Industry News

Fannie Mae Reports Record Second Quarter 2002 Financial Results

July 15, 2002

Operating Net Income of $1.573 Billion up 19.7 Percent over 2nd Qtr 2001

WASHINGTON, DC-- Fannie Mae (FNM/NYSE), the nation's largest source of financing for home mortgages, today reported operating net income for the second quarter of 2002 of $1.573 billion, a 19.7 percent increase compared with the second quarter of 2001. Operating earnings per diluted common share (operating EPS) of $1.55 rose 22.0 percent above the same period in 2001. For the first six months of 2002, Fannie Mae's operating net income was $3.091 billion, compared with $2.553 billion for the same period in 2001. Operating EPS for the first six months of 2002 was $3.03, or 22.7 percent above the first six months of 2001.

Operating net income and operating EPS exclude the variability in earnings that results from including unrealized gains and losses from the change in the market value of purchased options under Financial Accounting Standard No. 133 (FAS 133). Also excluded is the one-time cumulative change in accounting principle from the adoption of FAS 133 on January 1, 2001. Operating net income and operating EPS provide consistent accounting treatment for purchased options and the options embedded in callable debt, and are the performance measures used by company management.

Net income for the second quarter of 2002 including FAS 133 items was $1.464 billion, an increase of 4.4 percent over the second quarter of 2001. EPS including FAS 133 items was $1.44, 5.9 percent above the same period last year. Net income and EPS for the six months ended June 30, 2002, including FAS 133 items, were $2.672 billion and $2.61, respectively. Page one of the attachments to this release provides a reconciliation of net income and operating net income. Highlights of Fannie Mae's financial performance in the second quarter of 2002 compared with the second quarter of 2001 include:

• Growth in taxable-equivalent revenues of 21.4 percent;
• Growth in adjusted net interest income of 22.4 percent;
• An average net interest margin of 116 basis points compared with 109 basis points;
• Growth in guaranty fee income of 18.6 percent;
• Credit-related losses of $17.3 million compared with $16.2 million, and
• Losses of $224.7 million from the call and repurchase of debt compared with $142.5 million.

Franklin D. Raines, Fannie Mae's Chairman and Chief Executive Officer, said, "Strong business volumes, a rising net interest margin, and a continued low level of credit losses enabled Fannie Mae to report its 58th consecutive quarterly increase in operating earnings per share during the second quarter of 2002." Raines said that taxable-equivalent revenues in the second quarter of 2002 were 21.4 percent higher than the same period one year ago. Raines added that in part because of a higher-than-expected net interest margin, the second quarter slowdown in portfolio growth due to narrow mortgage-to-debt spreads would have little discernable effect on the company's financial performance. Raines said that the first application of the risk-based capital stress test by the company's financial regulator, the Office of Federal Housing Enterprise Oversight (OFHEO), showed that Fannie Mae's total capital was $6.1 billion in excess of the risk-based requirement as of March 31, 2002. The company had previously reported that its equity capital as of the same date was $0.9 billion above the statutory minimum. Said Raines, "This initial application of the OFHEO risk-based standard confirms that Fannie Mae is managing its business risks with exceptional discipline and prudence." Raines noted that OFHEO would not be using the risk-based standard to classify the company for regulatory capital purposes until the end of the third quarter 2002. The higher of the risk-based or the minimum capital standard will be binding, Raines said.

Outlook

Fannie Mae's Executive Vice President and Chief Financial Officer, Timothy Howard, reiterated the company's positive outlook for its financial performance, saying, "We continue to expect that growth in operating EPS in 2002 will be above the company's very positive long-term EPS trend." He added, "Although growth in operating EPS next year should be below the exceptional rates recorded in 2001 and anticipated for 2002, we expect another strong financial performance in 2003." Howard said that Fannie Mae's portfolio growth slowed to 4.9 percent during the second quarter, as mortgage-to-debt spreads remained narrow. Howard said, "We will continue to be disciplined in our approach to portfolio growth -- growing quickly when spreads are wide and more slowly or not at all when spreads are less favorable." Howard noted that with the reduced pace of mortgage commitments during the first half he now expected portfolio growth for the full year to be in the low-to-mid teens range.

