e10vq
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
Form 10-Q
 
     
     
þ
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
    For the quarterly period ended March 31, 2008
OR
     
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
     
    For the transition period from          to          
 
Commission File No.: 0-50231
 
Federal National Mortgage Association
(Exact name of registrant as specified in its charter)
 
Fannie Mae
 
     
Federally chartered corporation
(State or other jurisdiction of
incorporation or organization)

3900 Wisconsin Avenue, NW
Washington, DC
(Address of principal executive offices)
 
52-0883107
(I.R.S. Employer
Identification No.)

20016
(Zip Code)
 
Registrant’s telephone number, including area code:
(202) 752-7000
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
             
Large accelerated filer þ
  Accelerated filer o   Non-accelerated filer o
(Do not check if a smaller reporting company)
  Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ
 
As of March 31, 2008, there were 982,319,990 shares of common stock outstanding.
 


Table of Contents

 
TABLE OF CONTENTS
 
                 
    1  
      Financial Statements     79  
        Condensed Consolidated Balance Sheets     79  
        Condensed Consolidated Statements of Operations     80  
        Condensed Consolidated Statements of Cash Flows     81  
        Condensed Consolidated Statements of Changes in Stockholders’ Equity     82  
        Notes to Condensed Consolidated Financial Statements     83  
          Note 1— Summary of Significant Accounting Policies     83  
          Note 2— Consolidations     87  
          Note 3— Mortgage Loans     88  
          Note 4— Allowance for Loan Losses and Reserve for Guaranty Losses     90  
          Note 5— Investments in Securities     91  
          Note 6— Financial Guaranties     94  
          Note 7— Acquired Property, Net     96  
          Note 8— Short-term Borrowings and Long-term Debt     97  
          Note 9— Derivative Instruments     98  
          Note 10— Income Taxes     99  
          Note 11— Earnings (Loss) Per Share     101  
          Note 12— Employee Retirement Benefits     102  
          Note 13— Segment Reporting     103  
          Note 14— Regulatory Capital Requirements     104  
          Note 15— Concentrations of Credit Risk     105  
          Note 16— Fair Value of Financial Instruments     107  
          Note 17— Commitments and Contingencies     117  
      Management’s Discussion and Analysis of Financial Condition and Results of Operations     1  
        Introduction     1  
        Selected Financial Data     2  
        Executive Summary     5  
        Critical Accounting Policies and Estimates     11  
        Consolidated Results of Operations     16  
        Business Segment Results     33  
        Consolidated Balance Sheet Analysis     37  
        Supplemental Non-GAAP Information—Fair Value Balance Sheets     52  
        Liquidity and Capital Management     57  
        Off-Balance Sheet Arrangements and Variable Interest Entities     61  
        Risk Management     62  
        Impact of Future Adoption of Accounting Pronouncements     77  
        Forward-Looking Statements     77  
      Quantitative and Qualitative Disclosures About Market Risk     122  
      Controls and Procedures     122  


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    122  
      Legal Proceedings     122  
      Risk Factors     124  
      Unregistered Sales of Equity Securities and Use of Proceeds     124  
      Defaults Upon Senior Securities     127  
      Submission of Matters to a Vote of Security Holders     127  
      Other Information     127  
      Exhibits     127  
    128  
    E-1  
 Exhibit 3.2
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 Exhibit 32.2


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MD&A TABLE REFERENCE
 
 
             
Table
 
Description
  Page
 
  Selected Financial Data     2  
1
  Effect on Results of Operations of Significant Market-Based Valuation Adjustments     6  
2
  Level 3 Recurring Assets at Fair Value     12  
3
  Summary of Condensed Consolidated Results of Operations     16  
4
  Analysis of Net Interest Income and Yield     17  
5
  Rate/Volume Analysis of Net Interest Income     18  
6
  Guaranty Fee Income and Average Effective Guaranty Fee Rate     19  
7
  Investment Gains (Losses), Net     21  
8
  Fair Value Losses, Net     22  
9
  Derivatives Fair Value Losses, Net     23  
10
  Credit-Related Expenses     25  
11
  Allowance for Loan Losses and Reserve for Guaranty Losses     26  
12
  Statistics on Seriously Delinquent Loans Purchased from MBS Trusts Subject to SOP 03-3     27  
13
  Activity of Seriously Delinquent Loans Purchased from MBS Trusts Subject to SOP 03-3     28  
14
  Re-performance Rates of Seriously Delinquent Single-Family Loans Purchased from MBS Trusts     28  
15
  Re-performance Rates of Seriously Delinquent Single-Family Loans Purchased from MBS Trusts and Modified     29  
16
  Credit Loss Performance Metrics     31  
17
  Single-Family Credit Loss Sensitivity     32  
18
  Single-Family Business Results     34  
19
  HCD Business Results     35  
20
  Capital Markets Group Results     36  
21
  Mortgage Portfolio Activity     37  
22
  Mortgage Portfolio Composition     38  
23
  Trading and AFS Investment Securities     40  
24
  Investments in Private-Label Mortgage-Related Securities and Mortgage Revenue Bonds     41  
25
  Investments in Alt-A Private-Label Mortgage-Related Securities, Excluding Wraps     43  
26
  Investments in Subprime Private-Label Mortgage-Related Securities, Excluding Wraps     45  
27
  Alt-A and Subprime Private-Label Wraps     47  
28
  Debt Activity     49  
29
  Outstanding Debt     50  
30
  Changes in Risk Management Derivative Assets (Liabilities) at Fair Value, Net     51  
31
  Purchased Options Premiums     52  
32
  Supplemental Non-GAAP Consolidated Fair Value Balance Sheets     53  
33
  Non-GAAP Estimated Fair Value of Net Assets (Net of Tax Effect)     55  
34
  Selected Market Information     56  
35
  Fannie Mae Credit Ratings and Risk Ratings     57  
36
  Regulatory Capital Measures     59  
37
  Composition of Mortgage Credit Book of Business     62  


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Table
 
Description
  Page
 
38
  Product Distribution and Selected Risk Characteristics of Conventional Single-Family Business Volume and Mortgage Credit Book of Business     64  
39
  Serious Delinquency Rates     66  
40
  Nonperforming Single-Family and Multifamily Loans     67  
41
  Single-Family and Multifamily Foreclosed Properties     68  
42
  Mortgage Insurance Coverage     69  
43
  Activity and Maturity Data for Risk Management Derivatives     72  
44
  Interest Rate Sensitivity of Fair Value of Net Portfolio     74  
45
  Interest Rate Sensitivity of Fair Value of Net Assets     75  


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PART I—FINANCIAL INFORMATION
 
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
You should read this Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) in conjunction with our unaudited condensed consolidated financial statements and related notes, and the more detailed information contained in our Annual Report on Form 10-K for the year ended December 31, 2007 (“2007 Form 10-K”). The results of operations presented in our interim financial statements and discussed in MD&A are not necessarily indicative of the results that may be expected for the full year. Please refer to “Glossary of Terms Used in This Report” in our 2007 Form 10-K for an explanation of key terms used throughout this discussion.
 
INTRODUCTION
 
Fannie Mae is a government-sponsored enterprise (“GSE”), owned by private shareholders (NYSE: FNM) and chartered by Congress to support liquidity and stability in the secondary mortgage market. Our business includes three integrated business segments—Single-Family Credit Guaranty, Housing and Community Development, and Capital Markets—that work together to provide services, products and solutions to our lender customers and a broad range of housing partners. Together, our business segments contribute to our chartered mission objectives, helping to increase the total amount of funds available to finance housing in the United States and to make homeownership more available and affordable for low-, moderate- and middle-income Americans. We also work with our customers and partners to increase the availability and affordability of rental housing. Although we are a corporation chartered by the U.S. Congress, the U.S. government does not guarantee, directly or indirectly, our securities or other obligations. Our business is self-sustaining and funded exclusively with private capital.
 
Our Single-Family Credit Guaranty (“Single-Family”) business works with our lender customers to securitize single-family mortgage loans into Fannie Mae mortgage-backed securities (“Fannie Mae MBS”) and to facilitate the purchase of single-family mortgage loans for our mortgage portfolio. Revenues in the segment are derived primarily from: (i) the guaranty fees received on the mortgage loans underlying single-family Fannie Mae MBS and on the single-family mortgage loans held in our portfolio; and (ii) trust management income, which is a fee we earn derived from interest earned on cash flows between the date of remittance of mortgage and other payments to us by servicers and the date of distribution of these payments to MBS certificateholders.
 
Our Housing and Community Development (“HCD”) business works with our lender customers to securitize multifamily mortgage loans into Fannie Mae MBS and to facilitate the purchase of multifamily mortgage loans for our mortgage portfolio. Our HCD business also makes debt and equity investments to increase the supply of affordable housing. Revenues in the segment are derived from a variety of sources, including the guaranty fees received on the mortgage loans underlying multifamily Fannie Mae MBS and on the multifamily mortgage loans held in our portfolio, transaction fees associated with the multifamily business, and bond credit enhancement fees. In addition, HCD’s investments in rental housing projects eligible for the federal low-income housing tax credit and other investments generate both tax credits and net operating losses that reduce our federal income tax liability. Other investments in rental and for-sale housing generate revenue and losses from operations and the eventual sale of the assets.
 
Our Capital Markets group manages our investment activity in mortgage loans, mortgage-related securities and other investments, our debt financing activity, and our liquidity and capital positions. We fund our investments primarily through proceeds from our issuance of debt securities in the domestic and international capital markets. Our Capital Markets group generates most of its revenue from the difference, or spread, between the interest we earn on our mortgage assets and the interest we pay on the debt we issue to fund these assets. We refer to this spread as our net interest yield. Changes in the fair value of the derivative instruments and trading securities we hold impact the net income or loss reported by the Capital Markets group.


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SELECTED FINANCIAL DATA
 
The selected financial data presented below is summarized from our condensed consolidated results of operations for the three months ended March 31, 2008 and 2007, as well as from selected condensed consolidated balance sheet data as of March 31, 2008 and December 31, 2007. This data should be read in conjunction with this MD&A, as well as with the unaudited condensed consolidated financial statements and related notes included in this report and with our audited consolidated financial statements and related notes included in our 2007 Form 10-K.
 
                 
    For the
 
    Three Months Ended
 
    March 31,  
    2008     2007(1)  
    (Dollars and shares in
 
    millions, except per share amounts)  
 
Statement of Operations Data:
               
Net interest income
  $ 1,690     $ 1,194  
Guaranty fee income
    1,752       1,098  
Losses on certain guaranty contracts
          (283 )
Trust management income
    107       164  
Fair value losses, net(2)
    (4,377 )     (566 )
Other income (expenses), net(3)
    (170 )     400  
Credit-related expenses(4)
    (3,243 )     (321 )
Net income (loss)
    (2,186 )     961  
Preferred stock dividends and issuance costs at redemption
    (322 )     (135 )
Net income (loss) available to common stockholders
    (2,508 )     826  
Per Common Share Data:
               
Earnings (loss) per share:
               
Basic
  $ (2.57 )   $ 0.85  
Diluted
    (2.57 )     0.85  
Weighted-average common shares outstanding:
               
Basic
    975       973  
Diluted
    975       974  
Cash dividends declared per common share
  $ 0.35     $ 0.40  
New Business Acquisition Data:
               
Fannie Mae MBS issues acquired by third parties(5)
  $ 155,702     $ 125,202  
Mortgage portfolio purchases(6)
    36,323       36,157  
                 
New business acquisitions
  $ 192,025     $ 161,359  
                 
 


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    As of  
    March 31,
    December 31,
 
    2008     2007(1)  
    (Dollars in millions)  
 
Balance Sheet Data:
               
Investments in securities:
               
Trading
  $ 110,573     $ 63,956  
Available-for-sale
    228,228       293,557  
Mortgage loans:
               
Loans held for sale
    8,486       7,008  
Loans held for investment, net of allowance
    402,449       396,516  
Total assets
    843,227       879,389  
Short-term debt
    215,916       234,160  
Long-term debt
    544,424       562,139  
Total liabilities
    804,233       835,271  
Preferred stock
    16,913       16,913  
Total stockholders’ equity
    38,836       44,011  
Regulatory Capital Data:
               
Core capital(7)
  $ 42,676     $ 45,373  
Total capital(8)
    47,666       48,658  
Book of Business Data:
               
Mortgage portfolio(9)
  $ 726,705     $ 727,903  
Fannie Mae MBS held by third parties(10)
    2,200,958       2,118,909  
Other guarantees(11)
    40,817       41,588  
                 
Mortgage credit book of business
  $ 2,968,480     $ 2,888,400  
                 
Guaranty book of business(12)
  $ 2,827,370     $ 2,744,237  
                 
 
                 
    For the
 
    Three Months Ended
 
    March 31,  
    2008     2007  
 
Ratios:
               
Return on assets ratio(13)*
    (1.16 )%     0.39 %
Return on equity ratio(14)*
    (40.9 )     10.1  
Equity to assets ratio(15)*
    4.8       4.9  
Dividend payout ratio(16)
    N/A       47.2  
Average effective guaranty fee rate (in basis points)(17)*
    29.5 bp     21.8 bp
Credit loss ratio (in basis points)(18)*
    12.6 bp     3.4 bp
 
 
  (1) Certain prior period amounts have been reclassified to conform to the current period presentation.
 
  (2) Consists of the following: (a) derivatives fair value losses, net; (b) gains (losses) on trading securities, net; (c) debt fair value gains, net; and (d) debt foreign exchange gains (losses), net. Certain prior period amounts have been reclassified to conform with the current period presentation in our condensed consolidated statements of operations.
 
  (3) Consists of the following: (a) investment gains (losses), net; (b) debt extinguishment losses, net; (c) losses from partnership investments; and (d) fee and other income. Certain prior period amounts have been reclassified to conform with the current period presentation in our condensed consolidated statements of operations.
 
  (4) Consists of provision for credit losses and foreclosed property expense.
 
  (5) Unpaid principal balance of Fannie Mae MBS issued and guaranteed by us and acquired by third-party investors during the reporting period. Excludes securitizations of mortgage loans held in our portfolio and the purchase of Fannie Mae MBS for our investment portfolio.

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  (6) Unpaid principal balance of mortgage loans and mortgage-related securities we purchased for our investment portfolio during the reporting period. Includes advances to lenders, mortgage-related securities acquired through the extinguishment of debt and capitalized interest.
 
  (7) The sum of (a) the stated value of outstanding common stock (common stock less treasury stock); (b) the stated value of outstanding non-cumulative perpetual preferred stock; (c) paid-in capital; and (d) our retained earnings. Core capital excludes accumulated other comprehensive income (loss).
 
  (8) The sum of (a) core capital and (b) the total allowance for loan losses and reserve for guaranty losses, less (c) the specific loss allowance (that is, the allowance required on individually impaired loans).
 
  (9) Unpaid principal balance of mortgage loans and mortgage-related securities held in our portfolio.
 
(10) Unpaid principal balance of Fannie Mae MBS held by third-party investors. The principal balance of resecuritized Fannie Mae MBS is included only once in the reported amount.
 
(11) Includes single-family and multifamily credit enhancements that we have provided and that are not otherwise reflected in the table.
 
(12) Unpaid principal balance of: mortgage loans held in our mortgage portfolio; Fannie Mae MBS (whether held in our mortgage portfolio or held by third parties); and other credit enhancements that we provide on mortgage assets. Excludes non-Fannie Mae mortgage-related securities held in our investment portfolio for which we do not provide a guaranty. The principal balance of resecuritized Fannie Mae MBS is included only once in the reported amount.
 
(13) Annualized net income (loss) available to common stockholders divided by average total assets during the period.
 
(14) Annualized net income (loss) available to common stockholders divided by average outstanding common equity during the period.
 
(15) Average stockholders’ equity divided by average total assets during the period.
 
(16) Common dividends declared during the period divided by net income (loss) available to common stockholders for the period.
 
(17) Annualized guaranty fee income as a percentage of average outstanding Fannie Mae MBS and other guarantees during the period.
 
(18) Annualized (a) charge-offs, net of recoveries and (b) foreclosed property expense, as a percentage of the average guaranty book of business during the period. We exclude from our credit loss ratio any initial losses recorded on delinquent loans purchased from MBS trusts pursuant to Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”), when the purchase price of seriously delinquent loans that we purchase from Fannie Mae MBS trusts exceeds the fair value of the loans at the time of purchase. Our credit loss ratio including the effect of these initial losses recorded pursuant to SOP 03-3 would have been 20.7 basis points and 4.2 basis points for the three months ended March 31, 2008 and 2007, respectively. We previously calculated our credit loss ratio based on credit losses as a percentage of our mortgage credit book of business, which includes non-Fannie Mae mortgage-related securities held in our mortgage investment portfolio that we do not guarantee. Because losses related to non-Fannie Mae mortgage-related securities are not reflected in our credit losses, we revised the calculation of our credit loss ratio to reflect credit losses as a percentage of our guaranty book of business. Our credit loss ratio calculated based on our mortgage credit book of business would have been 12.0 basis points and 3.2 basis points for the three months ended March 31, 2008 and 2007, respectively.
 
Note:
 
* Average balances for purposes of the ratio calculations are based on beginning and end of period balances.


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EXECUTIVE SUMMARY
 
Summary of Our Financial Results
 
We recorded a net loss of $2.2 billion and a diluted loss per share of $2.57 for the first quarter of 2008, compared with a net loss of $3.6 billion and a diluted loss per share of $3.80 for the fourth quarter of 2007. We recorded net income of $961 million and diluted earnings per share of $0.85 for the first quarter of 2007.
 
Our results for this quarter reflect the ongoing disruption in the housing, mortgage and credit markets, which continued to deteriorate throughout the quarter. Specific trends that affected our financial results during the quarter included: increases in mortgage delinquencies, defaults and foreclosures; home price declines; lower interest rates; significantly wider credit spreads on securities; and reduced levels of liquidity in the mortgage and credit markets. As we continued to respond to the market’s need for liquidity and stability, we also saw continued growth in our single-family and multifamily books of business, market share and guaranty fee revenues, as well as an increase in our net interest income and net interest yield.
 
Our net loss for the first quarter was driven principally by credit-related expenses and fair value losses on our derivatives and trading securities, which more than offset our net interest income and guaranty fee income for the quarter.
 
  •  Net interest income and net interest yield increased compared with both the fourth quarter and the first quarter of 2007, due to a reduction in the cost of our short-term debt and our redemption of step-rate debt securities during the quarter.
 
