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| FNM > SEC Filings for FNM > Form 10-Q on 10-Nov-2008 | All Recent SEC Filings |
10-Nov-2008
Quarterly Report
You should read this Management's Discussion and Analysis of Financial Condition and Results of Operations, or 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 unaudited condensed consolidated financial statements and discussed in MD&A do not necessarily indicate the results that may be expected for the full year.
The Director of the Federal Housing Finance Agency, or FHFA, our safety, soundness and mission regulator, appointed FHFA as conservator of Fannie Mae on September 6, 2008. As conservator, FHFA succeeded to all rights, titles, powers and privileges of the company, and of any stockholder, officer or director of the company with respect to the company and our assets. Following the conservator's taking control of the company, a variety of factors that affect our business, results of operations, financial condition, liquidity position, net worth, corporate structure, management, business strategies and objectives, and controls and procedures changed materially prior to the end of the third quarter of 2008.
Please refer to "Description of our Business" below for a description of our business and to "Executive Summary" and "Conservatorship and Treasury Agreements" below for more information on the conservatorship and its impact on our business. Refer to "Glossary of Terms Used in this Report" in our 2007 10-K for an explanation of key terms used throughout this discussion.
INTRODUCTION
Fannie Mae is a government-sponsored enterprise, or GSE, that was chartered by Congress to support liquidity and stability in the secondary mortgage market, where existing mortgage loans are purchased and sold. We do not make mortgage loans to borrowers or conduct any other operations in the primary mortgage market, which is where mortgage loans are originated.
We securitize mortgage loans originated by lenders in the primary mortgage market into mortgage-backed securities that we refer to as Fannie Mae MBS. We describe the securitization process under "Description of Our Business." We also participate in the secondary mortgage market by purchasing mortgage loans (often referred to as "whole loans") and mortgage-related securities, including our own Fannie Mae MBS, for our mortgage portfolio.
The Federal Housing Finance Regulatory Reform Act of 2008, referred to as the Regulatory Reform Act, was signed into law by President Bush on July 30, 2008 and became effective immediately. The Regulatory Reform Act established FHFA as an independent agency with general supervisory and regulatory authority over Fannie Mae, Freddie Mac and the 12 Federal Home Loan Banks. FHFA assumed the duties of our former regulators, the Office of Federal Housing Enterprise Oversight, or OFHEO, and the Department of Housing and Urban Development, or HUD, with respect to safety, soundness and mission oversight of Fannie Mae and Freddie Mac. HUD remains our regulator with respect to fair lending matters. We reference OFHEO in this report with respect to actions taken by our safety and soundness regulator prior to the creation of FHFA on July 30, 2008.
EXECUTIVE SUMMARY
Our "Executive Summary" presents a high-level overview of the most significant factors that our management has focused on in currently evaluating our business and financial position and prospects, in addition to highlighting changes in business operations and strategies, structure, and controls since we were placed into conservatorship that we believe are significant.
Entry Into Conservatorship and Treasury Agreements
On September 7, 2008, Henry M. Paulson, Jr., Secretary of the U.S. Department of the Treasury, or Treasury, and James B. Lockhart III, Director of FHFA announced several actions taken by Treasury and FHFA regarding Fannie Mae. Mr. Lockhart stated that they took these actions "to help restore confidence in Fannie Mae and Freddie Mac, enhance their capacity to fulfill their mission, and mitigate the systemic risk that has contributed directly to the instability in the current market." These actions included the following:
• placing us in conservatorship;
• the execution of a senior preferred stock purchase agreement by our conservator, on our behalf, and Treasury, pursuant to which we issued to Treasury both senior preferred stock and a warrant to purchase common stock; and
• the agreement to establish a temporary secured lending credit facility that is available to us.
Entry into Conservatorship
On September 6, 2008, at the request of the Secretary of the Treasury, the Chairman of the Board of Governors of the Federal Reserve and the Director of FHFA, our Board of Directors adopted a resolution consenting to putting the company into conservatorship. After obtaining this consent, the Director of FHFA appointed FHFA as our conservator on September 6, 2008, in accordance with the Regulatory Reform Act and the Federal Housing Enterprises Financial Safety and Soundness Act of 1992.
Upon its appointment, the conservator immediately succeeded to all rights, titles, powers and privileges of Fannie Mae, and of any stockholder, officer or director of Fannie Mae with respect to Fannie Mae and its assets, and succeeded to the title to all books, records and assets of Fannie Mae held by any other legal custodian or third party. The conservator has the power to take over our assets and operate our business with all the powers of our stockholders, directors and officers, and to conduct all business of the company. The conservator announced at that time that it would eliminate the payment of dividends on common and preferred stock during the conservatorship.