Howard also said that the company's net interest margin was higher than expected in the second quarter. He said the company still expects the margin to move lower over the remainder of this year and into next year, although by a lesser degree and at a somewhat slower pace than previously projected. Howard commented that Fannie Mae's credit performance was continuing to exceed expectations. "For the first half of 2002 credit losses are running at a pace that is below the first six months of 2001," he said. Howard noted that the single-family delinquency rate had fallen by 7 basis points between January and May 2002, which was a positive indicator for future credit losses. Said Howard, "We keep anticipating that our credit losses will rise from their extremely low levels, but so far they have not."

Details of Fannie Mae's second quarter 2002 financial performance follow. Business volume

Fannie Mae's business volume -- mortgages purchased for portfolio plus mortgage-backed security (MBS) issues acquired by other investors -- totaled $159.8 billion in the second quarter of 2002, compared with $165.7 billion in the second quarter of 2001 and $197.8 billion in the first quarter of 2002. Business volume for the first six months of 2002 was $357.6 billion, a 31.8 percent increase from $271.3 billion for the first six months of 2001. Business volume in the second quarter of 2002 consisted of $56.9 billion in portfolio purchases and $102.9 billion in MBS issues acquired by investors other than Fannie Mae's portfolio, compared with $65.3 billion and $100.4 billion, respectively, in the second quarter of 2001. Retained commitments to purchase mortgages were $59.9 billion in the second quarter of 2002 compared with $65.6 billion in the second 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 14.9 percent during the second quarter of 2002, ending the period at $1.686 trillion. This growth resulted from a 4.9 percent annualized growth rate in the net mortgage portfolio to $741 billion and a 23.5 percent rate of growth in outstanding MBS to $945 billion at June 30, 2002. For the first six months of 2002, the combined book of business grew at an annual rate of 16.2 percent. 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 second quarter of 2002 was $2.202 billion, up 22.4 percent from $1.799 billion in the second quarter of 2001. This increase was driven by a 13.9 percent rise in the average net investment balance and a 7 basis point increase in the average net interest margin. Adjusted net interest income for the first six months of 2002 was $4.322 billion, up 25.5 percent from $3.443 billion during the comparable period in 2001.

Fannie Mae's net investment balance -- consisting of the net mortgage portfolio and the company's liquid investments -- averaged $802 billion during the second quarter of 2002 compared with $704 billion during the second quarter of 2001. The net investment balance was $806 billion at June 30, 2002. The company's net interest margin averaged 116 basis points in the second quarter of 2002, compared with 109 basis points in the second quarter of 2001 and 115 basis points in the first quarter of 2002. The company's net interest margin has averaged 116 basis points year-to-date, up from 106 basis points for the first six months of 2001. Fannie Mae's net interest margin for the second quarter and first six months of 2002 continued to benefit from an unusually steep yield curve and low short-term interest rates.

Fannie Mae's net mortgage portfolio grew at an annual rate of 4.9 percent during the second quarter of 2002, ending the quarter at $741 billion. Portfolio growth in June fell to an annual rate of 0.8 percent, as mortgage purchases slowed in response to tighter mortgage-to-debt spreads and liquidation rates remained relatively high. For the second quarter of 2002, the company realized losses from debt repurchases and debt calls of $224.7 million compared with losses of $142.5 million in the second quarter of 2001. During the quarter the company realized losses on debt repurchases of $179.8 million and losses on debt calls of $44.9 million. Debt repurchased and debt called in the second quarter of 2002 totaled $3.5 billion and $26.7 billion, respectively.

During the second quarter of 2002, Fannie Mae elected to early adopt the provision of FAS 145 that permits the recording of gains and losses on the call or repurchase of debt as part of recurring operations rather than as an extraordinary item. Fannie Mae regularly calls or repurchases debt as part of its interest rate risk management program. Prior period financial results have been reclassified to conform to the current presentation. 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 $423.5 million in the second quarter of 2002, an 18.6 percent increase compared with the second quarter of 2001. The increase in guaranty fee income was driven by a 22.5 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 second quarter of 2002 was 18.3 basis points compared with 18.9 basis points in the second quarter of 2001 and 18.6 basis points in the first quarter of 2002. Guaranty fee income for the first six months of 2002 was $831.1 million compared with $700.2 million for the first six months of 2001.

