UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
NOTIFICATION OF LATE FILING
Commission File Number 000-50231
||o Form 10-K
||o Form 20-F
||o Form 11-K
||þ Form l0-Q
||o Form N-SAR
||o Form N-CSR
For Period Ended: September 30, 2005
||o Transition Report on Form 10-K and Form 10-KSB
||o Transition Report on Form 20-F
||o Transition Report on Form 11-K
||o Transition Report on Form 10-Q and Form 10-QSB
||o Transition Report on Form N-SAR
For the Transition Period Ended:
Read Attached Instruction Sheet Before Preparing Form. Please Print or Type.
Nothing in this form shall be construed to imply that the Commission has verified any information
contained herein. If the notification relates to a portion of the filing checked above, identify the Item (s) to
which the notification relates:
Full name of registrant: Federal National Mortgage Association
Former name if applicable: Not Applicable
Address of principal executive office 3900 Wisconsin Avenue, NW
(Street and number):
City, state and zip code: Washington, D.C. 20016
RULE 12b-25 (b) AND (c)
If the subject report could not be filed without unreasonable effort or expense and the
registrant seeks relief pursuant to Rule 12b-25(b), the following should be completed. (Check box
||The reasons described in reasonable detail in Part III of this form could not be eliminated without
unreasonable effort or expense;
||The subject annual report, semi-annual report, transition report on Form 10-K, Form 20-F, Form 11-K,
Form N-SAR or Form N-CSR, or portion thereof, will be filed on or before the fifteenth calendar day
following the prescribed due date; or the subject quarterly report or transition report on Form 10-Q,
or portion thereof, will be filed on or before the fifth calendar day following the prescribed due
||The accountants statement or other exhibit required by Rule 12b-25(c) has been attached if applicable.
Fannie Mae (formally, the Federal National Mortgage Association) has determined that it is
unable to file its Form 10-Q for the quarter ended September 30, 2005 by the November 9, 2005 due
date or by November 14, 2005 and, accordingly, Fannie Mae is not requesting the five-day extension
permitted by the rules of the Securities and Exchange Commission (the SEC).
This notice and the attached explanation discuss the following matters:
||The process and potential timing of Fannie Maes restatement and re-audit;
||Certain New York Stock Exchange (NYSE) listing standards relating to SEC filings;
||Certain accounting matters that may significantly impact the
results of operations for third quarter 2005 and the results of operations for third quarter 2004 that Fannie Mae ultimately reports;
||Certain key business and market issues that have impacted the company;
||The election of a new director and appointment of new officers;
||Certain of our risks and risk management practices;
||Our estimate of the financial impact of Hurricanes Katrina and Rita on the company;
||An update regarding the achievement of our capital restoration plan; and
||Legislative developments to strengthen regulatory oversight of the government sponsored housing enterprises.
Fannie Maes restatement and re-audit
Fannie Mae is not able to file a timely Form 10-Q because Fannie Mae has not completed its
financial statements for the third quarter of 2005. As previously announced, Fannie Mae is in the
process of restating its historical financial statements and has determined that its previously
filed interim and audited financial statements for the periods from January 2001 through the second
quarter of 2004 should no longer be relied upon. More information regarding the matters discussed
in this Form 12b-25 may be found in Forms 8-K Fannie Mae filed with the SEC on March 18, 2005, May
11, 2005 and August 9, 2005.
On September 20, 2004, the Office of Federal Housing Enterprise Oversight (OFHEO) delivered
to the Board of Directors of Fannie Mae a report on the findings of its special examination to date
of Fannie Maes accounting policies and practices, which raised questions about Fannie Maes
application of Financial Accounting Standard No. 91, Accounting for Nonrefundable Fees and Costs
Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases (FAS 91) and
Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities
(FAS 133). OFHEO subsequently notified Fannie Mae of additional accounting and internal control
issues and questions the agency identified in its ongoing special examination. The issues and
questions pertain to the following areas: securities accounting, loan accounting, consolidations,
accounting for commitments, practices to smooth certain income and expense amounts, journal entry
controls, systems limitations, and database modifications, as well as additional issues relating to
FAS 91. On September 27, 2004, Fannie Mae entered into an agreement with OFHEO to take a series of
steps with respect to its
accounting, capital, organization and staffing, compensation, governance and internal
controls. On March 7, 2005, Fannie Mae and OFHEO entered into a supplement to the September 27,
2004 agreement. OHFEOs special examination of Fannie Maes accounting policies and practices is
On December 15, 2004, the SECs Office of the Chief Accountant advised Fannie Mae that it
should restate its financial statements filed with the SEC to eliminate the use of hedge
accounting, evaluate the accounting under FAS 91 and restate its financial statements filed with
the SEC if the amounts required for correction were material, and reevaluate the information
prepared under generally accepted accounting principles (GAAP) and non-GAAP information that
Fannie Mae previously provided to investors, particularly in view of the decision that hedge
accounting is not appropriate.