  •  Guaranty fee income increased compared with both the fourth quarter and the first quarter of 2007, due to an increase in the average guaranty book of business and an increase in our average effective guaranty fee rate. The increase in our average effective guaranty fee rate was primarily attributable to accelerated accretion of the guaranty obligation and deferred profit into guaranty fee income caused by declining mortgage interest rates during the quarter, which caused an increase in expected prepayment rates. Our guaranty fee pricing increases also contributed to the increase in our average effective guaranty fee rate for the quarter.
 
  •  Credit-related expenses increased compared with both the fourth quarter and the first quarter of 2007. The increase in credit-related expenses compared with the fourth quarter of 2007 was due primarily to an increase in charge-offs. This reflects higher defaults and average loan loss severities, driven by national home price declines and weak economic conditions in the Midwest.
 
  •  Net fair value losses increased compared with both the fourth quarter and the first quarter of 2007. The primary driver of our net fair value losses for the quarter was our derivatives fair value losses, which were primarily due to the decline in interest rates during the quarter. Also contributing to our net fair value losses for the quarter was an increase in fair value losses on our trading securities, primarily due to the negative impact of a significant widening of credit spreads during the first quarter of 2008, which more than offset the positive impact of the decline in interest rates during the quarter on the fair value of these securities.
 
  •  As a result of our implementation of a new accounting standard (as discussed in greater detail below), we did not incur any losses at inception of certain guaranty contracts during the first quarter of 2008, which positively impacted our results of operations for the quarter. In comparison, we recorded losses on certain guaranty contracts of $386 million for the fourth quarter of 2007 and $283 million for the first quarter of 2007. In addition, implementation of this new accounting standard contributed to a reduction in the non-GAAP estimated fair value of our net assets as of March 31, 2008, as discussed further in “Supplemental Non-GAAP Information—Fair Value Balance Sheets.”
 
We provide a more detailed discussion of key factors affecting changes in our results of operations and financial condition in “Consolidated Results of Operations,” “Business Segment Results,” “Consolidated Balance Sheet Analysis” and “Supplemental Non-GAAP Information—Fair Value Balance Sheets.”


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Impact of Market-Based Valuation Adjustments on our Financial Results
 
The factors that negatively affected our financial results during the first quarter of 2008 included $5.1 billion of losses reflecting market-based valuations related to the adverse conditions in the housing, mortgage and credit markets during the quarter. Table 1 below shows the effect for the three months ended March 31, 2008, December 31, 2007 and March 31, 2007 of the most significant market-based valuation adjustments included in our results of operations.
 
Table 1:  Effect on Results of Operations of Significant Market-Based Valuation Adjustments
 
                         
    For the Three Months Ended  
    March 31, 2008     December 31, 2007     March 31, 2007  
    (Dollars in millions)  
 
Derivatives fair value losses, net
  $ (3,003 )   $ (3,222 )   $ (563 )
Gains (losses) on trading securities, net
    (1,227 )     (215 )     61  
Debt fair value gains, net
    10              
Debt foreign exchange losses, net
    (157 )     (2 )     (64 )
                         
Fair value losses, net
    (4,377 )     (3,439 )     (566 )
Losses on certain guaranty contracts
          (386 )     (283 )
SOP 03-3 fair value losses(1)
    (728 )     (559 )     (69 )
                         
Total pre-tax effect on earnings
  $ (5,105 )   $ (4,384 )   $ (918 )
                         
 
 
(1) “SOP 03-3 fair value losses” refers to fair value losses we record in connection with our purchase of seriously delinquent loans from MBS trusts pursuant to SOP 03-3. SOP 03-3 fair value losses are reflected in our condensed consolidated statements of operations as a component of the “Provision for credit losses” (which is a component of our “Credit-related expenses”). For more information regarding our accounting for seriously delinquent loans purchased from MBS trusts, refer to “Item 7—MD&A—Critical Accounting Policies and Estimates—Fair Value of Financial Instruments—Fair Value of Loans Purchased with Evidence of Credit Deterioration—Effect on Credit-Related Expenses” in our 2007 Form 10-K.
 
We provide a more detailed discussion of the effect of these market-based valuation adjustments on our financial results in “Consolidated Results of Operations.”
 
Impact of Credit-Related Expenses on our Financial Results
 
Our first quarter 2008 results continued to reflect significantly elevated credit-related expenses compared with recent years. Our credit-related expenses for the first quarter of 2008 were 9% higher than for the fourth quarter of 2007, and more than ten times higher than our credit-related expenses for the first quarter of 2007. The key drivers of the increase in credit-related expenses for the quarter were the following:
 
  •  The provision for credit losses attributable to our guaranty book of business increased to $2.3 billion for the first quarter of 2008, compared with $2.2 billion for the fourth quarter of 2007 and $180 million for the first quarter of 2007. The increase in our provision for the quarter reflects the impact of the severe deterioration in the housing market, including significant increases in default rates and average loan loss severities.
 
  •  The provision for credit losses attributable to fair value losses recorded in connection with our purchase of seriously delinquent loans from MBS trusts pursuant to AICPA Statement of Position No. 03-3, Accounting for Certain Loans or Debt Securities Acquired in a Transfer (“SOP 03-3”), which we refer to as “SOP 03-3 fair value losses,” increased to $728 million for the first quarter of 2008, compared with $559 million for the fourth quarter of 2007 and $69 million for the first quarter of 2007. The increase in SOP 03-3 fair value losses compared with the fourth quarter was driven by a reduction in the market price of the delinquent loans we acquired from trusts during the quarter, as a result of the significant disruption in the housing market, which has severely reduced market liquidity for delinquent mortgage loans.
 
  •  Our foreclosed property expenses were $170 million for the first quarter of 2008, slightly less than our foreclosed property expenses of $179 million for the fourth quarter of 2007, but significantly higher than our foreclosed property expenses of $72 million for the first quarter of 2007.


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We substantially increased our loss reserves to reflect credit losses that we believe have been incurred and will be recognized over time in our charge-offs. Our combined loss reserves were $5.2 billion as of March 31, 2008, compared with $3.4 billion as of December 31, 2007 and $930 million as of March 31, 2007.
 
Our credit loss ratio (which excludes the impact of SOP 03-3 fair value losses) increased to 12.6 basis points for the first quarter of 2008, compared with 8.1 basis points for the fourth quarter of 2007 and 3.4 basis points for the first quarter of 2007. Our credit loss ratio including the effect of SOP 03-3 fair value losses would have been 20.7 basis points, 14.8 basis points and 4.2 basis points for those respective periods. Our credit losses for the quarter were concentrated primarily in our Alt-A and other higher risk loan categories, in loans originated in 2005 through 2007, and in areas of the country experiencing steep declines in home prices (such as Florida, California, Nevada and Arizona) or prolonged economic weakness (such as Ohio, Indiana and Michigan).
 
We provide a more detailed discussion of our credit-related expenses and credit loss performance metrics in “Consolidated Results of Operations—Credit-Related Expenses.” We also provide detailed credit performance information, including serious delinquency rates by geographic region, statistics on nonperforming loans and foreclosed property activity, in “Risk Management—Credit Risk Management—Mortgage Credit Risk Management—Mortgage Credit Book of Business Performance.”
 
Impact of Recent Changes in Fair Value Accounting on our Financial Results
 
Our financial results for the first quarter of 2008 were affected by our adoption of the following new accounting standards relating to the valuation of the financial instruments we hold.
 
  •  Fair Value Option.  In connection with our adoption of Statement of Financial Accounting Standards (“SFAS”) No. 159, The Fair Value Option for Financial Assets and Financial Liabilities (“SFAS 159”), effective January 1, 2008, we elected to report a larger portion of our financial instruments at fair value, with changes in the fair value of these instruments included in our results of operations. The financial instruments that we will now record at fair value through our results of operations include our non-mortgage-related securities, certain agency mortgage-related securities and certain structured debt instruments. Because changes in the fair value of mortgage-related securities resulting from changes in interest rates tend to offset the impact of interest rate changes on the fair value of our derivatives, we expect this election to reduce some of the volatility in our financial results. In connection with our election to report additional financial instruments at fair value, we now report all changes in the fair value of our trading securities, debt and derivatives collectively in the “Fair value losses, net” line item of our condensed consolidated statement of operations.
 
  •  Fair Value Measurements.  In connection with our adoption of SFAS No. 157, Fair Value Measurements (“SFAS 157”), on January 1, 2008, we implemented a prospective change in our method of measuring the fair value of the guaranty obligations we incur when we enter into guaranty contracts. This change results in the recognition of our guaranty obligations at the amount of the compensation we receive on our guaranty contracts. Accordingly, we no longer recognize losses or record deferred profit in our financial statements at inception of our guaranty contracts issued after December 31, 2007. This change had a favorable impact on our results of operations for the quarter. We believe this method of measuring the fair value of our guaranty obligations provides a more meaningful presentation of our guaranty obligations by better aligning the revenue we recognize for providing our guarantees with the total compensation we receive and by reflecting the pricing of actual market transactions. Although we will no longer recognize losses at the inception of our guaranty contracts, we will continue to accrete previously recognized losses into our guaranty fee income over time until these losses have been fully amortized. This change in our method of measuring the fair value of our guaranty obligations contributed to a reduction in the non-GAAP estimated fair value of our net assets as of March 31, 2008.
 
For more information on the effect of these changes on our results of operations and the estimated fair value of our net assets, refer to “Critical Accounting Policies and Estimates—Change in Measuring the Fair Value of Guaranty Obligations” and “Supplemental Non-GAAP Information—Fair Value Balance Sheets.”


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In addition to the changes described above, beginning in mid-April 2008, we implemented fair value hedge accounting with respect to a portion of our derivatives to hedge, for accounting purposes, changes in the fair value of some of our mortgage assets attributable to changes in interest rates. As a result of our election to report a larger portion of our financial instruments at fair value pursuant to SFAS 159 and our implementation of hedge accounting, we expect a reduction in the level of volatility in our financial results that is attributable to changes in interest rates. However, our implementation of SFAS 159 and hedge accounting will not affect our exposure to spread risk or the volatility in our financial results that is attributable to changes in credit spreads.
 
Recent Legislative and Regulatory Developments
 
Recent OFHEO Actions
 
The Office of Federal Housing Enterprise Oversight (“OFHEO”), our safety and soundness regulator, has recently taken the following actions:
 
  •  Effective March 1, 2008, OFHEO removed the limitation on the size of our mortgage portfolio.
 
  •  On March 19, 2008, OFHEO reduced the capital surplus requirement set forth in our May 2006 consent order with OFHEO from 30% to 20%. OFHEO also announced that we were in full compliance with the May 2006 consent order.
 
  •  OFHEO has informed us that it has lifted the May 2006 consent order effective May 6, 2008, and will reduce the current OFHEO-directed capital surplus requirement from 20% to 15% upon the successful completion of our capital-raising plan described below. OFHEO also indicated its intention to reduce the capital surplus requirement by an additional 5 percentage points to a 10% surplus requirement in September 2008, based upon our continued maintenance of excess capital well above OFHEO’s regulatory requirement and no material adverse change to our ongoing regulatory compliance.
 
Determination by HUD Regarding 2007 Home Purchase Subgoals
 
As described in our 2007 Form 10-K, we believe that we did not meet our “low- and moderate-income housing” and “special affordable housing” home purchase subgoals for 2007 established by the Department of Housing and Urban Development (“HUD”). In April 2008, HUD notified us of its determination that achievement of these subgoals was not feasible, primarily due to reduced housing affordability and turmoil in the mortgage market, which reduced the share of the conventional conforming primary home purchase market that would qualify for these subgoals. As a result, we will not be required to submit a housing plan for failure to meet the special affordable housing home purchase subgoal. Under the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, the low- and moderate-income housing home purchase subgoal is not enforceable.
 
Legislation Relating to Our Regulatory Framework
 
As described in our 2007 Form 10-K, there is legislation pending before the U.S. Congress that would change the regulatory framework under which we, the Federal Home Loan Mortgage Corporation (referred to as Freddie Mac) and the Federal Home Loan Banks operate. The House of Representatives approved a GSE reform bill in May 2007. Another GSE reform bill is expected to be introduced in the Senate in May 2008. We cannot predict the content of any Senate bill that may be introduced or its prospects for passage by the Congress. For a description of how changes in the regulation of our business and other legislative proposals could materially adversely affect our business and earnings, see “Item 1A—Risk Factors” of our 2007 Form 10-K.
 
Response to Market Challenges and Opportunities
 
Although our financial performance for the first quarter of 2008 continued to be negatively affected by the continuing weakness in the housing markets and disruption in the mortgage and credit markets, these challenging conditions also provided opportunities for us to both fulfill our mission and build a stronger competitive position for the longer term. Our principal strategy for responding to the current challenging market conditions is to


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prudently preserve and build our capital, while building a solid mortgage credit book of business and continuing to fulfill our chartered mission of providing liquidity, stability and affordability to the secondary mortgage market. We identify below a number of the steps we have taken and are taking to achieve that strategy.
 
Preserving and Building Capital
 
We intend to continue to take aggressive management actions to preserve and further build our capital. OFHEO’s reduction of the capital surplus requirement will facilitate our capital management efforts and enhance our ability to provide additional liquidity and stability to the secondary mortgage market.
 
We are also planning to raise $6 billion in new capital through public offerings of common stock, non-cumulative mandatory convertible preferred stock and non-cumulative, non-convertible preferred stock. We believe that this additional capital will enable us to pursue growth and investment opportunities while also maintaining a prudent capital cushion in a volatile and challenging market. As part of our plan to raise capital, our Board of Directors indicated it intends to reduce our quarterly common stock dividend beginning with the third quarter of 2008 to $0.25 per share, which will make available approximately $390 million of capital annually. For more information regarding our planned capital raise, refer to “Liquidity and Capital Management—Capital Management—Capital Activity—Capital Management Actions.”
 
Prior to OFHEO’s reduction of the capital surplus requirement on March 19, our need to maintain capital at levels sufficient to ensure we would meet our regulatory capital requirements continued to constrain our business activities during the first quarter. We therefore continued to take steps during the first quarter to bolster our capital position, including managing the size of our investment portfolio and limiting or forgoing business opportunities that we otherwise would have pursued.
 
Building a Solid Mortgage Credit Book of Business by Managing and Mitigating Credit Exposure
 
We have continued during the first quarter of 2008 to implement a variety of measures designed to help us manage and mitigate the credit exposure we face as a result of our investment and guaranty activities, including the following measures.
 
Tightening Our Underwriting and Eligibility Guidelines
 
We implemented several changes in our underwriting and eligibility criteria during the first quarter of 2008 to reduce our credit risk, including requiring larger down payments, higher credit scores and increased pricing for some of the loans we acquire. We have also limited or eliminated our acquisitions of certain higher risk loan products. We believe our new underwriting and eligibility criteria will promote stable financing and sustainable homeownership, particularly in the current market environment in which home prices are declining in many areas.
 
In March 2008, we announced the release of Desktop Underwriter® Version 7.0 (“DU 7.0”), which will become effective in June 2008. With the release of DU 7.0, we will implement a comprehensive update to DU’s credit risk assessment, as well as pricing requirements that align with this update. In connection with the release of DU 7.0, we will also update the pricing and eligibility requirements for our manually underwritten loans to more closely align with our requirements for loans underwritten through DU, which will allow us to more consistently manage our credit risk for the loans we acquire.
 
We believe these efforts to reduce our credit risk, particularly in the current market environment, are essential to our ability to sustain our business over the long term. By prudently managing our credit risk during this difficult market cycle, we help to ensure that we have the financial strength to continue to provide liquidity to the mortgage market, help stabilize that market and support continued, affordable homeownership.
 
Increasing Our Guaranty Fees
 
We have taken steps during the first quarter of 2008 to increase our guaranty fees in light of the increased credit risk and volatility in the current market environment. In March 2008, we increased our guaranty fees and implemented an adverse market delivery charge of 25 basis points on all loans delivered to us to


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compensate us for the added risk we incur during this period of increased market uncertainty. We also have announced further increases in our guaranty fees for some loan types beginning in June 2008 and August 2008.
 
Loss Mitigation Activities
 
We have also taken steps to reduce credit losses and help borrowers stay in their homes, including the following:
 
  •  We have increased our credit operations staff dedicated to on-site oversight at the offices of our largest loan servicers to help guide loss mitigation decisions and ensure adherence to our policies.
 
  •  We have implemented our HomeSaver Advancetm initiative, a loss mitigation tool that permits qualified borrowers who are behind on their mortgage loans to catch up on their payments without the need to modify the mortgage loans.
 
  •  We have extended our maximum collection forbearance period for delinquent loans from four to six months.
 
  •  We have increased our fees to those involved in the foreclosure process, including loan servicers and attorneys, to provide a workout solution for a delinquent mortgage loan, rather than proceeding with a foreclosure action.
 
We are continuing to explore additional loss mitigation actions. For a further description of loss mitigation initiatives we have recently implemented, refer to “Risk Management—Credit Risk Management—Mortgage Credit Risk Management—Recent Developments.”
 
Providing Liquidity, Stability and Affordability to the Secondary Mortgage Market
 
The mortgage and credit market disruption has created a need for additional credit and liquidity in the secondary mortgage market. In 2008, we have taken the following actions to provide liquidity, stability and affordability to the housing finance system:
 
  •  We continued to increase our participation in the securitization of mortgage loans, with our estimated market share of new single-family mortgage-related securities issuances increasing to approximately 50.1% for the first quarter of 2008, from approximately 48.5% for the fourth quarter of 2007 and approximately 25.1% for the first quarter of 2007.
 
  •  We increased our total mortgage credit book of business by 3% to $3.0 trillion as of March 31, 2008, from $2.9 trillion as of December 31, 2007.
 
  •  We began acquiring jumbo conforming loans in April 2008 in response to the Economic Stimulus Act of 2008, which temporarily increased our maximum loan limit in specified high-cost metropolitan areas to $729,750.
 
In addition, we plan to pursue a series of initiatives designed to help stabilize the housing market and increase home affordability in the United States.
 
Outlook for 2008
 
We expect severe weakness in the housing market to continue in 2008. We expect home prices to decline 7 to 9% on a national basis in 2008, with significant regional differences in the rate of home price decline, including steeper declines in certain areas such as Florida, California, Nevada and Arizona. We believe this housing market weakness will lead to increased delinquencies, defaults and foreclosures on mortgage loans, and slower growth in U.S. residential mortgage debt outstanding in 2008. Based on our market outlook, we currently have the following expectations about our future financial performance.
 