Credit-related losses -- foreclosed property expense plus charge-off recoveries -- remained low, driven by a strong housing market and continued home price gains. Losses totaled $17.3 million in the second quarter compared with $16.2 million in the second quarter of 2001. Foreclosed property expense was $54.2 million in the second quarter of 2002 compared with $47.4 million in the second quarter of 2001. Charge-off recoveries were $36.9 million in the second quarter of 2002 compared with $31.2 million in the second quarter of 2001. Fannie Mae's credit loss rate -- credit-related losses as a percentage of the average combined book of business -- was 0.4 basis points in the second quarter of 2002, down from 0.5 basis points during the second quarter of 2001. Fannie Mae's conventional at-risk single-family serious delinquency rate, an indicator of potential future loss activity, was .42 percent at May 31st -- the latest date available, down from the first quarter high point of .49 percent in January. 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 $24.2 million in the second quarter of 2002, in line with credit-related losses. Fannie Mae's loss provision was a negative $30.0 million in the second quarter of 2002, unchanged from the second quarter of 2001. The company's allowance for loan losses stood at $813 million at June 30, 2002 compared with $806 million at March 31, 2002 and $811 million at June 30, 2001.

Fee and other income

Fee and other income in the second quarter of 2002 totaled $41.6 million compared with $24.5 million in the second quarter of 2001. The increase from the second quarter of 2001 was primarily due to gains on the sale of mortgages. Fee and other income for the first six months of 2002 was $45.2 million compared with $51.8 million for the first six months of 2001. 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.

Efficiency

Administrative expenses totaled $301.3 million in the second quarter of 2002, up 18.4 percent from the second 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 second quarter of 2002 was .073 percent, unchanged from the second quarter of 2001. Fannie Mae's efficiency ratio -- administrative expense divided by taxable-equivalent revenue -- improved to 10.1 percent in the second quarter of 2002 from 10.4 percent in the second quarter of 2001.

Capital

Fannie Mae's core capital was $26.4 billion at June 30, 2002 compared with $25.5 billion at March 31, 2002 and $23.0 billion at June 30, 2001. The company repurchased 3.3 million shares of common stock during the second quarter of 2002 and 10.8 million shares year-to-date. Common stock repurchases for 2001 totaled 6.0 million shares. Year-to-date 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 June 30, 2002 Fannie Mae had 992.8 million shares of common stock outstanding compared with 995.5 million shares at March 31, 2002.

The company had $6 billion of subordinated debt outstanding at June 30, 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 June 30, 2002. Voluntary disclosures

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 June 30, 2002 Fannie Mae's ratio of liquid assets to total assets was 7.8 percent, compared with 7.1 percent at March 31, 2002. Fannie Mae has committed to maintain a portfolio of high-quality, liquid, non-mortgage securities equal to at least 5 percent of total assets. At March 31, 2002 the present value of Fannie Mae's net sensitivity of future credit losses to an immediate 5 percent decline in home prices was $425 million, taking into account the beneficial effect of third-party credit enhancements. This compares with $487 million at December 31, 2001. The March 31 figure reflects a gross credit loss sensitivity of $1,285 million before the effect of credit enhancements, and is net of projected credit risk sharing proceeds of $860 million.

At both March 31, 2002 and December 31, 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. On June 27, 2002, Fannie Mae's regulator, OFHEO, announced that as of March 31, 2002, the company's total capital exceeded the amount required by the OFHEO risk-based capital standard by $6.062 billion, or 23 percent. OFHEO will not use its risk-based standard to classify Fannie Mae for regulatory purposes until the end of the third quarter 2002.

Fannie Mae's quarterly disclosures, together with the monthly interest rate risk disclosures, are included with the company's Monthly Summary statistics.

Source: Fannie Mae

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