Fannie Maes Board of Directors and management are addressing the issues and questions raised
by OFHEO. In addition, the Board designated a Special Review Committee to review the findings of
OFHEOs September 2004 special examination report and to oversee an investigation by independent
counsel, as required by the September 27, 2004 agreement. The investigation, led by former Senator
Warren Rudman of the law firm of Paul, Weiss, Rifkind, Wharton & Garrison, is focused on:
accounting issues, including accounting policies, procedures and controls; organization, structure
and governance, including board oversight and management responsibilities and resources; and
executive compensation. Paul, Weiss continues its work as it examines these areas and other issues
that may arise in the course of its review and is reporting regularly to the Board. Fannie Mae and
Paul, Weiss will report to OFHEO regarding each of these issues and Fannie Mae will continue to
work with OFHEO to resolve these matters as part of the companys ongoing internal reviews and its
Management is undertaking a comprehensive review of accounting routines and controls, the
financial reporting process and the application of generally accepted accounting principles, which
includes the issues OFHEO has identified described in this notice, as well as issues identified by
management and Deloitte & Touche LLP, the companys independent auditor. Management, working with
accounting consultants, will develop a view on these issues, which then will be reviewed with the
Audit Committee, Deloitte & Touche and OFHEO. Upon conclusion of the issue review, the financial
statements will be restated where necessary and submitted to Deloitte & Touche for completion of
its audit. The company is committed to informing OFHEO, Paul, Weiss, and Deloitte & Touche of its
progress on these matters, including the companys approach to completing the restatement,
realigning financial control and audit functions and overhauling financial reporting systems. The
company is providing periodic updates to the SEC and the NYSE of its progress on the restatement.
In addition, the SEC and the U.S. Attorneys Office for the District of Columbia are conducting
ongoing investigations into these matters.
Restating Fannie Maes financial statements will require a substantial amount of time and
resources because the restatement entails significant complexities, including;
||a comprehensive review of Fannie Maes accounting practices, which are often
complex in nature such as accounting for derivatives or mortgage purchase and
||obtaining or validating market values for a large volume of transactions,
including all of our derivatives, commitments and securities at multiple
points in time over the restatement period;
||enhancing or developing new systems to track, value, and account for
securities, commitments and derivatives; amortize deferred price adjustments;
account for Fannie Maes guarantee obligations; and monitor and assess
||restating our financial statements for multiple interim and annual periods; and
||deficiencies in Fannie Maes accounting controls during the restatement period
that necessitate principally substantive audit testing procedures by our
Based on our current assessment, Fannie Mae believes that completion of its Annual Report on Form
10-K for the year ended December 31, 2004, which will include Fannie Maes restated results, is not
likely to occur prior to the second half of 2006. Fannie Mae is committed to devoting all resources
necessary to complete the restatement as expeditiously as possible. However, because many of the
activities are sequential in nature, acceleration from this timeline is difficult.
NYSE listing standards
Under the listing standards of the NYSE, the NYSE may initiate a delisting proceeding when a
listed company fails to file its Annual Report on Form 10-K with the SEC in a timely manner. The
current standards allow for the NYSE to continue a listing for up to nine months from the due date
of the filing (i.e., until December 16, 2005 in the case of Fannie Maes 2004 Form 10-K filing),
subject to ongoing monitoring by the NYSE. The NYSE, in its sole discretion, may extend the listing
for up to an additional three months following this initial nine month period, depending on the
companys circumstances. Under the NYSEs current standards, if a company has not filed its
periodic annual report by the end of the one year period, the NYSE will begin suspension and
The NYSE has filed with the SEC a proposed change to these standards that would allow the
NYSE, in its sole discretion, to refrain from commencing suspension and delisting proceedings,
notwithstanding a companys failure to file its annual report within one year of the filing due
date. Pursuant to the proposed new standards, in determining whether to allow trading in a companys
stock to continue, the NYSE will consider, among other things, a companys financial health and
compliance with the NYSEs qualitative and quantitative listing standards, as well as whether there
is a reasonable expectation that the company will be able to resume timely filings in the future.
Under the proposed new standards, the NYSE would advise the SEC of any determination to continue
the listing of such a company and publish notice of this determination on the NYSEs website. In
addition, the proposed new standards require the NYSE to reevaluate its determination to continue
the listing of such a company once every three months and, if the NYSE reaffirms its decision to
allow trading to continue, to advise the SEC of such reaffirmation, as well as publish the
reaffirmation on the NYSEs website. We expect the SEC will publish the proposed NYSE rule change for public
comment in the Federal Register.
Fannie Mae is engaged in regular discussions with the NYSE staff regarding the status of the
restatement and continued listing through completion of the restatement. Until Fannie Mae is
current with its SEC periodic reporting requirements, the NYSE will identify Fannie Mae as a late
filer on its website and will disseminate on the consolidated tape an indicator of the companys
The information provided in this notice and the attached explanation includes forward-looking
statements, including statements regarding the restatement of Fannie Maes financial statements for
prior periods and the timing and impact thereof, the anticipated impact of certain accounting
matters on the companys results of operations, the anticipated future performance of our Portfolio
Investment and Credit Guaranty businesses, maintenance of our
required 30 percent capital surplus, our estimated losses resulting from Hurricanes Katrina and Rita, our future approach to
managing credit risk and our portfolio and future administrative expenses. Statements that are not
historical facts, including statements about Fannie Maes beliefs and expectations, are
forward-looking statements. These statements are based on beliefs and assumptions by the companys
management, and on information currently available to management. Forward-looking statements speak
only as of the date they are made, and the company undertakes no obligation to update publicly any
of them in light of new information or future events. A number of important factors could cause
actual results to differ materially from those contained in any forward-looking statement. Examples
of such factors include, but are not limited to, the timing and nature of the final resolution of
the accounting issues discussed in this notice and those raised by OFHEO in the course of its
special examination discussed in this notice, the outcome of the review being conducted by
independent counsel on behalf of the companys Board of Directors and of OFHEOs ongoing special
examination, the outcome of the investigations being conducted by the SEC and the U.S. Attorneys
Office for the District of Columbia, the outcome of pending litigation, the factors discussed in
this notice and the attached explanation, and the reactions of the marketplace to the
(1) Name and telephone number of person to contact in regard to this notification
(2) Have all other periodic reports required under Section 13 or 15(d) of the Securities Exchange
Act of 1934 or Section 30 of the Investment Company Act of 1940 during the preceding 12 months or
for such shorter period that the registrant was required to file such report(s) been filed? If the
answer is no, identify report(s).
