Fannie Mae Reports Record 1st Quarter 2002 Financial Results
April 18, 2002
Operating Net Income of $1.519 Billion up 22.7 Percent Over 1st Quarter 2001>
WASHINGTON, DC -- Fannie Mae (FNM/NYSE reported operating net income for the first quarter of 2002 of $1.519 billion, a 22.7 percent increase compared with the first quarter of 2001. Operating earnings per diluted common share (operating EPS) of $1.48 were 23.3 percent above the same period in 2001.
Operating Net Income (in billions)
Operating EPS (in dollars)
Operating net income and operating EPS exclude the variability in earnings from both changes in the market value of purchased options and the one-time cumulative change in accounting principle from the implementation of Financial Accounting Standard 133 (FAS 133) on January 1, 2001. Net income and EPS for the first quarter of 2002 including FAS 133 items were $1.209 billion and $1.17, respectively, compared with $1.293 billion, or $1.25 per share, in the first quarter of 2001.
Timothy Howard, Fannie Mae's Executive Vice President and Chief Financial Officer, said, "We believe that the income statement volatility which results from the inclusion of unrealized gains or losses under FAS 133 does not accurately reflect the operating performance of the company. Under FAS 133, operating net income is a more accurate measure of the company's performance." Under FAS 133 net income in the first quarter of 2002 was $310.1 million less than operating net income. In the first quarter of 2001 net income was $55.0 million more than operating net income and in the fourth quarter of 2001 net income exceeded operating net income by $531.0 million. Page one of the attachments to this release provides a reconciliation of net income to operating net income.
Highlights of Fannie Mae's financial performance in the first quarter 2002 compared with the first quarter of 2001 include:
- Growth in taxable-equivalent revenues of 24.8 percent;
- Growth in adjusted net interest income of 29.0 percent;
- An average net interest margin of 115 basis points compared with 103 basis points;
- Growth in guaranty fee income of 18.8 percent;
- Credit-related losses of $21.5 million compared with $28.9 million;
- Losses of $171.7 million from the call and repurchase of debt compared with $83.5 million; and,
- Repurchase of 7.5 million shares of Fannie Mae common stock compared with 1.0 million shares.
Franklin D. Raines, Fannie Mae's Chairman and Chief Executive Officer, said, "Continued strong growth in top-line revenues enabled Fannie Mae to report its 57th consecutive quarterly increase in operating earnings per share during the first quarter of 2002. This is a performance record few other companies can match."
Raines said that Fannie Mae's earnings were fueled by growth in the company's combined book of business -- mortgages in portfolio plus outstanding mortgage-backed securities -- of 19.2 percent over the past 12 months. Over the first three months of 2002, Raines added, Fannie Mae's book of business increased at a 17.4 percent annual rate. Raines stated that the housing market remains unusually strong for this point in the economic cycle, with home prices having rebounded following the impact of the September 11th attacks and mortgage originations to purchase homes remaining buoyant.
Raines said that Fannie Mae's recent strong earnings growth had been accompanied by excellent management of its principal business risks. Raines said, "Fannie Mae's credit costs remain extremely low for this stage of the business cycle, we are maintaining a good match between the assets and liabilities in our portfolio, and over the past 12 months we have added $4.0 billion to our core capital." Raines noted that during the quarter Moody's Investors Service assigned Fannie Mae a bank financial strength rating of A- on a scale of A to E, putting the company among the highest rated financial institutions in America.
Fannie Mae's Executive Vice President and Chief Financial Officer, Timothy Howard, reiterated the company's positive outlook for its financial performance. "We continue to expect that growth in Fannie Mae's operating earnings per share in 2002 will be above the very positive long-term EPS trend we anticipate for the company," said Howard. Longer term, Howard said, Fannie Mae should benefit from strong growth in residential mortgage debt, which the company expects to increase by an average of 8 to 10 percent per year during the current decade. Howard added, "Over this period we expect to continue to be able to grow both our book of business and our earnings at rates that exceed the growth in mortgage debt."