  •  We expect the downturn in the housing market and the disruption in the mortgage and credit markets to continue to adversely affect our financial results in 2008.


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  •  We expect a significant increase in our credit-related expenses and credit loss ratio in 2008 relative to 2007.
 
  •  We also believe that our credit losses will increase in 2009 relative to 2008.
 
  •  We believe that our single-family guaranty book of business will continue to grow at a faster rate than the rate of overall growth in U.S. residential mortgage debt outstanding, and that our guaranty fee income will also grow in 2008 compared to 2007. Our single-family business volume has benefited in recent months from a significant reduction in competition from private issuers of mortgage-related securities and reduced demand for mortgage assets from other market participants. We expect to experience increased competition in 2008 from the Federal Housing Administration (“FHA”) due to the recent increase in the maximum loan limit for an FHA-insured loan in specified high-cost metropolitan areas to $729,750, from a previous limit of $362,790, pursuant to the Economic Stimulus Act of 2008. This increase in competition from the FHA may negatively affect our single-family business volume in 2008. Our single-family business volume may also be negatively affected by the eligibility changes and additional price increases that we are implementing this year.
 
  •  If current market conditions continue, we expect our taxable-equivalent net interest yield (excluding the benefit we received from the redemption of step-rate debt securities during the first quarter of 2008) to continue to increase for the remainder of 2008.
 
We provide additional detail on trends that may affect our result of operations, financial condition, liquidity and regulatory capital position in future periods in “Consolidated Results of Operations” below.
 
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
The preparation of financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) requires management to make a number of judgments, estimates and assumptions that affect the reported amount of assets, liabilities, income and expenses in the consolidated financial statements. Understanding our accounting policies and the extent to which we use management judgment and estimates in applying these policies is integral to understanding our financial statements. In our 2007 Form 10-K, we identified the following as our most critical accounting polices and estimates:
 
  •  Fair Value of Financial Instruments
 
  •  Other-than-temporary Impairment of Investment Securities
 
  •  Allowance for Loan Losses and Reserve for Guaranty Losses
 
During the first quarter of 2008, we added the assessment of the need for a deferred tax asset valuation allowance as a critical accounting policy. We describe below the basis for including this accounting estimate as a critical accounting policy. We also describe any significant changes in the judgments and assumptions we made during the first quarter of 2008 in applying our critical accounting policies. Also see “Part II—Item 7—MD&A—Critical Accounting Policies and Estimates” and “Notes to Consolidated Financial Statements—Note 1, Summary of Significant Accounting Policies” of our 2007 Form 10-K for additional information.
 
Fair Value of Financial Instruments
 
We adopted SFAS 157, which defines fair value, establishes a framework for measuring fair value and outlines a fair value hierarchy based on the inputs to valuation techniques used to measure fair value, effective January 1, 2008. SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (also referred to as an exit price). SFAS 157 categorizes fair value measurements into a three-level hierarchy based on the extent to which the measurement relies on observable market inputs in measuring fair value. Level 1, which is the highest priority in the fair value hierarchy, is based on unadjusted quoted prices in active markets for identical assets or liabilities. Level 2 is based on observable market-based inputs, other than quoted prices, in


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active markets for identical assets or liabilities. Level 3, which is the lowest priority in the fair value hierarchy, is based on unobservable inputs. Assets and liabilities are classified within this hierarchy in their entirety based on the lowest level of any input that is significant to the fair value measurement.
 
The use of fair value to measure our financial instruments is fundamental to our financial statements and is a critical accounting estimate because a substantial portion of our assets and liabilities are recorded at estimated fair value. The majority of our financial instruments carried at fair value fall within the level 2 category and are valued primarily utilizing inputs and assumptions that are observable in the marketplace, can be derived from observable market data or corroborated by observable levels at which transactions are executed in the marketplace. Because items classified as level 3 are generally based on unobservable inputs, the process to determine fair value is generally more subjective and involves a high degree of management judgment and assumptions. These assumptions may have a significant effect on our estimates of fair value, and the use of different assumptions as well as changes in market conditions could have a material effect on our results of operations or financial condition. We provide additional information regarding our level 3 assets below.
 
Fair Value Hierarchy—Level 3 Assets
 
Level 3 is primarily comprised of financial instruments whose fair value is estimated based on valuation methodologies utilizing significant inputs and assumptions that are generally less readily observable because of limited market activity or little or no price transparency. We typically classify financial instruments as level 3 if the valuation is based on inputs from a single source, such as a dealer quotation, where we are not able to corroborate the inputs and assumptions with other available, relevant market information. Our level 3 financial instruments include certain mortgage- and asset-backed securities and residual interests, certain performing residential mortgage loans, non-performing mortgage-related assets, our guaranty assets and buy-ups, our master servicing assets and certain highly structured, complex derivative instruments.
 
Some of our financial instruments, such as our trading and available-for-sale (“AFS”) securities and our derivatives, are measured at fair value on a recurring basis in periods subsequent to initial recognition. We measure some of our other financial instruments at fair value on a nonrecurring basis in periods subsequent to initial recognition, such as assets subject to other-than-temporary impairment. Table 2 presents, by balance sheet category, the amount of financial assets carried in our condensed consolidated balance sheets at fair value on a recurring basis and classified as level 3 as of March 31, 2008. We also identify the types of financial instruments within each asset category that are based on level 3 measurements and describe the valuation techniques used for determining the fair value of these financial instruments. The availability of observable market inputs to measure fair value varies based on changes in market conditions, such as liquidity. As a result, we expect the financial instruments carried at fair value on a recurring basis and classified as level 3 to vary each period.
 
Table 2:  Level 3 Recurring Assets at Fair Value
 
             
    As of March 31, 2008
    Estimated
     
Balance Sheet Category
  Fair Value    
Description and Valuation Technique
(Dollars in millions)
 
Trading securities
  $ 17,972     Primarily consists of mortgage-related securities backed by Alt-A loans and subprime loans. We generally have estimated the fair value based on the use of average prices obtained from multiple pricing services. In the absence of such information or if we are not able to corroborate these prices by other available, relevant market information, we estimate the fair value based on broker or dealer quotations or using internal calculations that incorporate inputs that are implied by market prices for similar securities and structure types. These inputs may be adjusted for various factors, such as prepayment speeds and credit spreads.


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    As of March 31, 2008
    Estimated
     
Balance Sheet Category
  Fair Value    
Description and Valuation Technique
(Dollars in millions)
 
AFS securities
    36,183     Primarily consists of mortgage-related securities backed by Alt-A loans and subprime loans and mortgage revenue bonds. The valuation techniques are the same as above.
Derivatives assets
    341     Primarily consists of a limited population of certain highly structured, complex interest rate management derivatives. Examples include certain swaps with embedded caps and floors or reference to non-standard indexes. We determine the fair value of these derivative instruments using indicative market prices obtained from large, experienced dealers. Indicative market prices from a single source that cannot be corroborated are classified as level 3.
Guaranty assets and buy-ups
    1,628     Represents the present value of the estimated compensation we expect to receive for providing our guaranty related to retained interests in portfolio securitization transactions. We generally have estimated the fair value based on internal models that calculate the present value of expected cash flows. Key model inputs and assumptions include prepayment speeds, forward yield curves and discount rates that are commensurate with the level of estimated risk.
             
Level 3 recurring assets
  $ 56,124      
             
Total assets
  $ 843,227      
Total recurring assets measured at fair value
  $ 341,461      
Total recurring assets measured at fair value as percentage of total assets
   
40
%    
Level 3 recurring assets as percentage of total assets
   
7
%    
Level 3 recurring assets as a percentage of total recurring assets measured at fair value
   
16
%    
 
Level 3 recurring assets totaled $56.1 billion as of March 31, 2008, which represented a significant increase from our level 3 recurring assets as of January 1, 2008. The increase during the first quarter of 2008 primarily reflected the ongoing effects of the significant disruption in the mortgage market and severe reduction in market liquidity for certain mortgage products, such as delinquent loans and private-label mortgage-related securities backed by Alt-A loans and subprime loans. Because of the reduction in recently executed transactions and market price quotations for these instruments, the market inputs for these instruments became less observable.
 
Financial assets measured at fair value on a non-recurring basis and classified as level 3, which are not presented in the table above, include held-for-sale (“HFS”) loans that are measured at lower of cost or market and that were written down to fair value as of the end of the period. The fair value of these loans totaled $596 million as of March 31, 2008. In addition, certain financial assets measured at cost that have been written down to fair value during the period due to impairment are classified as non-recurring. The fair value of these level 3 non-recurring financial assets, which primarily consisted of certain guaranty assets and buy-ups, totaled $6.2 billion as of March 31, 2008. Financial liabilities measured at fair value on a recurring basis and classified as level 3 as of March 31, 2008 consisted of $3.4 billion of long-term debt and $89 million of derivatives liabilities. See “Notes to Condensed Consolidated Financial Statements—Note 16, Fair Value of Financial Instruments” for further information regarding SFAS 157, including the classification within the three-level hierarchy of all of our assets and liabilities carried in our condensed consolidated balance sheets at fair value as of March 31, 2008.

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Fair Value Control Processes
 
We employ control processes to validate the fair value of our financial instruments. These control processes are designed to ensure that the values used for financial reporting are based on observable inputs wherever possible. In the event that observable market-based inputs are not available, the control processes are designed to assure that the valuation approach used is appropriate and consistently applied and that the assumptions are reasonable. Our control processes provide for segregation of duties and oversight of our fair value methodologies and valuations by our Valuation Oversight Committee. Valuations are performed by personnel independent of our business units. A price verification group reviews selected valuations and compares the valuations to alternative external market data (e.g., quoted market prices, broker or dealer quotations, pricing services, recent trading activity and comparative analyses to similar instruments) for reasonableness. The price verification group also performs independent reviews of the assumptions used in determining the fair value of products with material estimation risk for which observable market-based inputs do not exist. Valuation models are regularly reviewed and approved for use for specific products by the Chief Risk Office, which also is independent from our business units. Any changes to the valuation methodology or pricing are reviewed by the Valuation Oversight Committee to confirm the changes are appropriate.
 
We continue to refine our valuation methodologies as markets and products develop and the pricing for certain products becomes more or less transparent. While we believe our valuation methods are appropriate and consistent with those of other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a materially different estimate of fair value as of the reporting date.
 
Change in Measuring the Fair Value of Guaranty Obligations
 
Beginning January 1, 2008, as part of the implementation of SFAS 157, we changed our approach to measuring the fair value of our guaranty obligation. Specifically, we adopted a measurement approach that is based upon an estimate of the compensation that we would require to issue the same guaranty in a standalone arm’s-length transaction with an unrelated party. When we initially recognize a guaranty issued in a lender swap transaction after December 31, 2007, we measure the fair value of the guaranty obligation based on the fair value of the total compensation we receive, which primarily consists of the guaranty fee, credit enhancements, buy-downs, risk-based price adjustments and our right to receive interest income during the float period in excess of the amount required to compensate us for master servicing. Because the fair value of those guaranty obligations now equals the fair value of the total compensation we receive, we do not recognize losses or record deferred profit in our financial statements at inception of those guaranty contracts issued after December 31, 2007.
 
We also changed the way we measure the fair value of our existing guaranty obligations, as disclosed in “Supplemental Non-GAAP Information—Fair Value Balance Sheets” and in “Notes to Condensed Consolidated Financial Statements,” to be consistent with our new approach for measuring guaranty obligations at initial recognition. The fair value of all guaranty obligations measured subsequent to their initial recognition, is our estimate of a hypothetical transaction price we would receive if we were to issue our guarantees to an unrelated party in a standalone arm’s-length transaction at the measurement date. To measure this fair value, we will continue to use the models and inputs that we used prior to our adoption of SFAS 157 and calibrate those models to our current market pricing.
 
Prior to January 1, 2008, we measured the fair value of the guaranty obligations that we recorded when we issued Fannie Mae MBS based on market information obtained from spot transaction prices. In the absence of spot transaction data, which was the case for the substantial majority of our guarantees, we used internal models to estimate the fair value of our guaranty obligations. We reviewed the reasonableness of the results of our models by comparing those results with available market information. Key inputs and assumptions used in our models included the amount of compensation required to cover estimated default costs, including estimated unrecoverable principal and interest that we expected to incur over the life of the underlying mortgage loans backing our Fannie Mae MBS, estimated foreclosure-related costs, estimated administrative and other costs related to our guaranty, and an estimated market risk premium, or profit, that a market


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participant of similar credit standing would require to assume the obligation. If our modeled estimate of the fair value of the guaranty obligation was more or less than the fair value of the total compensation received, we recognized a loss or recorded deferred profit, respectively, at inception of the guaranty contract. See “Part II—Item 7—MD&A—Critical Accounting Policies and Estimates—Fair Value of Guaranty Assets and Guaranty Obligations—Effect on Losses on Certain Guaranty Contracts” of our 2007 Form 10-K for additional information.
 
The accounting for our guarantees in our condensed consolidated financial statements is unchanged with our adoption of SFAS 157. Accordingly, the guaranty obligation amounts recorded in our condensed consolidated balance sheets attributable to guarantees issued prior to January 1, 2008 will continue to be amortized in accordance with our established accounting policy. This change, however, affects the fair value of all our existing guaranty obligations as of each measurement date, which we disclose in “Notes to Condensed Consolidated Financial Statements” and “Supplemental Non-GAAP Information—Fair Value Balance Sheets.” As a result of this change, the fair value of our guaranty obligations as of December 31, 2007 decreased by $2.3 billion, to an estimated $18.2 billion, from the previously reported amount of $20.5 billion, effective upon our January 1, 2008 adoption of SFAS 157.
 
Deferred Tax Assets
 
We recognize deferred tax assets and liabilities for the future tax consequences related to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, and for tax credits. Our net deferred tax assets totaled $17.8 billion and $13.0 billion as of March 31, 2008 and December 31, 2007, respectively. We evaluate our deferred tax assets for recoverability based on available evidence, including assumptions about future profitability. We are required to establish a valuation allowance for deferred tax assets if we determine, based on available evidence at the time the determination is made, that it is more likely than not that some portion or all of the deferred tax assets will not be realized. In evaluating the need for a valuation allowance, we estimate future taxable income based on management approved business plans and ongoing tax planning strategies. We did not record a valuation allowance against our net deferred tax assets as of March 31, 2008 or December 31, 2007 because we anticipate that it is more likely than not that our results of future operations will generate sufficient taxable income to allow us to realize our deferred tax assets.
 
If we were to determine that we would not be able to realize all or a portion of our deferred tax assets in the future, we would reduce the deferred tax asset through a charge to income in the period in which that determination is made. This charge could have a material adverse affect on our results of operations and financial condition. In addition, the assumptions in making this determination are subject to change from period to period based on changes in tax laws or variances between our future projected operating performance and our actual results. As a result, significant management judgment is required in assessing the possible need for a deferred tax asset valuation allowance. For these reasons and because changes in these assumptions and estimates can materially affect our results of operations and financial condition, we have included the assessment of a deferred tax asset valuation allowance as a critical accounting policy.
 
Our analysis of the need for a valuation allowance recognizes that we are in a cumulative loss position as of the three-year period ended March 31, 2008, which is considered significant negative evidence that is objective and verifiable and therefore, difficult to overcome. However, we believe we will generate sufficient taxable income in future periods to realize deferred tax assets.
 
We are able to rely on our forecasts of future taxable income and overcome the uncertainty created by the cumulative loss position. While current market conditions create volatility in our pre-tax income, we have sufficient taxable income currently and in our forecasts because of the stability of our core business model and the nature of our book to tax differences. Our forecasts of future taxable income include assumptions about the depth and severity of housing price depreciation and credit losses; if future actual results adversely deviate in a material way, or if unforeseen events preclude our ability to maintain our funding spreads or manage our guaranty fees, we may not generate sufficient taxable income to realize our deferred tax assets, and a


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significant valuation allowance may be necessary. We will continue to assess the need for a valuation allowance.
 
We provide additional detail on the components of our deferred tax assets and deferred tax liabilities as of December 31, 2007 in our 2007 Form 10-K in “Notes to Consolidated Financial Statements—Note 11, Income Taxes” and we provide information on the increase in our deferred tax assets since December 31, 2007 in “Notes to Condensed Consolidated Financial Statements—Note 10, Income Taxes” of this report.
 
CONSOLIDATED RESULTS OF OPERATIONS
 
The following discussion of our condensed consolidated results of operations is based on a comparison of our results for the first quarter of 2008 and the first quarter of 2007. Table 3 presents a summary of our unaudited condensed consolidated results of operations for each of these periods.
 
Table 3:  Summary of Condensed Consolidated Results of Operations
 
                                 
    For the
       
    Three Months
       
    Ended
       
    March 31,     Variance  
    2008     2007     $     %  
    (Dollars in millions, except
 
    per share amounts)  
 
Net interest income
  $ 1,690     $ 1,194     $ 496       42 %
Guaranty fee income
    1,752       1,098       654       60  
Trust management income
    107       164       (57 )     (35 )
Fee and other income(1)
    227       277       (50 )     (18 )
                                 
Net revenues
    3,776       2,733       1,043       38  
                                 
Losses on certain guaranty contracts
          (283 )     283       100  
Investment gains (losses), net(1)
    (111 )     295       (406 )     (138 )
Fair value losses, net(1)
    (4,377 )     (566 )     (3,811 )     (673 )
Losses from partnership investments
    (141 )     (165 )     24       15  
Administrative expenses
    (512 )     (698 )     186       27  
Credit-related expenses(2)
    (3,243 )     (321 )     (2,922 )     (910 )
Other non-interest expenses(1)(3)
    (505 )     (104 )     (401 )     (386 )
                                 
Income (loss) before federal income taxes and extraordinary losses
    (5,113 )     891       (6,004 )     (674 )
Benefit for federal income taxes
    2,928       73       2,855       3,911  
Extraordinary losses, net of tax effect
    (1 )     (3 )     2       67  
                                 
Net income (loss)
  $ (2,186 )   $ 961     $ (3,147 )     (327 )%
                                 
Diluted earnings (loss) per common share
  $ (2.57 )   $ 0.85     $ (3.42 )     (402 )%
                                 
 
 
(1) Certain prior period amounts have been reclassified to conform with the current period presentation in our condensed consolidated statements of operations.
 
