life of the loans underlying our guarantees as of June 30, 2009, but also on the estimated profit that a market participant would require to assume that guaranty obligation.
 
Accounting Developments
 
Elimination of QSPEs and Changes in the Consolidation of Variable Interest Entities
 
In June 2009, the Financial Accounting Standards Board (the “FASB”) issued new accounting standards relating to the elimination of qualified special purpose entities (“QSPEs”) and changes in the consolidation of variable interest entities. We intend to adopt these new accounting standards effective January 1, 2010. The adoption of this new accounting guidance will have a major impact on our consolidated financial statements, including the consolidation of the substantial majority of our MBS trusts. Accordingly, we will record the underlying loans in these trusts on our balance sheet. The outstanding unpaid principal balance of our MBS trusts was approximately $2.8 trillion as of June 30, 2009. In addition, consolidation of these MBS trusts will have a material impact on our statements of operations and cash flows, including a significant increase in our interest income, interest expense and cash flows from investing and financing activities. We continue to evaluate the impact of the adoption of this new accounting guidance, including the impact on our net worth and capital. We also are in the process of making major operational and system changes to implement these new standards by the effective date.
 
Change in Assessment of Other-Than-Temporary Impairment
 
In April 2009, the FASB issued a new accounting standard that changed the accounting guidance for assessing other-than-temporary impairment for investments in debt securities. In connection with our adoption of this guidance on April 1, 2009, we recorded a cumulative-effect adjustment at April 1, 2009 of $8.5 billion on a pre-tax basis ($5.6 billion after tax) to reclassify the noncredit portion of previously recognized other-than-temporary impairments from “Accumulated deficit” to “Accumulated other comprehensive loss.” Because we have asserted an intent and ability to hold certain of these securities until recovery, we also


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reduced the “Accumulated deficit” and the valuation allowance for the deferred tax asset by $3.0 billion, which is the deferred tax asset amount related to the noncredit portion of the previously recognized other-than-temporary impairments that was reclassified to “Accumulated other comprehensive loss.” The adoption of this accounting standard resulted in $344 million of noncredit related losses for the second quarter of 2009 being recognized in “Other comprehensive loss” instead of being recorded in our condensed consolidated statement of operations, as previously required.
 
See “Critical Accounting Policies and Estimates—Other-Than-Temporary Impairment of Investment Securities,” “Off-Balance Sheet Arrangements and Variable Interest Entities—Elimination of QSPEs and Changes in the FIN 46R Consolidation Model” and “Notes to Condensed Consolidated Financial Statements—Note 2, Summary of Significant Accounting Policies” for further information on these accounting changes.
 
Liquidity
 
In response to the strong demand that we experienced for our debt securities during the first half of 2009, we issued a variety of non-callable and callable debt securities in a wide range of maturities to achieve cost efficient funding and an appropriate debt maturity profile. In particular, we issued a significant amount of long-term debt during this period, which we then used to repay maturing short-term debt and prepay more expensive long-term debt. As a result, our short-term debt decreased as a percentage of our total outstanding debt to 31% as of June 30, 2009 from 38% as of December 31, 2008, and the average interest rate on our long-term debt (excluding debt from consolidations) decreased to 3.81% as of June 30, 2009 from 4.66% as of December 31, 2008.
 
Our debt “roll-over,” or refinancing, risk has significantly declined since November 2008 due to the combination of our improved access to long-term debt funding, improved market conditions, the reduced proportion of our outstanding debt that consists of short-term debt, and our expected reduced debt funding needs in the future. We believe that the improvement in our access to long-term debt funding since November 2008 stems from actions taken by the federal government to support us and the financial markets. Accordingly, we believe that our status as a GSE and continued federal government support of our business and the financial markets is essential to maintaining our access to debt funding, and changes or perceived changes in the government’s support of us or the markets could lead to an increase in our debt roll-over risk in future periods and have a material adverse effect on our ability to fund our operations. Demand for our debt securities could decline in the future if the government does not extend or replace the Treasury credit facility and the Federal Reserve’s agency debt and MBS purchase programs, each of which expire on December 31, 2009, or for other reasons. As of the date of this filing, however, demand for our long-term debt securities continues to be strong.
 
See “Liquidity and Capital Management—Liquidity Management—Debt Funding” for more information on our debt funding activities and “Part II—Item 1A—Risk Factors” of this report and “Part I—Item 1A—Risk Factors” of our 2008 Form 10-K for a discussion of the risks to our business posed by our reliance on the issuance of debt to fund our operations.
 
Homeowner Assistance Initiatives
 
During the second quarter of 2009, we continued our efforts, pursuant to our mission, to help homeowners avoid foreclosure. Much of our effort during the quarter was focused on implementing the Making Home Affordable Program, the details of which were first announced by the Obama Administration on March 4, 2009. That program is designed to significantly expand the number of borrowers who can refinance or modify their mortgages to achieve a monthly payment that is more affordable now and into the future or to obtain a more stable loan product, such as a fixed-rate mortgage loan in lieu of an adjustable-rate mortgage loan. In addition, if it is determined that a borrower is not eligible for a refinance or modification under that program, we will attempt to find another foreclosure alternative solution for the borrower.


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The Making Home Affordable Program
 
Key elements of the Making Home Affordable Program are the Home Affordable Refinance Program and the Home Affordable Modification Program.
 
The Home Affordable Refinance Program provides for us to acquire or guarantee loans that are refinancings of mortgage loans we own or guarantee, and for Freddie Mac to acquire or guarantee loans that are refinancings of mortgage loans that it owns or guarantees. The program is targeted at borrowers who have demonstrated an acceptable payment history on their mortgage loans but may have been unable to refinance due to a decline in home values. We make refinancings under the Home Affordable Refinance Program through our Refi Plustm initiatives, which provide refinance solutions for eligible Fannie Mae loans. To qualify for the Home Affordable Refinance Program, the new mortgage loan must either:
 
  •  reduce the borrower’s monthly principal and interest payment, or
 
  •  provide a more stable loan product.
 
The Home Affordable Modification Program provides for the modification of mortgage loans owned or guaranteed by us or Freddie Mac, as well as other mortgage loans. The program is aimed at helping borrowers whose loan either is currently delinquent or who are at imminent risk of default by modifying their mortgage loan to make their monthly payments more affordable. Under the program, borrowers must satisfy the terms of a trial modification plan for a period of three or four months before the modification of the loan becomes effective. We have advised our servicers that we expect borrowers who are at risk of foreclosure to be evaluated for eligibility under the Home Affordable Modification Program before any other workout alternative is considered. The program is designed to provide a uniform, consistent regime for servicers to use in modifying mortgage loans to prevent foreclosures. For modifications under the program for loans that are not owned or guaranteed by Fannie Mae, we serve as the program administrator for Treasury. More detailed information regarding our role as program administrator for the Home Affordable Modification Program is provided in “Part I—Item 2—MD&A—Executive Summary—Homeowner Assistance and Foreclosure Prevention Initiatives” of our First Quarter 2009 Form 10-Q.
 
Both the Home Affordable Refinance Program and the Home Affordable Modification Program are now in operation. We began accepting delivery of newly refinanced mortgage loans under the Home Affordable Refinance Program on April 1, 2009, and we entered into the first trial modification plans for loans that we own or guarantee in March 2009.
 
We have taken a number of steps since the Home Affordable Refinance Program and the Home Affordable Modification Program were launched in March 2009 to let borrowers know that help may be available to them under the programs. We responded to an average of 7,300 phone calls each week from borrowers inquiring about the Making Home Affordable Program during the second quarter of 2009. During that period, the loan-lookup tool we added to our Web site, which allows borrowers to find out instantly whether we own their loans, was used over three million times. We also have worked with servicers to mail letters to approximately 288,000 Fannie Mae borrowers through July 15, 2009 regarding the possibility of modifying their loans. Together with Treasury, the Department of Housing and Urban Development (“HUD”), NeighborWorks, and Freddie Mac, we are implementing a Making Home Affordable marketing and communications outreach campaign. As part of that campaign, in June we launched a targeted market campaign that over the coming year will cover 40 communities experiencing high levels of foreclosure to raise awareness about the Making Home Affordable Program, educate borrowers about options available to them, prepare them to work more efficiently with their servicers, and help keep them from falling victim to foreclosure prevention scams. The targeted market campaign includes a variety of outreach activities, including distribution of brochures and other informational materials, community partner roundtables, training sessions with local housing counselors, and borrower foreclosure prevention workshops, where HUD-certified housing counselors and mortgage servicers meet one-on-one with borrowers.
 
We have also worked to support servicers who are modifying or refinancing our loans under the Making Home Affordable Program or who are modifying loans that we do not own or guarantee. Servicers face challenges putting in place personnel, training, systems and operations to support the Making Home


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Affordable programs. To help them address these challenges, we have established on-site support for 39 of our top servicers, developed recorded tutorials, and we continue to offer live, Web-based training to servicers. We have also revised Desktop Underwriter® (“DU®”), our proprietary underwriting system that assists lenders in underwriting loans, to permit many refinancings under the Home Affordable Refinance Program to be made using DU.
 
A number of updates have been announced to expand the Making Home Affordable Program since its initial announcement:
 
  •  On April 28, 2009, the Obama Administration announced the Second Lien Modification Program. Under the program when a borrower’s first lien mortgage loan is modified under the Home Affordable Modification Program, a servicer participating in the Second Lien Program will be required to offer either to modify the associated second lien according to a pre-set protocol or to extinguish the second lien mortgage loan in return for a lump sum payment under a pre-set formula determined by Treasury.
 
  •  On May 14, 2009, the Obama Administration announced two new components of the Making Home Affordable Program to help distressed borrowers:
 
  º  The Foreclosure Alternatives Program is aimed at assisting distressed borrowers by promoting alternatives to foreclosure when it is not an option for the borrower to keep the home. The program is designed to mitigate the impact of foreclosure on borrowers and communities by encouraging a “short sale” of the home (in which the borrower, working with the servicer, sells the home for less than the amount owed on the mortgage loan in full satisfaction of the loan) or a transfer of the home by a deed in lieu of foreclosure in cases where a borrower meets the eligibility requirements for a Home Affordable Modification but does not receive a modification offer or cannot maintain the required payments during the trial period or following modification.
 
  º  Home Price Decline Protection Incentives are intended to provide investors with additional incentives for Home Affordable Modifications of loans secured by homes in areas where home prices have recently declined and where investors are concerned that price declines may persist.
 
  •  On May 29, 2009, we announced a 2% limit on the cumulative loan level price adjustments and adverse market delivery charge we apply to loans refinanced through our Refi Plustm initiatives, through which we refinance loans under the Home Affordable Refinance Program. This limit was designed to reduce the cost of refinancing for some borrowers and thereby permit more borrowers to refinance under the program.
 
  •  On June 25, 2009, we announced that we are easing the restrictions on the type of credit enhancement to which an existing loan can be subject, allowing more loans to be eligible for refinancing through the Home Affordable Refinance Program.
 
  •  On July 1, 2009, FHFA authorized Fannie Mae and Freddie Mac to expand the Home Affordable Refinance Program to refinance their existing mortgage loans with an unpaid principal balance of up to 125% of the current value of the property covered by the mortgage loan, instead of the program’s initial 105% limit. We will begin acquiring these mortgage loans on September 1, 2009.
 
Not all of the announced program updates have been implemented at this time. More detailed information regarding the Home Affordable Refinance Program and the Home Affordable Modification Program is provided in “Part I—Item 2—MD&A—Executive Summary—Homeowner Assistance and Foreclosure Prevention Initiatives” of our First Quarter 2009 Form 10-Q.
 
Refinancing Activity
 
With long-term interest rates near record lows at the beginning of the second quarter of 2009, many borrowers took the opportunity to refinance their loans and obtain lower interest rates, a more stable loan product (such as a fixed-rate loan instead of an adjustable-rate loan), a lower monthly payment, or cash. During the second quarter and first six months of 2009, we acquired or guaranteed approximately 843,000 and 1,447,000 loans that were refinancings, including approximately 84,000 loans that represented refinancings in the second


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quarter through our Refi Plus initiatives. On average, during the second quarter of 2009, borrowers who refinanced through our Refi Plus initiatives reduced their monthly mortgage payments by $192. In addition, approximately 6.2% of the total loans refinanced through our Refi Plus initiatives provided the borrowers with a more stable loan product than their prior loan, such as a fixed-rate loan or a fully amortizing loan.
 
We acquired approximately 16,000 loans under the Home Affordable Refinance Program for our portfolio or for securitization during the second quarter of 2009. The pace of our acquisitions under the Home Affordable Refinance Program increased notably in July, with an estimated 16,000 loans acquired during the month. During the early phase of the program, we, along with servicers and other mortgage market participants, including mortgage insurers, took a number of steps—such as modifying systems and operations, and training personnel—that required time to put in place and therefore limited the number of loans that could be refinanced under the program during the second quarter. The number of loans that could be refinanced was also limited by the capacity of lenders to handle the large volume of refinancings generated by record-low rates and by the time it takes to go through the loan origination process from application to closing and delivery. As a result, we expect an increase in refinancings under this program in the third quarter as compared to the second quarter, as second quarter applications are closed and delivered.
 
We believe the most significant factor that will affect the number of borrowers refinancing under the program is mortgage rates. As rates increase, fewer borrowers benefit from refinancing their mortgage loan; as rates decrease, more borrowers benefit from refinancing. The number of borrowers who refinance under the Home Affordable Refinance Program is also likely to be constrained by a number of other factors, including lack of borrower awareness, lack of borrower action to initiate a refinancing, and borrower ineligibility due, for example, to severe home price declines or to borrowers failing to remain current in their mortgage payments. The increase in the maximum loan-to-value (“LTV”) ratio of the refinanced loan to up to 125% of the current value of the property and the increasing awareness of the availability of refinance options will, over time, help to lessen the effects of some of these constraints, but will take time to take effect.
 
Loan Workout Activity
 
During the second quarter of 2009, we continued our efforts to help homeowners avoid foreclosure through a variety of foreclosure alternatives. We refer to actions taken by servicers with a borrower to resolve the problem of delinquent loan payments as “workouts.” During the second quarter and first six months of 2009, we completed approximately 41,000 and 88,000 loan workouts, compared with approximately 124,000 workouts during all of 2008. These amounts do not include trial loan modifications under the Home Affordable Modification Program or repayment and forbearance plans that were initiated but not completed as of June 30, 2009. Loan modifications represented 40% of all workouts during the second quarter of 2009, compared with 27% of workouts during all of 2008. The workouts we completed during the second quarter of 2009 included approximately 17,000 loan modifications; 12,000 loans under our HomeSaver Advancetm program; and 5,000 repayment plans and forbearances completed.
 
During the second quarter, borrowers who accepted offers for modifications under the Home Affordable Modification Program entered three or four month trial periods that must be completed prior to the execution of a modification under the program. Activity during the early stages of the program has been affected by the need to build consumer awareness and by servicers’ success in identifying eligible borrowers and executing trial modification plans. Only a small number of loans had time to complete a trial modification period under the program prior to June 30, 2009.
 
We expect to see increased activity under the program in the coming months as servicers gain experience with the program, borrower awareness grows, and new updates aimed at expanding the program’s reach are implemented. As reported by servicers as part of the Making Home Affordable Program, there have been approximately 85,000 trial modifications started on Fannie Mae loans through July 30, 2009. The number of trial modifications started in July increased notably compared to monthly volumes during the second quarter.


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Factors that have affected and may in the future continue to affect the number of loans modified include the following.
 
  •  Servicer Capacity to Handle a New and Complex Process.  Modifications require servicers to handle a multi-step process that includes identifying loans that are candidates for modification, making contact with the borrower, obtaining current financial information from the borrower, evaluating whether the program is a viable workout option, structuring the terms of the modification, communicating those terms to the borrower, providing the legal documentation, and receiving the borrower’s agreements to both enter the trial period and modify the loan. As with the Home Affordable Refinance Program, during the early phase of the Home Affordable Modification program, servicers took a number of steps to implement the program, such as establishing or modifying systems and operations, and training personnel, that required time to put in place. Many servicers are still increasing their capacity to implement the program by hiring staff, enhancing technology, and changing their processes. Servicers will need to continue to adapt and take actions to implement new program elements as they are introduced to the program in an effort to assist more borrowers. The number of loans ultimately modified under the program depends on the extent to which servicers are able and willing to increase their capacity sufficiently to address the demand for modifications.
 
  •  Borrower Awareness, Initiation and Agreement.  Before a loan can be modified under the program, a borrower must learn of the program, initiate a request for a modification or respond to solicitations to apply for the program, provide current, accurate financial information, agree to the terms of a proposed modification and successfully complete the trial payment period. Many distressed borrowers are reluctant or unwilling even to contact their lenders, as demonstrated by the substantial percentage of foreclosures that are completed without the borrower having ever contacted the lender. Thus, extensive borrower outreach is required to encourage distressed borrowers to initiate a modification.
 
  •  Borrower Inability or Unwillingness to Make Payments Even under a Modified Loan.  Modifications under the Home Affordable Modification Program, or indeed under any program, will not be sufficient to help some borrowers keep their homes, particularly borrowers who have significant non-mortgage debt obligations or who are suffering from loss of income or other life events that impair their ability to maintain their mortgage even if it is modified. Other borrowers, particularly those whose mortgage obligations significantly exceed the value of their homes, may be unwilling to make payments even on a modified mortgage.
 
Our efforts to reach out to borrowers and support servicers, as well as the Obama Administration’s recently announced program expansions, such as the Second Lien Program, are designed to address these factors and maximize the program’s ability to help as many borrowers as possible. We discuss these efforts and program updates above under “The Making Home Affordable Program.”
 
The actions we are taking and the initiatives introduced to assist homeowners and limit foreclosures, including those under the Making Home Affordable Program, are significantly different from our historical approach to delinquencies, defaults and problem loans. The unprecedented nature of these actions and uncertainties related to interest rates and the broader economic environment mean that it will take time for us to assess and provide information on the success of these efforts. Some of the initiatives we undertook prior to the Making Home Affordable Program have not achieved the results we expected. As we move forward under the Making Home Affordable Program, we will continue to work with our conservator to help us best fulfill our objective of helping homeowners and the mortgage market.
 
Activity as Program Administrator for Modifications on non-Fannie Mae loans
 
We have been active in our role as program administrator for loans modified under the Home Affordable Modification Program that are not owned or guaranteed by us. To date, over 30 servicers have signed up to offer modifications on non-agency loans under the program. Loans serviced by these servicers, together with other loans owned or guaranteed by us or by Freddie Mac, cover over 85% of the loans that may be eligible to be modified under the Home Affordable Modification Program. To help support servicers participating in the program, we have rolled out extensive systems and new technology tools, as well as updates to technology


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tools in response to feedback we have received from servicers. Servicers can access these tools, as well as documentation, guidelines and materials for borrowers, on a Web site we launched to support their participation in the program.
 
Expected Impact of Making Home Affordable Program on Fannie Mae
 
The unprecedented nature of the Making Home Affordable Program and uncertainties related to interest rates and the broader economic environment make it difficult for us to predict the full extent of our activities under the program and how those will affect us, or the costs that we will incur either in the short term or over the long term. As we gain more experience under these programs, we may recommend supplementing the programs with other initiatives that would allow us, pursuant to our mission, to assist more homeowners.
 
We have included data relating to our borrower loss mitigation activities for the second quarter, which includes activities under the Making Home Affordable Program, and our borrower loss mitigation activities for prior periods in “Risk Management—Credit Risk Management—Mortgage Credit Risk Management.” A discussion of the risks to our business posed by the Making Home Affordable Program is included in “Part II—Item 1A—Risk Factors.”
 
We expect that modifications we make, pursuant to our mission, under the Home Affordable Modification Program of loans we own or guarantee will adversely affect our financial results and condition due to several factors, including:
 
  •  The requirement that we acquire any loan held in a Fannie Mae MBS prior to modifying it which, prior to January 1, 2010, will result in fair value loss charge-offs under SOP 03-3 against the “Reserve for guaranty losses” at the time we acquire the loan;
 
  •  Incentive and “pay for success” fees paid to our servicers for modification of loans we own or guarantee;
 
  •  Incentives to some borrowers under the program in the form of principal balance reductions if the borrowers continue to make payments due on the modified loan for specified periods; and
 
  •  The effect of holding modified loans in our mortgage portfolio, to the extent the loans provide a below market yield, which may be lower than our cost of funds.
 
We also expect to incur significant additional operational expenses associated with the Making Home Affordable Program.
 