Fannie Mae has not filed the following periodic reports: a Quarterly Report on Form 10-Q for
the period ended September 30, 2004; an Annual Report on Form 10-K for the period ended December
31, 2004; and Quarterly Reports on Form 10-Q for the periods ended March 31, 2005 and June 30,
(3) Is it anticipated that any significant change in results of operations from the corresponding
period for the last fiscal year will be reflected by the earnings statements to be included in the
subject report or portion thereof?
If so: attach an explanation of the anticipated change, both narratively and quantitatively,
and, if appropriate, state the reasons why a reasonable estimate of the results cannot be made.
Please see attached explanation.
||Federal National Mortgage Association
||(Name of Registrant as Specified in Charter)
Has caused this notification to be signed on its behalf by the undersigned thereunto duly
Date: November 10, 2005
||/s/ Robert Levin
||Executive Vice President, Chief Business
||Officer and Interim Chief Financial Officer
Explanation Referred to in Part IV, Item (3) of Form 12b-25
Fannie Mae is required by Part IV, Item (3) of Form 12b-25 to provide as part of this filing
an explanation regarding whether the results of operations it expects to report for the third
quarter of 2005 will reflect significant changes from results of operations for the third quarter
of 2004. Because of the restatement and re-audit process described above, Fannie Mae is unable to
provide a reasonable estimate of either its third quarter 2005 results of operations or its third
quarter 2004 results of operations. Accordingly, Fannie Mae cannot at this time estimate what
significant changes will be reflected in its third quarter 2005 results of operations from its
third quarter 2004 results of operations. Presented below is a discussion of certain accounting
matters that may significantly impact the results of operations for third quarter 2005 and the
results of operations for third quarter 2004 that Fannie Mae ultimately reports, followed by a
discussion of certain key business and market issues that have impacted the company, disclosures
regarding certain risks and risk management practices and updates on certain personnel and
As noted above, Fannie Mae is conducting a comprehensive review of its accounting policies and
practices. Set forth below are certain accounting errors identified in the course of that review,
which have been discussed with Deloitte & Touche and the Audit Committee of the Board of Directors.
These issues also were reviewed with OFHEO in the course of discussions preceding our minimum
capital submission as of September 30, 2005. We are continuing to review other policies and
practices, some of which may further impact the accounting for these matters. We are working to
quantify the financial statement impacts of these errors. Further, any conclusions reached during
the accounting policy review are subject to further analysis in the course of the restatement and
Deloitte & Touches re-audit.
||Hedge Accounting. Fannie Mae misapplied hedge accounting under Financial Accounting
Standard No. 133, Accounting for Derivative Instruments and Hedging Activities, for certain
of its derivatives, and as a result of this error expects to record an estimated net
cumulative after-tax loss of approximately $8.4 billion as of December 31, 2004, excluding
the impact of mortgage commitments (which are discussed below). This estimated loss is
subject to change as a result of other accounting issues under review.
||Accounting for Mortgage Commitments. Fannie Mae has concluded that, after adoption of
Financial Accounting Standard No. 149, Amendments of Statement 133 on Derivative
Instruments and Hedging Activities, it misapplied cash flow hedge accounting criteria for
its mortgage commitments. Fannie Mae estimates that the net cumulative amount of after-tax
losses relating to mortgage commitments deferred in accumulated other comprehensive income,
referred to as AOCI, was approximately $2.4 billion as of December 31, 2004. This estimated
loss is subject to change as a result of other accounting issues under review.
We expect that the impact of the misapplication of derivative accounting rules will be material
to Fannie Maes previously reported results for many, if not all, periods and will vary
substantially from period to period based on the amount and types of derivatives held and
fluctuations in interest rates and volatility. Fannie Maes restatements to eliminate hedge
accounting will result in the recognition of derivative gains and losses in the period of
occurrence that were previously deferred under hedge accounting and would have been recognized
in future period earnings.
Reclassification of Securities
Fannie Mae has determined that it misapplied generally
accepted accounting principles (GAAP) relating to the classification of its investments
in debt and equity securities under Financial Accounting Standard No. 115, Accounting for
Certain Investments in Debt and Equity Securities. As a result, Fannie Mae must reclassify
securities previously classified as held-to-maturity and discontinue use of the
held-to-maturity category until two years after the last misclassified transaction. Fannie
Mae expects to reclassify the majority of its held-to-maturity securities to the
available-for-sale category. To the extent that securities are classified as
available-for-sale, all unrealized gains and losses for those securities, net of taxes, for
each reporting period will be recorded in equity as a component of AOCI. AOCI will vary
substantially from period to period as a result of this reclassification, primarily due to
changes in interest rates which affect the fair value of debt securities, but will not
impact our regulatory capital position because AOCI is excluded from
this calculation. Gains and losses on these securities will impact
the carrying value of these assets, which will impact the amount of
capital we are required to hold, but we do not expect the impact to
As part of its ongoing accounting review, Fannie Mae is also evaluating whether a portion of
the securities in its portfolio should be reclassified as trading. To the extent that
securities are classified as trading, unrealized gains and losses on those securities for
each period will be recorded as a component of earnings.