(2) Consists of provision for credit losses and foreclosed property expense.
 
(3) Consists of debt extinguishment gains (losses), net, minority interest in earnings of consolidated subsidiaries and other expenses.
 
Our business generates revenues from four principal sources: net interest income, guaranty fee income, trust management income, and fee and other income. Other significant factors affecting our results of operations include: changes in the fair value of our derivatives, trading securities and debt; the timing and size of investment gains and losses; credit-related expenses; losses from partnership investments; and administrative expenses. We provide a comparative discussion of the effect of our principal revenue sources and other listed items on our condensed consolidated results of operations for the three months ended March 31, 2008 and


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2007 below. We also discuss other significant items presented in our unaudited condensed consolidated statements of operations.
 
Net Interest Income
 
Table 4 presents an analysis of our net interest income and net interest yield for the three months ended March 31, 2008 and 2007.
 
Table 4:  Analysis of Net Interest Income and Yield
 
                                                 
    For the Three Months Ended March 31,  
    2008     2007  
          Interest
    Average
          Interest
    Average
 
    Average
    Income/
    Rates
    Average
    Income/
    Rates
 
    Balance(1)     Expense     Earned/Paid     Balance(1)     Expense     Earned/Paid  
    (Dollars in millions)  
 
Interest-earning assets:
                                               
Mortgage loans(2)
  $ 410,318     $ 5,662       5.52 %   $ 385,810     $ 5,385       5.58 %
Mortgage securities
    315,795       4,144       5.25       331,229       4,567       5.52  
Non-mortgage securities(3)
    66,630       678       4.03       62,195       836       5.37  
Federal funds sold and securities purchased under agreements to resell
    36,233       393       4.29       13,666       182       5.32  
Advances to lenders
    4,229       65       6.08       4,674       36       3.11  
                                                 
Total interest-earning assets
  $ 833,205     $ 10,942       5.25 %   $ 797,574     $ 11,006       5.52 %
                                                 
Interest-bearing liabilities:
                                               
Short-term debt
  $ 257,445     $ 2,558       3.93 %   $ 161,575     $ 2,213       5.48 %
Long-term debt
    545,549       6,691       4.91       602,804       7,596       5.04  
Federal funds purchased and securities sold under agreements to repurchase
    448       3       2.65       210       3       5.33  
                                                 
Total interest-bearing liabilities
  $ 803,442     $ 9,252       4.59 %   $ 764,589     $ 9,812       5.13 %
                                                 
Impact of net non-interest bearing funding
  $ 29,763               0.16 %   $ 32,985               0.21 %
                                                 
Net interest income/net interest yield(4)
          $ 1,690       0.82 %           $ 1,194       0.60 %
Taxable-equivalent adjustment on tax-exempt investments(5)
            83       0.04 %             92       0.04 %
                                                 
Taxable-equivalent net interest income/taxable-equivalent net interest yield(6)
          $ 1,773       0.86 %           $ 1,286       0.64 %
                                                 
 
 
(1) For mortgage loans, average balances have been calculated based on the average of the amortized cost amounts at the beginning of the year and at the end of each month in the period. For all other categories, average balances have been calculated based on a daily average. The average balance for the three months ended March 31, 2008 for advances to lenders also has been calculated based on a daily average.
 
(2) Average balance amounts include nonaccrual loans with an average balance totaling $8.2 billion and $6.5 billion as of March 31, 2008 and December 31, 2007, respectively, and $5.9 billion and $6.7 billion as of March 31, 2007 and December 31, 2006, respectively. Interest income amounts include interest income related to SOP 03-3 loans, including accretion on loans returned to accrual status, of $145 million and $104 million for the three months ended March 31, 2008 and 2007, respectively. Of these amounts recognized into interest income, $35 million and $7 million for the three months ended March 31, 2008 and 2007, respectively, related to the accretion of the fair value loss recorded upon purchase of SOP 03-3 loans.
 
(3) Includes cash equivalents.
 
(4) Net interest yield computed by dividing annualized net interest income for the period by the average balance of total interest-earning assets during the period.
 
(5) Represents adjustment to permit comparison of yields on tax-exempt and taxable assets calculated using a 35% marginal tax rate for each of the periods presented.


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(6) Taxable-equivalent net interest yield is computed by dividing annualized taxable-equivalent net interest income for the period by the average balance of total interest-earning assets during the period.
 
Table 5 presents the total variance, or change, in our taxable-equivalent net interest income between the three months ended March 31, 2008 and 2007, and the extent to which that variance is attributable to (1) changes in the volume of our interest-earning assets and interest-bearing liabilities or (2) changes in the interest rates of these assets and liabilities.
 
Table 5:  Rate/Volume Analysis of Net Interest Income
 
                         
    For the Three Months
 
    Ended March 31,
 
    2008 vs. 2007  
    Total
    Variance Due to:(1)  
    Variance     Volume     Rate  
    (Dollars in millions)  
 
Interest income:
                       
Mortgage loans(2)
  $ 277     $ 339     $ (62 )
Mortgage securities
    (423 )     (208 )     (215 )
Non-mortgage securities
    (158 )     56       (214 )
Federal funds sold and securities purchased under agreements to resell
    211       250       (39 )
Advances to lenders
    29       (4 )     33  
                         
Total interest income
    (64 )     433       (497 )
                         
Interest expense:
                       
Short-term debt
    345       1,067       (722 )
Long-term debt
    (905 )     (706 )     (199 )
Federal funds purchased and securities sold under agreements to repurchase
          2       (2 )
                         
Total interest expense
    (560 )     363       (923 )
                         
Net interest income
    496       70       426  
Taxable-equivalent adjustment on tax-exempt investments(3)
    (9 )                
                         
Taxable-equivalent net interest income
  $ 487                  
                         
 
 
(1) Combined rate/volume variances are allocated to both rate and volume based on the relative size of each variance.
 
(2) Includes interest income related to SOP 03-3 loans, including accretion on loans returned to accrual status, of $145 million and $104 million for the three months ended March 31, 2008 and 2007, respectively. Of these amounts recognized into interest income, approximately $35 million and $7 million for the three months ended March 31, 2008 and 2007, respectively, related to the accretion of the fair value discount recorded upon purchase of SOP 03-3 loans.
 
(3) Represents adjustment to permit comparison of yields on tax-exempt and taxable assets calculated using a 35% marginal tax rate for each of the periods presented.
 
Taxable-equivalent net interest income of $1.8 billion for the first quarter of 2008 increased by 38% from the first quarter of 2007, driven by a 34% (22 basis points) increase in our taxable-equivalent net interest yield to 0.86%, and a 4% increase in our average interest-earning assets. During the first quarter of 2008, the U.S. Treasury yield curve assumed its steepest slope since mid-2004 as short-term interest rates fell and long-term rates remained relatively stable. Our net interest yield reflected the benefits from this steeper yield curve, as we shifted our funding mix to a higher proportion of lower-rate, short-term debt and redeemed $12.5 billion of step-rate debt securities during the quarter, which together reduced the average cost of our debt by 54 basis points, to 4.59%. Instead of having a fixed coupon for the life of the security, step-rate debt securities allow for the interest rate to increase at predetermined rates according to a specified schedule, resulting in increased interest payments. However, the interest expense on step-rate debt securities is recognized at a constant effective rate over the term of the security. Because we redeemed these securities prior to maturity, we reversed a portion of the interest expense that we had previously accrued, which provided a benefit to our net interest yield of approximately 17 basis points on an annualized basis. The decrease in the average cost of our debt was partially offset by a decrease in the average yield on our interest-earning assets of 27 basis points to


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5.25%, which was due in part to the accelerated amortization of net deferred premium amounts reflecting faster than expected prepayment speeds in response to the decline in interest rates during the quarter.
 
The periodic net contractual interest accruals on our interest rate swaps are not reflected in our taxable-equivalent net interest income, although we consider these amounts to be part of the cost of funding our mortgage investments. Instead, the net contractual interest accruals on our interest rate swaps are reflected in our condensed consolidated statements of operations as a component of “Fair value losses, net.” As indicated in Table 9 below, we recorded net contractual interest expense of $26 million for the three months ended March 31, 2008. In comparison, we recorded net contractual interest income on our interest rate swaps totaling $34 million for the three months ended March 31, 2007. The economic effect of the interest accruals on our interest rate swaps, which is not reflected in the comparative net interest yields presented above, resulted in an increase in our funding costs of approximately 1 basis point for the three months ended March 31, 2008 and a reduction in our funding costs of approximately 1 basis point for the three months ended March 31, 2007.
 
If current market conditions continue, we expect our taxable-equivalent net interest yield (excluding the benefit we received from the redemption of step-rate debt securities during the first quarter of 2008) to continue to increase for the remainder of 2008.
 
Guaranty Fee Income
 
Table 6 shows the components of our guaranty fee income, our average effective guaranty fee rate, and Fannie Mae MBS activity for the three months ended March 31, 2008 and 2007. As discussed above, the change in measuring the fair value of our guaranty obligations affects not only the losses recognized at inception of our guaranty contract, but also our guaranty fee income. Although we will no longer recognize losses at the inception of our guaranty contracts, we will continue to accrete previously recognized losses into our guaranty fee income over the remaining life of the mortgage loans underlying the MBS.
 
Table 6:  Guaranty Fee Income and Average Effective Guaranty Fee Rate(1)
 
                                         
    For the Three Months Ended March 31,        
    2008     2007     Amount
 
    Amount     Rate(2)     Amount     Rate(2)     Variance  
    (Dollars in millions)  
 
Guaranty fee income/average effective guaranty fee rate, excluding certain fair value adjustments and buy-up impairment
  $ 1,719       29.0 bp   $ 1,100       21.8 bp     56 %
Net change in fair value of buy-ups and guaranty assets
    62       1.0       2             3,000  
Buy-up impairment
    (29 )     (0.5 )     (4 )           625  
                                         
Guaranty fee income/average effective guaranty fee rate(3)
  $ 1,752       29.5 bp   $ 1,098       21.8 bp     60 %
                                         
Average outstanding Fannie Mae MBS and other guarantees(4)
  $ 2,374,033             $ 2,017,471               18 %
Fannie Mae MBS issues(5)
    168,592               132,423               27  
 
 
(1) Guaranty fee income primarily consists of contractual guaranty fees related to Fannie Mae MBS held in our portfolio and held by third-party investors, adjusted for (1) the amortization of upfront fees and impairment of guaranty assets, net of a proportionate reduction in the related guaranty obligation and deferred profit, and (2) impairment of buy-ups. The average effective guaranty fee rate reflects our average contractual guaranty fee rate adjusted for the impact of amortization of deferred amounts and buy-up impairment. Losses recognized at inception on certain guaranty contracts are excluded from guaranty fee income and the average effective guaranty fee rate; however, as described in footnote 3 below, the accretion of these losses into income over time is included in our guaranty fee income and average effective guaranty fee rate.
 
(2) Presented in basis points and calculated based on annualized amounts of our guaranty fee income components divided by average outstanding Fannie Mae MBS and other guarantees for each respective period.


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(3) Losses recognized at inception on certain guaranty contracts, which are excluded from guaranty fee income, are recorded as a component of our guaranty obligation. We accrete a portion of our guaranty obligation, which includes these losses, into income each period in proportion to the reduction in the guaranty asset for payments received. This accretion increases our guaranty fee income and reduces the related guaranty obligation.
 
(4) Other guarantees includes $40.8 billion and $41.6 billion as of March 31, 2008 and December 31, 2007, respectively, and $20.6 billion and $19.7 billion as of March 31, 2007 and December 31, 2006, respectively, related to long-term standby commitments we have issued and credit enhancements we have provided.
 
(5) Reflects unpaid principal balance of Fannie Mae MBS issued and guaranteed by us, including mortgage loans held in our portfolio that we securitized during the period and Fannie Mae MBS issued during the period that we acquired for our portfolio.
 
The 60% increase in guaranty fee income from the first quarter of 2007 was driven by an 18% increase in average outstanding Fannie Mae MBS and other guarantees, and a 35% increase in the average effective guaranty fee rate to 29.5 basis points from 21.8 basis points. The increase in average outstanding Fannie Mae MBS and other guarantees reflected the significant growth in our market share of mortgage-related securities issuances since the first quarter of 2007, due in large part to the disruption in the credit and mortgage markets and dramatic shift in market dynamics, including a significant reduction in the issuances of private-label mortgage-related securities.
 
The increase in our average effective guaranty fee rate was due in part to accretion of our guaranty obligation and deferred profit amounts into income, reflecting the impact of accelerated amortization due to faster expected prepayment speeds stemming from the decrease in interest rates during the quarter. The accretion of the guaranty obligation related to losses previously recognized at inception on certain guaranty contracts totaled an estimated $297 million and $92 million for the three months ended March 31, 2008 and 2007, respectively.
 
We implemented targeted guaranty fee pricing increases and an adverse market delivery charge of 25 basis points for all loans delivered to us effective March 1, 2008. As a result of these price increases, our average guaranty charge fee on acquisitions increased to 27.9 basis points for the month of March 2008, from 26.5 basis points for December 2007 and 25.6 basis points for March 2007. The impact of our targeted pricing increases during the first quarter of 2008 was partially offset by a reduction in the acquisition of higher-risk loan products, for which we typically charge a higher guaranty fee.
 
We announced a comprehensive update to our risk assessment, eligibility criteria and pricing that is effective June 1, 2008. The changes in our risk assessment and eligibility criteria are likely to result in changes in the risk profile of our new business, which may contribute to a reduction in our guaranty business volume for the year relative to our business volume for 2007. However, we expect overall growth in our guaranty book of business for the year and an increase in our guaranty fee income for 2008 relative to 2007.
 
Trust Management Income
 
Trust management income decreased to $107 million for the first quarter of 2008, from $164 million for the first quarter of 2007. The decrease was attributable to the reduction in short-term interest rates during the first quarter of 2008, which reduced the amount of float income derived from the cash flows between the date of remittance of mortgage and other payments to us by servicers and the date of distribution of these payments to MBS certificateholders.
 
Fee and Other Income
 
Fee and other income decreased to $227 million for the first quarter of 2008, from $277 million for the first quarter of 2007. The decrease was due to a reduction in multifamily fees that reflected lower liquidations during the first quarter of 2008.
 
Losses on Certain Guaranty Contracts
 
Beginning on January 1, 2008 with our adoption of SFAS 157, we changed how we measure the fair value of our guaranty obligation related to new MBS issuances. As a result of this change, we did not record any losses on certain guaranty contracts for the first quarter of 2008. We will no longer recognize losses or record deferred profit in our consolidated financial statements at inception of our guaranty contracts for MBS issued subsequent to


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December 31, 2007 because the estimated fair value of the guaranty obligation at inception will now equal the estimated fair value of the total compensation received. For further discussion of this change, see “Critical Accounting Policies and Estimates—Fair Value of Financial Instruments—Change in Measuring the Fair Value of Guaranty Obligations” and “Notes to Condensed Consolidated Financial Statements—Note 1, Summary of Significant Accounting Policies.”
 
We recorded losses on certain guaranty contracts totaling $283 million for the first quarter of 2007. These losses reflected the increase in the estimated market risk premium that a market participant would require to assume our guaranty obligations due to the decline in home prices and deterioration in credit conditions. As of March 31, 2008, unamortized losses on certain guaranty contracts in our condensed consolidated balance sheet were $2.2 billion. The unamortized losses represent the net guaranty asset and guaranty obligation in our condensed consolidated balance sheet that will be accreted into income over the remaining life of the mortgage loans underlying our Fannie Mae MBS as a component of guaranty fee income. The accretion to be recognized in future periods will be more than the original losses on certain guaranty contracts as a result of upfront cash fees and credit enhancements received at the inception of the guaranty arrangement that reduced the original recorded loss.
 
Investment Gains (Losses), Net
 
We summarize the components of investment gains (losses), for the three months ended March 31, 2008 and 2007 below in Table 7 and discuss significant changes in these components between periods.
 
Table 7:  Investment Gains (Losses), Net
 
                 
    For the
 
    Three Months
 
    Ended
 
    March 31,  
    2008     2007  
    (Dollars in millions)  
 
Other-than-temporary impairment on AFS securities(1)
  $ (55 )   $ (3 )
Lower-of-cost-or-market (“LOCOM”) adjustments on held-for-sale loans
    (71 )     (3 )
Gains on Fannie Mae portfolio securitizations, net
    42       49  
Gains on sale of AFS securities, net
    33       271  
Other investment losses, net
    (60 )     (19 )
                 
Investment gains (losses), net
  $ (111 )   $ 295  
                 
 
 
(1) Excludes other-than-temporary impairment on guaranty assets and buy-ups as these amounts are recognized as a component of guaranty fee income. Refer to Table 6: Guaranty Fee Income and Average Effective Guaranty Fee Rate.
 
The $406 million unfavorable variance in investment gains (losses), net, for the first quarter of 2008 compared with the first quarter of 2007 was primarily attributable to the following:
 
  •  An increase of $52 million in other-than-temporary impairment on AFS securities. We recognized other-than-temporary impairment on our AFS securities totaling $55 million for the first quarter of 2008, attributable to declines in the creditworthiness of certain securities, principally related to subprime private-label securities. In contrast, we recognized other-than-temporary impairment of $3 million for the first quarter of 2007.
 
  •  A $68 million increase in losses resulting from lower-of-cost-or-market adjustments on HFS loans, due to the significant widening of credit spreads during the quarter.
 
  •  A decrease of $238 million in gains on the sale of AFS securities, net. We recorded net gains of $33 million and $271 million for the first quarters of 2008 and 2007, respectively, related to the sale of securities totaling $13.5 billion and $17.0 billion, respectively. The investment gains recorded during the first quarter of 2007 were attributable to the recovery in value of securities we sold that we had previously written down due to other-than-temporary impairment.