Accordingly, the Making Home Affordable Program will likely have a material adverse effect on our business, results of operations and financial condition, including our net worth. If the program is successful in reducing foreclosures and keeping borrowers in their homes, however, it may benefit the overall housing market and help in reducing our long-term credit losses.
 
Providing Mortgage Market Liquidity
 
During the first half of 2009, we purchased or guaranteed an estimated $415.2 billion in new business, measured by unpaid principal balance, which provided financing for approximately 1,737,000 conventional single-family loans and approximately 193,000 multifamily units. Most of these purchases and guarantees were of single-family loans and approximately 84% of our single-family business during the first half of 2009 consisted of refinancings. The $415.2 billion in new single-family and multifamily business for the first half of 2009 consisted of $255.8 billion in Fannie Mae MBS that were issued, and $159.4 billion in mortgage loans and mortgage-related securities that we purchased for our mortgage investment portfolio.
 
We remain a constant source of liquidity in the multifamily market and we have been successful with our goal of reinvigorating our multifamily MBS business and broadening our multifamily investor base. Approximately 71% of total multifamily production in the first half of 2009 was an MBS execution, compared to 17% in the first half of 2008.


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In addition to purchasing and guaranteeing mortgage assets, we are taking a variety of other actions to provide liquidity to the mortgage market. These actions include:
 
  •  Whole Loan Conduit.  Whole loan conduit activities involve our purchase of loans principally for the purpose of securitizing them. We purchase loans from a large group of lenders and then securitize them as Fannie Mae MBS, which may then be sold to dealers and investors.
 
  •  Early Funding.  Normally, lenders must wait 30 to 45 days between loan closing and settlement of an MBS transaction before they receive payment for the loans they sell to us. Our early lender funding program allows lenders to deliver closed loans to us and receive payment for those loans within a more accelerated timeframe, which allows lenders to replenish their funds and make new loans as soon as possible.
 
  •  Dollar Roll Transactions.  We have increased the amount of our dollar roll activity in the second quarter of 2009 as a result of continued strain on financial institutions’ balance sheets, higher lending rates from prepayment uncertainty, attractive discount note funding and a desire to increase market liquidity by lending our balance sheet to the market at positive economic returns to us. A dollar roll transaction is a commitment to purchase a mortgage-related security with a concurrent agreement to re-sell a substantially similar security at a later date or vice versa. An entity who sells a mortgage-related security to us with a concurrent agreement to repurchase a security in the future gains immediate financing for their balance sheet.
 
Outlook
 
We anticipate that adverse market dynamics and certain of our activities undertaken, pursuant to our mission, to stabilize and support the housing and mortgage markets will continue to negatively affect our financial condition and performance through the remainder of 2009 and into 2010.
 
Overall Market Conditions.  We expect adverse conditions in the financial markets to continue through 2009. We expect further home price declines and rising default and severity rates during this period, all of which may worsen if unemployment rates continue to increase and if the U.S. continues to experience a broad-based economic recession. We continue to expect further increases in the level of foreclosures and single-family delinquency rates in 2009 and into 2010, as well as in the level of multifamily defaults and loss severity. We expect growth in residential mortgage debt outstanding to be flat in 2009 and 2010.
 
Home Price Declines:  Following a decline of approximately 10% in 2008, we expect that home prices will decline another 7% to 12% on a national basis in 2009. We also continue to expect that we will experience a peak-to-trough home price decline on a national basis of 20% to 30%. Based on the observed home price trend during the first half of 2009, we expect future home price declines to be on the lower end of our estimated ranges. These estimates 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 lower percentages for comparable declines. These estimates also contain significant inherent uncertainty in the current market environment, due to historically unprecedented levels of uncertainty regarding a variety of critical assumptions we make when formulating these estimates, including: the effect of actions the federal government has taken and may take with respect to national economic recovery; the impact of those actions on home prices, unemployment and the general economic environment; and the rate of unemployment and/or wage decline. Because of these uncertainties, the actual home price decline we experience may differ significantly from these estimates. We also expect significant regional variation in home price decline percentages.
 
Our estimate of a 7% to 12% home price decline for 2009 compares with a home price decline of approximately 12% to 18% using the S&P/Case-Shiller index method, and our 20% to 30% peak-to-trough home price decline estimate compares with an approximately 33% to 46% peak-to-trough decline using the S&P/Case-Shiller index method. Our estimates differ from the S&P/Case-Shiller index in two principal ways: (1) our estimates weight expectations for each individual property by number of properties, whereas the S&P/Case-Shiller index weights expectations of home price declines based on property value, causing declines in home prices on higher priced homes to have a greater effect on the overall result; and (2) our estimates do


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not include sales of foreclosed homes because we believe that differing maintenance practices and the forced nature of the sales make foreclosed home prices less representative of market values, whereas the S&P/Case-Shiller index includes sales of foreclosed homes. The S&P/Case-Shiller comparison numbers shown above are calculated using our models and assumptions, but modified to use these two factors (weighting of expectations based on property value and the inclusion of foreclosed property sales). In addition to these differences, our estimates are based on our own internally available data combined with publicly available data, and are therefore based on data collected nationwide, whereas the S&P/Case-Shiller index is based only on publicly available data, which may be limited in certain geographic areas of the country. Our comparative calculations to the S&P/Case-Shiller index provided above are not modified to account for this data pool difference.
 
Credit Losses and Credit-Related Expenses.  We currently expect our credit losses and our credit loss ratio (each of which excludes fair value losses under SOP 03-3 and our HomeSaver Advance product) in 2009 to exceed our credit losses and our credit loss ratio in 2008 by a significant amount. We also continue to expect a significant increase in our SOP 03-3 fair value losses in 2009 as we increase the number of loans we repurchase from MBS trusts in order to modify them, particularly as more servicers participate in the Home Affordable Modification Program. In addition, we expect our credit-related expenses to be higher in 2009 than they were in 2008.
 
Expected Lack of Profitability for Foreseeable Future.  We expect to continue to have losses as our guaranty book of business continues to deteriorate and as we continue to incur ongoing costs in our efforts to keep people in homes and provide liquidity to the mortgage market. We do not expect to operate profitably in the foreseeable future.
 
Uncertainty Regarding our Future Status and Long-Term Financial Sustainability:  We expect that we will experience adverse financial effects as we seek to fulfill our mission by concentrating our efforts on keeping people in their homes and preventing foreclosures, including our efforts under the Making Home Affordable Program, while remaining active in the secondary mortgage market. In addition, future activities that our regulators, other U.S. government agencies or Congress may request or require us to take to support the mortgage market and help borrowers may contribute to further deterioration in our results of operations and financial condition. Although Treasury’s additional funds under the senior preferred stock purchase agreement permit us to remain solvent and avoid receivership, the resulting dividend payments are substantial and will increase as we request additional funds from Treasury under the senior preferred stock purchase agreement. As a result of these factors, along with current and expected market and economic conditions and the deterioration in our single-family and multifamily books of business, there is significant uncertainty as to our long-term financial sustainability. We expect that, for the foreseeable future, the earnings of the company, if any, will not be sufficient to pay the dividends on the senior preferred stock. As a result, future dividend payments will be effectively funded from equity drawn from the Treasury.
 
Further, as described under “Legislative and Regulatory Matters—Obama Administration Financial Regulatory Reform Plan and Congressional Hearing,” Treasury and HUD are currently engaged in an initiative to develop recommendations on the future of our business. In July 2009, the Treasury Secretary stated that: “As a government, we’re going to have to figure out [Fannie Mae and Freddie Mac’s] future. What they are today is not going to be their future.” In addition, a Congressional subcommittee held hearings in June regarding the present condition and future status of our business, and future hearings are expected. We expect significant uncertainty regarding the future of our business, including whether we will continue to exist, to continue until February 2010 and beyond.
 
LEGISLATIVE AND REGULATORY MATTERS
 
Obama Administration Financial Regulatory Reform Plan and Congressional Hearing
 
In June 2009, the Obama Administration announced a comprehensive regulatory reform plan to transform the manner in which the financial services industry is regulated. The Administration’s white paper describing the plan notes that “[w]e need to maintain the continued stability and strength of the GSEs during these difficult financial times.” The white paper states that Treasury and HUD, in consultation with other government


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agencies, will engage in a wide-ranging initiative to develop recommendations on the future of Fannie Mae, Freddie Mac and the Federal Home Loan Bank system, and will report its recommendations to Congress and the American public at the time of the President’s 2011 budget release. The President’s 2011 budget is currently expected to be released in February 2010.
 
The Obama Administration’s white paper notes that there are a number of options for the reform of the GSEs, including:
 
  •  returning them to their previous status as GSEs with the paired interests of maximizing returns for private shareholders and pursuing public policy home ownership goals;
 
  •  gradually winding down the GSEs’ operations and liquidating their assets;
 
  •  incorporating the GSEs’ functions into a federal agency;
 
  •  implementing a public utility model where the government regulates the GSEs’ profit margin, sets guarantee fees, and provides explicit backing for GSE commitments;
 
  •  converting the GSEs’ role to providing insurance for covered bonds; and
 
  •  dissolving Fannie Mae and Freddie Mac into many smaller companies.
 
In June 2009, a Congressional subcommittee held a hearing to discuss the present condition and future status of Fannie Mae and Freddie Mac. The subcommittee chairman indicated that this was the first of many hearings regarding the roles and functions of Fannie Mae and Freddie Mac. In July 2009, GSE reform legislation was introduced in the House of Representatives that, if enacted, would substantially alter our current structure and provide for the eventual wind-down of the GSEs. It is unclear what action the House of Representatives will take on this legislation, if any. In addition, we believe additional GSE reform legislation is likely to be introduced in the future. As a result, there continues to be significant uncertainty regarding the future of our company, including whether we will continue to exist.
 
The Administration’s financial regulatory reform plan also proposes significantly altering the current regulatory framework applicable to the financial services industry, with enhanced and more comprehensive regulation of financial firms and markets. This regulation may directly and indirectly affect many aspects of our business and that of our business partners. The plan includes proposals relating to the enhanced regulation of securitization markets, changes to existing capital and liquidity requirements for financial firms, additional regulation of the over-the-counter derivatives market, stronger consumer protection regulations, regulations on compensation practices and changes in accounting standards. In July 2009, the House Financial Services Committee began a series of hearings on the Administration’s plan and proposed legislation.
 
We cannot predict the ultimate impact of these proposed regulatory reforms on our company or our industry.
 
Pending Legislation
 
In June 2009, the House of Representatives passed a bill that, among other things, would impose upon Fannie Mae and Freddie Mac a duty to develop loan products and flexible underwriting guidelines to facilitate a secondary market for “energy-efficient” and “location-efficient” mortgages. The legislation would also allow Fannie Mae and Freddie Mac additional credit toward their housing goals for purchases of energy-efficient and location-efficient mortgages. It is unclear what action the Senate will take on this legislation, or what impact it may have on our business if this legislation is enacted.
 
In May 2009, the House of Representatives passed a bill that, among other things, would require originators to retain a level of credit risk for certain mortgages that they sell, enhance consumer disclosures, impose new servicing standards and allow for assignee liability. If enacted, the legislation would impact our business and the overall mortgage market. However, it is unclear when, or if, the Senate will consider comparable legislation.
 
In March 2009, the House of Representatives passed a housing bill that, among other things, includes provisions intended to stem the rate of foreclosures by allowing bankruptcy judges to modify the terms of


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mortgages on principal residences for borrowers in Chapter 13 bankruptcy. Specifically, the House bill would allow bankruptcy judges to adjust interest rates, extend repayment terms and lower the outstanding principal amount to the current estimated fair value of the underlying property. If enacted, this legislation could have an adverse impact on our business. The Senate passed a similar housing bill in May 2009 that did not include comparable bankruptcy-related provisions. It is unclear when, or if, the Senate will reconsider other alternative bankruptcy-related legislation.
 
Housing Goals
 
On July 30, 2009, FHFA issued a final rule changing our 2009 housing goals from the goals initially set by the Regulatory Reform Act. FHFA determined that, in light of current market conditions, the previously established 2009 housing goals were not feasible unless adjusted. The final rule reduces our 2009 base housing goals and home purchase subgoals approximately to the levels that prevailed in 2004 through 2006. The final rule also raises our multifamily special affordable housing subgoal. The subgoal is 1% of the average annual dollar volume of combined (single-family and multifamily) mortgages purchased by Fannie Mae during specified years. To adjust the subgoal, FHFA changed the base years on which the average is calculated. HUD’s 2004 rule used the years 2000-2002 to set the subgoal. FHFA’s rule uses the years 1999-2008. The final rule also permits loan modifications that we make in accordance with the Making Home Affordable Program to be treated as mortgage purchases and count towards the housing goals. In addition, the final rule excludes from counting towards the 2009 housing goals any purchases of loans on one-to four-unit properties with a maximum original principal balance higher than the nationwide conforming loan limit (currently set at $417,000).
 
The following table sets forth our revised 2009 housing goals and subgoals.
 
         
    2009
 
    Goal  
 
Housing goals:(1)
       
Low- and moderate-income housing
    43.0 %
Underserved areas
    32.0  
Special affordable housing
    18.0  
         
Housing subgoals:
       
Home purchase subgoals:(2)
       
Low- and moderate-income housing
    40.0 %
Underserved areas
    30.0  
Special affordable housing
    14.0  
Multifamily special affordable housing subgoal ($ in billions)(3)
  $ 6.56  
 
 
(1) Goals are expressed as a percentage of the total number of dwelling units financed by eligible mortgage loan purchases during the period.
 
(2) Home purchase subgoals measure our performance by the number of loans (not dwelling units) providing purchase money for owner-occupied single-family housing in metropolitan areas.
 
(3) The multifamily subgoal is measured by loan amount and expressed as a dollar amount.
 
Regulation of New Products and Activities
 
In July 2009, FHFA published an interim final rule, “Prior Approval for Enterprise Products,” setting forth a process for FHFA to review new products and activities prior to their launch by Fannie Mae or Freddie Mac. This interim final rule, which became effective upon publication, implements a provision of the Housing and Economic Recovery Act of 2008 that requires Fannie Mae and Freddie Mac to obtain the approval of the Director of FHFA before initially offering a new product. The interim final rule requires that we submit detailed information about all new products and activities to the Director of FHFA prior to launching the product or commencing the activity. The Director will determine which proposed new activities require a 30-day public notice and comment period and prior approval. In determining whether to approve a proposed


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new product, the Director will consider whether the product is consistent with our charter, the public interest, and safety and soundness. We have received instructions from the Director of FHFA regarding compliance with the rule during the period that FHFA is receiving and considering comments on the interim final rule. Pursuant to these instructions, we are working with FHFA to finalize the processes and procedures to implement this statutory requirement. Depending on the manner in which it is implemented, this rule could have an adverse impact on our ability to develop and introduce new products and activities to the marketplace.
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
The preparation of financial statements in accordance with GAAP requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the condensed consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. We describe our most significant accounting policies in “Notes to Consolidated Financial Statements—Note 2, Summary of Significant Accounting Policies” of our 2008 Form 10-K and in “Notes to Condensed Consolidated Financial Statements—Note 2, Summary of Significant Accounting Policies” of this report.
 
We have identified four of our accounting policies as critical because they involve significant judgments and assumptions about highly complex and inherently uncertain matters and the use of reasonably different estimates and assumptions could have a material impact on our reported results of operations or financial condition. These critical accounting policies and estimates are as follows:
 
  •  Fair Value of Financial Instruments
 
  •  Other-Than-Temporary Impairment of Investment Securities
 
  •  Allowance for Loan Losses and Reserve for Guaranty Losses
 
  •  Deferred Tax Assets
 
We evaluate our critical accounting estimates and judgments required by our policies on an ongoing basis and update them as necessary based on changing conditions. We describe below significant changes in the judgments and assumptions we made during the second quarter of 2009 in applying our critical accounting policies and estimates. Management has discussed any significant changes in judgments and assumptions in applying our critical accounting policies with the Audit Committee of the Board of Directors. See “Part II—Item 7—MD&A—Critical Accounting Policies and Estimates” of our 2008 Form 10-K for additional information about our critical accounting policies and estimates.
 
Fair Value of Financial Instruments
 
The use of fair value to measure our financial instruments is fundamental to our financial statements and is a critical accounting estimate because we account for and record a substantial portion of our assets and liabilities at fair value. SFAS No. 157, Fair Value Measurements (“SFAS 157”), defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (also referred to as an exit price).
 
In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly (“FSP FAS 157-4”). FSP FAS 157-4 provides guidance on how to determine the fair value when the volume and level of activity for the asset or liability have significantly decreased. If there has been a significant decrease in the volume and level of activity for an asset or liability as compared to the normal level of market activity for the asset or liability, there is an increased likelihood that quoted prices or transactions for the instrument are not reflective of an orderly transaction and may therefore require significant adjustment to estimate fair value. We evaluate the existence of the following conditions in determining whether there is an inactive market for our financial instruments: (1) there are few transactions for the financial instrument; (2) price quotes are not based on current market information; (3) the price quotes we receive vary significantly


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either over time or among independent pricing services or dealers; (4) price indices that were previously highly correlated are demonstrably uncorrelated; (5) there is a significant increase in implied liquidity risk premiums, yields or performance indicators, such as delinquency rates or loss severities, for observed transactions or quoted prices when compared with our estimate of expected cash flows, considering all available market data about credit and other nonperformance risk for the financial instrument; (6) there is a wide bid-ask spread or significant increase in the bid-ask spread; (7) there is a significant decline or absence of a market for new issuances (i.e., primary market) for the financial instrument or similar financial instruments; or (8) there is limited availability of public market information.
 
In determining fair value, we use various valuation techniques. We disclose the carrying value and fair value of our financial assets and liabilities and describe the specific valuation techniques used to determine the fair value of these financial instruments in “Notes to Condensed Consolidated Financial Statements—Note 18, Fair Value of Financial Instruments.” Our adoption of FSP FAS 157-4 effective April 1, 2009 did not result in a change in our valuation techniques for estimating fair value.
 
SFAS 157 provides a three-level fair value hierarchy for classifying financial instruments. This hierarchy is based on whether the inputs to the valuation techniques used to measure fair value are observable or unobservable. Each asset or liability is assigned to a level based on the lowest level of any input that is significant to the fair value measurement. The three levels of the SFAS 157 fair value hierarchy are described below:
 
  Level 1:   Quoted prices (unadjusted) in active markets for identical assets or liabilities.
 
  Level 2:   Observable market-based inputs, other than quoted prices in active markets for identical assets or liabilities.
 
  Level 3:   Unobservable inputs.
 
The majority of our financial instruments carried at fair value fall within the level 2 category and are valued primarily utilizing inputs and assumptions that are observable in the marketplace, that can be derived from observable market data or that can be corroborated by recent trading activity of similar instruments with similar characteristics. For example, we generally request non-binding prices from at least four independent pricing services to estimate the fair value of our trading and available-for-sale investment securities at an individual security level. We use the average of these prices to determine the fair value. In the absence of such information or if we are not able to corroborate these prices by other available, relevant market information, we estimate their fair values based on single source quotations from brokers or dealers or by using internal calculations or discounted cash flow techniques that incorporate inputs, such as prepayment rates, discount rates and delinquency, default and cumulative loss expectations, that are implied by market prices for similar securities and collateral structure types. Because items classified as level 3 are valued using significant unobservable inputs, the process for determining the fair value of these items is generally more subjective and involves a high degree of management judgment and assumptions. These assumptions may have a significant effect on our estimates of fair value, and the use of different assumptions as well as changes in market conditions could have a material effect on our results of operations or financial condition.
 
Fair Value Hierarchy— Level 3 Assets and Liabilities
 
Our level 3 assets and liabilities consist primarily of financial instruments for which the fair value is estimated using valuation techniques that involve significant unobservable inputs because there is limited market activity and therefore little or no price transparency. Our level 3 financial instruments include certain mortgage- and asset-backed securities and residual interests, certain performing residential mortgage loans, nonperforming mortgage-related assets, our guaranty assets and buy-ups, our master servicing assets and certain highly structured, complex derivative instruments. We use the term “buy-ups” to refer to upfront payments that we make to lenders to adjust the monthly contractual guaranty fee rate so that the pass-through coupon rates on Fannie Mae MBS are in more easily tradable increments of a whole or half percent.


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Fair value measurements related to financial instruments that are reported at fair value in our condensed consolidated financial statements each period, such as our trading and available-for-sale securities and derivatives, are referred to as recurring fair value measurements. Fair value measurements related to financial instruments that are not reported at fair value each period, such as held-for-sale mortgage loans, are referred to as non-recurring fair value measurements. The following discussion identifies the primary types of financial assets and liabilities within each balance sheet category that are reported at fair value on a recurring basis and are based on level 3 inputs, We also describe the valuation techniques we use to determine their fair values, including key inputs and assumptions.
 