Amortization of Premiums and Discounts
Fannie Mae has determined that errors were made in its application of Financial Accounting
Standard No. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or
Acquiring Loans and Initial Direct Costs of Leases. The errors primarily relate to the assumptions
we used in estimating the amortization rates of various premiums and discounts on securities
and loans. To the extent that using the correct assumptions results in a change in amortization
rates from previous estimates, it will affect the timing of the companys recognition of premiums
and discounts on securities and loans.
Fannie Mae anticipates recording asset impairments with respect to certain of the periods
being restated relating to the companys accounting for certain guaranty assets that result from
the buy-up of guaranty fees in connection with certain Fannie Mae mortgage-backed security
(Fannie Mae MBS) issuances. To facilitate the pooling of mortgages into a Fannie Mae MBS, in
certain transactions the monthly Fannie Mae MBS guaranty fee rate is adjusted for an upfront cash
payment by Fannie Mae to the lender (a buy-up) or an
upfront cash receipt from the lender to Fannie Mae (a buy-down) when
the Fannie Mae MBS is formed. These amounts adjust Fannie Maes monthly guaranty fee so that the
coupon rates on the Fannie Mae MBS are generally in increments of whole or half a point, which tend
to be more easily traded. When Fannie Mae engages in buy-up transactions, it increases its
guaranty assets by the amount of the buy-up and recognizes income over the expected life of the
Fannie Mae MBS. Fannie Mae previously did not periodically assess these buy-ups for impairment,
which is required by GAAP. During the course of the restatement, Fannie Mae will assess these
guaranty assets for impairment and expects to record impairment relating to such assets in certain
LIHTC and Synthetic Fuel Investments
Fannie Mae has determined that it has made errors in the accounting for its Low Income Housing
Tax Credit (LIHTC) investments. Fannie Mae incorrectly accounted for certain of its LIHTC
investments using the effective yield method instead of the equity method of accounting. Restating
the accounting for these investments using the equity method will affect the timing of recognition
of losses during the restatement period and will result in more variability from period to period.
Fannie Mae also recorded certain of its LIHTC investments on an as funded basis, rather than
at the committed amount, as required by GAAP. Restating these investments at the committed amount will result in our recording an equal asset and liability for each of these
In addition, Fannie Mae incorrectly expensed interest on certain borrowings used to fund the
construction of qualified real estate investments as the expense was incurred, rather than
capitalizing the interest on such borrowings as required by GAAP. As a result, amounts previously
recorded as interest expense will be added to the carrying value of the investment. The carrying
value will then be subject to reduction through partnership losses and, potentially, impairments.
Fannie Mae also has determined that it made certain errors in the calculation of impairment on
these LIHTC investments. Previously reported impairment amounts also will need to be restated as a
result of the impact of the errors described above on the carrying value of the companys
Fannie Mae has concluded that it made certain similar errors in its accounting for investments
in three synthetic fuel (referred to as synfuel) partnerships established in the 1990s. Given
that Fannie Mae has limited investments in only three of
such partnerships, we expect that our restatement relating to synfuel investments will not
have a significant impact on our results of operations or financial condition.
Mortgage Insurance Accounting
Fannie Mae is reviewing its historical accounting for insurance. Given the number of
inquiries we have received on this topic, we are providing an interim discussion of this review.
Fannie Mae previously recognized approximately $210 million, $240 million and $185 million of
insurance premium expense for 2004, 2003 and 2002, respectively. The vast majority of these
premiums related to policies covering mortgage credit losses. Other policies are general forms of
corporate insurance, including directors and officers liability insurance, property and casualty
insurance and workers compensation. We conducted an initial assessment to identify policies with
terms or features that required further review to determine whether insurance accounting is
appropriate and are in the process of reviewing those policies so identified. We will undertake
additional review procedures relating to our accounting for insurance policies upon completion of
this initial review.
To date, we have determined that one mortgage insurance policy did not transfer sufficient
underlying risk of economic loss to the insurer, and therefore does not qualify for accounting as
insurance. Fannie Mae will restate its previously issued financial statements as a result of this
error, the effect of which will be to generally record the premium paid as a deposit, with
recoveries from the policy reflected as a reduction thereto, and to recognize credit losses with no
reduction for any recoveries resulting from the insurance policy. At the time this insurance policy
was originated, Fannie Mae paid a premium of approximately $35 million to insure the companys
losses in an amount equal to 20 percent of the unpaid principal balance of each loan contained within a
portfolio of lower credit quality mortgage loans, up to an aggregate of approximately $39 million
for all loans in the portfolio. This 20 percent coverage was supplemental to standard borrower- or
lender-paid mortgage insurance that was in place for every loan that
had an acquisition loan-to-value ratio in excess of 80 percent. Mortgage payments on this portfolio of loans were current at the time
the policy was originated, but there was a high probability that we would incur at least $39
million in losses on this portfolio. The premium was amortized at approximately $13.5 million in
each of 2002 and 2003 and approximately $8 million in 2004, while approximately $39 million of
payments under the policy were largely received over a three-year period, principally in 2003 and
2004. We expect that the restatement relating to accounting for this policy will have no cumulative
impact on our results of operations or financial condition as of September 30, 2005, but will
impact reported earnings for certain restatement periods.
We are continuing with the review of our accounting for insurance to determine whether
additional policies were not accounted for properly. The Board has asked Paul, Weiss to review the
circumstances surrounding this policy and to review other insurance arrangements. Fannie Mae is
providing documents and information to OFHEO and the SEC regarding these matters in connection with
their ongoing investigations.