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Fair Value Losses, Net
 
Fair value losses, net consists of derivatives fair value gains and losses, gains and losses on trading securities, debt foreign exchange gains and losses, and debt fair value gains and losses. Generally, we expect changes in the fair value of our trading securities to move inversely to changes in the fair value of our derivatives, resulting in an offset against a portion of our derivatives gains and losses. Because the fair value of our derivatives and trading securities are affected not only by interest rates, but also by other factors such as volatility and, for trading securities, changes in credit spreads, changes in the fair value of our trading securities may not always move inversely to changes in the fair value of our derivatives. Consequently, the gains and losses on our trading securities may not result in partially offsetting losses and gains on our derivatives. In addition, our foreign currency exchange gains and losses on our foreign-denominated debt are offset in part by corresponding losses and gains on foreign currency swaps. We seek to eliminate our exposure to fluctuations in foreign exchange rates by entering into foreign currency swaps that effectively convert debt denominated in a foreign currency to debt denominated in U.S. dollars. By presenting these items together in our condensed consolidated results of operations, we are able to show the net impact of mark-to-market adjustments that generally result in offsetting gains and losses due to changes in interest rates. Table 8 summarizes the components of fair value losses, net for the three months ended March 31, 2008 and 2007.
 
Table 8:  Fair Value Losses, Net
 
                 
    For the
 
    Three Months
 
    Ended
 
    March 31,  
    2008     2007  
    (Dollars in millions)  
 
Derivatives fair value losses, net
  $ (3,003 )   $ (563 )
Gains (losses) on trading securities, net
    (1,227 )     61  
                 
Derivatives and trading securities fair value losses, net
    (4,230 )     (502 )
Debt foreign exchange losses, net
    (157 )     (64 )
Debt fair value gains, net
    10        
                 
Fair value losses, net
  $ (4,377 )   $ (566 )
                 
 
We recorded fair value losses, net of $4.4 billion for the first quarter of 2008, compared with fair value losses of $566 million for the first quarter of 2007. As a result of the decrease in swap interest rates during the first quarter of 2008, we experienced a significant increase in fair value losses on our derivatives. We also experienced fair value losses on our trading securities due to the significant widening of credit spreads during the quarter, which more than offset an increase in value attributable to the decline in interest rates during the period.
 
Beginning in mid-April 2008, we implemented fair value hedge accounting with respect to a portion of our derivatives to hedge, for accounting purposes, the interest rate risk related to some of our mortgage assets. Hedge accounting allows us to offset the fair value gains or losses on some of our derivative instruments against the corresponding fair value losses or gains attributable to changes in interest rates on the specific hedged mortgage assets. As a result, we expect a reduction in the level of volatility in our financial results that is attributable to changes in interest rates. However, our implementation of hedge accounting will not affect our exposure to spread risk or the volatility in our financial results that is attributable to changes in credit spreads. Because changes in the fair value of our trading securities and derivatives are affected by market fluctuations that cannot be predicted, we cannot estimate the impact of changes in these items for the full year. We disclose the sensitivity of changes in the fair value of our trading securities and derivatives to changes in interest rates in “Risk Management—Interest Rate Risk Management and Other Market Risks—Measuring Interest Rate Risk.” Below we provide additional information on the most significant components of our fair value losses, net.


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Derivatives Fair Value Losses, Net
 
Table 9 presents, by type of derivative instrument, the fair value gains and losses on our derivatives for the three months ended March 31, 2008 and 2007. Table 9 also includes an analysis of the components of derivatives fair value gains and losses attributable to net contractual interest accruals on our interest rate swaps, the net change in the fair value of terminated derivative contracts through the date of termination and the net change in the fair value of outstanding derivative contracts. We consider the net contractual interest accruals on our interest rate swaps to be part of the cost of funding our mortgage investments.
 
Table 9:  Derivatives Fair Value Losses, Net
 
                 
    For the
 
    Three Months
 
    Ended
 
    March 31,  
    2008     2007  
    (Dollars in millions)  
 
Risk management derivatives:
               
Swaps:
               
Pay-fixed
  $ (15,895 )   $ (486 )
Receive-fixed
    12,792       363  
Basis
    5       (14 )
Foreign currency(1)
    146       20  
Swaptions:
               
Pay-fixed
    (189 )     (123 )
Receive-fixed
    273       (303 )
Interest rate caps
    (1 )     1  
Other(2)
    64       (1 )
                 
Risk management derivatives fair value losses, net
    (2,805 )     (543 )
Mortgage commitment derivatives fair value losses, net
    (198 )     (20 )
                 
Total derivatives fair value losses, net
  $ (3,003 )   $ (563 )
                 
Risk management derivatives fair value gains (losses) attributable to:
               
Net contractual interest income (expense) accruals on interest rate swaps
  $ (26 )   $ 34  
Net change in fair value of terminated derivative contracts from end of prior year to date of termination
    204       (82 )
Net change in fair value of outstanding derivative contracts, including derivative contracts entered into during the period
    (2,983 )     (495 )
                 
Risk management derivatives fair value losses, net(3)
  $ (2,805 )   $ (543 )
                 
 
                 
    2008     2007  
 
5-year swap interest rate:
               
As of January 1
    4.19 %     5.10 %
As of March 31
    3.31       4.99  
 
 
(1) Includes the effect of net contractual interest expense accruals of approximately $3 million and $18 million for the three months ended March 31, 2008 and 2007, respectively. The change in fair value of foreign currency swaps excluding this item resulted in a net gain of $149 million and $38 million for the three months ended March 31, 2008 and 2007, respectively.
 
(2) Includes MBS options, forward starting debt, swap credit enhancements and mortgage insurance contracts.
 
(3) Reflects net derivatives fair value losses, excluding mortgage commitments, recognized in the condensed consolidated statements of operations.
 
The derivatives fair value losses of $3.0 billion for the first quarter of 2008 were primarily driven by the decline in interest rates during the quarter. The 5-year swap interest rate, which is presented in Table 9, fell by


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88 basis points to 3.31% as of March 31, 2008 from 4.19% as of December 31, 2007. This decline resulted in fair value losses on our pay-fixed swaps that exceeded the fair value gains on our receive-fixed swaps. We experienced partially offsetting fair value gains on our option-based derivatives due to an increase in implied volatility that more than offset the combined effect of the time decay of these options and the decrease in swap interest rates during the first quarter of 2008.
 
The derivatives fair value losses of $563 million for the first quarter of 2007 also were primarily a result of a decline in interest rates during the quarter, as the 5-year swap interest rate fell by 11 basis points to 4.99% as of March 31, 2007 from 5.10% as of December 31, 2006. This decline contributed to a reduction in the fair value of our pay-fixed interest rate swaps, resulting in a reduction in the aggregate net fair value of our interest rate swaps. We also experienced a decrease in the aggregate fair value of our option-based derivatives due to the combined effect of the time decay of these options and a decrease in implied volatility during the quarter.
 
See “Consolidated Balance Sheet Analysis—Derivative Instruments” for additional information on the effect of our derivatives on our consolidated financial statements and “Risk Management—Interest Rate Risk Management and Other Market Risks—Derivatives Activity” for information on changes in our derivatives activity and the outstanding notional amounts of our derivatives.
 
Gains (Losses) on Trading Securities, Net
 
We recorded losses on trading securities of $1.2 billion during the first quarter of 2008. These losses were primarily related to a decline in value of our Alt-A, subprime and commercial real estate private-label mortgage-related securities due to the significant widening of credit spreads during the period, which more than offset an increase in value attributable to the decline in interest rates during the period. In contrast, we recorded gains on trading securities of $61 million during the first quarter of 2007, due to a decrease in interest rates and implied volatility during the quarter.
 
In the fourth quarter of 2007, we began designating an increasingly large portion of the agency mortgage-related securities that we purchased as trading securities to allow a better offset of the changes in the fair value of these securities and the derivative instruments. In addition, in conjunction with our January 1, 2008 adoption of SFAS 159, we elected to reclassify all of our non-mortgage investment securities to trading from AFS. Our portfolio of trading securities increased to $110.6 billion as of March 31, 2008, from $64.0 billion as of December 31, 2007. The decline in interest rates during the first quarter of 2008 contributed to an increase in the fair value of our trading securities. This increase, however, was more than offset by a decrease in the fair value of these securities due to the significant widening of credit spreads, particularly related to private-label mortgage-related securities backed by Alt-A and subprime loans and commercial mortgage-backed securities (“CMBS”) backed by multifamily mortgage loans.
 
We provide additional information on our trading and AFS securities in “Consolidated Balance Sheet Analysis—Trading and Available-for-Sale Investment Securities” and disclose the sensitivity of changes in the fair value of our securities to changes in interest rates in “Risk Management—Interest Rate Risk Management and Other Market Risks—Measuring Interest Rate Risk.”
 
Debt Foreign Exchange Losses, Net
 
We recorded a foreign currency exchange loss of $157 million on our foreign-denominated debt for the first quarter of 2008, primarily due to the continued weakening of the U.S. dollar. In comparison, we recorded a foreign currency exchange loss of $64 million for the first quarter of 2007. These amounts are offset in part by gains on our foreign currency swaps, which are included in derivatives fair value losses, net and presented in Table 9 above.


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Losses from Partnership Investments
 
Losses from partnership investments decreased to $141 million for the first quarter of 2008, from $165 million for the first quarter of 2007, primarily due to a reduction in net operating losses attributable to a decrease in our LIHTC and other tax-advantaged partnership investments. These reduced losses were partially offset by an increase in net operating losses related to our continued investment in other non-LIHTC affordable rental housing partnerships. For additional information on tax credits associated with our LIHTC investments, refer to “Federal Income Taxes” below.
 
Administrative Expenses
 
Administrative expenses decreased to $512 million for the first quarter of 2008, from $698 million for the first quarter of 2007, reflecting significant reductions in restatement and related regulatory expenses and a reduction in our ongoing operating costs due to efforts we undertook in 2007 to increase productivity and lower our administrative costs. We are actively managing our administrative expenses with the intent to maintain our ongoing operating costs for 2008, which exclude costs associated with our restatement, such as regulatory examinations and litigation related to the restatement, near the $2.0 billion level we achieved in 2007.
 
Credit-Related Expenses
 
The credit-related expenses included in our condensed consolidated statements of operations consist of the provision for credit losses and foreclosed property expense. Our credit-related expenses increased to $3.2 billion for the first quarter of 2008, from $321 million for the first quarter of 2007. Table 10 details the components of our credit-related expenses. We discuss each of these components below.
 
Table 10:  Credit-Related Expenses
 
                 
    For the
 
    Three Months Ended March 31,  
    2008     2007  
    (Dollars in millions)  
 
Provision attributable to guaranty book of business
  $ 2,345     $ 180  
Provision attributable to SOP 03-3 fair value losses
    728       69  
                 
Total provision for credit losses(1)
    3,073       249  
Foreclosed property expense
    170       72  
                 
Credit-related expenses
  $ 3,243     $ 321  
                 
 
 
(1) Reflects total provision for credit losses reported in Table 11 below under “Combined loss reserves.”
 
The $2.9 billion increase in our credit-related expenses for the first quarter of 2008 was principally due to the substantial increase of $2.2 billion in our provision for credit losses attributable to our guaranty book of business, reflecting the impact of the severe deterioration in the housing market, which has resulted in a significant increase in default rates and average loss severities, particularly related to loans in certain states, certain higher risk loan categories and loans originated in 2005 to 2007. We also experienced an increase of $659 million in our provision for credit losses attributable to SOP 03-3 fair value losses. Foreclosed property expense rose by $98 million due to an increase in our inventory of foreclosed properties, reflecting a sharp rise in the rate of foreclosures and a significant increase in the amount of time required to dispose of foreclosed properties, as well as reduced prices from the sale of foreclosed properties.


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Provision Attributable to Guaranty Book of Business
 
Our allowance for loan losses and reserve for guaranty losses, which we collectively refer to as our combined loss reserves, provide for probable credit losses inherent in our guaranty book of business as of each balance sheet date. We build our loss reserves, through the provision for credit losses, for losses that we believe have been incurred and will eventually be recorded over time as charge-offs. When we determine that a loan is uncollectible, we record the charge-off against our loss reserves. We record recoveries of previously charged-off amounts as a credit to our loss reserves. Table 11, which summarizes changes in our combined loss reserves for the three months ended March 31, 2008 and 2007, details the provision for credit losses recognized in our condensed consolidated statements of operations each period and the charge-offs recorded against our loss reserves.
 
Table 11:  Allowance for Loan Losses and Reserve for Guaranty Losses
 
                 
    For the
 
    Three Months
 
    Ended
 
    March 31,  
    2008     2007  
    (Dollars in millions)  
 
Changes in loss reserves:
               
Allowance for loan losses:
               
Beginning balance
  $ 698     $ 340  
Provision
    544       17  
Charge-offs(1)
    (279 )     (62 )
Recoveries
    30       17  
                 
Ending balance(2)
  $ 993     $ 312  
                 
Reserve for guaranty losses:
               
Beginning balance
  $ 2,693     $ 519  
Provision
    2,529       232  
Charge-offs(3)
    (1,037 )     (153 )
Recoveries
    17       20  
                 
Ending balance
  $ 4,202     $ 618  
                 
Combined loss reserves:
               
Beginning balance
  $ 3,391     $ 859  
Provision
    3,073       249  
Charge-offs(1)(3)
    (1,316 )     (215 )
Recoveries
    47       37  
                 
Ending balance(2)
  $ 5,195     $ 930  
                 
Allocation of loss reserves:
               
Balance at end of each period attributable to:
               
Single-family
  $ 5,140     $ 862  
Multifamily
    55       68  
                 
Total
  $ 5,195     $ 930  
                 
Loss reserve ratios:
               
Percent of combined allowance and reserve for guaranty losses in each category to related guaranty book of business:(4)
               
Single-family
    0.19 %     0.04 %
Multifamily
    0.04       0.06  
Total
    0.18       0.04  


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(1) Includes accrued interest of $78 million and $25 million for the three months ended March 31, 2008 and 2007, respectively.
 
(2) Includes $50 million and $42 million as of March 31, 2008 and 2007, respectively, for acquired loans subject to the application of SOP 03-3.
 
(3) Includes charges recorded at the date of acquisition of $728 million and $69 million for the three months ended March 31, 2008 and 2007, respectively, for acquired loans subject to the application of SOP 03-3 where the acquisition cost exceeded the fair value of the acquired loan.
 
(4) Represents ratio of combined allowance and reserve balance by loan type to the guaranty book of business by loan type.
 
The continued weakness in the housing market, including the national decline in home prices, the decrease in home sales and the substantial increase in the number of months supply of housing inventory, has contributed to significantly higher default rates and loan loss severities, which are the primary factors in determining the level of our loss reserves. The number of properties we acquired through foreclosure in the first quarter of 2008 increased by 88% from the first quarter of 2007 to 20,108 properties, and our average loan loss severity more than doubled. In response to these conditions as well as our view of current economic and market trends, we substantially increased our loss reserves in the first quarter of 2008 by recording a provision for credit losses attributable to our guaranty book of business of $2.3 billion, compared with $180 million for the first quarter of 2007. The $2.3 billion was comprised of $541 million related to actual charge-offs that occurred during the first quarter of 2008 and an incremental provision of $1.8 billion to further build our loss reserves. As a result of the increase in our provision for credit losses, our loss reserves totaled $5.2 billion, or 0.18% of our guaranty book of business, as of March 31, 2008, compared with $3.4 billion, or 0.12% of our guaranty book of business, as of December 31, 2007. If the current negative trend in the housing market continues, we expect a further increase in our loss reserves during 2008 due to higher delinquencies, defaults and loan loss severities.
 
Provision Attributable to SOP 03-3 Fair Value Losses
 
We experienced a substantial increase in the SOP 03-3 fair value losses recorded upon the purchase of seriously delinquent loans from MBS trusts for the first quarter of 2008 relative to the first quarter of 2007, due to the significant disruption in the mortgage market and severe reduction in market liquidity for certain mortgage products, such as delinquent loans, that has persisted since the beginning of July 2007. As indicated in Table 10 above, SOP 03-3 fair value losses increased to $728 million for the first quarter of 2008, compared with $69 million for the first quarter of 2007. We describe how we account for SOP 03-3 fair value losses and the process we use to value loans subject to SOP 03-3 in “Part II—Item 7—MD&A—Critical Accounting Policies and Estimates— Fair Value of Loans Purchased with Evidence of Credit Deterioration—Effect on Credit-Related Expenses” of our 2007 Form 10-K.
 
Table 12 provides a quarterly comparison of the average market price, as a percentage of the unpaid principal balance and accrued interest, of seriously delinquent loans purchased from MBS trusts and additional information related to these loans. The decrease in the average price to 62% during the first quarter of 2008 reflected the impact of a substantial decline in prices during the month of March 2008, to 59% from 66% for the month of January 2008.
 
Table 12:  Statistics on Seriously Delinquent Loans Purchased from MBS Trusts Subject to SOP 03-3
 
                                                                         
    2008     2007     2006  
    Q1     Q4     Q3     Q2     Q1     Q4     Q3     Q2     Q1  
 
Average market price(1)
    62 %     70 %     72 %     93 %     94 %     95 %     95 %     95 %     96 %
Unpaid principal balance and accrued interest of loans purchased (dollars in millions)
  $ 1,704     $ 1,832     $ 2,349     $ 881     $ 1,057     $ 899     $ 714     $ 759     $ 2,022  
Number of seriously delinquent loans purchased
    10,586       11,997       15,924       6,396       8,009       7,637       6,344       6,953       17,039  
 
 
(1) The value of primary mortgage insurance is included as a component of the average market price.


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Table 13 presents activity related to seriously delinquent loans subject to SOP 03-3 purchased from MBS trusts under our guaranty arrangements for the three months ended March 31, 2008.
 
Table 13:  Activity of Seriously Delinquent Loans Purchased from MBS Trusts Subject to SOP 03-3
 
                                         
                Allowance
             
    Contractual
    Market
    for Loan
    Net
       
    Amount(1)     Discount     Losses     Investment        
          (Dollars in millions)              
 
Balance as of December 31, 2007
  $ 8,096     $ (991 )   $ (39 )   $ 7,066          
Purchases of delinquent loans
    1,704       (728 )           976          
Provision for credit losses
                (35 )     (35 )        
Principal repayments
    (180 )     46       1       (133 )        
Modifications and troubled debt restructurings
    (915 )     331       5       (579 )        
Foreclosures, transferred to REO
    (619 )     169       18       (432 )        
                                         
Balance as of March 31, 2008
  $ 8,086     $ (1,173 )   $ (50 )   $ 6,863          
                                         
 
 
(1) Reflects contractually required principal and accrued interest payments that we believe are probable of collection.
 