Howard noted that during the quarter the pace of commitments to purchase mortgages for portfolio fell to $50.8 billion from the record $100.5 billion in the fourth quarter of 2001. Said Howard, "With mortgage-to-debt spreads tightening we backed away from the market somewhat in February and March. We expect that we will have more attractive opportunities for portfolio commitments later in the year, and believe that portfolio growth for the full year will approximate the growth rate achieved in 2001." Howard said that with year-to-date business growth so strong and with the interest margin rising in February and March, the slower pace of portfolio commitments over the past two months would not have any discernable effect on the company's net income outlook.
Howard added that credit losses in the first quarter came in lower than expected despite the weaker economy. He said that while the company still anticipates that credit losses may increase from their totals in 2001, it expects that any such increase would be relatively small.
Details of Fannie Mae's first quarter 2002 financial performance follow.
Fannie Mae's business volume -- mortgages purchased for portfolio plus mortgage-backed security (MBS) issues acquired by other investors -- totaled $197.8 billion in the first quarter of 2002, compared with $105.6 billion in the first quarter of 2001 and $185.2 billion in the fourth quarter of 2001. Business volume in the first quarter of 2002 consisted of $91.0 billion in portfolio purchases and $106.8 billion in MBS issues acquired by investors other than Fannie Mae's portfolio, compared with $58.7 billion and $46.9 billion, respectively, in the first quarter of 2001. Retained commitments to purchase mortgages were $50.8 billion in the first quarter of 2002 compared with $76.3 billion in the first quarter of 2001.
Fannie Mae's combined book of business -- the net mortgage portfolio and outstanding MBS held by other investors -- grew at a compound annual rate of 17.4 percent during the first quarter of 2002, ending the period at $1.628 trillion. This growth was fueled by a 15.9 percent annualized growth rate in the net mortgage portfolio to $732 billion and an 18.7 percent rate of growth in outstanding MBS to $896 billion at March 31, 2002.
Portfolio investment business results
Fannie Mae's portfolio investment business manages the interest rate risk of the company's mortgage portfolio and other investments. The results of this business are largely reflected in adjusted net interest income, which is net interest income less the amortization expense of purchased options. Adjusted net interest income for the first quarter of 2002 was $2.120 billion, up 29.0 percent from $1.643 billion in the first quarter of 2001. This increase was driven by a 15.1 percent rise in the average net investment balance and a 12 basis point increase in the average net interest margin.
Fannie Mae's net investment balance -- consisting of the net mortgage portfolio and the company's liquid investments -- averaged $781 billion during the first quarter of 2002 compared with $679 billion during the first quarter of 2001. The net investment balance was $789 billion at March 31, 2002.
The company's net interest margin averaged 115 basis points in the first quarter of 2002, compared with 103 basis points in the first quarter of 2001 and 121 basis points in the fourth quarter of 2001. During the quarter the margin was as low as 111 basis points in January, but rose to 119 basis points in March. Fannie Mae's net interest margin continues to benefit from the sharp declines in short-term interest rates in 2001, which enabled the company to call debt early in that year in amounts which substantially exceeded the timing and volume of mortgage liquidations.
Fannie Mae's net mortgage portfolio grew at an annual rate of 15.9 percent during the first quarter of 2002, ending the quarter at $732 billion. Portfolio growth fell to an annual rate of 2.4 percent in the month of March as mortgage commitments slowed due to tighter mortgage-to-debt spreads, portfolio sales increased, and liquidation rates remained high.
For the first quarter of 2002 the company realized net losses from debt repurchases and debt calls of $171.7 million ($111.6 million after tax) compared with net losses of $83.5 million ($54.3 million after tax) in the first quarter of 2001. During the quarter the company realized losses on debt repurchases of $150.0 million and losses on debt calls of $21.7 million. Fannie Mae regularly calls or repurchases debt as part of its interest rate risk management program.
Credit guaranty business results
Fannie Mae's credit guaranty business manages the company's credit risk. The results of this business are primarily reflected in guaranty fee income and credit-related losses. Guaranty fee income was $407.6 million in the first quarter of 2002, an 18.8 percent increase compared with the first quarter of 2001. Guaranty fee income was driven by a 22.2 percent rise in average outstanding MBS, partially offset by a decline in the average effective guaranty fee rate compared with the previous year. The effective guaranty fee rate in the first quarter of 2002 was 18.6 basis points compared with 19.1 basis points in the first quarter of 2001 and 18.9 basis points in the fourth quarter of 2001.