Key Business and Market Issues
Fannie Mae is a shareholder-owned corporation chartered by the U.S. Congress to increase the
availability and affordability of homeownership in America. In accordance with our charter, we seek
to achieve this mission objective by providing and maintaining liquidity in the secondary mortgage
market. Our two primary businessesour Portfolio Investment business and our Credit Guaranty
businesseach contribute to this liquidity function, and together serve to increase the total
amount of funds available to finance mortgages for low-, moderate- and middle-income Americans.
Our businesses are significantly affected by the dynamics of our underlying marketthe
secondary market for residential mortgage debt outstanding. These dynamics include the total amount
of mortgage debt outstanding, the volume and composition of mortgage originations and the level of
competition for mortgage assets among investors. Generally, the level of competition in our market
has intensified in recent years, and our market remained extremely competitive in the third quarter
The following discussion highlights recent developments in our primary businesses.
Credit Guaranty Business
Our single-family business recorded a notable increase in market share of new mortgage-related
securities issuance in the third quarter of 2005, with Fannie Maes market share rising
approximately 3.4 percentage points to 27.1 percent compared with 23.7 percent in the second
quarter of 2005. Our market share of new mortgage-related securities issuance also increased
relative to both government-sponsored enterprise (GSE) and private-label competitors during the
past year, a period marked by significant organizational transition. Our general success in
retaining and expanding relationships with existing lending partners was a key driver of these
gains, enabling substantial increases in our guarantee of lender-originated product. Additionally,
our increased market share in the third quarter reflects our somewhat more positive assessment of
dynamics underlying certain products available for guarantee.
Fannie Mae has been the largest agency issuer of mortgage-related securities in every year
since 1990. This has contributed to our leadership position in the overall market for outstanding
mortgage-related securities. Total gross Fannie Mae MBS outstanding (which includes Fannie Mae MBS
held in Fannie Maes portfolio) was $1.900 trillion at June 30, 2005, representing 38.5 percent of
outstanding mortgage-related securities. Total gross Fannie Mae MBS outstanding grew to $1.925
trillion at September 30, 2005 (comparable data for outstanding mortgage-related securities is not
yet available for this period). The higher volume of tradable Fannie Mae MBS in the secondary
market has generally enhanced the liquidity of our mortgage-backed securities compared to those
issued by other market participants.
The composition of mortgage originations continued to have a significant effect on our
single-family business in the third quarter of 2005. Adjustable-rate mortgage (ARM) originations
declined in the third quarter as a percentage of total originations, as the difference between
rates for ARM loans and long-term fixed-rate loans narrowed considerably, reaching the tightest
spreads recorded since 2001. Additionally, there was a notable decline in the proportion of ARM
applications in the third quarter of 2005 compared with the prior quarter. Notwithstanding the
third quarter decline in ARM originations, the proportion of ARM originations continued to exceed
what we believe is indicated by the difference between short- and long-term mortgage rates. We
believe that this dynamic reflects consumers use of ARM products to gain even marginally lower
initial mortgage payments and other affordability features in the face of rapid home price
appreciation in many markets. However, given the declines in both ARM originations and ARM
applications in the third quarter, we believe that the start of a shift in consumer preference away
from ARMs and towards conventional fixed-rate product may be occurring, though it is difficult to
anticipate the pace or duration of this shift.
Though long-term fixed-rate mortgages represent the substantial majority of assets underlying
our Fannie Mae MBS, Fannie Mae has also traditionally played an active role in the secondary market
for ARMs. We continue to believe that ARMs can be used as effective tools to manage personal
finances by certain borrowers.
The proportion of adjustable-rate assets acquired or guaranteed by Fannie Mae has increased
substantially over the past several years. For the nine months ended September 30, 2005, ARMs
represented an estimated 24 percent of our conventional single-family mortgage acquisitions;
however, we estimate that ARMs represented approximately 14 percent of our conventional
single-family mortgage credit book of business at September 30, 2005. Negative-amortizing and
interest-only ARMs have represented an increased proportion of new business year-to-date. We
estimate these products represent approximately 5 percent of our conventional single-family
mortgage credit book of business. These estimates are based on conventional single-family mortgage
loans (in our portfolio, underlying Fannie Mae MBS held in our portfolio and underlying Fannie Mae
MBS held by others) for which we have loan-level data. We do not have loan-level data for all of
the single-family credit risk exposure attributable to purchases by our Portfolio Investment
business, such as Freddie Mac securities, Ginnie Mae securities, private-label securities and
housing revenue bonds. These products for which we do not have loan-level data represent an
estimated 8 percent of our total single-family mortgage credit book of business as of September 30,
2005, and an estimated 10 percent of our single-family mortgage acquisitions during the nine months
ended September 30, 2005. We expect the inclusion of these products in our estimates would impact
the percentages set forth in this paragraph.
Originations of lower credit quality loans, loans with reduced documentation, and loans to
fund investor properties (where the owner is not the primary resident) in 2005 remained substantially
higher than historical norms. Private-label issuerscompanies other than Fannie Mae,
Freddie Mac and Ginnie Maecontinued to be a significant source of financing for these mortgages.
Many private-label issues continued to be characterized by significant levels of layered risk
mortgages (for example, an interest-only or negatively-amortizing ARM with reduced documentation
and a high combined loan-to-value ratio where there is both a first-lien and second-lien mortgage
at closing). While private-label market share of total mortgage-backed securities issuance
declined in the third quarter, with Fannie Mae gaining a significant portion of lost private-label
share, the dollar volume of private-label issuance reached an all-time high of $311.9 billion,
representing over 50 percent of total new mortgage-backed securities issuance.
single-family business has remained focused on the achievement of our regulatory and
corporate mission objectives. Meeting certain of the goals defined by the Department of Housing
and Urban Development (HUD), our mission regulator, has become more challenging largely due to
the same shift in originations composition that has driven increases in private-label market share.