Tables 14 and 15 provide information about the re-performance, or cure rates, of seriously delinquent single-family loans we purchased from MBS trusts during the first quarter of 2008, each of the quarters for 2007 and each of the years 2004 to 2006, as of both (1) March 31, 2008 and (2) the end of each respective period in which the loans were purchased. Table 14 includes all seriously delinquent loans we purchased from our MBS trusts, while Table 15 includes only those seriously delinquent loans that we purchased from our MBS trusts because we intended to modify the loan.
 
We believe there are inherent limitations in the re-performance statistics presented in Tables 14 and 15, both because of the significant lag between the time a loan is purchased from an MBS trust and the conclusion of the delinquent loan resolution process and because, in our experience, it generally takes at least 18 to 24 months to assess the ultimate re-performance of a delinquent loan. Accordingly, these re-performance statistics, particularly those for more recent loan purchases, are likely to change, perhaps materially. As a result, we believe the re-performance rates as of March 31, 2008 for delinquent loans purchased from MBS trusts during 2008 and 2007, and, to a lesser extent, the latter half of 2006, may not be indicative of the ultimate long-term performance of these loans. Moreover, as discussed in more detail following these tables, our cure rates may be affected by changes in our loss mitigation efforts and delinquent loan purchase practices.
 
Table 14:  Re-performance Rates of Seriously Delinquent Single-Family Loans Purchased from MBS Trusts(1)
 
                                                                         
    Status as of March 31, 2008  
    2008     2007                          
    Q1     Q4     Q3     Q2     Q1     2007     2006     2005     2004  
 
Cured without modification(2)
    7 %     14 %     18 %     18 %     25 %     18 %     37 %     44 %     43 %
Cured with modification(3)
    37       35       19       34       29       28       28       16       15  
                                                                         
Total cured
    44       49       37       52       54       46       65       60       58  
Defaults(4)
    2       11       25       18       23       19       22       32       37  
90 days or more delinquent
    54       40       38       30       23       35       13       8       5  
                                                                         
Total
    100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %
                                                                         
 


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    Status as of the End of Each Respective Period  
    2008     2007                          
    Q1     Q4     Q3     Q2     Q1     2007     2006     2005     2004  
 
Cured without modification(2)
    7 %     11 %     10 %     11 %     17 %     16 %     32 %     31 %     33 %
Cured with modification(3)
    37       26       12       31       26       26       29       12       12  
                                                                         
Total cured
    44       37       22       42       43       42       61       43       45  
Defaults(4)
    2       4       6       3       3       13       9       12       14  
90 days or more delinquent
    54       59       72       55       54       45       30       45       41  
                                                                         
Total
    100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %
                                                                         
 
 
(1) Re-performance rates calculated based on number of loans.
 
(2) Loans classified as cured without modification consist of the following: (1) loans that are brought current without modification; (2) loans that are paid in full; (3) loans that are repurchased by lenders; (4) loans that have not been modified but are returned to accrual status because they are less than 90 days delinquent; (5) loans for which the default is resolved through long-term forbearance; and (6) loans for which the default is resolved through a repayment plan. We do not extend the maturity date, change the interest rate or otherwise modify the principal amount of any loan that we resolve through long-term forbearance or a repayment plan unless we first purchase the loan from the MBS trust.
 
(3) Loans classified as cured with modification consist of loans that are brought current or are less than 90 days delinquent as a result of resolution of the default under the loan through the following: (1) a modification that does not result in a concession to the borrower; or (2) a modification that results in a concession to a borrower, which is referred to as a troubled debt restructuring. Concessions may include an extension of the time to repay the loan beyond its original maturity date or a temporary or permanent reduction in the loan’s interest rate.
 
(4) Consists of foreclosures, preforeclosure sales, sales to third parties and deeds in lieu of foreclosure.
 
Table 15 below presents cure rates only for seriously delinquent single-family loans that have been modified after their purchase from MBS trusts. The cure rates for these modified seriously delinquent loans differ substantially from those shown in Table 14, which presents the information for all seriously delinquent loans purchased from our MBS trusts. Loans that have not been modified tend to start with a lower cure rate than those of modified loans, and the cure rate tends to rise over time as loss mitigation strategies for those loans are developed and then implemented. In contrast, modified loans tend to start with a high cure rate, and the cure rate tends to decline over time. As shown in Table 15, the initial cure rate for modified loans as of the end of 2006 was higher than the cure rate as of March 31, 2008.
 
Table 15:   Re-performance Rates of Seriously Delinquent Single-Family Loans Purchased from MBS Trusts and Modified(1)
 
                                                                                 
    Status as of March 31, 2008        
    2008     2007                                
    Q1     Q4     Q3     Q2     Q1     2007     2006     2005     2004        
 
Cured
    99 %     88 %     78 %     70 %     71 %     78 %     79 %     76 %     73 %        
Defaults(2)
                1       3       4       2       6       11       16          
90 days or more delinquent
    1       12       21       27       25       20       15       13       11          
                                                                                 
Total
    100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %        
                                                                                 
 
                                                                                 
    Status as of the End of Each Respective Period        
    2008     2007                                
    Q1     Q4     Q3     Q2     Q1     2007     2006     2005     2004        
 
Cured
    99 %     100 %     100 %     99 %     99 %     85 %     91 %     87 %     88 %        
Defaults(2)
                                  1       1       1       1          
90 days or more delinquent
    1                   1       1       14       8       12       11          
                                                                                 
Total
    100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %     100 %        
                                                                                 

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(1) Re-performance rates calculated based on number of loans.
 
(2) Consists of foreclosures, preforeclosure sales, sales to third parties and deeds in lieu of foreclosure.
 
The substantial majority of the loans reported as cured in Tables 14 and 15 above represent loans for which we believe it is probable that we will collect all of the original contractual principal and interest payments because one or more of the following has occurred: (1) the borrower has brought the loan current without servicer intervention; (2) the loan has paid off; (3) the lender has repurchased the loan; or (4) we have resolved the loan through modification, long-term forbearances or repayment plans. The variance in the cumulative cure rates as of March 31, 2008, compared with the cure rates as of the end of each period in which the loans were purchased from the MBS trust, as displayed in Tables 14 and 15, is primarily due to the amount of time that has elapsed since the loan was purchased to allow for the implementation of a workout solution if necessary.
 
A troubled debt restructuring is the only form of modification in which we do not expect to collect the full original contractual principal and interest amount due under the loan, although other resolutions and modifications may result in our receiving the full amount due, or certain installments due, under the loan over a period of time that is longer than the period of time originally provided for under the loan. Of the percentage of loans reported as cured as of March 31, 2008 for the first quarter of 2008 and for the years 2007, 2006, 2005 and 2004, approximately 79%, 41%, 15%, 4% and 2%, respectively, represent troubled debt restructurings where we have provided a concession to the borrower.
 
For the quarters ended March 31, 2008 and December 31, 2007, the serious delinquency rate for single-family conventional loans in MBS trusts was 0.85% and 0.67%, respectively. We purchased from our MBS trusts approximately 11,400 single-family mortgage loans for the quarter ended March 31, 2008 with an aggregate unpaid principal balance and accrued interest of $1.8 billion. In comparison, we purchased approximately 13,200 loans for the quarter ended December 31, 2007 with an aggregate unpaid principal balance and accrued interest of $2.0 billion. Optional purchases represented 3% and 26% of the amounts purchased during the quarters ended March 31, 2008 and December 31, 2007, respectively, and required purchases, including purchases of loans we plan to modify, represented 97% and 74% of the amounts. The information in this paragraph, which is not necessarily indicative of the number or amount of loans we will purchase from our MBS trusts in the future, is based on information that we obtained from the direct servicers of the loans in our MBS trusts.
 
The total number of loans we purchase from MBS trusts is dependent on a number of factors, including management decisions about appropriate loss mitigation efforts, the expected increase in loan delinquencies within our MBS trusts resulting from the current adverse conditions in the housing market and our need to preserve capital to meet our regulatory capital requirements. The proportion of delinquent loans purchased from MBS trusts for the purpose of modification varies from period to period, driven primarily by factors such as changes in our loss mitigation efforts, as well as changes in interest rates and other market factors.
 
Beginning in November 2007, we decreased the number of optional delinquent loan purchases from our single-family MBS trusts in order to preserve capital in compliance with our regulatory capital requirements. Although we have decreased the number of our optional loan purchases, the total number of loans purchased from MBS trusts may increase in the future, which would result in an increase in our SOP 03-3 fair value losses. The total number of loans we purchase from MBS trusts is dependent on a number of factors, including management decisions about appropriate loss mitigation efforts, the expected increase in loan delinquencies within our MBS trusts resulting from the current adverse conditions in the housing market and our need to preserve capital to meet our regulatory capital requirements. In the first quarter of 2008, we began implementing HomeSaver Advancetm, which is a loss mitigation tool that provides qualified borrowers with an unsecured personal loan in an amount equal to all past due payments relating to their mortgage loan, allowing borrowers to cure their payment defaults under mortgage loans without requiring modification of their mortgage loans. By permitting qualified borrowers to cure their payment defaults without requiring that we purchase the loans from the MBS trusts in order to modify the loans, this loss mitigation tool may reduce the number of delinquent mortgage loans that we purchase from MBS trusts in the future and the fair value losses


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we record in connection with those purchases. However, we expect that our SOP 03-3 fair value losses for 2008 will be higher than the losses recorded for 2007.
 
Credit Loss Performance Metrics
 
Our credit loss performance metrics include our historical credit losses and our credit loss ratio. These metrics are not defined terms within GAAP, and the method we use to calculate these metrics may not be comparable to the method used to calculate similarly titled measures reported by other companies. Management, however, views our credit loss performance metrics as significant indicators of the effectiveness of our credit risk management strategies. Management uses these measures to evaluate our historical credit loss performance, assess the credit quality of our existing guaranty book of business, determine the level of our loss reserves and make determinations about our loss mitigation strategies.
 
Because management does not view changes in the fair value of our mortgage loans as credit losses, we exclude SOP 03-3 fair value losses that have not yet produced an economic loss from our credit loss performance metrics. If a loan subject to SOP 03-3 does not cure and we subsequently foreclose on the loan, we include in our credit loss performance metrics the impact of any credit losses we experience on the loan as a result of foreclosure.
 
Table 16 below details the components of our credit loss performance metrics for the three months ended March 31, 2008 and 2007. Our credit loss ratio excluding the effect of SOP 03-3 fair value losses was 12.6 basis points and 3.4 basis points for the three months ended March 31, 2008 and 2007, respectively. Our credit loss ratio including the effect of SOP 03-3 fair value losses would have been 20.7 basis points and 4.2 basis points for those respective periods.
 
We believe that our credit loss performance metrics, calculated excluding the effect of SOP 03-3 fair value losses, are useful to investors because they reflect how our management evaluates our credit risk management strategies and credit performance. They also provide a consistent treatment of credit losses for on- and off-balance sheet loans. Therefore, we believe these measures provide a meaningful indication of our credit losses and the effectiveness of our credit risk management strategies and loss mitigation efforts. Moreover, by presenting credit losses with and without the effect of SOP 03-3 fair value losses, which were not significant until the disruption in the mortgage markets that began in July 2007, investors are able to evaluate our credit performance on a more consistent basis among periods.
 
Table 16:  Credit Loss Performance Metrics
 
                                 
    For the Three Months Ended March 31,  
    2008     2007  
    Amount     Ratio(1)     Amount     Ratio(1)  
    (Dollars in millions)  
 
Charge-offs, net of recoveries
  $ 1,269       18.2  bp   $ 178       3.0  bp
Foreclosed property expense
    170       2.5       72       1.2  
Less: SOP 03-3 fair value losses(2)
    (728 )     (10.5 )     (69 )     (1.2 )
Plus: Impact of SOP 03-3 on charge-offs and foreclosed property expense(3)
    169       2.4       25       0.4  
                                 
Credit losses(4)
  $ 880       12.6  bp   $ 206       3.4  bp
                                 
 
 
(1) Based on the annualized amount for each line item presented divided by the average guaranty book of business during the period. We previously calculated our credit loss ratio based on annualized credit losses as a percentage of our mortgage credit book of business, which includes non-Fannie Mae mortgage-related securities held in our mortgage investment portfolio that we do not guarantee. Because losses related to non-Fannie Mae mortgage-related securities are not reflected in our credit losses, we revised the calculation of our credit loss ratio to reflect credit losses as a percentage of our guaranty book of business. Our credit loss ratio calculated based on our mortgage credit book of business would have been 12.0 basis points and 3.2 basis points for the three months ended March 31, 2008 and 2007, respectively. Our charge-off ratio calculated based on our mortgage credit book of business would have been 17.3 basis points and 2.8 basis points for the three months ended March 31, 2008 and 2007, respectively.
 
(2) Represents the amount recorded as a loss when the acquisition cost of a seriously delinquent loan purchased from an MBS trust exceeds the fair value of the loan at acquisition.


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(3) For seriously delinquent loans purchased from MBS trusts that are recorded at a fair value amount at acquisition that is lower than the acquisition cost, any loss recorded at foreclosure would be less than it would have been if we had recorded the loan at its acquisition cost instead of at fair value. Accordingly, we have added back to our credit losses the amount of charge-offs and foreclosed property expense that we would have recorded if we had calculated these amounts based on the purchase price.
 
(4) Interest forgone on nonperforming loans in our mortgage portfolio, which is presented in Table 40, reduces our net interest income but is not reflected in our credit losses total. In addition, other-than-temporary impairment losses resulting from deterioration in the credit quality of our mortgage-related securities and accretion of interest income on loans subject to SOP 03-3 are excluded from credit losses.
 
Our credit losses for the first quarter of 2008 increased sharply over the first quarter of 2007, reflecting the impact of further deterioration in the housing market. The national decline in home prices and the continued economic weakness in the Midwest have contributed to higher default rates and loss severities, particularly within certain states that have had the greatest home price depreciation and for certain higher risk loan categories. The states of Arizona, California, Florida and Nevada, which represented approximately 27% of our single-family conventional mortgage credit book of business as of March 31, 2008, accounted for 33% of our credit losses for the first quarter of 2008, compared with 3% for the first quarter of 2007. Certain higher risk loan categories, such as Alt-A loans, subprime loans, loans to borrowers with low credit scores and loans with high LTV ratios, represented approximately 25% of our single-family conventional mortgage credit book of business as of March 31, 2008, but accounted for approximately 66% of our credit losses for the first quarter of 2008, compared with 51% for the first quarter of 2007. Many of these higher risk loans were originated in 2006 and 2007.
 
Due to the continued housing market downturn and our expectation that home prices will decline further in 2008, we expect a significant increase in our credit-related expenses and credit loss ratio in 2008 relative to 2007.
 
We provide more detailed credit performance information, including serious delinquency rates by geographic region, statistics on nonperforming loans and foreclosed property activity, in “Risk Management—Credit Risk Management—Mortgage Credit Risk Management—Mortgage Credit Book of Business.”
 
Credit Loss Sensitivity
 
Pursuant to our September 2005 agreement with OFHEO, we disclose on a quarterly basis the present value of the change in future expected credit losses from our existing single-family guaranty book of business from an immediate 5% decline in single-family home prices for the entire United States. Table 17 shows for first lien single-family whole loans we own or that back Fannie Mae MBS as of March 31, 2008 and December 31, 2007, the credit loss sensitivity results before and after consideration of projected credit risk sharing proceeds, such as private mortgage insurance claims and other credit enhancement. The increase of $625 million in the net credit loss sensitivity to $5.2 billion as of March 31, 2008, from $4.5 billion as of December 31, 2007 was primarily attributable to the continued decline in home prices during the first quarter of 2008.
 
Table 17:  Single-Family Credit Loss Sensitivity(1)
 
                 
    As of  
    March 31,
    December 31,
 
    2008     2007  
    (Dollars in millions)  
 
Gross single-family credit loss sensitivity(2)
  $ 10,473     $ 9,644  
Less: Projected credit risk sharing proceeds
    (5,306 )     (5,102 )
                 
Net single-family credit loss sensitivity(2)
  $ 5,167     $ 4,542  
                 
Outstanding single-family whole loans and Fannie Mae MBS
  $ 2,598,625     $ 2,523,440  
Single-family net credit loss sensitivity as a percentage of outstanding single-family whole loans and Fannie Mae MBS
    0.20 %     0.18 %
 
 
(1) For purposes of this calculation, we assume that, after the initial 5% shock, home price growth rates return to the average of the possible growth rate paths used in our internal credit pricing models. The present value change reflects


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the increase in future expected credit losses under this scenario, which we believe represents a reasonably high stress scenario because it assumes an instantaneous nationwide decline in home prices, over the future expected credit losses generated by our internal credit pricing models without this shock.
 
(2) Represents total economic credit losses, which consists of credit losses and forgone interest. Calculations are based on approximately 97% of our total single-family guaranty book of business as of both March 31, 2008 and December 31, 2007. The mortgage loans and mortgage-related securities that are included in these estimates consist of: (i) single-family Fannie Mae MBS (whether held in our mortgage portfolio or held by third parties), excluding certain whole loan real estate mortgage investment conduits (“REMICs”) and private-label wraps; (ii) single-family mortgage loans, excluding mortgages secured only by second liens, subprime mortgages, manufactured housing chattel loans and reverse mortgages; and (iii) long-term standby commitments. We expect the inclusion in our estimates of the excluded products may impact the estimated sensitivities set forth in this table.
 
We generated these sensitivities using the same models that we use to estimate fair value. Because these sensitivities represent hypothetical scenarios, they should be used with caution. They are limited in that they assume an instantaneous uniform nationwide decline in home prices, which is not representative of the historical pattern of changes in home prices. Home prices generally vary on a local basis. In addition, these sensitivities are calculated independently without considering changes in other interrelated assumptions, such as unemployment rates or other economic factors, which are likely to have a significant impact on our credit losses.
 
Other Non-Interest Expenses
 
Other non-interest expenses increased to $505 million for the first quarter of 2008, from $104 million for the first quarter of 2007. The increase is predominately due to higher credit enhancement expenses and a reduction in the amount of net gains recognized on the extinguishment of debt.
 
Federal Income Taxes
 
We recorded a net tax benefit of $2.9 billion for the first quarter of 2008, due in part to the pre-tax loss for the period as well as the tax credits generated from our LIHTC partnership investments. Although we generated pre-tax income for the first quarter of 2007, we recorded a tax benefit of $73 million attributable to our tax credits. Our effective income tax rate, excluding the provision or benefit for taxes related to extraordinary amounts, was 57% and 8% for the three months ended March 31, 2008 and 2007, respectively.
 