On September 7, 2008, the Director of FHFA issued a statement that he had determined that we could not continue to operate safely and soundly and fulfill our critical public mission without significant action to address FHFA's concerns, which were principally: safety and soundness concerns as they existed at that time, including our capitalization; market conditions; our financial performance and condition; our inability to obtain funding according to normal practices and prices; and our critical importance in supporting the U.S. residential mortgage market. We describe the terms of the conservatorship and the powers of our conservator in detail below under "Conservatorship and Treasury Agreements-Conservatorship."
Overview of Treasury Agreements
Senior Preferred Stock Purchase Agreement
The conservator, acting on our behalf, entered into a senior preferred stock purchase agreement with Treasury on September 7, 2008. This agreement was amended and restated on September 26, 2008. We refer to this agreement as the "senior preferred stock purchase agreement." Under that agreement, Treasury provided us with its commitment to provide up to $100 billion in funding under specified conditions. The agreement requires Treasury, upon the request of the conservator, to provide funds to us after any quarter in which we have a negative net worth (that is, our total liabilities exceed our total assets, as reflected on our GAAP
balance sheet). In addition, the agreement requires Treasury, upon the request of the conservator, to provide funds to us if the conservator determines, at any time, that it will be mandated by law to appoint a receiver for us unless we receive funds from Treasury under the commitment. In exchange for Treasury's funding commitment, we issued to Treasury, as an initial commitment fee, (1) one million shares of Variable Liquidation Preference Senior Preferred Stock, Series 2008-2, which we refer to as the "senior preferred stock," and (2) a warrant to purchase, for a nominal price, shares of our common stock equal to 79.9% of the total number of shares of our common stock outstanding on a fully diluted basis at the time the warrant is exercised, which we refer to as the "warrant." We did not receive any cash proceeds from Treasury as a result of issuing the senior preferred stock or the warrant.
Under the terms of the senior preferred stock, Treasury is entitled to a quarterly dividend of 10% per year (which increases to 12% per year if not paid timely and in cash) on the aggregate liquidation preference of the senior preferred stock. To the extent we are required to draw on Treasury's funding commitment, the liquidation preference of the senior preferred stock will be increased by the amount of any funds we receive. The amounts payable for the senior preferred stock dividend could be substantial and have an adverse impact on our financial position and net worth. The senior preferred stock is senior in liquidation preference to our common stock and all other series of preferred stock. In addition, beginning on March 31, 2010, we are required to pay a quarterly commitment fee to Treasury, which fee will accrue from January 1, 2010. We are required to pay this fee each quarter for as long as the senior preferred stock purchase agreement is in effect, even if we do not request funds from Treasury under the agreement. The amount of this fee has not yet been determined.
The senior preferred stock purchase agreement includes significant restrictions on our ability to manage our business, including limiting the amount of indebtedness we can incur to 110% of our aggregate indebtedness as of June 30, 2008 and capping the size of our mortgage portfolio at $850 billion as of December 31, 2009. In addition, beginning in 2010, we must decrease the size of our mortgage portfolio at the rate of 10% per year until it reaches $250 billion. Depending on the pace of future mortgage liquidations, we may need to reduce or eliminate our purchases of mortgage assets or sell mortgage assets to achieve this reduction. In addition, while the senior preferred stock is outstanding, we are prohibited from paying dividends (other than on the senior preferred stock) or issuing equity securities without Treasury's consent. The terms of the senior preferred stock purchase agreement and warrant make it unlikely that we will be able to obtain equity from private sources.
The senior preferred stock purchase agreement has an indefinite term and can terminate only in very limited circumstances, which do not include the end of the conservatorship. The agreement therefore could continue after the conservatorship ends. Treasury has the right to exercise the warrant, in whole or in part, at any time on or before September 7, 2028. As of November 7, 2008, we have not drawn any funds from Treasury pursuant to the senior preferred stock purchase agreement. We provide more detail about the provisions of the senior preferred stock purchase agreement, the senior preferred stock and the warrant, the limited circumstances under which those agreements terminate, and the limitations they place on our ability to manage our business under "Conservatorship and Treasury Agreements-Treasury Agreements" below. See "Part II-Item 1A-Risk Factors" for a discussion of how the restrictions under the senior preferred stock purchase agreement may have a material adverse effect on our business.