As home price appreciation has grown considerably faster than per capita income gains in each of the past
three years, many borrowers who fall into categories that would count toward our housing goals have
opted for loan products other than conventional fixed-rate products to maintain affordability.
We have maintained a disciplined approach to the management of credit risk in the current
environment. Credit quality in our single-family business has remained strong. The weighted
average original loan-to-value ratio for our conventional single-family mortgage credit book of
business was 70 percent and the weighted average credit score was 720 at September 30, 2005.
The weighted average estimated mark-to-market loan-to-value ratio for our conventional
single-family mortgage credit book of business was 54 percent at
September 30, 2005. As noted above, we do not have loan-level data for an estimated 8 percent of our total
single-family mortgage credit book of business as of September 30, 2005. We expect the inclusion
of these products in our estimates would impact the averages set forth in this paragraph.
our single-family delinquency measures remained low through
September 2005. We expect that our
single-family delinquency rate will increase beginning in the fourth quarter of 2005 due to the
impact of the Gulf Coast hurricanes. We will continue to evaluate the risk and pricing dynamics in
this market and run our business in accordance with our risk disciplines.
Fannie Mae is one of the most active participants in the multifamily mortgage market and the
largest single holder of multifamily mortgage debt (including mortgage-related securities). Our
multifamily business provides financing for affordable and market-rate rental housing on a
nationwide basis and through a full range of economic conditions, thereby supporting both
accessibility to financing and the liquidity of multifamily mortgage debt.
Real estate fundamentals for the multifamily property sector continued to improve in the third
quarter. Vacancies declined to approximately 6.5 percent nationally for institutional-type
properties. In addition, asking rents generally increased during the third quarter.
The dynamics of the multifamily originations market were largely unchanged from the second
quarter, with historically high investor demand continuing to drive an intensely competitive market
for multifamily product.
As a result of the intensity of investor demand for multifamily
assets, the proportion of loans meeting our credit profile and risk return requirements has declined.
We believe that our adherence to disciplined credit standards is evident in our delinquency
statistics, which remain within an historically low range. Fannie Maes multifamily delinquency
rate was 0.09 percent at September 30, 2005. Our multifamily delinquency rate may increase
beginning in the fourth quarter of 2005 due to the impact of the Gulf Coast hurricanes. We remain
disciplined in our approach to underwriting and credit standards, and will continue to maintain our
disciplined and proactive risk management approach to capital investment in the multifamily sector
over the long-term.
Portfolio Investment Business
Our portfolio investment business supports our primary liquidity function by purchasing and
selling mortgage loans and mortgage-related securities through a full range of economic and
competitive environments. Additionally, by issuing debt to both domestic and international
investors to fund our mortgage purchases, our portfolio investment business helps to maintain a
diversified funding base and to expand the total amount of capital available to finance housing in
the United States.
Prior to our September 27, 2004 agreement with OFHEO, Fannie Maes mortgage portfolio business
pursued a disciplined growth strategy, buying mortgage loans and mortgage-backed securities when
anticipated returns met or exceeded our hurdle rates, and generally holding these assets to
Since our September 27, 2004 agreement with OFHEO, our portfolio activities have been
conducted in the context of our capital plan, which defined the management of total balance sheet
size by reducing the portfolio principally through normal mortgage liquidations as one of the key
elements that would contribute to the achievement of our capital goal. Our assessment of the
economic attractiveness of purchase and sale opportunities has been aligned with our need to lower
portfolio balances to achieve our capital plan objectives. As in the first and second quarters,
competition for mortgage assets in the third quarter significantly curtailed economically
attractive purchase opportunities, while increasing the number of economically attractive
opportunities to sell certain mortgage assets from our portfolio. Consequently, we have sold a
considerably higher amount of mortgage assets from our portfolio in 2005 compared with historical
norms. The heightened level of sales in our portfolio in 2005 has been facilitated by the
previously announced reclassification of securities from held-to-maturity to available-for-sale,
which will also provide greater flexibility in the future to sell assets from our portfolio. The
$52.9 billion of assets sold from our portfolio in the third quarter were primarily traditional
15-year and 30-year mortgage-related securities, in addition to Real Estate Mortgage Investment
Conduits (REMICs) that were structured from 15-year and 30-year Fannie Mae MBS held in our
Market dynamics have also affected the composition of assets in our portfolio. The proportion
of floating rate assets in our portfolio remained high by historical standards in the third
quarter, reflecting the composition of mortgage originations, the generally diminished availability
of fixed-rate product that met our criteria for economic returns, and sales of fixed-rate Fannie
Mae MBS from our portfolio. Floating rate assets generally have much lower prepayment variability
than 30-year fixed rate
As a result of lower prepayment variability, a higher proportion of floating rate assets
serves to lessen the overall levels of interest rate risk in our portfolio.
The total notional value of outstanding derivative instruments used to hedge interest rate
risk in our portfolio declined to $627.9 billion at September 30, 2005 compared with $989.3 billion
at September 30, 2004. The key driver of this decline was the termination of off-setting positions
in pay-fixed and receive-fixed swaps. The notional amount of
swaptions at September 30, 2005 declined only slightly from
year-ago levels despite a decrease in the amount of fixed-rate mortgages held in the portfolio.
We have maintained our disciplined approach to managing interest rate risk in our portfolio.