The difference between our statutory income tax rate of 35% and our effective tax rate is primarily due to the tax benefits we receive from our investments in LIHTC partnerships that help to support our affordable housing mission. The variance in our effective tax rate between periods is primarily due to the combined effect of fluctuations in our actual pre-tax income and our estimated annual taxable income, which affects the relative tax benefit we expect to receive from tax-exempt income and tax credits, and changes in the actual dollar amount of these tax benefits. In calculating our interim provision for income taxes, we use an estimate of our annual effective tax rate, which we update each quarter based on actual historical information and forward-looking estimates. The estimated annual effective tax rate may fluctuate each period based upon changes in facts and circumstances, if any, as compared to those forecasted at the beginning of the year and each interim period thereafter.
 
BUSINESS SEGMENT RESULTS
 
The presentation of the results of each of our three business segments is intended to reflect each segment as if it were a stand-alone business. We describe the management reporting and allocation process that we use to generate our segment results in our 2007 Form 10-K in “Notes to Consolidated Financial Statements—Note 15, Segment Reporting.” We summarize our segment results for the first quarters of 2008 and 2007 in the tables below and provide a discussion of these results. We include more detail on our segment results in “Notes to Condensed Consolidated Financial Statements—Note 13, Segment Reporting.”


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Single-Family Business
 
Our Single-Family business recorded a net loss of $1.0 billion for the first quarter of 2008, compared with net income of $355 million for the first quarter of 2007. Table 18 summarizes the financial results for our Single-Family business for the periods indicated.
 
Table 18:  Single-Family Business Results
 
                                 
    For the
       
    Three Months Ended
       
    March 31,     Variance  
    2008     2007     $     %  
          (Dollars in millions)        
 
Statement of operations data:
                               
Guaranty fee income
  $ 1,942     $ 1,287     $ 655       51 %
Trust management income
    105       154       (49 )     (32 )
Other income(1)(2)
    188       176       12       7  
Losses on certain guaranty contracts
          (280 )     280       100  
Credit-related expenses(3)
    (3,254 )     (326 )     (2,928 )     (898 )
Other expenses(1)(4)
    (533 )     (468 )     (65 )     (14 )
                                 
Income (loss) before federal income taxes
    (1,552 )     543       (2,095 )     (386 )
Benefit (provision) for federal income taxes
    544       (188 )     732       389  
                                 
Net income (loss)
  $ (1,008 )   $ 355     $ (1,363 )     (384 )%
                                 
Other key performance data:
                               
Average single-family guaranty book of business(5)
  $ 2,634,526     $ 2,285,347     $ 349,179       15 %
 
 
(1) Certain prior period amounts have been reclassified to conform with the current period presentation in our condensed consolidated statements of operations.
 
(2) Consists of net interest income, investment gains and losses, and fee and other income.
 
(3) Consists of the provision for credit losses and foreclosed property expense.
 
(4) Consists of administrative expenses and other expenses.
 
(5) The single-family guaranty book of business consists of single-family mortgage loans held in our mortgage portfolio, single-family Fannie Mae MBS held in our mortgage portfolio, single-family Fannie Mae MBS held by third parties, and other credit enhancements that we provide on single-family mortgage assets. Excludes non-Fannie Mae mortgage-related securities held in our investment portfolio for which we do not provide a guaranty.
 
Key factors affecting the results of our Single-Family business for the first quarter of 2008 compared with the first quarter of 2007 included the following.
 
  •  Increased guaranty fee income, attributable to growth in the average single-family guaranty book of business, coupled with an increase in the average effective single-family guaranty fee rate.
 
  —  Our average single-family guaranty book of business for the first quarter of 2008 increased 15% over the average for the first quarter of 2007, reflecting the significant increase in our market share since the end of the first quarter of 2007. The average single-family guaranty book of business increased to $2.6 trillion as of March 31, 2008, from $2.3 trillion as of March 31, 2007. Our estimated market share of new single-family mortgage-related securities issuances increased to approximately 50.1% for the first quarter of 2008, from 25.1% for the first quarter of 2007. These market share estimates are based on publicly available data and exclude previously securitized mortgages.
 
  —  The growth in our average effective single-family guaranty fee rate reflects increased income from the accretion of our guaranty obligation and deferred profit amounts into income, including losses recognized at inception on certain guaranty contracts in previous periods, and the impact of targeted pricing increases on new business for some loan types. We experienced accelerated amortization of deferred amounts during the first quarter of 2008 due to faster expected prepayment speeds stemming from the decrease in interest rates during the quarter.


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  •  A decrease in losses on certain guaranty contracts, attributable to the change in measuring the fair value of our guaranty obligation upon adoption of SFAS 157.
 
  •  A substantial increase in credit-related expenses, primarily due to an increase in the provision for credit losses to reflect higher charge-offs from the significant increase in default rates and average loss severities, particularly in certain states and higher risk loan categories. We also experienced an increase in SOP 03-3 fair value losses, which are recorded as a component of our provision for credit losses.
 
  •  A relatively stable effective income tax rate of approximately 35%, which represents our statutory tax rate.
 
HCD Business
 
Net income for our HCD business decreased by $13 million, or 8%, to $150 million for the first quarter of 2008, from $163 million for the first quarter of 2007. Table 19 summarizes the financial results for our HCD business for the periods indicated.
 
Table 19:  HCD Business Results
 
                                 
    For the
       
    Three Months Ended
       
    March 31,     Variance  
    2008     2007     $     %  
          (Dollars in millions)        
 
Statement of operations data:
                               
Guaranty fee income
  $ 148     $ 101     $ 47       47 %
Other income(1)
    64       94       (30 )     (32 )
Losses on partnership investments
    (141 )     (165 )     24       15  
Credit-related income(2)
    11       5       6       120  
Other expenses(3)
    (254 )     (247 )     (7 )     (3 )
                                 
Loss before federal income taxes
    (172 )     (212 )     40       19  
Benefit for federal income taxes
    322       375       (53 )     (14 )
                                 
Net income
  $ 150     $ 163     $ (13 )     (8 )%
                                 
Other key performance data:
                               
Average multifamily guaranty book of business(4)
  $ 151,278     $ 122,480     $ 28,798       24 %
 
 
(1) Consists of trust management income and fee and other income.
 
(2) Consists of benefit for credit losses and foreclosed property income.
 
(3) Consists of net interest expense, losses on certain guaranty contracts, administrative expenses, minority interest in earnings of consolidated subsidiaries and other expenses.
 
(4) The multifamily guaranty book of business consists of multifamily mortgage loans held in our mortgage portfolio, multifamily Fannie Mae MBS held in our mortgage portfolio, multifamily Fannie Mae MBS held by third parties and other credit enhancements that we provide on multifamily mortgage assets. Excludes non-Fannie Mae mortgage-related securities held in our investment portfolio for which we do not provide a guaranty.
 
Key factors affecting the results of our HCD business for the first quarter of 2008 compared with the first quarter of 2007 included the following.
 
  •  Increased guaranty fee income, attributable to growth in the average multifamily guaranty book of business and an increase in the average effective multifamily guaranty fee rate. These increases reflect the increased investment and liquidity that we are providing to the multifamily mortgage market.
 
  •  A decrease in other income due to a reduction in loan prepayment and yield maintenance fees as liquidations slowed during the quarter.
 
  •  A decrease in losses on partnership investments, primarily due to a reduction in net operating losses attributable to a decrease in our LIHTC and other tax-advantaged partnership investments. These reduced


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  losses were partially offset by an increase in net operating losses related to our continued investment in other non-LIHTC affordable rental housing partnerships.
 
  •  A tax benefit of $322 million for the first quarter of 2008 driven primarily by tax credits of $261 million, compared with a tax benefit of $375 million for the first quarter of 2007 driven by tax credits of $300 million.
 
Capital Markets Group
 
Our Capital Markets group generated a net loss of $1.3 billion for the first quarter of 2008, compared with net income of $443 million for the first quarter of 2007. Table 20 summarizes the financial results for our Capital Markets group for the periods indicated.
 
Table 20:  Capital Markets Group Results
 
                                 
    For the
       
    Three Months Ended
       
    March 31,     Variance  
    2008     2007     $     %  
          (Dollars in millions)        
 
Net interest income
  $ 1,659     $ 1,209     $ 450       37 %
Investment gains (losses), net(1)
    (63 )     287       (350 )     (122 )
Fair value losses, net(1)
    (4,377 )     (566 )     (3,811 )     (673 )
Fee and other income(1)
    63       104       (41 )     (39 )
Other expenses(2)
    (671 )     (474 )     (197 )     (42 )
                                 
Income (loss) before federal income taxes and extraordinary losses, net of tax effect
    (3,389 )     560       (3,949 )     (705 )
Benefit (provision) for federal income taxes
    2,062       (114 )     2,176       1,909  
Extraordinary losses, net of tax effect
    (1 )     (3 )     2       67  
                                 
Net income (loss)
  $ (1,328 )   $ 443     $ (1,771 )     (400 )%
                                 
 
 
(1) Certain prior period amounts have been reclassified to conform with the current period presentation in our condensed consolidated statements of operations.
 
(2) Includes debt extinguishment losses, allocated guaranty fee expense, administrative expenses and other expenses.
 
Key factors affecting the results of our Capital Markets group for the first quarter of 2008 compared with the first quarter of 2007 included the following.
 
  •  An increase in net interest income, reflecting the benefit to our net interest yield due to the reduction in the average cost of our debt as short-term interest rates fell during the first quarter of 2008 and the reversal of accrued interest expense on step-rate debt that we redeemed during the quarter.
 
  •  A shift to net investment losses for the first quarter of 2008, from net investment gains for the first quarter of 2007, primarily due to an increase in other-than-temporary impairment on AFS investment securities and an increase in losses from LOCOM adjustments on HFS loans. The increase in other-than-temporary impairment on investment was attributable to a deterioration in the credit quality of certain securities during the first quarter of 2008, principally related to subprime private-label securities. We recorded higher LOCOM losses on HFS loans due to the significant widening of credit spreads during the quarter.
 
  •  An increase in fair value losses, reflecting the combined effect of greater losses on our derivatives in the first quarter of 2008 due to the significant decline in swap interest rates and losses on our trading securities. Although we experienced an increase in the fair value of our trading securities due to the decrease in interest rates during the first quarter of 2008, this increase was more than offset by a decrease in value resulting from the significant widening of credit spreads during the quarter.


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  •  An effective tax rate of 61% for the first quarter of 2008, compared with an effective tax rate of 20% for the first quarter of 2007. The variance in the effective tax rate and statutory rate was primarily due to fluctuations in our pre-tax earnings and the relative benefit of tax-exempt income generated from our investments in mortgage revenue bonds.
 
CONSOLIDATED BALANCE SHEET ANALYSIS
 
Total assets of $843.2 billion as of March 31, 2008 decreased by $36.2 billion, or 4%, from December 31, 2007. Total liabilities of $804.2 billion decreased by $31.0 billion, or 4%, from December 31, 2007. Stockholders’ equity of $38.8 billion reflected a decrease of $5.2 billion, or 12%, from December 31, 2007. Following is a discussion of material changes in the major components of our assets and liabilities since December 31, 2007.
 
Mortgage Investments
 
Table 21 summarizes our mortgage portfolio activity for the three months ended March 31, 2008 and 2007.
 
Table 21:  Mortgage Portfolio Activity(1)
 
                                 
    For the
       
    Three Months
       
    Ended
       
    March 31,     Variance  
    2008     2007     $     %  
          (Dollars in millions)        
 
Purchases(2)
  $ 35,500     $ 35,717     $ (217 )     (1 )%
Sales
    13,529       16,991       (3,462 )     (20 )
Liquidations(3)
    23,571       32,237       (8,666 )     (27 )
 
 
(1) Excludes unamortized premiums, discounts and other cost basis adjustments.
 
(2) Excludes advances to lenders and mortgage-related securities acquired through the extinguishment of debt.
 
(3) Includes scheduled repayments, prepayments and foreclosures.
 
For the first two months of 2008, we were subject to an OFHEO-directed limitation on the size of our mortgage portfolio. OFHEO’s mortgage portfolio cap requirement, which is described in our 2007 Form 10-K, was eliminated by OFHEO effective March 1, 2008. Although mortgage-to-debt spreads were significantly wider during the first quarter of 2008, which presented more opportunities for us to purchase mortgage assets at attractive prices and spreads, our portfolio purchases during the first quarter of 2008 were comparable to the first quarter of 2007, as we continued to manage the size of our mortgage portfolio to meet our capital surplus requirements. Our portfolio sales decreased in the first quarter of 2008 compared with the first quarter of 2007, due in part to the wider mortgage-to-debt spreads during the first quarter of 2008. We experienced a decrease in mortgage liquidations during the first quarter of 2008 relative to the first quarter of 2007, reflecting the impact of the weaker housing market and tightening of credit availability in the primary mortgage markets.


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Table 22 shows the composition of our net mortgage portfolio by product type and the carrying value as of March 31, 2008 and December 31, 2007. Our net mortgage portfolio totaled $716.5 billion as of March 31, 2008, reflecting a decrease of less than 1% from December 31, 2007. Our investment activities may be constrained by our regulatory capital requirements, specific operational limitations, tax classifications and our intent to hold identified temporarily impaired securities until recovery in value, as well as risk parameters applied to the mortgage portfolio.
 
Table 22:  Mortgage Portfolio Composition(1)
 
                 
    As of  
    March 31,
    December 31,
 
    2008     2007  
    (Dollars in millions)  
 
Mortgage loans:(2)
               
Single-family:
               
Government insured or guaranteed
  $ 32,051     $ 28,202  
Conventional:
               
Long-term, fixed-rate
    193,703       193,607  
Intermediate-term, fixed-rate(3)
    45,560       46,744  
Adjustable-rate
    42,144       43,278  
                 
Total conventional single-family
    281,407       283,629  
                 
Total single-family
    313,458       311,831  
                 
Multifamily:
               
Government insured or guaranteed
    781       815  
Conventional:
               
Long-term, fixed-rate
    5,515       5,615  
Intermediate-term, fixed-rate(3)
    78,845       73,609  
Adjustable-rate
    13,239       11,707  
                 
Total conventional multifamily
    97,599       90,931  
                 
Total multifamily
    98,380       91,746  
                 
Total mortgage loans
    411,838       403,577  
                 
Unamortized premiums and other cost basis adjustments, net
    216       726  
Lower of cost or market adjustments on loans held for sale
    (126 )     (81 )
Allowance for loan losses for loans held for investment
    (993 )     (698 )
                 
Total mortgage loans, net
    410,935       403,524  
                 
Mortgage-related securities:
               
Fannie Mae single-class MBS
    98,076       102,258  
Fannie Mae structured MBS
    75,681       77,905  
Non-Fannie Mae single-class mortgage securities
    27,967       28,129  
Non-Fannie Mae structured mortgage securities(4)
    93,804       96,373  
Mortgage revenue bonds
    16,118       16,315  
Other mortgage-related securities
    3,221       3,346  
                 
Total mortgage-related securities
    314,867       324,326  
                 
Market value adjustments(5)
    (7,448 )     (3,249 )
Other-than-temporary impairments
    (719 )     (603 )
Unamortized discounts and other cost basis adjustments, net(6)
    (1,099 )     (1,076 )
                 
Total mortgage-related securities, net
    305,601       319,398  
                 
Mortgage portfolio, net(7)
  $ 716,536     $ 722,922  
                 
 
 
(1) Mortgage loans and mortgage-related securities are reported at unpaid principal balance.


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(2) Mortgage loans include unpaid principal balance totaling $80.0 billion and $81.8 billion as of March 31, 2008 and December 31, 2007, respectively, related to mortgage-related securities that were consolidated under Financial Accounting Standards Board Interpretation (“FIN”) No. 46R (revised December 2003), Consolidation of Variable Interest Entities (an interpretation of ARB No. 51) (“FIN 46R”), and mortgage-related securities created from securitization transactions that did not meet the sales criteria under SFAS No. 140, Accounting for Transfer and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of FASB Statement No. 125) (“SFAS 140”), which effectively resulted in mortgage-related securities being accounted for as loans.
 
(3) Intermediate-term, fixed-rate consists of mortgage loans with contractual maturities at purchase equal to or less than 15 years.
 
(4) Includes private-label mortgage-related securities backed by Alt-A or subprime mortgage loans totaling $60.9 billion and $64.5 billion as of March 31, 2008 and December 31, 2007, respectively. Refer to “Trading and Available-for-Sale Investment Securities—Investments in Private-Label Mortgage-Related Securities” for a description of our investments in Alt-A and subprime securities.
 
(5) Includes unrealized gains and losses on mortgage-related securities and securities commitments classified as trading and available-for-sale.
 
(6) Includes the impact of other-than-temporary impairments of cost basis adjustments.
 
(7) Includes consolidated mortgage-related assets acquired through the assumption of debt. Also includes $921 million and $538 million as of March 31, 2008 and December 31, 2007, respectively, of mortgage loans and mortgage-related securities that we have pledged as collateral and which counterparties have the right to sell or repledge.
 
Liquid Investments
 
Our liquid assets consist of cash and cash equivalents, funding agreements with our lenders, including advances to lenders and repurchase agreements, and non-mortgage investment securities. Our liquid assets, net of cash equivalents pledged as collateral, decreased to $65.8 billion as of March 31, 2008 from $102.0 billion as of December 31, 2007, as we used funds to redeem a significant amount of higher cost long-term debt.
 
Our non-mortgage investments primarily consist of high-quality securities that are readily marketable or have short-term maturities. Our non-mortgage investment securities, which are carried at fair value in our condensed consolidated balance sheets, totaled $33.2 billion and $38.1 billion as of March 31, 2008 and December 31, 2007, respectively. In conjunction with our January 1, 2008 adoption of SFAS 159, we elected to reclassify all of our non-mortgage investment securities from AFS to trading. We provide additional detail on our non-mortgage investment securities in “Notes to Condensed Consolidated Financial Statements—Note 5, Investments in Securities.”


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Trading and Available-for-Sale Investment Securities
 
Our mortgage investment securities are classified in our condensed consolidated balance sheets as either trading or AFS and reported at fair value. All of our non-mortgage investment securities are classified in our condensed consolidated balance sheets as trading and reported at fair value. Table 23 shows the composition of our trading and AFS securities at amortized cost and fair value as of March 31, 2008, which totaled $346.8 billion and $338.8 billion, respectively. We also disclose the gross unrealized gains and gross unrealized losses related to our AFS securities as of March 31, 2008, and a stratification of these losses based on securities that have been in a continuous unrealized loss position for less than 12 months and for 12 months or longer.
 