  •  Trading and Available-for-Sale Investment Securities.  Our financial instruments within these asset categories that are classified as level 3 primarily consist of mortgage-related securities backed by Alt-A loans, subprime loans and manufactured housing loans and mortgage revenue bonds. We have relied on external pricing services to estimate the fair value of these securities and validated those results with our internally derived prices, which may incorporate spread, yield, or vintage and product matrices, and standard cash flow discounting techniques. The inputs we use in estimating these values are based on multiple factors, including market observations, relative value to other securities, and non-binding dealer quotes. If we are not able to corroborate vendor-based prices, we rely on management’s best estimate of fair value.
 
  •  Derivatives.  Our derivative financial instruments that are classified as level 3 primarily consist of a limited population of certain highly structured, complex interest rate risk management derivatives. Examples include certain swaps with embedded caps and floors that reference non-standard indices. We determine the fair value of these derivative instruments using indicative market prices obtained from independent third parties. If we obtain a price from a single source and we are not able to corroborate that price, the fair value measurement is classified as level 3.
 
  •  Guaranty Assets and Buy-ups.  We determine the fair value of our guaranty assets and buy-ups based on the present value of the estimated compensation we expect to receive for providing our guaranty. We generally estimate the fair value using proprietary internal models that calculate the present value of expected cash flows. Key model inputs and assumptions include prepayment speeds, forward yield curves and discount rates that are commensurate with the level of estimated risk.
 
  •  Guaranty Obligations.  The fair value of all guaranty obligations, measured subsequent to their initial recognition, reflects our estimate of a hypothetical transaction price that we would receive if we were to issue our guaranty to an unrelated party in a standalone arm’s-length transaction at the measurement date. We estimate the fair value of the guaranty obligations using internal valuation models that calculate the present value of expected cash flows based on management’s best estimate of certain key assumptions, such as default rates, severity rates and a required rate of return. During 2008, we further adjusted the model-generated values based on our current market pricing to arrive at our estimate of a hypothetical transaction price for our existing guaranty obligations. Beginning in the first quarter of 2009, we concluded that the credit characteristics of the pools of loans upon which we were issuing new guarantees increasingly did not reflect the credit characteristics of our existing guaranteed pools; thus, current market prices for our new guarantees were not a relevant input to our estimate of the hypothetical transaction price for our existing guaranty obligations. Therefore, at June 30, 2009, we based our estimate of the fair value of our existing guaranty obligations solely upon our model without further adjustment.
 
Table 2 presents a comparison, by balance sheet category, of the amount of financial assets carried in our consolidated balance sheets at fair value on a recurring basis and classified as level 3 as of June 30, 2009 and December 31, 2008. The availability of observable market inputs to measure fair value varies based on changes in market conditions, such as liquidity. As a result, we expect the amount of financial instruments carried at fair value on a recurring basis and classified as level 3 to vary each period.


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Table 2:  Level 3 Recurring Financial Assets at Fair Value
 
                 
    As of  
    June 30,
    December 31,
 
Balance Sheet Category
  2009     2008  
    (Dollars in millions)  
 
Trading securities
  $ 9,728     $ 12,765  
Available-for-sale securities
    39,915       47,837  
Derivatives assets
    256       362  
Guaranty assets and buy-ups
    1,483       1,083  
                 
Level 3 recurring assets
  $ 51,382     $ 62,047  
                 
Total assets
  $ 911,382     $ 912,404  
Total recurring assets measured at fair value
  $ 369,205     $ 359,246  
Level 3 recurring assets as a percentage of total assets
    6 %     7 %
Level 3 recurring assets as a percentage of total recurring assets measured at fair value
    14 %     17 %
Total recurring assets measured at fair value as a percentage of total assets
    41 %     39 %
 
Level 3 recurring assets totaled $51.4 billion, or 6% of our total assets, as of June 30, 2009, compared with $62.0 billion, or 7% of our total assets, as of December 31, 2008. The decrease in assets classified as level 3 during the first six months of 2009 was principally the result of a net transfer of approximately $6.3 billion in assets to level 2 from level 3. The transferred assets consisted primarily of private-label mortgage-related securities backed by non-fixed rate Alt-A loans. The market for Alt-A securities continues to be relatively illiquid. However, during the first half of 2009, price transparency improved as a result of recent transactions, and we noted some convergence in prices obtained from third party vendors. As a result, we determined that it was appropriate to rely on level 2 inputs to value these securities.
 
Financial assets measured at fair value on a non-recurring basis and classified as level 3, which are not presented in the table above, include held-for-sale loans that are measured at lower of cost or fair value and that were written down to fair value during the period. Held-for-sale loans that were reported at fair value, rather than amortized cost, totaled $2.4 billion and $1.3 billion as of June 30, 2009 and December 31, 2008, respectively. In addition, certain other financial assets carried at amortized cost that have been written down to fair value during the period due to impairment are classified as non-recurring. The fair value of these level 3 non-recurring financial assets, which primarily consisted of certain guaranty assets, low income housing tax credit (“LIHTC”) partnership investments and acquired property, totaled $18.1 billion and $22.4 billion as of June 30, 2009 and December 31, 2008, respectively.
 
Our LIHTC investments trade in a market with limited observable transactions. There is decreased market demand for LIHTC investments because there are fewer tax benefits derived from these investments by traditional investors, as these investors are currently projecting much lower levels of future profits than in previous years. This decreased demand has reduced the value of these investments. We determine the fair value of our LIHTC investments using internal models that estimate the present value of the expected future tax benefits (tax credits and tax deductions for net operating losses) expected to be generated from the properties underlying these investments. Our estimates are based on assumptions that other market participants would use in valuing these investments. The key assumptions used in our models, which require significant management judgment, include discount rates and projections related to the amount and timing of tax benefits. We compare the model results to the limited number of observed market transactions and make adjustments to reflect differences between the risk profile of the observed market transactions and our LIHTC investments.
 
Financial liabilities measured at fair value on a recurring basis and classified as level 3 consisted of long-term debt with a fair value of $1.0 billion and $2.9 billion as of June 30, 2009 and December 31, 2008, respectively, and derivatives liabilities with a fair value of $24 million and $52 million as of June 30, 2009 and December 31, 2008, respectively.


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Fair Value Control Processes
 
We have control processes that are designed to ensure that our fair value measurements are appropriate and reliable, that they are based on observable inputs wherever possible and that our valuation approaches are consistently applied and the assumptions used are reasonable. Our control processes consist of a framework that provides for a segregation of duties and oversight of our fair value methodologies and valuations and validation procedures.
 
Our Valuation Oversight Committee, which includes senior representation from business areas, our Enterprise Risk Management office and our Finance Division, is responsible for reviewing the valuation and pricing methodologies used in our fair value measurements and any significant valuation adjustments, judgments, controls and results. Actual valuations are performed by personnel independent of our business units. Our Price Verification Group, which is an independent control group separate from the group that is responsible for obtaining the prices, also is responsible for performing monthly independent price verification. The Price Verification Group also performs independent reviews of the assumptions used in determining the fair value of products we hold that have material estimation risk because observable market-based inputs do not exist.
 
Our validation procedures are intended to ensure that the individual prices we receive are consistent with our observations of the marketplace and prices that are provided to us by pricing services or other dealers. We verify selected prices using a variety of methods, including comparing the prices to secondary pricing services, corroborating the prices by reference to other independent market data, such as non-binding broker or dealer quotations, relevant benchmark indices, and prices of similar instruments, checking prices for reasonableness based on variations from prices provided in previous periods, comparing prices to internally calculated expected prices and conducting relative value comparisons based on specific characteristics of securities. In addition, we compare our derivatives valuations to counterparty valuations as part of the collateral exchange process. We have formal discussions with the pricing services as part of our due diligence process in order to maintain a current understanding of the models and related assumptions and inputs that these vendors use in developing prices. The prices provided to us by independent pricing services reflect the existence of credit enhancements, including monoline insurance coverage, and the current lack of liquidity in the marketplace. If we determine that a price provided to us is outside established parameters, we will further examine the price, including having follow-up discussions with the specific pricing service or dealer. If we conclude that a price is not valid, we will adjust the price for various factors, such as liquidity, bid-ask spreads and credit considerations. These adjustments are generally based on available market evidence. In the absence of such evidence, management’s best estimate is used. All of these processes are executed before we use the prices in the financial statement process.
 
We continually refine our valuation methodologies as markets and products develop and the pricing for certain products becomes more or less transparent. While we believe our valuation methods are appropriate and consistent with those of other market participants, using different methodologies or assumptions to determine fair value could result in a materially different estimate of the fair value of some of our financial instruments.
 
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. In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments (“FSP FAS 115-2”), which modifies the model for assessing other-than-temporary impairment for investments in debt securities. Under this guidance, a debt security is evaluated for other-than-temporary impairment if its fair value is less than its amortized cost basis. Other-than-temporary impairment is recognized in earnings if one of the following conditions exists: (1) the intent is to sell the security; (2) it is more likely than not that we will be required to sell the security before the impairment is recovered; or (3) the amortized cost basis is not expected to be recovered. If, however, we do not intend to sell the security and will not be required to sell prior to recovery of the amortized cost basis, only the credit component of other-than-temporary impairment is recognized in earnings. The noncredit component is recorded in other comprehensive income (“OCI”). The credit component is the difference between the security’s amortized cost basis and the present value of its expected future cash flows,


24


 

while the noncredit component is the remaining difference between the security’s fair value and the present value of expected future cash flows. We adopted this new accounting guidance effective April 1, 2009, which resulted in a cumulative-effect pre-tax reduction of $8.5 billion ($5.6 billion after tax) in our accumulated deficit to reclassify to accumulated other comprehensive income (“AOCI”) the noncredit component of other-than-temporary impairment losses previously recognized in earnings. We also reversed $3.0 billion of our deferred tax asset valuation allowance, which resulted in a $3.0 billion reduction in our accumulated deficit, because we continue to have the intent and ability to hold these securities to recovery.
 
We conduct periodic reviews of each investment security that has an unrealized loss to determine whether other-than-temporary impairment has occurred. As a result of our April 1, 2009 adoption of the new other-than-temporary impairment guidance, we revised our approach for measuring and recognizing impairment. Our evaluation continues to require significant management judgment and a consideration of various factors to determine if we will receive the amortized cost basis of our investment securities. These factors include, but are not limited to, 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. These cash flow projections are derived from internal models that consider particular attributes of the loans underlying our securities and assumptions about changes in the economic environment, such as home prices and interest rates, to predict borrower behavior and the impact on default frequency, loss severity and remaining credit enhancement.
 
We provide more detailed information on our accounting for other-than-temporary impairment in “Notes to Condensed Consolidated Financial Statements—Note 2, Summary of Significant Accounting Policies.” Also refer to “Consolidated Balance Sheet Analysis—Mortgage Investments—Trading and Available-for-Sale Investment Securities—Investments in Private-Label Mortgage-Related Securities” for a discussion of other-than-temporary impairment recognized on our investments in Alt-A and subprime private-label securities.
 
Allowance for Loan Losses and Reserve for Guaranty Losses
 
We maintain an allowance for loan losses for loans in our mortgage portfolio classified as held-for-investment. We maintain a reserve for guaranty losses for loans that back Fannie Mae MBS we guarantee and loans that we have guaranteed under long-term standby commitments. We report the allowance for loan losses and reserve for guaranty losses as separate line items in the consolidated balance sheets. These amounts, which we collectively refer to as our combined loss reserves, represent our best estimate of credit losses incurred in our guaranty book of business as of the balance sheet date.
 
We have an established process, using analytical tools, benchmarks and management judgment, to determine our loss reserves. Although our loss reserve process benefits from extensive historical loan performance data, this process is subject to risks and uncertainties, including a reliance on historical loss information that may not be representative of current conditions. It is our practice to continually monitor delinquency and default trends and make changes in our historically developed assumptions and estimates as necessary to better reflect the impact of present conditions, including current trends in borrower risk and/or general economic trends, changes in risk management practices, and changes in public policy and the regulatory environment.
 
Because of the current stress in the housing and credit markets, and the speed and extent to which these markets have deteriorated, our process for determining our loss reserves has become more complex and involves a greater degree of management judgment. As a result of the continued decline in home prices, more limited opportunities for refinancing due to the tightening of the credit markets and the sharp rise in unemployment, mortgage delinquencies have reached record levels. Our historical loan performance data indicates a pattern of default rates and credit losses that typically occur over time, which are strongly dependent on the age of a mortgage loan. However, we have witnessed significant changes in traditional loan performance and delinquency patterns, including an increase in early-stage delinquencies for certain loan categories and faster transitions to later stage delinquencies. We believe that recently announced government policies and our initiatives under these policies have partly contributed to these newly observed delinquency


25


 

patterns. For example, our level of foreclosures and associated charge-offs were lower during the first and second quarters of 2009 than they otherwise would have been due to foreclosure delays resulting from our foreclosure suspension, our requirement that loan modification options be pursued with the borrower before proceeding to a foreclosure sale, and state-driven changes in foreclosure rules to slow and extend the foreclosure process. As a result, we determined that it was necessary to refine our loss reserve estimation process to reflect these newly observed delinquency patterns, as we describe in more detail below.
 
We historically have relied on internally developed default loss curves derived from observed default trends in our single-family guaranty book of business to determine our single-family loss reserve. These loss curves are shaped by the normal pattern of defaults, based on the age of the book, and informed by historical default trends and the performance of the loans in our book to date. We develop the loss curves by aggregating homogeneous loans into pools based on common underlying risk characteristics, such as origination year and seasoning, original LTV ratio and loan product type, to derive an overall estimate. We use these loss curve models to estimate, based on current events and conditions, the number of loans that will default (“default rate”) and how much of a loan’s balance will be lost in the event of default (“loss severity”). For the majority of our loan risk categories, our default rate estimates have traditionally been based on loss curves developed from available historical loan performance data dating back to 1980. However, we have recently used a shorter, more near-term default loss curve based on a one quarter “look-back” period to generate estimated default rates for loans originated in 2006 and 2007 and for Alt-A loans originated in 2005. More recently, we also have relied on a one-quarter look back period to develop loss severity estimates for all of our loan categories.
 
We experienced a substantial reduction in foreclosures and charge-offs during the periods November 26, 2008 through January 31, 2009 and February 17, 2009 through March 6, 2009 when our foreclosure suspension was in effect and a surge in foreclosures during the two-week period of February 1, 2009 through February 16, 2009. Since February 16, 2009, we have continued to observe a reduced level of foreclosures as our servicers, in keeping with our guidelines, evaluate borrowers for newly introduced workout options before proceeding to a foreclosure. Because of the distortion in defaults caused by these temporary events, we adjusted our loss curves to incorporate default estimates derived from an assessment of our most recently observed loan delinquencies and the related transition of loans through the various delinquency categories. We used this delinquency assessment and our most recent default information prior to the foreclosure suspension to estimate the number of defaults that we would have expected to occur during the first six months of 2009 if the foreclosure moratorium and our new foreclosure guidelines had not been in effect. We then used these estimated defaults, rather than the actual number of defaults that occurred during the first six months of 2009, to estimate our loss curves and derive the default rates used in determining our single-family loss reserves as of June 30, 2009. Consistent with the approach we used as of December 31, 2008, we also made management adjustments to our model-generated results to capture incremental losses that may not be fully reflected in our models related to geographically concentrated areas that are experiencing severe stress as a result of significant home price declines and the sharp rise in unemployment rates.
 
In determining our multifamily loss reserves, we made several enhancements in the first and second quarters of 2009 to the models used in determining our multifamily loss reserves to reflect the impact of the continuing deterioration in the credit performance of loans in our multifamily guaranty book of business. These model enhancements involved weighting more heavily recent loan default and severity experience to derive the key parameters used in calculating our expected default rates. We expect increased multifamily defaults and loss severities in 2009.
 
Our combined loss reserves increased by $30.4 billion during the first six months of 2009 to $55.1 billion as of June 30, 2009, reflecting further deterioration in both our single-family and multifamily guaranty book of business, as evidenced by the significant increase in delinquent, seriously delinquent and nonperforming loans, as well as an increase in our average loss severities as a result of the decline in home prices during the first six months of 2009. The incremental management adjustment to our loss reserves for geographic and unemployment stresses accounted for approximately $8.2 billion of our combined loss reserves of


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$55.1 billion as of June 30, 2009, compared with approximately $2.3 billion of our combined loss reserves of $24.8 billion as of December 31, 2008.
 
We provide additional information on our combined loss reserves and the impact of adjustments to our loss reserves on our condensed consolidated financial statements in “Consolidated Results of Operations—Credit-Related Expenses” and “Notes to Condensed Consolidated Financial Statements—Note 5, Allowance for Loan Losses and Reserve for Guaranty Losses.”
 
CONSOLIDATED RESULTS OF OPERATIONS
 
Our business generates revenues from three principal sources: net interest income; guaranty fee income; and fee and other income. Other significant factors affecting our results of operations include: fair value gains and losses; the timing and size of investment gains and losses; credit-related expenses; losses from partnership investments; administrative expenses and our effective tax rate. We expect high levels of period-to-period volatility in our results of operations and financial condition, principally due to changes in market conditions that result in periodic fluctuations in the estimated fair value of financial instruments that we mark-to-market through our earnings. These instruments include trading securities and derivatives. The estimated fair value of our trading securities and derivatives may fluctuate substantially from period to period because of changes in interest rates, credit spreads and expected interest rate volatility, as well as activity related to these financial instruments.
 
Table 3 presents a condensed summary of our consolidated results of operations for the three and six months ended June 30, 2009 and 2008 and selected performance metrics that we believe are useful in evaluating changes in our results between periods.
 
Table 3:  Summary of Condensed Consolidated Results of Operations and Performance Metrics
 
                                                                 
    For the
    For the
             
    Three Months Ended
    Six Months Ended
    Quarterly
    Year-to-Date
 
    June 30,     June 30,     Variance     Variance  
    2009     2008     2009     2008     $     %     $     %  
    (Dollars in millions, except per share amounts)  
 
Net interest income
  $ 3,735     $ 2,057     $ 6,983     $ 3,747     $ 1,678       82 %   $ 3,236       86 %
Guaranty fee income
    1,659       1,608       3,411       3,360       51       3       51       2  
Trust management income
    13       75       24       182       (62 )     (83 )     (158 )     (87 )
Fee and other income
    184       225       365       452       (41 )     (18 )     (87 )     (19 )
                                                                 
Net revenues
    5,591       3,965       10,783       7,741       1,626       41       3,042       39  
                                                                 
Investment gains (losses), net(1)
    (45 )     (376 )     178       (432 )     331       88       610       141  
Net other-than-temporary impairments(1)
    (753 )     (507 )     (6,406 )     (562 )     (246 )     (49 )     (5,844 )     (1,040 )
Fair value gains (losses), net(2)
    823       517       (637 )     (3,860 )     306       59       3,223       83  
Losses from partnership investments
    (571 )     (195 )     (928 )     (336 )     (376 )     (193 )     (592 )     (176 )
Administrative expenses
    (510 )     (512 )     (1,033 )     (1,024 )     2             (9 )     (1 )
Credit-related expenses(3)
    (18,784 )     (5,349 )     (39,656 )     (8,592 )     (13,435 )     (251 )     (31,064 )     (362 )
Other non-interest expenses(4)
    (508 )     (283 )     (866 )     (788 )     (225 )     (80 )     (78 )     (10 )
                                                                 
Loss before federal income taxes and extraordinary losses
    (14,757 )     (2,740 )     (38,565 )     (7,853 )     (12,017 )     (439 )     (30,712 )     (391 )
Benefit (provision) for federal income taxes
    (23 )     476       600       3,404       (499 )     (105 )     (2,804 )     (82 )
Extraordinary losses, net of tax effect
          (33 )           (34 )     33       100       34       100  
                                                                 
Net loss
    (14,780 )     (2,297 )     (37,965 )     (4,483 )     (12,483 )     (543 )     (33,482 )     (747 )
Less: Net (income) loss attributable to the noncontrolling interest
    26       (3 )     43       (3 )     29       967       46       1,533  
                                                                 
Net loss attributable to Fannie Mae
  $ (14,754 )   $ (2,300 )   $ (37,922 )   $ (4,486 )   $ (12,454 )     (541 )%   $ (33,436 )     (745 )%
                                                                 
Diluted loss per common share
  $ (2.67 )   $ (2.54 )   $ (6.76 )   $ (5.11 )   $ (0.13 )     (5.12 )%   $ (1.65 )     (32.29 )%
                                                                 
Performance metrics:
                                                               
Net interest yield(5)
    1.69 %     1.00 %     1.57 %     0.91 %                                
Average effective guaranty fee rate (in basis points)(6)
    25.5 bp     26.3 bp     26.4 bp     27.9 bp                                
Credit loss ratio (in basis points)(7)
    44.1       17.5       38.6       15.1                                  


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(1) Certain prior period amounts have been reclassified to conform with the current period presentation in our consolidated statements of operations.
 