Treasury Credit Facility
On September 19, 2008, we entered into a lending agreement with Treasury pursuant to which Treasury established a new secured lending credit facility that is available to us until December 31, 2009 as a liquidity back-stop. We refer to this as the "Treasury credit facility." In order to borrow pursuant to the Treasury credit facility, we are required to post collateral in the form of Fannie Mae MBS or Freddie Mac mortgage-backed securities to secure all borrowings under the facility. The terms of any borrowings under the credit facility, including the interest rate payable on the loan and the amount of collateral we will need to provide as security for the loan, will be determined by Treasury. Treasury is not obligated under the credit facility to make any loan to us.
Treasury does not have authority to extend the term of this credit facility beyond December 31, 2009, which is when Treasury's temporary authority to purchase our obligations and other securities, granted by the Regulatory Reform Act, expires. After December 31, 2009, Treasury may purchase up to $2.25 billion of our obligations under its permanent authority, as set forth in the Charter Act.
As of November 7, 2008, we have not borrowed any amounts under the Treasury credit facility. The terms of the Treasury credit facility are described in more detail in "Conservatorship and Treasury Agreements-Treasury Agreements."
Changes in Company Management and our Board of Directors
Since our entry into conservatorship on September 6, 2008, ten members of our
Board of Directors have resigned, including Stephen B. Ashley, our former
Chairman of the Board. On September 16, 2008, the conservator appointed Philip
A. Laskawy as the new non-executive Chairman of our Board of Directors. We
currently have four members of our Board of Directors and nine vacancies.
As noted above, as our conservator, FHFA has assumed the powers of our Board of Directors. Accordingly, the current Board of Directors acts with neither the power nor the duty to manage, direct or oversee our business and affairs. The conservator has indicated that it intends to appoint a full Board of Directors to which it will delegate specified roles and responsibilities.
On September 7, 2008, the conservator appointed Herbert M. Allison, Jr. as our President and Chief Executive Officer, effective immediately.
Supervision of our Business under the Regulatory Reform Act and During Conservatorship
During the third quarter of 2008, we experienced a number of significant changes in our regulatory supervisory environment. First, on July 30, 2008, President Bush signed into law the Regulatory Reform Act, which placed us under the regulation of a new regulator, FHFA. That legislation strengthened the existing safety and soundness oversight of the GSEs and provided FHFA with new safety and soundness authority that is comparable to and in some respects broader than that of the federal bank agencies. That legislation gave FHFA enhanced powers that, even if we had not been placed into conservatorship, gave FHFA the authority to raise capital levels above statutory minimum levels, regulate the size and content of our portfolio, and approve new mortgage products. That legislation also gave FHFA the authority to place the GSEs into conservatorship or receivership under conditions set forth in the statute. Refer to "Legislation Relating to Our Regulatory Framework" in our Form 10-Q for the period ended June 30, 2008 for additional detail regarding the provisions of the Regulatory Reform Act and "Part II-Item 1A-Risk Factors" of this report for additional risks and information regarding this regulation, including the receivership provisions.
Second, we experienced a change in control when we were placed into conservatorship on September 6, 2008. Under conservatorship, we have additional heightened supervision and direction from our regulator, FHFA, which is also acting as our conservator.
The table below presents a summary comparison of various features of our business before and after we were placed into conservatorship. Following this table, we provide additional information about a number of aspects of our business now that we are in conservatorship under "Managing Our Business During Conservatorship."
Topic Before Conservatorship During Conservatorship
Authority of Board of • Board of Directors • FHFA, as conservator,
Directors, management and with right to determine has all of the power and
stockholders the general policies authority of the Board of
governing the operations Directors, management and
of the corporation and the shareholders
exercise all power and
authority of the • The conservator has
company, except as delegated authority to
vested in stockholders management to conduct
or as the Board chooses day-to-day operations so
to delegate to that the company can
management continue to operate in
the ordinary course of
• Board of Directors business. The conservator
delegated significant retains overall
authority to management management authority,
including the authority
• Stockholders with to withdraw its
specified voting rights delegations to management
at any time.