We believe the general effectiveness of our risk management strategies is reflected in our
portfolios duration gap, a principal measure of interest rate risk, which has not exceeded plus or
minus one month for twelve months, despite interest rate volatility that has resulted in 10-year
Treasury yields ranging from a high of 4.64 to a low of 3.89 during that period.
OFHEO announced on November 1, 2005 that Fannie Mae had achieved a 30 percent surplus over
minimum capital at September 30, 2005. However, our requirement to maintain a 30 percent capital
surplus will remain in effect at OFHEOs discretion, and will not be automatically rescinded as a
result of our achieving our capital plan requirements.
When our capital surplus requirement is no longer in effect, our portfolio investment business
will continue to focus on effectively supporting our chartered liquidity function while seeking to
maximize total return for our investors. Management will not consider portfolio growth as a primary
measure of performance for our Portfolio Investment business. Instead, management will measure the
success of the Portfolio Investment business by our ability to maintain liquidity in the secondary
mortgage market, and the total return we generate for our shareholders subject to our risk
constraints. Consequently, our portfolio may grow or decline based upon the specific market
dynamics during a given period. We will continue to generate revenue in the portfolio business
principally through the difference between our cost of funding and the yield we earn on retained
assets. We expect that revenue will be enhanced by our ability to capture economic value through
purchase or sale transactions when market demand makes such transactions economically attractive.
Additionally, management believes that our liquidity function will be enhanced by our consideration
of both purchase and sale opportunities in the context of a given spread environment.
expenses totaled an estimated $562 million and $1,514 million for the third
quarter and first nine months of 2005, respectively, compared to an estimated $382 million,
$1,150 million, and $1,511 million for the third quarter, first nine months, and full year of
2004, respectively. Costs associated with the restatement process and related regulatory
examinations, investigations and related litigation significantly increased administrative expenses
through the third quarter of 2005. These costs totaled $168 million and $315 million for the third
quarter and first nine months of 2005, respectively. Based on our current projections, we estimate
restatement-related costs, including costs associated with technology investments, our litigation
defense and our investigations and agreement with OFHEO, will total over $560 million for full year
2005. We anticipate that these restatement-related costs will have a substantial impact on
administrative expenses until the restatement is completed.
The Election of a New Director and Appointment of New Officers
Fannie Mae is announcing today the following officer appointments:
||Robert T. Blakely, III as Chief Financial Officer;
||Robert J. Levin as Chief Business Officer;
||Michael J. Williams as Chief Operating Officer;
||Carolyn Groobey as Senior Vice President, Strategy; and
||David S. Worley, III as Senior Vice President, Housing and Community Development Credit Risk.
The company is also announcing today that Bridget A. Macaskill has been elected to join Fannie
Maes Board of Directors as of December 1, 2005 and that Frederic V. Malek will retire from the
Board of Directors at the end of the year.
In a press release dated November 3, 2005, Fannie Mae announced the appointment of Mark Winer
as Deputy and Acting Head of the companys Chief Risk Officer organization.
information, please see the announcements we are issuing today and issued on November 3, 2005,
which we are posting on
our website, www.fanniemae.com, and including as exhibits to a Form 8-K we will file with the
SEC today that will also contain the narrative portions of this Form 12b-25.
Disclosures Regarding Certain Risks and Risk Management Practices
Pursuant to a September 1, 2005 agreement with OFHEO, Fannie Mae is providing the following
periodic disclosures regarding risks and risk management practices.
Fannie Mae has committed to issue subordinated debt in a quantity such that the sum of total
capital (core capital plus general allowance for losses) plus the outstanding balance of qualifying
subordinated debt will equal or exceed the sum of outstanding Fannie Mae MBS times 0.45 percent and
total on-balance sheet assets times 4 percent. Subordinated debt will be discounted for the
purposes of this calculation during the last five years before maturity in the following manner:
one-fifth of the outstanding amount is excluded each year during the instruments last five years
before maturity. When remaining maturity is less than one year, the instrument is entirely
excluded. We have determined that, as of September 30, 2005, our outstanding subordinated debt
plus total capital exceeded the sum of 0.45 percent of outstanding Fannie Mae MBS plus 4 percent of
total on-balance sheet assets. Our determination that we are in compliance with our subordinated
debt commitment reflects our current assessment of accounting issues we are reviewing and their
estimated financial impact.
Fannie Mae has made a commitment to maintain a functional contingency plan providing for at
least three months of liquidity without relying upon the issuance of unsecured debt, and to
periodically test the contingency plan in consultation with its OFHEO Examiner-in-Charge. As of
September 30, 2005, we were in compliance with our commitment to maintain and test our contingency
Interest Rate Risk
In its September 1, 2005 agreement with OFHEO, Fannie Mae agreed to provide periodic public
disclosures regarding the monthly averages of our duration gap. We disclose the duration gap on a
monthly basis in our Monthly Summary Report, which is available on our website and filed with the
SEC in a current report on Form 8-K. (See, e.g., the Form 8-K Fannie Mae filed with the SEC on
October 28, 2005.) The duration gap on Fannie Maes portfolio averaged one month in September 2005.
Mae also agreed to provide public disclosure regarding the impact on
condition of both a 50-basis point shift in rates and a 25-basis point change in the slope of the
yield curve. We will begin providing this disclosure once we have current financial statements.
Pursuant to its September 1, 2005 agreement with OFHEO, Fannie Mae agreed to provide quarterly
assessments of the impact on its expected credit losses from an immediate 5 percent decline in
single-family home prices for the entire United States.