(2) Consists of the following: (a) derivatives fair value gains (losses), net; (b) trading securities gains (losses), net; (c) hedged mortgage assets losses, net; (d) debt foreign exchange gains (losses), net; and (e) debt fair value gains (losses), net.
 
(3) Consists of provision for credit losses and foreclosed property expense.
 
(4) Consists of the following: (a) debt extinguishment gains (losses), net and (b) other expenses.
 
(5) Calculated based on annualized net interest income for the reporting period divided by the average balance of total interest-earning assets during the period, expressed as a percentage.
 
(6) Calculated based on annualized guaranty fee income for the reporting period divided by average outstanding Fannie Mae MBS and other guarantees during the period, expressed in basis points.
 
(7) Calculated based on annualized (a) charge-offs, net of recoveries; plus (b) foreclosed property expense; adjusted to exclude (c) the impact of SOP 03-3 and HomeSaver Advance fair value losses for the reporting period divided by the average guaranty book of business during the period, expressed in basis points.
 
The section below provides a comparative discussion of our condensed consolidated results of operations for the three and six months ended June 30, 2009 and 2008. Following this section, we provide a discussion of our business segment results. You should read this section together with our “Executive Summary” where we discuss trends and other factors that we expect will affect our future results of operations.
 
Net Interest Income
 
Net interest income represents the difference between interest income and interest expense and is a primary source of our revenue. Our net interest yield represents the difference between the yield on our interest-earning assets and the cost of our debt. We supplement our issuance of debt with interest rate-related derivatives to manage the prepayment and duration risk inherent in our mortgage investments. The effect of these derivatives, in particular the periodic net interest expense accruals on interest rate swaps, is not reflected in net interest income. See “Fair Value Gains (Losses), Net” for additional information.
 
We expect net interest income and our net interest yield to fluctuate based on changes in interest rates and changes in the amount and composition of our interest-earning assets and interest-bearing liabilities. Table 4 presents an analysis of our net interest income and net interest yield for the three and six months ended June 30, 2009 and 2008.


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Table 4:  Analysis of Net Interest Income and Yield
 
                                                 
    For the Three Months Ended June 30,  
    2009     2008  
          Interest
    Average
          Interest
    Average
 
    Average
    Income/
    Rates
    Average
    Income/
    Rates
 
    Balance(1)     Expense     Earned/Paid     Balance(1)     Expense     Earned/Paid  
    (Dollars in millions)  
 
Interest-earning assets:
                                               
Mortgage loans(2)
  $ 428,975     $ 5,611       5.23 %   $ 418,504     $ 5,769       5.51 %
Mortgage securities
    343,031       4,162       4.85       318,396       4,063       5.10  
Non-mortgage securities(3)
    55,338       68       0.49       57,504       400       2.75  
Federal funds sold and securities purchased under agreements to resell
    49,678       110       0.87       26,869       186       2.74  
Advances to lenders
    5,970       29       1.92       3,332       46       5.46  
                                                 
Total interest-earning assets
  $ 882,992     $ 9,980       4.52 %   $ 824,605     $ 10,464       5.07 %
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
  $ 290,189     $ 600       0.82 %   $ 242,453     $ 1,685       2.75 %
Long-term debt
    576,008       5,645       3.92       550,940       6,720       4.88  
Federal funds purchased and securities sold under agreements to repurchase
    3             4.27       303       2       2.61  
                                                 
Total interest-bearing liabilities
  $ 866,200     $ 6,245       2.88 %   $ 793,696     $ 8,407       4.23 %
                                                 
Impact of net non-interest bearing funding
  $ 16,792               0.05 %   $ 30,909               0.16 %
                                                 
Net interest income/net interest yield(4)
          $ 3,735       1.69 %           $ 2,057       1.00 %
                                                 
Selected benchmark interest rates at end of period:(5)
                                               
3-month LIBOR
                    0.60 %                     2.78 %
2-year swap interest rate
                    1.53                       3.55  
5-year swap interest rate
                    2.97                       4.26  
30-year Fannie Mae MBS par coupon rate
                    4.59                       5.84  
 
                                                 
    For the Six Months Ended June 30,  
    2009     2008  
          Interest
    Average
          Interest
    Average
 
    Average
    Income/
    Rates
    Average
    Income/
    Rates
 
    Balance(1)     Expense     Earned/Paid     Balance(1)     Expense     Earned/Paid  
    (Dollars in millions)  
 
Interest-earning assets:
                                               
Mortgage loans(2)
  $ 429,969     $ 11,209       5.21 %   $ 414,163     $ 11,431       5.52 %
Mortgage securities
    344,985       8,782       5.09       317,107       8,207       5.18  
Non-mortgage securities(3)
    51,862       159       0.61       62,067       1,078       3.44  
Federal funds sold and securities purchased under agreements to resell
    56,893       214       0.74       31,551       579       3.63  
Advances to lenders
    5,118       52       2.02       3,780       111       5.81  
                                                 
Total interest-earning assets
  $ 888,827     $ 20,416       4.59 %   $ 828,668     $ 21,406       5.16 %
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
  $ 310,200       1,707       1.09 %   $ 249,949     $ 4,243       3.36 %
Long-term debt
    565,407       11,726       4.15       548,244       13,411       4.89  
Federal funds purchased and securities sold under agreements to repurchase
    41             1.24       371       5       2.67  
                                                 
Total interest-bearing liabilities
  $ 875,648     $ 13,433       3.07 %   $ 798,564     $ 17,659       4.41 %
                                                 
Impact of net non-interest bearing funding
  $ 13,179               0.05 %   $ 30,104               0.16 %
                                                 
Net interest income/net interest yield(4)
          $ 6,983       1.57 %           $ 3,747       0.91 %
                                                 
 
 
(1) We have calculated the average balances for mortgage loans based on the average of the amortized cost amounts as of the beginning of the period and as of the end of each month in the period. For all other categories, the average balances have been calculated based on a daily average.
 
(2) Average balance amounts include nonaccrual loans with an average balance totaling $20.9 billion and $8.4 billion for the three months ended June 30, 2009 and 2008, respectively, and $19.7 billion and $8.3 billion for the six months ended June 30, 2009 and 2008, respectively. Interest income includes interest income on loans purchased from MBS


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trusts subject to SOP 03-3, which totaled $256 million and $168 million for the three months ended June 30, 2009 and 2008, respectively, and $409 million and $313 million for the six months ended June 30, 2009 and 2008, respectively. These interest income amounts included accretion of $198 million and $53 million for the three months ended June 30, 2009 and 2008, respectively and $263 million and $88 million for the six months ended June 30, 2009 and 2008, respectively, relating to a portion of the fair value losses recorded upon the acquisition of loans subject to SOP 03-3.
 
(3) Includes cash equivalents.
 
(4) We compute net interest yield by dividing annualized net interest income for the period by the average balance of our total interest-earning assets during the period.
 
(5) Data from British Bankers’ Association, Thomson Reuters Indices and Bloomberg.
 
Table 5 presents the change in our net interest income between periods and the extent to which that variance is attributable to: (1) changes in the volume of our interest-earning assets and interest-bearing liabilities or (2) changes in the interest rates of these assets and liabilities.
 
Table 5:  Rate/Volume Analysis of Net Interest Income
 
                                                 
    For the Three Months
    For the Six Months
 
    Ended June 30,
    Ended June 30,
 
    2009 vs. 2008     2009 vs. 2008  
    Total
    Variance Due to:(1)     Total
    Variance Due to:(1)  
    Variance     Volume     Rate     Variance     Volume     Rate  
    (Dollars in millions)  
 
Interest income:
                                               
Mortgage loans
  $ (158 )   $ 142     $ (300 )   $ (222 )   $ 426     $ (648 )
Mortgage securities
    99       304       (205 )     575       712       (137 )
Non-mortgage securities(2)
    (332 )     (15 )     (317 )     (919 )     (153 )     (766 )
Federal funds sold and securities purchased under agreements to resell
    (76 )     99       (175 )     (365 )     279       (644 )
Advances to lenders
    (17 )     23       (40 )     (59 )     30       (89 )
                                                 
Total interest income
    (484 )     553       (1,037 )     (990 )     1,294       (2,284 )
                                                 
Interest expense:
                                               
Short-term debt
    (1,085 )     281       (1,366 )     (2,536 )     841       (3,377 )
Long-term debt
    (1,075 )     294       (1,369 )     (1,685 )     409       (2,094 )
Federal funds purchased and securities sold under agreements to repurchase
    (2 )     (3 )     1       (5 )     (3 )     (2 )
                                                 
Total interest expense
    (2,162 )     572       (2,734 )     (4,226 )     1,247       (5,473 )
                                                 
Net interest income
  $ 1,678     $ (19 )   $ 1,697     $ 3,236     $ 47     $ 3,189  
                                                 
 
 
(1) Combined rate/volume variances are allocated to both rate and volume based on the relative size of each variance.
 
(2) Includes cash equivalents.
 
Net interest income increased 82% and 86% in the second quarter and first six months of 2009, respectively, from comparable prior year periods driven primarily by a 69% and 73% expansion of our net interest yield for the second quarter and first six months, respectively, and a 7% increase in average interest earning assets for both the second quarter and first six months. The 69 basis point increase in our net interest yield during the second quarter of 2009 as compared with the second quarter of 2008 was primarily attributable to a 135 basis point reduction in the average cost of our debt for the second quarter of 2009 to 2.88%, which more than offset the 55 basis point decline in the average yield on our interest-earning assets to 4.52%. The 66 basis point increase in our net interest yield during the first six months of 2009 as compared with the first six months of 2008 was primarily attributable to a 134 basis point reduction in the average cost of our debt for the first six months of 2009 to 3.07%, which more than offset the 57 basis point decline in the average yield on our interest-earning assets to 4.59%.
 
The significant reduction in the average cost of our debt during the second quarter and first six months of 2009 from the comparable prior year periods was primarily attributable to a decline in borrowing rates, a shift in our funding mix in the second half of 2008 to more short-term debt because of the reduced demand for our longer-term and callable debt securities, and significant repurchasing activity of callable debt. Due to the


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improved demand and attractive pricing for our non-callable and callable long-term debt during the first half of 2009, we issued a significant amount of long-term debt during this period, which we then used to repay maturing short-term debt and prepay more expensive long-term debt. Our net interest yield for the second quarter and first six months of 2008 reflected a benefit from the redemption of step-rate debt securities, which reduced the average cost of our debt. Because we paid off these securities prior to maturity, we reversed a portion of the interest expense that we had previously accrued using an average effective rate.
 
Although we consider the periodic net contractual interest accruals on our interest rate swaps to be part of the cost of funding our mortgage investments, these amounts are not reflected in our net interest income and net interest yield. Instead, these amounts are included in our derivatives gains (losses) and reflected in our condensed consolidated statements of operations as a component of “Fair value gains (losses), net.” As shown in Table 8 below, we recorded net contractual interest expense on our interest rate swaps totaling $779 million and $1.7 billion for the second quarter and first six months of 2009, respectively, and $304 million and $330 million for the second quarter and first six months of 2008, respectively. The economic effect of the interest accruals on our interest rate swaps increased our funding costs by 35 and 39 basis points for the second quarter and first six months of 2009, respectively, and 15 basis points and 8 basis points for the second quarter and first six months of 2008, respectively.
 
The 7% increase in our average interest-earning assets for both the second quarter and first six months of 2009 compared to the second quarter and first six months of 2008 was attributable to the second half of 2008 when we increased portfolio purchases, as mortgage-to-debt spreads reached historic highs, and there was a reduction in liquidations due to the disruption in the housing and credit markets. However, in the second quarter and first six months of 2009, we significantly reduced our net purchases of agency MBS, largely due to the significant narrowing of spreads on agency MBS during this period in response to the Federal Reserve’s program to purchase up to $1.25 trillion of agency MBS by the end of 2009. The Federal Reserve currently is the primary purchaser of agency MBS.
 
Under the senior preferred stock purchase agreement, we are limited in the amount of mortgage assets we are allowed to own and the amount of debt we are allowed to issue. Although the debt and mortgage portfolio caps did not have a significant impact on our portfolio activities during the second quarter or first six months of 2009, these limits may have a significant adverse impact on our future portfolio activities and net interest income. For additional information on our portfolio investment and funding activity, see “Consolidated Balance Sheet Analysis—Mortgage Investments” and “Liquidity and Capital Management—Liquidity Management—Debt Funding.”
 
Guaranty Fee Income
 
Guaranty fee income primarily consists of contractual guaranty fees related to both Fannie Mae MBS held in our portfolio and held by third-party investors, adjusted for the amortization of upfront fees over the estimated life of the loans underlying the MBS and impairment of guaranty assets, net of a proportionate reduction in the related guaranty obligation and deferred profit, and impairment of buy-ups.
 
Table 6 shows the components of our guaranty fee income, our average effective guaranty fee rate and Fannie Mae MBS activity for the three and six months ended June 30, 2009 and 2008.


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Table 6:  Guaranty Fee Income and Average Effective Guaranty Fee Rate(1)
 
                                         
    For the Three Months Ended June 30,        
    2009     2008        
    Amount     Rate(2)     Amount     Rate(2)     %Change  
    (Dollars in millions)  
 
Guaranty fee income/average effective guaranty fee rate excluding certain fair value adjustments and buy-up impairment
  $ 1,545       23.7 bp   $ 1,458       23.8 bp     6 %
Net change in fair value of buy-ups and certain guaranty assets
    116       1.8       152       2.5       (24 )
Buy-up impairment
    (2 )           (2 )            
                                         
Guaranty fee income/average effective guaranty fee rate
  $ 1,659       25.5 bp   $ 1,608       26.3 bp     3 %
                                         
Average outstanding Fannie Mae MBS and other guarantees(3)
  $ 2,600,781             $ 2,442,886               6 %
Fannie Mae MBS issues(4)
    315,911               177,763               78  
 
                                         
    For the Six Months Ended June 30,        
    2009     2008        
    Amount     Rate(2)     Amount     Rate(2)     %Change  
    (Dollars in millions)  
 
Guaranty fee income/average effective guaranty fee rate excluding certain fair value adjustments and buy-up impairment
  $ 3,271       25.3 bp   $ 3,177       26.4 bp     3 %
Net change in fair value of buy-ups and certain guaranty assets
    162       1.3       214       1.8       (24 )
Buy-up impairment
    (22 )     (0.2 )     (31 )     (0.3 )     29  
                                         
Guaranty fee income/average effective guaranty fee rate
  $ 3,411       26.4 bp   $ 3,360       27.9 bp     2 %
                                         
Average outstanding Fannie Mae MBS and other guarantees(3)
  $ 2,581,968             $ 2,407,296               7 %
Fannie Mae MBS issues(4)
    470,231               346,355               36  
 
 
(1) Guaranty fee income includes the accretion of losses recognized at inception on certain guaranty contracts for periods prior to January 1, 2008.
 
(2) Presented in basis points and calculated based on annualized guaranty fee income components divided by average outstanding Fannie Mae MBS and other guarantees for each annualized respective period.
 
(3) Includes unpaid principal balance of other guarantees totaling $26.1 billion and $27.8 billion as of June 30, 2009 and December 31, 2008, respectively, and $31.8 billion and $41.6 billion on June 30, 2008 and December 31, 2007, respectively.
 
(4) Reflects unpaid principal balance of Fannie Mae MBS issued and guaranteed by us, including mortgage loans held in our portfolio that we securitized during the period and Fannie Mae MBS issued during the period that we acquired for our portfolio.
 
The 3% and 2% increase in our guaranty fee income in the second quarter and first six months of 2009 was driven by a 6% and 7% increase in our average outstanding Fannie Mae MBS and other guarantees in the respective periods that was partially offset by a decrease in the average charged guaranty fee. Other factors contributing to higher guaranty fee income include an increase in the recognition of deferred amounts into income partially offset by lower fair value adjustments of buy-ups and certain guaranty assets. We experienced an increase in our average outstanding Fannie Mae MBS and other guarantees throughout 2008 and for the first six months of 2009 as our market share of new single-family mortgage-related securities issuances remained high and new MBS issuances outpaced liquidations.
 
The decrease in our average effective guaranty fee rate for the second quarter and first six months of 2009 was attributable to a lower average charged guaranty fee on new business as well as lower fair value adjustments on buy-ups and certain guaranty assets. This was partially offset by the recognition of deferred amounts into income as interest rates in the second quarter and first six months of 2009 were lower than


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comparable prior year periods. The average charged guaranty fee on our new single-family business for the second quarter and first six months of 2009 was 23.7 basis points and 22.5 basis points, respectively, compared with 28.0 basis points and 26.9 basis points for the second quarter and first six months of 2008, respectively. The average charged guaranty fee represents the average contractual fee rate for our single-family guaranty arrangements plus the recognition of any upfront cash payments ratably over an estimated average life. The decrease in the average charged guaranty fee was primarily the result of a shift in the composition of our new business given changes in underwriting and eligibility standards. The change in the average charged guaranty fee reflects a reduction in our acquisition of loans with higher risk, higher fee categories such as higher LTV and lower FICO credit scores. Beginning in 2009, we extended the estimated average life used in calculating the recognition of upfront cash payments for the purpose of determining our average charged guaranty fee for new single-family business to reflect a longer expected duration because of the record low interest rate environment. This change did not have a material impact on the average charged guaranty fee on our new single-family business in the second quarter or first six months of 2009.
 
Our guaranty fee income includes an estimated $141 million and $334 million for the second quarter and first six months of 2009, respectively, and $127 million and $424 million for the second quarter and first six months of 2008, respectively, related to the accretion of deferred amounts on guaranty contracts where we recognized losses at the inception of the contract.
 
Trust Management Income
 
Trust management income consists of the fees we earn as master servicer, issuer and trustee for Fannie Mae MBS. We derive these fees from the interest earned on cash flows between the date of remittance of mortgage and other payments to us by servicers and the date of distribution of these payments to MBS certificateholders, which we refer to as float income. Trust management income decreased to $13 million and $24 million for the second quarter and first six months of 2009, respectively, from $75 million and $182 million for the second quarter and first six months of 2008, respectively. The decrease during each period was attributable to significantly lower short-term interest rates for the first six months of 2009 relative to the first six months of 2008.
 
Fee and Other Income
 
Fee and other income consists of transaction fees, technology fees and multifamily fees. These fees are largely driven by our business volume. Fee and other income decreased to $184 million and $365 million for the second quarter and first six months of 2009, respectively, from $225 million and $452 million for the second quarter and first six months of 2008, respectively. The decrease during each period was primarily attributable to lower multifamily fees due to slower multifamily loan prepayments during the second quarter and first six months of 2009 relative to the second quarter and first six months of 2008.
 
Investment Gains (Losses), Net
 
Investment gains and losses, net includes lower of cost or fair value adjustments on held-for-sale loans; gains and losses recognized on the securitization of loans or securities from our portfolio and from the sale of available-for-sale securities; and other investment losses. Investment gains and losses may fluctuate significantly from period to period depending upon our portfolio investment and securitization activities. The $331 million decrease in investment losses and $610 million shift from losses to gains for the second quarter and first six months of 2009, respectively, from the second quarter and first six months of 2008 was primarily attributable to an increase in gains on securitizations as a result of increased whole loan conduit activity as we focus on providing liquidity to the market and realized gains on sales of available-for-sale securities partially offset by higher lower of cost or market adjustments on loans.
 
Net Other-Than-Temporary Impairment
 
The net other-than-temporary impairment of $753 million and $6.4 billion that we recognized in the second quarter and first six months of 2009, respectively, increased from the second quarter and first six months of


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2008 as it included additional impairment losses on some of our Alt-A and subprime private-label securities that we had previously impaired, as well as impairment losses on other Alt-A and subprime securities, due to continued deterioration in the credit quality of the loans underlying these securities and further declines in the expected cash flows. Beginning in the second quarter of 2009 with the change in impairment accounting, only the credit portion of an other-than-temporary impairment is recognized in our condensed consolidated statement of operations. See “Consolidated Balance Sheet Analysis—Trading and Available-for-Sale Investment Securities— Investments in Private-Label Mortgage-Related Securities” for additional information on the other-than-temporary impairment recognized on our investments in Alt-A and subprime private-label mortgage-related securities. See “Part II—Item 1A—Risk Factors” for a discussion of the risks associated with possible future write-downs of our investment securities.
 