Credit-related losses -- foreclosed property expense plus charge-off recoveries -- remained low in spite of the weaker economy, totaling $21.5 million compared with $28.9 million in the first quarter of 2001. Foreclosed property expense was $51.7 million in the first quarter of 2002 compared with $54.4 million in the first quarter of 2001. Charge-off recoveries were $30.2 million in the first quarter of 2002 compared with $25.5 million in the first quarter of 2001. Fannie Mae's credit loss rate -- credit-related losses as a percentage of the average combined book of business -- was 0.5 basis points in the first quarter of 2002 compared with 0.9 basis points in the first quarter of 2001.
Credit-related expense, which includes foreclosed property expense and the provision for losses and is the amount recorded on the company's income statement, totaled $21.7 million in the first quarter of 2002, in line with credit-related losses. Fannie Mae's loss provision was a negative $30.0 million in the first quarter of 2002 compared with a negative $25.0 million in the first quarter of 2001. The company's allowance for loan losses stood at $806 million at both March 31, 2002 and December 31, 2001 compared with $810 million at March 31, 2001.
Fee and other income
Fee and other income in the first quarter of 2002 totaled $3.6 million compared with $27.3 million in the first quarter of 2001. The decline from the first quarter of 2001 was primarily due to losses on sales of mortgages and an increase in credit enhancement expenses -- principally for new products with higher-than-average risk characteristics -- both of which are included in other miscellaneous items.
Fee and other income includes technology fees, transaction fees, multifamily fees and other miscellaneous items, and is net of operating losses from certain tax-advantaged investments -- primarily investments in affordable housing which qualify for the low income housing tax credit. Tax credits associated with housing tax credit investments are recorded in the federal income tax line.
Administrative expenses totaled $290.1 million in the first quarter of 2002, up 21.1 percent from the first quarter of 2001. This above-average growth in expenses is related to Fannie Mae's reengineering of its core technology infrastructure to enhance its ability to process and manage the risk on mortgage assets. Due to this initiative, the company expects its administrative expenses to grow at a mid-to-high teens rate in 2002.
The company's ratio of administrative expense to the average combined book of business in the first quarter of 2002 was .073 percent compared with .072 percent in the first quarter of 2001. Fannie Mae's efficiency ratio -- administrative expense divided by taxable-equivalent revenue -- was 10.2 percent in the first quarter of 2002 compared with 10.5 percent in the first quarter of 2001.
Fannie Mae's core capital was $25.5 billion at March 31, 2002 compared with $25.2 billion at December 31, 2001 and $21.5 billion at March 31, 2001.
The company repurchased 7.5 million shares of common stock during the first quarter of 2002, compared with 1.0 million shares in the first quarter of 2001 and 6.0 million shares for all of 2001. First quarter 2002 repurchases included shares used to fund the company's $300 million commitment to the Fannie Mae Foundation made in the fourth quarter of 2001. At March 31, 2002 Fannie Mae had 995.5 million shares of common stock outstanding compared with 997.2 million shares at December 31, 2001. The company called $375 million of preferred stock in the first quarter of 2002. At March 31, 2002 preferred stock made up 7.6 percent of Fannie Mae's core capital.
The company issued $1.0 billion of subordinated debt during the first quarter of 2002, and had $6.0 billion of subordinated debt outstanding at March 31, 2002. Subordinated debt serves as an important supplement to Fannie Mae's equity capital, although it is not a component of core capital. After providing for capital to support its off-balance sheet MBS, Fannie Mae's capital and outstanding subordinated debt as a percent of on-balance sheet assets was 3.5 percent at March 31, 2002.
As part of Fannie Mae's voluntary market discipline, liquidity and safety and soundness initiatives of October 2000, the company now discloses on a quarterly basis its liquid assets as a percent of total assets, the sensitivity of its future credit losses to an immediate 5 percent decline in home prices, and whether it has passed or failed an internal interim version of the risk-based capital stress test based on its interpretation of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992.