The estimated sensitivity of our expected future credit losses to an immediate five percent
decline in home values for all single-family mortgages held in Fannie Maes retained portfolio and
underlying guaranteed Fannie Mae MBS at June 30, 2005 (the most recent date for which data are
available), prior to the receipt of private mortgage insurance claims or any other credit
enhancements, was $1,838 million, or 0.09 percent of our conventional single-family mortgage credit
book of business, compared with 0.13 percent at June 30, 2004.
After receipt of expected mortgage insurance and other credit enhancements, the estimated
sensitivity of our expected future credit losses to an immediate five percent decline in home
values for all single-family mortgages held in Fannie Maes retained portfolio and underlying
guaranteed Fannie Mae MBS at June 30, 2005, was $802 million, or 0.04 percent of our conventional
single-family mortgage credit book of business, compared with 0.06 percent at June 30, 2004.
Fannie Mae agreed to seek to obtain a rating that will be continuously monitored by at least
one nationally recognized statistical rating organization and that it would provide periodic public
disclosure of the rating or ratings. The rating will assess, among other things, the independent
financial strength or risk to the government rating of Fannie Mae operating under its authorizing
legislation but without assuming a cash infusion or extraordinary support of the government in the
event of a financial crisis.
Standard & Poors current risk to the government rating for Fannie Mae is AA- and on
CreditWatch Negative. Standard & Poors continually monitors this rating. The rating has remained
on CreditWatch Negative since September 23, 2004.
Moodys Investors Services current Bank Financial Strength Rating for Fannie Mae is B+
with a stable outlook. Moodys Investors Service continually monitors this rating.
Impact of Hurricanes Katrina and Rita
Fannie Mae has previously reported that it estimates that its after-tax losses as of September
30, 2005 as a result of Hurricanes Katrina and Rita will be in a range of $250 million to $550
million. As a result, Fannie Mae has recorded a $257 million after-tax charge for the quarter
ended September 30, 2005 relating to these hurricanes. The company will continue to assess the
impact of Hurricanes Katrina and Rita as more information becomes available.
Fannie Maes exposure to losses as a result of Hurricanes Katrina and Rita arises primarily
from its guaranty of principal and interest payments due to holders of Fannie Mae MBS secured by
property in the affected areas, its portfolio holdings of mortgages and mortgage-related securities
secured by property in the affected areas, and real estate that it owns in the affected areas.
Fannie Maes preliminary estimates of the financial impact of Hurricanes Katrina and Rita involve
the exercise of considerable judgment and assumptions about uncertain matters. For example, these
estimates could be impacted negatively or positively if insurance recoveries, including flood
insurance, the number of properties damaged, the extent of the damage, or property values are less
or more than the company has assumed. These preliminary estimates are inherently imprecise due to a
variety of factors, including the companys inability to access portions of the affected areas and
the limited availability of reliable data regarding the condition of properties in the affected
areas. Further, the estimated range does not reflect potential issues with the pace of economic
recovery in the regions affected by Hurricanes Katrina and Rita. Accordingly, the range Fannie Mae
has estimated is based on current information, and may change as new information becomes available.
In response to Hurricanes Katrina and Rita, Fannie Mae has instituted mortgage relief
provisions designed to meet the individual needs of borrowers facing hardship as a result of the
hurricanes. Fannie Maes disaster relief provisions allow lenders to help borrowers in several
ways, including suspending or reducing mortgage payments for up to 18 months or more and permitting
repayment of the amounts deferred over time. In addition, Fannie Mae has established new
single-family underwriting flexibilities for disaster relief that will help borrowers affected by
the hurricanes to acquire new homes. Fannie Mae has also identified 1,500 single-family properties
from its inventory of real estate owned for rent-free leasing to individuals and families displaced
by Hurricanes Katrina and Rita for up to 18 months.
Achievement of Capital Restoration Plan
On November 1, 2004, OFHEO announced that Fannie Mae achieved the 30 percent capital surplus
requirement over the minimum capital requirement as of September 30, 2005, as required by OFHEO.
The minimum capital requirement takes into account Fannie Maes current assessment of accounting
issues it is reviewing and their estimated financial impact, as well as Fannie Maes preliminary
estimate of after-tax losses related to Hurricanes Katrina and Rita.
The U.S. Congress is considering legislation to strengthen regulatory oversight of the
government sponsored housing enterprises. We support these efforts as part of restoring the
markets trust and confidence in Fannie Mae, which, in turn, is critical to our ability to fulfill
our mission of raising capital to finance affordable housing.
The House Financial Services Committee and the Senate Banking, Housing, and Urban Affairs
Committee have advanced GSE regulatory oversight legislation during the current session of
Congress. The separate House and Senate bills address key elements of the GSEs business and
regulation including regulatory structure, capital standards, receivership, scope of GSE
activities, affordable housing goals, portfolio composition and size, and expanded regulatory
oversight over GSE officers and directors. The House bill also
provides for a fund to support affordable housing to be funded by a
specified percentage of our profits. On October 26, 2005, the House of Representatives
passed H.R. 1461, the bill reported by the House Financial Services Committee, by a vote of 331-90.
The enactment into law of the various legislative provisions under consideration, depending on
their final terms and on how they were applied by our regulator within the scope of its authority,
could have a material adverse effect on future earnings, shareholder returns, ability to fulfill
our mission, and ability to recruit and retain qualified officers and directors. It is also
possible that in the legislative process provisions that go beyond the elements described above and
that further alter Fannie Maes charter and ability to fulfill its affordable housing mission could
We cannot predict the prospects for the enactment, timing or content of any legislation or its
impact on our financial prospects.