Table 23:  Trading and AFS Investment Securities
 
                                                                 
    As of March 31, 2008  
                            Less Than 12
    12 Consecutive
 
                            Consecutive Months     Months or Longer  
    Total
    Gross
    Gross
    Total
    Gross
    Total
    Gross
    Total
 
    Amortized
    Unrealized
    Unrealized
    Fair
    Unrealized
    Fair
    Unrealized
    Fair
 
    Cost(1)     Gains     Losses     Value     Losses     Value     Losses     Value  
    (Dollars in millions)  
 
Trading:
                                                               
Fannie Mae single-class MBS
  $ 44,107     $     $     $ 45,217     $     $     $     $  
Fannie Mae structured MBS
    11,304                   10,885                          
Non-Fannie Mae single-class mortgage-related securities
    1,171                   1,190                          
Non-Fannie Mae structured mortgage-related securities
    21,153                   19,302                          
Mortgage revenue bonds
    801                   779                          
Other mortgage-related securities
                                               
Asset-backed securities
    14,380                   14,110                          
Corporate debt securities
    13,050                   12,772                          
Other non-mortgage-related securities
    6,314                   6,318                          
                                                                 
Total trading
  $ 112,280     $     $     $ 110,573     $     $     $     $  
                                                                 
Available for sale:
                                                               
Fannie Mae single-class MBS
  $ 53,189     $ 776     $ (143 )   $ 53,822     $ (30 )   $ 6,358     $ (113 )   $ 7,238  
Fannie Mae structured MBS
    64,239       1,199       (196 )     65,242       (74 )     6,518       (122 )     7,732  
Non-Fannie Mae single-class mortgage-related securities
    26,570       523       (21 )     27,072       (10 )     2,639       (11 )     1,385  
Non-Fannie Mae structured mortgage-related securities
    72,353       205       (8,195 )     64,363       (3,448 )     25,184       (4,747 )     27,366  
Mortgage revenue bonds
    15,328       92       (706 )     14,714       (282 )     6,046       (424 )     4,028  
Other mortgage-related securities
    2,834       203       (22 )     3,015       (16 )     486       (6 )     60  
                                                                 
Total available for sale
  $ 234,513     $ 2,998     $ (9,283 )   $ 228,228     $ (3,860 )   $ 47,231     $ (5,423 )   $ 47,809  
                                                                 
Total investments in securities
  $ 346,793     $ 2,998     $ (9,283 )   $ 338,801     $ (3,860 )   $ 47,231     $ (5,423 )   $ 47,809  
                                                                 
 
 
(1) Amortized cost includes unamortized premiums, discounts and other cost basis adjustments, as well as other-than-temporary impairment write downs.
 
Gains and losses on our trading securities are recognized in our consolidated results of operations as a component of “Fair value gains (losses), net,” while unrealized gains and losses on AFS securities are recorded in stockholders’ equity as a component of AOCI. As of March 31, 2008, the amortized cost and estimated fair value of our AFS securities totaled $234.5 billion and $228.2 billion, respectively, and the gross unrealized gains and gross unrealized losses totaled $3.0 billion and $9.3 billion, respectively. In comparison, as of December 31, 2007, the amortized cost and estimated fair value of our AFS securities totaled $296.1 billion and $293.6 billion, respectively, and the gross unrealized gains and gross unrealized losses totaled $2.3 billion and $4.8 billion, respectively. The increase in gross unrealized losses during the first


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quarter of 2008 was primarily due to the continued widening of credit spreads during the quarter, which reduced the fair value of substantially all of our mortgage-related securities, particularly our private-label mortgage-related securities backed by Alt-A, subprime, and commercial loans.
 
Investments in Private-Label Mortgage-Related Securities
 
The non-Fannie Mae mortgage-related security categories presented in Table 23 above include AAA-rated agency mortgage-related securities issued or guaranteed by Freddie Mac and Ginnie Mae and private-label mortgage-related securities backed by Alt-A, subprime, commercial, manufactured housing and other mortgage loans. We do not have any exposure to collateralized debt obligations, or CDOs. We classify private-label securities as Alt-A, subprime, commercial or manufactured housing if the securities were labeled as such when issued. We also have invested in private-label Alt-A and subprime mortgage-related securities that we have resecuritized to include our guaranty (“wraps”), which we report in Table 23 above as a component of Fannie Mae structured MBS. We generally have focused our purchases of these securities on the highest-rated tranches available at the time of acquisition. Higher-rated tranches typically are supported by credit enhancements to reduce the exposure to losses. The credit enhancements on our private-label security investments generally are in the form of initial subordination provided by lower level tranches of these securities, excess interest payments within the trust, prepayment proceeds within the trust and guarantees from monoline financial guarantors based on specific performance triggers.
 
We owned $108.3 billion of private-label mortgage-related securities backed by Alt-A, subprime, commercial, manufactured housing and other mortgage loans as of March 31, 2008, down from $111.1 billion as of December 31, 2007, reflecting a reduction of $2.8 billion due to principal payments. Table 24 summarizes, by loan type, the composition of our investments in private-label securities and mortgage revenue bonds as of March 31, 2008 and the average credit enhancement. The average credit enhancement generally reflects the level of cumulative losses that must be incurred before we experience a loss on the tranche of securities that we own. Table 24 also provides information on the credit ratings of our private-label securities as of April 30, 2008. The credit rating reflects the lowest rating as reported by Standard & Poor’s (“Standard & Poor’s”), Moody’s Investors Service (“Moody’s”), Fitch Ratings (“Fitch”) or DBRS, Limited, each of which is a nationally recognized statistical rating organization.
 
Table 24:  Investments in Private-Label Mortgage-Related Securities and Mortgage Revenue Bonds
 
                                                 
    As of March 31, 2008     As of April 30, 2008        
    Unpaid
    Average
                % Below
       
    Principal
    Credit
          % AA
    Investment
    Current %
 
    Balance     Enhancement(1)     % AAA(2)     to BBB-(2)     Grade(2)     Watchlist(3)  
                (Dollars in millions)              
 
Private-label mortgage-related securities backed by:
                                               
Alt-A mortgage loans
  $ 30,563       23 %     100 %     %     %     15 %
Subprime mortgage loans
    30,383       37       42       48       10       21  
Commercial multifamily mortgage loans
    25,617       30       100                    
Manufactured housing mortgage loans
    3,193       37       20       26       54       1  
Other mortgage loans(4)
    2,473       6       98             2        
                                                 
Total private-label mortgage-related securities
    92,229                                          
Mortgage revenue bonds(5)
    16,118       36       55       43       2       4  
                                                 
Total
  $ 108,347                                          
                                                 
 
 
(1) Average credit enhancement percentage reflects both subordination and financial guarantees. Reflects the ratio of the current amount of the securities that will incur losses in a securitization structure before any losses are allocated to securities that we own. Percentage calculated based on the quotient of the total unpaid principal balance of all credit enhancement in the form of subordination or financial guaranty of the security divided by the total unpaid principal balance of all of the tranches of collateral pools from which credit support is drawn for the security that we own.


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(2) Reflects credit ratings as of April 30, 2008, calculated based on unpaid principal balance as of March 31, 2008. Investment securities with a credit rating below BBB- or its equivalent are classified as below investment grade.
 
(3) Reflects percentage of investment securities, calculated based on unpaid principal balance as of March 31, 2008, that have been placed under review by either Standard & Poor’s, Moody’s, Fitch or DBRS, Limited.
 
(4) The average credit enhancement for private-label mortgage-related securities backed by other mortgage loans excludes unpaid principal balance of approximately $1.2 billion. Approximately $27 million of this amount is excluded from the credit ratings and current watchlist percentages.
 
(5) The average credit enhancement for private-label mortgage revenue bonds excludes unpaid principal balance of approximately $54 million. This amount is also excluded from the credit ratings and current watchlist percentages.
 
Since the end of 2007 through April 30, 2008, there have been multiple credit rating downgrades of various classes of Alt-A and subprime private-label mortgage-related securities. However, all of our Alt-A private-label mortgage securities continued to be rated AAA as of April 30, 2008. Approximately $4.5 billion, or 15%, of our Alt-A private-label mortgage-related securities had been placed under review for possible credit downgrade or on negative watch as of April 30, 2008.
 
The percentages of our subprime private-label mortgage-related securities rated AAA and rated AA to BBB- were 42% and 48%, respectively, as of April 30, 2008, compared with 97% and 3%, respectively, as of December 31, 2007. The percentage of our subprime private-label mortgage-related securities rated below investment grade was 10% as of April 30, 2008. None of these securities were rated below investment grade as of December 31, 2007. Approximately $6.4 billion, or 21%, of our subprime private-label mortgage-related securities had been placed under review for possible credit downgrade or on negative watch as of April 30, 2008.
 
We discuss our process for assessing other-than-temporary impairment on our Alt-A and subprime private-label mortgage-related securities under “Other-than-temporary Impairment Assessment” below.
 
Investments in Alt-A and Subprime Private-Label Mortgage-Related Securities
 
Tables 25 and 26 present additional information as of March 31, 2008 for our investments in Alt-A and subprime private-label mortgage-related securities, stratified by year of issuance (vintage) and by credit enhancement quartile for securities issued in 2005, 2006 and 2007. The 2006 and 2007 vintages of loans underlying these securities have experienced significantly higher delinquency and default rates. Accordingly, the year of issuance or origination of the collateral underlying these securities is a significant factor in evaluating our potential loss exposure.
 
The ABX indices, which are widely used by market participants as a barometer for evaluating the broader subprime market, have reflected significant increases in expected default rates and a dramatic reduction in asset prices of subprime securities, due in part to the significant illiquidity in this market. The bonds that underlie the ABX indices at each ratings level generally are those with the longest-duration and the highest credit risk relative to other bonds within the same respective ratings category. All AAA-rated asset-backed security tranches, including those referenced by the ABX index, typically benefit from similar forms of credit enhancement. However, the risk profile of the securities we hold is significantly different from the risk profile of the subprime securities referenced in the ABX index because of the structure and duration of our securities, which affect the timing of the cash flows. Because the substantial majority of our subprime securities represent the highest class within each issuance, we have an earlier call on the cash flows from the principal payments on the loans underlying these securities such that we typically receive a larger portion of our cash flows in the first several years of the average life of our securities. As a result, we are exposed to losses for a shorter duration and the prices on our securities are generally higher and less volatile than those reflected in the ABX index. In contrast, the securities referenced by the ABX index are exposed to higher losses because they are generally lower rated tranches that have a later call on the cash flows from the principal pay downs on the loans underlying a particular mortgage-related security issuance.
 
We perform hypothetical scenarios, including Monte Carlo simulations, on our Alt-A and subprime securities to assess changes in expected performance of the securities based on changes in economic conditions and related changes in assumptions and the collectability of our outstanding principal and interest. Two key factors that drive projected losses on the securities are default rates and average loss severity. We disclose projected losses under three scenarios that assume certain cumulative constant default and loss severity rates against the


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outstanding underlying collateral of the securities. The stress test scenarios for our Alt-A securities are as follows: (1) 20% cumulative default rate and 40% average loss severity; (2) 20% cumulative default rate and 50% average loss severity; and (3) 30% cumulative default rate and 40% average loss severity. The stress test scenarios for our subprime securities are as follows: (1) 50% cumulative default rate and 50% average loss severity; (2) 50% cumulative default rate and 60% average loss severity; and (3) 60% cumulative default rate and 50% average loss severity. These stress test scenarios, which we consider to be highly stressful, are designed to stress the weaker components of our securities. Accordingly, we do not believe the estimates are indicative of the likely overall credit performance of our securities.
 
Table 25:  Investments in Alt-A Private-Label Mortgage-Related Securities, Excluding Wraps*
 
                                                                                         
    As of March 31, 2008  
    Unpaid Principal Balance                 Credit Enhancement Statistics     Stress Test Scenarios(6)  
                                              Monoline
                   
                                              Financial
                   
Vintage and
  Trading
    AFS
    Average
    Fair
    Average
          Minimum
    Guaranteed
    20d/40s
    20d/50s
    30d/40s
 
CE Quartile(1)
  Securities(2)     Securities(3)     Price     Value     Current(4)     Original(4)     Current(4)     Amount(5)     NPV     NPV     NPV  
    (Dollars in millions)  
 
Investments in Alt-A securities:(7)
                                                                                       
Option ARM Alt-A securities:
                                                                                       
2004 and prior
  $     $ 769     $ 81.05     $ 623       22 %     9 %     16 %   $     $     $     $  
                                                                                         
2005-1(1)
          109       78.83       86       18       7       17                          
2005-1(2)
          180       78.67       142       19       8       19                          
2005-1(3)
          167       78.22       131       24       13       20                          
2005-1(4)
          176       77.44       136       55       39       33                          
                                                                                         
2005-1 subtotal
          632       78.23       495       30       18       17                          
                                                                                         
2005-2(1)
          278       78.36       218       30       21       24                          
2005-2(2)
          126       78.19       99       35       28       35                          
2005-2(3)
          505       78.58       396       45       39       39                          
2005-2(4)
          351       82.86       291       100       100       100       351                    
                                                                                         
2005-2 subtotal
          1,260       79.68       1,004       56       51       24       351                    
                                                                                         
2006-1(1)
          136       75.84       103       21       19       11                          
2006-1(2)
          429       76.66       329       41       38       40                          
2006-1(3)
          403       76.54       308       45       42       45                            
2006-1(4)
          444       75.74       337       89       88       49       345                    
                                                                                         
2006-1 subtotal
          1,412       76.26       1,077       55       53       11       345                      
                                                                                         
2006-2(1)
                                                                 
2006-2(2)
          219       76.66       168       37       35       37                          
2006-2(3)
          101       76.79       78       41       40       41                          
2006-2(4)
          228       80.67       183       69       68       47       94                    
                                                                                         
2006-2 subtotal
          548       78.35       429       51       50       37       94                    
                                                                                         
2007-1(1)
    216             71.33       154       24       24       24                          
2007-1(2)
    379             75.83       288       46       45       45                          
2007-1(3)
    271             75.81       205       48       47       48                          
2007-1(4)
    544             75.98       413       100       100       100       544                    
                                                                                         
2007-1 subtotal
    1,410             75.19       1,060       64       64       24       544                    
                                                                                         
2007-2(1)
    302             75.98       229       33       32       25                          
2007-2(2)
    219             76.78       168       47       47       47                          
2007-2(3)
    317             77.35       245       48       47       48                          
2007-2(4)
    429             73.58       316       100       100       100       429                    
                                                                                         
2007-2 subtotal
    1,267             75.65       958       62       62       25       429                    
                                                                                         
Total
    2,677       4,621       77.37       5,646       52       48       11       1,763                    
                                                                                         


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    As of March 31, 2008  
    Unpaid Principal Balance                 Credit Enhancement Statistics     Stress Test Scenarios(6)  
                                              Monoline
                   
                                              Financial
                   
Vintage and
  Trading
    AFS
    Average
    Fair
    Average
          Minimum
    Guaranteed
    20d/40s
    20d/50s
    30d/40s
 
CE Quartile(1)
  Securities(2)     Securities(3)     Price     Value     Current(4)     Original(4)     Current(4)     Amount(5)     NPV     NPV     NPV  
    (Dollars in millions)  
 
Other Alt-A securities:
                                                                                       
2004 and prior
          9,611       88.85       8,539       11       6       4       31       27       90       196  
                                                                                         
2005-1(1)
          411       87.44       359       9       5       6             2       4       11  
2005-1(2)
          454       88.26       401       12       7       11                   1       3  
2005-1(3)
          458       90.33       414       14       10       13                   2       6  
2005-1(4)
          537       87.32       469       17       10       15                   1       4  
                                                                                         
2005-1 subtotal
          1,860       88.32       1,643       13       9       6             2       8       24  
                                                                                         
2005-2(1)
          1,057       89.71       948       6       5       4             18       38       58  
2005-2(2)
          1,038       89.17       926       10       8       8                   12       15  
2005-2(3)
          1,134       82.18       932       16       14       14                         3  
2005-2(4)
          1,086       84.44       917       22       17       19                          
                                                                                         
2005-2 subtotal
          4,315       86.27       3,723       14       11       4             18       50       76  
                                                                                         
2006-1(1)
    35       1,246       90.60       1,160       5       4       4             32       56       81  
2006-1(2)
          1,057       91.57       968       9       8       9             6       17       30  
2006-1(3)
    53       1,376       87.59       1,251       15       12       12                         2  
2006-1(4)
          1,432       78.88       1,130       22       17       19                          
                                                                                         
2006-1 subtotal
    88       5,111       86.74       4,509       13       11       4             38       73       113  
                                                                                         
2006-2(1)
                                                                 
2006-2(2)
          537       76.64       411       11       10       6                         2  
2006-2(3)
                                                                 
2006-2(4)
          640       75.12       481       17       16       17                          
                                                                                         
2006-2 subtotal
          1,177       75.82       892       14       13       6                         2  
                                                                                         
2007-1(1)
    79             76.41       60       6       5       6                          
2007-1(2)
    194             78.48       152       8       7       7             2       3       4  
2007-1(3)
    115             75.32       87       11       11       8                          
2007-1(4)
    240             76.54       184       17       16       16                          
                                                                                         
2007-1 subtotal
    628             76.89       483       12       11       6             2       3       4  
                                                                                         
2007-2(1)
                                                                 
2007-2(2)
                                                                 
2007-2(3)
                                                                 
2007-2(4)
    475             86.03       409       100       100       100       475                    
                                                                                         
2007-2 subtotal
    475             86.03       409       100       100       100       475                    
                                                                                         
Total
    1,191       22,074       86.82       20,198       14       10       4       506       87       224       415  
                                                                                         
Total Alt-A securities
  $ 3,868     $ 26,695     $ 84.56     $ 25,844       23 %     19 %     4 %   $ 2,269     $ 87     $ 224     $ 415  
                                                                                         
 
 
* The footnotes to this table are presented following Table 26.

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Table of Contents

 
Table 26:  Investments in Subprime Private-Label Mortgage-Related Securities, Excluding Wraps
 
                                                                      &nb