At March 31, 2002 Fannie Mae's ratio of liquid assets to total assets was 7.1 percent, compared with 9.5 percent at December 31, 2001. The company has committed to maintain a portfolio of high-quality, liquid, non-mortgage securities equal to at least 5 percent of total assets.
At December 31, 2001 the present value of Fannie Mae's net sensitivity of future credit losses to an immediate 5 percent decline in home prices was $487 million, taking into account the beneficial effect of third-party credit enhancements. This compares with $467 million at September 30, 2001. The December 31st figure reflects a gross credit loss sensitivity of $1,332 million before the effect of credit enhancements, and is net of projected credit risk sharing proceeds of $845 million.
At both December 31st and September 30, 2001, the company passed its internal interim risk-based capital test with a capital cushion that exceeded 30 percent of total capital. The company intends to manage its risks so that the cushion between total capital and internally calculated risk-based capital is at least 10 percent of total capital.
Fannie Mae's quarterly disclosures, together with the monthly interest rate risk disclosures, are included with the company'sMonthly Summary statistics.
Derivatives and FAS 133
Fannie Mae's primary use of derivative instruments is as a substitute for noncallable and callable debt issued in the cash markets. Fannie Mae uses derivatives to help match the cash flow characteristics of its debt with those of its mortgages to reduce the interest rate risk in its portfolio.
Fannie Mae accounts for its derivatives under Financial Accounting Standard No. 133 (FAS 133),Accounting for Derivative Instruments and Hedging Activities. The company implemented this standard, which resulted in changes to accounting presentations on both the company's income statement and balance sheet, on January 1, 2001.
FAS 133 requires that Fannie Mae mark to market on its income statement the changes in the time value of its purchased options -- interest rate swaptions and interest rate caps -- although it does not permit the company to mark to market its options embedded in debt or mortgage investments. The mark to market of Fannie Mae's purchased options during the first quarter of 2002 resulted in a net loss of $787.2 million compared with a net gain of $577.9 million in the fourth quarter of 2001. The large change in the time value of Fannie Mae's purchased options between the fourth quarter of 2001 and the first quarter of 2002 was primarily the result of a significant change in interest rate volatility, which affected the time value of all options. Purchased options expense in the first quarter of 2002 includes $310.2 million in amortization of the cost to purchase these options, which was included in net interest income prior to the adoption of FAS 133 and currently is included in adjusted net interest income and in operating earnings.
At March 31, 2002 the notional balance of Fannie Mae's purchased options totaled $238 billion. At December 31, 2001 the notional balance of Fannie Mae's purchased options was $220 billion.
FAS 133 also requires that the company record any change in the fair values of certain derivatives, primarily interest rate swaps it uses as substitutes for noncallable debt, on the balance sheet in a separate component of stockholders' equity called accumulated other comprehensive income, or AOCI. For these types of transactions, FAS 133 does not require or permit noncallable debt to be marked to market. At March 31, 2002, the AOCI component of stockholders' equity included a $4.8 billion reduction, or 0.7 percent of the net mortgage balance, from the marking to market of these derivatives, down from $7.4 billion at December 31, 2001. Accumulated other comprehensive income is not a component of core capital.
At March 31, 2002 Fannie Mae had $290 billion in interest rate swaps that were marked to market through accumulated other comprehensive income. The company had $282 billion in comparable derivatives at December 31, 2001.
Fannie Mae's primary credit exposure on derivatives is that a counterparty might default on payments due, which could result in Fannie Mae having to replace the derivative with a different counterparty at a higher cost. Fannie Mae's exposure on derivative contracts (taking into account master settlement agreements that allow for netting of payments and excluding collateral received) was $1,033 million at March 31, 2002. All of this exposure was to counterparties rated A-/A3 or higher. Fannie Mae held $833 million of collateral through custodians for these instruments. Fannie Mae's exposure, net of collateral, was $200 million.
This release includes forward-looking statements based on management's estimates of trends and economic factors in the markets in which Fannie Mae is active as well as the company's business plans. Such estimates and plans may change without notice and future results may vary from expected results if there are significant changes in economic, regulatory, or legislative conditions affecting Fannie Mae or its competitors. Investors should review the most recent Information Statement dated April 1, 2002, for a discussion of these factors.
Source: Fannie Mae