Fair Value Gains (Losses), Net
 
Fair value gains and losses, net consists of (1) derivatives fair value gains and losses; (2) trading securities gains and losses; (3) hedged mortgage assets losses; (4) foreign exchange gains and losses on our foreign-denominated debt; and (5) fair value gains and losses on certain debt securities carried at fair value. By presenting these items together in our consolidated results of operations, we are able to show the net impact of mark-to-market adjustments that generally result in offsetting gains and losses attributable to changes in interest rates.
 
We seek to eliminate our exposure to fluctuations in foreign exchange rates by entering into foreign currency swaps that effectively convert debt denominated in a foreign currency to debt denominated in U.S. dollars. The foreign currency exchange gains and losses on our foreign-denominated debt are offset in part by corresponding losses and gains on foreign currency swaps.
 
Table 7 summarizes the components of fair value gains (losses), net for the three and six months ended June 30, 2009 and 2008.
 
Table 7:  Fair Value Gains (Losses), Net
 
                                 
    For the
    For the
 
    Three Months
    Six Months
 
    Ended
    Ended
 
    June 30,     June 30,  
    2009     2008     2009     2008  
    (Dollars in millions)  
 
Derivatives fair value gains (losses), net
  $ (537 )   $ 2,293     $ (2,243 )   $ (710 )
Trading securities gains (losses), net
    1,561       (965 )     1,728       (2,192 )
Hedged mortgage assets losses, net(1)
          (803 )           (803 )
                                 
Fair value gains (losses) on derivatives, trading securities, and hedged mortgage assets, net
    1,024       525       (515 )     (3,705 )
Debt foreign exchange losses, net
    (169 )     (12 )     (114 )     (169 )
Debt fair value gains (losses), net
    (32 )     4       (8 )     14  
                                 
Fair value gains (losses), net
  $ 823     $ 517     $ (637 )   $ (3,860 )
                                 
 
 
(1) Represents adjustments to the carrying value of mortgage assets designated for hedge accounting that are attributable to changes in interest rates.
 
Derivatives Fair Value Gains (Losses), Net
 
Derivative instruments are an integral part of our management of interest rate risk. We supplement our issuance of debt with derivative instruments to manage our duration and prepayment risks. Table 8 presents, by type of derivative instrument, the fair value gains and losses on our derivatives for the three and six months ended June 30, 2009 and 2008. Table 8 also includes an analysis of the components of derivatives fair value gains and losses attributable to net contractual interest accruals on our interest rate swaps, the net change in the fair value of terminated derivative contracts through the date of termination and the net change in the fair


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value of outstanding derivative contracts. The 5-year swap interest rate, which is shown below in Table 8, is a key reference interest rate that affects the fair value of our derivatives.
 
Table 8:  Derivatives Fair Value Gains (Losses), Net
 
                                 
    For the
    For the
 
    Three Months
    Six Months
 
    Ended
    Ended
 
    June 30,     June 30,  
    2009     2008     2009     2008  
          (Dollars in millions)        
 
Risk management derivatives:
                               
Swaps:
                               
Pay-fixed
  $ 19,430     $ 15,782     $ 22,744     $ (113 )
Receive-fixed
    (16,877 )     (11,092 )     (18,239 )     1,700  
Basis
    45       (73 )     22       (68 )
Foreign currency(1)
    159       (20 )     86       126  
Swaptions:
                               
Pay-fixed
    900       270       885       81  
Receive-fixed
    (4,250 )     (2,499 )     (7,488 )     (2,226 )
Interest rate caps
    21       4       21       3  
Other(2)
    (52 )     (13 )     (23 )     51  
                                 
Total risk management derivatives fair value gains (losses), net
    (624 )     2,359       (1,992 )     (446 )
Mortgage commitment derivatives fair value gains (losses), net
    87       (66 )     (251 )     (264 )
                                 
Total derivatives fair value gains (losses), net
  $ (537 )   $ 2,293     $ (2,243 )   $ (710 )
                                 
Risk management derivatives fair value gains (losses) attributable to:
                               
Net contractual interest income (expense) accruals on interest rate swaps
    (779 )     (304 )     (1,719 )     (330 )
Net change in fair value of terminated derivative contracts from end of prior period to date of termination
    (1,000 )     (108 )     (1,825 )     174  
Net change in fair value of outstanding derivative contracts, including derivative contracts entered into during the period
    1,155       2,771       1,552       (290 )
                                 
Total risk management derivatives fair value gains (losses), net(3)
  $ (624 )   $ 2,359     $ (1,992 )   $ (446 )
                                 
 
                 
    2009     2008  
 
5-year swap interest rate:
               
As of January 1
    2.13 %     4.19 %
As of March 31
    2.22       3.31  
As of June 30
    2.97       4.26  
 
 
(1) Includes the effect of net contractual interest income accruals of $9 million and $6 million for the three months ended June 30, 2009 and 2008, respectively, and $15 million and $3 million for the six months ended June 30, 2009 and 2008, respectively. The change in fair value of foreign currency swaps excluding this item resulted in a net gain of $150 million and a net loss of $26 million for the three months ended June 30, 2009 and 2008, and a net gain of $71 million and $123 million for the six months ended June 30, 2009 and 2008, respectively.
 
(2) Includes MBS options, swap credit enhancements and mortgage insurance contracts.
 
(3) Reflects net derivatives fair value gains (losses), excluding mortgage commitments, recognized in the condensed consolidated statements of operations.
 
During the second quarter and first six months of 2009, increases in swap rates resulted in gains on our net pay-fixed swap position. These gains were more than offset by losses on our option-based derivatives as swap rate increases drove losses on our receive-fixed swaptions.
 
The derivatives fair value gains of $2.3 billion for the second quarter of 2008 were driven by an increase of 95 basis points in 5-year swap interest rates, resulting in fair value gains on our pay-fixed swaps that exceeded the fair value losses on our receive-fixed swaps. The derivatives fair value losses of $710 million for the first


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six months of 2008 were largely attributable to losses resulting from a combination of the time decay on our purchased options and rebalancing activities.
 
For additional information on our interest rate risk management strategy and our use of derivatives in managing our interest rate risk, see “Part II—Item 7—MD&A—Risk Management—Interest Rate Risk Management and Other Market Risks—Interest Rate Risk Management Strategies” of our 2008 Form 10-K and “Interest Rate Risk Management Strategies” below.
 
Trading Securities Gains (Losses), Net
 
We recorded net gains on trading securities of $1.6 billion and $1.7 billion for the second quarter and first six months of 2009, respectively, compared with net losses of $965 million and $2.2 billion for the second quarter and first six months of 2008, respectively. The gains on our trading securities during the second quarter and first six months of 2009 were primarily attributable to the narrowing of spreads on commercial mortgage-backed securities (“CMBS”), asset-backed securities, and corporate debt securities. Narrowing of spreads on agency MBS also contributed to the gains in the first six months of 2009. The losses on our trading securities during the second quarter and first six months of 2008 were attributable to an increase in long-term interest rates during the second quarter of 2008 and a significant widening of credit spreads during the first six months of 2008, particularly related to private-label mortgage-related securities backed by Alt-A and subprime loans and CMBS.
 
We provide additional information on our trading and available-for-sale securities in “Consolidated Balance Sheet Analysis—Trading and Available-for-Sale Investment Securities” and disclose the sensitivity of changes in the fair value of our trading securities to changes in interest rates in “Risk Management—Interest Rate Risk Management and Other Market Risks—Interest Rate Risk Metrics.”
 
Hedged Mortgage Assets Losses, Net
 
We did not apply hedge accounting in the first six months of 2009; however, we did apply hedge accounting in the second quarter of 2008. Our hedge accounting relationships during the second quarter of 2008 consisted of pay-fixed interest rate swaps designated as fair value hedges of changes in the fair value, attributable to changes in the London Interbank Offered Rate (“LIBOR”) benchmark interest rate, of specified mortgage assets. These fair value accounting hedges resulted in losses on the hedged mortgage assets for the second quarter and first six months of 2008 of $803 million, which were partially offset by gains of $789 million on the pay-fixed swaps designated as hedging instruments. The gains on these pay-fixed swaps are included as a component of derivatives fair value gains (losses), net. We also recorded as a component of derivatives fair value gains (losses), net the ineffectiveness, or the portion of the change in the fair value of our derivatives that was not effective in offsetting the change in the fair value of the designated hedged mortgage assets. Included in our derivatives fair value gains (losses), net was a loss of $14 million for the second quarter and first six months of 2008, representing the ineffectiveness of our fair value hedges.
 
Losses from Partnership Investments
 
Losses from partnership investments increased to $571 million and $928 million for the second quarter and first six months of 2009, respectively, from $195 million and $336 million for the second quarter and first six months of 2008, respectively. The increase in losses during each period was largely due to the recognition of additional other-than-temporary impairment of $302 million and $449 million in the second quarter and first six months of 2009, respectively, on a portion of our LIHTC and other affordable housing investments, reflecting the decline in value of these investments as a result of the economic recession. In addition, our partnership losses for the first six months of 2008 were partially reduced by gains on sales of some of our LIHTC investments. We did not have any sales of LIHTC investments during the first six months of 2009. If we determine that in the future a market for our LIHTC investments does not exist or that we do not have both the intent and ability to participate in the LIHTC market, we may not be able to realize the full value of this asset. This would result in significant additional other-than-temporary impairment on our LIHTC investments.


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Administrative Expenses
 
Administrative expenses include ongoing operating costs, such as salaries and employee benefits, professional services, occupancy costs and technology expenses. Administrative expenses were $510 million and $1.0 billion for the second quarter and first six months of 2009, respectively, compared with $512 million and $1.0 billion for the second quarter and first six months of 2008, respectively. We took steps in the first six months of 2009 to realign our organization, personnel and resources to focus on our most critical priorities, which include providing liquidity to the mortgage market and preventing foreclosures. As part of this realignment, we reduced staffing levels in some areas of the company. This reduction in staff, however, was partially offset by an increase in employee and contractor staffing levels in other areas, particularly those divisions of the company that focus on our foreclosure-prevention efforts, which we expect will continue as we increase these efforts.
 
Credit-Related Expenses
 
Credit-related expenses included in our consolidated statements of operations consist of the provision for credit losses and foreclosed property expense. We detail the components of our credit-related expenses below in Table 9. The substantial increase in our credit-related expenses in the second quarter and first six months of 2009 from the second quarter and first six months of 2008 was largely due to the significant increase in our provision for credit losses, reflecting the deteriorating credit performance of the loans in our guaranty book of business given the current economic environment, including continued weakness in the housing market and rising unemployment.
 
Table 9:  Credit-Related Expenses
 
                                 
    For the
    For the
 
    Three Months
    Six Months
 
    Ended
    Ended
 
    June 30,     June 30,  
    2009     2008     2009     2008  
          (Dollars in millions)        
 
Provision for credit losses attributable to guaranty book of business
  $ 16,060     $ 4,591     $ 34,869     $ 6,927  
Provision for credit losses attributable to SOP 03-3 and HomeSaver Advance fair value losses
    2,165       494       3,690       1,231  
                                 
Total provision for credit losses(1)
    18,225       5,085       38,559       8,158  
Foreclosed property expense
    559       264       1,097       434  
                                 
Credit-related expenses
  $ 18,784     $ 5,349     $ 39,656     $ 8,592  
                                 
 
 
(1) Reflects total provision for credit losses reported in our condensed consolidated statements of operations and in Table 10 below under “Combined loss reserves.”
 
Provision for Credit Losses Attributable to Guaranty Book of Business
 
Our allowance for loan losses and reserve for guaranty losses, which we collectively refer to as our combined loss reserves, provide for probable credit losses inherent in our guaranty book of business as of each balance sheet date. We build our loss reserves through the provision for credit losses for losses that we believe have been incurred and will eventually be reflected over time in our charge-offs. When we determine that a loan is uncollectible, typically upon foreclosure, we record the charge-off against our loss reserves. We record recoveries of previously charged-off amounts as a credit to our loss reserves. Table 10, which summarizes changes in our loss reserves for the three and six months ended June 30, 2009 and 2008, details the provision for credit losses recognized in our condensed consolidated statements of operations each period and the charge-offs recorded against our combined loss reserves.


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Table 10:  Allowance for Loan Losses and Reserve for Guaranty Losses (Combined Loss Reserves)
 
                                 
    For the
    For the
 
    Three Months
    Six Months
 
    Ended
    Ended
 
    June 30,     June 30,  
    2009     2008     2009     2008  
          (Dollars in millions)        
 
Changes in combined loss reserves:
                               
Allowance for loan losses:
                               
Beginning balance(1)
  $ 4,830     $ 993     $ 2,923     $ 698  
Provision for credit losses
    2,615       880       5,124       1,424  
Charge-offs(2)
    (672 )     (495 )     (1,309 )     (774 )
Recoveries
    68       98       103       128  
                                 
Ending balance(1)
  $ 6,841     $ 1,476     $ 6,841     $ 1,476  
                                 
Reserve for guaranty losses:
                               
Beginning balance
    36,876       4,202       21,830       2,693  
Provision for credit losses
    15,610       4,205       33,435       6,734  
Charge-offs(3)(4)
    (4,314 )     (989 )     (7,258 )     (2,026 )
Recoveries
    108       32       273       49  
                                 
Ending balance
  $ 48,280     $ 7,450     $ 48,280     $ 7,450  
                                 
Combined loss reserves:
                               
Beginning balance(1)
    41,706       5,195       24,753       3,391  
Provision for credit losses
    18,225       5,085       38,559       8,158  
Charge-offs(2)(3)(4)
    (4,986 )     (1,484 )     (8,567 )     (2,800 )
Recoveries
    176       130       376       177  
                                 
Ending balance(1)
  $ 55,121     $ 8,926     $ 55,121     $ 8,926  
                                 
 
                 
    As of  
    June 30,
    December 31,
 
    2009     2008  
    (Dollars in millions)  
 
Combined loss reserves
  $ 55,121     $ 24,753  
Allocation of combined loss reserves:
               
Balance at end of each period attributable to:
               
Single-family
  $ 54,152     $ 24,649  
Multifamily
    969       104  
                 
Total
  $ 55,121     $ 24,753  
                 
Single-family and multifamily loss reserve ratios:(5)
               
Single-family loss reserves as a percentage of single-family guaranty book of business
    1.88 %     0.88 %
Multifamily loss reserves as a percentage of multifamily guaranty book of business
    0.54       0.06  
Combined loss reserves as a percentage of:
               
Total guaranty book of business
    1.80 %     0.83 %
Total nonperforming loans(6)
    32.24       20.76  
 
 
(1) Includes $309 million and $114 million as of June 30, 2009 and 2008, respectively, and $150 million as of December 31, 2008, for acquired loans subject to the application of SOP 03-3.
 
(2) Includes accrued interest of $328 million and $161 million for the three months ended June 30, 2009 and 2008, respectively, and $575 million and $239 million for the six months ended June 30, 2009 and 2008, respectively.


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(3) Includes charges of $73 million and $114 million for the three months ended June 30, 2009 and 2008, respectively, and $188 million and $123 million for the six months ended June 30, 2009 and 2008, respectively, related to unsecured HomeSaver Advance loans.
 
(4) Includes charges recorded at the date of acquisition totaling $2.1 billion and $380 million for the three months ended June 30, 2009 and 2008, respectively, and $3.5 billion and $1.1 billion for the six months ended June 30, 2009 and 2008, respectively, for acquired loans subject to the application of SOP 03-3 where the acquisition cost exceeded the fair value of the acquired loan.
 
(5) Represents amount of loss reserves attributable to each loan type as a percentage of the guaranty book of business for each loan type.
 
(6) Loans are classified as nonperforming when we believe collectability of interest or principal on the loan is not reasonably assured, which typically occurs when payment of principal or interest on the loan is two months or more past due. Additionally, troubled debt restructurings and HomeSaver Advance first-lien loans are classified as nonperforming loans. See Table 41: Nonperforming Single-Family and Multifamily Loans for additional information on our nonperforming loans.
 
We have continued to build our combined loss reserves, both in absolute terms and as a percentage of our total guaranty book of business and nonperforming loans, through provisions that have been well in excess of our charge-offs due to the general deterioration in the overall credit performance of loans in our guaranty book of business. Certain states, certain higher risk loan categories and our 2006 and 2007 loan vintages continue to account for a disproportionate share of our foreclosures and charge-offs. Our mortgage loans in the Midwest, which has experienced prolonged economic weakness, and California, Florida, Arizona and Nevada, which are experiencing the most significant declines in home prices coupled with rising unemployment rates that, except for Arizona, are near or above the national average, have exhibited much higher delinquency rates and accounted for a disproportionate share of our foreclosures and charge-offs. Loans in our Alt-A book, particularly the 2006 and 2007 loan vintages, also have exhibited significantly higher delinquency rates and represented a disproportionate share of our foreclosures and charge-offs. We are also experiencing deterioration in the credit performance of loans in our single-family guaranty book of business with fewer risk layers, reflecting the adverse impact of the sharp rise in unemployment and home price declines.
 
The provision for credit losses attributable to our guaranty book of business of $16.1 billion and $34.9 billion for the second quarter and first six months of 2009, respectively, exceeded net charge-offs of $2.7 billion and $4.5 billion for the second quarter and first six months of 2009, respectively, and included an incremental build in our combined loss reserves of $13.4 billion and $30.4 billion for the second quarter and first six months of 2009, respectively. In comparison, we recorded a provision for credit losses attributable to our guaranty book of business of $4.6 billion and $6.9 billion for the second quarter and first six months of 2008, respectively. Our increased provision levels were largely driven by a substantial increase in nonperforming single-family loans, higher delinquencies and an increase in the average loss severity. Our conventional single-family serious delinquency rate increased to 3.94% as of June 30, 2009, from 3.15% as of March 31, 2009, 2.42% as of December 31, 2008 and 1.36% as of June 30, 2008. The average default rate and loss severity, excluding fair value losses related to SOP 03-3 and HomeSaver Advance loans, was 0.24% and 39%, respectively, for the second quarter of 2009, compared with 0.13% and 23% for the second quarter of 2008, respectively.
 
We increased the portion of our combined loss reserves attributable to our multifamily guaranty book of business to $969 million, or 0.54% of our multifamily guaranty book of business, as of June 30, 2009, from $104 million, or 0.06% of our multifamily guaranty book of business, as of December 31, 2008. The increase in the multifamily reserve was primarily driven by larger loans within the non- performing loan population and increased reliance on the most recent severity and default experience, which is a reflection of the current economic recession and lack of liquidity in the market.
 
Provision for Credit Losses Attributable to SOP 03-3 and HomeSaver Advance Fair Value Losses
 
In our capacity as guarantor of our MBS trusts, we have the option under the trust agreements to purchase specified mortgage loans from our MBS trusts. We generally are not permitted to complete a modification of a loan while the loan is held in the MBS trust. As a result, we must exercise our option to purchase any delinquent loan that we intend to modify from an MBS trust prior to the time that the modification becomes


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effective. The proportion of delinquent loans purchased from MBS trusts for the purpose of modification varies from period to period, driven primarily by factors such as changes in our loss mitigation efforts, as well as changes in interest rates and other market factors. See “Part I—Item 1—Business—Business Segments—Single-Family Credit Guaranty Business—MBS Trusts” of our 2008 10-K for additional information on the provisions in our MBS trusts agreements that govern the purchase of loans from our MBS trusts and the factors that we consider in determining whether to purchase delinquent loans from our MBS trusts.
 
“SOP 03-3” refers to the accounting guidance issued by the American Institute of Certified Public Accountants Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer. This guidance is generally applicable to delinquent loans purchased from our MBS trusts and delinquent loans held in any MBS trust that we are required to consolidate, which we collectively refer to as “Acquired Loans from MBS Trusts Subject to SOP 03-3.” We record our net investment in these loans at the lower of the acquisition cost of the loan or the estimated fair value at the date of purchase or consolidation. To the extent the acquisition cost exceeds the estimated fair value, we record a SOP 03-3 fair value loss charge-off against the “Reserve for guaranty losses” at the time we acquire the loan.
 