• Stockholders have no
voting rights
Regulatory Supervision • Regulated by FHFA, our • Regulated by FHFA, with
new regulator created by powers as provided by
the Regulatory Reform Regulatory Reform Act
Act
• Additional management
• Regulatory Reform Act authority by FHFA, which
gave regulator is serving as our
significant additional conservator
safety and soundness
supervisory powers
Structure of Board of • 13 directors: 12 • Currently four
Directors independent plus directors, consisting of
President and Chief a non-executive Chairman
Executive Officer; of the Board and three
independent, independent directors
non-executive Chairman (who were also directors
of the Board of Fannie Mae immediately
prior to
• Eight separate Board conservatorship), with
committees, including neither the power nor the
Audit Committee in which duty to manage, direct or
four of the five oversee our business and
independent members were affairs
"audit committee
financial experts" • No Board committees
have members or authority
to act
• Conservator has
indicated its intent to
appoint a full Board of
Directors to which it
will delegate specified
roles and
responsibilities
Management • Daniel H. Mudd served • Herbert M. Allison, Jr.
as President and Chief began serving as
Executive Officer from President and Chief
June 2005 to September Executive Officer on
6, 2008 September 7, 2008
Capital • Statutory and • Capital requirements
regulatory capital not binding
requirements
• Quarterly capital
• Capital classifications by FHFA
classifications as to suspended
adequacy of capital
issued by FHFA on
quarterly basis
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Topic Before Conservatorship During Conservatorship
Net Worth1 • Receivership mandatory • Conservator has
if we have negative net directed management to
worth for 60 days focus on maintaining
positive stockholders'
equity1 in order to avoid
both the need to request
funds under the senior
preferred stock purchase
agreement and our
mandatory receivership
• Receivership mandatory
if we have negative net
worth for 60 days2
Managing for the Benefit of • Maximize shareholder • No longer managed with
Shareholders value over the long term a strategy to maximize
common shareholder
• Fulfill our mission of returns
providing liquidity,
stability and • Maintain positive net
affordability to the worth and fulfill our
mortgage market mission of providing
liquidity, stability and
affordability to the
mortgage market
• Focus on returning to
long-term profitability
if it does not adversely
affect our ability to
maintain positive net
worth or fulfill our
mission
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1 Our "net worth" refers to our assets less our liabilities, as reflected on our GAAP balance sheet. If we have a negative net worth, then, if requested by the conservator (or by our Chief Financial Officer if we are not under conservatorship), Treasury is required to provide funds to us pursuant to the senior preferred stock purchase agreement. In addition, if we have a negative net worth for a period of 60 days, the Director of FHFA is required by the Regulatory Reform Act to place us in receivership. "Net worth" is substantially the same as "stockholders equity;" however, "net worth" also includes the minority interests that third parties own in our consolidated subsidiaries (which was $159 million as of September 30, 2008), which is excluded from stockholders' equity.
2 Treasury's funding commitment under the senior preferred stock purchase agreement is expected to enable us to maintain a positive net worth as long as Treasury has not yet invested the full $100 billion provided for in that agreement.
The conservatorship has no specified termination date. There can be no assurance as to when or how the conservatorship will be terminated, whether we will continue to exist following conservatorship, or what our business structure will be during or following our conservatorship. In a statement issued on September 7, 2008, the Secretary of the Treasury indicated that 2008 and 2009 should be viewed as a "time out" where we and Freddie Mac are stabilized while policymakers decide our future role and structure. He also stated that there is a consensus that we and Freddie Mac pose a systemic risk and that we cannot continue in our current form. For more information on the risks to our business relating to the conservatorship and uncertainties regarding the future of our business, see "Part II-Item 1A-Risk Factors."
Managing Our Business During Conservatorship
Our Management
FHFA, in its role as conservator, has overall management authority over our business. During the conservatorship, the conservator has delegated authority to management to conduct day-to-day operations so that the company can continue to operate in the ordinary course of business. We can, and have continued to, enter into and enforce contracts with third parties. The conservator retains the authority to withdraw its delegations to us at any time. The conservator is working actively with management to address and determine the strategic direction for the enterprise, and in general has retained final decision-making authority in areas regarding: significant impacts on operational, market, reputational or credit risk; major accounting determinations, including policy changes; the creation of subsidiaries or affiliates and transacting with them; significant litigation; setting executive compensation; retention of external auditors; significant mergers and
acquisitions; and any other matters the conservator believes are strategic or critical to the enterprise in order for the conservator to fulfill its obligations during conservatorship. See "Conservatorship and Treasury Agreements-Conservatorship-General Powers of the Conservator Under the Regulatory Reform Act" for more information.
Our Objectives
Based on the Federal National Mortgage Association Charter Act, or Charter Act, public statements from Treasury officials and guidance from our conservator, we have a variety of different, and potentially conflicting, objectives, including:
• providing liquidity, stability and affordability in the mortgage market;
• immediately providing additional assistance to the struggling housing and . . .
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