We introduced HomeSaver Advance in the first quarter of 2008. HomeSaver Advance serves as a foreclosure prevention tool early in the delinquency cycle and does not conflict with our MBS trust requirements because it allows borrowers to cure their payment defaults without modifying their mortgage loan. HomeSaver Advance allows servicers to provide qualified borrowers with a 15-year unsecured personal loan in an amount equal to all past due payments relating to their mortgage loan, generally up to the lesser of $15,000 or 15% of the unpaid principal balance of the delinquent first lien loan. We record HomeSaver Advance loans at their estimated fair value at the date we purchase these loans from servicers, and, to the extent the acquisition cost exceeds the estimated fair value, we record a HomeSaver fair value loss charge-off against the “Reserve for guaranty losses” at the time we acquire the loan.
 
As indicated in Table 9, SOP 03-3 and HomeSaver Advance fair value losses increased to $2.2 billion and $3.7 billion in the second quarter and first six months of 2009, respectively, from $494 million and $1.2 billion in the second quarter and first six months of 2008, respectively, reflecting both an increase in the number of acquired delinquent loans and a decrease in the fair value of these loans.
 
Table 11 provides a quarterly comparison of the number of delinquent loans acquired from MBS trusts subject to SOP 03-3, the unpaid principal balance and accrued interest of these loans, and the average fair value based on indicative market prices. The decline in home prices and significant reduction in liquidity in the mortgage markets, along with the increase in mortgage credit risk, have resulted in continued downward pressure on the fair value of these loans.
 
Table 11:  Statistics on Acquired Loans from MBS Trusts Subject to SOP 03-3
 
                                                 
    2009     2008  
    Q2     Q1     Q4     Q3     Q2     Q1  
                (Dollars in millions)              
 
Number of acquired loans from MBS trusts subject to SOP 03-3
    17,580       12,223       6,124       3,678       4,618       10,586  
Average indicative market price(1)
    43 %     45 %     50 %     53 %     53 %     60 %
Unpaid principal balance and accrued interest of loans acquired
  $ 3,717     $ 2,561     $ 1,286     $ 744     $ 807     $ 1,704  
 
 
(1) Calculated based on the estimated fair value at the date of acquisition of delinquent loans subject to SOP 03-3 divided by the unpaid principal balance and accrued interest of these loans at the date of acquisition. The value of primary mortgage insurance is included as a component of the average market price. Beginning in the first quarter of 2009, we incorporated the average fair value of acquired multifamily loans subject to SOP 03-3 into the calculation of our average indicative market price. We have revised the previously reported prior period amounts to reflect this change.
 
During the fourth quarter of 2008, we began increasing the number of delinquent loans we purchased from MBS trusts in response to our efforts to take a more proactive approach to prevent foreclosures by addressing potential problem loans earlier and offering additional, more flexible workout alternatives. As a result of the


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increase in our loan modification volume, which we expect will continue throughout 2009, particularly as we modify more loans through the Home Affordable Modification Program, we expect our acquisition of delinquent loans from MBS trusts to continue to increase during 2009. We also expect to continue to incur significant losses in 2009 in connection with the acquisition of delinquent loans and the modification of loans. We provide additional information on our loan workout activities in “Risk Management—Credit Risk Management—Mortgage Credit Risk Management—Problem Loan Management and Foreclosure Prevention.”
 
Credit Loss Performance Metrics
 
Management views our credit loss performance metrics, which include our historical credit losses and our credit loss ratio, as significant indicators of the effectiveness of our credit risk management strategies. Management uses these metrics together with other credit risk measures to assess the credit quality of our existing guaranty book of business, make determinations about our loss mitigation strategies, evaluate our historical credit loss performance and determine the level of our loss reserves. These metrics, however, are not defined terms within GAAP and may not be calculated in the same manner as similarly titled measures reported by other companies. Because management does not view changes in the fair value of our mortgage loans as credit losses, we exclude SOP 03-3 and HomeSaver Advance fair value losses from our credit loss performance metrics. However, we include in our credit loss performance metrics the impact of any credit losses we experience on loans subject to SOP 03-3 or first lien loans associated with HomeSaver Advance loans that ultimately result in foreclosure.
 
We believe that our credit loss performance metrics are useful to investors because they reflect how management evaluates our credit performance and the effectiveness of our credit risk management strategies and loss mitigation efforts. They also provide a consistent treatment of credit losses for on- and off-balance sheet loans. Moreover, by presenting credit losses with and without the effect of SOP 03-3 and HomeSaver Advance fair value losses, investors are able to evaluate our credit performance on a more consistent basis among periods.
 
Table 12 below details the components of our credit loss performance metrics, which exclude the effect of SOP 03-3 and HomeSaver Advance fair value losses, for the three and six months ended June 30, 2009 and 2008.
 
Table 12:  Credit Loss Performance Metrics
 
                                                                 
    For the Three Months Ended
    For the Six Months Ended
 
    June 30,     June 30,  
    2009     2008     2009     2008  
    Amount     Ratio(1)     Amount     Ratio(1)     Amount     Ratio(1)     Amount     Ratio(1)  
    (Dollars in millions)  
 
Charge-offs, net of recoveries
  $ 4,810       63.4  bp   $ 1,354       18.9  bp   $ 8,191       54.3  bp   $ 2,623       18.6  bp
Foreclosed property expense
    559       7.4       264       3.7       1,097       7.3       434       3.1  
Less: SOP 03-3 and HomeSaver Advance fair value losses(2)
    (2,165 )     (28.5 )     (494 )     (6.9 )     (3,690 )     (24.5 )     (1,231 )     (8.7 )
Plus: Impact of SOP 03-3 on charge-offs and foreclosed property expense(3)
    139       1.8       129       1.8       228       1.5       298       2.1  
                                                                 
Credit losses(4)
  $ 3,343       44.1  bp   $ 1,253       17.5  bp   $ 5,826       38.6  bp   $ 2,124       15.1  bp
                                                                 
 
 
(1) Based on the annualized amount for each line item presented divided by the average guaranty book of business during the period.
 
(2) Represents the amount recorded as a loss when the acquisition cost of a delinquent loan purchased from an MBS trust that is subject to SOP 03-3 exceeds the fair value of the loan at acquisition. Also includes the difference between the unpaid principal balance of unsecured HomeSaver Advance loans at origination and the estimated fair value of these loans that we record in our consolidated balance sheets.
 
(3) For delinquent loans purchased from MBS trusts that are recorded at a fair value amount at acquisition that is lower than the acquisition cost, any loss recorded at foreclosure is less than it would have been if we had recorded the loan at its acquisition cost instead of at fair value. Accordingly, we have added back to our credit losses the amount of


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charge-offs and foreclosed property expense that we would have recorded if we had calculated these amounts based on the purchase price.
 
(4) Interest forgone on nonperforming loans in our mortgage portfolio, which is presented in Table 42, reduces our net interest income but is not reflected in our credit losses total. In addition, other-than-temporary impairment losses resulting from deterioration in the credit quality of our mortgage-related securities and accretion of interest income on loans subject to SOP 03-3 are excluded from credit losses.
 
Our credit loss ratio increased to 44.1 basis points and 38.6 basis points in the second quarter and first six months of 2009, respectively, from 17.5 basis points and 15.1 basis points in the second quarter and first six months of 2008, respectively. Our credit loss ratio including the effect of SOP 03-3 and HomeSaver Advance fair value losses would have been 70.8 basis points and 61.6 basis points for the second quarter and first six months of 2009, respectively, compared with 22.6 basis points and 21.7 basis points for the second quarter and first six months of 2008, respectively. The substantial increase in our credit losses in the second quarter and first six months of 2009 from the second quarter and first six months of 2008 reflected the adverse impact of the decline in home prices, as well as the economic recession. These conditions have resulted in an increase in delinquencies, defaults and loss severities across our entire guaranty book of business as we are also now experiencing deterioration in the credit performance of loans with fewer risk layers. Additionally, certain higher risk loan categories, loan vintages and loans within certain states that have had the greatest home price depreciation from their recent peaks continue to account for a disproportionate share of our credit losses.
 
Specific credit loss statistics related to loans within certain states that have had the greatest home price declines; loans within states in the Midwest which have experienced a prolonged economic recession; and certain higher risk loan categories and loan vintages include the following:
 
  •  California, Florida, Arizona and Nevada, which represented 28% and 27% of our single-family conventional mortgage credit book of business as of June 30, 2009 and 2008, respectively, accounted for 57% and 48% of our single-family credit losses for the second quarter of 2009 and 2008, respectively, and 57% and 42% of our single-family credit losses for the first six months of 2009 and 2008, respectively.
 
  •  Michigan and Ohio, two key states driving credit losses in the Midwest, represented 5% and 6% of our single-family conventional mortgage credit book of business as of June 30, 2009 and 2008, respectively, but accounted for 10% and 18% of our single-family credit losses for the second quarter of 2009 and 2008, respectively, and 10% and 23% of our single-family credit losses for the first six months of 2009 and 2008, respectively.
 
  •  Certain higher risk loan categories, including Alt-A loans, interest-only loans, loans to borrowers with low FICO credit scores and loans with high loan-to-value ratios, represented 26% and 29% of our single-family conventional mortgage credit book of business as of June 30, 2009 and 2008, respectively, but accounted for approximately 63% and 72% of our single-family credit losses for the second quarter of 2009 and 2008, respectively, and 64% and 70% of our single-family credit losses for the first six months of 2009 and 2008, respectively. A significant portion of these higher risk loan categories were originated in 2006 and 2007 in states that have experienced the steepest declines in home prices, such as California, Florida, Arizona and Nevada.
 
The suspension of foreclosure sales on occupied single-family properties between the periods November 26, 2008 through January 31, 2009 and February 17, 2009 through March 6, 2009 and our directive to delay foreclosure sales until the loan servicer has exhausted all other foreclosure prevention alternatives reduced our foreclosure activity in the first six months of 2009, which resulted in a reduction in our charge-offs and credit losses below what we believe we would have otherwise recorded in the first six months of 2009 had the moratorium not been in place. We record a charge-off upon foreclosure for loans subject to the foreclosure moratorium that we are not able to modify and that ultimately result in foreclosure. While the foreclosure moratorium affects the timing of when we incur a credit loss, it does not necessarily affect the credit-related expenses recognized in our consolidated statements of operations because we estimate probable losses inherent in our guaranty book of business as of each balance sheet date in determining our loss reserves. See “Critical Accounting Policies and Estimates—Allowance for Loan Losses and Reserve for Guaranty Losses” for a


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discussion of changes we made in our loss reserve estimation process to address the impact of the foreclosure moratorium and the change in our foreclosure requirements.
 
We provide more detailed credit performance information, including serious delinquency rates by geographic region, statistics on nonperforming loans and foreclosure activity, in “Risk Management—Credit Risk Management—Mortgage Credit Risk Management.”
 
Regulatory Hypothetical Stress Test Scenario
 
Under a September 2005 agreement with the Office of Federal Housing Enterprise Oversight (“OFHEO”), the predecessor to FHFA, we are required to disclose on a quarterly basis the present value of the change in future expected credit losses from our existing single-family guaranty book of business from an immediate 5% decline in single-family home prices for the entire United States. Although this agreement was suspended on March 18, 2009 by FHFA until further notice, we are continuing to provide this disclosure. For purposes of this calculation, we assume that, after the initial 5% shock, home price growth rates return to the average of the possible growth rate paths used in our internal credit pricing models. The sensitivity results represent the difference between future expected credit losses under our base case scenario, which is derived from our internal home price path forecast, and a scenario that assumes an instantaneous nationwide 5% decline in home prices.
 
Table 13 compares the credit loss sensitivities as of June 30, 2009 and December 31, 2008 for first lien single-family whole loans we own or that back Fannie Mae MBS, before and after consideration of projected credit risk sharing proceeds, such as private mortgage insurance claims and other credit enhancement.
 
Table 13:  Single-Family Credit Loss Sensitivity(1)
 
                 
    As of  
    June 30,
    December 31,
 
    2009     2008  
    (Dollars in millions)  
 
Gross single-family credit loss sensitivity
  $ 22,910     $ 13,232  
Less: Projected credit risk sharing proceeds
    (3,520 )     (3,478 )
                 
Net single-family credit loss sensitivity
  $ 19,390     $ 9,754  
                 
Outstanding single-family whole loans and Fannie Mae MBS
  $ 2,793,295     $ 2,724,253  
Single-family net credit loss sensitivity as a percentage of outstanding single-family whole loans and Fannie Mae MBS
    0.69 %     0.36 %
 
 
(1) Represents total economic credit losses, which consist of credit losses and forgone interest. Calculations are based on approximately 97% of our total single-family guaranty book of business as of both June 30, 2009 and December 31, 2008. The mortgage loans and mortgage-related securities that are included in these estimates consist of: (i) single-family Fannie Mae MBS (whether held in our mortgage portfolio or held by third parties), excluding certain whole loan Real Estate Mortgage Investment Conduits (“REMICs”) and private-label wraps; (ii) single-family mortgage loans, excluding mortgages secured only by second liens, subprime mortgages, manufactured housing chattel loans and reverse mortgages; and (iii) long-term standby commitments. We expect the inclusion in our estimates of the excluded products may impact the estimated sensitivities set forth in this table.
 
The increase in the projected credit loss sensitivities during the first six months of 2009 reflected the continued decline in home prices and the current negative outlook for the housing and credit markets. Because these sensitivities represent hypothetical scenarios, they should be used with caution. Our regulatory stress test scenario is limited in that it assumes an instantaneous uniform 5% nationwide decline in home prices, which is not representative of the historical pattern of changes in home prices. Changes in home prices generally vary on a regional, as well as a local, basis. In addition, these stress test scenarios are calculated independently without considering changes in other interrelated assumptions, such as unemployment rates or other economic factors, which are likely to have a significant impact on our future expected credit losses.


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Other Non-Interest Expenses
 
Other non-interest expenses consist of credit enhancement expenses, which reflect the amortization of the credit enhancement asset we record at the inception of guaranty contracts, costs associated with the purchase of additional mortgage insurance to protect against credit losses, net gains and losses on the extinguishment of debt, and other miscellaneous expenses. Other non-interest expenses increased to $508 million and $866 million for the second quarter and first six months of 2009, respectively, from $283 million and $788 million for the second quarter and first six months of 2008, respectively. The increase in each period was largely due to an increase in net losses recorded on the extinguishment of debt offset by a reduction in interest expense associated with unrecognized tax benefits related to certain unresolved tax positions.
 
Federal Income Taxes
 
We recorded a tax provision for federal income taxes of $23 million and a benefit of $600 million for the second quarter and first six months of 2009, respectively. The provision for income taxes in the second quarter of 2009 reflects our current estimate of our annual effective tax rate, which we update each quarter based on actual historical information and forward-looking estimates. The tax benefit for the first six months of 2009 represents the benefit of carrying back a portion of our expected current year tax loss, net of the reversal of the use of certain tax credits, to prior years. We were not able to recognize a net tax benefit associated with the majority of our pre-tax loss of $14.8 billion and $38.6 billion in the second quarter and first six months of 2009, respectively, as there has been no change in the conclusion we reached in 2008 that it was more likely than not that we would not generate sufficient taxable income in the foreseeable future to realize our net deferred tax assets. As a result, we recorded an increase in our valuation allowance of $5.3 billion and $14.1 billion in our condensed consolidated statements of operations in the second quarter and first six months of 2009, respectively, which represented the tax effect associated with the majority of the pre-tax losses we recorded in the second quarter and first six months. The valuation allowance recorded against our deferred tax assets totaled $41.9 billion as of June 30, 2009, resulting in a net deferred tax asset of $3.8 billion as of June 30, 2009 and includes the reversal of $3.0 billion of previously recorded valuation allowance as a result of our adoption of FSP FAS 115-2. Our net deferred tax asset totaled $3.9 billion as of December 31, 2008. We discuss the factors that led us to record a partial valuation allowance against our net deferred tax assets in “Part II—Item 7—MD&A—Critical Accounting Policies and Estimates—Deferred Tax Assets” and “Notes to Consolidated Financial Statements—Note 12, Income Taxes” of our 2008 Form 10-K.
 
In comparison, we recorded a net tax benefit of $476 million and $3.4 billion for the second quarter and first six months of 2008, respectively, due in part to the pre-tax loss for the period as well as the tax credits generated from our LIHTC partnership investments.
 
BUSINESS SEGMENT RESULTS
 
Results of our three business segments are intended to reflect each segment as if it were a stand-alone business. We describe the management reporting and allocation process used to generate our segment results in our 2008 Form 10-K in “Notes to Consolidated Financial Statements—Note 16, Segment Reporting.” We summarize our segment results for the three and six months ended June 30, 2009 and 2008 in the tables below and provide a comparative discussion of these results. See “Notes to Condensed Consolidated Financial Statements—Note 15, Segment Reporting” of this report for additional information on our segment results.
 
Single-Family Business
 
Our Single-Family business recorded a net loss of $16.6 billion and $34.7 billion for the second quarter and first six months of 2009, respectively, compared with a net loss of $2.4 billion and $3.4 billion for the second quarter and first six months of 2008, respectively. Table 14 summarizes the financial results for our Single-Family business for the periods indicated. The primary source of revenue for our Single-Family business is guaranty fee income. Other sources of revenue include trust management income and other fee income, primarily related to technology fees. Expenses primarily include credit-related expenses and administrative expenses.


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Table 14:  Single-Family Business Results
 
                                                                 
    For the
    For the
             
    Three Months Ended
    Six Months Ended
    Quarterly
    Year-to-Date
 
    June 30,     June 30,     Variance     Variance  
    2009     2008     2009     2008     $     %     $     %  
    (Dollars in millions)  
 
Statement of operations data:
                                                               
Guaranty fee income
  $ 1,865     $ 1,819     $ 3,831     $ 3,761     $ 46       3 %   $ 70       2 %
Trust management income
    13       74       24       179       (61 )     (82 )     (155 )     (87 )
Other income(1)
    264       197       437       385       67       34       52       14  
Credit-related expenses(2)
    (18,391 )     (5,339 )     (38,721 )     (8,593 )     (13,052 )     (244 )     (30,128 )     (351 )
Other expenses(3)
    (529 )     (461 )     (1,052 )     (994 )     (68 )     (15 )     (58 )     (6 )
                                                                 
Loss before federal income taxes
    (16,778 )     (3,710 )     (35,481 )     (5,262 )     (13,068 )     (352 )     (30,219 )     (574 )
Benefit for federal income taxes
    138       1,304       783       1,848       (1,166 )     (89 )     (1,065 )     (58 )
                                                                 
Net loss attributable to Fannie Mae
  $ (16,640 )   $ (2,406 )   $ (34,698 )   $ (3,414 )   $ (14,234 )     (592 )%   $ (31,284 )     (916 )%
                                                                 
Other key performance data:
                                                               
Average single-family guaranty book of business(4)
  $ 2,855,504     $ 2,704,345     $ 2,837,800     $ 2,668,099     $ 151,159       6 %   $ 169,701       6 %
 
 
(1) Consists of net interest income, investment gains and losses, and fee and other income.
 
(2) Consists of the provision for credit losses and foreclosed property expense.
 
(3) Consists of administrative expenses and other expenses.
 
(4) The single-family guaranty book of business consists of single-family mortgage loans held in our mortgage portfolio, single-family Fannie Mae MBS held in our mortgage portfolio, single-family Fannie Mae MBS held by third parties, and other credit enhancements that we provide on single-family mortgage assets. Excludes non-Fannie Mae mortgage-related securities held in our investment portfolio for which we do not provide a guarantee.
 
Key factors affecting the results of our Single-Family business for the second quarter and first six months of 2009 compared with the second quarter and first six months of 2008 included the following.
 
  •  A modest increase in guaranty fee income, primarily attributable to growth in the average single-family guaranty book of business, and a decrease in our average effective guaranty fee rate.
 
  —  Our average single-family guaranty book of business increased by 6% for both the second quarter and first six months of 2009, over the second quarter and first six months of 2008. We experienced an increase in our average outstanding Fannie Mae MBS and other guarantees throughout 2008 and for the first six months of 2009 as our market share of new single-family mortgage-related securities issuances remained high and new MBS issuances outpaced liquidations.
 
  —  The decrease in our average effective guaranty fee rate for the second quarter and first six months of 2009 was attributable to a lower average charged guaranty fee on new business, as well as lower fair value adjustments on buy-ups and certain guaranty assets. This was partially offset by the recognition of deferred amounts into income as interest rates in the second quarter and first six months of 2009 were lower than comparable perior year periods. The average charged guaranty fee on our new single-family business for the second quarter and first six months of 2009 was 23.7 basis points and 22.5 basis points, respectively, compared with 28.0 basis points and 26.9 basis points for the second quarter and first six months of 2008, respectively. The average charged guaranty fee represents the average contractual fee rate for our single-family guaranty arrangements plus the recognition of any upfront cash payments ratably over an estimated average life. The decrease in the average charged fee was primarily the result of a shift in the composition of our new business given changes in underwriting and eligibility standards. The change in the average charged guaranty fee reflects a reduction in our acquisition of higher risk, higher fee categories such as higher LTV and lower FICO


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  scores. Beginning in 2009, we extended the estimated average life used in calculating the recognition of upfront cash payments for the purpose of determining our single-family new business average charged guaranty fee to reflect a longer expected duration because of the record low interest rate environment. This change did not have a material impact on the average charged guaranty fee on our new single-family business in the second quarter or first six months of 2009.
 
  •  A substantial increase in credit-related expenses, reflecting a significantly higher incremental provision for credit losses as well as higher charge-offs due to worsening credit performance trends, including significant increases in delinquencies, defaults and loss severities, across our entire guaranty book of business as the credit performance of loans with fewer risk layers has deteriorated reflecting the adverse impact of the continued rise in unemployment and the decline in home prices. Certain higher risk loan categories, loan vintages and loans within certain states that have had the greatest home price depreciation from their recent peaks continue to account for a disproportionate share of our credit losses. We also experienced a significant increase in SOP 03-3 fair value losses during the second quarter and first six months of 2009, reflecting the increase in the number of delinquent loans we purchased from MBS trusts for loan modification as part of our increased efforts in preventing foreclosures and the decreases in the estimated fair value of these loans.
 
  •  A significant reduction in the relative tax benefits associated with our pre-tax losses. We recorded a tax benefit of $138 million and $783 million on pre-tax losses of $16.8 billion and $35.5 billion for the second quarter and first six months of 2009, respectively, compared with a tax benefit of $1.3 billion and $1.8 billion on pre-tax losses of $3.7 billion and $5.3 billion for the second quarter and first six months of 2008, respectively. We recorded a valuation allowance for the majority of the tax benefits associated with the pre-tax losses recognized in the second quarter and first six months of 2009 as there has been no change in the conclusion we reached in 2008 that it was more likely than not that we would not generate sufficient taxable income in the foreseeable future to realize all of the tax benefits generated from these losses.
 
HCD Business
 
Our HCD business recorded a net loss attributable to Fannie Mae of $930 million and $2.0 billion for the second quarter and first six months of 2009, respectively, compared with net income of $72 million and $222 million for the second quarter and first six months of 2008, respectively. Table 15 summarizes the financial results for our HCD business for the periods indicated. The primary sources of revenue for our HCD business are guaranty fee income and other income, consisting of transaction fees associated with our multifamily business. Expenses primarily include administrative expenses, credit-related expenses and net operating losses associated with our partnership investments, the majority of which generate tax benefits that may reduce our federal income tax liability. However, as with the second half of 2008 and first quarter of 2009, we are currently unable to recognize tax benefits generated from our partnership investments.


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Table 15:  HCD Business Results
 
                                                                 
    For the
    For the
             
    Three Months Ended
    Six Months Ended
    Quarterly
    Year-to-Date
 
    June 30,     June 30,     Variance     Variance  
    2009     2008     2009     2008     $     %     $     %  
    (Dollars in millions)  
 
Statement of operations data:(1)
                                                               
Guaranty fee income
  $ 164     $ 134     $ 322     $ 282     $ 30       22 %   $ 40       14 %
Other income(2)
    20       52       47       116       (32 )     (62 )     (69 )     (59 )
Losses on partnership investments
    (571 )     (195 )     (928 )     (336 )     (376 )     (193 )     (592 )     (176 )
Credit-related income (expenses)(3)
    (393 )     (10 )     (935 )     1       (383 )     (3,830 )     (936 )     (93,600 )
Other expenses(4)
    (133 )     (222 )     (302 )     (476 )     89       40       174       37  
                                                                 
Loss before federal income taxes
    (913 )     (241 )     (1,796 )     (413 )     (672 )     (279 )     (1,383 )     (335 )
Benefit (provision) for federal income taxes
    (43 )     316       (211 )     638       (359 )     (114 )     (849 )     (133 )
                                                                 
Net income (loss)
    (956 )     75       (2,007 )     225       (1,031 )     (1,375 )%     (2,232 )     (992 )%
Less: Net (income) loss attributable to the noncontrolling interest
    26       (3 )     43       (3 )     29       967       46       1,533  
                                                                 
Net income (loss) attributable to Fannie Mae
  $ (930 )   $ 72     $ (1,964 )   $ 222     $ (1,002 )     (1,392 )%   $ (2,186 )     (985 )%
                                                                 
Other key performance data:
                                                               
Average multifamily guaranty book of business(5)
  $ 177,475     $ 158,444     $ 176,089     $ 155,173     $ 19,031       12 %   $ 20,916       13 %
 
 
(1) Certain prior period amounts have been reclassified to conform to the current period presentation.
 
(2) Consists of trust management income and fee and other income.
 
(3) Consists of the provision for credit losses and foreclosed property income/expense.
 
(4) Consists of net interest expense, administrative expenses and other expenses.
 
(5) The multifamily guaranty book of business consists of multifamily mortgage loans held in our mortgage portfolio, multifamily Fannie Mae MBS held in our mortgage portfolio, multifamily Fannie Mae MBS held by third parties and other credit enhancements that we provide on multifamily mortgage assets. Excludes non-Fannie Mae mortgage-related securities held in our investment portfolio for which we do not provide a guarantee.
 
Key factors affecting the results of our HCD business for the second quarter and first six months of 2009 compared with the second quarter and first six months of 2008 included the following.
 
  •  An increase in guaranty fee income, which was attributable to growth in the average multifamily guaranty book of business, and an increase in the average effective multifamily guaranty fee rate. The increases in our book of business and guaranty fee rate reflected the investment and liquidity we provided to the multifamily mortgage market.
 
  •  A $383 million and $936 million increase in credit-related expenses, as we increased our multifamily combined loss reserves by $345 million and $865 million during the second quarter and first six months of 2009, respectively. This increase reflects the continuing stress on our multifamily guaranty book of business due to the economic recession and lack of liquidity in the market, which has adversely affected multifamily property values, vacancy rates and rent levels, the cash flows generated from these investments and refinancing options.
 
  •  A $376 million and $592 million increase in losses on partnership investments for the second quarter and first six months of 2009, respectively, largely due to the recognition of other-than-temporary impairment of $302 million and $449 million, respectively, on a portion of our LIHTC partnership investments and other affordable housing investments. In addition, our partnership losses for both the second quarter and first six months of 2008 were partially reduced by a gain on the sale of some of our LIHTC investments. We did not have any sales of LIHTC investments during the first six months of 2009. If we determine that in the future a market for our LIHTC investments does not exist or that we do not have both the intent and ability to participate in the LIHTC market, we may not be able to realize the full value of this


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  asset. This would result in significant additional other-than-temporary impairment on our LIHTC investments.
 
  •  A provision for federal income taxes of $43 million and $211 million for the second quarter and first six months of 2009, respectively, compared with a tax benefit of $316 million and $638 million for the second quarter and first six months of 2008, respectively. The tax provision recognized in the second quarter and first six months of 2009 was attributable to the reversal of previously utilized tax credits because of our ability to carry back, for tax purposes, to prior years net operating losses expected to be generated in the current year. In addition, we recorded a valuation allowance for the majority of the tax benefits associated with the pre-tax losses and tax credits generated by our partnership investments in the second quarter and first six months of 2009.
 
Capital Markets Group
 
Our Capital Markets group recorded net income of $2.8 billion and a net loss of $1.3 billion for the second quarter and first six months of 2009, respectively, compared with net income of $34 million and a net loss of $1.3 billion for the second quarter and first six months of 2008, respectively. Table 16 summarizes the financial results for our Capital Markets group for the periods indicated. The primary source of revenue for our Capital Markets group is net interest income. Expenses primarily consist of administrative expenses and allocated guaranty fee expense. Fair value gains and losses, investment gains and losses, and debt extinguishment gains and losses also have a significant impact on the financial performance of our Capital Markets group.
 
Table 16:  Capital Markets Group Results
 
                                                                 
    For the
    For the
             
    Three Months
    Six Months
             
    Ended
    Ended
    Quarterly
    Year-to-date
 
    June 30,     June 30,     Variance     Variance  
    2009     2008     2009     2008     $     %     $     %  
    (Dollars in millions)  
 
Statement of operations data:(1)
                                                               
Net interest income
  $ 3,600     $ 2,003     $ 6,895     $ 3,662     $ 1,597       80 %   $ 3,233       88 %
Investment gains (losses), net
    (30 )     (339 )     120       (347 )     309       91       467       135  
Net other-than-temporary impairments
    (753 )     (507 )     (6,406 )     (562 )     (246 )     (49 )     (5,844 )     (1,040 )
Fair value gains (losses), net
    823       517       (637 )     (3,860 )     306       59       3,223       83  
Fee and other income, net
    71       82       140       145       (11 )     (13 )     (5 )     (3 )
Other expenses(2)
    (777 )     (545 )     (1,400 )     (1,216 )     (232 )     (43 )     (184 )     (15 )
                                                                 
Income (loss) before federal income taxes and extraordinary losses, net of tax effect
    2,934       1,211       (1,288 )     (2,178 )     1,723       142       890       41  
Benefit (provision) for federal income taxes
    (118 )     (1,144 )     28       918       1,026       90       (890 )     (97 )
Extraordinary losses, net of tax effect
          (33 )           (34 )     33       100       34       100  
                                                                 
Net income (loss) attributable to Fannie Mae
  $ 2,816     $ 34     $ (1,260 )   $ (1,294 )   $ 2,782       8,182 %   $ 34       3 %
                                                                 
 
 
(1) Certain prior period amounts have been reclassified to conform to the current period presentation.
 
(2) Consists of debt extinguishment losses, allocated guaranty fee expense, administrative expenses and other expenses.
 
Key factors affecting the results of our Capital Markets group for the second quarter and first six months of 2009 compared with the second quarter and first six months of 2008 included the following.
 
  •  An increase in net interest income, primarily attributable to an expansion of our net interest yield driven by a reduction in the average cost of our debt that more than offset a decline in the average yield on our interest-earning assets.


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  —  The significant reduction in the average cost of our debt during the second quarter and first six months of 2009 from the comparable prior year periods was primarily attributable to a decline in borrowing rates, a shift in our funding mix in the second half of 2008 to more short-term debt because of the reduced demand for our longer-term and callable debt securities, and significant repurchasing activity of callable debt. Due to the improved demand and attractive pricing for our non-callable and callable long-term debt during the first half of 2009, we issued a significant amount of long-term debt during this period, which we then used to repay maturing short-term debt and prepay more expensive long-term debt. Our net interest yield for the second quarter and first six months of 2008 reflected a benefit from the redemption of step-rate debt securities, which reduced the average cost of our debt.
 
  —  Our net interest income does not include the effect of the periodic net contractual interest accruals on our interest rate swaps, which increased to an expense of $779 million and $1.7 billion in the second quarter and first six months of 2009, respectively, from an expense of $304 million and $330 million in the second quarter and first six months of 2008, respectively. These amounts are included in derivatives gains (losses) and reflected in our condensed consolidated statements of operations as a component of “Fair value gains (losses), net.”
 
  •  An increase in fair value gains for the second quarter of 2009 and a decrease in fair value losses in the first six months of 2009.
 
  —  The gains on our trading securities during the second quarter and first six months of 2009 were primarily attributable to the narrowing of spreads CMBS asset-backed securities and corporate debt securities. Narrowing of spreads on agency MBS also contributed to the gains in the first six months. The losses on our trading securities during the second quarter and first six months of 2008 were attributable to an increase in long-term interest rates during the second quarter of 2008 and a significant widening of credit spreads during the first six months of 2008.
 
  —  We recorded derivatives fair value losses of $537 million and $2.2 billion in the second quarter and first six months of 2009, respectively, compared with a gain of $2.3 billion and a loss of $710 million in the second quarter and first six months of 2008, respectively. During the second quarter and first six months of 2009, increases in swap rates resulted in gains on our net pay-fixed swap position. These gains were more than offset by losses on our option-based derivatives as swap rate increases drove losses on our receive-fixed swaptions. The derivatives fair value gain of $2.3 billion in the second quarter of 2008 was attributable to our interest rate swaps due to a considerable increase in the 5-year swap interest rate during the quarter and was offset by $803 million of losses on our hedged mortgage assets. The derivatives fair value loss of $710 million in the first six months of 2008 was attributable to our interest rate swaps due to a decrease in the 5-year swap interest rate during the six months period.
 
  —  Due to our discontinuation of hedge accounting in the fourth quarter of 2008, we had no losses on hedged mortgage assets during the second quarter and first six months of 2009 compared with $803 million in losses on hedged mortgage assets in the second quarter and first six months of 2008.
 
  •  A decrease in investment losses in the second quarter of 2009 and a shift from losses to gains in the first six months of 2009 from increased gains on securitizations as a result of increased whole loan conduit activity as we focus on providing liquidity to the market, as well as realized gains on sales of available-for-sale securities, partially offset by higher lower of cost or market adjustments on loans.
 
  •  A significant increase in net other-than-temporary impairment, attributable to other-than-temporary impairment on available-for-sale securities totaling $753 million and $6.4 billion in the second quarter and first six months of 2009, respectively, compared with $507 million and $562 million in the second quarter and first six months of 2008, respectively. The other-than-temporary impairment losses that we recognized in the second quarter and first six months of 2009 included additional impairment losses on some of our Alt-A and subprime private-label securities that we had previously impaired, as well as impairment losses on other Alt-A and subprime securities attributable to continued deterioration in the


49


 

  credit quality of the loans underlying these securities and further declines in the expected cash flows. Beginning in the second quarter of 2009, only the credit portion of our other-than-temporary impairment is recognized in our condensed consolidated statement of operations as a result of our adoption of FSP FAS 115-2.
 
  •  We recorded a tax provision of $118 million and a tax benefit of $28 million on pre-tax income of $2.9 billion and a pre-tax loss of $1.3 billion for the second quarter and first six months of 2009, respectively, compared with a tax provision of $1.1 billion and a tax benefit of $918 million on pre-tax income of $1.2 billion and a pre-tax loss of $2.2 billion for the second quarter and first six months of 2008, respectively. We recorded a valuation allowance for the majority of the tax benefits associated with the pre-tax income or losses recognized in the second quarter or first six months of 2009 as there has been no change in the conclusion we reached in 2008 that it was more likely than not that we would not generate sufficient taxable income in the foreseeable future to realize all of the tax benefits generated from Fannie Mae losses.
 
CONSOLIDATED BALANCE SHEET ANALYSIS
 
Total assets of $911.4 billion as of June 30, 2009 decreased by $1.0 billion, or 0.1%, from December 31, 2008. Total liabilities of $922.0 billion decreased by $5.6 billion, or 0.6%, from December 31, 2008. Total Fannie Mae’s stockholders’ deficit decreased by $4.6 billion during the first six months of 2009, to a deficit of $10.7 billion as of June 30, 2009. The decrease in total Fannie Mae’s stockholders’ deficit was due to the $34.2 billion in funds received from Treasury under the senior preferred stock purchase agreement, $5.9 billion in unrealized gains on available-for-sale securities and a $3.0 billion reduction in our accumulated deficit to eliminate a portion of our deferred tax asset valuation allowance in conjunction with our April 1, 2009 adoption of the new accounting guidance for assessing other-than-temporary impairment, partially offset by our net loss attributable to Fannie Mae of $37.9 billion for the first six months of 2009. Following is a discussion of material changes in the major components of our assets and liabilities since December 31, 2008.
 
Mortgage Investments
 
Our mortgage investment activities may be constrained by our regulatory requirements, operational limitations, tax classifications and our intent to hold certain temporarily impaired securities until recovery in value, as well as risk parameters applied to the mortgage portfolio. In addition, the senior preferred stock purchase agreement with Treasury permits us to increase our mortgage portfolio temporarily up to a cap of $900 billion through December 31, 2009. Beginning in 2010, we are required to reduce the size of our mortgage portfolio by 10% per year, until the amount of our mortgage assets reaches $250 billion. We also are required to limit the amount of indebtedness that we can incur to 120% of the amount of mortgage assets we are allowed to own. Through December 30, 2010, our debt cap equals $1,080 billion. Beginning December 31, 2010, and on December 31 of each year thereafter, our debt cap that will apply through December 31 of the following year will equal 120% of the amount of mortgage assets we are allowed to own on December 31 of the immediately preceding calendar year.
 
Table 17 summarizes our mortgage portfolio activity for the three and six months ended June 30, 2009 and 2008.
 
Table 17:  Mortgage Portfolio Activity(1)
 
                                                                 
    For the
          For the
       
    Three Months Ended
          Six Months Ended
       
    June 30,     Variance     June 30,     Variance  
    2009     2008     $     %     2009     2008     $     %  
    (Dollars in millions)  
 
Purchases(2)
  $ 108,833     $ 60,315     $ 48,518       80 %   $ 158,420     $ 95,815     $ 62,605       65 %
Sales
    65,839       9,051       56,788       627       89,931       22,580       67,351       298  
Liquidations(3)
    37,688       25,020       12,668       51       67,073       48,591       18,482       38  
 
 
(1) Excludes unamortized premiums, discounts and other cost basis adjustments.
 
(2) Excludes advances to lenders and mortgage-related securities acquired through the extinguishment of debt.


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(3) Includes scheduled repayments, prepayments, foreclosures and lender repurchases.
 
Our recent portfolio activities have been focused on providing liquidity to lenders through dollar roll transactions, whole loan conduit activities and early lender funding. Our portfolio purchase and sales activity does not include activity related to dollar roll transactions that are accounted for as secured financings, but it does include the settlement of dollar roll transactions that are accounted for as purchases and sales. These transactions often settle in different periods, which may cause period to period fluctuations in our mortgage portfolio balance. In the second quarter of 2009, we increased our dollar roll activity, which resulted in more volatility in our purchases, sales, and ending balances. Whole loan conduit activities involve our purchase of loans principally for the purpose of securitizing them. We may, however, from time to time purchase loans and hold them for an extended period prior to securitization.
 
Portfolio purchases and sales were significantly higher in the second quarter and first six months of 2009, relative to the second quarter and first six months of 2008, due to increased mortgage originations, increased volume of loan deliveries to us, and increased securitizations from our portfolio. The increase in mortgage liquidations during the second quarter and first six months of 2009 reflected the surge in the volume of refinancings, as mortgage interest rates fell to record lows during the second quarter of 2009.
 
As a result of the Federal Reserve’s agency MBS purchase program, which was announced in November 2008 and expanded in March 2009 to include the purchase of up to $1.25 trillion of agency MBS by the end of 2009, the Federal Reserve currently is the primary purchaser of our MBS. The Federal Reserve’s agency MBS purchase program has caused spreads on agency MBS to narrow. As a result, we significantly reduced our purchases of agency MBS during the first six months of 2009.
 
Table 18 shows the composition of our mortgage portfolio by product type and the carrying value, which reflects the net impact of our purchases, sales and liquidations, as of June 30, 2009 and December 31, 2008. Our net mortgage portfolio totaled $766.2 billion as of June 30, 2009, an increase of less than 1% from December 31, 2008.


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Table 18:  Mortgage Portfolio Composition(1)
 
                 
    As of  
    June 30
    December 31,
 
    2009     2008  
    (Dollars in millions)  
 
Mortgage loans:(2)
               
Single-family:
               
Government insured or guaranteed(3)(9)
  $ 51,173     $ 43,799  
Conventional:
               
Long-term, fixed-rate
    180,173       186,550  
Intermediate-term, fixed-rate(4)
    36,774       37,546  
Adjustable-rate
    37,796       44,157  
                 
Total conventional single-family
    254,743       268,253  
                 
Total single-family
    305,916       312,052  
                 
Multifamily:
               
Government insured or guaranteed(3)
    644       699  
Conventional:
               
Long-term, fixed-rate
    5,671       5,636  
Intermediate-term, fixed-rate(4)
    92,634       90,837  
Adjustable-rate
    21,845       20,269  
                 
Total conventional multifamily
    120,150       116,742  
                 
Total multifamily
    120,794       117,441  
                 
Total mortgage loans
    426,710       429,493  
                 
Unamortized premiums and other cost basis adjustments, net
    (3,826 )     (894 )
Lower of cost or market adjustments on loans held for sale
    (462 )     (264 )
Allowance for loan losses for loans held for investment
    (6,841 )     (2,923 )
                 
Total mortgage loans, net
    415,581       425,412  
                 
Mortgage-related securities:
               
Fannie Mae single-class MBS
    171,160       159,712  
Fannie Mae structured MBS
    63,472       69,238  
Non-Fannie Mae single-class mortgage securities
    33,231       26,976  
Non-Fannie Mae structured mortgage securities(5)
    58,225       62,642  
Commercial mortgage backed securities
    25,769       25,825  
Mortgage revenue bonds
    15,019       15,447  
Other mortgage-related securities
    2,670       2,863  
                 
Total mortgage-related securities
    369,546       362,703  
                 
Market value adjustments(6)
    (15,119 )     (15,996 )
Other-than-temporary impairments, net of accretion
    (4,752 )     (7,349 )
Unamortized discounts and other cost basis adjustments, net(7)
    920       296  
                 
Total mortgage-related securities, net
    350,595       339,654  
                 
Mortgage portfolio, net(8)
  $ 766,176     $ 765,066  
                 
 
 
(1) Mortgage loans and mortgage-related securities are reported at unpaid principal balance.
 
(2) Mortgage loans include unpaid principal balances totaling $152.1 billion and $65.8 billion as of June 30, 2009 and December 31, 2008, respectively, related to mortgage-related securities that were consolidated under FASB Interpretation (“FIN”) No. 46R (revised December 2003), Consolidation of Variable Interest Entities (an interpretation of ARB No. 51) (“FIN 46R”), and mortgage-related securities created from securitization transactions that did not meet


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the sales criteria under SFAS No. 140, Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125) (“SFAS 140”), which effectively resulted in mortgage-related securities being accounted for as loans.
 
(3) Refers to mortgage loans that are guaranteed or insured by the U.S. government or its agencies, such as the Department of Veterans Affairs, Federal Housing Administration or the Rural Development Housing and Community Facilities Program of the Department of Agriculture.
 
(4) Intermediate-term, fixed-rate consists of mortgage loans with contractual maturities at purchase equal to or less than 15 years.
 
(5) Includes private-label mortgage-related securities backed by subprime or Alt-A mortgage loans totaling $48.7 billion and $52.4 billion as of June 30, 2009 and December 31, 2008, respectively. Refer to “Trading and Available-for-Sale Investment Securities—Investments in Private-Label Mortgage-Related Securities—Investments in Alt-A and Subprime Private-Label Mortgage-Related Securities” for a description of our investments in subprime and Alt-A securities.
 
(6) Includes unrealized gains and losses on mortgage-related securities and securities commitments classified as trading and available for sale.
 
(7) Includes the impact of other-than-temporary impairments of cost basis adjustments.
 
(8) Includes consolidated mortgage-related assets acquired through the assumption of debt. Also includes $1.4 billion and $720 million as of June 30, 2009 and December 31, 2008, respectively, of mortgage loans and mortgage-related securities that we have pledged as collateral and that counterparties have the right to sell or repledge.
 
(9) Includes reverse mortgages with an outstanding unpaid principal balance of approximately $48.6 billion and $41.2 billion as of June 30, 2009 and December 31, 2008, respectively.
 
Cash and Other Investments Portfolio
 
Our cash and other investments portfolio consists of cash and cash equivalents, federal funds sold and securities purchased under agreements to resell and non-mortgage investment securities. Our cash and other investments portfolio totaled $69.8 billion as of June 30, 2009, compared with $93.0 billion as of December 31, 2008. See “Liquidity and Capital Management—Liquidity Management—Liquidity Contingency Planning—Cash and Other Investments Portfolio” for additional information on our cash and other investments portfolio.
 
Trading and Available-for-Sale Investment Securities
 
Our mortgage investment securities are classified in our condensed consolidated balance sheets as either trading or available for sale and reported at fair value. Table 19 shows the composition of our trading and available-for-sale securities at amortized cost and fair value as of June 30, 2009, which totaled $381.8 billion and $366.3 billion, respectively. We also disclose the gross unrealized gains and gross unrealized losses related to our available-for-sale securities as of June 30, 2009, and a stratification of the gross unrealized losses based on securities that have been in a continuous unrealized loss position for less than 12 months and for 12 months or longer.


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Table 19:  Trading and Available-for-Sale Investment Securities
 
                                                                         
    As of June 30, 2009  
                                  Less Than 12
    12 Consecutive
 
                Gross
    Gross
          Consecutive Months(3)     Months or Longer(3)  
    Total
    Gross
    Unrealized
    Unrealized
    Total
    Gross
    Total
    Gross
    Total
 
    Amortized
    Unrealized
    Losses
    Losses
    Fair
    Unrealized
    Fair
    Unrealized
    Fair
 
    Cost(1)     Gains     OTTI(2)     Other     Value     Losses     Value     Losses     Value  
    (Dollars in millions)  
 
Trading:
                                                                       
Fannie Mae single-class MBS
  $ 40,886     $     $     $     $ 42,973     $     $     $     $  
Fannie Mae structured MBS
    8,980                         9,130                          
Non-Fannie Mae single-class mortgage-related securities
    918                         959                          
Non-Fannie Mae structured mortgage-related securities
    8,230                         4,626                          
Non-Fannie Mae structured multifamily mortgage-related securities (CMBS)(4)
    11,001                         8,349                          
Mortgage revenue bonds
    788                         617                          
Asset-backed securities
    10,143                         9,808                          
Corporate debt securities
    946                         935                          
Other non-mortgage-related securities(5)
    5,003                         5,003                          
                                                                         
Total trading
  $ 86,895     $     $     $     $ 82,400     $     $     $     $  
                                                                         
Available for sale:
                                                                       
Fannie Mae single-class MBS
    130,623       3,856             (79 )     134,400       (79 )     16,104             26  
Fannie Mae structured MBS
    54,300       1,984       (41 )     (52 )     56,191       (57 )     1,718       (36 )     572  
Non-Fannie Mae single-class mortgage-related securities
    32,117       1,100             (8 )     33,209       (7 )     551       (1 )     48  
Non-Fannie Mae structured mortgage-related securities
    45,219       252       (7,971 )     (4,089 )     33,411       (6,991 )     13,412       (5,069 )     14,152  
Non-Fannie Mae structured multifamily mortgage-related securities (CMBS)(4)
    15,918                   (4,123 )     11,795                   (4,123 )     11,795  
Mortgage revenue bonds
    14,241       40       (53 )     (1,187 )     13,041       (85 )     1,786       (1,155 )     8,516  
Other mortgage-related securities
    2,494       25       (560 )     (65 )     1,894       (457 )     1,259       (168 )     610  
                                                                         
Total available for sale
  $ 294,912     $ 7,257     $ (8,625 )   $ (9,603 )   $ 283,941     $ (7,676 )   $ 34,830     $ (10,552 )   $ 35,719  
                                                                         
Total investments in securities
  $ 381,807     $ 7,257     $ (8,625 )   $ (9,603 )   $ 366,341     $ (7,676 )   $ 34,830     $ (10,552 )   $ 35,719  
                                                                         
 
 
(1) Amortized cost includes unamortized premiums, discounts and other cost basis adjustments, and is adjusted to reflect net other-than-temporary impairment write downs recognized in our condensed consolidated statements of operations.
 
(2) Reflects the noncredit component of other-than-temporary losses recorded in OCI as of June 30, 2009.
 
(3) Reflects total gross unrealized losses, including the noncredit component of other-than-temporary impairment, and the related fair value of securities that are in a loss position as of June 30, 2009.
 
(4) Consists of non-Fannie Mae CMBS. Prior to June 30, 2009, we reported these securities as a component of non-Fannie Mae structured mortgage-related securities.
 
(5) Includes a certificate of deposit issued by Bank of America that had a fair value of $5.0 billion as of June 30, 2009, which exceeded 10% of our stockholders’ deficit as of June 30, 2009.
 
Gross unrealized losses on our available-for-sale securities increased to $18.2 billion as of June 30, 2009, from $16.7 billion as of December 31, 2008. The increase in gross unrealized losses was primarily attributable to the continued deterioration in the performance of the underlying collateral of non-agency private-label mortgage-related securities and the weakened financial condition of our mortgage insurer and financial guarantor counterparties. We had previously recognized other-than-temporary impairment in earnings on some of these securities, a portion of which was reclassified to AOCI as a result of our April 1, 2009 adoption of the new other-than-temporary impairment accounting guidance. See “Critical Accounting Policies and Estimates—Other-Than-Temporary Impairment of Investment Securities” for additional information. Included in the $18.2 billion of gross unrealized losses as of June 30, 2009 was $10.6 billion of losses that have existed


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for 12 months or longer. These losses relate to securities that we do not intend to sell and it is not more likely than not that we will be required to sell these securities before recovery of their amortized cost basis.
 
Investments in Private-Label Mortgage-Related Securities
 
The non-Fannie Mae mortgage-related security categories presented in Table 19 above include agency mortgage-related securities issued or guaranteed by Freddie Mac or Ginnie Mae and private-label mortgage-related securities backed by Alt-A, subprime, multifamily, manufactured housing or other mortgage loans. We have no exposure to collateralized debt obligations, or CDOs. We classify private-label securities as Alt-A, subprime, multifamily or manufactured housing if the securities were labeled as such when issued. We also have invested in private-label subprime mortgage-related securities that we have resecuritized to include our guaranty (“wraps”). We report these wraps in Table 19 above as a component of Fannie Mae structured MBS. We generally focused our purchases of these securities on the highest-rated tranches available at the time of acquisition. Higher-rated tranches typically are supported by credit enhancements to reduce the exposure to losses. The credit enhancements on our private-label security investments generally are in the form of initial subordination provided by lower level tranches of these securities. In addition, monoline financial guarantors have provided secondary guarantees on some of our holdings that are based on specific performance triggers. Based on the stressed financial condition of our financial guarantor counterparties, we do not believe these counterparties will fully meet their obligations to us in the future. See “Risk Management—Credit Risk Management—Institutional Counterparty Credit Risk Management—Financial Guarantors” for additional information on our financial guarantor exposure and the counterparty risk associated with our financial guarantors.
 
The unpaid principal balance of private-label mortgage-related securities backed by Alt-A, subprime, multifamily, manufactured housing and other mortgage loans and mortgage revenue bonds held in our mortgage portfolio was $94.4 billion as of June 30, 2009, down from $98.9 billion as of December 31, 2008, primarily due to principal payments. Table 20 summarizes, by the underlying loan type, the composition of our investments in private-label securities, excluding wraps, and mortgage revenue bonds as of June 30, 2009 and the average credit enhancement. The average credit enhancement generally reflects the level of cumulative losses that must be incurred before we experience a loss of principal on the tranche of securities that we own. Table 20 also provides information on the credit ratings of our private-label securities as of July 28, 2009. The credit rating reflects the lowest rating reported by Standard & Poor’s (“Standard & Poor’s”), Moody’s Investors Service, Inc. (“Moody’s”), Fitch Ratings Ltd. (“Fitch”) or DBRS Limited, each of which is a nationally recognized statistical rating organization.
 
Table 20:  Investments in Private-Label Mortgage-Related Securities, Excluding Wraps, and Mortgage Revenue Bonds
 
                                                 
    As of June 30, 2009     As of July 28, 2009  
    Unpaid
    Average
                % Below
       
    Principal
    Credit
          % AA
    Investment
    Current %
 
    Balance     Enhancement(1)     % AAA(2)     to BBB-(2)     Grade(2)     Watchlist(3)  
    (Dollars in millions)  
 
Private-label mortgage-related securities backed by:
                                               
Alt-A mortgage loans:
                                               
Option ARM Alt-A mortgage loans
  $ 6,421       52 %     3 %     20 %     77 %     11 %
Other Alt-A mortgage loans
    19,709       13       22       26       52       1  
                                                 
Total Alt-A mortgage loans
    26,130                                          
Subprime mortgage loans(4)
    22,603       33       11       9       80       2  
                                                 
Total Alt-A and subprime mortgage loans
    48,733                                          
Multifamily mortgage loans (CMBS)
    25,769       30       96       4             75  
Manufactured housing mortgage loans
    2,647       36       2       21       77       1  
Other mortgage loans
    2,226       6       53       28       19        
                                                 
Total private-label mortgage-related securities
    79,375                                          
Mortgage revenue bonds(5)
    15,019       35       36       61       3       15  
                                                 
Total
  $ 94,394                                          
                                                 


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(1) Average credit enhancement percentage reflects both subordination and financial guarantees. Reflects the ratio of the current amount of the securities that will incur losses in the securitization structure before any losses are allocated to securities that we own. Percentage generally calculated based on the quotient of the total unpaid principal balance of all credit enhancement in the form of subordination or financial guarantee of the security divided by the total unpaid principal balance of all of the tranches of collateral pools from which credit support is drawn for the security that we own.
 
(2) Reflects credit ratings as of July 28, 2009, calculated based on unpaid principal balance as of June 30, 2009. Investment securities that have a credit rating below BBB- or its equivalent or that have not been rated are classified as below investment grade.
 
(3) Reflects percentage of investment securities, calculated based on unpaid principal balance as of June 30, 2009, that have been placed under review by either Standard & Poor’s, Moody’s, Fitch or DBRS Limited.
 
(4) Excludes resecuritizations, or wraps, of private-label securities backed by subprime loans that we have guaranteed and hold in our mortgage portfolio. These wraps totaled $6.5 billion as of June 30, 2009.
 
(5) Reflects that 35% of the outstanding unpaid principal balance of our mortgage revenue bonds are guaranteed by third parties. See “Risk Management—Credit Risk Management—Institutional Counterparty Credit Risk Management—Financial Guarantors” for additional information on our financial guarantor exposure and the counterparty exposure associated with our financial guarantors.
 
Investments in Alt-A and Subprime Private-Label Mortgage-Related Securities
 
The unpaid principal balance of our investments in Alt-A and subprime private-label securities, excluding wraps, totaled $48.7 billion as of June 30, 2009, compared with $52.4 billion as of December 31, 2008. The current market pricing of Alt-A and subprime securities has been adversely affected by the increasing level of defaults on the mortgages underlying these securities and the uncertainty as to the extent of further deterioration in the housing market. In addition, market participants are requiring a significant risk premium, which can be measured as a significant increase in the required yield on the investment, for taking on the increased uncertainty related to cash flows. Further, there continues to be less liquidity for these securities than was available prior to the onset of the housing and credit liquidity crises, which has also contributed to lower prices. Although our portfolio of Alt-A and subprime private-label mortgage-related securities primarily consists of senior level tranches, we have recorded significant losses on these securities.
 
Table 21 presents the fair value of our investments in Alt-A and subprime private-label securities, excluding wraps, as of June 30, 2009 and an analysis of the cumulative losses on these investments as of June 30, 2009. The total cumulative losses presented for our Alt-A and subprime private-label securities classified as trading represent the cumulative fair value losses recognized in our condensed consolidated statements of operations, while the total cumulative losses presented for our Alt-A and subprime private-label securities classified as available for sale represent the total other-than-temporary impairment related to these securities. As discussed in “Critical Accounting Policies and Estimates—Other-Than-Temporary Impairment of Investment Securities,” we adopted the new accounting rules for other-than-temporary impairment effective April 1, 2009, which changed our method for assessing, measuring and recognizing other-than-temporary impairment and resulted in a cumulative-effect pre-tax reduction of $8.5 billion ($5.6 billion after tax) in our accumulated deficit to reclassify to AOCI the noncredit component of other-than-temporary impairment losses previously recognized in earnings. As a result of this change, we no longer record in earnings the noncredit component of other-than-temporary impairment on our available-for-sale securities that we do not intend to sell and will not be required to sell prior to recovery of the amortized cost basis. Instead, we record this amount in OCI. Table 21 displays the estimated noncredit and credit-related components of the fair value losses on our trading securities and our available-for-sale securities.


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Table 21:  Analysis of Losses on Alt-A and Subprime Private-Label Mortgage-Related Securities, Excluding Wraps(1)
 
                                         
    As of June 30, 2009  
    Unpaid
          Total
             
    Principal
    Fair
    Cumulative
    Noncredit
    Net
 
    Balance     Value     Losses(2)     Component(3)     Losses(4)  
    (Dollars in millions)  
 
Trading securities:
                                       
Alt-A private-label securities
  $ 3,468     $ 1,232     $ 2,225     $ 1,330     $ 895  
Subprime private-label securities
    3,667       2,121       1,551       654       897  
                                         
Total Alt-A and subprime private-label securities classified as trading
  $ 7,135     $ 3,353     $ 3,776     $ 1,984     $ 1,792  
                                         
Available-for-sale securities:
                                       
Alt-A private-label securities
    22,662       13,635       9,067       6,479       2,588  
Subprime private-label securities
    18,936       11,927       7,045       5,097       1,948  
                                         
Total Alt-A and subprime private-label securities classified as available for sale
  $ 41,598     $ 25,562     $ 16,112     $ 11,576     $ 4,536  
                                         
 
 
(1) Excludes resecuritizations, or wraps, of private-label securities backed by subprime loans that we have guaranteed and hold in our mortgage portfolio. These wraps totaled $6.5 billion as of June 30, 2009.
 
(2) Amounts reflect the difference between the amortized cost basis (unpaid principal balance net of unamortized premiums, discounts and cost basis adjustments), excluding other-than-temporary impairment losses recorded in earnings and the fair value.
 
(3) Represents the estimated portion of the total cumulative losses that is noncredit related. We have calculated the credit component based on the difference between the amortized cost basis of the securities and the present value of expected future cash flows. The remaining difference between the fair value and the present value of expected future cash flows is classified as noncredit-related.
 
(4) For securities classified as trading, net loss amounts reflect the estimated portion of the total cumulative losses that is credit-related. For securities classified as available for sale, net loss amounts reflect the portion of other-than-temporary impairment losses that is recognized in earnings in accordance with the new other-than-temporary impairment accounting guidance that we adopted on April 1, 2009.
 
The gross unrealized losses on our Alt-A and subprime private-label securities classified as available-for-sale and included in AOCI totaled $7.5 billion, net of tax, as of June 30, 2009. Approximately $3.1 billion, net of tax, of these unrealized losses relate to securities that have been in a loss position for 12 months or longer as of June 30, 2009. For those available-for-sale securities for which we have not recognized other-than-temporary impairment in earnings, we believe that the performance of the underlying collateral will still allow us to recover our initial investment, although at significantly lower yields than what is being required currently by new investors.
 
The current economic environment, including the continued weakness in the housing market and rising unemployment, have had an adverse effect on the performance of the loans underlying our Alt-A and subprime private-label securities. These securities reflect increasing delinquencies, a sharp rise in expected defaults and loss severities, and slower voluntary prepayment rates, particularly for the 2006 and 2007 loan vintages, which were originated in an environment of significant increases in home prices and relaxed underwriting criteria and eligibility standards. Table 22 presents the 60 days or more delinquency rates and average loss severities for the loans underlying our Alt-A and subprime private-label mortgage-related securities for the most recent remittance period of the current reporting quarter. The delinquency rates and average loss severities are based on available data provided by Intex Solutions, Inc. (“Intex”) and First American CoreLogic, LoanPerformance (“First American CoreLogic”). We also present the average credit enhancement and monoline financial guaranteed amount for these securities as of June 30, 2009.


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Table 22:   Credit Statistics of Loans Underlying Alt-A and Subprime Private-Label Mortgage-Related Securities, Including Wraps
 
                                                         
    As of June 30, 2009  
    Unpaid Principal Balance                       Monoline
 
          Available
                Average
    Average
    Financial
 
          for
          ³ 60 Days
    Loss
    Credit
    Guaranteed
 
    Trading     Sale     Wraps(1)     Delinquent(2)(3)     Severity(3)(4)     Enhancement(3)(5)     Amount(6)  
                            Dollars in Millions        
 
Private-label mortgage-related securities backed by:(7)
                               
Alt-A mortgage loans:
                                                       
Option ARM Alt-A mortgage loans:
                                                       
2004 and prior
  $     $ 618     $       28.8 %     53.6 %     22.7 %   $  
2005
          1,609             36.8       57.3       47.3       312  
2006
          1,734             43.5       62.6       51.4       384  
2007
    2,460                   37.6       61.8       62.8       892  
Other Alt-A mortgage loans:
                                                       
2004 and prior
          7,990             6.7       54.5       12.0       21  
2005
          5,226       190       19.6       53.6       12.1        
2006
    78       5,331             28.2       56.9       10.5        
2007
    930             263       42.3       64.5       37.1       384  
2008(8)
          154                                      
                                                         
Total Alt-A mortgage loans:
    3,468       22,662       453